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Derivative Instruments
9 Months Ended
Apr. 30, 2011
Derivative Instruments  
Derivative Instruments
11. Derivative Instruments

(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):

 

   

DERIVATIVE ASSETS

   

DERIVATIVE LIABILITIES

 
   

Balance Sheet Line Item

  April  30,
2011
    July  31,
2010
   

Balance Sheet Line Item

  April  30,
2011
    July  31,
2010
 

Derivatives designated as hedging instruments:

           

Foreign currency derivatives

  Other current assets   $ 100      $ 82      Other current liabilities   $ 14      $ 7   

Interest rate derivatives

  Other assets     75        72      Other long-term liabilities     —          —     
                                   

Total

      175        154          14        7   
                                   

Derivatives not designated as hedging instruments:

           

Foreign currency derivatives

  Other current assets     8        6      Other current liabilities     8        12   

Total return swaps-deferred compensation

  Other current assets     —          1      Other current liabilities     —          —     

Equity derivatives

  Other assets     2        2      Other long-term liabilities     —          —     
                                   

Total

      10        9          8        12   
                                   

Total

    $ 185      $ 163        $ 22      $ 19   
                                   

 

The effects of the Company's cash flow hedging instruments on other comprehensive income (OCI) and the Consolidated Statements of Operations are summarized as follows (in millions):

 

DERIVATIVES DESIGNATED AS CASH

FLOW HEDGING INSTRUMENTS

  GAINS (LOSSES) RECOGNIZED IN OCI
ON DERIVATIVES
(EFFECTIVE PORTION)
    GAINS (LOSSES) RECLASSIFIED FROM AOCI INTO
INCOME
(EFFECTIVE PORTION)
 

Three Months Ended

  April 30,
2011
    May 1,
2010
    Line Item in Statements of Operations     April  30,
2011
    May 1,
2010
 
Foreign currency derivatives   $ 51      $ (21     Operating expenses      $ 28      $ (2
        Cost of sales-service        5        —     
Interest rate derivatives     —          —          Interest expense        1        —     
                                 

Total

  $ 51      $ (21     $ 34      $ (2
                                 

DERIVATIVES DESIGNATED AS CASH

FLOW HEDGING INSTRUMENTS

  GAINS (LOSSES) RECOGNIZED IN OCI
ON DERIVATIVES
(EFFECTIVE PORTION)
    GAINS (LOSSES) RECLASSIFIED FROM AOCI INTO
INCOME
(EFFECTIVE PORTION)
 

Nine Months Ended

  April 30,
2011
    May 1,
2010
    Line Item in Statements of Operations     April 30,
2011
    May 1,
2010
 

Foreign currency derivatives

  $ 96      $ (12     Operating expenses      $ 51      $ 5   
        Cost of sales-service        9        1   

Interest rate derivatives

    —          23        Interest expense        1        —     
                                 

Total

  $ 96      $ 11        $ 61      $ 6   
                                 

During the three and nine months ended April 30, 2011 and May 1, 2010, the amounts recognized in earnings on derivative instruments designated as cash flow hedges related to the ineffective portion were not material, and the Company did not exclude any component of the changes in fair value of the derivative instruments from the assessment of hedge effectiveness.

As of April 30, 2011, the Company estimates that approximately $76 million of net derivative gains related to its cash flow hedges included in accumulated other comprehensive income (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):

 

        GAINS (LOSSES) ON
DERIVATIVE INSTRUMENTS
    GAINS (LOSSES) RELATED  TO
HEDGED ITEMS
 
        Three Months Ended  

Derivatives Designated as

Fair Value Hedging Instruments

 

Line Item in Statements

of Operations

  April  30,
2011
    May 1,
2010
    April  30,
2011
    May 1,
2010
 

Equity derivatives

  Other income, net   $ —        $ 3      $ —        $ (3 )

Interest rate derivatives

  Interest expense     26        1        (27     (1 )
                                 

Total

    $ 26      $ 4      $ (27   $ (4 )
                                 
        GAINS (LOSSES) ON
DERIVATIVE INSTRUMENTS
    GAINS (LOSSES) RELATED  TO
HEDGED ITEMS
 
        Nine Months Ended  

Derivatives Designated as

Fair Value Hedging

Instruments

 

Line Item in Statements

of Operations

  April  30,
2011
    May 1,
2010
    April  30,
2011
    May 1,
2010
 

Equity derivatives

  Other income, net   $ —        $ 2      $ —        $ (2 )

Interest rate derivatives

  Interest expense     3        1        (4 )     (1
                                 

Total

    $ 3      $ 3      $ (4 )   $ (3 )
                                 

The effect on the Consolidated Statements of Operations of derivative instruments not designated as hedges is summarized as follows (in millions):

 

          GAINS (LOSSES) FOR  THE
THREE MONTHS ENDED
    GAINS (LOSSES) FOR  THE
NINE MONTHS ENDED
 

Derivatives Not Designated as

Hedging Instruments

  

Line Item in Statements

of Operations

   April 30,
2011
     May 1,
2010
    April 30,
2011
     May 1,
2010
 

Foreign currency derivatives

   Other income, net    $ 114       $ (118 )   $ 244       $ (69 )

Total return swaps-deferred compensation

   Operating expenses      13         5        37         23   

Equity derivatives

   Other income, net      8         5        16         12   
                                     

Total

      $ 135       $ (108   $ 297       $ (34 )
                                     

(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 foreign currency forecasted transactions related to certain operating expenses and service cost of sales with currency option 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. The Company did not discontinue any hedges during any of the periods presented because it was probable that the original 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, 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.

During the nine months ended May 1, 2010, the Company entered into foreign exchange forward and options contracts denominated in Norwegian kroner to hedge against a portion of the foreign currency exchange risk associated with the purchase consideration for Tandberg ASA ("Tandberg"). These contracts were not designated as hedging instruments and were substantially settled in the third quarter of fiscal 2010 in connection with the close of the acquisition. The Company recognized net losses of $14 million and $10 million for the third quarter and first nine months of fiscal 2010, respectively, relating to such contracts denominated in Norwegian kroner.

The Company hedges certain net investments in its foreign subsidiaries with forward contracts which generally have maturities of up to six months. The Company recognized a loss of $9 million in OCI for the effective portion of its net investment hedges for the nine months ended April 30, 2011. The Company's net investment hedges are not included in the preceding tables.

 

The notional amounts of the Company's foreign currency derivatives are summarized as follows (in millions):

 

     April  30,
2011
     July  31,
2010
 

Cash flow hedging instruments

   $ 2,137       $ 2,611   

No hedge designation

     3,382         4,619   

Net investment hedging instruments

     72         105   
                 

Total

   $ 5,591       $ 7,335   
                 

(c) Interest Rate Risk

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 April 30, 2011 and July 31, 2010, 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 the third quarter of fiscal 2011, the Company entered into interest rate swaps for an aggregate notional amount of $2.75 billion designated as fair value hedges of 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 for an aggregate notional amount of $1.5 billion 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 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 $75 million and $72 million as of April 30, 2011 and July 31, 2010, respectively, and was reflected in other assets.

Interest Rate Derivatives Designated as Cash Flow Hedges, Long-Term Debt

During the nine months ended May 1, 2010, the Company entered into $3.7 billion of interest rate derivatives designated as cash flow hedges to hedge against interest rate movements in connection with the anticipated issuance of senior notes in November 2009. The effective portion of these hedges was recorded to AOCI, net of tax, and is amortized to interest expense over the respective lives of the notes. These derivative instruments were settled in connection with the actual issuance of the senior notes in November 2009.

(d) Equity Price Risk

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 may enter into equity derivatives that are designated as fair value hedges. The changes in the value of the hedging instruments are included in other income, 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 were also included in other income, net. As of April 30, 2011 and July 31, 2010, the Company did not have any equity derivatives outstanding related to its investment portfolio.

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. As of April 30, 2011 and July 31, 2010, the notional amount of the total return swaps used to hedge such liabilities was $260 million and $169 million, respectively.

 

(e) Credit-Risk-Related Contingent Features

Certain derivative instruments are executed under agreements that have provisions requiring the Company and counterparty to maintain a specified credit rating from certain credit-rating agencies. If the Company's or 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 April 30, 2011 and July 31, 2010.