Tractor Supply Company — Fiscal 2014 Third-Quarter Form 10-Q
Business context and reporting period
Tractor Supply Company operates one reportable segment: retail sales of products serving the rural lifestyle market. The filing covers the fiscal three and nine months ended September 27, 2014, compared with the periods ended September 28, 2013. The company had 1,361 stores at quarter-end, including 85 stores opened during the first nine months.
Financial performance and liquidity
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $1.360 billion | $1.208 billion | $4.127 billion | $3.750 billion |
| Gross profit | $464.1 million | $415.7 million | $1.411 billion | $1.274 billion |
| Gross margin | 34.1% | 34.4% | 34.2% | 34.0% |
| Operating income | $122.0 million | $101.7 million | $411.8 million | $367.6 million |
| Net income | $76.6 million | $64.8 million | $258.8 million | $232.4 million |
| Diluted EPS | $0.55 | $0.46 | $1.85 | $1.64 |
Q3 net sales increased 12.6%, while comparable-store sales increased 5.6%, supported by 3.3% higher transaction counts and a 2.2% higher average ticket. Nine-month sales increased 10.1%, with comparable-store sales up 3.2%.
Q3 operating margin was approximately 9.0%, versus 8.4% in the prior-year quarter. Nine-month operating margin was approximately 10.0%, versus 9.8%. Q3 SG&A including depreciation and amortization improved to 25.2% of sales from 26.0%; the nine-month ratio was unchanged at 24.2%.
For the first nine months, operating activities generated $167.6 million of cash versus $98.6 million in the prior-year period. Capital expenditures were $125.4 million versus $156.8 million, and free cash flow before financing activities was approximately $42.4 million.
Cash and cash equivalents were $47.5 million at September 27, 2014, compared with $142.7 million at December 28, 2013. Working capital was $750.3 million. Inventories were $1.296 billion, up from $979.3 million at year-end, primarily reflecting seasonal purchases and new-store growth.
The company had $150.0 million outstanding under its unsecured Senior Credit Facility, which was expanded from $250 million to $400 million in May 2014. The facility matures in October 2016; the company was in compliance with all covenants. Outstanding letters of credit totaled $59.4 million, including $41.1 million under the facility and $18.3 million elsewhere.
Material changes versus the prior comparable period
- Net income increased 18.3% in Q3 and 11.4% for the first nine months; diluted EPS increased 19.6% and 12.8%, respectively.
- Q3 gross margin declined 30 basis points because of higher transportation costs and merchandise mix. Nine-month gross margin increased 20 basis points, benefiting from deflation, retail price management and winter-goods sell-through.
- Q3 SG&A including depreciation and amortization increased 8.9%, below the 12.6% sales growth rate, reflecting store-cost leverage and incentive compensation leverage.
- Share repurchases increased to $244.4 million for the first nine months from $90.6 million, and shares outstanding declined year over year. Remaining repurchase authorization was $917.4 million at quarter-end.
- Net cash used in financing activities increased to $137.7 million from $43.2 million, primarily because of higher repurchases, partly offset by $110.0 million of incremental net borrowings.
- Quarter-end liabilities increased to $958.5 million from $656.5 million at December 28, 2013, primarily reflecting the revolving credit borrowing and higher accounts payable.
- The quarterly dividend increased to $0.16 per share from $0.13. A further $0.16 per-share dividend was declared on October 29, 2014.
Guidance, outlook, risks and unusual items
Management expected the full-year 2014 effective tax rate to be approximately 36.9% and expected to open 102 to 106 new stores, compared with 102 stores opened in fiscal 2013. Management stated that cash balances, operating cash flow, available credit, leases and trade credit should fund operations and capital requirements through the end of fiscal 2014.
Management attributed Q3 comparable-sales performance partly to favorable weather, which benefited consumable, usable and edible products and seasonal merchandise. Deflation, principally in livestock feed and bird-feeding products, reduced comparable-store sales by an estimated 90 basis points. The business is seasonal, with sales and profits historically highest in the second and fourth quarters.
Key risks include consumer spending, weather, competition, commodity and transportation-price volatility, inventory and growth execution, new-store performance, foreign-supplier dependence, employee retention, technology and data-security failures, regulatory and litigation matters, tax-rate changes, self-insurance estimates and accounting changes.
The company is discussing a potential settlement with the DOJ and EPA concerning alleged Clean Air Act violations involving certain imported engines. Management does not expect a material adverse effect and does not believe a loss exceeding the accrued amount is reasonably possible. Net self-insurance reserves were $45.6 million at September 27, 2014.
ASU 2014-09, Revenue from Contracts with Customers, will apply for reporting periods beginning after December 15, 2016. Management was assessing its impact and transition method; early adoption was prohibited.
Important facts for investors to verify
- Whether favorable weather and seasonal strength were temporary contributors to comparable-store sales and earnings.
- The sustainability of gross-margin performance given transportation costs, merchandise mix and commodity deflation.
- Inventory growth, seasonal sell-through and the potential effect of higher average inventory per store on markdowns and cash flow.
- Leverage, liquidity headroom and covenant compliance as share repurchases and store expansion continue.
- The final amount and timing of any DOJ/EPA settlement and the adequacy of related accruals.
- The effect of the higher effective tax rate and reduced tax credits on full-year earnings.
- Progress toward the 102-to-106-store opening target and the returns generated by new locations and capital expenditures.