Note 2 – Financial Instruments

Cash, Cash Equivalents and Marketable Securities

The following tables show the Company’s cash and available-for-sale securities’ adjusted cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category recorded as cash and cash equivalents or short- and long-term marketable securities as of June 30, 2012 and September 24, 2011 (in millions):

 

		June 30, 2012
		Adjusted Cost				Unrealized Gains				Unrealized Losses				Fair Value				Cash and Cash Equivalents				Short-Term Marketable Securities				Long-Term Marketable Securities
Cash		$	3,269			$	0			$	0			$	3,269			$	3,269			$	0			$	0
Level 1:
Money market funds			1,181				0				0				1,181				1,181				0				0
Mutual funds			1,894				34				(17	)			1,911				0				1,911				0
Subtotal			3,075				34				(17	)			3,092				1,181				1,911				0
Level 2:
U.S. Treasury securities			20,587				10				(6	)			20,591				1,100				4,169				15,322
U.S. agency securities			19,197				41				(3	)			19,235				479				2,026				16,730
Non-U.S. government securities			6,919				103				(7	)			7,015				1				1,842				5,172
Certificates of deposit and time deposits			2,411				2				0				2,413				857				377				1,179
Commercial paper			2,301				0				0				2,301				991				1,310				0
Corporate securities			44,545				306				(31	)			44,820				24				7,482				37,314
Municipal securities			5,541				61				(3	)			5,599				43				588				4,968
Mortgage- and asset-backed securities			8,867				24				(5	)			8,886				0				4				8,882
Subtotal			110,368				547				(55	)			110,860				3,495				17,798				89,567
Total		$	116,712			$	581			$	(72	)		$	117,221			$	7,945			$	19,709			$	89,567

 

		September 24, 2011
		Adjusted Cost				Unrealized Gains				Unrealized Losses				Fair Value				Cash and Cash Equivalents				Short-Term Marketable Securities				Long-Term Marketable Securities
Cash		$	2,903			$	0			$	0			$	2,903			$	2,903			$	0			$	0
Level 1:
Money market funds			1,911				0				0				1,911				1,911				0				0
Mutual funds			1,227				0				(34	)			1,193				0				1,193				0
Subtotal			3,138				0				(34	)			3,104				1,911				1,193				0
Level 2:
U.S. Treasury securities			10,717				39				(3	)			10,753				1,250				2,149				7,354
U.S. agency securities			13,467				24				(3	)			13,488				225				1,818				11,445
Non-U.S. government securities			5,559				11				(2	)			5,568				551				1,548				3,469
Certificates of deposit and time deposits			4,175				2				(2	)			4,175				728				977				2,470
Commercial paper			2,853				0				0				2,853				2,237				616				0
Corporate securities			35,241				132				(114	)			35,259				10				7,241				28,008
Municipal securities			3,411				56				0				3,467				0				595				2,872
Subtotal			75,423				264				(124	)			75,563				5,001				14,944				55,618
Total		$	81,464			$	264			$	(158	)		$	81,570			$	9,815			$	16,137			$	55,618

The net unrealized gains as of June 30, 2012 and September 24, 2011 are related primarily to long-term marketable securities. The Company may sell certain of its marketable securities prior to their stated maturities for strategic reasons including, but not limited to, anticipation of credit deterioration and duration management. The net realized gains or losses recognized during the three- and nine-month periods ended June 30, 2012 and June 25, 2011 related to such sales were not significant. The maturities of the Company’s long-term marketable securities generally range from one to five years.

As of June 30, 2012 and September 24, 2011, gross unrealized losses related to individual securities that had been in a continuous loss position for 12 months or longer were not significant.

As of June 30, 2012, the Company considers the declines in market value of its marketable securities investment portfolio to be temporary in nature and does not consider any of its investments other-than-temporarily impaired. The Company typically invests in highly-rated securities, and its investment policy generally limits the amount of credit exposure to any one issuer. The policy requires investments generally to be investment grade, with the primary objective of minimizing the potential risk of principal loss. Fair values were determined for each individual security in the investment portfolio. When evaluating an investment for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer and any changes thereto, and the Company’s intent to sell, or whether it is more likely than not it will be required to sell the investment before recovery of the investment’s cost basis. During the three- and nine-month periods ended June 30, 2012 and June 25, 2011, the Company did not recognize any significant impairment charges.

Derivative Financial Instruments

The Company uses derivatives to partially offset its business exposure to foreign currency exchange risk. The Company may enter into foreign currency forward and option contracts to offset some of the foreign exchange risk on expected future cash flows on certain forecasted revenue and cost of sales, on net investments in certain foreign subsidiaries, and on certain existing assets and liabilities.

 

To help protect gross margins from fluctuations in foreign currency exchange rates, certain of the Company’s subsidiaries whose functional currency is the U.S. dollar hedge a portion of forecasted foreign currency revenue. The Company’s subsidiaries whose functional currency is not the U.S. dollar and who sell in local currencies may hedge a portion of forecasted inventory purchases not denominated in the subsidiaries’ functional currencies. The Company typically hedges portions of its forecasted foreign currency exposure associated with revenue and inventory purchases generally up to six months.

To help protect the net investment in a foreign operation from adverse changes in foreign currency exchange rates, the Company may enter into foreign currency forward and option contracts to offset the changes in the carrying amounts of these investments due to fluctuations in foreign currency exchange rates.

The Company may also enter into foreign currency forward and option contracts to partially offset the foreign currency exchange gains and losses generated by the re-measurement of certain assets and liabilities denominated in non-functional currencies. However, the Company may choose not to hedge certain foreign currency exchange exposures for a variety of reasons including, but not limited to, accounting considerations and the prohibitive economic cost of hedging particular exposures. There can be no assurance the hedges will offset more than a portion of the financial impact resulting from movements in foreign currency exchange rates.

The Company records all derivatives in the Condensed Consolidated Balance Sheets at fair value. The Company’s accounting treatment of these instruments are based on whether the instruments are designated as hedge or non-hedge instruments. The effective portions of cash flow hedges are recorded in accumulated other comprehensive income (“AOCI”) until the hedged item is recognized in earnings. The effective portions of net investment hedges are recorded in other comprehensive income as a part of the cumulative translation adjustment. The ineffective portions of cash flow hedges and net investment hedges are recorded in other income and expense. Derivatives that are not designated as hedging instruments are adjusted to fair value through earnings in the financial statement line item to which the derivative relates.

The Company had a net deferred gain associated with cash flow hedges of $201 million and $290 million, net of taxes, recorded in AOCI as of June 30, 2012 and September 24, 2011, respectively. Deferred gains and losses associated with cash flow hedges of forecasted foreign currency revenue are recognized as a component of net sales in the same period as the related revenue is recognized, and deferred gains and losses related to cash flow hedges of forecasted inventory purchases are recognized as a component of cost of sales in the same period as the related costs are recognized. Substantially all of the Company’s hedged transactions as of June 30, 2012 are expected to occur within six months.

Derivative instruments designated as cash flow hedges must be de-designated as hedges when it is probable the forecasted hedged transaction will not occur in the initially identified time period or within a subsequent two-month time period. Deferred gains and losses in AOCI associated with such derivative instruments are reclassified immediately into other income and expense. Any subsequent changes in fair value of such derivative instruments are reflected in other income and expense unless they are re-designated as hedges of other transactions. The Company did not recognize any significant net gains or losses related to the loss of hedge designation on discontinued cash flow hedges during the three- and nine-month periods ended June 30, 2012 and June 25, 2011.

The Company’s unrealized net gains and losses on net investment hedges, included in the cumulative translation adjustment account of AOCI, were not significant as of June 30, 2012 and September 24, 2011, respectively. The ineffective portions of and amounts excluded from the effectiveness test of net investment hedges are recorded in other income and expense.

During the three and nine-month periods ended June 30, 2012 and June 25, 2011, the gain/loss recognized in other income and expense for foreign currency forward and option contracts not designated as hedging instruments was not significant. These amounts represent the net gain or loss on the derivative contracts and do not include changes in the related exposures, which generally offset a portion of the gain or loss on the derivative contracts.

 

The following table shows the notional principal amounts of the Company’s outstanding derivative instruments and credit risk amounts associated with outstanding or unsettled derivative instruments as of June 30, 2012 and September 24, 2011 (in millions):

 

		June 30, 2012								September 24, 2011
		Notional Principal				Credit Risk Amounts				Notional Principal				Credit Risk Amounts
Instruments designated as accounting hedges:
Foreign exchange contracts		$	33,892			$	569			$	13,705			$	537
Instruments not designated as accounting hedges:
Foreign exchange contracts		$	10,637			$	40			$	9,891			$	56

The notional principal amounts for outstanding derivative instruments provide one measure of the transaction volume outstanding and does not represent the amount of the Company’s exposure to credit or market loss. The credit risk amounts represent the Company’s gross exposure to potential accounting loss on derivative instruments that are outstanding or unsettled if all counterparties failed to perform according to the terms of the contract, based on then-current currency exchange rates at each respective date. The Company’s gross exposure on these transactions may be further mitigated by collateral received from certain counterparties. The Company’s exposure to credit loss and market risk will vary over time as a function of currency exchange rates. Although the table above reflects the notional principal and credit risk amounts of the Company’s foreign exchange instruments, it does not reflect the gains or losses associated with the exposures and transactions that the foreign exchange instruments are intended to hedge. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures, will depend on actual market conditions during the remaining life of the instruments.

The Company generally enters into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. To further limit credit risk, the Company generally enters into collateral security arrangements that provide for collateral to be received or posted when the net fair value of certain financial instruments fluctuates from contractually established thresholds. The Company presents its derivative assets and derivative liabilities at their gross fair values. The Company received cash collateral related to the derivative instruments under its collateral security arrangements of $492 million and $288 million as of June 30, 2012 and September 24, 2011, respectively. These amounts are classified as accrued expenses in the Condensed Consolidated Balance Sheets. The Company did not have any derivative instruments with credit risk-related contingent features that would require it to post additional collateral as of June 30, 2012 or September 24, 2011.

The following tables show the Company’s derivative instruments at gross fair value as reflected in the Condensed Consolidated Balance Sheets as of June 30, 2012 and September 24, 2011 (in millions):

 

		June 30, 2012
		Fair Value of Derivatives Designated as Hedge Instruments				Fair Value  of Derivatives Not Designated as Hedge Instruments				Total Fair Value
Derivative assets (a):
Foreign exchange contracts		$	548			$	40			$	588
Derivative liabilities (b):
Foreign exchange contracts		$	165			$	13			$	178

 

		September 24, 2011
		Fair Value of Derivatives Designated as Hedge Instruments				Fair Value of Derivatives Not Designated as Hedge Instruments				Total Fair Value
Derivative assets (a):
Foreign exchange contracts		$	460			$	56			$	516
Derivative liabilities (b):
Foreign exchange contracts		$	72			$	37			$	109

 

 

(a)	The fair value of derivative assets is measured using Level 2 fair value inputs and is recorded as other current assets in the Condensed Consolidated Balance Sheets.

 

(b)	The fair value of derivative liabilities is measured using Level 2 fair value inputs and is recorded as accrued expenses in the Condensed Consolidated Balance Sheets.

The following tables show the pre-tax effect of the Company’s derivative instruments designated as cash flow and net investment hedges in the Condensed Consolidated Statements of Operations for the three- and nine-month periods ended June 30, 2012 and June 25, 2011 (in millions):

 

		Three Months Ended
		Gains/(Losses) Recognized in  OCI - Effective Portion (e)								Gains/(Losses) Reclassified  from AOCI into Income - Effective Portion (e)								Gains/(Losses) Recognized - Ineffective Portion and Amount Excluded from Effectiveness Testing
		June 30, 2012				June 25, 2011				June 30, 2012 (a)				June 25, 2011 (b)				Location		June 30, 2012				June 25, 2011
Cash flow hedges:
Foreign exchange contracts		$	234			$	12			$	84			$	(162	)		Other income and expense		$	(39	)		$	15
Net investment hedges:
Foreign exchange contracts			3				(7	)			0				0			Other income and expense			1				1
Total		$	237			$	5			$	84			$	(162	)				$	(38	)		$	16

 

		Nine Months Ended
		Gains/(Losses) Recognized in OCI - Effective Portion (e)								Gains/(Losses) Reclassified from AOCI into Income - Effective Portion (e)								Gains/(Losses) Recognized - Ineffective Portion and Amount Excluded from Effectiveness Testing
		June 30, 2012				June 25, 2011				June 30, 2012 (c)				June 25, 2011 (d)				Location		June 30, 2012				June 25, 2011
Cash flow hedges:
Foreign exchange contracts		$	337			$	(270	)		$	468			$	(701	)		Other income and expense		$	(248	)		$	(104	)
Net investment hedges:
Foreign exchange contracts			10				(21	)			0				0			Other income and expense			2				1
Total		$	347			$	(291	)		$	468			$	(701	)				$	(246	)		$	(103	)

 

 

(a)

Includes gains/(losses) reclassified from AOCI into net income for the effective portion of cash flow hedges, of which $63 million and $21 million were recognized within net sales and cost of sales, respectively, within the Condensed Consolidated Statement of Operations for the three months ended June 30, 2012. There were no amounts reclassified from AOCI into net income for the effective portion of net investment hedges for the three months ended June 30, 2012.

 

(b)

Includes gains/(losses) reclassified from AOCI into net income for the effective portion of cash flow hedges, of which $(101) million and $(61) million were recognized within net sales and cost of sales, respectively, within the Condensed Consolidated Statement of Operations for the three months ended June 25, 2011. There were no amounts reclassified from AOCI into net income for the effective portion of net investment hedges for the three months ended June 25, 2011.

 

(c)

Includes gains/(losses) reclassified from AOCI into net income for the effective portion of cash flow hedges, of which $404 million and $64 million were recognized within net sales and cost of sales, respectively, within the Condensed Consolidated Statement of Operations for the nine months ended June 30, 2012. There were no amounts reclassified from AOCI into net income for the effective portion of net investment hedges for the nine months ended June 30, 2012.

 

(d)

Includes gains/(losses) reclassified from AOCI into net income for the effective portion of cash flow hedges, of which $(382) million and $(319) million were recognized within net sales and cost of sales, respectively, within the Condensed Consolidated Statement of Operations for the nine months ended June 25, 2011. There were no amounts reclassified from AOCI into net income for the effective portion of net investment hedges for the nine months ended June 25, 2011.

 

(e)	Refer to Note 5, “Shareholders’ Equity and Share-based Compensation” of this Form 10-Q, which summarizes the activity in AOCI related to derivatives.

Accounts Receivable

The Company has considerable trade receivables outstanding with its third-party cellular network carriers, wholesalers, retailers, value-added resellers, small and mid-sized businesses, and education, enterprise and government customers that are not covered by collateral, third-party financing arrangements or credit insurance. There were no customers that accounted for 10% or more of the Company’s trade receivables as of June 30, 2012 and September 24, 2011, respectively. The Company’s cellular network carriers accounted for 47% and 52% of trade receivables as of June 30, 2012 and September 24, 2011, respectively.

 

Additionally, the Company has non-trade receivables from certain of its manufacturing vendors. Vendor non-trade receivables from two of the Company’s vendors accounted for 56% and 26% of non-trade receivables as of June 30, 2012 and two of the Company’s vendors accounted for 53% and 29% of non-trade receivables as of September 24, 2011.