Derivative Instruments and Hedging Activities

9 Months Ended

Jul. 29, 2012

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Hedging Activities

Derivative Instruments and Hedging Activities

Derivative Financial Instruments

Applied conducts business in a number of foreign countries, with certain transactions denominated in local currencies, such as Japanese yen, euro, Israeli shekel, Taiwanese dollar and Swiss franc. Applied uses derivative financial instruments, such as forward exchange contracts and currency option contracts, to hedge certain forecasted foreign currency denominated transactions expected to occur typically within the next 24 months. The purpose of Applied’s foreign currency management is to mitigate the effect of exchange rate fluctuations on certain foreign currency denominated revenues, costs and eventual cash flows. The terms of currency instruments used for hedging purposes are generally consistent with the timing of the transactions being hedged. Applied does not use derivative financial instruments for trading or speculative purposes.

Derivative instruments and hedging activities, including foreign currency exchange contracts, are recognized on the balance sheet at fair value. Changes in the fair value of derivatives that do not qualify for hedge treatment, as well as the ineffective portion of any hedges, are recognized currently in earnings. All of Applied’s derivative financial instruments are recorded at their fair value in other current assets or in accounts payable and accrued expenses.

Hedges related to anticipated transactions are designated and documented at the inception of the hedge as cash flow hedges and are typically entered into once per month. Cash flow hedges are evaluated for effectiveness quarterly. The effective portion of the gain or loss on these hedges is reported as a component of accumulated other comprehensive income or loss (AOCI) in stockholders’ equity and is reclassified into earnings when the hedged transaction affects earnings. The majority of the after-tax net income or loss related to derivative instruments included in AOCI at July 29, 2012 is expected to be reclassified into earnings within 12 months. Changes in the fair value of currency forward exchange and option contracts due to changes in time value are excluded from the assessment of effectiveness. Both ineffective hedge amounts and hedge components excluded from the assessment of effectiveness are recognized promptly in earnings. If the transaction being hedged is no longer probable to occur, or if a portion of any derivative is deemed to be ineffective, Applied promptly recognizes the gain or loss on the associated financial instrument in selling, general and administrative expenses. The amount recognized due to discontinuance of cash flow hedges that were probable not to occur by the end of the originally specified time period was not significant for the three and nine months ended July 29, 2012 and July 31, 2011.

Additionally, forward exchange contracts are generally used to hedge certain foreign currency denominated assets or liabilities. These derivatives are typically entered into once per month and are not designated for hedge accounting treatment. Accordingly, changes in the fair value of these hedges are recorded promptly in earnings to offset the changes in the fair value of the assets or liabilities being hedged.

The fair values of derivative instruments at July 29, 2012 and October 30, 2011 were not material.

The effect of derivative instruments on the Consolidated Condensed Statement of Operations for the three and nine months ended July 29, 2012 and July 31, 2011 was as follows:

		Three Months Ended July 29, 2012									Three Months Ended July 31, 2011
		Effective Portion						Ineffective Portion and Amount Excluded from Effectiveness Testing			Effective Portion					Ineffective Portion and Amount Excluded from Effectiveness Testing
	Location of Gain or (Loss) Reclassified from AOCI into Income	Gain or (Loss) Recognized in AOCI			Gain or (Loss) Reclassified from AOCI into Income			Gain or (Loss) Recognized in Income			Gain or (Loss) Recognized in AOCI			Gain or (Loss) Reclassified from AOCI into Income		Gain or (Loss) Recognized in Income
		(In millions)
Derivatives in Cash Flow Hedging Relationships
Foreign exchange contracts	Cost of products sold	$	(8	)	$	—		$	(1	)	$	(7	)	$	1	$	(2	)
Foreign exchange contracts	General and administrative	—			(2		)	—			—			2		—
Total		$	(8	)	$	(2	)	$	(1	)	$	(7	)	$	3	$	(2	)

		Nine Months Ended July 29, 2012									Nine Months Ended July 31, 2011
		Effective Portion						Ineffective Portion and Amount Excluded from Effectiveness Testing			Effective Portion				Ineffective Portion and Amount Excluded from Effectiveness Testing
	Location of Gain or (Loss) Reclassified from AOCI into Income	Gain or (Loss) Recognized in AOCI			Gain or (Loss) Reclassified from AOCI into Income			Gain or (Loss) Recognized in Income			Gain or (Loss) Recognized in AOCI		Gain or (Loss) Reclassified from AOCI into Income		Gain or (Loss) Recognized in Income
		(In millions)
Derivatives in Cash Flow Hedging Relationships
Foreign exchange contracts	Cost of products sold	$	(3	)	$	5		$	(1	)	$	5	$	6	$	(5	)
Foreign exchange contracts	General and administrative	—			(3		)	(1		)	—		5		(1		)
Total		$	(3	)	$	2		$	(2	)	$	5	$	11	$	(6	)

		Amount of Gain or (Loss) Recognized in Income
		Three Months Ended						Nine Months Ended
	Location of Gain or (Loss) Recognized in Income	July 29, 2012			July 31, 2011			July 29, 2012		July 31, 2011
		(In millions)
Derivatives Not Designated as Hedging Instruments
Foreign exchange contracts	General and administrative	$	(11	)	$	(5	)	$	3	$	(2	)
Total		$	(11	)	$	(5	)	$	3	$	(2	)

Credit Risk Contingent Features

If Applied’s credit rating were to fall below investment grade, it would be in violation of credit risk contingent provisions of the derivative instruments discussed above, and certain counterparties to the derivative instruments could request immediate payment on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit risk-related contingent features that were in a net liability position was immaterial as of July 29, 2012.

Entering into foreign exchange contracts with banks exposes Applied to credit-related losses in the event of the banks’ nonperformance. However, Applied’s exposure is not considered significant.