filings.toolsItem 8. . Financial Statements and Supplementary Data
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Item 8. . Financial Statements and Supplementary Data
INDEX
TRACTOR SUPPLY COMPANY
Management’s Report on Internal Control Over Financial Reporting
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 25, 2021. 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 25, 2021, 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/ Harry A. Lawton, III | /s/ Kurt D. Barton | |||||||||||||
| Harry A. Lawton, III President and Chief Executive Officer | Kurt D. Barton Executive Vice President - Chief Financial Officer and Treasurer | |||||||||||||
| February 17, 2022 | February 17, 2022 |
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Tractor Supply Company
Opinion on Internal Control Over Financial Reporting
We have audited Tractor Supply Company’s internal control over financial reporting as of December 25, 2021, 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). In our opinion, Tractor Supply Company (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 25, 2021, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Consolidated Balance Sheets of Tractor Supply Company as of December 25, 2021 and December 26, 2020, and the related Consolidated Statements of Income, Comprehensive Income, Stockholders’ Equity, and Cash Flows for each of the three fiscal years in the period ended December 25, 2021, and the related notes and our report dated February 17, 2022, expressed an unqualified opinion thereon.
Basis for Opinion
The 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 are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. 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.
Definition and Limitations of Internal Control Over Financial Reporting
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.
/s/ Ernst & Young LLP
Nashville, Tennessee
February 17, 2022
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Tractor Supply Company
Opinion on the Financial Statements
We have audited the accompanying Consolidated Balance Sheets of Tractor Supply Company (the Company) as of December 25, 2021 and December 26, 2020, the related Consolidated Statements of Income, Comprehensive Income, Stockholders’ Equity and Cash Flows for each of the three fiscal years in the period ended December 25, 2021, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 25, 2021 and December 26, 2020, and the results of its operations and its cash flows for each of the three fiscal years in the period ended December 25, 2021, 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) (PCAOB), the Company’s internal control over financial reporting as of December 25, 2021, 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 17, 2022, expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
| Estimate of Workers' Compensation Self-Insurance Reserves | |||||
| Description of the Matter | At December 25, 2021, the Company’s reserve for workers’ compensation self-insurance risks was $67.1 million. As discussed in Note 1 of the consolidated financial statements, the Company retains a significant portion of risk for its workers’ compensation exposures. Accordingly, provisions are recorded based upon periodic estimates of such losses, as determined by management. The future claim costs for workers’ compensation exposures are estimated using actuarial methods that consider assumptions for a number of factors including, but not limited to, historical claims experience, loss development factors, and severity factors. | ||||
| Auditing management’s estimate of the recorded workers’ compensation self-insurance reserves was complex and judgmental due to the significant assumptions and judgments required by management to project the exposure on incurred claims that remain unresolved, including those which have not yet been reported to the Company. | |||||
| How We Addressed the Matter in Our Audit | We obtained an understanding, evaluated the design, and tested the operating effectiveness of controls over the Company’s accounting for worker’ compensation self-insurance exposures. For example, we tested controls over the appropriateness of management’s review of the significant assumptions described above, including the completeness and accuracy of the underlying data, as well as management’s review of the actuarial calculations. | ||||
| To test the Company’s estimate of the workers’ compensation self-insurance reserves, we performed audit procedures that included, among others, assessing the appropriateness of the actuarial valuation methodologies utilized by management and the significant assumptions within, testing the related underlying data used by the Company in its evaluation for completeness and accuracy, and testing the mathematical accuracy of the calculations. Our audit procedures also included, among others, comparing the significant assumptions used by management to industry accepted actuarial assumptions and reassessing the accuracy of management’s historical estimates utilized in prior period evaluations. We involved our actuarial valuation specialists to assist in assessing the valuation methodologies and significant assumptions noted above and to develop an independent range of estimates for the workers’ compensation self-insurance reserves which were then compared to management’s estimates. |
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2001.
Nashville, Tennessee
February 17, 2022
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| (52 weeks) | (52 weeks) | (52 weeks) | |||||||||||||||
| Net sales | $ | 12,731,105 | $ | 10,620,352 | $ | 8,351,931 | |||||||||||
| Cost of merchandise sold | 8,253,952 | 6,858,803 | 5,480,161 | ||||||||||||||
| Gross profit | 4,477,153 | 3,761,549 | 2,871,770 | ||||||||||||||
| Selling, general and administrative expenses | 2,900,297 | 2,478,524 | 1,932,572 | ||||||||||||||
| Depreciation and amortization | 270,158 | 217,124 | 195,978 | ||||||||||||||
| Impairment of goodwill and other intangible assets | — | 68,973 | — | ||||||||||||||
| Operating income | 1,306,698 | 996,928 | 743,220 | ||||||||||||||
| Interest expense, net | 26,610 | 28,781 | 19,843 | ||||||||||||||
| Income before income taxes | 1,280,088 | 968,147 | 723,377 | ||||||||||||||
| Income tax expense | 282,974 | 219,189 | 161,023 | ||||||||||||||
| Net income | $ | 997,114 | $ | 748,958 | $ | 562,354 | |||||||||||
| Net income per share – basic | $ | 8.69 | $ | 6.44 | $ | 4.70 | |||||||||||
| Net income per share – diluted | $ | 8.61 | $ | 6.38 | $ | 4.66 | |||||||||||
| Weighted average shares outstanding | |||||||||||||||||
| Basic | 114,794 | 116,370 | 119,727 | ||||||||||||||
| Diluted | 115,824 | 117,436 | 120,743 | ||||||||||||||
| Dividends declared per common share outstanding | $ | 2.08 | $ | 1.50 | $ | 1.36 |
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| (52 weeks) | (52 weeks) | (52 weeks) | |||||||||||||||
| Net income | $ | 997,114 | $ | 748,958 | $ | 562,354 | |||||||||||
| Other comprehensive income/(loss): | |||||||||||||||||
| Change in fair value of interest rate swaps, net of taxes | 4,588 | (3,442) | (4,332) | ||||||||||||||
| Total other comprehensive income/(loss) | 4,588 | (3,442) | (4,332) | ||||||||||||||
| Total comprehensive income | $ | 1,001,702 | $ | 745,516 | $ | 558,022 |
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 25, 2021 | December 26, 2020 | ||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | 878,030 | 1,341,756 | |||||||||
| Inventories | 2,191,192 | 1,783,270 | |||||||||
| Prepaid expenses and other current assets | 164,118 | 133,659 | |||||||||
| Income taxes receivable | 17,100 | — | |||||||||
| Total current assets | 3,250,440 | 3,258,685 | |||||||||
| Property and equipment, net | 1,617,806 | 1,248,960 | |||||||||
| Operating lease right-of-use assets | 2,785,858 | 2,423,881 | |||||||||
| Goodwill and other intangible assets | 55,520 | 55,520 | |||||||||
| Deferred income taxes | 2,437 | 31,586 | |||||||||
| Other assets | 55,406 | 30,484 | |||||||||
| Total assets | $ | 7,767,467 | $ | 7,049,116 | |||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | 1,155,630 | $ | 976,096 | |||||||
| Accrued employee compensation | 109,618 | 119,701 | |||||||||
| Other accrued expenses | 474,412 | 324,813 | |||||||||
| Current portion of finance lease liabilities | 3,897 | 4,554 | |||||||||
| Current portion of operating lease liabilities | 321,285 | 298,696 | |||||||||
| Income taxes payable | — | 19,938 | |||||||||
| Total current liabilities | 2,064,842 | 1,743,798 | |||||||||
| Long-term debt | 986,382 | 984,324 | |||||||||
| Finance lease liabilities, less current portion | 32,848 | 33,096 | |||||||||
| Operating lease liabilities, less current portion | 2,574,882 | 2,220,904 | |||||||||
| Other long-term liabilities | 105,848 | 143,154 | |||||||||
| Total liabilities | 5,764,802 | 5,125,276 | |||||||||
| Stockholders’ equity: | |||||||||||
| Common stock | 1,411 | 1,401 | |||||||||
| Additional paid-in capital | 1,210,512 | 1,095,500 | |||||||||
| Treasury stock | (4,155,846) | (3,356,953) | |||||||||
| Accumulated other comprehensive income/(loss) | 1,345 | (3,243) | |||||||||
| Retained earnings | 4,945,243 | 4,187,135 | |||||||||
| Total stockholders’ equity | 2,002,665 | 1,923,840 | |||||||||
| Total liabilities and stockholders’ equity | $ | 7,767,467 | $ | 7,049,116 |
Preferred Stock (shares in thousands): $1.00 par value; 40 shares authorized; no shares were issued or outstanding during any period presented.
Common Stock (shares in thousands): $0.008 par value; 400,000 shares authorized at all periods presented. 176,371 and 175,128 shares issued; 113,125 and 116,246 shares outstanding at December 25, 2021 and December 26, 2020, respectively.
Treasury Stock (at cost, shares in thousands): 63,246 and 58,882 shares at December 25, 2021 and December 26, 2020, respectively.
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 | Accum. Other Comp. Income | Retained Earnings | Total Stockholders’ Equity | ||||||||||||||||||||||||||||||||||||
| Shares | Dollars | ||||||||||||||||||||||||||||||||||||||||
| Stockholders' equity at December 29, 2018 | 121,828 | $ | 1,375 | $ | 823,413 | $ | (2,480,677) | $ | 3,814 | $ | 3,213,895 | $ | 1,561,820 | ||||||||||||||||||||||||||||
| Common stock issuance under stock award plans & ESPP | 1,721 | 14 | 115,967 | 115,981 | |||||||||||||||||||||||||||||||||||||
| Share-based compensation expense | 31,136 | 31,136 | |||||||||||||||||||||||||||||||||||||||
| Repurchase of shares to satisfy tax obligations | (3,818) | (3,818) | |||||||||||||||||||||||||||||||||||||||
| Repurchase of common stock | (5,384) | (533,319) | (533,319) | ||||||||||||||||||||||||||||||||||||||
| Cash dividends paid to stockholders | (162,699) | (162,699) | |||||||||||||||||||||||||||||||||||||||
| Change in fair value of interest rate swaps, net of taxes | (4,332) | (4,332) | |||||||||||||||||||||||||||||||||||||||
| Net income | 562,354 | 562,354 | |||||||||||||||||||||||||||||||||||||||
| Reclassification of stranded tax effects as a result of ASU 2018-02 adoption | 717 | (717) | — | ||||||||||||||||||||||||||||||||||||||
| Stockholders' equity at December 28, 2019 | 118,165 | 1,389 | 966,698 | (3,013,996) | 199 | 3,612,833 | 1,567,123 | ||||||||||||||||||||||||||||||||||
| Common stock issuance under stock award plans & ESPP | 1,520 | 12 | 99,328 | 99,340 | |||||||||||||||||||||||||||||||||||||
| Share-based compensation expense | 37,273 | 37,273 | |||||||||||||||||||||||||||||||||||||||
| Repurchase of shares to satisfy tax obligations | (7,799) | (7,799) | |||||||||||||||||||||||||||||||||||||||
| Repurchase of common stock | (3,439) | (342,957) | (342,957) | ||||||||||||||||||||||||||||||||||||||
| Cash dividends paid to stockholders | (174,656) | (174,656) | |||||||||||||||||||||||||||||||||||||||
| Change in fair value of interest rate swaps, net of taxes | (3,442) | (3,442) | |||||||||||||||||||||||||||||||||||||||
| Net income | 748,958 | 748,958 | |||||||||||||||||||||||||||||||||||||||
| Stockholders' equity at December 26, 2020 | 116,246 | 1,401 | 1,095,500 | (3,356,953) | (3,243) | 4,187,135 | 1,923,840 | ||||||||||||||||||||||||||||||||||
| Common stock issuance under stock award plans & ESPP | 1,243 | 10 | 82,239 | 82,249 | |||||||||||||||||||||||||||||||||||||
| Share-based compensation expense | 47,649 | 47,649 | |||||||||||||||||||||||||||||||||||||||
| Repurchase of shares to satisfy tax obligations | (14,876) | (14,876) | |||||||||||||||||||||||||||||||||||||||
| Repurchase of common stock | (4,364) | (798,893) | (798,893) | ||||||||||||||||||||||||||||||||||||||
| Cash dividends paid to stockholders | (239,006) | (239,006) | |||||||||||||||||||||||||||||||||||||||
| Change in fair value of interest rate swaps, net of taxes | 4,588 | 4,588 | |||||||||||||||||||||||||||||||||||||||
| Net income | 997,114 | 997,114 | |||||||||||||||||||||||||||||||||||||||
| Stockholders' equity at December 25, 2021 | 113,125 | $ | 1,411 | $ | 1,210,512 | $ | (4,155,846) | $ | 1,345 | $ | 4,945,243 | $ | 2,002,665 |
The accompanying notes are an integral part of these Consolidated Financial Statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| (52 weeks) | (52 weeks) | (52 weeks) | |||||||||||||||
| Cash flows from operating activities: | |||||||||||||||||
| Net income | $ | 997,114 | $ | 748,958 | $ | 562,354 | |||||||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||||||||
| Depreciation and amortization | 270,158 | 217,124 | 195,978 | ||||||||||||||
| Impairment of goodwill and other intangible assets | — | 68,973 | — | ||||||||||||||
| Impairment of other long-lived assets | — | 5,078 | — | ||||||||||||||
| Loss/(gain) on disposition of property and equipment | 4,045 | (1,157) | (297) | ||||||||||||||
| Share-based compensation expense | 47,649 | 37,273 | 31,136 | ||||||||||||||
| Deferred income taxes | 29,149 | (31,739) | 6,760 | ||||||||||||||
| Change in assets and liabilities: | |||||||||||||||||
| Inventories | (407,922) | (180,489) | (13,239) | ||||||||||||||
| Prepaid expenses and other current assets | (30,459) | (32,794) | 13,582 | ||||||||||||||
| Accounts payable | 179,534 | 333,060 | 23,055 | ||||||||||||||
| Accrued employee compensation | (10,083) | 79,946 | (14,291) | ||||||||||||||
| Other accrued expenses | 137,833 | 72,405 | 10,351 | ||||||||||||||
| Income taxes | (37,038) | 13,954 | 8,327 | ||||||||||||||
| Other | (41,260) | 63,923 | (12,000) | ||||||||||||||
| Net cash provided by operating activities | 1,138,720 | 1,394,515 | 811,716 | ||||||||||||||
| Cash flows from investing activities: | |||||||||||||||||
| Capital expenditures | (628,431) | (294,002) | (217,450) | ||||||||||||||
| Proceeds from sale of property and equipment | 1,091 | 1,792 | 2,489 | ||||||||||||||
| Net cash used in investing activities | (627,340) | (292,210) | (214,961) | ||||||||||||||
| Cash flows from financing activities: | |||||||||||||||||
| Borrowings under debt facilities | — | 2,009,000 | 1,002,000 | ||||||||||||||
| Repayments under debt facilities | — | (1,406,500) | (1,013,250) | ||||||||||||||
| Debt discounts and issuance costs | — | (17,048) | — | ||||||||||||||
| Principal payments under finance lease liabilities | (4,580) | (4,170) | (3,708) | ||||||||||||||
| Repurchase of shares to satisfy tax obligations | (14,876) | (7,799) | (3,818) | ||||||||||||||
| Repurchase of common stock | (798,893) | (342,957) | (533,319) | ||||||||||||||
| Net proceeds from issuance of common stock | 82,249 | 99,340 | 115,981 | ||||||||||||||
| Cash dividends paid to stockholders | (239,006) | (174,656) | (162,699) | ||||||||||||||
| Net cash (used in)/provided by financing activities | (975,106) | 155,210 | (598,813) | ||||||||||||||
| Net (decrease)/increase in cash and cash equivalents | (463,726) | 1,257,515 | (2,058) | ||||||||||||||
| Cash and cash equivalents at beginning of period | 1,341,756 | 84,241 | 86,299 | ||||||||||||||
| Cash and cash equivalents at end of period | $ | 878,030 | $ | 1,341,756 | $ | 84,241 | |||||||||||
| Supplemental disclosures of cash flow information: | |||||||||||||||||
| Cash paid during the period for: | |||||||||||||||||
| Interest | $ | 23,601 | $ | 24,540 | $ | 19,146 | |||||||||||
| Income taxes | 291,665 | 235,319 | 144,377 | ||||||||||||||
| Supplemental disclosures of non-cash activities: | |||||||||||||||||
| Non-cash accruals for property and equipment | $ | 24,408 | $ | 12,642 | $ | 7,924 | |||||||||||
| Increase of operating lease assets and liabilities from new or modified leases | 678,092 | 524,141 | 365,233 | ||||||||||||||
| Increase of finance lease assets and liabilities from new or modified leases | 3,675 | 7,395 | 5,217 | ||||||||||||||
| Operating lease assets and liabilities recognized upon adoption of ASC 842 | — | — | 2,084,880 |
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
Founded in 1938, Tractor Supply Company (the “Company” or "Tractor Supply" 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). The Company's stores are located primarily in towns outlying major metropolitan markets and in rural communities. The Company also owns and operates Petsense, LLC (“Petsense”), a small-box pet specialty supply retailer focused on meeting the needs of pet owners, primarily in small and mid-sized communities, and offering a variety of pet products and services. At December 25, 2021, the Company operated a total of 2,181 retail stores in 49 states (2,003 Tractor Supply and Del’s retail stores and 178 Petsense retail stores) and also offered an expanded assortment of products through the Tractor Supply Company mobile application and online at TractorSupply.com and Petsense.com.
On February 17, 2021, the Company announced that it entered into an agreement to acquire all of the outstanding equity interests of Orscheln Farm and Home, LLC, a farm and ranch retailer with 167 retail stores in 11 states, in an all-cash transaction for approximately $320 million. The Company intends to fund the acquisition through cash-on-hand. The acquisition is conditioned on the receipt of regulatory clearance and the satisfactory completion of customary closing conditions within a specified timeframe.
Basis of Presentation
The accompanying Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and the rules and regulations of the Securities and Exchange Commission ("SEC").
COVID-19 Pandemic
The COVID-19 pandemic has created significant public health concerns as well as economic disruption, uncertainty, and
volatility which may negatively affect our business operations. As a result, as the pandemic persists and/or if it worsens, our accounting estimates and assumptions could be impacted in subsequent periods, and it is reasonably possible such changes could be significant.
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 25, 2021, December 26, 2020, and December 28, 2019, all 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 U.S. GAAP 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 typically performs physical inventories at least once a year for each store that has been open more than 12 months, 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.
The Company assessed the risks associated with the stores not inventoried and concluded there is no material risk of misstatement to the financial statements for the stores not inventoried and further concluded that effective compensating controls are in place to ensure completeness and accuracy of reported inventory balances and estimated shrink losses.
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 sold 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.
Self-Insurance Reserves
The Company self-insures a significant portion of its workers’ compensation 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. 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 $500,000. 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 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, loss development 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 25, 2021, the Company had insurance reserves for workers' compensation of $67.1 million compared to $55.0 million at December 26, 2020. Insurance reserves for general liability plans was $41.3 million at December 25, 2021 compared to $31.7 million at December 26, 2020. In addition, insurance receivables recorded in Other assets on the Consolidated Balance Sheets for claims greater than our insurance stop-loss limits were $14.9 million and $11.2 million as of December 25, 2021 and December 26, 2020.
Impairment of Long-Lived Assets
Long-lived assets, including lease right-of-use 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, the Company first compares 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, the Company calculates 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. 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 2021 or 2019 related to long-lived assets. In fiscal 2020, we recognized $5.1 million of impairment charges related to long-lived assets for Petsense stores. Impairment charges, if recognized, are included in selling, general and administrative (“SG&A”) expenses in the Consolidated Statements of Income.
Impairment of 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. Our annual impairment evaluation is conducted on the first day of our fiscal fourth quarter.
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.
No impairment charges were recognized in fiscal 2021 or 2019 related to indefinite-lived intangible assets. As described in further detail in Note 3 to the Consolidated Financial Statements, in fiscal 2020 we recognized goodwill impairment of $60.8 million and trade name asset impairment of $8.2 million related to Petsense. Impairment charges, if recognized, are included as a separate line item within 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 agency on a periodic basis. These taxes and fees 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. The Company had a liability for sales returns of $17.9 million and $14.2 million as of December 25, 2021 and December 26, 2020, respectively.
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 $4.2 million, $3.6 million, and $3.0 million in fiscal 2021, 2020, and 2019, respectively.
Cost of Merchandise Sold
Cost of merchandise sold includes the total cost of products sold; freight and duty expenses associated with moving merchandise inventories from vendors to distribution facilities, from distribution facilities to retail stores, from one distribution facility to another, and directly to our customers; tariffs on imported products; 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; share-based compensation expenses; 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 digital and social media offerings, television, newspaper circulars, and customer-targeted direct e-mail and direct mail, as well as limited events through radio and other media channels. 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 were approximately $95.4 million, $100.9 million, and $86.6 million for fiscal 2021, 2020, and 2019, respectively. Prepaid advertising costs were approximately $1.7 million and $1.6 million as of December 25, 2021, and December 26, 2020, 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 were approximately $367.4 million, $292.6 million, and $231.5 million for fiscal 2021, 2020, and 2019, 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 $10.4 million, $8.6 million, and $8.1 million for fiscal 2021, 2020, and 2019, respectively.
Share-Based Compensation
The Company has share-based compensation plans covering certain members of management and non-employee directors, which include non-qualified stock options, restricted stock units, and performance-based restricted share units. Performance-based restricted share units are subject to performance conditions that include both Company and market performance. In addition, the Company offers an Employee Stock Purchase Plan (“ESPP”) to eligible employees.
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, expected term and forfeiture rates. The Company relies on historical volatility trends 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.
The forfeiture rate at the time of valuation was estimated based on historical experience for similar options and 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 units is the closing stock price of the Company’s common stock the day preceding the grant date, discounted for the expected dividend yield over the term of the award. The fair value of the Company's performance-based restricted share units is estimated using a Monte Carlo simulation model on the grant date. Key assumptions used in the Monte Carlo simulation include expected volatility, dividend yield and risk-free interest rate.
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.
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.
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.
Net Income Per Share
The Company presents both basic and diluted net income per share on the Consolidated Statements of Income. 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 during the period. Dilutive shares are computed using the treasury stock method for share-based awards. Performance-based restricted share units are included in diluted shares only if the related performance conditions have been considered satisfied as of the end of the reporting period.
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, debt instruments, and interest rate swaps. 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 $1.00 billion in borrowings under our debt facilities (as discussed in Note 4) as of December 25, 2021 and December 26, 2020. Based on current market interest rates (Level 2 inputs), the carrying value of our borrowings under our debt facilities approximates fair value for each period reported. The fair value of the Company’s interest rate swaps is determined based on the present value of expected future cash flows using forward rate curves (a Level 2 input). The fair value of the interest rate swaps, excluding accrued interest, was a net asset of $1.8 million and net liability $4.4 million as of December 25, 2021 and December 26, 2020, respectively.
Derivative Financial Instruments
The Company accounts for derivative financial instruments in accordance with applicable accounting standards for such instruments and hedging activities, which require that all derivatives are recorded on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting.
Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge a certain portion of its risk, even though hedge accounting does not apply or the Company elects not to apply the hedge accounting standards.
The fair value of the interest rate swaps, excluding accrued interest, was a net asset of $1.8 million and net liability $4.4 million as of December 25, 2021 and December 26, 2020, respectively.
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, duties, and tariffs. Inventories are net of shrinkage, obsolescence, other valuations, and vendor allowances.
Property and Equipment
Property and equipment are initially recorded 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 remaining term of the lease or the useful life of the improvement, whichever is less. The following table summarizes the Company's property and equipment balances and includes the estimated useful lives which are generally applied (in thousands, except estimated useful lives):
| Estimated Useful Lives | December 25, 2021 | December 26, 2020 | |||||||||||||||
| Land | $ | 100,129 | $ | 100,138 | |||||||||||||
| Buildings and improvements | 1 – 35 years | 1,517,052 | 1,319,559 | ||||||||||||||
| Furniture, fixtures and equipment | 5 – 10 years | 900,272 | 773,178 | ||||||||||||||
| Computer software and hardware | 2 – 7 years | 694,455 | 563,509 | ||||||||||||||
| Construction in progress | 211,486 | 73,950 | |||||||||||||||
| Property and equipment, gross | 3,423,394 | 2,830,334 | |||||||||||||||
| Accumulated depreciation and amortization | (1,805,588) | (1,581,374) | |||||||||||||||
| Property and equipment, net | $ | 1,617,806 | $ | 1,248,960 |
The Company entered into agreements with various governmental entities in the states of Kentucky, Georgia, Ohio 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), its distribution center in Navarre, Ohio (Stark 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 25, 2021:
| 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 | $58.0 | |||||||||||||||||
| Brentwood, Tennessee Store Support Center | 10 years | $78.0 | $75.3 | |||||||||||||||||
| Navarre, Ohio Distribution Center | 30 years | $90.0 | $— |
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 two to seven years. Computer software consists of software developed for internal-use and 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 property and equipment in the accompanying Consolidated Balance Sheets. Certain software costs not meeting the criteria for capitalization are expensed as incurred.
Store Closing Costs
The Company regularly evaluates the performance of its stores and periodically closes those stores that are underperforming. 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 the results of operations for any of the fiscal years presented.
Leases
Operating lease assets and liabilities are recognized at the lease commencement date. Operating lease liabilities represent the present value of lease payments not yet paid. Operating lease assets represent our right to use an underlying asset and are based upon the operating lease liabilities adjusted for prepayments or accrued lease payments, initial direct costs, lease incentives, and impairment, if any, of operating lease assets. To determine the present value of lease payments not yet paid, we estimate incremental borrowing rates corresponding to the reasonably certain lease term. As substantially all of our leases do not provide an implicit rate, we estimate our collateralized incremental borrowing rate based upon a Company specific credit rating and yield curve analysis at commencement or modification date in determining the present value of lease payments.
Assets under finance 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.
New Accounting Pronouncements Not Yet Adopted
In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” In January 2021, the FASB issued ASU 2021-01, "Reference Rate Reform (Topic 848): Scope." This collective guidance is in response to accounting concerns regarding contract modifications and hedge accounting because of impending rate reform associated with structural risks of interbank offered rates ("IBOR"s), and, particularly, the risk of cessation of the London Inter-Bank Offer Rate ("LIBOR") related to regulators in several jurisdictions around the world having undertaken reference rate reform initiatives to identify alternative reference rates. The guidance provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The adoption of this guidance is effective for all entities as of March 12, 2020
through December 31, 2022. The primary contract and hedging relationship for which LIBOR is used is our November 2020 Term Loan (as defined below) and related interest rate swap. As the interest rate swap is designed to be a highly effective cash flow hedge against the variable LIBOR rates of the Term Loan, the impact of using LIBOR rates is effectively offset in our financial statements. As such, the Company does not expect the adoption of this guidance to have a material impact on its Condensed Consolidated Financial Statements and related disclosures.
Note 2 – Share-Based Compensation:
Share-based compensation includes stock options, restricted stock units, performance-based restricted share units, and certain transactions under the Company’s ESPP. Share-based compensation expense is recognized based on the grant date fair value of all stock options, restricted stock units, and performance-based restricted share units. Share based compensation expense is also recognized for the value of the 15% discount on shares purchased by employees as a part of the ESPP. The discount under the ESPP represents the difference between the market value on the first day of the purchase period or the market value on the purchase date, whichever is lower, and the employee’s purchase price.
There were no significant modifications to the Company's share-based compensation plans since the adoption of the 2018 Omnibus Incentive Plan (the “2018 Plan”) on May 10, 2018, which replaced the 2009 Stock Incentive Plan. Following the adoption of the 2018 Plan, no further grants may be made under the 2009 Stock Incentive Plan.
Under our share-based compensation plans, awards may be granted to officers, non-employee directors, and other employees. 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 awards will expire no later than ten years from the date of grant. Vesting of awards commences at various anniversary dates following the dates of each grant. Performance-based awards will vest if established performance conditions are met subject to continued employment. Certain performance-based awards are also subject to a market condition such that the actual number of shares vest are further modified based on the achievement of a relative stockholder return modifier. At December 25, 2021, the Company had approximately 9.9 million shares available for future equity awards under the Company’s 2018 Plan.
Share-based compensation expense, including changes in expense for modifications, if any, of awards, was $47.6 million, $37.3 million, and $31.1 million for fiscal 2021, 2020, and 2019, respectively.
Stock Options
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 2021, 2020, and 2019, as well as a summary of the methodology applied to develop each assumption, are as follows:
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| Expected price volatility | 29.8% - 30.3% | 26.7% - 30.0% | 26.4% - 27.6% | ||||||||||||||
| Risk-free interest rate | 0.3% - 1.0% | 0.2% - 1.3% | 1.6% - 2.5% | ||||||||||||||
| Weighted average expected lives (in years) | 4.3 | 4.3 | 4.5 | ||||||||||||||
| Forfeiture rate | 7.0 | % | 7.0 | % | 7.3 | % | |||||||||||
| Dividend yield | 1.5 | % | 1.5 | % | 1.4 | % |
Expected Price Volatility — This is a measure of the amount by which a price has fluctuated or is expected to fluctuate. The Company applies a historical volatility rate. 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. The Company believes the use of historical price volatility provides an appropriate 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 term of the option. An increase in the risk-free interest rate will increase compensation expense.
Weighted Average Expected Term — 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 term 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 term 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:
| Stock Option Activity | Options | Weighted Average Exercise Price | Weighted Average Fair Value | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value **(**in thousands) | |||||||||||||||||||||||||||
| Outstanding at December 26, 2020 | 1,932,410 | 80.44 | 5.8 | $ | 128,411 | |||||||||||||||||||||||||||
| Granted | 248,808 | 145.87 | $ | 30.78 | ||||||||||||||||||||||||||||
| Exercised | (974,878) | 77.63 | ||||||||||||||||||||||||||||||
| Canceled | (38,029) | 106.98 | ||||||||||||||||||||||||||||||
| Outstanding at December 25, 2021 | 1,168,311 | $ | 95.85 | 6.9 | $ | 154,706 | ||||||||||||||||||||||||||
| Exercisable at December 25, 2021 | 598,807 | $ | 77.15 | 5.4 | $ | 90,489 |
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 25, 2021, total unrecognized compensation expense related to non-vested stock options was approximately $8.4 million with a weighted average expense recognition period of 1.8 years.
There were no material modifications to options in fiscal 2021, 2020, or 2019.
Other information relative to options activity during fiscal 2021, 2020, and 2019 is as follows (in thousands):
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| Total fair value of stock options vested | $ | 8,478 | $ | 12,546 | $ | 16,060 | |||||||||||
| Total intrinsic value of stock options exercised | $ | 90,532 | $ | 64,395 | $ | 45,101 |
Restricted Stock Units
The Company issues shares for restricted stock units once vesting occurs and related restrictions lapse. The fair value of the restricted stock units is the closing price of the Company’s common stock the day preceding the grant date, discounted for the expected dividend yield over the term of the award. The units generally vest over a one to three-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, those shares are not issued until a later date. A summary of restricted stock unit activity is presented below:
| Restricted Stock Unit Activity | Restricted Stock Units | Weighted Average Grant Date Fair Value | ||||||||||||
| Restricted at December 26, 2020 | 595,645 | $ | 85.27 | |||||||||||
| Granted | 276,268 | 144.52 | ||||||||||||
| Vested | (305,704) | 82.51 | ||||||||||||
| Forfeited | (42,790) | 118.70 | ||||||||||||
| Restricted at December 25, 2021 | 523,419 | $ | 115.59 |
As of December 25, 2021, total unrecognized compensation expense related to non-vested restricted stock units was approximately $36.4 million with a weighted average expense recognition period of 1.9 years.
There were no material modifications to restricted stock units in fiscal 2021, 2020, or 2019.
Other information relative to restricted stock unit activity during fiscal 2021, 2020, and 2019 is as follows (in thousands):
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| Total grant date fair value of restricted stock units vested and issued | $ | 25,222 | $ | 17,935 | $ | 8,301 | |||||||||||
| Total intrinsic value of restricted stock units vested and issued | $ | 47,136 | $ | 23,011 | $ | 10,623 |
Performance-Based Restricted Share Units
We issue performance-based restricted share units to senior executives that represent shares potentially issuable in the future, subject to the achievement of specified performance goals. The performance metrics for the units are growth in net sales and growth in earnings per diluted share over a specified performance period. The performance metrics for the performance-based restricted share units granted in fiscal 2021 also include a relative total shareholder return ("TSR") modifier such that the actual number of shares that vest at the end of the respective three-year period is determined based on the Company's TSR performance relative to the constituents of the S&P 500 as well as the level of achievement of the performance goals. If the performance targets are achieved, the performance-based restricted share units will be issued based on the achievement level, inclusive of the relative TSR modifier and the grant date fair value, and will cliff vest in full on the third anniversary of the date of the grant. The fair value of the performance-based restricted share units is estimated using a Monte Carlo simulation model on the grant date. Key assumptions used in the Monte Carlo simulation for the performance shares with a TSR modifier granted during fiscal 2021 include an expected volatility of 31.47%, a risk-free interest rate of 0.18% and a compounded dividend yield of 1.13%.
A summary of performance-based restricted share unit activity is presented below:
| Performance-Based Restricted Share Unit Activity | Performance-Based Restricted Share Units | Weighted Average Grant Date Fair Value | |||||||||||||||||||||
| Restricted at December 26, 2020 | 143,268 | $ | 87.94 | ||||||||||||||||||||
| Granted (a) | 60,317 | 148.05 | |||||||||||||||||||||
| Vested | (10,015) | 64.70 | |||||||||||||||||||||
| Forfeited | (6,552) | 104.65 | |||||||||||||||||||||
| Restricted at December 25, 2021 | 187,018 | $ | 107.99 |
(a)Assumes 100% target level achievement of the relative performance targets. The actual number of shares that will be issued, which may be higher or lower than the target, will be determined by the level of achievement of the relative performance targets, inclusive of the TSR modifier.
As of December 25, 2021, total unrecognized compensation expense related to non-vested performance-based restricted share units was approximately $17.4 million with a weighted average expense recognition period of 1.9 years
There were no material modifications to performance-based restricted share units in fiscal 2021, 2020, or 2019.
Other information relative to performance-based restricted share unit activity during fiscal 2021 is as follows (in thousands):
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| Total grant date fair value of performance-based restricted share units vested and issued | $ | 648 | $ | 1,895 | $ | 2,035 | |||||||||||
| Total intrinsic value of performance-based restricted share units vested and issued | $ | 1,538 | $ | 2,826 | $ | 2,666 |
Shares Withheld to Satisfy Tax Withholding Requirements
For the majority of restricted stock units and performance-based restricted share units granted, the number of shares issued on the date the stock awards vest is net of shares withheld by the Company to satisfy the minimum statutory tax withholding requirements, which the Company pays on behalf of its employees. The Company issued 219,723, 186,751, and 103,124 shares as a result of vested restricted stock units and performance-based restricted share units during fiscal 2021, 2020, and 2019, 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 95,996, 81,946, and 41,786 shares withheld to satisfy $14.9 million, $7.8 million, and $3.8 million of employees’ tax obligations during fiscal 2021, 2020, and 2019, respectively.
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 48,446, 63,704, and 61,678 shares of common stock during fiscal 2021, 2020, and 2019, respectively. The total cost related to the ESPP, including the compensation expense calculations, was approximately $1.4 million, $1.4 million, and $1.1 million in fiscal 2021, 2020, and 2019, respectively. There is a maximum of 16.0 million shares of common stock that are reserved under the ESPP. At December 25, 2021, there were approximately 11.8 million remaining shares of common stock reserved for future issuance under the ESPP.
Note 3 – Goodwill and Other Intangible Assets:
Goodwill
The changes in the carrying amount of goodwill by reporting unit for the years ended December 25, 2021 and December 26, 2020 are as follows (in thousands):
| Fiscal Year 2021 | Fiscal Year 2020 | ||||||||||||||||||||||||||||||||||||||||
| Tractor Supply | Petsense | Consolidated | Tractor Supply | Petsense | Consolidated | ||||||||||||||||||||||||||||||||||||
| Balance, beginning of year | $ | 10,258 | $ | 22,161 | $ | 32,419 | $ | 10,258 | $ | 82,934 | $ | 93,192 | |||||||||||||||||||||||||||||
| Impairment expense | — | — | — | — | (60,773) | (60,773) | |||||||||||||||||||||||||||||||||||
| Balance, end of year | $ | 10,258 | $ | 22,161 | $ | 32,419 | $ | 10,258 | $ | 22,161 | $ | 32,419 |
Goodwill is allocated to each identified reporting unit, which is defined as an operating segment or one level below the operating segment. Goodwill is not amortized, but is evaluated for impairment annually and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. The Company's annual impairment evaluation is conducted on the first day of the fiscal fourth quarter.
In the fourth quarter of fiscal 2021, the Company completed its annual impairment assessment of goodwill for all reporting units. As part of this analysis, the Company assessed the current environment to determine if there were any indicators of impairment as a result of the operating conditions resulting from COVID-19 or otherwise and concluded, that while there have been events and circumstances in the macro-environment that have impacted the Company's business, there were no any entity-specific indicators of impairment of goodwill that would require the Company to perform a quantitative impairment assessment. Therefore, there were no impairment charges related to goodwill being recognized in fiscal 2021.
In the fourth quarter of fiscal 2020, the Company identified qualitative indicators of impairment as a result of a strategic reassessment of the Petsense business, including an evaluation of current operations and its future growth outlook due to changing consumer trends within certain identified growth markets, which resulted in a decision to reduce the number of new store openings planned over the long term. The carrying value of goodwill for the Petsense reporting unit is indicative of the expected growth and development of the business. The aforementioned decision to reduce the long-term growth outlook resulted in a downward adjustment of the future financial forecasts for the Petsense business which indicated that impairment of the goodwill asset was a more-likely-than-not outcome.
We conducted a quantitative impairment analysis of the Petsense reporting unit using the income approach. As a result of the quantitative impairment analysis of the Petsense reporting unit, it was determined that the carrying value exceeded the fair value, resulting in a pre-tax impairment loss of approximately $60.8 million in fiscal 2020.
Other Intangible Assets
The Company had approximately $23.1 million of intangible assets other than goodwill at December 25, 2021 and December 26, 2020. The intangible asset balance represents the carrying value of the Petsense trade name, which is not subject to amortization as it has an indefinite useful life on the basis that it is expected to contribute cash flows beyond the foreseeable horizon. The trade name asset is evaluated for impairment annually and whenever events or changes in circumstances indicate the carrying value of the asset may not be recoverable. The Company's annual impairment evaluation is conducted on the first day of the fiscal fourth quarter.
In the fourth quarter of fiscal 2021, the Company completed its annual impairment testing of intangible assets and no impairment was identified. The Company determined that the fair value of the intangible asset was in excess of the carrying value.
In the fourth quarter of fiscal 2020, the aforementioned decision to reduce the long-term growth outlook for Petsense resulted in a downward adjustment of its future financial forecasts which indicated that impairment of the trade name asset was a more-likely-than-not outcome. The Company conducted a quantitative impairment analysis in the fourth quarter of fiscal 2020 using the relief-from-royalty method. As a result of the quantitative impairment analysis, it was determined that the carrying value of the Petsense trade name was in excess of the fair value, resulting in a pre-tax impairment loss of approximately $8.2 million in fiscal 2020.
Note 4 – Debt:
The following table summarizes the Company’s outstanding debt as of the dates indicated (in millions):
| December 25, 2021 | December 26, 2020 | |||||||||||||||||||
| 1.75% Senior Notes due 2030 | $ | 650.0 | $ | 650.0 | ||||||||||||||||
| 3.70% Senior Notes due 2029 | 150.0 | 150.0 | ||||||||||||||||||
| Senior Credit Facility: | ||||||||||||||||||||
| November 2020 Term Loan due 2023 | 200.0 | 200.0 | ||||||||||||||||||
| Revolving credit loans | — | — | ||||||||||||||||||
| Total outstanding borrowings | 1,000.0 | 1,000.0 | ||||||||||||||||||
| Less: unamortized debt discounts and issuance costs | (13.6) | (15.7) | ||||||||||||||||||
| Total debt | 986.4 | 984.3 | ||||||||||||||||||
| Less: current portion of long-term debt | — | — | ||||||||||||||||||
| Long-term debt | $ | 986.4 | $ | 984.3 | ||||||||||||||||
| Outstanding letters of credit | $ | 52.9 | $ | 48.7 |
1.75% Senior Notes due 2030
On October 30, 2020, the Company issued and sold, in a public offering, $650 million in aggregate principal amount of senior unsecured notes due November 1, 2030 bearing interest at 1.75% per annum (the “1.75% Senior Notes”). The entire principal amount of the 1.75% Senior Notes is due in full on November 1, 2030. Interest is payable semi-annually in arrears on each November 1 and May 1. The terms of the 1.750% Notes are governed by an indenture dated as of October 30, 2020 (the “Base Indenture”) between the Company and Regions Bank, as trustee, as amended and supplemented by a first supplemental indenture dated as of October 30, 2020 (the “Supplemental Indenture”) between the Company and Regions Bank, as trustee.
The 1.75% Senior Notes are senior unsecured debt obligations of the Company and will rank equally with the Company’s other senior unsecured liabilities and senior to any future subordinated indebtedness of the Company. The 1.75% Senior Notes are subject to customary covenants restricting the Company’s ability, subject to certain exceptions, to incur debt secured by liens, to enter into sale and leaseback transactions or to merge or consolidate with another entity or sell substantially all of its assets to another person.
At any time prior to August 1, 2030, the Company will have the right, at its option, to redeem the 1.75% Senior Notes, in whole or in part, at any time and from time to time, by paying the greater of 100% of the principal amount of the 1.75% Senior Notes
to be redeemed, or the sum of the present values of the remaining scheduled payments of principal and interest through the par call date, plus, in each case, accrued and unpaid interest to, but not including, the date of redemption. In addition, on or after August 1, 2030, the Company will have the right, at its option, to redeem the 1.75% Senior Notes, in whole or in part, at any time and from time to time, at a redemption price equal to 100% of the principal amount of the 1.75% Senior Notes to be redeemed, plus accrued and unpaid interest to, but not including, the date of redemption.
If a Change of Control Triggering Event (as defined in the Supplemental Indenture) occurs, unless the Company has exercised its right to redeem the 1.75% Senior Notes, holders of the 1.75% Senior Notes may require the Company to repurchase all or any part of such holder’s 1.75% Senior Notes at a purchase price of 101% of the principal amount, plus accrued and unpaid interest, if any, on such 1.75% Senior Notes to, but not including, the purchase date. Upon the occurrence of an event of default with respect to the 1.75% Senior Notes, which includes payment defaults, defaults in the performance of certain covenants, cross defaults, and bankruptcy and insolvency related defaults, the Company’s obligations under the 1.75% Senior Notes may be accelerated, in which case the entire principal amount of the 1.75% Senior Notes would be due and payable immediately.
Senior Note Facility (including 3.70% Senior Notes due 2029)
On August 14, 2017, the Company entered into a note purchase and private shelf agreement (the “Note Purchase Agreement”), as amended from time to time, pursuant to which the Company agreed to sell, in a private placement, $150 million aggregate principal amount of senior unsecured notes due August 14, 2029 bearing interest at 3.70% per annum (the “3.70% Senior Notes”). The entire principal amount of the 3.70% Senior Notes is due in full on August 14, 2029. Interest is payable semi-annually in arrears on each annual and semi-annual anniversary of the issuance date. The obligations under the Note Purchase Agreement are unsecured.
The Company may from time to time issue and sell additional senior unsecured notes (the “Shelf Notes”) pursuant to the Note Purchase Agreement, in an aggregate principal amount of up to $300 million minus the aggregate principal amount of all notes outstanding and issued under the Note Purchase Agreement. The Shelf Notes will have a maturity date of no more than 12 years after the date of original issuance and may be issued through November 4, 2023, unless earlier terminated in accordance with the terms of the Note Purchase Agreement.
Pursuant to the Note Purchase Agreement, the 3.70% Senior Notes and any Shelf Notes (collectively, the "Senior Note Facility") are redeemable by the Company, in whole at any time or in part from time to time, at 100% of the principal amount of the Senior Note Facility being redeemed, together with accrued and unpaid interest thereon and a make whole amount calculated by discounting all remaining scheduled payments on the Senior Note Facility by the yield on the U.S. Treasury security with a maturity equal to the remaining average life of the Senior Note Facility plus 0.50%.
Senior Credit Facility
On February 19, 2016, the Company entered into a senior credit facility, as amended from time to time, and as amended and restated on November 4, 2020 (the “Senior Credit Facility”), which provides borrowing capacity under term loan facilities as well as a revolving credit facility. There are no compensating balance requirements associated with the Senior Credit Facility.
The Senior Credit Facility contains a $500 million revolving credit facility (the “Revolver”) with a sublimit of $50 million for swingline loans and a sublimit of $150 million for letters of credit. This agreement is unsecured and matures on November 4, 2023, which, subject to satisfaction of certain terms and conditions, may be extended at the option of the Company to November 4, 2024 (as may be extended, the “Senior Credit Facility Maturity Date”).
Under the Senior Credit Facility, on November 4, 2020, a $200 million term loan (the “November 2020 Term Loan”) was extended to the Company. The November 2020 Term Loan is unsecured and the entire principal amount is due in full on the Senior Credit Facility Maturity Date.
Borrowings under both the Revolver and the November 2020 Term Loan each bear interest either at the bank’s base rate (3.250% at December 25, 2021) plus an additional amount ranging from 0.000% to 0.375% (0.125% at December 25, 2021) or at the LIBOR (0.101% at December 25, 2021) plus an additional amount ranging from 0.875% to 1.375% per annum (1.125% at December 25, 2021), adjusted based on the Company's public credit ratings. The Company is also required to pay, quarterly in arrears, a commitment fee related to unused capacity on the Revolver ranging from 0.090% to 0.200% per annum (0.125% at December 25, 2021), adjusted based on the Company's public credit ratings.
On February 19, 2016, the Company entered into a $200 million term loan agreement (the “February 2016 Term Loan”). This agreement was repaid in full on November 4, 2020 and is no longer in effect.
On June 15, 2017, the Company entered into a $100 million incremental term loan agreement (the “June 2017 Term Loan”). This agreement was repaid in full on November 4, 2020 and is no longer in effect.
On March 12, 2020, the Company entered into a $200 million incremental term loan agreement (the “March 2020 Term Loan”). This agreement was repaid in full on November 4, 2020 and is no longer in effect.
On April 22, 2020, the Company entered into a $350 million incremental term loan agreement (the "April 2020 Term Loan"). This agreement was repaid in full on October 30, 2020 and is no longer in effect.
Covenants and Default Provisions of the Debt Agreements
The Senior Credit Facility and the Note Purchase Agreement (collectively, the “Debt Agreements”) require quarterly compliance with respect to two material covenants: a fixed charge coverage ratio and a leverage ratio. Both ratios are calculated on a trailing twelve-month basis at the end of each fiscal quarter. The fixed charge coverage ratio compares earnings before interest, taxes, depreciation, amortization, share-based compensation and rent expense (“consolidated EBITDAR”) to the sum of interest paid and rental expense (excluding any straight-line rent adjustments). The fixed charge coverage ratio shall be greater than or equal to 2.0 to 1.0 as of the last day of each fiscal quarter. The leverage ratio compares total funded debt to consolidated EBITDAR. The leverage ratio shall be less than or equal to 4.0 to 1.0 as of the last day of each fiscal quarter. The Debt Agreements also contain certain other restrictions regarding additional subsidiary indebtedness, business operations, subsidiary guarantees, mergers, consolidations and sales of assets, transactions with subsidiaries or affiliates, and liens. As of December 25, 2021, the Company was in compliance with all debt covenants.
The Debt Agreements contain customary events of default, including payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to other material indebtedness, certain events of bankruptcy and insolvency, material judgments, certain ERISA events and invalidity of loan documents. Upon certain changes of control, payment under the Debt Agreements could become due and payable. In addition, under the Note Purchase Agreement, upon an event of default or change of control, the make whole payment described above may become due and payable.
The Note Purchase Agreement also requires that, in the event the Company amends its Senior Credit Facility, or any subsequent credit facility of $100 million or greater, such that it contains covenant or default provisions that are not provided in the Note Purchase Agreement or that are similar to those contained in the Note Purchase Agreement but which contain percentages, amounts, formulas or grace periods that are more restrictive than those set forth in the Note Purchase Agreement or are otherwise more beneficial to the lenders thereunder, the Note Purchase Agreement shall be automatically amended to include such additional or amended covenants and/or default provisions.
Note 5 – Leases:
The Company leases the majority of its retail store locations, two distribution sites, its Merchandise Innovation Center, and certain equipment under various non-cancellable operating leases. The leases have varying terms and expire at various dates through 2042. Store leases typically have initial terms of between 10 years and 15 years, with two to four optional renewal periods of five years each. The exercise of lease renewal options is at our sole discretion. The Company has included lease renewal options in the lease term for calculations of its right-of-use assets and liabilities when it is reasonably certain that the Company plans to renew these leases. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.
The Company accounts for lease components (e.g., fixed payments including rent, real estate taxes, and insurance costs) together with non-lease components (e.g., fixed payment common-area maintenance) as a single component for all classes of underlying assets. Certain lease agreements require variable payments based upon actual costs of common-area maintenance, real estate taxes, and insurance. Further, certain lease agreements require variable payments based upon store sales above agreed-upon sales levels for the year and others require payments adjusted periodically for inflation. As substantially all of our leases do not provide an implicit rate, we estimate our collateralized incremental borrowing rate based upon a Company specific credit rating and yield curve analysis at commencement or modification date in determining the present value of lease payments.
The Company has elected not to recognize leases with an original term of one year or less on the balance sheet. Short-term lease cost during the periods presented was immaterial.
In addition to the operating lease right-of-use assets presented on the Consolidated Balance Sheets, assets, net of accumulated amortization, under finance leases of $32.0 million and $33.5 million are recorded within the Property and equipment, net line on the Consolidated Balance Sheets as of December 25, 2021 and December 26, 2020, respectively.
The following table summarizes the Company’s classification of lease cost (in thousands):
| Fiscal Year Ended | ||||||||||||||||||||
| Statement of Income Location | December 25, 2021 | December 26, 2020 | ||||||||||||||||||
| Finance lease cost: | ||||||||||||||||||||
| Amortization of lease assets | Depreciation and amortization | $ | 5,085 | $ | 4,765 | |||||||||||||||
| Interest on lease liabilities | Interest expense, net | 1,740 | 1,765 | |||||||||||||||||
| Operating lease cost | Selling, general and administrative expenses | 400,908 | 379,318 | |||||||||||||||||
| Variable lease cost | Selling, general and administrative expenses | 79,479 | 80,154 | |||||||||||||||||
| Net lease cost | $ | 487,212 | $ | 466,002 |
The following table summarizes the future maturities of the Company’s lease liabilities (in thousands):
| Operating Leases (a) | Finance Leases | Total | ||||||||||||||||||
| 2022 | $ | 418,059 | $ | 5,542 | $ | 423,601 | ||||||||||||||
| 2023 | 406,847 | 4,382 | 411,229 | |||||||||||||||||
| 2024 | 383,843 | 4,397 | 388,240 | |||||||||||||||||
| 2025 | 360,302 | 4,324 | 364,627 | |||||||||||||||||
| 2026 | 326,304 | 4,294 | 330,599 | |||||||||||||||||
| After 2026 | 1,540,093 | 23,281 | 1,563,375 | |||||||||||||||||
| Total lease payments | 3,435,449 | 46,220 | 3,481,669 | |||||||||||||||||
| Less: Interest | (539,283) | (9,475) | (548,758) | |||||||||||||||||
| Present value of lease liabilities | $ | 2,896,167 | $ | 36,745 | $ | 2,932,912 |
(a) Operating lease payments exclude $239.2 million of legally binding minimum lease payments for leases signed, but not yet commenced.
The following table summarizes the Company’s lease term and discount rate:
| December 25, 2021 | December 26, 2020 | |||||||||||||
| Weighted-average remaining lease term (years): | ||||||||||||||
| Finance leases | 10.5 | 10.4 | ||||||||||||
| Operating leases | 10.0 | 9.1 | ||||||||||||
| Weighted-average discount rate: | ||||||||||||||
| Finance leases | 4.8 | % | 4.9 | % | ||||||||||
| Operating leases | 3.6 | % | 4.1 | % |
The following table summarizes the other information related to the Company’s lease liabilities (in thousands):
| Fiscal Year Ended | ||||||||||||||
| December 25, 2021 | December 26, 2020 | |||||||||||||
| Cash paid for amounts included in the measurement of lease liabilities: | ||||||||||||||
| Financing cash flows used for finance leases | $ | 4,580 | $ | 4,170 | ||||||||||
| Operating cash flows used for finance leases | 1,740 | 1,765 | ||||||||||||
| Operating cash flows for operating leases | 404,864 | 385,529 |
Note 6 – 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 thousand shares of preferred stock, with such designations, rights and preferences as may be determined from time to time by the Company’s Board of Directors.
Dividends
During fiscal 2021 and 2020, the Company’s Board of Directors declared the following cash dividends:
| Date Declared | Dividend Amount Per Share of Common Stock | Record Date | Date Paid | |||||||||||||||||
| November 3, 2021 | $0.52 | November 22, 2021 | December 8, 2021 | |||||||||||||||||
| August 4, 2021 | $0.52 | August 23, 2021 | September 8, 2021 | |||||||||||||||||
| May 5, 2021 | $0.52 | May 24, 2021 | June 8, 2021 | |||||||||||||||||
| January 27, 2021 | $0.52 | February 22, 2021 | March 9, 2021 | |||||||||||||||||
| November 4, 2020 | $0.40 | November 23, 2020 | December 8, 2020 | |||||||||||||||||
| August 5, 2020 | $0.40 | August 24, 2020 | September 9, 2020 | |||||||||||||||||
| May 6, 2020 | $0.35 | May 26, 2020 | June 9, 2020 | |||||||||||||||||
| February 5, 2020 | $0.35 | February 24, 2020 | March 10, 2020 |
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 amount 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.
On January 26, 2022, the Company’s Board of Directors declared a quarterly cash dividend of $0.92 per share of the Company’s outstanding common stock. The dividend will be paid on March 8, 2022, to stockholders of record as of the close of business on February 21, 2022.
Note 7 – Treasury Stock:
The Company’s Board of Directors has authorized common stock repurchases under a share repurchase program which was announced in February 2007. As of December 25, 2021, the authorization amount of the program, which has been increased from time to time, was authorized for up to $4.5 billion, exclusive of any fees, commissions or other expenses related to such repurchases. The total authorized amount was increased by the Company's Board of Directors on January 26, 2022 by $2.0 billion for a total authorization of $6.5 billion. The share repurchase program does not have an expiration date. 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, temporarily paused, or terminated at any time without prior notice. As of December 25, 2021, prior to the expanded $2.0 billion repurchase authorization, the Company had remaining authorization under the share repurchase program of $345.0 million, exclusive of any fees, commissions or other expenses.
The following table provides the number of shares repurchased, average price paid per share, and total amount paid for share repurchases in fiscal 2021, 2020, and 2019, respectively (in thousands, except per share amounts):
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| Total number of shares repurchased | 4,364 | 3,439 | 5,384 | ||||||||||||||
| Average price paid per share | $ | 183.07 | $ | 99.72 | $ | 99.05 | |||||||||||
| Total cash paid for share repurchases | $ | 798,893 | $ | 342,957 | $ | 533,319 |
Shares repurchased in fiscal 2020 were impacted by the temporary suspension of our share repurchase program from March 12, 2020 until November 5, 2020, in order to strengthen our liquidity and preserve cash while navigating the COVID-19 pandemic.
Note 8 – Net Income Per Share:
Net income per share is calculated as follows (in thousands, except per share amounts):
| Fiscal Year | |||||||||||||||||
| 2021 | |||||||||||||||||
| Net Income | Shares | Per Share Amount | |||||||||||||||
| Basic net income per share: | $ | 997,114 | 114,794 | $ | 8.69 | ||||||||||||
| Dilutive effect of share-based awards | — | 1,030 | (0.08) | ||||||||||||||
| Diluted net income per share: | $ | 997,114 | 115,824 | $ | 8.61 |
| Fiscal Year | |||||||||||||||||
| 2020 | |||||||||||||||||
| Net Income | Shares | Per Share Amount | |||||||||||||||
| Basic net income per share: | $ | 748,958 | 116,370 | $ | 6.44 | ||||||||||||
| Dilutive effect of share-based awards | — | 1,066 | (0.06) | ||||||||||||||
| Diluted net income per share: | $ | 748,958 | 117,436 | $ | 6.38 |
| Fiscal Year | |||||||||||||||||
| 2019 | |||||||||||||||||
| Net Income | Shares | Per Share Amount | |||||||||||||||
| Basic net income per share: | $ | 562,354 | 119,727 | $ | 4.70 | ||||||||||||
| Dilutive effect of share-based awards | — | 1,016 | (0.04) | ||||||||||||||
| Diluted net income per share: | $ | 562,354 | 120,743 | $ | 4.66 |
Anti-dilutive share-based awards excluded from the above calculations totaled less than 0.1 million in fiscal 2021 and 2020 and were approximately 0.4 million shares in fiscal 2019.
Note 9 – Income Taxes:
The provision for income taxes consists of the following (in thousands):
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| Current tax expense: | |||||||||||||||||
| Federal | $ | 221,152 | $ | 211,228 | $ | 128,490 | |||||||||||
| State | 34,238 | 38,511 | 25,091 | ||||||||||||||
| Total current | 255,390 | 249,739 | 153,581 | ||||||||||||||
| Deferred tax expense/(benefit): | |||||||||||||||||
| Federal | 24,303 | (21,997) | 11,770 | ||||||||||||||
| State | 3,281 | (8,553) | (4,328) | ||||||||||||||
| Total deferred | 27,584 | (30,550) | 7,442 | ||||||||||||||
| Total provision | $ | 282,974 | $ | 219,189 | $ | 161,023 |
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):
| December 25, 2021 | December 26, 2020 | ||||||||||
| Tax assets: | |||||||||||
| Inventory valuation | $ | 23,365 | $ | 20,539 | |||||||
| Accrued employee benefits costs | 36,810 | 44,625 | |||||||||
| Nondeductible reserves | 7,099 | 5,967 | |||||||||
| Finance lease liabilities | 8,958 | 8,595 | |||||||||
| Operating lease liabilities | 740,478 | 645,719 | |||||||||
| Deferred compensation | 12,201 | 12,289 | |||||||||
| Workers' compensation insurance | 14,271 | 11,804 | |||||||||
| General liability insurance | 9,402 | 7,346 | |||||||||
| Income tax credits | 7,986 | 8,744 | |||||||||
| Amortization | 7,803 | 7,269 | |||||||||
| Other | 12,799 | 10,746 | |||||||||
| 881,172 | 783,643 | ||||||||||
| Tax liabilities: | |||||||||||
| Finance lease assets | (7,797) | (7,584) | |||||||||
| Operating lease right-of-use assets | (702,197) | (612,658) | |||||||||
| Depreciation | (161,137) | (124,280) | |||||||||
| Other | (7,604) | (7,535) | |||||||||
| (878,735) | (752,057) | ||||||||||
| Net deferred tax asset | $ | 2,437 | $ | 31,586 |
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 $6.6 million and $8.6 million as of December 25, 2021 and December 26, 2020, respectively, with varying dates of expiration through 2036. The Company provided no valuation allowance as of December 25, 2021 and December 26, 2020 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):
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| Tax provision at statutory rate | $ | 268,819 | $ | 203,311 | $ | 151,909 | |||||||||||
| Tax effect of: | |||||||||||||||||
| State income taxes, net of federal tax benefits | 36,116 | 27,642 | 19,722 | ||||||||||||||
| Tax credits, net of federal tax benefits | (13,157) | (8,828) | (7,768) | ||||||||||||||
| Share-based compensation programs | (13,368) | (9,303) | (4,484) | ||||||||||||||
| Other | 4,564 | 6,367 | 1,644 | ||||||||||||||
| Total income tax expense | $ | 282,974 | $ | 219,189 | $ | 161,023 |
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 2017. Various states have completed an examination of our income tax returns for 2017 through 2019 with minimal adjustments.
The total amount of unrecognized tax positions that, if recognized, would decrease the effective tax rate, is $3.2 million at December 25, 2021. 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 has considered the reasonably possible expected net change in uncertain tax positions during the next 12 months and does not expect any material changes to our liability for uncertain tax positions through December 25, 2021.
A reconciliation of the beginning and ending gross amount of unrecognized tax benefits (exclusive of interest and penalties) is as follows (in thousands):
| Fiscal Year | |||||||||||||||||
| 2021 | 2020 | 2019 | |||||||||||||||
| Balance at beginning of year | $ | 3,236 | $ | 2,760 | $ | 2,451 | |||||||||||
| Additions based on tax positions related to the current year | 927 | 816 | 650 | ||||||||||||||
| Additions for tax positions of prior years | 51 | 32 | 59 | ||||||||||||||
| Reductions for tax positions of prior years | (465) | (372) | (400) | ||||||||||||||
| Balance at end of year | $ | 3,749 | $ | 3,236 | $ | 2,760 |
The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted in the U.S. on March 27, 2020. The enactment of this legislation did not have a material impact on income tax expense in fiscal 2020. However, the Company did elect to participate in the deferral of the employer’s share of social security tax deposits, with $24.5 million included within other accrued expenses in the Consolidated Balance Sheet as of December 25, 2021. This amount will become due on December 31, 2022.
Note 10 – 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 were approximately $15.3 million, $12.9 million, and $9.8 million during fiscal 2021, 2020, and 2019, 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 $0.3 million, $0.6 million, and $0.7 million during fiscal 2021, 2020, and 2019, respectively.
Note 11 – Commitments and Contingencies:
Contractual Commitments
At December 25, 2021, the Company had contractual commitments of approximately $107.8 million, of which $56.9 million is related to the construction of the new distribution center in Navarre, Ohio, and the remaining is related to purchase obligations such as inventory purchases and marketing-related contracts. The Company does not have material contractual commitments related to construction projects extending greater than twelve months. In addition, the Company had $239.2 million legally binding minimum lease payments for leases signed, but not yet commenced.
Letters of Credit
At December 25, 2021, there were $52.9 million outstanding letters of credit under the Senior Credit Facility.
Litigation
On October 9, 2020, an alleged stockholder, the City of Pontiac Police and Fire Retirement System, filed a derivative lawsuit in the U.S. District Court for the Middle District of Tennessee, purportedly on the Company's behalf, against certain current and former members of our Board of Directors, and the Company as a nominal defendant, seeking unspecified compensatory and punitive damages payable to the Company, disgorgement, restitution, corporate governance and hiring changes, mandated community investment, and attorneys' fees and costs. Plaintiff alleges that defendants violated the federal securities laws governing proxy solicitations and breached their fiduciary duties by misrepresenting the Company’s commitment to and support for diversity and inclusion. The Company disputes the allegations of the complaint. The Company and the individual defendants moved to dismiss the complaint based on plaintiff’s failure to make a demand on the Board of Directors and to state a claim upon which relief may be granted. While the ultimate outcome of this matter is currently not determinable, we do not believe this litigation will have a material impact to the Company's Consolidated Financial Statements.
The Company is also involved in various litigation matters arising in the ordinary course of business. The Company believes that, based upon information currently available, any estimated loss related to such matters has been adequately provided for 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. However, litigation and other legal matters involve an element of uncertainty. Future developments in such matters, including adverse decisions or settlements or resulting required changes to the Company’s business operations, could affect our consolidated operating results when resolved in future periods or could result in liability or other amounts material to the Company’s Consolidated Financial Statements.
Note 12 – Segment Reporting:
The Company has one reportable segment which is the retail sale of products that support the rural lifestyle. The following table indicates the percentage of net sales represented by each major product category during fiscal 2021, 2020, and 2019:
| Percent of Net Sales | |||||||||||||||||
| Fiscal Year | |||||||||||||||||
| Product Category: | 2021 | 2020 | 2019 | ||||||||||||||
| Livestock and Pet | 47 | % | 47 | % | 47 | % | |||||||||||
| Hardware, Tools and Truck | 21 | 21 | 21 | ||||||||||||||
| Seasonal, Gift and Toy Products | 21 | 21 | 20 | ||||||||||||||
| Clothing and Footwear | 8 | 7 | 8 | ||||||||||||||
| Agriculture | 3 | 4 | 4 | ||||||||||||||
| Total | 100 | % | 100 | % | 100 | % |
Note 13 – Subsequent Events:
On January 26, 2022, the Company announced plans to build a new distribution center in Maumelle, Arkansas. This new distribution center is expected to be approximately 900,000 square feet. Construction is planned to begin in the middle of 2022 and is currently anticipated to be completed in late 2023.
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