Dollar General 2012 Annual Report Download - page 129

10-K
In addition to making valuation estimates, we also bear the risk that certain derivative instruments
that have been designated as hedges and currently meet the strict hedge accounting requirements may
not qualify in the future as ‘‘highly effective,’’ as defined, as well as the risk that hedged transactions in
cash flow hedging relationships may no longer be considered probable to occur. Further, new
interpretations and guidance related to these instruments may be issued in the future, and we cannot
predict the possible impact that such guidance may have on our use of derivative instruments going
forward.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Financial Risk Management
We are exposed to market risk primarily from adverse changes in interest rates, and to a lesser
degree commodity prices. To minimize this risk, we may periodically use financial instruments, including
derivatives. As a matter of policy, we do not buy or sell financial instruments for speculative or trading
purposes and all derivative financial instrument transactions must be authorized and executed pursuant
to approval by the Board of Directors. All financial instrument positions taken by us are intended to be
used to reduce risk by hedging an underlying economic exposure. Because of high correlation between
the derivative financial instrument and the underlying exposure being hedged, fluctuations in the value
of the financial instruments are generally offset by reciprocal changes in the value of the underlying
economic exposure.
Interest Rate Risk
We manage our interest rate risk through the strategic use of fixed and variable interest rate debt
and, from time to time, derivative financial instruments. Our principal interest rate exposure relates to
outstanding amounts under our Credit Facilities. As of February 1, 2013, we had variable rate
borrowings of $1.964 billion under our Term Loan Facility and $286.5 million under our ABL Facility.
In order to mitigate a portion of the variable rate interest exposure under the Credit Facilities, we have
entered into various interest rate swaps in recent years.
Currently, we are counterparty to certain interest rate swaps with a total notional amount of
$875.0 million entered into in May 2012 in order to mitigate a portion of the variable rate interest
exposure under the Credit Facilities. These swaps are scheduled to mature in May 2015. Under the
terms of these agreements we swapped one month LIBOR rates for fixed interest rates, resulting in the
payment of an all-in fixed rate of 3.34% on a notional amount of $875.0 million.
A change in interest rates on variable rate debt impacts our pre-tax earnings and cash flows;
whereas a change in interest rates on fixed rate debt impacts the economic fair value of debt but not
our pre-tax earnings and cash flows. Our interest rate swaps qualify for hedge accounting as cash flow
hedges. Therefore, changes in market fluctuations related to the effective portion of these cash flow
hedges do not impact our pre-tax earnings until the accrued interest is recognized on the derivatives
and the associated hedged debt. Based on our variable rate borrowing levels and interest rate swaps
outstanding as of February 1, 2013 and February 3, 2012, respectively, the annualized effect of a one
percentage point increase in variable interest rates would have resulted in a pretax reduction of our
earnings and cash flows of approximately $13.9 million in 2012 and $16.3 million in 2011.
The conditions and uncertainties in the global credit markets may increase the credit risk of
counterparties to our swap agreements. In the event such counterparties fail to perform under our swap
agreements and we are unable to enter into new swap agreements on terms favorable to us, our ability
to effectively manage our interest rate risk may be materially impaired. We attempt to manage
counterparty credit risk by periodically evaluating the financial position and creditworthiness of such
counterparties, monitoring the amount for which we are at risk with each counterparty, and where
possible, dispersing the risk among multiple counterparties. There can be no assurance that we will
manage or mitigate our counterparty credit risk effectively.
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