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Fair Value Measurements
 6 Months Ended
Jul. 03, 2011
Fair Value Measurements [Abstract]  
FAIR VALUE MEASUREMENTS
NOTE 4 — FAIR VALUE MEASUREMENTS
The Company uses forward exchange contracts to manage its exposure to the variability of cash flows, primarily related to the foreign exchange rate changes of future intercompany product and third- party purchases of raw materials denominated in foreign currency. The Company also uses cross currency interest rate swaps to manage currency risk primarily related to borrowings. Both types of derivatives are designated as cash flow hedges. The Company also uses forward exchange contracts to manage its exposure to the variability of cash flows for repatriation of foreign dividends. These contracts are designated as net investment hedges. Additionally, the Company uses forward exchange contracts to offset its exposure to certain foreign currency assets and liabilities. These forward exchange contracts are not designated as hedges, and therefore, changes in the fair values of these derivatives are recognized in earnings, thereby offsetting the current earnings effect of the related foreign currency assets and liabilities. The Company does not enter into derivative financial instruments for trading or speculative purposes, or that contain credit risk related contingent features or requirements to post collateral. On an ongoing basis, the Company monitors counterparty credit ratings. The Company considers credit non-performance risk to be low, because the Company enters into agreements with commercial institutions that have at least an A (or equivalent) credit rating. As of July 3, 2011, the Company had notional amounts outstanding for forward foreign exchange contracts and cross currency interest rate swaps of $23 billion and $3 billion, respectively.
All derivative instruments are recorded on the balance sheet at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether the derivative is designated as part of a hedge transaction, and if so, the type of hedge transaction.
During the fiscal second quarter of 2011, the Company entered into an option to hedge the currency risk associated with the cash portion of the payment for the planned acquisition of Synthes, Inc. The option was not designated as a hedge, and therefore, the change in the fair value of the option of $102 million was recognized as Other Income in the fiscal second quarter of 2011.
The designation as a cash flow hedge is made at the entrance date of the derivative contract. At inception, all derivatives are expected to be highly effective. Changes in the fair value of a derivative that is designated as a cash flow hedge and is highly effective are recorded in accumulated other comprehensive income until the underlying transaction affects earnings, and are then reclassified to earnings in the same account as the hedged transaction. Gains/losses on net investment hedges are accounted for through the currency translation account and are insignificant. On an ongoing basis, the Company assesses whether each derivative continues to be highly effective in offsetting changes in the cash flows of hedged items. If and when a derivative is no longer expected to be highly effective, hedge accounting is discontinued. Hedge ineffectiveness, if any, is included in current period earnings in other (income)/expense, net, and was not material for the fiscal quarters ended July 3, 2011 and July 4, 2010. Refer to Note 7 for disclosures of movements in Accumulated Other Comprehensive Income.
As of July 3, 2011, the balance of deferred net gains on derivatives included in accumulated other comprehensive income was $228 million after-tax. For additional information, see Note 7. The Company expects that substantially all of the amounts related to foreign exchange contracts will be reclassified into earnings over the next 12 months as a result of transactions that are expected to occur over that period. The maximum length of time over which the Company is hedging transaction exposure is 18 months excluding interest rate swaps. The amount ultimately realized in earnings will differ as foreign exchange rates change. Realized gains and losses are ultimately determined by actual exchange rates at maturity of the derivative.
The following table is a summary of the activity related to derivatives designated as hedges for the fiscal second quarters in 2011 and 2010:
                                                 
                    Gain/ (Loss)    
    Gain/ (Loss)   reclassified   Gain/ (Loss)
    recognized in   from   recognized in
    Accumulated   Accumulated OCI   other
    OCI(1)   into income(1)   income/expense(2)
    Fiscal   Fiscal   Fiscal   Fiscal   Fiscal   Fiscal
    second   second   second   second   second   second
(Dollars in Millions)   quarter   quarter   quarter   quarter   quarter   quarter
Cash Flow Hedges   2011   2010   2011   2010   2011   2010
Foreign exchange contracts
  $ —     $ (53 )   $ —     $ (9 )(A)   $ —     $ (20 )
 
                                               
Foreign exchange contracts
    12       (102 )     (44 )     (76 )(B)     6       (149 )
 
                                               
Foreign exchange contracts
    28       44       18       20  (C)     (2 )     16  
 
                                               
Cross currency interest rate swaps
    (31 )     (82 )     (16 )     11  (D)     —       —  
 
                                               
Foreign exchange contracts
    (7 )     35       2       —  (E)     —       20  
 
                                               
Total
  $ 2     $ (158 )   $ (40 )   $ (54 )   $ 4     $ (133 )
All amounts shown in the table above are net of tax.
The following table is a summary of the activity related to derivatives designated as hedges for the first fiscal six months in 2011 and 2010:
                                                 
                    Gain/ (Loss)    
    Gain/ (Loss)   reclassified   Gain/ (Loss)
    recognized in   from   recognized in
    Accumulated   Accumulated OCI   other
    OCI(1)   into income(1)   income/expense(2)
    Fiscal   Fiscal   Fiscal   Fiscal   Fiscal   Fiscal
    six   six   six   six   six   six
(Dollars in Millions)   months   months   months   months   months   months
Cash Flow Hedges   2011   2010   2011   2010   2011   2010
Foreign exchange contracts
  $ 27     $ (84 )   $ (10 )   $ (29 )(A)   $ (2 )   $ (21 )
 
                                               
Foreign exchange contracts
    92       (206 )     (106 )     (98 )(B)     3       (154 )
 
                                               
Foreign exchange contracts
    (8 )     73       19       21  (C)     (2 )     16  
 
                                               
Cross currency interest rate swaps
    (40 )     (49 )     (18 )     11  (D)     —       —  
 
                                               
Foreign exchange contracts
    (59 )     81       (3 )     (1 )(E)     2       20  
 
                                               
Total
  $ 12     $ (185 )   $ (118 )   $ (96 )   $ 1     $ (139 )
All amounts shown in the table above are net of tax.
 
(1)   Effective portion
 
(2)   Ineffective portion
 
(A)   Included in Sales to customers
 
(B)   Included in Cost of products sold
 
(C)   Included in Research and development expense
 
(D)   Included in Interest (income)/Interest expense, net
 
(E)   Included in Other (income)/expense, net
For the fiscal second quarters ended July 3, 2011 and July 4, 2010, a loss of $7 million and $21 million, respectively, were recognized in Other (income)/expense, net, relating to foreign exchange contracts not designated as hedging instruments.
For the first fiscal six months ended July 3, 2011 and July 4, 2010, a gain of $8 million and a loss of $69 million, respectively, were recognized in Other (income)/expense, net, relating to foreign exchange contracts not designated as hedging instruments.
Fair value is the exit price that would be received to sell an asset or paid to transfer a liability. Fair value is a market-based measurement that is determined using assumptions that market participants would use in pricing an asset or liability. The authoritative literature establishes a three-level hierarchy to prioritize the inputs used in measuring fair value. The levels within the hierarchy are described below with Level 1 having the highest priority and Level 3 having the lowest.
The fair value of a derivative financial instrument (i.e. forward exchange contract or currency swap) is the aggregation by currency of all future cash flows discounted to its present value at the prevailing market interest rates and subsequently converted to the U.S. dollar at the current spot foreign exchange rate. The Company does not believe that fair values of these derivative instruments materially differ from the amounts that could be realized upon settlement or maturity, or that the changes in fair value will have a material effect on the Company’s results of operations, cash flows or financial position. The Company also holds equity investments which are classified as Level 1 because they are traded in an active exchange market. The Company did not have any other significant financial assets or liabilities which would require revised valuations under this standard that are recognized at fair value.
The following three levels of inputs are used to measure fair value:
Level 1 — Quoted prices in active markets for identical assets and liabilities.
Level 2 — Significant other observable inputs.
Level 3 — Significant unobservable inputs.
The Company’s significant financial assets and liabilities measured at fair value as of July 3, 2011 and January 2, 2011 were as follows:
                                         
            July 3, 2011           January 2, 2011
(Dollars in Millions)   Level 1   Level 2   Level 3   Total   Total(1)
Derivatives designated as hedging instruments:
                                       
Assets:
                                       
Foreign exchange contracts
    —     $ 487       —     $ 487     $ 321  
Cross currency interest rate swaps(2)
    —       2       —       2       17  
Total
    —       489       —       489       338  
 
                                       
Liabilities:
                                       
Foreign exchange contracts
    —       646       —       646       586  
Cross currency interest rate swaps(3)
    —       404       —       404       502  
Total
    —       1,050       —       1,050       1,088  
 
                                       
Derivatives not designated as hedging instruments:
                                       
Assets:
                                       
Foreign exchange contracts
    —       28       —       28       19  
Swiss Franc Option*
    —       569       —       569       —  
Total
    —       597       —       597       19  
 
                                       
Liabilities:
                                       
Foreign exchange contracts
    —       27       —       27       39  
 
                                       
Other Investments(4)
  $ 1,371       —       —     $ 1,371     $ 1,165  
 
*   Currency option related to the planned acquisition of Synthes, Inc.
 
(1)   As of January 2, 2011, these assets and liabilities are classified as Level 2 with the exception of Other Investments of $1,165 which are classified as Level 1.
 
(2)   Includes $2 million and $14 million of non-current assets for July 3, 2011 and January 2, 2011, respectively.
 
(3)   Includes $404 million and $502 million of non-current liabilities for July 3, 2011 and January 2, 2011, respectively.
 
(4)   Classified as non-current other assets.
Financial Instruments not measured at Fair Value:
The following financial assets and liabilities are held at carrying amount on the consolidated balance sheet as of July 3, 2011:
                 
    Carrying     Estimated  
(Dollars in Millions)   Amount     Fair Value  
Financial Assets
               
Current Investments
               
Cash
  $ 2,299       2,299  
Government securities and obligations
    23,951       23,951  
Corporate debt securities
    515       515  
Money market funds
    1,820       1,820  
Time deposits
    1,097       1,097  
 
               
Total cash, cash equivalents and current marketable securities
  $ 29,682       29,682  
 
               
Fair value of government securities and obligations and non-current marketable securities was estimated using quoted broker prices in active markets.
 
               
Financial Liabilities
               
Current Debt
  $ 5,046       5,046  
Non-Current Debt
               
5.15% Debentures due 2012
    599       632  
0.70% Notes due 2013
    500       503  
3.80% Debentures due 2013
    500       527  
3 month LIBOR+0% FRN due 2013
    500       500  
3 month LIBOR+0.09% FRN due 2014
    750       750  
1.20% Notes due 2014
    999       1,006  
2.15% Notes due 2016
    898       903  
5.55% Debentures due 2017
    1,000       1,161  
5.15% Debentures due 2018
    898       1,015  
4.75% Notes due 2019 (1B Euro 1.4476)
    1,440       1,569  
3% Zero Coupon Convertible Subordinated Debentures due in 2020
    197       246  
2.95% Debentures due 2020
    541       522  
3.55% Notes due 2021
    446       456  
6.73% Debentures due 2023
    250       323  
5.50% Notes due 2024 (500 GBP1.6025)
    795       856  
6.95% Notes due 2029
    294       375  
4.95% Debentures due 2033
    500       523  
5.95% Notes due 2037
    995       1,120  
5.86% Debentures due 2038
    700       773  
4.50% Debentures due 2040
    539       489  
4.85% Notes due 2041
    298       291  
Other (Includes Industrial Revenue Bonds)
    41       41  
 
               
Total Non-Current Debt
  $ 13,680       14,581  
The weighted average effective rate on non-current debt is 4.08%.
Fair value of the non-current debt was estimated using market prices, which were corroborated by quoted broker prices in active markets.