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, 2019 (our fiscal years 2019, 2018 and 2017). 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.

Tractor Supply reports its financial results in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). Tractor Supply also uses certain non-GAAP measures that fall within the meaning of Securities and Exchange Commission Regulation G and Regulation S-K Item 10(e), which may provide users of the financial information with additional meaningful comparison to prior reported results. Non-GAAP measures do not have standardized definitions and are not defined by U.S. GAAP. Therefore, Tractor Supply’s non-GAAP measures are unlikely to be comparable to similar measures presented by other companies. The presentation of these non-GAAP measures should not be considered in isolation from, as a substitute for, or as superior to the financial information presented in accordance with U.S. GAAP. We believe this information is useful in providing period-to-period comparisons of the results of our continuing operations.

Overview

Founded in 1938, Tractor Supply Company (the “Company” or “we” or “our” or “us”) is the largest rural lifestyle retailer in the United States (“U.S.”). The Company is focused on supplying the needs of recreational farmers, ranchers, and all those who enjoy living the rural lifestyle (which we refer to as the “Out Here” lifestyle), as well as tradesmen and small businesses. As of December 28, 2019, we operated 2,024 retail stores in 49 states under the names Tractor Supply Company, Del’s Feed & Farm Supply, and Petsense. We also operate websites under the names TractorSupply.com and Petsense.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 heating, lawn and garden items, power equipment, gifts, and toys;

• Work/recreational clothing and footwear; and

• Maintenance products for agricultural and rural use.

Tractor Supply Company believes we can grow our business by being the most dependable supplier of relevant products and services for the “Out Here” lifestyle, creating customer loyalty through personalized experiences, and providing convenience that our customers expect at anytime, anywhere, and in any way they choose. Our long-term growth strategy is to: (1) drive profitable growth through new store openings and by expanding omni-channel capabilities, thus tying together our website product content, social media, digital, and online shopping experience, attracting new customers and driving loyalty, (2) build customer-centric engagement by leveraging analytics to deliver legendary customer service, seasoned advice, and personalized experiences, (3) offer relevant assortments and services across all channels through exclusive and national brands and continue to introduce new products and services through our test and learn strategy, (4) enhance our core and foundational capabilities by investing in infrastructure and process improvements which will support growth, scale, and agility while improving the customer experience, and (5) expand through selective acquisitions, as such opportunities arise, to add complementary businesses and to enhance penetration into new and existing markets to supplement organic growth.

Achieving this strategy will require a foundational focus on: (1) organizing, optimizing, and empowering our team members for growth by developing skills, talent, and leadership across the organization, and (2) implementing operational efficiency initiatives, including leverage of technology and automation, to align our cost structure to support new business capabilities for margin improvement and cost reductions.

Over the past five years, we have experienced considerable growth in stores, growing from 1,382 stores at the end of fiscal 2014 to 2,024 stores (1,844 Tractor Supply and Del’s retail stores and 180 Petsense retail stores) at the end of fiscal 2019, and in net sales, with a compounded annual growth rate of approximately 7.9%. 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 600 additional opportunities for new Tractor Supply stores. We also believe that there is opportunity for up to 1,000 Petsense stores.

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Executive Summary

In fiscal 2019, we opened 80 new Tractor Supply stores in 29 states and eight new Petsense stores in four states. In fiscal 2018, we opened 80 new Tractor Supply stores in 33 states and 18 new Petsense stores in 14 states. This resulted in a selling square footage increase of approximately 4.3% in fiscal 2019 and approximately 4.9% in fiscal 2018.

Net sales increased 5.6% to $8.35 billion in fiscal 2019 from $7.91 billion in fiscal 2018. Comparable store sales increased 2.7% in fiscal 2019 versus a 5.1% increase in fiscal 2018. Gross profit increased 6.3% to $2.87 billion in fiscal 2019 from $2.70 billion in fiscal 2018, and gross margin increased 22 basis points to 34.38% of net sales in fiscal 2019 from 34.16% of net sales in fiscal 2018. Operating income increased three basis points to 8.90% of net sales in fiscal 2019 from 8.87% of net sales in fiscal 2018. For fiscal 2019, net income was $562.4 million, or $4.66 per diluted share, compared to $532.4 million, or $4.31 per diluted share, in fiscal 2018.

We ended the year with $84.2 million in cash and outstanding debt of $396.5 million, after returning $696.0 million to our stockholders through stock repurchases and quarterly cash 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 U.S. GAAP. 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 the 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. We have established an inventory valuation reserve to recognize the estimated impairment in value (i.e., an inability to realize the full carrying value) 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 inventory impairment reserve as of December 28, 2019, would have affected net income by approximately $1.1 million in fiscal 2019.

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Description						Judgments and Uncertainties						Effect if Actual Results Differ from Assumptions
Shrinkage
We perform physical inventories at least once a year for each store that has been open more than 12 months, and we have 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. 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 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 as of December 28, 2019, would have affected net income by approximately $2.2 million in fiscal 2019.
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 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 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 be different 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 collectability.						We have not made any material changes in the accounting methodology used to establish our vendor funding 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 funding. We do not believe there is a significant collectability risk related to vendor funding amounts due to us at the end of fiscal 2019. If a 10% reserve had been applied against our outstanding vendor funding due as of December 28, 2019, net income would have been affected by approximately $2.2 million in fiscal 2019. Although it is unlikely that there will be any significant reduction in historical levels of vendor funding, 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, 2019, net income would have been affected by approximately $10.4 million in fiscal 2019.

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Description						Judgments and Uncertainties						Effect if Actual Results Differ from Assumptions
Self-Insurance Reserves:
We self-insure a significant portion of our workers’ compensation insurance and general liability (including product liability) insurance plans. We have stop-loss insurance policies to protect from individual losses over specified dollar values. Provisions for losses related to our self-insured liabilities are based upon periodic independent actuarially determined estimates that consider a number of factors including historical claims experience, loss development factors, and severity factors.						The full extent of certain 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 as of December 28, 2019, would have affected net income by approximately $5.0 million in fiscal 2019.
Impairment of Long-Lived Assets:
Long-lived assets, including lease assets, 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 or asset group to its 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 related asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the related asset or asset group to its estimated fair value, which may be based on an estimated future cash flow model, market valuation, or other valuation technique, as appropriate. 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.						We have not made any material changes in our impairment loss assessment methodology in the financial periods presented, other than to include operating lease right-of-use assets in our ongoing impairment assessment upon adoption of the new lease accounting standard in fiscal 2019. 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.

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Description						Judgments and Uncertainties						Effect if Actual Results Differ from Assumptions
Impairment of Goodwill and Other Indefinite-Lived Intangible Assets:
Goodwill and other indefinite-lived intangible assets are evaluated for impairment annually, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In accordance with the accounting standards, an entity has the option first to assess qualitative factors to determine whether events and circumstances indicate that it is more likely than not that goodwill or an indefinite-lived intangible asset is impaired. If after such assessment an entity concludes that the asset is not impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the asset using a quantitative impairment test, and if impaired, the associated assets must be written down to fair value. The quantitative impairment test for goodwill 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, an impairment charge would be recorded to the Company’s operations, for the amount in which the carrying amount exceeds the reporting unit’s fair value. We determine fair values for each reporting unit using the market approach, when available and appropriate, the income approach, or a combination of both. The income approach involves forecasting projected financial information (such as revenue growth rates, profit margins, tax rates, and capital expenditures) and selecting a discount rate that reflects the risk inherent in estimated future cash flows. Under the market approach, the fair value is based on observed market data. If multiple valuation methodologies are used, the results are weighted appropriately. The quantitative impairment test for other indefinite-lived intangible assets involves comparing the carrying amount of the asset to the sum of the discounted cash flows expected to be generated by the asset. If the implied fair value of the indefinite-lived intangible asset is less than the carrying value, an impairment charge would be recorded to the Company’s operations.						Our impairment loss calculation contains uncertainties because they require management to make assumptions and to apply judgment to qualitative factors as well as estimate future cash flows and asset fair values, including forecasting projected financial information and selecting the discount rate that reflects the risk inherent in future cash flows.						The valuation approaches utilized to estimate fair value for the purposes of the impairment tests of goodwill and other indefinite-lived intangible assets require the use of assumptions and estimates, which involve a degree of uncertainty. 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 non-cash impairment losses that could be material.

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Quarterly Financial Data

Our unaudited quarterly operating results for each fiscal quarter of 2019 and 2018 are shown below (in thousands, except per share amounts):

						First Quarter						Second Quarter						Third Quarter						Fourth Quarter						Total
2019						(13 weeks)						(13 weeks)						(13 weeks)						(13 weeks)						(52 weeks)
Net sales						$	1,822,220					$	2,353,782					$	1,984,144					$	2,191,785					$	8,351,931
Gross profit						614,984						820,745						694,240						741,801						2,871,770
Operating income						103,408						287,557						161,817						190,438						743,220
Net income						76,832						219,210						122,133						144,179						562,354
Net income per share:
Basic						$	0.63					$	1.82					$	1.03					$	1.22					$	4.70
Diluted						$	0.63					$	1.80					$	1.02					$	1.21					$	4.66
Comparable store sales increase (a)						5.0		%				3.2		%				2.9		%				0.1		%				2.7		%

						First Quarter						Second Quarter						Third Quarter						Fourth Quarter						Total
2018						(13 weeks)						(13 weeks)						(13 weeks)						(13 weeks)						(52 weeks)
Net sales						$	1,682,901					$	2,213,249					$	1,881,625					$	2,133,271					$	7,911,046
Gross profit						563,649						769,414						653,132						716,333						2,702,528
Operating income						94,749						273,458						153,148						180,382						701,737
Net income						71,433						207,289						116,784						136,851						532,357
Net income per share:
Basic						$	0.57					$	1.70					$	0.96					$	1.12					$	4.34
Diluted						$	0.57					$	1.69					$	0.95					$	1.11					$	4.31
Comparable store sales increase (a)						3.7		%				5.6		%				5.1		%				5.7		%				5.1		%

(a) Comparable store metrics are calculated using sales generated from all stores open at least one year and all online sales, excluding certain adjustments to net sales. Closed stores are removed from our comparable store metrics calculations. Stores relocated during the periods being compared are not removed from our comparable store metrics. If the effect of relocated stores on our comparable store metrics becomes material, we would remove relocated stores from the calculations.

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Results of Operations

The following table sets forth, for the periods indicated, certain items in the Consolidated Statements of Income expressed as a percentage of net sales.

			Fiscal Year
			2019						2018						2017
Net sales			100.00		%				100.00		%				100.00		%
Cost of merchandise sold (a)			65.62						65.84						65.66
Gross margin (a)			34.38						34.16						34.34
Selling, general and administrative expenses (a)			23.14						23.05						22.60
Depreciation and amortization			2.34						2.24						2.28
Operating income			8.90						8.87						9.46
Interest expense, net			0.24						0.23						0.19
Income before income taxes			8.66						8.64						9.27
Income tax expense			1.93						1.91						3.45
Net income			6.73		%				6.73		%				5.82		%

(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 facility network in cost of merchandise sold and others (like our Company) exclude a portion of these distribution facility network costs from gross margin and instead include them in selling, general, and administrative expenses; refer to Note 1 – Significant Accounting Policies of the Notes to the Consolidated Financial Statements, included in Item 8 Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

Fiscal 2019 Compared to Fiscal 2018

Net sales increased 5.6% to $8.35 billion in fiscal 2019 from $7.91 billion in fiscal 2018. Comparable store sales for fiscal 2019 were $8.13 billion, a 2.7% increase over fiscal 2018. This compares to a 5.1% comparable store sales increase in the prior year. The comparable store average ticket increased 2.4% and comparable store transaction count increased 0.3% for fiscal 2019, as compared to an increase of 2.8% and 2.2% in fiscal 2018, respectively.

Comparable store metrics are calculated on an annual basis using sales generated from all stores open at least one year and all online sales, excluding certain adjustments to net sales. Stores closed during the year are removed from our comparable store metrics calculations. Stores relocated during the years being compared are not removed from our comparable store metrics. If the effect of relocated stores on our comparable store metrics becomes material, we would remove relocated stores from the calculations.

All geographic regions of the Company had positive comparable store sales growth. The growth in comparable store sales was led by strength in everyday merchandise, including consumable, usable, and edible (“C.U.E.”) products throughout the year as well as growth in seasonal merchandise categories. The growth in seasonal merchandise was driven from solid demand throughout the first three fiscal quarters of the year; however, the fourth fiscal quarter experienced weakness in sales of cold-weather seasonal and holiday discretionary products primarily as a result of unseasonably warm weather across much of the country and six fewer selling days between Thanksgiving and Christmas compared to last year.

In addition to comparable store sales growth in fiscal 2019, sales from stores opened less than one year were $237.6 million in fiscal 2019, which represented 3.0 percentage points of the 5.6% increase over fiscal 2018 net sales. Sales from stores opened less than one year were $300.5 million in fiscal 2018, which represented 4.1 percentage points of the 9.0% increase over fiscal 2017 net sales.

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The following table summarizes our store growth during fiscal 2019 and 2018:

						Fiscal Year
Store Count Information:						2019						2018
Tractor Supply
Beginning of period						1,765						1,685
New stores opened						80						80
Stores closed						(1)						—
End of period						1,844						1,765
Petsense
Beginning of period						175						168
New stores opened						8						18
Stores closed						(3)						(11)
End of period						180						175
Consolidated end of period						2,024						1,940
Stores relocated						2						4

The following table indicates the percentage of net sales represented by each of our major product categories during fiscal 2019 and 2018:

						Percent of Net Sales
						Fiscal Year
Product Category:						2019						2018
Livestock and Pet						47		%				47		%
Hardware, Tools and Truck						21						22
Seasonal, Gift and Toy Products						20						19
Clothing and Footwear						8						8
Agriculture						4						4
Total						100		%				100		%

Gross profit increased 6.3% to $2.87 billion in fiscal 2019 compared to $2.70 billion in fiscal 2018. As a percent of net sales, gross margin increased 22 basis points to 34.38% for fiscal 2019 compared to 34.16% for fiscal 2018. The increase in gross margin resulted primarily from strength in the Company's price management program and, to a lesser extent, improvements in freight expense as a percent of net sales in the second half of the year.

Total selling, general and administrative (“SG&A”) expenses, including depreciation and amortization, increased 6.4% to $2.13 billion in fiscal 2019 from $2.00 billion in fiscal 2018. SG&A expenses, as a percent of net sales, increased 19 basis points to 25.48% in fiscal 2019 from 25.29% in fiscal 2018. SG&A expenses increased as a percentage of net sales due principally to incremental costs associated with a new distribution facility in Frankfort, New York, and, to a lesser extent, investment in store team member wages. These SG&A increases were partially offset by lower year-over-year incentive compensation as a percent of net sales, as well as leverage in occupancy and other costs from the increase in comparable store sales. SG&A expenses were also negatively impacted in fiscal 2019 by approximately $2.9 million related to an executive transition agreement.

Our effective income tax rate increased to 22.3% for fiscal 2019 compared to 22.1% in fiscal 2018. The primary cause of the increase in the Company's effective income tax rate was a reduction in state investment credits.

Net income in fiscal 2019 was $562.4 million, or $4.66 per diluted share, compared to $532.4 million, or $4.31 per diluted share, in fiscal 2018. Excluding the after-tax impact of an executive transition agreement in fiscal 2019 of approximately $2.3 million, or $0.02 per diluted share, adjusted net income for fiscal 2019 was $564.7 million, or $4.68 per diluted share. Adjusted net income is a non-GAAP measure which has been provided in order to enhance comparability for the periods presented.

During fiscal 2019, we repurchased approximately 5.4 million shares of the Company’s common stock at a total cost of $533.3 million as part of our share repurchase program. In fiscal 2018, we repurchased approximately 5.0 million shares at a total cost of $349.8 million.

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Fiscal 2018 Compared to Fiscal 2017

Net sales increased 9.0% to $7.91 billion in fiscal 2018 from $7.26 billion in fiscal 2017. Comparable store sales for fiscal 2018 were $7.63 billion, a 5.1% increase over fiscal 2017. This compares to a 2.7% comparable store sales increase in the prior year. The comparable store transaction count increased 2.2% and comparable store average ticket increased 2.8% for fiscal 2018, as compared to an increase of 2.2% and 0.5% in fiscal 2018, respectively.

Comparable store metrics are calculated on an annual basis using sales generated from all stores open at least one year and all online sales, excluding certain adjustments to net sales. Stores closed during the year are removed from our comparable store metrics calculations. Stores relocated during the years being compared are not removed from our comparable store metrics. If the effect of relocated stores on our comparable store metrics becomes material, we would remove relocated stores from the calculations. Acquired Petsense stores are considered comparable beginning in the fourth quarter of fiscal 2017.

The comparable store sales increase was broad-based across all merchandise categories and all geographic regions. The growth in comparable store sales was led by strength in everyday merchandise, including C.U.E. products, along with strong demand for seasonal merchandise in each quarter of the year.

In addition to comparable store sales growth in fiscal 2018, sales from stores opened less than one year were $300.5 million in fiscal 2018, which represented 4.1 percentage points of the 9.0% increase over fiscal 2017 net sales. Sales from stores opened less than one year, including acquired Petsense stores, were $405.0 million in fiscal 2017, which represented 6.0 percentage points of the 7.0% increase over fiscal 2016 net sales.

The following table summarizes our store growth during fiscal 2018 and 2017:

						Fiscal Year
Store Count Information:						2018						2017
Tractor Supply
Beginning of period						1,685						1,595
New stores opened						80						101
Stores closed						—						(11)
End of period						1,765						1,685
Petsense
Beginning of period						168						143
New stores opened						18						25
Stores closed						(11)						—
End of period						175						168
Consolidated end of period						1,940						1,853
Stores relocated						4						3

The following table indicates the percentage of net sales represented by each of our major product categories during fiscal 2018 and 2017:

						Percent of Net Sales
						Fiscal Year
Product Category:						2018						2017
Livestock and Pet						47		%				47		%
Hardware, Tools and Truck						22						22
Seasonal, Gift and Toy Products						19						19
Clothing and Footwear						8						8
Agriculture						4						4
Total						100		%				100		%

Index

Gross profit increased 8.4% to $2.70 billion in fiscal 2018 compared to $2.49 billion in fiscal 2017. As a percent of net sales, gross margin decreased 18 basis points to 34.16% for fiscal 2018 compared to 34.34% for fiscal 2017. The decline in gross margin resulted primarily from an increase in freight expense driven by higher carrier rates and increased diesel fuel prices as well as a negative impact from a mix shift of products sold during the fourth quarter, partially offset by strength in the Company’s price management program and strong sell through of seasonal merchandise throughout the year.

Total SG&A expenses, including depreciation and amortization, increased 10.8% to $2.00 billion in fiscal 2018 from $1.81 billion in fiscal 2017. SG&A expenses, as a percent of net sales, increased 41 basis points to 25.29% in fiscal 2018 from 24.88% in fiscal 2017. SG&A expenses increased as a percentage of net sales due principally to higher incentive compensation from the strong year-over-year growth in comparable store sales, along with planned investments in infrastructure, technology, and team member wages at both the stores and distribution centers, to support the Company’s long-term strategic growth initiatives. These SG&A increases as a percent of net sales were partially offset by leverage in occupancy and other costs from the increase in comparable store sales.

Our effective income tax rate decreased to 22.1% for fiscal 2018 compared to 37.2% in fiscal 2017. The decrease in the effective income tax rate was primarily related to the U.S. Tax Cuts and Jobs Act (the “TCJA”) that was signed into law in December 2017 which made broad and complex changes to the U.S. tax code including, but not limited to, a reduction of the federal income tax rate from 35% to 21% for years beginning after December 31, 2017. To a lesser extent, the effective income tax rate in fiscal 2018 also incrementally benefited from state investment credits and share-based compensation. The tax legislation also increased the effective income tax rate in fiscal 2017 due to the revaluation of the Company’s existing deferred tax balances at the lower federal income tax rate.

Net income in fiscal 2018 was $532.4 million, or $4.31 per diluted share, compared to $422.6 million, or $3.30 per diluted share, in fiscal 2017. Excluding the impact of the revaluation of the Company’s net deferred tax asset in fiscal 2017 resulting in a one-time, non-cash charge of approximately $4.9 million, or $0.03 per diluted share, adjusted net income for fiscal 2017 was $427.5 million, or $3.33 per diluted share. Adjusted net income is a non-GAAP measure which has been provided in order to enhance comparability for the periods presented.

During fiscal 2018, we repurchased approximately 5.0 million shares of the Company’s common stock at a total cost of $349.8 million as part of our share repurchase program. In fiscal 2017, we repurchased approximately 5.9 million shares at a total cost of $369.4 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 facility capacity and improvements, information technology, inventory purchases, repayment of existing borrowings under our debt facilities, share repurchases, cash dividends, and selective acquisitions as opportunities arise.

Our primary ongoing sources of liquidity are existing cash balances, cash provided from operations, remaining funds available under our debt facilities, operating and finance 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.

We believe that our existing cash balances, expected cash flow from future operations, funds available under our debt facilities, operating and finance 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, and distribution facility capacity, through the end of fiscal 2020.

Index

Working Capital

At December 28, 2019, the Company had working capital of $540.3 million, which decreased $316.0 million from 2018. The shifts in working capital were attributable to changes in the following components of current assets and current liabilities (in millions):

			December 28, 2019						December 29, 2018						Variance
Current assets:
Cash and cash equivalents			$	84.2					$	86.3					$	(2.1)
Inventories			1,602.8						1,589.5						13.3
Prepaid expenses and other current assets			100.9						114.5						(13.6)
Income taxes receivable			—						4.1						(4.1)
Total current assets			1,787.9						1,794.4						(6.5)
Current liabilities:
Accounts payable			643.0						620.0						23.0
Accrued employee compensation			39.8						54.0						(14.2)
Other accrued expenses			247.7						232.4						15.3
Current portion of long-term debt			30.0						26.3						3.7
Current portion of finance lease obligations			4.0						3.6						0.4
Current portion of operating lease obligations			277.1						—						277.1
Income taxes payable			6.0						1.8						4.2
Total current liabilities			1,247.6						938.1						309.5
Working capital			$	540.3					$	856.3					$	(316.0)

In comparison to December 29, 2018, working capital as of December 28, 2019 was impacted most significantly by the change in operating lease liabilities due to the adoption of the new lease accounting standard under ASC 842. No other changes in our working capital were significant as increases in inventory for new store growth were offset by a slight reduction in average inventory per store.

Debt

The following table summarizes the Company’s outstanding debt as of the dates indicated (in millions):

						December 28, 2019						December 29, 2018
Senior Notes						$	150.0					$	150.0
Senior Credit Facility:
February 2016 Term Loan						145.0						165.0
June 2017 Term Loan						87.5						93.8
Revolving credit loans						15.0						—
Total outstanding borrowings						397.5						408.8
Less: unamortized debt issuance costs						(1.0)						(1.4)
Total debt						396.5						407.4
Less: current portion of long-term debt						(30.0)						(26.3)
Long-term debt						$	366.5					$	381.1
Outstanding letters of credit						$	32.0					$	33.5

For additional information about the Company’s debt and credit facilities, refer to Note 4 to the Consolidated Financial Statements. As further described in Note 5 to the Consolidated Financial Statements, the Company has entered into interest rate swap agreements in order to hedge our exposure to variable rate interest payments associated with each of the term loans under the Senior Credit Facility.

Index

Sources and Uses of Cash

Our primary source of liquidity is cash provided by operations and funds available under our debt facilities. Principal uses of cash for investing activities are capital expenditures while principal 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 provided by or used in operating, investing, and financing activities for fiscal years 2019, 2018, and 2017 (in millions):

			Fiscal Year
			2019						2018						2017
			(52 weeks)						(52 weeks)						(52 weeks)
Net cash provided by operating activities			$	811.7					$	694.4					$	631.5
Net cash used in investing activities			(215.0)						(276.3)						(238.0)
Net cash used in financing activities			(598.8)						(440.9)						(338.3)
Net (decrease) increase in cash and cash equivalents			$	(2.1)					$	(22.8)					$	55.2

Operating Activities

Operating activities provided net cash of $811.7 million, $694.4 million, and $631.5 million in fiscal 2019, 2018, and 2017, respectively. The $117.3 million increase in net cash provided by operating activities in fiscal 2019, compared to fiscal 2018, was due to changes in the following (in millions):

			Fiscal Year																		Variance
			2019						2018
			(52 weeks)						(52 weeks)
Net income			$	562.4					$	532.4					$	30.0
Depreciation and amortization			196.0						177.4						18.6
Share-based compensation expense			31.1						28.9						2.2
Deferred income taxes			6.8						11.9						(5.1)
Inventories and accounts payable			9.8						(92.9)						102.7
Prepaid expenses and other current assets			13.6						(26.2)						39.8
Accrued expenses			(3.9)						58.8						(62.7)
Income taxes			8.3						(8.4)						16.7
Other, net			(12.4)						12.5						(24.9)
Net cash provided by operating activities			$	811.7					$	694.4					$	117.3

The $117.3 million increase in net cash provided by operating activities in fiscal 2019, compared to fiscal 2018, is primarily driven by the fluctuation in our inventory, net of accounts payable, as a result of a slight decrease in our average inventory per store based on selling trends year-over-year. The increase in net cash provided by operating activities was also affected to a lesser extent by incremental profitability from Company growth and the net impact of changes in our operating assets and liabilities which fluctuated due primarily to the timing of payments.

Index

The $62.9 million increase in net cash provided by operating activities in fiscal 2018, as compared to fiscal 2017, was due to changes in the following (in millions):

			Fiscal Year																		Variance
			2018						2017
			(52 weeks)						(52 weeks)
Net income			$	532.4					$	422.6					$	109.8
Depreciation and amortization			177.4						165.8						11.6
Share-based compensation expense			28.9						29.2						(0.3)
Deferred income taxes			11.9						26.7						(14.8)
Inventories and accounts payable			(92.9)						(26.5)						(66.4)
Prepaid expenses and other current assets			(26.2)						2.3						(28.5)
Accrued expenses			58.8						(3.9)						62.7
Income taxes			(8.4)						4.2						(12.6)
Other, net			12.5						11.1						1.4
Net cash provided by operating activities			$	694.4					$	631.5					$	62.9

The $62.9 million increase in net cash provided by operating activities in fiscal 2018, compared with fiscal 2017, primarily reflects incremental profitability, partially offset by the increase in inventory, net of accounts payable, to support new store growth and the net impact of changes in our operating assets and liabilities which fluctuated due primarily to new store growth and the timing of payments.

Investing Activities

Investing activities used cash of $215.0 million, $276.3 million, and $238.0 million in fiscal 2019, 2018, and 2017, respectively. Cash flows from investing activities in the years presented are primarily composed of capital expenditures. Capital expenditures for fiscal 2019, 2018, and 2017 were as follows (in millions):

			Fiscal Year
			2019						2018						2017
			(52 weeks)						(52 weeks)						(52 weeks)
Information technology			$	89.3					$	86.7					$	82.1
New and relocated stores and stores not yet opened			59.3						68.0						79.3
Existing stores			45.5						41.5						43.0
Distribution center capacity and improvements			19.7						82.0						45.8
Corporate and other			3.7						0.3						0.2
Total capital expenditures			$	217.5					$	278.5					$	250.4

The sustained levels of spending on information technology represents continued support of our store growth and our omni-channel initiatives, as well as improvements in security and compliance, enhancements to our customer relationship management program, and other strategic initiatives.

The above table reflects an investment in 80 new Tractor Supply stores, eight new Petsense stores, and two store relocations during fiscal 2019. In fiscal 2018, we opened 80 new Tractor Supply stores, 18 new Petsense stores, and had four store relocations. In fiscal 2017, we opened 101 new Tractor Supply stores and 25 Petsense stores and had three store relocations. Spending on existing stores principally reflects routine refresh activity.

Spending for distribution center capacity and improvements decreased in fiscal 2019 compared to fiscal 2018 and 2017 related to the completion of construction of the new northeast distribution center in Frankfort, New York, and the expansion of our distribution center in Waverly, Nebraska. The new northeast distribution center in Frankfort, New York was completed and began shipping merchandise to our stores in the first quarter of fiscal 2019. The expansion of the Waverly, Nebraska distribution center was completed during fiscal 2018.

Index

Our projected capital expenditures for fiscal 2020 principally include a plan to open approximately 80 new Tractor Supply stores and 10 to 15 new Petsense stores, continued improvements in technology and infrastructure at our existing stores, and ongoing investments to enhance our digital and omni-channel capabilities to better serve our customers.

Financing Activities

Financing activities used cash of $598.8 million, $440.9 million, and $338.3 million in fiscal 2019, 2018, and 2017, respectively. The $157.9 million increase in net cash used in financing activities in fiscal 2019, compared to fiscal 2018, was due to changes in the following (in millions):

			Fiscal Year
			2019						2018						Variance
			(52 weeks)						(52 weeks)
Net borrowings and repayments under debt facilities			$	(11.3)					$	(18.8)					$	7.5
Repurchase of common stock			(533.3)						(349.8)						(183.5)
Net proceeds from issuance of common stock			116.0						79.6						36.4
Cash dividends paid to stockholders			(162.7)						(147.1)						(15.6)
Other, net			(7.5)						(4.8)						(2.7)
Net cash used in financing activities			$	(598.8)					$	(440.9)					$	(157.9)

The increase in net cash used in financing activities in fiscal 2019, compared to fiscal 2018, principally reflects an increase in repurchases of common stock and, to a lesser extent, increased quarterly cash dividends, partially offset by an increase in net proceeds from the issuance of common stock associated with the exercise of share-based compensation awards.

The $102.6 million increase in net cash used in financing activities in fiscal 2018, compared to fiscal 2017, was due to changes in the following (in millions):

			Fiscal Year
			2018						2017						Variance
			(52 weeks)						(52 weeks)
Net borrowings and repayments under debt facilities			$	(18.8)					$	152.5					$	(171.3)
Repurchase of common stock			(349.8)						(369.4)						19.6
Net proceeds from issuance of common stock			79.6						16.3						63.3
Cash dividends paid to stockholders			(147.1)						(133.8)						(13.3)
Other, net			(4.8)						(3.9)						(0.9)
Net cash used in financing activities			$	(440.9)					$	(338.3)					$	(102.6)

The increase in net cash used in financing activities in fiscal 2018, as compared to fiscal 2017, is largely due to a decrease in borrowings, net of repayments, under our debt facilities, partially offset by an increase in proceeds from the issuance of common stock associated with the exercise of share-based compensation awards.

Repurchase of Common Stock

The Company’s Board of Directors has authorized common stock repurchases under a share repurchase program of up to $4.5 billion, exclusive of any fees, commissions or other expenses related to such repurchases. 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 5.4 million, 5.0 million, and 5.9 million shares of common stock under the share repurchase program at a total cost of $533.3 million, $349.8 million, and $369.4 million in fiscal 2019, 2018, and 2017, respectively. As of December 28, 2019, the Company had remaining authorization under the share repurchase program of $1.49 billion, exclusive of any fees, commissions, or other expenses.

Index

Cash Dividends Paid to Stockholders

We paid cash dividends totaling $162.7 million, $147.1 million, and $133.8 million in fiscal 2019, 2018, and 2017, respectively. In fiscal 2019, we declared and paid cash dividends to stockholders of $1.36 per common share outstanding as compared to $1.20 and $1.05 per common share outstanding in fiscal 2018 and fiscal 2017, respectively. These payments reflect an increase in the quarterly dividend in the second quarter of fiscal 2019 to $0.35 per share from $0.31 per share and an increase in the quarterly dividend in the second quarter of fiscal 2018 from $0.27 per share.

It is the present intention of the Company’s Board of Directors to continue to pay a quarterly cash dividend; however, the declaration and payment of future dividends will be determined by the Company’s Board of Directors in its sole discretion and will depend upon the earnings, financial condition, and capital needs of the Company, along with any other factors which the Company’s Board of Directors deem relevant.

Significant Contractual Obligations and Commercial Commitments

The following table reflects our future obligations and commitments as of December 28, 2019 (in thousands):

						Payment Due by Period
						Total						2020						2021-2022						2023-2024						Thereafter
Operating leases (a) (b)						$	2,786,223					$	369,079					$	677,435					$	570,038					$	1,169,671
Finance leases (b)						44,638						5,663						10,324						6,833						21,818
Long-term debt (c)						461,162						55,421						218,957						11,100						175,684
						$	3,292,023					$	430,163					$	906,716					$	587,971					$	1,367,173

(a) Operating lease payments exclude $212.8 million of legally binding minimum lease payments for leases signed, but not yet commenced.

(b) Operating and finance lease obligations both include related interest.

(c) Long-term debt obligations include an estimate of related interest after consideration of the interest rate swap agreements. See Notes 4 and 5 to the Consolidated Financial Statements for additional information regarding our interest rates.

At December 28, 2019, there were $32.0 million outstanding letters of credit under the 2016 Senior Credit Facility.

Off-Balance Sheet Arrangements

Our off-balance sheet arrangements are limited to lease agreements signed but not yet commenced and outstanding letters of credit. The balances for these arrangements are previously discussed. Letters of credit allow us to purchase inventory, primarily sourced overseas, in a timely manner and support certain risk management programs.

New Accounting Pronouncements

The Company adopted new lease accounting guidance in the first quarter of fiscal 2019 which had a material impact on our Consolidated Balance Sheets and related disclosures. For additional information, including the required disclosures, related to the impact of adopting this new accounting guidance, see Note 1, Note 6, and Note 14 to the Consolidated Financial Statements.

Refer to Note 14 to the Consolidated Financial Statements for recently adopted accounting pronouncements and recently issued pronouncements not yet adopted as of December 28, 2019.

Index