Business Context and Reporting Period
Tractor Supply Company operates rural lifestyle retail stores and an online channel serving farmers, ranchers, tradesmen, small businesses and rural-lifestyle consumers. The unaudited Form 10-Q covers the fiscal three and nine months ended September 30, 2017, compared with September 24, 2016. At quarter-end, the company operated 1,827 stores in 49 states, including 1,665 Tractor Supply and Del’s stores and 162 Petsense stores.
Financial Performance and Position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $1.72 billion | $1.54 billion | $5.30 billion | $4.86 billion |
| Gross profit | $600.5 million | $535.3 million | $1.82 billion | $1.68 billion |
| Gross margin | 34.9% | 34.7% | 34.4% | 34.5% |
| Operating income | $148.3 million | $142.0 million | $502.5 million | $499.5 million |
| Operating margin | 8.6% | 9.2% | 9.5% | 10.3% |
| Net income | $91.9 million | $89.4 million | $312.9 million | $313.5 million |
| Diluted EPS | $0.72 | $0.67 | $2.43 | $2.33 |
- Third-quarter comparable-store sales increased 6.6%, supported by a 5.0% increase in transactions and a 1.5% increase in average ticket. Nine-month comparable-store sales increased 2.2%.
- Third-quarter net sales increased 11.6%, gross profit increased 12.2%, operating income increased 4.4%, and net income increased 2.7%. Nine-month net sales increased 9.1%, while net income decreased 0.2%.
- SG&A, including depreciation and amortization, increased 15.0% in the third quarter and 12.0% for the first nine months. SG&A increased to 26.3% of sales in Q3 from 25.5% and to 24.9% for the nine months from 24.3%.
- Cash provided by operating activities was $341.0 million for the first nine months, compared with $285.6 million in the prior-year period. Capital expenditures were $152.0 million versus $167.2 million.
- Cash and cash equivalents were $70.0 million at September 30, 2017. Working capital was $869.8 million.
- Total outstanding borrowings were $511.3 million, or $509.7 million net of debt issuance costs, compared with $275.0 million at December 31, 2016. The increase reflects $150 million of senior notes and a $98.8 million June 2017 term loan, partly offset by repayments.
- The company had $41.6 million of outstanding letters of credit and remained in compliance with all debt covenants.
- The company repurchased 5.2 million shares for $326.6 million during the first nine months and paid $100.0 million in cash dividends. Approximately $912.5 million remained available under the repurchase authorization at quarter-end.
Material Changes Versus Prior Comparable Period
- Sales growth benefited from broad-based comparable-store gains, new-store growth, the Petsense acquisition, an extended spring and summer selling season, and hurricane-related emergency-response merchandise sales.
- Gross margin improved in Q3 due to favorable seasonal conditions, strong sell-through and inventory management, but declined slightly for the nine months because of cold-weather markdowns, promotions, higher freight expense and fuel costs.
- Profit growth lagged sales growth because of higher incentive compensation, store payroll, technology and infrastructure investment, and the integration of Petsense. Petsense also operates at a higher SG&A rate.
- Weighted-average diluted shares declined to 126.9 million in Q3 and 128.9 million for the nine months, from 134.3 million and 134.5 million, respectively, supporting diluted EPS growth despite largely flat nine-month net income.
- Inventory increased to $1.59 billion from $1.49 billion at September 24, 2016, primarily due to new-store growth and seasonal purchasing. Average inventory per Tractor Supply store declined during Q3 due to strong sell-through.
- Debt increased materially year over year. The company entered into $150 million of 3.70% senior unsecured notes due 2029 and added a $100 million term-loan facility in June 2017.
Guidance, Outlook, Risks and Unusual Items
- Management expected the full-year 2017 effective tax rate to be approximately 36.6%.
- The company expected to open approximately 100 new Tractor Supply stores and approximately 25 new Petsense stores in fiscal 2017. It opened 74 Tractor Supply stores and 19 Petsense stores during the first nine months.
- Management stated that cash balances, operating cash flow, debt-facility availability, leases and trade credit were expected to fund operations and capital needs through the end of fiscal 2017.
- A new distribution center in Frankfort, New York, began construction during Q3, with approximately $30 million of contractual commitments and expected operations by the end of fiscal 2018.
- The business is seasonal and weather-sensitive. Management noted that the 2017 period was affected by an extended spring and summer season and hurricane-related demand, while prior-year comparisons were affected by a 53-week fiscal 2016 and a one-week shift in fiscal 2017.
- Key disclosed risks include consumer spending, weather, seasonality, competition from online retailers, merchandise and freight costs, foreign sourcing, labor availability, store expansion, Petsense integration, technology and cybersecurity, regulatory matters, tax-rate volatility and changes in accounting standards.
- The company settled an environmental matter in California involving a civil penalty and supplemental environmental projects; management stated that the settlement would not materially affect financial position, results or cash flows. Other litigation was described as ordinary-course and adequately reserved where probable and estimable.
- The company adopted several accounting updates in 2017, including ASU 2016-09, which reclassified excess tax benefits from financing to operating cash flows. Adoption did not materially affect the financial statements. Revenue recognition guidance was scheduled for adoption in the first quarter of fiscal 2018 and was not expected to have a material impact.
Important Facts for Investors to Verify
- Whether comparable-store sales momentum and hurricane-related demand were sustainable after the quarter.
- Whether SG&A growth, technology investments and Petsense integration costs moderate enough to restore operating-margin leverage.
- Inventory levels, markdown exposure, freight costs and gross-margin trends during the cold-weather selling season.
- Debt reduction, interest-rate exposure and compliance with the fixed-charge coverage and leverage covenants.
- Execution of the planned store openings, Petsense integration and Frankfort distribution-center construction.
- The effect of the 53-week prior fiscal year, the one-week period shift and seasonal weather patterns on future comparisons.
- Future capital allocation among share repurchases, dividends, store expansion, information technology and debt repayment.