7. DERIVATIVE FINANCIAL INSTRUMENTS
GAAP defines derivatives, requires that derivatives be carried at fair value on the balance sheet, and provides for hedge accounting when certain conditions are met. The Company’s derivative financial instruments are recognized on the balance sheet at fair value. Changes in the fair value of derivative instruments designated as “cash flow” hedges, to the extent the hedges are highly effective, are recorded in other comprehensive income, net of tax effects. Ineffective portions of cash flow hedges, if any, are recognized in current period earnings. Other comprehensive income or loss is reclassified into current period earnings when the hedged transaction affects earnings. Changes in the fair value of derivative instruments designated as “fair value” hedges, along with corresponding changes in the fair values of the hedged assets or liabilities, are recorded in current period earnings. Ineffective portions of fair value hedges, if any, are recognized in current period earnings.
The Company assesses, both at the inception of the hedge and on an ongoing basis, whether derivatives used as hedging instruments are highly effective in offsetting the changes in the fair value or cash flow of the hedged items. If it is determined that a derivative is not highly effective as a hedge or ceases to be highly effective, the Company discontinues hedge accounting prospectively.
Interest Rate Risk Management
The Company is exposed to market risk from fluctuations in interest rates. The Company manages its exposure to interest rate fluctuations through the use of a commercial paper program, interest rate swaps (fair value hedges) and forward-starting interest rate swaps (cash flow hedges). The Company’s current program relative to interest rate protection contemplates hedging the exposure to changes in the fair value of fixed-rate debt attributable to changes in interest rates. To do this, the Company uses the following guidelines: (i) use average daily outstanding borrowings to determine annual debt amounts subject to interest rate exposure, (ii) limit the average annual amount subject to interest rate reset and the amount of floating rate debt to a combined total of $2,500 or less, (iii) include no leveraged products, and (iv) hedge without regard to profit motive or sensitivity to current mark-to-market status.
The Company reviews compliance with these guidelines annually with the Financial Policy Committee of the Board of Directors. These guidelines may change as the Company’s needs dictate.
Fair Value Interest Rate Swaps
The table below summarizes the outstanding interest rate swaps designated as fair value hedges as of February 1, 2014 and February 2, 2013.
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|
|
2013 |
|
2012 |
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|
|
|
Pay |
|
Pay |
|
Pay |
|
Pay |
| ||||
|
Notional amount |
|
$ |
100 |
|
$ |
— |
|
$ |
475 |
|
$ |
— |
|
|
Number of contracts |
|
2 |
|
— |
|
6 |
|
— |
| ||||
|
Duration in years |
|
4.94 |
|
— |
|
1.41 |
|
— |
| ||||
|
Average variable rate |
|
5.83 |
% |
— |
|
3.29 |
% |
— |
| ||||
|
Average fixed rate |
|
6.80 |
% |
— |
|
5.38 |
% |
— |
| ||||
|
Maturity |
|
December 2018 |
|
Between April 2013 and December 2018 |
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During the first quarter of 2013, four of the Company’s fair value swaps, with a notional amount aggregating $375, matured.
The gain or loss on these derivative instruments as well as the offsetting gain or loss on the hedged items attributable to the hedged risk is recognized in current earnings as “Interest expense.” These gains and losses for 2013 and 2012 were as follows:
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Year-To-Date |
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|
|
February 1, 2014 |
|
February 2, 2013 |
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|
Consolidated Statement of Operations Classification |
|
Gain/(Loss) on |
|
Gain/(Loss) on |
|
Gain/(Loss) on |
|
Gain/(Loss) on |
| ||||
|
Interest Expense |
|
$ |
(3 |
) |
$ |
4 |
|
$ |
(24 |
) |
$ |
16 |
|
The following table summarizes the location and fair value of derivative instruments designated as fair value hedges on the Company’s Consolidated Balance Sheets:
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Asset Derivatives |
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|
Fair Value |
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|
| ||||
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Derivatives Designated as Fair Value Hedging Instruments |
|
February 1, |
|
February 2, |
|
Balance Sheet Location |
| ||
|
Interest Rate Hedges |
|
$ |
(2 |
) |
$ |
1 |
|
(Other Long-Term Liabilities)/Other Assets |
|
Cash Flow Forward-Starting Interest Rate Swaps
As of February 1, 2014, the Company did not have any outstanding forward-starting interest rate swap agreements.
As of February 2, 2013, the Company had 17 forward-starting interest rate swap agreements with maturity dates between April 2013 and January 2014 with an aggregate notional amount totaling $850. In 2012, the Company entered into seven of these forward-starting interest rate swap agreements with an aggregate notional amount totaling $350. A forward-starting interest rate swap is an agreement that effectively hedges the variability in future benchmark interest payments attributable to changes in interest rates on the forecasted issuance of fixed-rate debt. The Company entered into the forward-starting interest rate swaps in order to lock in fixed interest rates on its forecasted issuances of debt in fiscal year 2013. Accordingly, the forward-starting interest rate swaps were designated as cash-flow hedges as defined by GAAP. As of February 2, 2013, the fair value of the interest rate swaps was recorded in other assets and other long-term liabilities for $14 and $9, respectively, and AOCI and accumulated other comprehensive loss for $9 net of tax and $6 net of tax, respectively.
During 2013, the Company terminated 29 forward-starting interest rate swap agreements with maturity dates of April 2013 and January 2014 with an aggregate notional amount totaling $1,700. Twelve of these forward-starting interest rate swap agreements, with an aggregate notional amount totaling $850, were entered into and terminated in 2013. These forward-starting interest rate swap agreements were hedging the variability in future benchmark interest payments attributable to changing interest rates on the forecasted issuance of fixed-rate debt issued in 2013. As discussed in Note 6, the Company issued $3,500 of senior notes in 2013. Since these forward-starting interest rate swap agreements were classified as cash flow hedges, the unamortized loss of $15, $9 net of tax, has been deferred net of tax in AOCI and will be amortized to earnings as the interest payments are made.
The following table summarizes the effect of the Company’s derivative instruments designated as cash flow hedges for 2013 and 2012:
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|
Year-To-Date |
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|
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Derivatives in Cash Flow Hedging |
|
Amount of Gain/(Loss) in |
|
Amount of Gain/(Loss) |
|
Location of Gain/(Loss) |
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Relationships |
|
2013 |
|
2012 |
|
2013 |
|
2012 |
|
(Effective Portion) |
| ||||
|
Forward-Starting Interest Rate Swaps, net of tax* |
|
$ |
(25 |
) |
$ |
(14 |
) |
$ |
(1 |
) |
$ |
(3 |
) |
Interest expense |
|
*The amounts of Gain/(Loss) in AOCI on derivatives include unamortized proceeds and payments from forward-starting interest rate swaps once classified as cash flow hedges that were terminated prior to end of 2013.
For the above fair value and cash flow interest rate swaps, the Company has entered into International Swaps and Derivatives Association master netting agreements that permit the net settlement of amounts owed under their respective derivative contracts. Under these master netting agreements, net settlement generally permits the Company or the counterparty to determine the net amount payable for contracts due on the same date and in the same currency for similar types of derivative transactions. These master netting agreements generally also provide for net settlement of all outstanding contracts with a counterparty in the case of an event of default or a termination event.
Collateral is generally not required of the counterparties or of the Company under these master netting agreements. As of February 1, 2014 and February 2, 2013, no cash collateral was received or pledged under the master netting agreements.
The effect of the net settlement provisions of these master netting agreements on the Company’s derivative balances upon an event of default or termination event is as follows as of February 1, 2014 and February 2, 2013:
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|
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|
|
|
|
Net Amount |
|
Gross Amounts Not Offset in the |
|
|
| |||||||||
|
February 1, 2014 |
|
Gross Amount |
|
Gross Amounts Offset |
|
Presented in the |
|
Financial |
|
Cash Collateral |
|
Net Amount |
| |||||||
|
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
|
Fair Value Interest Rate Swaps |
|
$ |
2 |
|
$ |
— |
|
$ |
2 |
|
$ |
— |
|
$ |
— |
|
$ |
2 |
| |
|
|
|
|
|
|
|
Net Amount |
|
Gross Amounts Not Offset in the |
|
|
| |||||||||
|
February 2, 2013 |
|
Gross Amount |
|
Gross Amounts Offset |
|
Presented in the |
|
Financial |
|
Cash Collateral |
|
Net Amount |
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|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
|
Cash Flow Forward-Starting Interest Rate Swaps |
|
$ |
16 |
|
$ |
(2 |
) |
$ |
14 |
|
$ |
— |
|
$ |
— |
|
$ |
14 |
| |
|
Fair Value Interest Rate Swaps |
|
1 |
|
— |
|
1 |
|
— |
|
— |
|
1 |
| |||||||
|
Total |
|
$ |
17 |
|
$ |
(2 |
) |
$ |
15 |
|
$ |
— |
|
$ |
— |
|
$ |
15 |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
|
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||
|
Cash Flow Forward-Starting Interest Rate Swaps |
|
$ |
11 |
|
$ |
(2 |
) |
$ |
9 |
|
$ |
— |
|
$ |
— |
|
$ |
9 |
| |
Commodity Price Protection
The Company enters into purchase commitments for various resources, including raw materials utilized in its manufacturing facilities and energy to be used in its stores, warehouses, manufacturing facilities and administrative offices. The Company enters into commitments expecting to take delivery of and to utilize those resources in the conduct of normal business. Those commitments for which the Company expects to utilize or take delivery in a reasonable amount of time in the normal course of business qualify as normal purchases and normal sales.