AutoZone 2003 Annual Report Download - page 41

38
Notes to Consolidated Financial Statements
(continued)
At August 30, 2003, the Company held treasury lock agreements with notional amounts of $300 million and forward starting swaps with
notional amounts of $200 million. These agreements, which expire in November 2003, are used to hedge the exposure to variability in future
cash flows resulting from changes in variable interest rates relating to anticipated debt transactions. It is expected that upon settlement of the
agreements, the realized gain or loss will be deferred in other comprehensive income and reclassified to interest expense over the life of the
underlying debt. In addition, during fiscal 2003, the Company entered into and settled forward starting interest rate swaps with a notional
amount of $200 million, used to hedge the variability in future cash flows resulting from changes in variable interest rates related to
AutoZone’s issuance of $200 million 4.375% Senior Notes. The loss realized upon settlement was deferred in other comprehensive income
and is being reclassified to interest expense over the life of the underlying senior notes, resulting in an effective interest rate of 5.65%
At August 31, 2002, the Company held interest rate swap contracts related to $190 million of variable rate debt. Of the $190 million, $115
million of the swaps, due in December 2003, were used to hedge the variable rate debt associated with AutoZone’s $115 million term loan.
The remaining $75 million of swaps, with expiration dates throughout fiscal years 2003 and 2004, were designated to hedge the variable rate
debt associated with commercial paper borrowings. Additionally, at August 31, 2002, the Company held treasury lock agreements with
notional amounts of $300 million that expired in October 2002 and hedged the exposure to variability in future cash flows resulting from
changes in variable interest rates related to AutoZone’s issuance of $300 million 5.875% Senior Notes. The loss realized upon settlement was
deferred in other comprehensive income and is being reclassified to interest expense over the life of the underlying senior notes, resulting in
an effective interest rate of 6.33%. A portion of the proceeds generated from the issuance of the senior notes was used to prepay a $115
million term loan. Accordingly, the related interest rate swap agreements were settled in cash and the realized loss was deferred in other
comprehensive income and is being reclassified to interest expense over the life of underlying term loan.
The Company reflects the current fair value of all interest rate hedge instruments on its balance sheet. The related gains or losses on these
transactions are deferred in stockholders’ equity as a component of other comprehensive income or loss. These deferred gains and losses
are recognized in income in the period in which the related interest rates being hedged have been recognized in expense. However, to
the extent that the change in value of an interest rate hedge instrument agreement does not perfectly offset the change in the value of the
interest rate being hedged, that ineffective portion is immediately recognized in income. For the years ended August 30, 2003, and August 31,
2002, all of the Company’s interest rate hedge instruments were determined to be highly effective, and no ineffective portion was recognized
in income. The fair values of the interest rate hedge instruments at August 30, 2003 were an asset of $41.6 million. The fair values of the
interest rate hedge instruments at August 31, 2002, were a liability of $10.4 million.
The following table summarizes the fiscal 2003 activity in Accumulated Other Comprehensive Income (Loss) as it relates to interest rate
hedge instruments:
Before-Tax Income After-Tax
(in thousands) Amount Tax Amount
Accumulated net losses as of August 31, 2002 $(10,445) $ — $(10,445)
Net gains on outstanding derivatives 41,566 (15,710) 25,856
Net losses on terminated/matured derivatives (20,014) — (20,014)
Reclassification of net losses into earnings 6,479 — 6,479
Accumulated net gains as of August 30, 2003 $ 17,586 $(15,710) $ 1,876
The Company primarily executes derivative transactions of relatively short duration with strong creditworthy counterparties. These counter-
parties expose the Company to credit risk in the event of non-performance. The amount of such exposure is limited to the unpaid portion
of amounts due to the Company pursuant to the terms of the derivative financial instruments, if any. Although there are no collateral
requirements, if a downgrade in the credit rating of these counterparties occurs, management believes that this exposure is mitigated by pro-
visions in the derivative agreements which allow for the legal right of offset of any amounts due to the Company from the counterparties
with amounts payable, if any, to the counterparties by the Company. Management considers the risk of counterparty default to be minimal.