filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis is intended to provide the reader with information that will assist in understanding the significant factors affecting our consolidated operating results, financial condition, liquidity and capital resources during the three-year period ended December 28, 2013 (our fiscal years 2013, 2012 and 2011). Fiscal years 2013 and 2012 contained 52 weeks of operating results compared to fiscal year 2011 which contained 53 weeks. This discussion should be read in conjunction with our consolidated financial statements and notes to the consolidated financial statements included elsewhere in this report. This discussion contains forward-looking statements. See "Forward-Looking Statements" and "Risk Factors" included elsewhere in this report.
Overview
Tractor Supply Company is the largest operator of retail farm and ranch stores in the United States and is focused on supplying the lifestyle needs of recreational farmers and ranchers and others who enjoy the rural lifestyle, as well as tradesmen and small businesses. As of December 28, 2013, we operated 1,276 retail stores in 48 states under the names Tractor Supply Company and Del’s Feed & Farm Supply. We also operate a website under the name TractorSupply.com. Our stores are located primarily in towns outlying major metropolitan markets and in rural communities, and they offer the following comprehensive selection of merchandise:
| • | Equine, livestock, pet and small animal products, including items necessary for their health, care, growth and containment; |
| • | Hardware, truck, towing and tool products; |
| • | Seasonal products, including lawn and garden items, power equipment, gifts and toys; |
| • | Work/recreational clothing and footwear; and |
| • | Maintenance products for agricultural and rural use. |
Our current and long-term growth strategy is to: (1) expand geographic market presence through opening new retail stores, (2) enhance financial performance through comparable store sales growth achieved through targeted merchandising programs with an “everyday value price” philosophy and supported by strong customer service, (3) enhance product margin through strategic product sourcing, inventory and markdown management, a strong exclusive brand offering, and optimization of product pricing and transportation costs, (4) leverage operating costs by focusing on opportunities for continuous improvement and elimination of waste in all of our processes, (5) expand market opportunities via e-commerce and internet-supported sales accomplished by improving our website product content and enhancing our customers’ online experience and (6) expand through selective acquisition, as such opportunities arise, to enhance penetration into new and existing markets to complement organic growth.
Over the past five years we have experienced considerable growth in stores, growing from 855 stores at the end of 2008 to 1,276 stores at the end of fiscal 2013, and in sales, with a compounded annual growth rate of approximately 11.4%. Given the size of the communities that we target, we believe that there is ample opportunity for new store growth in existing and new markets. We have developed a proven method for selecting store sites and have identified over 800 additional markets for new Tractor Supply stores.
Stock Split
On August 28, 2013, our Board of Directors declared a two-for-one split of our outstanding shares of common stock to be effected in the form of a stock dividend. On September 26, 2013, stockholders of record at the close of business on September 18, 2013, received one additional share of common stock for each share owned by such stockholder. All share and per-share information in the Annual Report on Form 10-K has been retroactively restated to reflect the stock split. The total number of authorized common shares and the par value of each share was not changed by the split.
Executive Summary
We opened 102 new stores in 2013 and 93 new stores in 2012, a selling square footage increase of approximately 8.3% and 7.9%, respectively. During 2013, we opened stores in 34 states, including our first stores in Arizona, Nevada and Wyoming, and in 2014 we expect to continue our expansion into these new markets.
We achieved strong performance in fiscal 2013, delivering diluted earnings per share growth of 22.1%, $2.32 versus $1.90 in fiscal 2012.
Net sales increased 10.7% to $5.16 billion in fiscal 2013 from $4.66 billion in fiscal 2012. Comparable store sales increased 4.8% in fiscal 2013 versus a 5.3% increase in fiscal 2012. Gross profit increased 12.0% to $1.75 billion in fiscal 2013 from $1.57 billion
in fiscal 2012, and gross margin increased 40 basis points to 34.0% of sales in fiscal 2013 from 33.6% of sales in fiscal 2012. Operating profit increased 60 basis points to 10.0% of sales in fiscal 2013 from 9.4% of sales in fiscal 2012. In fiscal 2013, diluted earnings per share grew 22.1%, to $2.32 compared to $1.90 in fiscal 2012.
We ended the year with approximately $143 million in cash, after returning nearly $198 million to our stockholders through stock repurchases and dividends.
Significant Accounting Policies and Estimates
Management’s discussion and analysis of our financial position and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires management to make informed estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Our financial position and/or results of operations may be materially different when reported under different conditions or when using different assumptions in the application of such policies. In the event estimates or assumptions prove to be different from actual amounts, adjustments are made in subsequent periods to reflect more current information. Our significant accounting policies are disclosed in Note 1 to our Consolidated Financial Statements. The following discussion addresses our most critical accounting policies, which are those that are both important to the portrayal of our financial condition and results of operations and that require significant judgment or use of complex estimates.
| Description | Judgments and Uncertainties | Effect if Actual Results Differ From Assumptions | ||
| Inventory Valuation: | ||||
| Inventory Impairment | ||||
| We identify potentially excess and slow-moving inventory by evaluating turn rates, historical and expected future sales trends, age of merchandise, overall inventory levels, current cost of inventory and other benchmarks. The estimated inventory valuation reserve to recognize any impairment in value (i.e., an inability to realize the full carrying value) is based on our aggregate assessment of these valuation indicators under prevailing market conditions and current merchandising strategies. | We do not believe our merchandise inventories are subject to significant risk of obsolescence in the near term. However, changes in market conditions or consumer purchasing patterns could result in the need for additional reserves. Our impairment reserve contains uncertainties because the calculation requires management to make assumptions and to apply judgment regarding forecasted customer demand and the promotional environment. | We have not made any material changes in the accounting methodology used to recognize inventory impairment reserves in the financial periods presented. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate impairment. However, if assumptions regarding consumer demand or clearance potential for certain products are inaccurate, we may be exposed to losses or gains that could be material. A 10% change in our impairment reserve at December 28, 2013, would have affected net income by approximately $0.4 million in fiscal 2013. |
| Description | Judgments and Uncertainties | Effect if Actual Results Differ From Assumptions | ||
| Shrinkage | ||||
| We perform physical inventories at each store at least once a year, and we have established reserves for estimating inventory shrinkage between physical inventory counts. The reserve is established by assessing the chain-wide average shrinkage experience rate, applied to the related periods' sales volumes. Such assessments are updated on a regular basis for the most recent individual store experiences. | The estimated store inventory shrink rate is based on historical experience. We believe historical rates are a reasonably accurate reflection of future trends. Our shrinkage reserve contains uncertainties because the calculation requires management to make assumptions and to apply judgment regarding future shrinkage trends, the effect of loss prevention measures and new merchandising strategies. | We have not made any material changes in the accounting methodology used to recognize shrinkage in the financial periods presented. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our shrinkage reserve. However, if our estimates regarding inventory losses are inaccurate, we may be exposed to losses or gains that could be material. A 10% change in our shrinkage reserve at December 28, 2013, would have affected net income by approximately $1.0 million in fiscal 2013. | ||
| Vendor Funding | ||||
| We receive funding from substantially all of our significant merchandise vendors, in support of our business initiatives, through a variety of programs and arrangements, including guaranteed vendor support funds ("vendor support") and volume-based rebate funds ("volume rebates"). The amounts received are subject to terms of vendor agreements, most of which are "evergreen", reflecting the on-going relationship with our significant merchandise vendors. Certain of our agreements, primarily volume rebates, are renegotiated annually, based on expected annual purchases of the vendor’s product. Vendor funding is initially deferred as a reduction of the purchase price of inventory and then recognized as a reduction of cost of merchandise as the related inventory is sold. During interim periods, the amount of vendor support is known and is debited to vendors systematically; however, volume rebates are estimated during interim periods based upon initial commitments and anticipated purchase levels with applicable vendors. | The estimated purchase volume (and related vendor funding through volume rebates) is based on our current knowledge of inventory levels, sales trends and expected customer demand, as well as planned new store openings and relocations. Although we believe we can reasonably estimate purchase volume and related volume rebates at interim periods, it is possible that actual year-end results could differ from previously estimated amounts. Our allocation methodology contains uncertainties because the calculation requires management to make assumptions and to apply judgment regarding customer demand, purchasing activity, target thresholds, vendor attrition and collectibility. | We have not made any material changes in the accounting methodology used to establish our vendor support reserves in the financial periods presented. At the end of each fiscal year, a significant portion of the actual purchase activity is known. Thus, we do not believe there is a reasonable likelihood that there will be a material change in the amounts recorded as vendor support. We do not believe there is a significant collectibility risk related to vendor support amounts due us at the end of fiscal 2013. If a 10% reserve had been applied against our outstanding vendor support due as of December 28, 2013, net income would have been affected by approximately $1.1 million in fiscal 2013. Although it is unlikely that there will be any significant reduction in historical levels of vendor support, if such a reduction were to occur in future periods, the Company could experience a higher inventory balance and higher cost of sales. | ||
| Freight | ||||
| We incur various types of transportation and delivery costs in connection with inventory purchases and distribution. Such costs are included as a component of the overall cost of inventories (on an aggregate basis) and recognized as a component of cost of merchandise sold as the related inventory is sold. | We allocate freight as a component of total cost of sales without regard to inventory mix or unique freight burden of certain categories. This assumption has been consistently applied for all years presented. | We have not made any material changes in the accounting methodology used to establish our capitalized freight balance or freight allocation in the financial periods presented. If a 10% increase or decrease had been applied against our current inventory capitalized freight balance as of December 28, 2013, net income would have been affected by approximately $4.9 million in fiscal 2013. |
| Description | Judgments and Uncertainties | Effect if Actual Results Differ From Assumptions | ||
| Self-Insurance Reserves: | ||||
| We self-insure a significant portion of our employee medical insurance, workers' compensation and general liability insurance plans. We have stop-loss insurance policies to protect from individual losses over specified dollar values. When estimating our self-insured liabilities, we consider a number of factors, including historical claims experience, demographic factors and severity factors. | The full extent of certain claims, especially workers' compensation and general liability claims, may not become fully determined for several years. Our self-insured liabilities contain uncertainties because management is required to make assumptions and to apply judgment to estimate the ultimate cost to settle reported claims and claims incurred but not reported as of the balance sheet date based upon historical data and experience, including actuarial calculations. | We have not made any material changes in the accounting methodology used to establish our self-insurance reserves in the financial periods presented. We do not believe there is a reasonable likelihood that there will be a material change in the assumptions we use to calculate insurance reserves. However, if we experience a significant increase in the number of claims or the cost associated with these claims, we may be exposed to losses that could be material. A 10% change in our self-insurance reserves at December 28, 2013, would have affected net income by approximately $2.6 million in fiscal 2013. | ||
| Sales Tax Audit Reserve: | ||||
| A portion of our sales are to tax-exempt customers, predominantly agricultural-based. We obtain exemption information as a necessary part of each tax-exempt transaction. Many of the states in which we conduct business will perform audits to verify our compliance with applicable sales tax laws. The business activities of our customers and the intended use of the unique products sold by us create a challenging and complex compliance environment. These circumstances also create some risk that we could be challenged as to the accuracy of our sales tax compliance. While we believe we appropriately enforce sales tax compliance with our customers and endeavor to fully comply with all applicable sales tax regulations, there can be no assurance that we, upon final completion of such audits, would not have a significant liability for disallowed exemptions. | We review our past audit experience and assessments with applicable states to continually determine if we have potential exposure for non-compliance. Any estimated liability is based on an initial assessment of compliance risk and our historical experience with each state. We continually reassess the exposure based on historical audit results, changes in policies, preliminary and final assessments made by state sales tax auditors, and additional documentation that may be provided to reduce the assessment. Our sales tax audit reserve contains uncertainties because management is required to make assumptions and to apply judgment regarding the complexity of agricultural-based exemptions, the ambiguity in state tax regulations, the number of ongoing audits and the length of time required to settle with the state taxing authorities. | We have not made any material changes to our sales tax audit assessment methodology in the financial periods presented. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate the sales tax liability reserve. However, if our estimates regarding the ultimate sales tax liability are inaccurate, we may be exposed to losses or gains that could be material. A 10% change in our sales tax audit reserve at December 28, 2013, would have affected net income by approximately $0.6 million in fiscal 2013. |
| Description | Judgments and Uncertainties | Effect if Actual Results Differ From Assumptions | ||
| Tax Contingencies: | ||||
| Our income tax returns are periodically audited by U.S. federal and state tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any time, multiple tax years are subject to audit by the various tax authorities. In evaluating the exposures associated with our various tax filing positions, we record a liability for uncertain tax positions taken or expected to be taken in a tax return. A number of years may elapse before a particular matter, for which we have established a reserve, is audited and fully resolved or clarified. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We adjust our tax contingencies reserve and income tax provision in the period in which actual results of a settlement with tax authorities differs from our established reserve, the statute of limitations expires for the relevant tax authority to examine the tax position or when more information becomes available. | Our tax contingencies reserve contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various filing positions and whether or not the minimum requirements for recognition of tax benefits have been met. | We have not made any material changes in the accounting methodology used to establish our tax contingencies in the financial periods presented. We do not believe there is a reasonable likelihood that there will be a material change in the reserves established for tax benefits not recognized. Although management believes that the judgments and estimates discussed herein are reasonable, actual results could differ, and we may be exposed to losses or gains that could be material. To the extent we prevail in matters for which reserves have been established, or are required to pay amounts in excess of our reserves, our effective income tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement would require use of our cash and would result in an increase in our effective income tax rate in the period of resolution. A favorable tax settlement would be recognized as a reduction in our effective income tax rate in the period of resolution. A 10% change in our uncertain tax position reserve at December 28, 2013 would have affected net income by approximately $0.2 million in fiscal 2013. |
| Description | Judgments and Uncertainties | Effect if Actual Results Differ From Assumptions | ||
| Impairment of Long-Lived Assets: | ||||
| Long-lived assets other than goodwill and indefinite-lived intangible assets, which are separately tested for impairment, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. When evaluating long-lived assets for potential impairment, we first compare the carrying value of the asset to the asset’s estimated future cash flows (undiscounted and without interest charges). The evaluation for long-lived assets is performed at the lowest level of identifiable cash flows, which is generally the individual store level. The significant assumptions used to determine estimated undiscounted cash flows include cash inflows and outflows directly resulting from the use of those assets in operations, including margin on net sales, payroll and related items, occupancy costs, insurance allocations and other costs to operate a store. If the estimated future cash flows are less than the carrying value of the asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the asset to the asset’s estimated fair value, which may be based on an estimated future cash flow model. We recognize an impairment loss if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If we recognize an impairment loss, the adjusted carrying amount of the asset becomes its new cost basis. For a depreciable long-lived asset, the new cost basis will be depreciated (amortized) over the remaining estimated useful life of that asset. | Our impairment loss calculations contain uncertainties because they require management to make assumptions and to apply judgment to estimate future cash flows and asset fair values, including forecasting useful lives of the assets and selecting the discount rate that reflects the risk inherent in future cash flows. | We have not made any material changes in our impairment loss assessment methodology in the financial periods presented. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate long-lived asset impairment losses. None of these estimates and assumptions are significantly sensitive, and a 10% change in any of these estimates would not have a material impact on our analysis. However, if actual results are not consistent with our estimates and assumptions used in estimating future cash flows and asset fair values, we may be exposed to losses that could be material. |
Quarterly Financial Data
Our unaudited quarterly operating results for each fiscal quarter of 2013 and 2012 are shown below (in thousands, except per share amounts):
| 2013 | First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Total | |||||||||||||||
| Net sales | $ | 1,085,838 | $ | 1,455,767 | $ | 1,208,090 | $ | 1,415,089 | $ | 5,164,784 | ||||||||||
| Gross margin | 352,091 | 506,140 | 415,666 | 479,712 | 1,753,609 | |||||||||||||||
| Operating income | 67,923 | 197,979 | 101,670 | 147,078 | 514,650 | |||||||||||||||
| Net income | 44,006 | 123,580 | 64,767 | 95,881 | 328,234 | |||||||||||||||
| Net income per share: (a) | ||||||||||||||||||||
| Basic | $ | 0.32 | $ | 0.89 | $ | 0.46 | $ | 0.69 | $ | 2.35 | ||||||||||
| Diluted | $ | 0.31 | $ | 0.87 | $ | 0.46 | $ | 0.68 | $ | 2.32 | ||||||||||
| Comparable store sales increase | 0.5 | % | 7.2 | % | 7.5 | % | 3.5 | % | 4.8 | % |
| 2012 | First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Total | |||||||||||||||
| Net sales | $ | 1,020,417 | $ | 1,291,899 | $ | 1,065,638 | $ | 1,286,166 | $ | 4,664,120 | ||||||||||
| Gross margin | 332,800 | 451,461 | 357,171 | 424,622 | 1,566,054 | |||||||||||||||
| Operating income | 64,393 | 169,844 | 77,779 | 124,776 | 436,792 | |||||||||||||||
| Net income | 40,328 | 106,621 | 50,021 | 79,487 | 276,457 | |||||||||||||||
| Net income per share: (a) | ||||||||||||||||||||
| Basic | $ | 0.28 | $ | 0.74 | $ | 0.35 | $ | 0.57 | $ | 1.94 | ||||||||||
| Diluted | $ | 0.27 | $ | 0.73 | $ | 0.35 | $ | 0.55 | $ | 1.90 | ||||||||||
| Comparable store sales increase | 11.5 | % | 3.2 | % | 2.9 | % | 4.7 | % | 5.3 | % |
(a) Due to the nature of interim net income per share calculations, the sum of quarterly net income per share amounts may not equal the reported net income per share for the year. All net income per share amounts except the third quarter and fourth quarter of fiscal 2013 have been split adjusted.
Results of Operations
Our fiscal year includes 52 or 53 weeks and ends on the last Saturday of the calendar year. References to fiscal year mean the year in which that fiscal year ended. The fiscal years ended December 28, 2013 and December 29, 2012 consisted of 52 weeks and the fiscal year ended December 31, 2011 consisted of 53 weeks.
The following table sets forth, for the periods indicated, certain items in our Consolidated Statements of Income expressed as a percentage of net sales.
| 2013 | 2012 | 2011 | ||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | ||
| Cost of merchandise sold (a) | 66.0 | 66.4 | 66.8 | |||||
| Gross margin (a) | 34.0 | 33.6 | 33.2 | |||||
| Selling, general and administrative expenses(a) | 22.1 | 22.3 | 23.0 | |||||
| Depreciation and amortization | 1.9 | 1.9 | 1.9 | |||||
| Income before income taxes | 10.0 | 9.4 | 8.3 | |||||
| Income tax provision | 3.6 | 3.4 | 3.0 | |||||
| Net income | 6.4 | % | 6.0 | % | 5.3 | % |
(a) Our gross margin amounts may not be comparable to those of other retailers since some retailers include all of the costs related to their distribution network in cost of merchandise sold and others (like the Company) exclude a portion of these distribution network costs from gross margin and instead include them in selling, general and administrative (“SG&A”) expenses; refer to Note 1 – Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included in Item 8 Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Fiscal 2013 Compared to Fiscal 2012
Net sales increased 10.7% to $5.16 billion in fiscal 2013 from $4.66 billion in fiscal 2012. Comparable store sales for fiscal 2013 were $4.89 billion, a 4.8% increase over fiscal 2012. This compares to a 5.3% comparable store sales increase in the prior year. The comparable store transaction count increased 4.7%, while comparable store average ticket remained flat for fiscal 2013, principally as a result of big ticket sales being less of the sales mix. Comparable store sales are calculated based on the change in net sales of stores open at least one year and exclude certain adjustments to net sales.
The comparable store sales increase was driven by continued strong results in key consumable, usable, edible (C.U.E.) products, principally animal- and pet-related merchandise. This was a result of continued investment in C.U.E. inventory, expanded product assortments and improved localized product offerings. Winter seasonal merchandise, predominantly heating and insulated outerwear, also performed well during the first part of the year and the end of the year due to the colder than average weather. We also estimate that comparable store sales were favorably impacted by approximately 70 basis points due to inflation, principally in pet food and livestock feed.
In addition to comparable store sales growth in fiscal 2013, sales from new stores and stores opened less than one year were $281.2 million in fiscal 2013, which represented 6.0 percentage points of the 10.7% increase over fiscal 2012 net sales. Sales from stores opened less than one year were $276.2 million in fiscal 2012, which represented 6.5 percentage points of the 10.2% increase over fiscal 2011 net sales.
The following chart summarizes our store growth during fiscal 2013 and 2012:
| 2013 | 2012 | ||||
| Store Count, Beginning of Period | 1,176 | 1,085 | |||
| New Stores Opened | 102 | 93 | |||
| Stores Closed | (2 | ) | (2 | ) | |
| Store Count, End of Period | 1,276 | 1,176 | |||
| Stores Relocated | 3 | 1 |
The following chart indicates the percentage of sales represented by each of our major product categories during fiscal 2013 and 2012:
| Percent of Sales | |||||
| Product Category: | 2013 | 2012 | |||
| Livestock and Pet | 43 | % | 42 | % | |
| Hardware, Tools,Truck and Towing | 23 | 23 | |||
| Seasonal, Gift and Toy Products | 20 | 20 | |||
| Clothing and Footwear | 9 | 9 | |||
| Agriculture | 5 | 6 | |||
| Total | 100 | % | 100 | % |
Gross profit increased 12.0% to $1.75 billion in fiscal 2013 compared to $1.57 billion in fiscal 2012. As a percent of sales, gross margin increased 40 basis points to 34.0% for fiscal 2013 compared to 33.6% for fiscal 2012. This improvement in gross margin reflects improved direct product margin. Direct product margin increased as a result of continued progress on our four strategic margin initiatives which include inventory and markdown management, strategic sourcing, exclusive branding and retail price management.
As a percent of sales, SG&A expenses, including depreciation and amortization, improved 20 basis points to 24.0% in fiscal 2013 from 24.2% in fiscal 2012. The SG&A improvement as a percent of sales was primarily attributable to the leverage of continued solid comparable store sales growth, expense control related to store operating costs and lower year-over-year incentive compensation expense, partially offset by costs related to the new and expanded Southeast distribution center and relocation of our corporate data center. Total SG&A expenses for fiscal 2013 increased 9.7% to $1.24 billion from $1.13 billion in fiscal 2012. The increase in SG&A primarily reflects new store growth and variable costs associated with our comparable store sales growth as well as operating costs relating to our new and expanded Southeast distribution center and corporate data center.
Our effective tax rate decreased to 36.2% for fiscal 2013 compared to 36.6% in fiscal 2012. The reduction in the tax rate resulted primarily from the favorable impact of the reversal of various reserves for uncertain tax positions.
As a result of the foregoing factors, net income for fiscal 2013 increased 18.7% to $328.2 million, or $2.32 per diluted share, as compared to net income of $276.5 million, or $1.90 per diluted share, in fiscal 2012.
During fiscal 2013, we repurchased approximately 2.3 million shares of the Company's common stock at a total cost of $129.4 million as part of our previously announced $1 billion share repurchase program. In fiscal 2012, we repurchased approximately 6.1 million shares at a total cost of $271.8 million.
Fiscal 2012 Compared to Fiscal 2011
Net sales increased 10.2% to $4.66 billion in fiscal 2012 from $4.23 billion in fiscal 2011. Fiscal 2012 included one less sales week compared to fiscal 2011 as a part of the Company's 53-week calendar in fiscal 2011. Adjusting for the impact of the extra sales week in fiscal 2011, our fiscal 2012 net sales increase was 11.6%. Comparable store sales for fiscal 2012 were $4.39 billion, a 5.3% increase over fiscal 2011. This compares to an 8.2% comparable store sales increase in the prior year. The comparable store transaction count increased 3.0%, while comparable store average ticket increased 2.0% for fiscal 2012.
The comparable store sales increase was driven by continued strong results in C.U.E. products, principally animal and pet-related merchandise. We estimate that comparable store sales were favorably impacted by approximately 250 basis points due to inflation, principally in key C.U.E. categories.
In addition to comparable store sales growth in fiscal 2012, sales from new stores and stores opened less than one year were $276.2 million in fiscal 2012, which represented 6.5 percentage points of the 10.2% increase over fiscal 2011 net sales. Sales from stores opened less than one year were $237.5 million in fiscal 2011, which represented 6.4 percentage points of the 16.3% increase over fiscal 2010 net sales.
The following chart summarizes our store growth during fiscal 2012 and 2011:
| 2012 | 2011 | ||||
| Store Count, Beginning of Period | 1,085 | 1,001 | |||
| New Stores Opened | 93 | 85 | |||
| Stores Closed | (2 | ) | (1 | ) | |
| Store Count, End of Period | 1,176 | 1,085 | |||
| Stores Relocated | 1 | 3 |
The following chart indicates the percentage of sales represented by each of our major product categories during fiscal 2012 and 2011:
| Percent of Sales | |||||
| Product Category: | 2012 | 2011 | |||
| Livestock and Pet | 42 | % | 40 | % | |
| Hardware, Tools, Truck and Towing | 23 | 23 | |||
| Seasonal, Gift and Toy Products | 20 | 21 | |||
| Clothing and Footwear | 9 | 10 | |||
| Agriculture | 6 | 6 | |||
| Total | 100 | % | 100 | % |
Gross profit increased 11.3% to $1.57 billion in fiscal 2012 compared to $1.41 billion in fiscal 2011. As a percent of sales, gross margin increased 40 basis points to 33.6% for fiscal 2012 compared to 33.2% for fiscal 2011. These changes reflect improved direct product margin, partially offset by increased transportation costs. Direct product margin increased as we continued to make progress on our four strategic margin initiatives which include inventory and markdown management, strategic sourcing, exclusive branding and price optimization. Transportation costs increased primarily as a result of higher fuel costs, coupled with the continued mix shift to more freight-intensive C.U.E. products.
As a percent of sales, SG&A expenses, including depreciation and amortization, improved 70 basis points to 24.2% in fiscal 2012 from 24.9% in fiscal 2011. This improvement was primarily attributable to the leverage of continued strong comparable store sales, expense control related to store operating costs and lower year-over-year incentive compensation expense. Total SG&A expenses for fiscal 2012 increased 7.1% to $1.13 billion from $1.05 billion in fiscal 2011. The increase in SG&A primarily reflects new store growth as well as operating costs relating to our Franklin, Kentucky distribution center, which became operational in the fourth quarter of fiscal 2011, offset in part by the favorable impact of one less week in fiscal 2012 compared to fiscal 2011, as part of the Company's 53-week calendar in the prior year.
Our effective tax rate increased to 36.6% for fiscal 2012 compared to 36.5% in fiscal 2011. The change in the effective tax rate was principally due to a reduction in the benefit provided by certain federal tax credits during fiscal 2012 compared to fiscal 2011.
As a result of the foregoing factors, net income for fiscal 2012 increased 24.1% to $276.5 million, or $1.90 per diluted share, as compared to net income of $222.7 million, or $1.51 per diluted share, in fiscal 2011.
During fiscal 2012, we repurchased approximately 6.1 million shares of the Company's common stock at a total cost of $271.8 million as part of our previously announced $1 billion share repurchase program. In fiscal 2011, we repurchased approximately 6.2 million shares at a total cost of $180.0 million.
Liquidity and Capital Resources
In addition to normal operating expenses, our primary ongoing cash requirements are for new store expansion, remodeling and relocation programs, distribution center and store support center capacity and improvements, information technology, inventory purchases, share repurchases and cash dividends. Our primary ongoing sources of liquidity are existing cash balances, funds provided from operations, borrowings available under our Senior Credit Facility, capital and operating leases and normal trade credit. Our inventory and accounts payable levels typically build in the first and third fiscal quarters to support the higher sales volume of the spring and cold-weather selling seasons, respectively.
Working Capital
At December 28, 2013, the Company had working capital of $677.1 million, which increased $107.6 million from December 29, 2012. The shifts in working capital were attributable to changes in the following components of current assets and current liabilities (in millions):
| 2013 | 2012 | Variance | |||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 142.7 | $ | 138.6 | $ | 4.1 | |||||
| Restricted cash | — | 8.4 | (8.4 | ) | |||||||
| Inventories | 979.3 | 908.1 | 71.2 | ||||||||
| Prepaid expenses and other current assets | 57.4 | 51.8 | 5.6 | ||||||||
| Deferred income taxes | 29.8 | 23.1 | 6.7 | ||||||||
| Total current assets | 1,209.2 | 1,130.0 | 79.2 | ||||||||
| Current liabilities: | |||||||||||
| Accounts payable | 316.5 | 320.4 | (3.9 | ) | |||||||
| Accrued employee compensation | 50.6 | 48.4 | 2.2 | ||||||||
| Other accrued expenses | 155.6 | 148.3 | 7.3 | ||||||||
| Income taxes payable | 9.4 | 43.4 | (34.0 | ) | |||||||
| Total current liabilities | 532.1 | 560.5 | (28.4 | ) | |||||||
| Working capital | $ | 677.1 | $ | 569.5 | $ | 107.6 |
In comparison to December 29, 2012, working capital as of December 28, 2013 was impacted most significantly by changes in our inventory and income taxes payable.
| • | We actively manage our inventory balances and in-stock levels at our stores. The increase in inventory was primarily due to new store growth. Average inventory per store decreased 0.5% compared to the prior year. |
| • | The timing of receipt of seasonal goods was much earlier in the fourth quarter in the current year and imports made up a larger percentage of fourth quarter receipts, requiring payment on trade credit prior to year end. These factors drove the decline in accounts payable. |
| • | Income taxes payable decreased due to timing of estimated tax payments, as a result of changes in allowable deductions for depreciation expense. |
Borrowings and Credit Facilities
The Senior Credit Facility provides for borrowings of up to $250 million (with a sub-limit of $20 million for swing-line loans). The Senior Credit Facility has an Increase Option for $150 million (subject to additional lender group commitments). This agreement is unsecured and matures in October 2016, with proceeds available to be used for working capital, capital expenditures, dividends, share repurchases and other matters.
At December 28, 2013 and December 29, 2012, there were no outstanding borrowings under the Senior Credit Facility. There were $38.2 million and $51.4 million outstanding letters of credit under the Senior Credit Facility as of December 28, 2013 and December 29, 2012, respectively. Borrowings bear interest at either the bank’s base rate (3.25% at December 28, 2013) or the London Inter-Bank Offer Rate (“LIBOR”) (0.16% at December 28, 2013) plus an additional amount ranging from 0.40% to 1.00% per annum (0.50% at December 28, 2013), adjusted quarterly based on our leverage ratio. We are also required to pay, quarterly in arrears, a commitment fee for unused capacity ranging from 0.08% to 0.20% per annum (0.10% at December 28, 2013), adjusted quarterly based on our leverage ratio. There are no compensating balance requirements associated with the Senior Credit Facility.
The Senior Credit Facility requires quarterly compliance with respect to two material covenants: a fixed charge coverage ratio and a leverage ratio. The fixed charge coverage ratio compares earnings before interest, taxes, depreciation, amortization, stock compensation and rent expense (“consolidated EBITDAR”) to the sum of interest paid and rental expense (excluding any straight-line rent adjustments). The leverage ratio compares total debt plus rental expense (excluding any straight-line rent adjustments) multiplied by a factor of six to consolidated EBITDAR. The Senior Credit Facility also contains certain other restrictions regarding additional indebtedness, capital expenditures, business operations, guarantees, investments, mergers, consolidations and sales of assets, transactions with subsidiaries or affiliates, and liens. We were in compliance with all covenants at December 28, 2013.
Sources and Uses of Cash
Our primary source of liquidity is cash provided by operations. Principal uses of cash for investing activities are capital expenditures, while uses of cash for financing activities are repurchase of the Company’s common stock and cash dividends paid to stockholders. The following table presents a summary of cash flows from operating, investing and financing activities for the last three fiscal years (in millions):
| 2013 | 2012 | 2011 | |||||||||
| Net cash provided by operating activities | $ | 333.7 | $ | 378.3 | $ | 254.1 | |||||
| Net cash used in investing activities | (209.3 | ) | (139.1 | ) | (171.3 | ) | |||||
| Net cash used in financing activities | (120.3 | ) | (277.5 | ) | (163.2 | ) | |||||
| Net increase (decrease) in cash and cash equivalents | $ | 4.1 | $ | (38.3 | ) | $ | (80.4 | ) |
Operating Activities
Operating activities provided net cash of $333.7 million, $378.3 million and $254.1 million in fiscal 2013, 2012 and 2011, respectively. The $44.6 million decrease in net cash provided by operating activities in fiscal 2013 compared to fiscal 2012 was primarily due to changes in the following operating activities (in millions):
| 2013 | 2012 | Variance | |||||||||
| Net income | $ | 328.2 | $ | 276.5 | $ | 51.7 | |||||
| Depreciation and amortization | 100.0 | 89.0 | 11.0 | ||||||||
| Stock compensation expense | 13.9 | 17.6 | (3.7 | ) | |||||||
| Excess tax benefit of stock options exercised | (43.5 | ) | (25.8 | ) | (17.7 | ) | |||||
| Deferred income taxes | (8.3 | ) | (26.6 | ) | 18.3 | ||||||
| Inventories and accounts payable | (75.1 | ) | (23.3 | ) | (51.8 | ) | |||||
| Prepaid expenses and other current assets | (5.5 | ) | (0.1 | ) | (5.4 | ) | |||||
| Accrued expenses | 12.1 | 9.0 | 3.1 | ||||||||
| Income taxes payable | 9.6 | 57.3 | (47.7 | ) | |||||||
| Other, net | 2.3 | 4.7 | (2.4 | ) | |||||||
| Net cash provided by operations | $ | 333.7 | $ | 378.3 | $ | (44.6 | ) |
The $44.6 million decrease in net cash provided by operating activities in fiscal 2013 compared with fiscal 2012 primarily relates to increased inventory levels, a reduction in accounts payable and timing of estimated tax payments, partially offset by an increase in net earnings. Inventory increased in proportion to store growth as expected, but the accounts payable balance declined year over year. The timing of receipt of seasonal goods was much earlier in the fourth quarter in the current year and imports made up a larger percentage of fourth quarter receipts, requiring payment on trade credit prior to year end. These factors drove the decline in accounts payable. Income taxes payable declined due to the timing of estimated tax payments resulting from changes in allowable deductions for depreciation expense.
The $124.2 million increase in net cash provided by operations in fiscal 2012 over fiscal 2011 is primarily due to changes in the following operating activities (in millions):
| 2012 | 2011 | Variance | |||||||||
| Net income | $ | 276.5 | $ | 222.7 | $ | 53.8 | |||||
| Depreciation and amortization | 89.0 | 80.3 | 8.7 | ||||||||
| Stock compensation expense | 17.6 | 15.1 | 2.5 | ||||||||
| Excess tax benefit of stock options exercised | (25.8 | ) | (17.4 | ) | (8.4 | ) | |||||
| Deferred income taxes | (26.6 | ) | 1.9 | (28.5 | ) | ||||||
| Inventories and accounts payable | (23.3 | ) | (75.3 | ) | 52.0 | ||||||
| Prepaid expenses and other current assets | (0.1 | ) | (17.8 | ) | 17.7 | ||||||
| Accrued expenses | 9.0 | 20.0 | (11.0 | ) | |||||||
| Income taxes payable | 57.3 | 21.0 | 36.3 | ||||||||
| Other, net | 4.7 | 3.6 | 1.1 | ||||||||
| Net cash provided by operations | $ | 378.3 | $ | 254.1 | $ | 124.2 |
The change in deferred income taxes is due primarily to temporary differences related to tax law changes regarding depreciation. Inventory, net of accounts payable, increased at a lesser rate compared to prior year, as we achieved a higher increase in accounts payable relative to inventory primarily due to timing of payments. Income taxes payable increased due to higher income in the period as well as timing of estimated tax payments, as a result of changes in allowable deductions for depreciation expense.
Investing Activities
Investing activities used cash of $209.3 million, $139.1 million and $171.3 million in fiscal 2013, 2012 and 2011, respectively. The increase in cash used for investing activities primarily reflects an increase in capital expenditures slightly offset by a reduction in restricted cash. The decrease in restricted cash during fiscal 2013 and fiscal 2012 related to less cash required as collateral for an outstanding letter of credit at a financial institution outside of the Senior Credit Facility. Capital expenditures for fiscal 2013, 2012 and 2011 were as follows (in millions):
| 2013 | 2012 | 2011 | |||||||||
| New and relocated stores and stores not yet opened | $ | 69.1 | $ | 60.4 | $ | 44.9 | |||||
| Distribution center capacity and improvements | 44.9 | 16.4 | 56.3 | ||||||||
| Corporate and other | 40.7 | 13.8 | 1.8 | ||||||||
| Information technology | 29.8 | 28.2 | 12.3 | ||||||||
| Existing stores | 22.3 | 22.2 | 18.7 | ||||||||
| Purchase of previously leased stores | 11.4 | 11.9 | 32.2 | ||||||||
| Total capital expenditures | $ | 218.2 | $ | 152.9 | $ | 166.2 |
The above table reflects 102 new stores and three relocations during fiscal 2013, compared to 93 new stores and one relocation during fiscal 2012. We purchased three of our existing leased stores during fiscal 2013 compared to five existing leased stores in fiscal 2012. The capital expenditures in fiscal 2013 for distribution center capacity and improvements relate primarily to the construction of our new Macon, Georgia distribution center, which is the relocation of our former Southeast distribution center in Braselton, Georgia. The increase in corporate and other primarily reflects the construction of our new store support center in Brentwood, Tennessee.
We currently estimate that capital expenditures will range between $240 million and $250 million in fiscal 2014.
| • | We plan to open between 102 to 106 stores in fiscal 2014. |
| • | We plan to invest in our distribution center network in fiscal 2014, principally for development of a new Southwest distribution center and the ongoing rollout of a new warehouse management system in our distribution centers. |
| • | We plan to finish construction of our new store support center, which we expect to be completed by end of third quarter 2014. |
| • | We also plan to invest in information technology upgrades at our stores and store support center which will include additional multi-channel capabilities, improved inventory allocation and price optimization and continued improvements in data security. |
Financing Activities
Financing activities used cash of $120.3 million, $277.5 million, and $163.2 million in fiscal 2013, 2012 and 2011, respectively. The cash used in financing activities in fiscal 2013 was mainly the result of repurchases of common stock and quarterly cash dividends paid to stockholders, partially offset by net proceeds from issuance of common stock related to share-based compensation and excess tax benefits recognized on options exercised. The reduction in net cash used in financing activities is largely due to $142.4 million less in common stock repurchases in fiscal 2013 compared to fiscal 2012.
Our Board of Directors has authorized common stock repurchases under the share repurchase program up to $1 billion, exclusive of any fees, commissions, or other expenses related to such repurchases, through April 2015. The repurchases may be made from time to time on the open market or in privately negotiated transactions. The timing and amount of any shares repurchased under the program will depend on a variety of factors, including price, corporate and regulatory requirements, capital availability, and other market conditions. Repurchased shares are accounted for at cost and will be held in treasury for future issuance. The program may be limited or terminated at any time without prior notice.
We repurchased approximately 2.3 million, 6.1 million and 6.2 million shares of common stock under the share repurchase program at a total cost of $129.4 million, $271.8 million and $180.0 million in fiscal 2013, 2012 and 2011, respectively. As of December 28, 2013, we had remaining authorization under the share repurchase program of $161.8 million, exclusive of any fees, commissions, or other expenses.
In the second quarter of fiscal 2013, we increased our quarterly dividend from $0.10 per share to $0.13 per share and, in the second quarter of fiscal 2012, we increased our quarterly dividend from $0.06 per share to $0.10 per share. We paid dividends totaling $68.5 million, $51.3 million and $30.9 million in fiscal 2013, 2012 and 2011, respectively.
We believe that our existing cash balances, expected cash flow from future operations, borrowings available under the Senior Credit Facility, operating and capital leases and normal trade credit will be sufficient to fund our operations and our capital expenditure needs, including new store openings, store acquisitions, relocations and renovations, new store support center and distribution center capacity, through the end of fiscal 2014.
Significant Contractual Obligations and Commercial Commitments
The following table reflects our future obligations and commitments as of December 28, 2013 (in thousands):
| Payment Due by Period | ||||||||||||||||||||
| Total | 2014 | 2015-2016 | 2017-2018 | Thereafter | ||||||||||||||||
| Operating leases | $ | 1,855,318 | $ | 220,389 | $ | 414,548 | $ | 369,303 | $ | 851,078 | ||||||||||
| Capital leases(a) | 2,218 | 146 | 292 | 292 | 1,488 | |||||||||||||||
| Construction commitments (b) | 27,893 | 27,893 | — | — | — | |||||||||||||||
| $ | 1,885,429 | $ | 248,428 | $ | 414,840 | $ | 369,595 | $ | 852,566 |
(a) Capital lease obligations include related interest.
(b) Reflects $6.0 million for the land and construction of stores expected to be opened in fiscal 2014, and $22.0 million for the construction of our new store support center.
At December 28, 2013, there were $38.2 million outstanding letters of credit under the Senior Credit Facility and an $18.3 million outstanding letter of credit at a financial institution outside of the Senior Credit Facility.
Effective April 1, 2013, the outstanding letter of credit at the financial institution outside of the Senior Credit Facility increased from $8.4 million to $18.3 million, and the restriction on $8.4 million in restricted cash lapsed.
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements are limited to operating leases and outstanding letters of credit. The balances for these arrangements are previously discussed. We typically lease buildings for retail stores and offices rather than acquiring these assets which allows us to utilize financial capital to operate the business rather than invest in fixed assets. Letters of credit allow us to purchase inventory, primarily sourced overseas, in a timely manner and support certain risk management programs.
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