filings.toolsItem 8. Financial Statements and Supplementary Data
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Item 8. Financial Statements and Supplementary Data
INDEX
TRACTOR SUPPLY COMPANY
| Page | |
| Management's Report on Internal Control over Financial Reporting | 36 |
| Reports of Independent Registered Public Accounting Firm | 37 |
| Consolidated Statements of Income for the fiscal years ended December 26, 2015, December 27, 2014, and December 28, 2013 | 39 |
| Consolidated Balance Sheets as of December 26, 2015 and December 27, 2014 | 40 |
| Consolidated Statements of Stockholders’ Equity for the fiscal years ended December 26, 2015, December 27, 2014, and December 28, 2013 | 41 |
| Consolidated Statements of Cash Flows for the fiscal years ended December 26, 2015, December 27, 2014, and December 28, 2013 | 42 |
| Notes to Consolidated Financial Statements | 43 |
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) under the Securities Exchange Act of 1934, as amended). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 26, 2015. In making this assessment, management used the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Based on this assessment, management believes that, as of December 26, 2015, the Company’s internal control over financial reporting is effective based on those criteria.
Ernst & Young LLP, the independent registered public accounting firm which also audited the Company’s consolidated financial statements, has issued a report on the Company’s internal control over financial reporting, which is included herein.
| /s/ Gregory A. Sandfort | /s/ Anthony F. Crudele | |||
| Gregory A. Sandfort President and Chief Executive Officer | Anthony F. Crudele Executive Vice President - Chief Financial Officer and Treasurer | |||
| February 22, 2016 | February 22, 2016 |
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Tractor Supply Company
We have audited Tractor Supply Company’s internal control over financial reporting as of December 26, 2015, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Tractor Supply Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Tractor Supply Company maintained, in all material respects, effective internal control over financial reporting as of December 26, 2015, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Tractor Supply Company as of December 26, 2015 and December 27, 2014, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three fiscal years in the period ended December 26, 2015, and our report dated February 22, 2016, expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Nashville, Tennessee
February 22, 2016
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Tractor Supply Company
We have audited the accompanying consolidated balance sheets of Tractor Supply Company as of December 26, 2015 and December 27, 2014, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three fiscal years in the period ended December 26, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tractor Supply Company at December 26, 2015 and December 27, 2014, and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended December 26, 2015, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Tractor Supply Company’s internal control over financial reporting as of December 26, 2015, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 22, 2016, expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Nashville, Tennessee
February 22, 2016
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
| Fiscal Year | |||||||||||
| 2015 | 2014 | 2013 | |||||||||
| Net sales | $ | 6,226,507 | $ | 5,711,715 | $ | 5,164,784 | |||||
| Cost of merchandise sold | 4,083,333 | 3,761,300 | 3,411,175 | ||||||||
| Gross profit | 2,143,174 | 1,950,415 | 1,753,609 | ||||||||
| Selling, general and administrative expenses | 1,369,097 | 1,246,308 | 1,138,934 | ||||||||
| Depreciation and amortization | 123,569 | 114,635 | 100,025 | ||||||||
| Operating income | 650,508 | 589,472 | 514,650 | ||||||||
| Interest expense, net | 2,891 | 1,885 | 557 | ||||||||
| Income before income taxes | 647,617 | 587,587 | 514,093 | ||||||||
| Income tax expense | 237,222 | 216,702 | 185,859 | ||||||||
| Net income | $ | 410,395 | $ | 370,885 | $ | 328,234 | |||||
| Net income per share – basic | $ | 3.03 | $ | 2.69 | $ | 2.35 | |||||
| Net income per share – diluted | $ | 3.00 | $ | 2.66 | $ | 2.32 | |||||
| Weighted average shares outstanding | |||||||||||
| Basic | 135,582 | 137,769 | 139,415 | ||||||||
| Diluted | 136,845 | 139,435 | 141,723 | ||||||||
| Dividends declared per common share outstanding | $ | 0.76 | $ | 0.61 | $ | 0.49 |
The accompanying notes are an integral part of these consolidated financial statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
| December 26, 2015 | December 27, 2014 | ||||||
| ASSETS | |||||||
| Current assets: | |||||||
| Cash and cash equivalents | $ | 63,813 | $ | 51,134 | |||
| Inventories | 1,284,375 | 1,115,450 | |||||
| Prepaid expenses and other current assets | 87,510 | 66,444 | |||||
| Income taxes receivable | 3,763 | — | |||||
| Deferred income taxes | 45,970 | 40,962 | |||||
| Total current assets | 1,485,431 | 1,273,990 | |||||
| Property and equipment: | |||||||
| Land | 86,991 | 79,571 | |||||
| Buildings and improvements | 814,802 | 698,462 | |||||
| Furniture, fixtures and equipment | 523,383 | 453,692 | |||||
| Computer software and hardware | 180,020 | 154,818 | |||||
| Construction in progress | 38,720 | 30,803 | |||||
| Property and equipment, gross | 1,643,916 | 1,417,346 | |||||
| Accumulated depreciation and amortization | (796,340 | ) | (696,346 | ) | |||
| Property and equipment, net | 847,576 | 721,000 | |||||
| Goodwill | 10,258 | 10,258 | |||||
| Deferred income taxes | 9,224 | 8,782 | |||||
| Other assets | 18,337 | 20,541 | |||||
| Total assets | $ | 2,370,826 | $ | 2,034,571 | |||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
| Current liabilities: | |||||||
| Accounts payable | $ | 427,249 | $ | 370,823 | |||
| Accrued employee compensation | 42,684 | 37,056 | |||||
| Other accrued expenses | 195,024 | 182,565 | |||||
| Current portion of capital lease obligations | 878 | 213 | |||||
| Income taxes payable | 5,449 | 12,436 | |||||
| Total current liabilities | 671,284 | 603,093 | |||||
| Revolving credit loan | 150,000 | — | |||||
| Capital lease obligations, less current maturities | 16,992 | 4,957 | |||||
| Deferred rent | 84,793 | 79,807 | |||||
| Other long-term liabilities | 54,463 | 53,153 | |||||
| Total liabilities | 977,532 | 741,010 | |||||
| Stockholders’ equity: | |||||||
| Preferred Stock, $1.00 par value; 40 shares authorized; no shares issued | — | — | |||||
| Common Stock, $0.008 par value; 400,000 shares authorized at December 26, 2015 and December 27, 2014; 168,974 shares issued and 134,224 shares outstanding at December 26, 2015 and 167,716 shares issued and 136,382 shares outstanding at December 27, 2014 | 1,352 | 1,342 | |||||
| Additional paid-in capital | 596,131 | 510,997 | |||||
| Treasury stock, at cost, 34,750 shares at December 26, 2015 and 31,334 shares at December 27, 2014 | (1,429,790 | ) | (1,137,085 | ) | |||
| Retained earnings | 2,225,601 | 1,918,307 | |||||
| Total stockholders’ equity | 1,393,294 | 1,293,561 | |||||
| Total liabilities and stockholders’ equity | $ | 2,370,826 | $ | 2,034,571 |
The accompanying notes are an integral part of these consolidated financial statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands)
| Common Stock | Additional Paid-in Capital | Treasury Stock | Retained Earnings | Total Stockholders’ Equity | |||||||||||||||
| Stockholders' equity at December 29, 2012 | $ | 1,307 | $ | 361,106 | $ | (709,172 | ) | $ | 1,371,733 | $ | 1,024,974 | ||||||||
| Issuance of common stock under employee stock purchase plan (87 shares) | 1 | 3,595 | 3,596 | ||||||||||||||||
| Exercise of stock options (2,681 shares) and restricted stock units (166 shares) | 23 | 34,699 | 34,722 | ||||||||||||||||
| Stock compensation | 13,893 | 13,893 | |||||||||||||||||
| Tax benefit of stock options exercised | 43,517 | 43,517 | |||||||||||||||||
| Repurchase of shares to satisfy tax obligations | (4,142 | ) | (4,142 | ) | |||||||||||||||
| Repurchase of common stock (2,287 shares) | (129,416 | ) | (129,416 | ) | |||||||||||||||
| Dividends paid | (68,484 | ) | (68,484 | ) | |||||||||||||||
| Net income | 328,234 | 328,234 | |||||||||||||||||
| Stockholders' equity at December 28, 2013 | 1,331 | 452,668 | (838,588 | ) | 1,631,483 | 1,246,894 | |||||||||||||
| Issuance of common stock under employee stock purchase plan (79 shares) | 1 | 4,326 | 4,327 | ||||||||||||||||
| Exercise of stock options (1,179 shares) and restricted stock units (135 shares) | 10 | 23,746 | 23,756 | ||||||||||||||||
| Stock compensation | 16,173 | 16,173 | |||||||||||||||||
| Tax benefit of stock options exercised | 18,850 | 18,850 | |||||||||||||||||
| Repurchase of shares to satisfy tax obligations | (4,766 | ) | (4,766 | ) | |||||||||||||||
| Repurchase of common stock (4,664 shares) | (298,497 | ) | (298,497 | ) | |||||||||||||||
| Dividends paid | (84,061 | ) | (84,061 | ) | |||||||||||||||
| Net income | 370,885 | 370,885 | |||||||||||||||||
| Stockholders' equity at December 27, 2014 | 1,342 | 510,997 | (1,137,085 | ) | 1,918,307 | 1,293,561 | |||||||||||||
| Issuance of common stock under employee stock purchase plan (68 shares) | 1 | 4,709 | 4,710 | ||||||||||||||||
| Exercise of stock options (1,117 shares) and restricted stock units (72 shares) | 9 | 36,970 | 36,979 | ||||||||||||||||
| Stock compensation | 19,420 | 19,420 | |||||||||||||||||
| Tax benefit of stock options exercised | 27,032 | 27,032 | |||||||||||||||||
| Repurchase of shares to satisfy tax obligations | (2,997 | ) | (2,997 | ) | |||||||||||||||
| Repurchase of common stock (3,416 shares) | (292,705 | ) | (292,705 | ) | |||||||||||||||
| Dividends paid | (103,101 | ) | (103,101 | ) | |||||||||||||||
| Net income | 410,395 | 410,395 | |||||||||||||||||
| Stockholders' equity at December 26, 2015 | $ | 1,352 | $ | 596,131 | $ | (1,429,790 | ) | $ | 2,225,601 | $ | 1,393,294 |
The accompanying notes are an integral part of these consolidated financial statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| Fiscal Year | ||||||||||||
| 2015 | 2014 | 2013 | ||||||||||
| Cash flows from operating activities: | ||||||||||||
| Net income | $ | 410,395 | $ | 370,885 | $ | 328,234 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Depreciation and amortization | 123,569 | 114,635 | 100,025 | |||||||||
| Loss on disposition of property and equipment | 315 | 389 | 35 | |||||||||
| Share-based compensation expense | 19,420 | 16,173 | 13,893 | |||||||||
| Excess tax benefit of stock options exercised | (27,032 | ) | (18,850 | ) | (43,517 | ) | ||||||
| Deferred income taxes | (5,450 | ) | (19,814 | ) | (8,309 | ) | ||||||
| Change in assets and liabilities: | ||||||||||||
| Inventories | (168,925 | ) | (136,142 | ) | (71,192 | ) | ||||||
| Prepaid expenses and other current assets | (21,066 | ) | (9,085 | ) | (5,551 | ) | ||||||
| Accounts payable | 56,426 | 54,336 | (3,905 | ) | ||||||||
| Accrued employee compensation | 5,628 | (13,517 | ) | 2,173 | ||||||||
| Other accrued expenses | 11,252 | 20,365 | 9,938 | |||||||||
| Income taxes | 16,282 | 21,862 | 9,582 | |||||||||
| Other | 8,366 | 7,941 | 2,275 | |||||||||
| Net cash provided by operating activities | 429,180 | 409,178 | — | 333,681 | ||||||||
| Cash flows from investing activities: | ||||||||||||
| Capital expenditures | (236,496 | ) | (160,613 | ) | (218,200 | ) | ||||||
| Proceeds from sale of property and equipment | 584 | 331 | 477 | |||||||||
| Decrease in restricted cash | — | — | 8,400 | |||||||||
| Net cash used in investing activities | (235,912 | ) | (160,282 | ) | (209,323 | ) | ||||||
| Cash flows from financing activities: | ||||||||||||
| Borrowings under revolving credit agreement | 680,000 | 355,000 | 185,000 | |||||||||
| Repayments under revolving credit agreement | (530,000 | ) | (355,000 | ) | (185,000 | ) | ||||||
| Excess tax benefit of stock options exercised | 27,032 | 18,850 | 43,517 | |||||||||
| Principal payments under capital lease obligations | (507 | ) | (114 | ) | (38 | ) | ||||||
| Repurchase of shares to satisfy tax obligations | (2,997 | ) | (4,766 | ) | (4,142 | ) | ||||||
| Repurchase of common stock | (292,705 | ) | (298,497 | ) | (129,416 | ) | ||||||
| Net proceeds from issuance of common stock | 41,689 | 28,083 | 38,318 | |||||||||
| Cash dividends paid to stockholders | (103,101 | ) | (84,061 | ) | (68,484 | ) | ||||||
| Net cash used in financing activities | (180,589 | ) | (340,505 | ) | (120,245 | ) | ||||||
| Net change in cash and cash equivalents | 12,679 | (91,609 | ) | 4,113 | ||||||||
| Cash and cash equivalents at beginning of year | 51,134 | 142,743 | 138,630 | |||||||||
| Cash and cash equivalents at end of year | $ | 63,813 | $ | 51,134 | $ | 142,743 | ||||||
| Supplemental disclosures of cash flow information: | ||||||||||||
| Cash paid during the year for: | ||||||||||||
| Interest | $ | 2,283 | $ | 906 | $ | 780 | ||||||
| Income taxes | 226,968 | 213,637 | 188,003 | |||||||||
| Supplemental disclosures of non-cash activities: | ||||||||||||
| Property and equipment acquired through capital lease | $ | 13,207 | $ | 4,042 | $ | — | ||||||
| Non-cash accruals for construction in progress | 16,050 | 14,843 | 8,258 |
The accompanying notes are an integral part of these consolidated financial statements.
TRACTOR SUPPLY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 – Significant Accounting Policies:
Nature of Business
Tractor Supply Company is the largest operator of rural lifestyle retail stores in the United States. The Company is focused on supplying the needs of recreational farmers and ranchers and those who enjoy the rural lifestyle, as well as tradesmen and small businesses. Stores are located primarily in towns outlying major metropolitan markets and in rural communities. At December 26, 2015, the Company operated a total of 1,488 retail stores in 49 states and also offered a number of products online at TractorSupply.com.
Fiscal Year
The Company’s fiscal year includes 52 or 53 weeks and ends on the last Saturday of the calendar year. The fiscal years ended December 26, 2015, December 27, 2014, and December 28, 2013 consisted of 52 weeks.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts and transactions have been eliminated.
Management Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States inherently requires estimates and assumptions by management of the Company that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosures. Actual results could differ from those estimates.
Significant estimates and assumptions by management primarily impact the following key financial statement areas:
Inventory Valuation
Inventory Impairment Risk
The Company identifies 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 Company has established an inventory valuation reserve to recognize the estimated impairment in value (i.e. an inability to realize the full carrying value) based on the Company’s aggregate assessment of these valuation indicators under prevailing market conditions and current merchandising strategies. The Company does not believe its 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.
Shrinkage
The Company performs physical inventories at each store at least once a year, and the Company has established a reserve 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. The Company believes historical rates are a reasonably accurate reflection of future trends.
Vendor Funding
The Company receives funding from substantially all of its significant merchandise vendors, in support of its 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 the Company’s 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 and volume rebates are estimated based upon initial commitments and anticipated purchase levels with applicable vendors. The estimated purchase volume (and related vendor funding) is based on the Company’s current knowledge of inventory levels, sales trends and expected customer demand, as well as planned new store openings and relocations. Although the Company believes it can reasonably estimate purchase volume and related volume rebates at interim periods, it is possible that actual year-end results could be different from previously estimated amounts.
Freight
The Company incurs 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.
Self-Insurance Reserves
The Company self-insures a significant portion of its employee medical insurance, workers’ compensation insurance and general liability (including product liability) insurance plans. The Company has stop-loss insurance policies to protect it from individual losses over specified dollar values. For self-insured employee medical claims, we have a stop loss limit of $300,000 per person per year. Our deductible or self-insured retention, as applicable, for each claim involving workers’ compensation insurance and general liability insurance is limited to $500,000 and our Texas Work Injury Policy is limited to $750,000. Further, we maintain a commercially reasonable umbrella/excess policy that covers liabilities in excess of the primary insurance policy limits.
The full extent of certain claims, especially workers’ compensation and general liability claims, may not become fully determined for several years. Therefore, the Company estimates potential obligations based upon historical claims experience, industry factors, severity factors and other actuarial assumptions. Although the Company believes the reserves established for these obligations are reasonably estimated, any significant change in the number of claims or costs associated with claims made under these plans could have a material effect on the Company’s financial results. At December 26, 2015, the Company had recorded net insurance reserves of $51.2 million compared to $48.3 million at December 27, 2014.
Sales Tax Audit Reserve
A portion of the Company’s sales are to tax-exempt customers, predominantly agricultural-based. The Company obtains exemption information as a necessary part of each tax-exempt transaction. Many of the states in which the Company conducts business will perform audits to verify the Company’s compliance with applicable sales tax laws. The business activities of the Company’s customers and the intended use of the unique products sold by the Company create a challenging and complex tax compliance environment. These circumstances also create some risk that the Company could be challenged as to the accuracy of the Company’s sales tax compliance.
The Company reviews past audit experience and assessments with applicable states to continually determine if it has potential exposure for non-compliance. Any estimated liability is based on an initial assessment of compliance risk and historical experience with each state. The Company continually reassesses 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. The reserve for these tax audits can fluctuate depending on numerous factors, including 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.
Tax Contingencies
The Company’s income tax returns are periodically audited by U.S. federal and state tax authorities. These audits include questions regarding 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 the Company’s various tax filing positions, the Company records 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 the Company has established a reserve, is audited and fully resolved or clarified. The Company recognizes 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. The Company adjusts its tax contingencies reserve and income tax provision in the period in which actual results of a settlement with tax authorities differs from the established reserve, the statute of limitations expires for the relevant tax authority to examine the tax position or when more information becomes available.
The Company’s tax contingencies reserve contains uncertainties because management is required to make assumptions and apply judgment to estimate the exposures associated with the Company’s various filing positions and whether or not the minimum requirements for recognition of tax benefits have been met.
The effective income tax rate is also affected by changes in tax law, the tax jurisdiction of new stores or business ventures, the level of earnings and the results of tax audits.
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, the Company first compares the carrying value of the asset to the asset’s estimated undiscounted future cash flows. 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, the Company calculates 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. The Company recognizes an impairment loss if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If the Company recognizes 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.
No significant impairment charges were recognized in fiscal 2015, 2014 and 2013. Impairment charges are included in selling, general and administrative (“SG&A”) expenses in the Consolidated Statements of Income.
Revenue Recognition and Sales Returns
The Company recognizes revenue at the time the customer takes possession of merchandise. If the Company receives payment before completion of its customer obligations (as per the Company’s special order and layaway programs), the revenue is deferred until the customer takes possession of the merchandise and the sale is complete.
The Company is required to collect certain taxes and fees from customers on behalf of government agencies and remit such collections to the applicable governmental entity on a periodic basis. These taxes are collected from customers at the time of purchase, but are not included in net sales. The Company records a liability upon collection from the customer and relieves the liability when payments are remitted to the applicable governmental agency.
The Company estimates a liability for sales returns based on a rolling average of historical return trends, and the Company believes that its estimate for sales returns is an accurate reflection of future returns associated with past sales. However, as with any estimate, refund activity may vary from estimated amounts. At December 26, 2015, the Company had a liability of $3.3 million reserved for sales returns compared to $3.2 million at December 27, 2014.
The Company recognizes revenue when a gift card or merchandise return card is redeemed by the customer and recognizes income when the likelihood of the gift card or merchandise return card being redeemed by the customer is remote (referred to as “breakage”). The gift cards and merchandise return card breakage rate is based upon historical redemption patterns and income is recognized for unredeemed gift cards and merchandise return cards in proportion to those historical redemption patterns. The Company recognized breakage income of $1.6 million, $0.9 million and $1.6 million in fiscal 2015, 2014 and 2013, respectively.
Cost of Merchandise Sold
Cost of merchandise sold includes the total cost of products sold; freight expenses associated with moving merchandise inventories from vendors to distribution facilities, from distribution facilities to retail stores, and from one distribution facility to another; vendor support; damaged, junked or defective product; cash discounts from payments to merchandise vendors; and adjustments for shrinkage (physical inventory losses), lower of cost or net realizable value, slow moving product and excess inventory quantities.
Selling, General and Administrative Expenses
SG&A expenses include payroll and benefit costs for retail, distribution facility and corporate employees; occupancy costs of retail, distribution and corporate facilities; advertising; tender costs, including bank charges and costs associated with credit and debit card interchange fees; outside service fees; and other administrative costs, such as computer maintenance, supplies, travel and lodging.
Advertising Costs
Advertising costs consist of expenses incurred in connection with newspaper circulars and customer-targeted direct mail, as well as limited television, radio and other promotions. Costs are expensed when incurred with the exception of television advertising and circular and direct mail promotions, which are expensed upon first showing. Advertising expenses for fiscal 2015, 2014 and 2013 were approximately $73.9 million, $70.4 million and $65.6 million, respectively. Prepaid advertising costs were approximately $1.6 million and $0.5 million at December 26, 2015 and December 27, 2014, respectively.
Warehousing and Distribution Facility Costs
Costs incurred at the Company’s distribution facilities for receiving, warehousing and preparing product for delivery are expensed as incurred and are included in SG&A expenses in the Consolidated Statements of Income. Because the Company does not include these costs in cost of sales, the Company’s gross margin may not be comparable to other retailers that include these costs in the calculation of gross margin. Distribution facility costs including depreciation for fiscal 2015, 2014 and 2013 were approximately $145.4 million, $121.1 million and $111.3 million, respectively.
Pre-opening Costs
Non-capital expenditures incurred in connection with opening new stores, primarily payroll and rent, are expensed as incurred. Pre-opening costs were approximately $9.6 million, $8.9 million and $7.8 million in fiscal 2015, 2014 and 2013, respectively.
Share-Based Compensation
The Company has share-based compensation plans covering certain members of management and non-employee directors, which include incentive and non-qualified stock options and restricted stock units. In addition, the Company offers an Employee Stock Purchase Plan (“ESPP”) to most employees that work at least 20 hours per week.
The Company estimates the fair value of its stock option awards at the date of grant utilizing a Black-Scholes option pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of short-term traded options that have no vesting restrictions and are fully transferable. However, key assumptions used in the Black-Scholes model are adjusted to incorporate the unique characteristics of the Company’s stock option awards. Option pricing models and generally accepted valuation techniques require management to make subjective assumptions including expected stock price volatility, expected dividend yield, risk-free interest rate and expected life. The Company relies on a blended volatility approach, weighting historical volatility trends and implied volatility, to estimate future volatility assumptions. The risk-free interest rates used were actual U.S. Treasury Constant Maturity rates for bonds matching the expected term of the option on the date of grant. The expected term of the option on the date of grant was estimated based on the Company’s historical experience for similar options.
In addition to the key assumptions used in the Black-Scholes model, the estimated forfeiture rate at the time of valuation (which is based on historical experience for similar options) is a critical assumption, as it reduces expense ratably over the vesting period. The Company adjusts this estimate periodically, based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate.
The fair value of the Company’s restricted stock unit awards is the closing price of the Company’s common stock the day preceding the grant date.
The Company believes its estimates are reasonable in the context of historical experience. Future results will depend on, among other matters, levels of share-based compensation granted in the future, actual forfeiture rates and the timing of option exercises.
Depreciation and Amortization
Depreciation includes expenses related to all retail, distribution facility and corporate assets. Amortization includes expenses related to definite-lived intangible assets.
Income Taxes
The Company uses the asset and liability method to account for income taxes whereby deferred tax assets and liabilities are determined based on differences between the financial carrying amounts of assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates and laws that are anticipated to be in effect when temporary differences reverse or are settled. The effect of a tax rate change is recognized in the period in which the law is enacted in the provision for income taxes. The Company records a valuation allowance when it is more likely than not that a deferred tax asset will not be realized.
Net Income Per Share
Basic net income per share is calculated by dividing net income by the weighted average number of shares outstanding during the period. Diluted net income per share is calculated by dividing net income by the weighted average diluted shares outstanding. Dilutive shares are computed using the treasury stock method for stock options and restricted stock units.
Comprehensive Income
The Company’s comprehensive income is equal to net income in fiscal 2015, 2014 and 2013.
Cash and Cash Equivalents
Temporary cash investments, with a maturity of three months or less when purchased, are considered to be cash equivalents. The majority of payments due from banks for customer credit cards are classified as cash and cash equivalents, as they generally settle within 24-48 hours.
Sales generated through the Company’s private label credit cards are not reflected as accounts receivable. Under an agreement with Citi Cards, a division of Citigroup, consumer and business credit is extended directly to customers by Citigroup. All credit program and related services are performed and controlled directly by Citigroup. Payments due from Citigroup are classified as cash and cash equivalents as they generally settle within 24-48 hours.
Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The Company uses a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
The Company’s financial instruments consist of cash and cash equivalents, short-term receivables, trade payables and long-term debt instruments. Due to their short-term nature, the carrying values of cash and cash equivalents, short-term receivables and trade payables approximate current fair value at each balance sheet date. The Company had $150.0 million in borrowings under the 2011 Senior Credit Facility (as defined in Note 3) at December 26, 2015 and no borrowings as of December 27, 2014. Based on current market interest rates (Level 2 inputs), the carrying value of our borrowings under the 2011 Senior Credit Facility approximates fair value as of December 26, 2015.
Inventories
Inventories are stated at the lower of cost, as determined by the average cost method, or net realizable value. Inventory cost consists of the direct cost of merchandise including freight. Inventories are net of shrinkage, obsolescence, other valuations and vendor allowances.
Property and Equipment
Property and equipment are carried at cost. Depreciation is recorded using the straight-line method over the estimated useful lives of the assets. Improvements to leased premises are amortized using the straight-line method over the initial term of the lease or the useful life of the improvement, whichever is less. Leasehold improvements added late in the lease term are amortized over the term of the lease (including the first renewal option, if the renewal is reasonably assured) or the useful life of the improvement, whichever is less. The following estimated useful lives are generally applied:
| Life | |
| Buildings | 30 – 35 years |
| Leasehold and building improvements | 5 – 35 years |
| Furniture, fixtures and equipment | 5 – 10 years |
| Computer software and hardware | 3 – 5 years |
The Company entered into agreements with various governmental entities in the states of Kentucky, Georgia and Tennessee to implement tax abatement plans related to its distribution center in Franklin, Kentucky (Simpson County), its distribution center in Macon, Georgia (Bibb County) and its Store Support Center in Brentwood, Tennessee (Williamson County). The tax abatement plans provide for reduction of real property taxes for specified time frames by legally transferring title to its real property in exchange for industrial revenue bonds. This property was then leased back to the Company. No cash was exchanged.
The lease payments are equal to the amount of the payments on the bonds. The tax abatement period extends through the term of the lease, which coincides with the maturity date of the bonds. At any time, the Company has the option to purchase the real property by paying off the bonds, plus $1. The terms and amounts authorized and drawn under each industrial revenue bond agreement are outlined as follows, as of December 26, 2015:
| Bond Term | Bond Authorized Amount (in millions) | Amount Drawn (in millions) | ||||||
| Franklin, Kentucky Distribution Center | 30 years | $ | 54.0 | $ | 51.8 | |||
| Macon, Georgia Distribution Center | 15 years | $ | 58.0 | $ | 49.9 | |||
| Brentwood, Tennessee Store Support Center | 10 years | $ | 78.0 | $ | 75.3 |
Due to the form of these transactions, the Company has not recorded the bonds or the lease obligation associated with the sale lease-back transaction. The original cost of the Company’s property and equipment is recorded on the balance sheet and is being depreciated over its estimated useful life.
Capitalized Software Costs
The Company capitalizes certain costs related to the acquisition and development of software and amortizes these costs using the straight-line method over the estimated useful life of the software, which is three to five years. Computer software consists primarily of third-party software purchased for internal use. A subsequent addition, modification or upgrade to internal-use software is capitalized to the extent that it enhances the software’s functionality or extends its useful life. These costs are included in computer software and hardware in the accompanying Consolidated Balance Sheets. Certain software costs not meeting the criteria for capitalization are expensed as incurred.
Goodwill
All goodwill is associated with the Company as a whole. Goodwill is not amortized, but is evaluated for impairment annually and whenever events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable. The Company completes its impairment evaluation by performing internal valuation analyses and considering other publicly available market information, as appropriate.
The test for goodwill impairment is a two step process. The first step of the goodwill impairment test, used to identify the potential for impairment, compares the fair value of a reporting unit with the carrying value of its net assets, including goodwill. If the fair value of the reporting unit is less than the carrying value of the reporting unit, the second step of the goodwill impairment test is performed to measure the amount of impairment loss to be recorded, if any. The second step, if required, would compare the
implied fair value of goodwill with the current carrying amount of goodwill. If the implied fair value of goodwill is less than the carrying value, an impairment charge would be recorded as a charge to the Company’s operations.
In the fourth quarter of fiscal 2015, the Company completed its annual impairment testing of goodwill and no impairment was identified. The Company determined that the fair value of the reporting unit (including goodwill) was in excess of the carrying value of the reporting unit and as such, the second step was not necessary. In reaching this conclusion, the fair value of the reporting unit was determined based on a market approach. Under the market approach, the fair value is based on observed market prices.
Store Closing Costs
The Company regularly evaluates the performance of its stores and periodically closes those that are under-performing. The Company records a liability for costs associated with an exit or disposal activity when the liability is incurred, usually in the period the store closes. Store closing costs were not significant to results of operations for any of the fiscal years presented.
Leases
Assets under capital leases are amortized in accordance with the Company’s normal depreciation policy for owned assets or over the lease term, if shorter, and the related charge to operations is included in depreciation expense in the Consolidated Statements of Income.
Certain operating leases include rent increases during the lease term. For these leases, the Company recognizes the related rental expense on a straight-line basis over the term of the lease (which includes the pre-opening period of construction, renovation, fixturing and merchandise placement) and records the difference between the expense charged to operations and amounts paid as a deferred rent liability.
The Company occasionally receives reimbursements from landlords to be used towards improving the related store to be leased. Leasehold improvements are recorded at their gross costs including items reimbursed by landlords. Related reimbursements are deferred and amortized on a straight-line basis as a reduction of rent expense over the applicable lease term.
Note 2 - Share-Based Compensation:
Share-based compensation includes stock option and restricted stock unit awards and certain transactions under the Company’s ESPP. Share-based compensation expense is recognized based on the grant date fair value of all stock option and restricted stock unit awards plus a discount on shares purchased by employees as a part of the ESPP. The discount under the ESPP represents the difference between the purchase date market value and the employee’s purchase price.
There were no significant modifications to the Company’s share-based compensation plans during fiscal 2015. At December 26, 2015, the Company had approximately 4.8 million shares available for future equity awards under the Company’s 2009 Stock Incentive Plan.
Share-based compensation expense, including changes in expense for modifications of awards, was $19.4 million, $16.2 million and $13.9 million for fiscal 2015, 2014 and 2013, respectively.
Stock Options
Under the Company’s 2009 Stock Incentive Plan, options may be granted to current or prospective officers or employees, non-employee directors and consultants. The per share exercise price of options granted shall not be less than the fair market value of the stock on the date of grant and such options will expire no later than ten years from the date of grant. Vesting of options commences at various anniversary dates following the dates of grant.
The fair value is separately estimated for each option grant. The fair value of each option is recognized as compensation expense ratably over the vesting period. The Company has estimated the fair value of all stock option awards as of the date of the grant by applying a Black-Scholes pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense. The ranges of key assumptions used in determining the fair value of options granted during fiscal 2015, 2014 and 2013, as well as a summary of the methodology applied to develop each assumption, are as follows:
| Fiscal Year | |||||
| 2015 | 2014 | 2013 | |||
| Expected price volatility | 27.3 – 28.8% | 28.0 – 29.3% | 30.7 – 35.4% | ||
| Risk-free interest rate | 1.2 – 1.5% | 1.1 – 1.3% | 0.6 – 1.2% | ||
| Weighted average expected lives (in years) | 4.5 | 4.5 | 4.7 | ||
| Forfeiture rate | 6.9% | 6.9% | 7.0% | ||
| Dividend yield | 1.0% | 0.8% | 0.8% |
Expected Price Volatility — This is a measure of the amount by which a price has fluctuated or is expected to fluctuate. The Company uses a blended volatility approach, weighting (i) actual historical changes in the market value of the stock at 75% and (ii) average implied volatility using tradable option data at 25%. To calculate historical changes in market value, the Company uses daily market value changes from the date of grant over a past period generally representative of the expected life of the options to determine volatility. To derive implied volatility, the Company relies on publicly traded options, with maturities of six months or greater. The Company believes this blended calculation of historical and expected price volatility provides the most relevant indicator of future volatility. An increase in the expected volatility will increase compensation expense.
Risk-Free Interest Rate — This is the U.S. Treasury Constant Maturity rate over a term equal to the expected life of the option. An increase in the risk-free interest rate will increase compensation expense.
Weighted Average Expected Lives — This is the period of time over which the options granted are expected to remain outstanding and is based on historical experience. Options granted generally have a maximum term of ten years. An increase in the expected life will increase compensation expense.
Forfeiture Rate — This is the estimated percentage of options granted that are expected to be forfeited or canceled before becoming fully vested. This estimate is based on historical experience. An increase in the forfeiture rate will decrease compensation expense.
Dividend Yield —This is the estimated dividend yield for the weighted average expected life of the option granted. An increase in the dividend yield will decrease compensation expense.
The Company issues shares for options when exercised. A summary of stock option activity is as follows:
| Options | Weighted Average Exercise Price | Weighted Average Fair Value | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value (in thousands) | ||||||||||||
| Outstanding December 29, 2012 | 6,060,382 | $ | 19.48 | 6.6 | $ | 147,229 | ||||||||||
| Granted | 1,027,251 | 51.87 | $ | 14.67 | ||||||||||||
| Exercised | (2,681,225 | ) | 12.95 | |||||||||||||
| Canceled | (97,360 | ) | 43.27 | |||||||||||||
| Outstanding December 28, 2013 | 4,309,048 | $ | 30.72 | 7.1 | $ | 193,123 | ||||||||||
| Granted | 1,167,060 | 64.08 | $ | 15.36 | ||||||||||||
| Exercised | (1,179,175 | ) | 20.15 | |||||||||||||
| Canceled | (213,507 | ) | 57.14 | |||||||||||||
| Outstanding December 27, 2014 | 4,083,426 | $ | 41.93 | 7.2 | $ | 146,967 | ||||||||||
| Granted | 1,080,490 | 83.70 | $ | 19.53 | ||||||||||||
| Exercised | (1,116,828 | ) | 33.11 | |||||||||||||
| Canceled | (185,582 | ) | 67.28 | |||||||||||||
| Outstanding December 26, 2015 | 3,861,506 | $ | 54.95 | 7.1 | $ | 119,050 | ||||||||||
| Exercisable at December 26, 2015 | 1,965,084 | $ | 37.53 | 5.8 | $ | 94,598 |
The aggregate intrinsic values in the table above represent the total difference between the Company’s closing stock price at each year-end and the option exercise price, multiplied by the number of in-the-money options at each year-end. As of December 26, 2015, total unrecognized compensation expense related to non-vested stock options was approximately $20.5 million with a weighted average expense recognition period of 1.3 years.
There were no material modifications to options in fiscal 2015, 2014 or 2013.
Other information relative to option activity during fiscal 2015, 2014 and 2013 is as follows (in thousands):
| 2015 | 2014 | 2013 | |||||||||
| Total fair value of stock options vested | $ | 13,207 | $ | 10,855 | $ | 10,535 | |||||
| Total intrinsic value of stock options exercised | $ | 60,082 | $ | 60,656 | $ | 122,621 |
Restricted Stock Units
The Company issues shares for restricted stock unit awards once vesting occurs and related restrictions lapse. The units vest over a one- to four-year term; some plan participants have elected to defer receipt of shares of common stock upon vesting of restricted stock units, and as a result, shares are not issued until a later date. The status of restricted stock units is presented below:
| Restricted Stock Units | Shares | Weighted Average Grant Date Fair Value | |||||
| Restricted at December 29, 2012 | 603,394 | $ | 18.76 | ||||
| Granted | 59,864 | 51.72 | |||||
| Exercised | (244,462 | ) | 14.00 | ||||
| Forfeited | (5,638 | ) | 36.24 | ||||
| Restricted at December 28, 2013 | 413,158 | $ | 26.12 | ||||
| Granted | 97,817 | 70.09 | |||||
| Exercised | (212,156 | ) | 21.91 | ||||
| Forfeited | (21,472 | ) | 54.54 | ||||
| Restricted at December 27, 2014 | 277,347 | $ | 42.64 | ||||
| Granted | 56,052 | 84.86 | |||||
| Exercised | (107,548 | ) | 25.97 | ||||
| Forfeited | (6,234 | ) | 63.57 | ||||
| Restricted at December 26, 2015 | 219,617 | $ | 60.99 |
Other information relative to restricted stock unit activity during fiscal 2015, 2014 and 2013 is as follows (in thousands):
| 2015 | 2014 | 2013 | |||||||||
| Total grant date fair value of restricted stock units vested and issued | $ | 2,793 | $ | 4,647 | $ | 3,422 | |||||
| Total intrinsic value of restricted stock units vested and issued | $ | 9,139 | $ | 13,205 | $ | 12,876 |
For the majority of restricted stock units granted, the number of shares issued on the date the restricted stock units vest is net of shares withheld by the Company for the minimum statutory tax withholding requirements, which the Company pays on behalf of its employees. The Company issued 72,206, 134,964, and 165,519 shares as a result of vested restricted stock units during fiscal 2015, 2014 and 2013, respectively. Although shares withheld are not issued, they are treated similar to common stock repurchases as they reduce the number of shares that would have been issued upon vesting. The amounts are net of 35,342, 77,192, and 78,943 shares withheld to satisfy $3.0 million, $4.8 million, and $4.1 million of employees’ tax obligations during fiscal 2015, 2014 and 2013, respectively.
There were no material modifications to restricted stock units in fiscal 2015, 2014 or 2013.
As of December 26, 2015, total unrecognized compensation expense related to non-vested restricted stock units was approximately $6.5 million with a weighted average expense recognition period of 2.2 years.
Employee Stock Purchase Plan
The ESPP provides Company employees the opportunity to purchase, through payroll deductions, shares of common stock at a 15% discount. Pursuant to the terms of the ESPP, the Company issued 68,428, 78,670 and 86,555 shares of common stock during fiscal 2015, 2014 and 2013, respectively. The total cost related to the ESPP, including the compensation expense calculations, was approximately $1.1 million, $1.0 million and $0.9 million in fiscal 2015, 2014 and 2013, respectively. There are a maximum of 16.0 million shares of common stock that are reserved under the ESPP. At December 26, 2015, there were approximately 12.2 million remaining shares of common stock reserved for future issuance under the ESPP.
Note 3 - Senior Credit Facility:
During the period of October 24, 2011 through February 19, 2016, the Company was party to a senior credit facility (the “2011 Senior Credit Facility”), which provided for borrowings up to $400 million (with a sublimit of $30 million for swingline loans) as of December 26, 2015 and December 27, 2014. The 2011 Senior Credit Facility was unsecured and would have matured on October 24, 2016.
On February 19, 2016, the Company replaced the 2011 Senior Credit Facility by entering into a new senior credit facility (the “2016 Senior Credit Facility”) consisting of a $200 million term loan and a $500 million revolving credit facility (with a sublimit of $50 million for swingline loans). This agreement is unsecured and matures in February 2021, with proceeds available to be used for working capital, capital expenditures, dividends, share repurchases, and other matters. As a result of the maturity date in the new agreement, the Company has presented any outstanding borrowings under the 2011 Senior Credit Facility as of December 26, 2015 as a non-current liability in the Consolidated Balance Sheet in accordance with the applicable accounting guidance.
2011 Senior Credit Facility
At December 26, 2015 there were $150.0 million in outstanding borrowings under the 2011 Senior Credit Facility and no outstanding borrowings at December 27, 2014. There were $48.7 million and $40.7 million outstanding letters of credit under the 2011 Senior Credit Facility as of December 26, 2015 and December 27, 2014, respectively. Borrowings bore interest at either the bank’s base rate (3.50% at December 26, 2015) or the London Inter-Bank Offer Rate (“LIBOR”) (0.42% at December 26, 2015) plus an additional amount ranging from 0.40% to 1.00% per annum (0.50% at December 26, 2015), adjusted quarterly based on our leverage ratio. The Company was 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 26, 2015), adjusted quarterly based on the Company’s leverage ratio. There were no compensating balance requirements associated with the 2011 Senior Credit Facility.
The 2011 Senior Credit Facility required quarterly compliance with respect to two material covenants: a fixed charge coverage ratio and a leverage ratio. The fixed charge coverage ratio compared 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 compared total debt plus rental expense (excluding any straight-line rent adjustments) multiplied by a factor of six to consolidated EBITDAR. The 2011 Senior Credit Facility also contained 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. The Company was in compliance with all covenants at December 26, 2015.
2016 Senior Credit Facility
The 2016 Senior Credit Facility contains a $200 million term loan which requires quarterly payments totaling $10 million a year in years one and two and $20 million a year in years three through five, with the remaining balance due in full on the maturity date of February 19, 2021. The 2016 Senior Credit Facility also contains a $500 million revolving credit facility (with a sublimit of $50 million for swingline loans).
Borrowings for both the term loan and the revolving credit facility bear interest at either the bank’s base rate or LIBOR plus an additional amount ranging from 0.500% to 1.125% per annum, adjusted quarterly based on our leverage ratio. The Company is also required to pay, quarterly in arrears, a commitment fee for unused capacity ranging from 0.075% to 0.200% per annum, adjusted quarterly based on the Company’s leverage ratio.
Proceeds from the 2016 Senior Credit Facility are available to be used for working capital, capital expenditures, dividends, share repurchases, and other matters. There are no compensating balance requirements associated with the 2016 Senior Credit Facility.
The 2016 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 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 2016 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.
Note 4 - Leases:
The Company leases the majority of its retail store locations, two distribution sites, its Merchandise Innovation Center, transportation equipment and other equipment under various non-cancellable operating leases. The leases have varying terms and expire at various dates through 2031. Store leases typically have initial terms of between 10 and 15 years, with two to four optional renewal periods of five years each. Some leases require the payment of contingent rent that is based upon store sales above agreed-upon sales levels for the year. The sales levels vary for each store and are established in the lease agreements. Generally, most of the leases also require that the Company pays associated taxes, insurance and maintenance costs.
Total rent expense for fiscal 2015, 2014 and 2013 was approximately $262.1 million, $239.3 million and $216.8 million, respectively. Total contingent rent expense for fiscal 2015, 2014 and 2013 was insignificant.
Future minimum payments, by year and in the aggregate, under leases with initial or remaining terms of one year or more consist of the following (in thousands):
| Capital Leases | Operating Leases | ||||||
| 2016 | $ | 1,876 | $ | 265,327 | |||
| 2017 | 1,876 | 258,361 | |||||
| 2018 | 1,876 | 249,250 | |||||
| 2019 | 1,876 | 236,796 | |||||
| 2020 | 1,876 | 218,764 | |||||
| Thereafter | 16,713 | 1,070,995 | |||||
| Total minimum lease payments | 26,093 | $ | 2,299,493 | ||||
| Amount representing interest | (8,223 | ) | |||||
| Present value of minimum lease payments | 17,870 | ||||||
| Less: current portion | (878 | ) | |||||
| Long-term capital lease obligations | $ | 16,992 |
Assets under capital leases were as follows (in thousands):
| 2015 | 2014 | ||||||
| Building and improvements | $ | 18,831 | $ | 5,623 | |||
| Less: accumulated depreciation and amortization | (1,656 | ) | (935 | ) | |||
| $ | 17,175 | $ | 4,688 |
Note 5 - Capital Stock and Dividends:
Capital Stock
The authorized capital stock of the Company consists of common stock and preferred stock. The Company is authorized to issue 400 million shares of common stock. The Company is also authorized to issue 40,000 shares of preferred stock, with such designations, rights and preferences as may be determined from time to time by the Board of Directors.
Dividends
During fiscal 2015 and 2014, the Company’s Board of Directors declared the following cash dividends:
| Date Declared | Dividend Amount Per Share | Stockholders of Record Date | Date Paid | |||
| November 2, 2015 | $0.20 | November 16, 2015 | December 1, 2015 | |||
| August 3, 2015 | $0.20 | August 17, 2015 | September 1, 2015 | |||
| May 4, 2015 | $0.20 | May 18, 2015 | June 2, 2015 | |||
| February 4, 2015 | $0.16 | February 23, 2015 | March 10, 2015 | |||
| October 29, 2014 | $0.16 | November 17, 2014 | December 2, 2014 | |||
| July 30, 2014 | $0.16 | August 18, 2014 | September 3, 2014 | |||
| April 30, 2014 | $0.16 | May 19, 2014 | June 3, 2014 | |||
| February 5, 2014 | $0.13 | February 24, 2014 | March 11, 2014 |
It is the present intention of the Board of Directors to continue to pay a quarterly cash dividend; however, the declaration and payment of future dividends will be determined by the Board of Directors in its sole discretion and will depend upon the earnings, financial condition, and capital needs of the Company, as well as other factors which the Board of Directors deem relevant.
On February 3, 2016, the Company’s Board of Directors declared a quarterly cash dividend of $0.20 per share of common stock. The dividend will be paid on March 8, 2016 to stockholders of record as of the close of business on February 22, 2016.
Note 6 - Treasury Stock:
The Company’s Board of Directors has authorized common stock repurchases under the share repurchase program up to $2 billion, exclusive of any fees, commissions, or other expenses related to such repurchases, through December 2017. 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.
The Company repurchased 3.4 million, 4.7 million and 2.3 million shares of common stock under the share repurchase program at a total cost of $292.7 million, $298.5 million and $129.4 million in fiscal 2015, 2014 and 2013, respectively. As of December 26, 2015, the Company had remaining authorization under the share repurchase program of $570.7 million, exclusive of any fees, commissions, or other expenses.
Note 7 - Net Income Per Share:
Net income per share is calculated as follows (in thousands, except per share amounts):
| 2015 | ||||||||||
| Net Income | Shares | Per Share Amount | ||||||||
| Basic net income per share | $ | 410,395 | 135,582 | $ | 3.03 | |||||
| Dilutive stock options and restricted stock units outstanding | — | 1,263 | (0.03 | ) | ||||||
| Diluted net income per share | $ | 410,395 | 136,845 | $ | 3.00 |
| 2014 | ||||||||||
| Net Income | Shares | Per Share Amount | ||||||||
| Basic net income per share | $ | 370,885 | 137,769 | $ | 2.69 | |||||
| Dilutive stock options and restricted stock units outstanding | — | 1,666 | (0.03 | ) | ||||||
| Diluted net income per share | $ | 370,885 | 139,435 | $ | 2.66 |
| 2013 | ||||||||||
| Net Income | Shares | Per Share Amount | ||||||||
| Basic net income per share | $ | 328,234 | 139,415 | $ | 2.35 | |||||
| Dilutive stock options and restricted stock units outstanding | — | 2,308 | (0.03 | ) | ||||||
| Diluted net income per share | $ | 328,234 | 141,723 | $ | 2.32 |
Anti-dilutive stock options excluded from the above calculations totaled approximately 0.9 million, 1.0 million and 0.6 million in fiscal 2015, 2014 and 2013, respectively.
Note 8 – Income Taxes:
The provision for income taxes consists of the following (in thousands):
| 2015 | 2014 | 2013 | |||||||||
| Current tax expense: | |||||||||||
| Federal | $ | 225,253 | $ | 211,383 | $ | 175,039 | |||||
| State | 17,419 | 25,133 | 19,129 | ||||||||
| Total current | 242,672 | 236,516 | 194,168 | ||||||||
| Deferred tax (benefit) expense: | |||||||||||
| Federal | (7,017 | ) | (14,493 | ) | (5,341 | ) | |||||
| State | 1,567 | (5,321 | ) | (2,968 | ) | ||||||
| Total deferred | (5,450 | ) | (19,814 | ) | (8,309 | ) | |||||
| Total provision | $ | 237,222 | $ | 216,702 | $ | 185,859 |
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the deferred tax assets and liabilities are as follows (in thousands):
| 2015 | 2014 | ||||||
| Current tax assets: | |||||||
| Inventory valuation | $ | 18,147 | $ | 16,602 | |||
| Accrued employee benefit costs | 21,368 | 18,770 | |||||
| Accrued sales tax audit reserve | 2,316 | 2,053 | |||||
| Other | 10,369 | 11,585 | |||||
| 52,200 | 49,010 | ||||||
| Current tax liabilities: | |||||||
| Inventory basis difference | (3,497 | ) | (4,657 | ) | |||
| Prepaid expenses | (2,108 | ) | (2,109 | ) | |||
| Other | (625 | ) | (1,282 | ) | |||
| (6,230 | ) | (8,048 | ) | ||||
| Net current tax asset | $ | 45,970 | $ | 40,962 | |||
| Non-current tax assets: | |||||||
| Rent expenses in excess of cash payments required | 29,179 | 27,166 | |||||
| Deferred compensation | 20,125 | 17,956 | |||||
| Workers compensation insurance | 7,233 | 6,989 | |||||
| General liability insurance | 3,141 | 2,741 | |||||
| Lease exit obligations | 2,378 | 2,437 | |||||
| Income tax credits | 825 | 2,205 | |||||
| Accrued sales tax audit reserve | 2,505 | 2,085 | |||||
| Other | 3,274 | 3,745 | |||||
| 68,660 | 65,324 | ||||||
| Non-current tax liabilities: | |||||||
| Depreciation | (55,805 | ) | (52,626 | ) | |||
| Other | (3,631 | ) | (3,916 | ) | |||
| (59,436 | ) | (56,542 | ) | ||||
| Net non-current tax asset | $ | 9,224 | $ | 8,782 | |||
| Net deferred tax asset | $ | 55,194 | $ | 49,744 |
The Company has evaluated the need for a valuation allowance for all or a portion of the deferred tax assets. The Company believes that all of the deferred tax assets will more likely than not be realized through future earnings. The Company had state tax credit carryforwards of $4.4 million and $5.0 million as of December 26, 2015 and December 27, 2014, respectively, with varying dates of expiration between 2016 and 2025. The Company provided no valuation allowance as of December 26, 2015 and December 27, 2014 for state tax credit carryforwards, as the Company believes it is more likely than not that all of these credits will be utilized before their expiration dates.
A reconciliation of the provision for income taxes to the amounts computed at the federal statutory rate is as follows (in thousands):
| 2015 | 2014 | 2013 | |||||||||
| Tax provision at statutory rate | $ | 226,666 | $ | 205,656 | $ | 179,933 | |||||
| Tax effect of: | |||||||||||
| State income taxes, net of federal tax benefits | 12,341 | 12,878 | 10,505 | ||||||||
| Permanent differences | (1,785 | ) | (1,832 | ) | (4,579 | ) | |||||
| $ | 237,222 | $ | 216,702 | $ | 185,859 |
The Company and its affiliates file income tax returns in the U.S. and various state and local jurisdictions. With few exceptions, the Company is no longer subject to federal, state and local income tax examinations by tax authorities for years before 2011. Various states have completed an examination of our income tax returns for 2010 through 2013 with minimal adjustments.
The total amount of unrecognized tax positions that, if recognized, would decrease the effective tax rate, is $1.9 million at December 26, 2015. In addition, the Company recognizes current interest and penalties accrued related to these uncertain tax positions as interest expense, and the amount is not material to the Consolidated Statements of Income. The Company estimates the overall decrease in unrecognized tax positions in the next twelve months will range between $0.2 million and $0.6 million. A reconciliation of the beginning and ending gross amount of unrecognized tax positions (exclusive of interest and penalties) is as follows (in thousands):
| 2015 | 2014 | 2013 | |||||||||
| Balance at beginning of year | $ | 3,500 | $ | 2,482 | $ | 5,898 | |||||
| Additions based on tax positions related to the current year | 869 | 1,104 | 741 | ||||||||
| Additions for tax positions of prior years | — | 280 | — | ||||||||
| Reductions for tax positions of prior years | (1,447 | ) | (366 | ) | (3,937 | ) | |||||
| Reductions due to audit results | — | — | (220 | ) | |||||||
| Balance at end of year | $ | 2,922 | $ | 3,500 | $ | 2,482 |
Note 9 - Retirement Benefit Plans:
The Company has a defined contribution benefit plan, the Tractor Supply Company 401(k) Retirement Savings Plan (the “401(k)Plan”), which provides retirement benefits for eligible employees. The Company matches (in cash) 100% of the employee’s elective contributions up to 3% of eligible compensation plus 50% of the employee’s elective contributions from 3% to 6% of eligible compensation. In no event shall the total Company match made on behalf of the employee exceed 4.5% of the employee’s eligible compensation. All current contributions are immediately vested. Company contributions to the 401(k) Plan during fiscal 2015, 2014 and 2013, were approximately $5.9 million, $5.6 million and $4.9 million, respectively.
The Company offers, through a deferred compensation program, the opportunity for certain qualifying employees to elect to defer a portion of their annual base salary and/or their annual incentive bonus. Under the deferred compensation program, a percentage of the participants’ salary deferral is matched by the Company, limited to a maximum annual matching contribution of $4,500. The Company’s contributions, including accrued interest, were $0.5 million in each of the fiscal years 2015, 2014 and 2013.
Note 10 – Commitments and Contingencies:
Construction and Real Estate Commitments
At December 26, 2015, the Company had no material commitments related to construction projects extending greater than twelve months.
Letters of Credit
At December 26, 2015, there were $48.7 million outstanding letters of credit under the 2011 Senior Credit Facility.
Litigation
The Company responded to a Request for Information from the United States Environmental Protection Agency (“EPA”) in the first quarter of fiscal 2009 relating to certain recreational vehicles and non-road spark ignition engines sold by the Company. In the first quarter of fiscal 2011, the Environmental Enforcement Section of the Department of Justice (“DOJ”), on behalf of the EPA, informed the Company that it believed the Company had violated the Clean Air Act by importing or causing the importation of certain engines that were noncompliant.
The products at issue were purchased by the Company pursuant to agreements with vendors under which the vendors represented that their products complied with all the applicable laws and regulations and under which the vendors agreed to indemnify the Company for any liabilities or costs relating to, among other matters, the noncompliance or alleged noncompliance of their products. The Company notified these vendors of the EPA’s position and worked with these vendors to provide additional information to the DOJ and EPA regarding the alleged violations. As a result of this process, the Company and its vendors provided evidence that many of the products identified by the DOJ and EPA in early 2011 were, in fact, in compliance with the Clean Air Act and that most of the remaining issues related to products purchased from one vendor. The vendor of these products and the
Company engaged in settlement discussions with the DOJ and EPA that resulted in the settlement of the matter. A consent decree reflecting the terms of the settlement was filed with the United States District Court in Washington, D.C. on September 30, 2015.
Under the settlement, the Company agreed to implement a formal compliance program for the small-engine products purchased by the Company for resale to its customers. The Company also agreed to pay a civil penalty, most of which was reimbursed by the vendor who sold the small-engine products at issue to the Company. In addition, the Company agreed to sponsor an emissions offset program that will result in the replacement of 22 older wood-burning stoves with EPA-certified wood-burning stoves. The settlement was approved by the court on January 19, 2016. The civil penalty did not differ materially from the amount accrued. The cost of the settlement and the compliance and emission offset program will not have a material effect on our financial condition, results of operations or cash flows.
The Company is also involved in various litigation matters arising in the ordinary course of business. The Company believes that any estimated loss related to such matters has been adequately provided in accrued liabilities to the extent probable and reasonably estimable. Accordingly, the Company currently expects these matters will be resolved without material adverse effect on its consolidated financial position, results of operations or cash flows.
Note 11 – Segment Reporting:
The Company has one reportable segment which is the retail sale of products that support the rural lifestyle. The Company manages the business on the basis of one operating segment. The following chart indicates the percentage of sales represented by each major product category during fiscal 2015, 2014, and 2013:
| Percent of Sales | ||||||||
| Product Category: | 2015 | 2014 | 2013 | |||||
| Livestock and Pet | 44 | % | 44 | % | 43 | % | ||
| Hardware, Tools and Truck | 23 | 22 | 23 | |||||
| Seasonal, Gift and Toy Products | 20 | 20 | 20 | |||||
| Clothing and Footwear | 8 | 9 | 9 | |||||
| Agriculture | 5 | 5 | 5 | |||||
| Total | 100 | % | 100 | % | 100 | % |
Note 12 – New Accounting Pronouncements:
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). ASU 2014-09 amends the guidance for revenue recognition to replace numerous, industry-specific requirements and converges areas under this topic with those of the International Financial Reporting Standards. The ASU implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. Other major provisions include the capitalization and amortization of certain contract costs, ensuring the time value of money is considered in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. In August 2015, the FASB issued ASU 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date” which implemented a one-year deferral of ASU 2014-09. As a result of the deferral, the amendments in ASU 2014-09 are effective for reporting periods beginning after December 15, 2017. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. Management is currently assessing the impact the adoption of ASU 2014-09 will have on our Consolidated Financial Statements and related disclosures, including which transition method it will adopt.
In April 2015, the FASB issued ASU 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”). This update requires that debt issuance costs related to a recognized debt liability be presented in the consolidated balance sheet as a direct reduction from the carrying amount of that debt liability. ASU 2015-03 requires retrospective application and is effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The Company does not expect that the adoption of this guidance will have a material impact on our Consolidated Financial Statements and related disclosures.
In July 2015, the FASB issued ASU 2015-11, "Inventory (Topic 330): Simplifying the Measurement of Inventory" (“ASU 2015-11”). This update requires an entity that determines the cost of inventory by methods other than last-in, first-out and the retail inventory
method to measure inventory at the lower of cost and net realizable value. ASU 2015-11 requires prospective application and is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. The Company does not expect that the adoption of this guidance will have a material impact on our Consolidated Financial Statements and related disclosures.
In November 2015, the FASB issued ASU 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes” (“ASU 2015-17”). This update requires that deferred tax liabilities and assets be classified as noncurrent in the consolidated balance sheet. ASU 2015-17 may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The updated guidance is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. Upon adoption, the updated guidance will affect the presentation of the deferred tax liabilities and assets within the Company’s Consolidated Balance Sheet; however, the updated guidance will not affect the accounting for deferred tax liabilities and assets. Other than the change in presentation, the Company does not expect that the adoption of this guidance will have a material impact on our Consolidated Financial Statements and related disclosures.
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