March
7,
2006
United
States Securities and Exchange Commission
Attn:
George F. Ohsiek, Jr.
100
F
Street, NE
Washington,
DC 20549
| RE: |
Form
10-K for fiscal year ended August 27,
2005
|
Form
10-Q
for the quarter ended November 19, 2005
File
No.
001-10714
Dear
Mr.
Ohsiek,
Below
is
our response to your question in your letter dated February 28, 2006. We have
repeated your question and replied in bold
immediately under the question.
Form
10-K for Fiscal Year Ended August 27, 2005
Exhibit
13.1, Fiscal 2005 Annual Report
Consolidated
Financial Statements, page 18
Note
A. Significant Accounting Policies, page 22
| 1. |
We
have reviewed your response to comment 3 in our letter dated February
9,
2006. In light of your disclosure that instruments designated as
qualifying hedges are reflected in the statements of cash flows in
the
same categories as the cash flows from the items being hedged, please
tell
us in detail why you believe that cash flows relating to interest
rate
derivatives hedging the forecasted issuance of debt should be reflected
as
a component of financing cash flows. In
this regards, we assume that the item being hedged is the cash
flows associated with interest payments. Accordingly, we would expect
the
cash flows associated with such interest rate derivatives to be classified
as operating cash flows consistent with the cash flows associated
with the
interest payments on the hedged forecasted debt
issuance.
|
AutoZone
Response:
In
order to clarify the Company’s accounting treatment for the classification of
cash flows associated with an interest rate derivative hedging the forecasted
issuance of fixed rate debt, management thought it might be beneficial to
provide the Staff with a brief description of how we utilize such derivatives
as
cash flow hedges and how and when they impact the Company’s cash flows and
earnings. On the date that the Company reaches a final decision to issue fixed
rate debt at a future date, management, with the approval of the Board of
Directors, oftentimes elects to enter into an interest rate derivative to hedge
against changes in the benchmark interest rate between such decision date and
the forecasted debt issuance date. As required by the provisions of SFAS No.
133, as amended, the Company accounts for such derivative as a cash flow hedge
and, at each balance sheet date, records such derivative at fair value with
the
effective portion of the change in fair value recorded in accumulated other
comprehensive income/loss. In most instances, the maturity date relating to
such
interest rate derivative is set to coincide with the date on which the
forecasted fixed rate debt is to be issued, with the settlement of such
derivative at maturity generally representing the only cash flow during its
term.
On
the date that the derivative is cash settled, neither the underlying debt being
hedged nor the related effective interest rate derivative has impacted earnings,
and therefore, we believe that it would be inappropriate to reflect the receipt
or payment of cash relating to the settlement of the derivative as an operating
cash flow. Instead, we believe that it is more appropriate to reflect such
cash
receipt or payment as a financing cash flow that “attaches” to the underlying
debt being hedged (and effectively modifies the effective interest rate that
will be expensed over the term of the debt, as disclosed in the Company’s
Financing footnote included in the consolidated financial statements), in much
the same manner that deferred debt issuance costs are reflected in the statement
of cash flows. As required by the provisions of SFAS No. 133, as amended, we
then reclassify the deferred gains or losses associated with the terminated
interest rate derivative out of accumulated other comprehensive income/loss
over
the term of the underlying debt that was hedged to effectively modify the
interest expense being recognized relating to such fixed rate debt (although
there are no cash flows associated with such reclassifications). Because such
reclassifications impact interest expense being recognized over the term of
the
underlying debt, they are effectively included as a component of operating
cash
flows in periods subsequent to settlement as interest expense impacts net
income.
In
order to clarify our accounting for derivative instruments, beginning with
our
Form 10-K for the fiscal year ending August 26, 2006, we will revise our
disclosures in Note A as follows:
Derivative
Instruments and Hedging Activities: AutoZone is exposed to market risk from,
among other things, changes in interest rates, foreign exchange rates and fuel
prices. From time to time, the Company uses various financial instruments to
reduce such risks. To date, based upon the Company’s current level of foreign
operations, hedging costs and past changes in the associated foreign exchange
rates, no instruments have been utilized to reduce this market risk. All of
the
Company’s hedging activities are governed by guidelines that are authorized by
AutoZone’s Board of Directors. Further, the Company does not buy or sell
financial instruments for trading purposes.
AutoZone’s
financial market risk results primarily from changes in interest rates. At
times, AutoZone reduces its exposure to changes in interest rates by entering
into various interest rate hedge instruments such as interest rate swap
contracts, treasury lock agreements and forward-starting interest rate swaps.
The Company complies with Statement of Financial Accounting Standards Nos.
133,
137, 138 and 149 (collectively “SFAS 133”) pertaining to the accounting for
these derivatives and hedging activities which require all such interest rate
hedge instruments to be recognized on the balance sheet at fair value. All
of
the Company’s interest rate hedge instruments are designated as cash flow
hedges. Refer to “Note B - Derivative Instruments and Hedging Activities” for
additional disclosures regarding the Company’s derivatives instruments and
hedging activities. Cash flows related to these instruments designated as
qualifying hedges are reflected in the accompanying consolidated statements
of
cash flows in the same categories as the cash flows from the items being hedged.
Accordingly, cash flows relating to the settlement of interest rate derivatives
hedging the forecasted issuance of debt have been reflected upon settlement
as a
component of financing cash flows. The resulting gain or loss from such
settlement is deferred to accumulated other comprehensive loss and reclassified
to interest expense over the term of the underlying debt. This reclassification
of the deferred gains and losses impacts the interest expense recognized on
the
underlying debt that was hedged and is therefore reflected as a component of
operating cash flows in periods subsequent to settlement. The periodic
settlement of interest rate derivatives hedging outstanding variable rate debt
are recorded as an adjustment to interest expense and are therefore reflected
as
a component of operating cash flows.
Please
let us know if you have any further questions or if we can clarify any other
issues that you may have.
Yours
truly,
AUTOZONE,
INC.
| By: | /s/ Charlie Pleas, III | |
| Vice President and Controller | ||
|
(Principal
Accounting Officer)
|