Dollar Tree 2012 Annual Report Download - page 24

Management’s Discussion & Analysis of
Financial Condition and Results of Operations
non-cashchargetogrossprotandacorresponding
reductionininventory,atcost,ofapproximately$26.3
millionintherstquarterof2010.eretailinventory
method is an averaging method that is widely used in the
retail industry and results in valuing inventories at lower
of cost or market when markdowns are taken as a reduc-
tion of the retail value of inventories on a timely basis.
Inventoryvaluationmethodsrequirecertainsigni-
cantmanagementestimatesandjudgments,including
estimates of future merchandise markdowns and shrink,
whichsignicantlyaecttheendinginventoryvaluation
at cost as well as the resulting gross margins. e aver-
aging required in applying the retail inventory method
and the estimates of shrink and markdowns could, under
certain circumstances, result in costs not being recorded
in the proper period.
Weestimateourmarkdownreservebasedonthe
consideration of a variety of factors, including, but not
limited to, quantities of slow moving or seasonal, carryover
merchandise on hand, historical markdown statistics and
future merchandising plans. e accuracy of our estimates
canbeaectedbymanyfactors,someofwhichareoutside
of our control, including changes in economic conditions
and consumer buying trends. Historically, we have not
experiencedsignicantdierencesinourestimatedreserve
for markdowns compared with actual results.
Our accrual for shrink is based on the actual, histor-
ical shrink results of our most recent physical inventories
adjusted,ifnecessary,forcurrenteconomicconditions
and business trends. ese estimates are compared to
actual results as physical inventory counts are taken and
reconciled to the general ledger. Our physical inven-
tory counts are generally taken between January and
September of each year; therefore, the shrink accrual
recordedatFebruary2,2013isbasedonestimatedshrink
formostof2012,includingthefourthquarter.Wehave
notexperiencedsignicantuctuationsinhistorical
shrinkratesbeyondapproximately10-20basispointsin
our Dollar Tree stores for the last few years. However, we
have sometimes experienced higher than typical shrink in
acquiredstoresintheyearfollowinganacquisition.We
periodicallyadjustourshrinkestimatestoaddressthese
factors as they become apparent.
Our management believes that our application of the
retail inventory method results in an inventory valuation
that reasonably approximates cost and results in carrying
inventory at the lower of cost or market each year on a
consistent basis.
Derivative Financial Instruments
In2012,wewerepartytofuelderivativecontractswith
thirdpartieswhichincludedapproximately4.8million
gallonsofdieselfuel,orapproximately35%ofour
domestic truckload fuel needs. ese derivative contracts
do not qualify for hedge accounting and therefore all
changes in fair value for these derivatives are included in
earnings.Wecurrentlyhavefuelderivativecontractsto
hedge0.7milliongallonsofdieselfuel,orapproximately
20%ofourdomestictruckloadfuelneedsfromFebruary
2013throughApril2013.
InMarch2008,weenteredintotwo$75.0million
interest rate swap agreements. ese interest rate swaps
were used to manage the risk associated with interest
rateuctuationsonaportionofour2008$250.0million
variable rate term loan. Under these agreements, we paid
interesttonancialinstitutionsataxedrateof2.8%.In
exchange,thenancialinstitutionspaidusatavariable
rate, which approximated the variable rate on the debt,
excludingthecreditspread.eseswapsqualiedfor
hedgeaccountingtreatmentandexpiredinMarch2011.
Critical Accounting Policies
epreparationofnancialstatementsrequirestheuse
of estimates. Certain of our estimates require a high level
ofjudgmentandhavethepotentialtohaveamaterial
eectonthenancialstatementsifactualresultsvary
signicantlyfromthoseestimates.Followingisadiscus-
sion of the estimates that we consider critical.
Inventory Valuation
AsdiscussedinNote1totheConsolidatedFinancial
Statements, inventories at the distribution centers
are stated at the lower of cost or market with cost
determined on a weighted-average basis. Cost is assigned
to store inventories using the retail inventory method
on a weighted-average basis. Under the retail inven-
tory method, the valuation of inventories at cost and
the resulting gross margins are computed by applying
a calculated cost-to-retail ratio to the retail value of
inventories.Fromourinceptionandthroughscal2009,
we used one inventory pool for this calculation. Because
of our investments over the years in our retail technology
systems,wewereabletoreneourestimateofinventory
costundertheretailmethodandonJanuary31,2010,
therstdayofscal2010,webeganusingapproximately
30inventorypoolsinourretailinventorycalculation.
As a result of this change, we recorded a non-recurring,
22 Dollar Tree, Inc.