Pep Boys 2007 Annual Report Download - page 79

Interest Rate Swaps
On June 3, 2003, the Company entered into an interest rate swap for a notional amount of
$130,000,000. The Company had designated the swap as a cash flow hedge of the Company’s real estate
operating lease payments. The interest rate swap converts the variable LIBOR portion of the lease payment
to a fixed rate of 2.90% and terminates on July 1, 2008. If the critical terms of the interest rate swap or
hedge item do not change, the interest rate swap is considered to be highly effective with all changes in fair
value included in other comprehensive income. As of February 2, 2008 and February 3, 2007, the fair value
was an asset of $22,000 and $4,150,000, respectively, recorded within other long-term assets on the balance
sheet. In the fourth quarter of fiscal 2006, the Company determined it was not in compliance with SFAS
No. 133 for hedge accounting and, accordingly, recorded a reduction of rent expense, which is included in
Costs of Merchandise and Costs of Service Revenues, for the cumulative fair value change of $4,150,000. This
change in fair value had previously been recorded in Accumulated Other Comprehensive Income (Loss) on
the consolidated balance sheets. The Company evaluated the impact of this error, along with three other
errors discussed in the next sentence, on an annual and quarterly basis and concluded there was no material
impact on the fourth quarter of fiscal 2006 or any historical periods, on an individual or aggregate basis. The
three other errors consisted of: (i) $3,700,000 of amortization expense on leasehold improvements classified in
land and therefore not depreciated, (ii) $500,000 of understated closed store reserves and (iii) $400,000 of an
overstated accrual for non-qualified defined contributions. The Company corrected these errors in the fourth
quarter of fiscal 2006, resulting in no material impact to the consolidated financial statements. The Company
has removed its designation as a cash flow hedge on this transaction and records the change in fair value
through its operating statement until the date of termination.
On November 2, 2006, the Company entered into an interest rate swap for a notional amount of
$200,000,000. The Company has designated the swap a cash flow hedge on the first $200,000,000 of the
Company’s $320,000,000 senior secured notes. The interest rate swap converts the variable LIBOR
portion of the interest payments to a fixed rate of 5.036% and terminates in October 2013. The
Company did not meet the documentation requirements of SFAS No. 133, at inception or as of
February 3, 2007 and, accordingly, recorded the increase in the fair value of the interest rate swap of
$1,490,000 as a reduction to Interest Expense. The Company documented that the swap met the
requirements of SFAS No. 133 for hedge accounting on April 9, 2007, and prospectively records the
effective portion of the change in fair value of the swap through Accumulated Other Comprehensive
Loss. During the period from February 4, 2007 through April 8, 2007, a $974,000 expense was recorded
in interest expense for the change in fair value of this swap.
On November 27, 2007, the Company sold the land and buildings for 34 owned properties to an
independent third party. The Company used $162,558,000 of the net proceeds from such transaction to
prepay a portion of the Senior Secured Term Loan facility which eliminated a portion of the future interest
payments hedged by the November 2, 2006 interest rate swap. The Company concluded that it was not
probable that those future interest payments would occur. In accordance with SFAS No. 133, the Company
discontinued hedge accounting for the unmatched portion of the November 2, 2006 swap and reclassified a
$2,259,000 pre-tax loss applicable to the unmatched portion of the $200,000,000 interest rate swap from other
comprehensive income to interest expense. On November 27, 2007, the Company re-designated $145,000,000
notional amount of the interest rate swap as a cash flow hedge to fully match the future interest payments
under the Senior Secured Notes. As a result, all future changes in this interest rate swap’s fair value that has
been re-designated as a hedge will be recorded to Accumulated Other Comprehensive Loss. From the period
of November 27, 2007 through February 1, 2008, interest expense includes $4,166,000 related to the
$55,000,000 unmatched portion of this swap. On February 1, 2008, the Company recorded $4,539,000 within
accrued expenses to reduce the notional amount of the interest rate swap to $145,000,000 from the original
$200,000,000 amount. The $4,539,000 was paid on February 4, 2008. The fair value of the swap was a net
$10,985,000 payable recorded within other long-term liabilities on the balance sheet at February 2, 2008 and a
net $1,372,000 receivable recorded within other long-term assets on the balance sheet at February 3, 2007.
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10-K