EFTA01117862.pdf

EDGAROnline DOLLAR GENERAL CORP FORM 10-O (Quarterly Report) Filed 12/11/12 for the Period Ending 11/02/12 Address 100 MISSION RIDGE GOODLETTSVILLE, TN 37072 Telephone CIK 0000029534 Symbol DG SIC Code 5331 - Variety Stores Industry Retail (Specialty) Sector Services Fiscal Year 02/01 EDGAR0nline http:/Avwye.edgar.online.com Copyright 2012. EDGAR Online, Inc. All Rights Reserved. Distribution and use of this document restricted under EDGAR Online, Inc. Terms of Use. EFTA01117862  UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended November 2, 2012 Commission File Number: 001-11421 DOLLAR GENERAL CORPORATION (Exact name of Registrant as specified in its charter) TENNESSEE 61.0502302 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 100 MISSION RIDGE GOODLETTSVILLE, TN 37072 (Address of principal executive offices, zip code) Registrant's telephone number, including area code: Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes M No ❑ Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes M No Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer." and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filer Accelerated filer El Non-accelerated filer El Smaller reporting company Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes CI No 0 The registrant had 328,712,549 shares of common stock outstanding on December 3, 2012. EFTA01117863  PART I-FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS. DOLLAR GENERAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands) November 2, February 3, 2012 2012 (Unaudited) (see Note I) ASSETS Current assets: Cash and cash equivalents $ 142,580 $ 126,126 Merchandise inventories 2.330.436 2.009.206 Income taxes receivable 13,554 Prepaid expenses and other current assets 131.622 139,742 Total current assets 2,618,192 2,275,074 Net property and equipment 2.047.434 1.794.960 Goodwill 4,338.589 4.338.589 Other intangible assets, net 1.223.407 1.235.954 Other assets, net 46.055 43.943 Total assets $ 10.273.677 $ 9.688.520 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term obligations 891 $ 590 Accounts payable 1,199,727 1,064,087 Accrued expenses and other 392,439 397.075 Income taxes payable 997 44,428 Deferred income taxes 39,785 3.722 Total current liabilities 1,633,839 1,509,902 Long-term obligations 3.023.367 2.617.891 Deferred income taxes 655,910 656,996 Other liabilities 225.699 229.149 Commitments and contingencies Shareholders' equity: Preferred stock Common stock 287,613 295,828 Additional paid-in capital 2,983,323 2,967,027 Retained earnings 1.468.534 1,416.918 Accumulated other comprehensive loss (4,608) (5,191) Total shareholders' equity 4.734.862 4.674.582 Total liabilities and shareholders' equity $ 10.273.677 $ 9.688.520 See notes to condensed consolidatedfinancial statements. 1 EFTA01117864  DOLLAR GENERAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (In thousands, except per share amounts) For the 13 weeks ended For the 39 weeks ended November 2. October 28. November 2. October 28. 2012 2011 2012 2011 Net sales $ 3,964,647 $ 3,595,224 $ 11,814.507 $ 10,622,115 Cost of goods sold 2.738,524 2.479.422 8.096,905 7.270.574 Gross profit 1,226,123 1,115,802 3,717,602 3,351,541 Selling, general and administrative expenses 864,734 804.885 2.584,675 2.368.977 Operating profit 361,389 310,917 1,132,927 982,564 Interest expense 27,726 38,632 100,466 164.831 Other (income) expense 1,728 53 29,956 60.564 Income before income taxes 331,935 272,232 1,002,505 757.169 Income tax expense 124.250 101.068 367.265 282.994 Net income $ 207.685 $ 171.164 $ 635.240 $ 474.175 Earnings per share: Basic 0.62 $ 0.50 $ 1.90 $ 1.39 Diluted 0.62 $ 0.50 $ 1.89 $ 1.37 Weighted average shares outstanding: Basic 332,337 341,955 333,806 341,670 Diluted 334,004 345.777 336,339 345.598 See notes to condensed consolidatedfinancial statements. 2 EFTA01117865  DOLLAR GENERAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (In thousands) For the 13 weeks ended For the 39 weeks ended November 2, October 28. November 2. October 28. 2012 21)11 2012 2011 Comprehensive income 208.249 $ 174.269 S 635.823 $ 486.594 See notes to condensed consolidatedfinancial statements. EFTA01117866  DOLLAR GENERAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) For the 39 weeks ended November 2, October 28. 2012 2011 Cash flowsfrom operating activities: Net income $ 635,240 $ 474,175 Adjustments to reconcile net income to net cash from operating activities: Depreciation and amortization 222,398 204,771 Deferred income taxes 24,221 23,977 Tax benefit of stock options (85,335) (16,101) Loss on debt retirement, net 30,620 60,303 Noncash share-based compensation 15.357 10,969 Other noncash gains and losses 9,548 31,656 Change in operating assets and liabilities: Merchandise inventories (326,076) (350,932) Prepaid expenses and other current assets 12,399 (30,899) Accounts payable 130,733 164,336 Accrued expenses and other liabilities (4,334) 89,993 Income taxes 28,350 (57,575) Other (2,235) (174) Net cash provided by (used in) operating activities 690,886 604,499 Cash flowsfrom investing activities: Purchases of property and equipment (453,626) (363.099) Proceeds from sales of property and equipment 1,144 729 Net cash provided by (used in) investing activities (452.482) (362.370) Cash flowsfromfinancing activities: Issuance of long-term obligations 500,000 Repayments of long-term obligations (478,026) (911.708) Borrowings under revolving credit facility 1,703,400 649,100 Repayments of borrowings under revolving credit facility (1,349,800) (361.300) Debt issue costs (15,278) Repurchases of common stock (596,442) Equity transactions with employees, net of taxes paid (71,139) (13,188) Tax benefit of stock options 85,335 16,101 Net cash provided by (used in) financing activities (221,950) (620,995) Net increase (decrease) in cash and cash equivalents 16,454 (378,866) Cash and cash equivalents. beginning of period 126.126 497.446 Cash and cash equivalents, end of period 142.580 $ 1 18.580 Supplemental schedule ofnon-cash investing andfinancing activities: Purchases of property and equipment awaiting processing for payment, included in Accounts payable $ 40,569 $ 44,225 Purchases of property and equipment under capital lease obligations 3,440 $ See notes to condensed consolidatedfinancial statements. 4 EFTA01117867  DOLLAR GENERAL CORPORATION AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Unaudited) 1. Basis of presentation The accompanying unaudited condensed consolidated financial statements of Dollar General Corporation and its subsidiaries (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and are presented in accordance with the requirements of Form 10-Q and Rule 10-01 of Regulation S-X. Such financial statements consequently do not include all of the disclosures normally required by U.S. GAAP or those normally made in the Company's Annual Report on Form 10-K, including the condensed consolidated balance sheet as of February 3, 2012 which has been derived from the audited consolidated financial statements at that date. Accordingly, readers of this Quarterly Report on Form 10-Q should refer to the Company's Annual Report on Form 10-K for the fiscal year ended February 3, 2012 for additional information. The Company's fiscal year ends on the Friday closest to January 31. Unless the context requires otherwise, references to years contained herein pertain to the Company's fiscal year. The Company's 2012 fiscal year will be a 52-week accounting period ending on February 1, 2013 and the 2011 fiscal year was a 53-week accounting period that ended on February 3, 2012. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the Company's customary accounting practices. In management's opinion, all adjustments (which are of a normal recurring nature) necessary for a fair presentation of the consolidated financial position as of November 2, 2012 and results of operations for the 13-week and 39-week accounting periods ended November 2, 2012 and October 28, 2011 have been made. The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. The Company uses the last-in, first-out (LIFO) method of valuing inventory. An actual valuation of inventory under the LIFO method is made at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management's estimates of expected year-end inventory levels, sales for the year and the expected rate of inflation/deflation for the year. The interim LIFO calculations are subject to adjustment in the final year-end LIFO inventory valuation. The Company recorded a LIFO provision of $0.1 million and $11.1 million in the respective 13-week periods, and $1.2 million and $25.4 million in the respective 39-week periods, ended November 2, 2012 and October 28, 2011. In addition, ongoing estimates of inventory shrinkage and initial markups and markdowns are included in the interim cost of goods sold calculation. Because the Company's business is 5 EFTA01117868 moderately seasonal, the results for interim periods are not necessarily indicative of the results to be expected for the entire year. In July 2012, the Financial Accounting Standards Board issued new accounting guidance relating to impairment testing for indefinite- lived intangible assets. In accordance with this guidance, an entity has the option first to assess qualitative factors to determine whether events and circumstances indicate that it is more likely than not that an indefinite-lived intangible asset is impaired. If after such assessment an entity concludes that the indefinite-lived intangible asset is not impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test as required by existing standards. This guidance is effective for annual and interim impairment tests for fiscal years beginning after September 15, 2012 and early adoption is permitted. The Company adopted this guidance in the third quarter of 2012 and it did not have a material impact on its condensed consolidated financial statements. Certain financial statement amounts relating to prior periods have been reclassified to conform to the current period presentation. 2. Common stock transactions On August 29, 2012, the Company's Board of Directors authorized a $500 million common stock repurchase program, of which $218.6 million remained available for repurchase as of November 2, 2012. The repurchase authorization has no expiration date and allows repurchases from time to time in the open market or in privately negotiated transactions, which could include repurchases from Buck Holdings, L.P., a Delaware limited partnership controlled by KKR and Goldman Sachs and Co., or other related parties if appropriate. The timing and number of shares purchased will depend on a variety of factors, such as price, market conditions, compliance with the covenants and restrictions under our debt agreements and other factors. Repurchases under the program may be funded from available cash or borrowings under our senior secured asset-based revolving credit facility, which is discussed in further detail in Note 5. On November 30, 2011, the Company's Board of Directors authorized a $500 million common stock repurchase program, which was completed during the period ended November 2, 2012 as discussed below. The repurchase authorization had terms similar to the August 2012 authorization. During the 39-week period ended November 2, 2012, the Company repurchased approximately 7.1 million shares under the November 2011 authorization at a total cost of $315.0 million, including approximately 6.8 million shares purchased from Buck Holdings, L.P. for an aggregate purchase price of $300.0 million, and approximately 5.6 million shares under the August 2012 authorization at a total cost of $281.4 million, including approximately 4.9 million shares purchased from Buck Holdings, L.P. for an aggregate purchase price of $250.0 million. 6 EFTA01117869 3. Earnings per share Earnings per share is computed as follows (in thousands, except per share data): 13 Weeks Ended November 2,2012 13 Weeks Ended October 28.2011 Net Per Share Net Per Share Income Shares Amount Income Shares Amount Basic earnings per share $ 207.685 332,337 $ 0.62 $ 171.164 341,955 $ 0.50 Effect of dilutive share-based awards 1.667 3.822 Diluted earnings per share $ 207.685 334.004 S 0.62 $ 171.164 345.777 $ 0.50 39 Weeks Ended November 2.2012 39 Weeks Ended October 28.2011 Net Per Share Net Per Share Income Shares Amount Income Shares Amount Basic earnings per share $ 635.240 333.806 $ 1.90 $ 474.175 341.670 $ 1.39 Effect of dilutive share-based awards ").533 3.928 Diluted earnings per share $ 635.240 336.339 1.89 $ 474.175 345.598 $ 1.37 Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is determined based on the dilutive effect of stock options using the treasury stock method. Options to purchase shares of common stock that were outstanding at the end of the respective periods, but were not included in the computation of diluted earnings per share because the effect of exercising such options would be antidilutive, were 0.8 million and 0.3 million in the 2012 and 201 I periods, respectively. 4. Income taxes Under the accounting standards for income taxes, the asset and liability method is used for computing the future income tax consequences of events that have been recognized in the Company's consolidated financial statements or income tax returns. Income tax reserves are determined using the methodology established by accounting standards for income taxes which require companies to assess each income tax position taken using a two-step approach. A determination is first made as to whether it is more likely than not that the position will be sustained, based upon the technical merits, upon examination by the taxing authorities. If the tax position is expected to meet the more likely than not criteria, the benefit recorded for the tax position equals the largest amount that is greater than 50% likely to be realized upon ultimate settlement of the respective tax position. The Internal Revenue Service ("IRS") has completed its examination of the Company's federal income tax returns for fiscal years 2006, 2007. and 2008. As a result, the 2008 and earlier tax years are not open for examination by the IRS. The IRS, at its discretion, may choose to examine the Company's 2009, 2010, or 2011 fiscal year income tax filings. The Company has 7 EFTA01117870 various state income tax examinations that are currently in progress. Generally, the Company's 2009 and later tax years remain open for examination by the various state taxing authorities. As of November 2, 2012, the total reserves for uncertain tax benefits, interest expense related to income taxes and potential income tax penalties were $22.7 million, $2.1 million and $0.4 million, respectively, for a total of $25.2 million. Of this amount, $0.3 million and $24.9 million are reflected in current liabilities as Accrued expenses and other and in noncurrent Other liabilities, respectively, in the condensed consolidated balance sheet. The reserve for uncertain tax benefits decreased during the 39-week period ended November 2, 2012 by $19.3 million due principally to the favorable resolution of matters associated with examination activity. As of November 2. 2012, approximately $22.7 million of the reserve for uncertain tax positions would impact the Company's effective income tax rate if the Company were to recognize the tax benefit for these positions. The Company believes it is reasonably possible that the reserve for uncertain tax positions may be reduced by approximately $15.0 million in the coming twelve months due principally to the effective settlement of reserved amounts. The effective income tax rates for the 13-week and 39-week periods ended November 2, 2012 were 37.4% and 36.6%, compared to rates of 37.1% and 37.4% for the respective 13-week and 39-week periods ended October 28, 2011. The increase in the effective income tax rate for the 13-week period is primarily associated with state income tax items. The 2011 period benefited, to a greater extent, from a decrease in a state income tax valuation allowance associated with state income tax credits and from decreases in state income tax reserves as compared to 2012's reserve increases. The decrease in the 39-week period effective income tax rate was due to benefits (recorded earlier in the current fiscal year) associated with the adjustment of accruals due to the favorable resolution of income tax examinations that exceeded increases in the effective tax rate associated with the expiration of various federal jobs credits for workers hired after December 31, 2011 (primarily the Work Opportunity Tax Credit), the expiration of the Hire Act's Retention Credit and an increase in the state income tax rate as noted earlier in this paragraph. 5. Current and long-term obligations Current and long-term obligations consist of the following: November 2, February 3, (In thousands) 2012 2012 Senior secured term loan facility: Maturity July 6.2014 $ 1,083.800 $ 1.963,500 Maturity July 6, 2017 879,700 ABL Facility, maturity July 6, 2014 538.300 184,700 4 1/8% Senior Notes due July 15, 2017 500,000 1 I 7/8%/12 5/8% Senior Subordinated Notes due July 15, 2017 450,697 Capital lease obligations 7,963 5,089 Tax increment financing due February 1, 2035 14.495 14,495 3,024,258 2.618,481 Less: current portion (891) (590) Long-term portion $ 3,023,367 $ 2.617,891 8 EFTA01117871  As of November 2, 2012 the Company has senior secured credit agreements (the "Credit Facilities") which provide total financing of $3.16 billion, consisting of a senior secured term loan facility ("Term Loan Facility"), and a senior secured asset-based revolving credit facility ("ABL Facility"). On March 15, 2012, the ABL Facility was amended and restated. The maturity date was extended by a year to July 6, 2014 and the total commitment was increased to $1.2 billion (of which up to $350.0 million is available for letters of credit), subject to borrowing base availability. The Company capitalized $2.7 million of debt issue costs, and incurred a pretax loss of $1.6 million for the write off of a portion of existing debt issue costs associated with the amendment, which is reflected in Other (income) expense in the condensed consolidated statement of income for the 39-week period ended November 2, 2012. On March 30, 2012, the Term Loan Facility was amended and restated. Pursuant to the amendment, the maturity date for a portion ($879.7 million) of the Term Loan Facility was extended from July 6, 2014 to July 6, 2017. The applicable margin for borrowings under the Term Loan Facility remains unchanged. The Company capitalized $5.2 million of debt issue costs associated with the amendment. On October 9, 2012, the Credit Facilities were further amended to add additional capacity for the Company to repurchase, redeem or otherwise acquire shares of its capital stock, not to exceed $250.0 million. The Company incurred a fee of $1.7 million associated with these amendments which is included in Other (income) expense in the condensed consolidated statements of income for the 13-week and 39-week periods ended November 2, 2012. The Company was reimbursed for these fees as further discussed in Note 9. Borrowings under the Credit Facilities bear interest at a rate equal to an applicable margin plus, at the Company's option, either (a) LIBOR or (b) a base rate (which is usually equal to the prime rate). The applicable margin for borrowings as of November 2, 2012 and February 3, 2012 was (i) under the Term Loan, 2.75% for LIBOR borrowings and 1.75% for base-rate borrowings and (ii) under the ABL Facility, 1.75% and 1.50%, respectively, for LIBOR borrowings and 0.75% and 0.50%, respectively, for base-rate borrowings. At February 3, 2012, prior to the amendment discussed above, the ABL Facility also had a "last out" tranche of $101.0 million for which the applicable margin was 2.25% for LIBOR borrowings and 1.25% for base rate borrowings. The applicable margins for borrowings under the ABL Facility are subject to adjustment each quarter based on average daily excess availability under the ABL Facility. The Company also must pay customary letter of credit fees. The interest rate for borrowings under the Term Loan Facility was 3.0% and 3.1% (without giving effect to the interest rate swaps discussed in Note 7), as of November 2, 2012 and February 3, 2012, respectively. The senior secured credit agreement for the Term Loan Facility requires the Company to prepay outstanding term loans, subject to certain exceptions, with percentages of excess cash flow, proceeds of non-ordinary course asset sales or dispositions of property, and proceeds of incurrences of certain debt. In addition, the senior secured credit agreement for the ABL Facility requires the Company to prepay the ABL Facility, subject to certain exceptions, with proceeds of non-ordinary course asset sales or dispositions of property and any borrowings in excess of the then current borrowing base. The Term Loan Facility can be prepaid in whole or in part at any 9 EFTA01117872 time. No prepayments have been required under any prepayment provisions through November 2, 2012. All obligations under the Credit Facilities are unconditionally guaranteed by substantially all of the Company's existing and future domestic subsidiaries (excluding certain immaterial subsidiaries and certain subsidiaries designated by the Company under the Credit Facilities as "unrestricted subsidiaries"). All obligations and guarantees of those obligations under the Term Loan Facility are secured by, subject to certain exceptions, a second-priority security interest in all existing and after-acquired inventory and accounts receivable; a first priority security interest in substantially all of the Company's and the guarantors' tangible and intangible assets (other than the inventory and accounts receivable collateral); and a first-priority pledge of the capital stock held by the Company. All obligations under the ABL Facility are secured by all existing and after-acquired inventory and accounts receivable, subject to certain exceptions. The Credit Facilities contain certain covenants, including, among other things, covenants that limit the Company's ability to incur additional indebtedness, sell assets, incur additional liens, pay dividends, make investments or acquisitions, or repay certain indebtedness. As of November 2, 2012 and February 3, 2012, the respective letter of credit amounts related to the ABL Facility were $41.1 million and $38.4 million, and borrowing availability under the ABL Facility was $620.6 million and $807.9 million, respectively. On July 12, 2012, the Company issued $500.0 million aggregate principal amount of 4.125% senior notes due 2017 (the "Senior Notes") which mature on July 15, 2017, pursuant to an indenture dated as of July 12, 2012 (the "Senior Indenture"). The Company capitalized $7.3 million of debt issue costs associated with the Senior Notes. Interest on the Senior Notes is payable in cash on January 15 and July 15 of each year, commencing on January 15, 2013. The Senior Notes are fully and unconditionally guaranteed on a senior unsecured basis by each of the existing and future direct or indirect domestic subsidiaries that guarantee the obligations under the Credit Facilities discussed above. The Company may redeem some or all of the Senior Notes at any time at redemption prices described or set forth in the Senior Indenture. The Company also may seek, from time to time, to retire some or all of the Senior Notes through cash purchases in the open market, in privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, the Company's liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. Upon the occurrence of a change of control triggering event, which is defined in the Senior Indenture, each holder of the Senior Notes has the right to require the Company to repurchase some or all of such holder's Senior Notes at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the repurchase date. 10 EFTA01117873  The Senior Indenture contains covenants limiting, among other things, the ability of the Company and its restricted subsidiaries to (subject to certain exceptions): consolidate, merge. sell or otherwise dispose of all or substantially all of the Company's assets; and i ncur or guarantee indebtedness secured by liens on any shares of voting stock of significant subsidiaries. The Senior Indenture also provides for events of default which, if any of them occurs, would permit or require the principal of and accrued interest on the Senior Notes to become or to be declared due and payable. On July 15, 2012, the Company redeemed the entire $450.7 million outstanding aggregate principal amount of its 11.875%/12.625% Senior Subordinated Notes due 2017 (the "Senior Subordinated Notes") at a premium. The pretax loss on this transaction of $29.0 million is reflected in Other (income) expense in the condensed consolidated statements of income for the 39-week period ended November 2, 2012. The Company funded the redemption price for the Senior Subordinated Notes with proceeds from the issuance of the Senior Notes. In April and July 2011, the Company repurchased or redeemed all $864.3 million outstanding aggregate principal amount of its 10.625% senior notes due 2015 at a premium. The Company funded the redemption price for the senior notes due 2015 with cash on hand and borrowings under the ABL Facility. The 2011 redemption and repurchase resulted in pretax losses totaling $60.3 million, which is reflected in Other (income) expense in the condensed consolidated statements of income for 39-week period ended October 28, 2011. Approximately $1.6 billion of the Company's outstanding long-term debt balances as of November 2, 2012 will mature in 2014 and approximately $1.4 billion of such debt will mature after 2016. 6. Assets and liabilities measured at fair value Fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, fair value accounting standards establish a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity's own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). In connection with accounting standards for fair value measurement, the Company has made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio. The Company has determined that the majority of the inputs used to value its derivative financial instruments using the income approach fall within Level 2 of the fair value hierarchy. However, the credit valuation adjustments associated with the Company's derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. As of November 2, 2012, the Company has assessed the significance of ll EFTA01117874 the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that such adjustments are not significant to the derivative? valuation. As a result, the Company has classified its derivative valuations, as discussed in detail in Note 7, in Level 2 of the fair value hierarchy. The Company's long-term obligations that are classified in Level 2 of the fair value hierarchy are valued at cost. The Company does not have any fair value measurements categorized within Level 3 as of November 2, 2012. Quoted Prices in Active Markets Significant for Identical Other Significant Assets and Observable Unobservable Balance al Liabilities Inputs Inputs November 2, tin thousands) (Level I) (Level 21 (Level 3) 2012 Assets: Trading securities (a) 5,742 $ — S — $ 5,742 Liabilities: Long-term obligations (b) 3,032,042 22,458 3,054,500 Derivative financial instruments (c) 7,567 7,567 Deferred compensation (d) 21,380 21,380 (a) Reflected at fair value in the condensed consolidated balance sheet as Prepaid expenses and other current assets of $4,047 and Other assets, net of $1,695. (b) Reflected at book value in the condensed consolidated balance sheet as Current portion of long-term obligations of $891 and Long-term obligations of $3,023,367. (c) Reflected in the condensed consolidated balance sheet as Accrued expenses and other current liabilities of $1,557 and non-current Other liabilities of $6,010. (d) Reflected at fair value in the condensed consolidated balance sheet as Accrued expenses and other current liabilities of $4,047 and non- current Other liabilities of $17,333. 7. Derivatives and hedging activities The Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that arc attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge a certain portion of its risk, even though hedge accounting does not apply or the Company elects not to apply the hedge accounting standards. 12 EFTA01117875 Risk management objective of using derivatives The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company's derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company's known or expected cash receipts and its known or expected cash payments principally related to the Company's borrowings. The Company is exposed to certain risks arising from uncertainties of future market values caused by the fluctuation in the prices of commodities. From time to time the Comp