Derivative instruments

6 Months Ended

Jun. 30, 2011

Derivative instruments [Abstract]

Derivative instruments

11. Derivative instruments

The Company is exposed to risks related to its business operations, certain of which are managed through derivative instruments. The risks that we manage by using derivative instruments are foreign exchange rate risk and interest rate risk. We use financial instruments including foreign currency forward, foreign currency option, forward interest rate and interest rate swap contracts to reduce our risk to these exposures. We do not use derivatives for speculative trading purposes.

We recognize all of our derivative instruments as either assets or liabilities at fair value in the Condensed Consolidated Balance Sheets (see Note 10, Fair value measurement). The accounting for changes in the fair value of a derivative instrument depends on whether it has been formally designated and qualifies as part of a hedging relationship under the applicable accounting standards and, further, on the type of hedging relationship. For derivatives formally designated as hedges, we assess both at inception and quarterly thereafter, whether the hedging derivatives are highly effective in offsetting changes in either the fair value or cash flows of the hedged item. Our derivatives that are not designated and do not qualify as hedges are adjusted to fair value through current earnings.

Cash flow hedges

We are exposed to possible changes in values of certain anticipated foreign currency cash flows resulting from changes in foreign currency exchange rates, associated primarily with our international product sales denominated in euros. Increases or decreases in the cash flows associated with our international product sales due to movements in foreign currency exchange rates are partially offset by the corresponding increases and decreases in our international operating expenses resulting from these foreign currency exchange rate movements. To further reduce our exposure to foreign currency exchange rate fluctuations on our international product sales, we enter into foreign currency forward and option contracts to hedge a portion of our projected international product sales primarily over a three-year time horizon with, at any given point in time, a higher percentage of nearer term projected product sales being hedged than successive periods. As of June 30, 2011 and December 31, 2010, we had open foreign currency forward contracts with notional amounts of $3.7 billion and $3.2 billion, respectively, and open foreign currency option contracts with notional amounts of $232 million and $398 million, respectively. These foreign currency forward and option contracts, primarily euro based, have been designated as cash flow hedges, and accordingly, the effective portion of the unrealized gains and losses on these contracts are reported in Accumulated Other Comprehensive Income (AOCI) in the Condensed Consolidated Balance Sheets and reclassified to earnings in the same periods during which the hedged transactions affect earnings.

In connection with the anticipated issuance of long-term fixed-rate debt, we occasionally enter into forward interest rate contracts in order to hedge the variability in cash flows due to changes in the applicable Treasury rate between the time we enter into these contracts and the time the related debt is issued. Gains and losses on such contracts, which are designated as cash flow hedges, are reported in AOCI and amortized into earnings over the lives of the associated debt issuances.

The effective portion of the unrealized gain/(loss) recognized in OCI for our cash flow hedge contracts was as follows (in millions):

	Three months ended					Six months ended
	June 30,					June 30,
Derivatives in cash flow hedging relationships	2011			2010		2011			2010
Foreign currency contracts	$	(21	)	$	224	$	(218	)	$	399
Forward interest rate contracts		—			—		—			—
Total	$	(21	)	$	224	$	(218	)	$	399

The location in the Condensed Consolidated Statements of Income and the effective portion of the loss reclassified from AOCI into earnings for our cash flow hedge contracts was as follows (in millions):

		Three months ended					Six months ended
		June 30,					June 30,
Derivatives in cash flow hedging relationships	Statements of Income location	2011			2010		2011			2010
Foreign currency contracts	Product sales	$	(33	)	$	21	$	(41	)	$	15
Forward interest rate contracts	Interest expense, net		—			—		—			—
Total		$	(33	)	$	21	$	(41	)	$	15

No portions of our cash flow hedge contracts are excluded from the assessment of hedge effectiveness and the ineffective portions of these hedging instruments were approximately $1 million of expense for both the three and six months ended June 30, 2011. The ineffective portions of these hedging instruments were approximately $1 million of income for both the three and six months ended June 30, 2010. As of June 30, 2011, the amounts expected to be reclassified from AOCI into earnings over the next 12 months are approximately $96 million of losses on foreign currency forward and option contracts and approximately $1 million of losses on forward interest rate contracts.

Fair value hedges

To achieve a desired mix of fixed and floating interest rate debt, we have entered into interest rate swap agreements, which qualify and have been designated as fair value hedges. The terms of these interest rate swap agreements correspond to the related hedged debt instruments and effectively convert a fixed interest rate coupon to a floating LIBOR-based coupon over the lives of the respective notes. The rates on these swaps range from LIBOR plus 0.3% to LIBOR plus 2.6%. We had interest rate swap agreements with aggregate notional amounts of $3.6 billion as of June 30, 2011 and December 31, 2010, respectively. The interest rate swap agreements as of June 30, 2011 and December 31, 2010 were for our notes due in 2014, 2017, 2018 and 2019. For derivative instruments that are designated and qualify as a fair value hedge, the unrealized gain or loss on the derivative resulting from the change in fair value during the period as well as the offsetting unrealized loss or gain of the hedged item resulting from the change in fair value during the period attributable to the hedged risk are recognized in current earnings. For the three and six months ended June 30, 2011, we included the unrealized losses on the hedged debt of $84 million and $37 million, respectively, in the same line item, Interest expense, net in the Condensed Consolidated Statements of Income, as the offsetting unrealized gains of $84 million and $37 million, respectively, on the related interest rate swap agreements. For the three and six months ended June 30, 2010, we included the unrealized losses on the hedged debt of $107 million and $124 million, respectively, in the same line item, Interest expense, net in the Condensed Consolidated Statements of Income, as the offsetting unrealized gains of $107 million and $124 million, respectively, on the related interest rate swap agreements.

Derivatives not designated as hedges

We enter into foreign currency forward contracts to reduce our exposure to foreign currency fluctuations of certain assets and liabilities denominated in foreign currencies which are not designated as hedging transactions. These exposures are hedged on a month-to-month basis. As of June 30, 2011 and December 31, 2010, the total notional amounts of these foreign currency forward contracts, primarily euro based, were $972 million and $670 million, respectively.

The location in the Condensed Consolidated Statements of Income and the amount of gain/(loss) recognized in earnings for the derivative instruments not designated as hedging instruments were as follows (in millions):

		Three months ended					Six months ended
Derivatives not designated as		June 30,					June 30,
hedging instruments	Statements of Income location	2011			2010		2011			2010
Foreign currency contracts	Interest and other income, net.	$	(9	)	$	53	$	(60	)	$	76

The fair values of both derivatives designated as hedging instruments and not designated as hedging instruments included in the Condensed Consolidated Balance Sheets were as follows (in millions):

	Derivative assets			Derivative liabilities
June 30, 2011	Balance Sheet location	Fair value		Balance Sheet location	Fair value
Derivatives designated as hedging instruments:
Interest rate swap contracts	Other current assets/Other non-current assets	$	232	Accrued liabilities/Other non-current liabilities	$	—
Foreign currency contracts	Other current assets/Other non-current assets		50	Accrued liabilities/Other non-current liabilities		170
Total derivatives designated as hedging instruments			282			170
Derivatives not designated as hedging instruments:
Foreign currency contracts	Other current assets		—	Accrued liabilities		—
Total derivatives not designated as hedging instruments			—			—
Total derivatives		$	282		$	170

	Derivative assets			Derivative liabilities
December 31, 2010	Balance Sheet location	Fair value		Balance Sheet location	Fair value
Derivatives designated as hedging instruments:
Interest rate swap contracts	Other current assets/Other non-current assets	$	195	Accrued liabilities/Other non-current liabilities	$	—
Foreign currency contracts	Other current assets/Other non-current assets		154	Accrued liabilities/Other non-current liabilities		103
Total derivatives designated as hedging instruments			349			103
Derivatives not designated as hedging instruments:
Foreign currency contracts	Other current assets		—	Accrued liabilities		—
Total derivatives not designated as hedging instruments			—			—
Total derivatives		$	349		$	103

Our derivative contracts that were in a liability position as of June 30, 2011 contain certain credit risk related contingent provisions that are triggered if (i) we were to undergo a change in control and (ii) our or the surviving entity’s creditworthiness deteriorates, which is generally defined as having either a credit rating that is below investment grade or a materially weaker creditworthiness after the change in control. If these events were to occur, the counterparties would have the right, but not the obligation, to close the contracts under early termination provisions. In such circumstances, the counterparties could request immediate settlement of these contracts for amounts that approximate the then current fair values of the contracts.

The cash flow effects of our derivatives contracts are included within Net cash provided by operating activities in the Condensed Consolidated Statements of Cash Flows.