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(a) | Summary of Derivative Instruments |
The Company uses derivative instruments primarily to manage exposures to foreign currency exchange rate, interest rate, and equity price risks. The Company’s primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange rates, interest rates, and equity prices. The Company’s derivatives expose it to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. The Company does, however, seek to mitigate such risks by limiting its counterparties to major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored. Management does not expect material losses as a result of defaults by counterparties.
The fair values of the Company’s derivative instruments and the line items on the Consolidated Balance Sheets to which they were recorded are summarized as follows (in millions):
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| DERIVATIVE ASSETS | | DERIVATIVE LIABILITIES |
| Balance Sheet Line Item | | July 27, 2013 | | July 28, 2012 | | Balance Sheet Line Item | | July 27, 2013 | | July 28, 2012 |
Derivatives designated as hedging instruments: | | | | | | | | | | | |
Foreign currency derivatives | Other current assets | | $ | 33 |
| | $ | 24 |
| | Other current liabilities | | $ | 7 |
| | $ | 26 |
|
Interest rate derivatives | Other assets | | 147 |
| | 223 |
| | Other long-term liabilities | | 2 |
| | — |
|
Equity derivatives | Other current assets | | — |
| | — |
| | Other current liabilities | | 155 |
| | 4 |
|
Total | | | 180 |
| | 247 |
| | | | 164 |
| | 30 |
|
Derivatives not designated as hedging instruments: | | | | | | | | | | | |
Foreign currency derivatives | Other current assets | | 2 |
| | 16 |
| | Other current liabilities | | 7 |
| | 12 |
|
Equity derivatives | Other assets | | — |
| | 1 |
| | Other long-term liabilities | | — |
| | — |
|
Total | | | 2 |
| | 17 |
| | | | 7 |
| | 12 |
|
Total | | | $ | 182 |
| | $ | 264 |
| | | | $ | 171 |
| | $ | 42 |
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The effects of the Company’s cash flow and net investment hedging instruments on OCI and the Consolidated Statements of Operations are summarized as follows (in millions):
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GAINS (LOSSES) RECOGNIZED IN OCI ON DERIVATIVES FOR THE YEARS ENDED (EFFECTIVE PORTION) | | GAINS (LOSSES) RECLASSIFIED FROM AOCI INTO INCOME FOR THE YEARS ENDED (EFFECTIVE PORTION) |
| | July 27, 2013 | | July 28, 2012 | | July 30, 2011 | | Line Item in Statements of Operations | | July 27, 2013 | | July 28, 2012 | | July 30, 2011 |
Derivatives designated as cash flow hedging instruments: | | | | | | | | | | | | | | |
Foreign currency derivatives | | $ | 73 |
| | $ | (131 | ) | | $ | 87 |
| | Operating expenses | | $ | 10 |
| | $ | (59 | ) | | $ | 89 |
|
| | | | | | | | Cost of sales - service | | 2 |
| | (14 | ) | | 17 |
|
Interest rate derivatives | | — |
| | — |
| | — |
| | Interest expense | | — |
| | 1 |
| | 2 |
|
Total | | $ | 73 |
| | $ | (131 | ) | | $ | 87 |
| | | | $ | 12 |
| | $ | (72 | ) | | $ | 108 |
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| | | | | | | | | | | | | | |
Derivatives designated as net investment hedging instruments: | | | | | | | | | | | | | | |
Foreign currency derivatives | | $ | (1 | ) | | $ | 23 |
| | $ | (10 | ) | | Other income (loss), net | | $ | — |
| | $ | — |
| | $ | — |
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As of July 27, 2013, the Company estimates that approximately $20 million of net derivative gains related to its cash flow hedges included in AOCI will be reclassified into earnings within the next 12 months.
The effect on the Consolidated Statements of Operations of derivative instruments designated as fair value hedges and the underlying hedged items is summarized as follows (in millions):
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| | | | GAINS (LOSSES) ON DERIVATIVES INSTRUMENTS FOR THE YEARS ENDED | | GAINS (LOSSES) RELATED TO HEDGED ITEMS FOR THE YEARS ENDED |
Derivatives Designated as Fair Value Hedging Instruments | | Line Item in Statements of Operations | | July 27, 2013 | | July 28, 2012 | | July 30, 2011 | | July 27, 2013 | | July 28, 2012 | | July 30, 2011 |
Equity derivatives | | Other income (loss), net | | $ | (155 | ) | | $ | (4 | ) | | $ | — |
| | $ | 155 |
| | $ | 4 |
| | $ | — |
|
Interest rate derivatives | | Interest expense | | (78 | ) | | 78 |
| | 74 |
| | 78 |
| | (80 | ) | | (77 | ) |
Total | | | | $ | (233 | ) | | $ | 74 |
| | $ | 74 |
| | $ | 233 |
| | $ | (76 | ) | | $ | (77 | ) |
The effect on the Consolidated Statements of Operations of derivative instruments not designated as hedges is summarized as follows (in millions):
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| | | | | | | | | | | | | | |
| | | | GAINS (LOSSES) FOR THE YEARS ENDED |
Derivatives Not Designated as Hedging Instruments | | Line Item in Statements of Operations | | July 27, 2013 | | July 28, 2012 | | July 30, 2011 |
Foreign currency derivatives | | Other income (loss), net | | $ | (74 | ) | | $ | (206 | ) | | $ | 264 |
|
Total return swaps - deferred compensation | | Cost of sales - product | | — |
| | 4 |
| | — |
|
Total return swaps - deferred compensation | | Operating expenses | | 61 |
| | 3 |
| | 33 |
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Equity derivatives | | Other income (loss), net | | — |
| | 6 |
| | 25 |
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Total | | | | $ | (13 | ) | | $ | (193 | ) | | $ | 322 |
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The notional amounts of the Company’s outstanding derivatives are summarized as follows (in millions):
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| | | | | | | |
| July 27, 2013 | | July 28, 2012 |
Derivatives designated as hedging instruments: | | | |
Foreign currency derivatives - cash flow hedges | $ | 1,885 |
| | $ | 2,910 |
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Interest rate derivatives | 5,250 |
| | 4,250 |
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Net investment hedging instruments | 662 |
| | 468 |
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Equity derivatives | 1,098 |
| | 272 |
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Derivatives not designated as hedging instruments: | | | |
Foreign currency derivatives | 3,739 |
| | 6,241 |
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Total return swaps-deferred compensation | 358 |
| | 269 |
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Total | $ | 12,992 |
| | $ | 14,410 |
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(b) | Foreign Currency Exchange Risk |
The Company conducts business globally in numerous currencies. Therefore, it is exposed to adverse movements in foreign currency exchange rates. To limit the exposure related to foreign currency changes, the Company enters into foreign currency contracts. The Company does not enter into such contracts for trading purposes.
The Company hedges forecasted foreign currency transactions related to certain operating expenses and service cost of sales with currency options and forward contracts. These currency option and forward contracts, designated as cash flow hedges, generally have maturities of less than 18 months. The Company assesses effectiveness based on changes in total fair value of the derivatives. The effective portion of the derivative instrument’s gain or loss is initially reported as a component of AOCI and subsequently reclassified into earnings when the hedged exposure affects earnings. The ineffective portion, if any, of the gain or loss is reported in earnings immediately. During the fiscal years presented, the Company did not discontinue any cash flow hedges for which it was probable that a forecasted transaction would not occur.
The Company enters into foreign exchange forward and option contracts to reduce the short-term effects of foreign currency fluctuations on assets and liabilities such as foreign currency receivables, including long-term customer financings, investments, and payables. These derivatives are not designated as hedging instruments. Gains and losses on the contracts are included in other income (loss), net, and substantially offset foreign exchange gains and losses from the remeasurement of intercompany balances or other current assets, investments, or liabilities denominated in currencies other than the functional currency of the reporting entity.
The Company hedges certain net investments in its foreign operations with forward contracts to reduce the effects of foreign currency fluctuations on the Company’s net investment in those foreign subsidiaries. These derivative instruments generally have maturities of up to six months.
Interest Rate Derivatives, Investments The Company’s primary objective for holding fixed income securities is to achieve an appropriate investment return consistent with preserving principal and managing risk. To realize these objectives, the Company may utilize interest rate swaps or other derivatives designated as fair value or cash flow hedges. As of July 27, 2013 and July 28, 2012, the Company did not have any outstanding interest rate derivatives related to its fixed income securities.
Interest Rate Derivatives Designated as Fair Value Hedge, Long-Term Debt In fiscal 2013, the Company entered into interest rate swaps designated as fair value hedges related to fixed-rate senior notes that were issued in February 2009 and November 2009 and are due in 2019 and 2020, respectively. In fiscal 2011, the Company entered into interest rate swaps designated as fair value hedges related to fixed-rate senior notes that were issued in March 2011 and are due in 2014 and 2017. In fiscal 2010, the Company entered into interest rate swaps designated as fair value hedges for a portion of senior fixed-rate notes that were issued in 2006 and are due in 2016. Under these interest rate swaps, the Company receives fixed-rate interest payments and makes interest payments based on LIBOR plus a fixed number of basis points. The effect of such swaps is to convert the fixed interest rates of the senior fixed-rate notes to floating interest rates based on LIBOR. The gains and losses related to changes in the fair value of the interest rate swaps are included in interest expense and substantially offset changes in the fair value of the hedged portion of the underlying debt that are attributable to the changes in market interest rates. The fair value of the interest rate swaps was reflected in other assets.
The Company may hold equity securities for strategic purposes or to diversify its overall investment portfolio. The publicly traded equity securities in the Company’s portfolio are subject to price risk. To manage its exposure to changes in the fair value of certain equity securities, the Company has entered into equity derivatives that are designated as fair value hedges. The changes in the value of the hedging instruments are included in other income (loss), net, and offset the change in the fair value of the underlying hedged investment. In addition, the Company periodically manages the risk of its investment portfolio by entering into equity derivatives that are not designated as accounting hedges. The changes in the fair value of these derivatives are also included in other income (loss), net.
The Company is also exposed to variability in compensation charges related to certain deferred compensation obligations to employees. Although not designated as accounting hedges, the Company utilizes derivatives such as total return swaps to economically hedge this exposure.
For the fiscal years presented, amounts excluded from the assessment of hedge effectiveness were not material for fair value, cash flow, and net investment hedges. In addition, hedge ineffectiveness for fair value, cash flow, and net investment hedges was not material for any of the fiscal years presented.
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(f) | Credit-Risk-Related Contingent Features |
Certain derivative instruments are executed under agreements that have provisions requiring the Company and the counterparty to maintain a specified credit rating from certain credit-rating agencies. If the Company’s or the counterparty’s credit-rating falls below a specified credit rating, either party has the right to request collateral on the derivatives’ net liability position. Such provisions did not affect the Company’s financial position as of July 27, 2013 and July 28, 2012.
