Annual report pursuant to Section 13 and 15(d)

DERIVATIVES

v2.4.0.6
DERIVATIVES
12 Months Ended
Dec. 31, 2011
DERIVATIVES  
DERIVATIVES

NOTE 20. DERIVATIVES

        We are exposed to financial risk resulting from volatility in foreign exchange rates, commodity prices and interest rates. This risk is closely monitored and managed through the use of financial derivative instruments including foreign currency forward contracts, commodity swap contracts and interest rate swaps. As stated in our policies and procedures, financial derivatives are used expressly for hedging purposes, and under no circumstances are they used for speculative purposes. When material, we adjust the value of our derivative contracts for counter-party or our credit risk.

Foreign Exchange Rates

        As a result of our international business presence, we are exposed to foreign currency exchange risks. We transact business in foreign currencies and, as a result, our income experiences some volatility related to movements in foreign currency exchange rates. To help manage our exposure to exchange rate volatility, we use foreign exchange forward contracts on a regular basis to hedge forecasted intercompany and third-party sales and purchases denominated in non-functional currencies. Our internal policy allows for managing anticipated foreign currency cash flows for up to one year. These foreign currency forward contracts are designated and qualify as foreign currency cash flow hedges under GAAP. The effective portion of the unrealized gain or loss on the forward contract is deferred and reported as a component of "Accumulated other comprehensive loss" (AOCL). When the hedged forecasted transaction (sale or purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income. The ineffective portion of the hedge, unrealized gain or loss, if any, is recognized in current income during the period of change. As of December 31, 2011, the amount we expect to reclassify from AOCL to income over the next year is an unrealized net loss of $6 million. For the years ended December 31, 2011 and 2010, there were no circumstances that would have resulted in the discontinuance of a foreign currency cash flow hedge.

        To minimize the income volatility resulting from the remeasurement of net monetary assets and payables denominated in a currency other than the functional currency, we enter into foreign currency forward contracts, which are considered economic hedges. The objective is to offset the gain or loss from remeasurement with the gain or loss from the fair market valuation of the forward contract. These derivative instruments are not designated as hedges under GAAP.

        The table below summarizes our outstanding foreign currency forward contracts. Only the U.S. dollar forward contracts are designated and qualify for hedge accounting as of each period presented below. The currencies in this table represent 98 percent and 97 percent of the notional amounts of contracts outstanding as of December 31, 2011 and December 31, 2010.

 
  Notional amount in millions  
Currency denomination
  December 31,
2011
  December 31,
2010
 

United States Dollar (USD)

    181     142  

British Pound Sterling (GBP)

    347     87  

Euro (EUR)

    47     46  

Singapore Dollar (SGD)

    20     17  

Indian Rupee (INR)

    1,701     1,275  

Japanese Yen (JPY)

    3,348     3,722  

Canadian Dollar (CAD)

    39     39  

South Korea Won (KRW)

    36,833     28,028  

Chinese Renmimbi (CNY)

    61     60  

Commodity Price Risk

        We are exposed to fluctuations in commodity prices due to contractual agreements with component suppliers. In order to protect ourselves against future price volatility and, consequently, fluctuations in gross margins, we periodically enter into commodity swap contracts with designated banks to fix the cost of certain raw material purchases with the objective of minimizing changes in inventory cost due to market price fluctuations. Certain commodity swap contracts are derivative contracts that are designated as cash flow hedges under GAAP. We also have commodity swap contracts that represent an economic hedge, however do not qualify for hedge accounting and are marked to market through earnings. For those contracts that qualify for hedge accounting, the effective portion of the unrealized gain or loss is deferred and reported as a component of AOCL. When the hedged forecasted transaction (purchase) occurs, the unrealized gain or loss is reclassified into income in the same line item associated with the hedged transaction in the same period or periods during which the hedged transaction affects income. The ineffective portion of the hedge, if any, is recognized in current income in the period in which the ineffectiveness occurs. As of December 31, 2011, we expect to reclassify an unrealized net loss of $11 million from AOCL to income over the next year. Our internal policy allows for managing these cash flow hedges for up to three years.

        The following table summarizes our outstanding commodity swap contracts that were entered into to hedge the cost of certain raw material purchases:

 
  December 31, 2011   December 31, 2010
Dollars in millions
Commodity
  Notional
Amount
  Quantity   Notional
Amount
  Quantity

Copper

  $ 78   9,220 metric tons(1)   $ 55   7,560 metric tons(1)

Platinum

    84   50,750 troy ounces(2)     11   9,157 troy ounces(2)

Palladium

    5   7,141 troy ounces(2)     1   1,763 troy ounces(2)

(1)
A metric ton is a measurement of mass equal to 1,000 kilograms.

(2)
A troy ounce is a measurement of mass equal to approximately 31 grams.

Interest Rate Risk

        We are exposed to market risk from fluctuations in interest rates. We manage our exposure to interest rate fluctuations through the use of interest rate swaps. The objective of the swaps is to more effectively balance our borrowing costs and interest rate risk.

        In November 2005, we entered into an interest rate swap to effectively convert our $250 million debt issue, due in 2028, from a fixed rate of 7.125 percent to a floating rate based on a LIBOR spread. The terms of the swap mirror those of the debt, with interest paid semi-annually. This swap qualifies as a fair value hedge under GAAP. The gain or loss on this derivative instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in current income as "Interest expense." The following table summarizes these gains and losses for the years presented below:

 
  For the years ended
December 31,
 
 
  2011   2010  
In millions
Income Statement Classification
  Gain/(Loss)
on Swaps
  Gain/(Loss)
on Borrowings
  Gain/(Loss)
on Swaps
  Gain/(Loss)
on Borrowings
 

Interest expense

  $ 41   $ (41 ) $ 16   $ (16 )

Cash Flow Hedging

        The following table summarizes the effect on our Consolidated Statements of Income for derivative instruments classified as cash flow hedges for the years ended December 31, 2011 and 2010 presented below. The table does not include amounts related to ineffectiveness as it was not material for the periods presented.

 
   
  For the years ended
December 31,
 
 
   
   
   
  Amount of
Gain/(Loss)
Reclassified
from
AOCL into
Income
(Effective
Portion)
 
 
   
  Amount of
Gain/(Loss)
Recognized in
AOCL on
Derivative
(Effective
Portion)
 
 
  Location of Gain/(Loss)
Reclassified into Income
(Effective Portion)
 
In millions
Derivatives in Cash Flow Hedging Relationships
  2011   2010   2011   2010  

Foreign currency forward contracts

  Net sales   $ (4 ) $ (5 ) $ 3   $ (6 )

Commodity swap contracts

  Cost of sales     (22 )   13     19     8  
                       

Total

      $ (26 ) $ 8   $ 22   $ 2  
                       

Derivatives Not Designated as Hedging Instruments

        The following table summarizes the effect on our Consolidated Statements of Income for derivative instruments that are not classified as hedges for the years ended December 31, 2011 and 2010.

 
   
  For the years
ended
December 31,
 
 
   
  Amount of
Gain/(Loss)
Recognized in
Income on
Derivatives
 
 
  Location of Gain/(Loss)
Recognized in Income
on Derivatives
 
In millions
Derivatives Not Designated as Hedging Instruments
  2011   2010  

Foreign currency forward contracts

  Cost of sales   $ (2 ) $ (3 )

Foreign currency forward contracts

  Other income (expense), net     (14 )   4  

Commodity swap contracts

  Cost of sales     (6 )    

Fair Value Amount and Location of Derivative Instruments

        The following tables summarize the location and fair value of derivative instruments on our Consolidated Balance Sheets:

 
  Derivative assets
 
  Fair Value    
In millions
  December 31,
2011
  December 31,
2010
  Balance Sheet Location

Derivatives designated as hedging instruments

               

Commodity swap contracts

  $   $ 20   Prepaid expenses and other current assets

Commodity swap contracts

        1   Other assets

Interest rate contract

    82     41   Other assets
             

Total derivative assets

  $ 82   $ 62    
             

 

 
  Derivative liabilities
 
  Fair Value    
In millions
  December 31,
2011
  December 31,
2010
  Balance Sheet Location

Derivatives designated as hedging instruments

               

Foreign currency forward contracts

  $ 7   $ 1   Other accrued expenses

Commodity swap contracts

    16       Other accrued expenses
             

Total derivatives designated as hedging instruments

    23     1    
             

Derivatives not designated as hedging instruments

               

Foreign currency forward contracts

    1       Other accrued expenses

Commodity swap contracts

    6       Other accrued expenses
             

Total derivatives not designated as hedging instruments

    7        
             

Total derivative liabilities

  $ 30   $ 1