Tractor Supply Company — Fiscal 2018 Third-Quarter Form 10-Q
Business Context and Reporting Period
Tractor Supply Company is a rural lifestyle retailer serving recreational farmers, ranchers, tradespeople, small businesses and pet owners through Tractor Supply, Del’s and Petsense stores and e-commerce channels. The filing covers the fiscal three and nine months ended September 29, 2018, compared with September 30, 2017. The company operated 1,929 stores in 49 states at quarter-end, including 1,748 Tractor Supply and Del’s stores and 181 Petsense stores.
Financial Performance and Key Metrics
| Metric | Q3 FY2018 | Q3 FY2017 | 9M FY2018 | 9M FY2017 |
|---|---|---|---|---|
| Net sales | $1.882 billion | $1.722 billion | $5.778 billion | $5.304 billion |
| Comparable-store sales growth | 5.1% | 6.6% | 4.9% | 2.2% |
| Gross profit | $653.1 million | $600.5 million | $1.986 billion | $1.823 billion |
| Gross margin | 34.7% | 34.9% | 34.4% | 34.4% |
| Operating income | $153.1 million | $148.3 million | $521.4 million | $502.5 million |
| Net income | $116.8 million | $91.9 million | $395.5 million | $312.9 million |
| Diluted EPS | $0.95 | $0.72 | $3.20 | $2.43 |
- Third-quarter sales increased 9.3%, gross profit increased 8.8% and net income increased 27.1%. Nine-month sales increased 8.9%, gross profit increased 8.9% and net income increased 26.4%.
- Third-quarter operating margin was approximately 8.1%, versus approximately 8.6% in the prior-year quarter. Nine-month operating margin was approximately 9.0%, versus approximately 9.5% in the prior-year period.
- Third-quarter SG&A, including depreciation and amortization, rose 10.6% to $500.0 million and increased to 26.6% of sales from 26.3%. Nine-month SG&A rose 10.9% to $1.46 billion and increased to 25.4% of sales from 24.9%.
- The effective tax rate declined to 21.5% from 36.4% in the third quarter and to 22.1% from 36.5% for the first nine months, primarily because of the Tax Cuts and Jobs Act, with additional benefits from tax credits and share-based compensation.
- Cash and cash equivalents were $71.3 million at September 29, 2018, compared with $109.1 million at December 30, 2017 and $70.0 million at September 30, 2017. Working capital was $967.2 million.
- Operating cash flow was $353.4 million for the first nine months, compared with $341.0 million in the prior-year period. Capital expenditures were $193.7 million, compared with $152.0 million.
- Inventory was $1.737 billion, up from $1.453 billion at fiscal year-end 2017 and $1.592 billion at September 30, 2017, reflecting seasonal needs, new-store growth, commodity inflation and selected higher inventory levels.
- Total outstanding borrowings were $575.3 million, excluding $1.5 million of unamortized debt issuance costs, compared with $427.5 million at December 30, 2017. Long-term debt was $547.5 million. The company was in compliance with all debt covenants.
- The company paid $109.2 million in dividends and repurchased $289.2 million of common stock during the first nine months. Remaining share-repurchase authorization was $580.6 million at quarter-end.
Material Changes Versus the Prior Comparable Period
- Comparable-store sales growth improved to 5.1% in the third quarter from 2.2% in the prior-year nine-month period, but was below the 6.6% third-quarter growth recorded in fiscal 2017. Third-quarter comparable growth reflected a 3.6% increase in average ticket and a 1.4% increase in transaction count.
- Sales benefited from broad-based strength in everyday merchandise and seasonal categories. Livestock and pet products represented 49% of third-quarter sales, followed by hardware, tools and truck at 22% and seasonal, gift and toy products at 18%.
- Gross margin declined modestly in the third quarter because higher carrier rates and diesel costs offset benefits from price management. Nine-month gross margin was unchanged at 34.4%.
- SG&A deleveraged because of higher incentive compensation and planned investments in infrastructure, technology, distribution capabilities and wages. These factors more than offset occupancy and other cost leverage.
- Store expansion continued but at a slower pace: 63 Tractor Supply and 14 Petsense stores opened during the first nine months, compared with 74 and 19, respectively, in the prior-year period. The company ended the period with 1,929 stores versus 1,827 a year earlier.
- Debt increased primarily because of $166.5 million in revolving credit borrowings at quarter-end. Capital spending increased substantially, particularly for information technology and distribution-center capacity.
- The company adopted revenue-recognition guidance and other accounting updates in fiscal 2018 without a material impact. Adoption of income-tax presentation guidance resulted in a $0.6 million reclassification from accumulated other comprehensive income to retained earnings.
Guidance, Outlook, Risks and Unusual Items
- Management expected a fiscal 2018 effective tax rate of 22.3% to 22.5%.
- Management expected approximately 80 new Tractor Supply stores and approximately 20 new Petsense stores in fiscal 2018, below fiscal 2017 openings as capital allocation shifted toward technology and supply-chain infrastructure.
- The company expected cash balances, operating cash flow, debt-facility availability, leases and trade credit to fund operations and capital needs through the end of fiscal 2018.
- The Frankfort, New York distribution center was expected to become operational in the first quarter of fiscal 2019. Approximately $20.0 million of construction commitments remained at September 29, 2018.
- Tariffs and broader international trade actions were identified as a material risk. Management expected minimal fiscal 2018 impact but stated that effects in fiscal 2019 and beyond could be significant through higher costs, pricing pressure, reduced sales or supply-chain disruption.
- Other material risks include consumer spending, weather and seasonality, commodity and freight-cost volatility, competition from online retailers, store expansion execution, foreign sourcing, employee retention, information-security incidents, technology and supply-chain implementation, litigation, regulation and tax-rate changes.
- The business is seasonal, with higher inventory and accounts payable typically occurring in the first and third quarters. Management cautioned that quarterly results may be affected by weather-driven shifts in demand.
- Interest-rate swaps hedged the company’s term-loan exposure. A 1% change in rates on variable-rate debt not covered by swaps would have affected nine-month interest expense by approximately $1.3 million in fiscal 2018.
- Routine litigation was not expected to have a material adverse effect. Outstanding letters of credit totaled $36.7 million.
Important Facts for Investors to Verify
- Whether sales growth and comparable-store momentum continue after the favorable seasonal period and despite slower new-store openings.
- Whether freight, fuel, tariffs, commodity inflation and other sourcing costs pressure gross margin.
- Whether planned investments in technology, wages and distribution infrastructure generate sufficient sales and productivity benefits to reverse SG&A deleveraging.
- Inventory growth, seasonal sell-through and working-capital requirements, particularly in the fourth quarter.
- Revolving-credit usage, debt paydown, covenant headroom and liquidity after dividends, buybacks and capital expenditures.
- The final fiscal 2018 tax rate and any additional effects from implementation of the Tax Cuts and Jobs Act.
- The timing, cost and execution of the Frankfort distribution center and the planned fiscal 2019 adoption of lease accounting, which management expected to materially increase reported assets and liabilities.