Item 1. Business
Overview
Tractor Supply Company is the largest operator of retail farm and ranch stores in the United States and is focused on supplying the lifestyle needs of recreational farmers and ranchers and those who enjoy the rural lifestyle, as well as tradesmen and small businesses. We operate retail stores under the names Tractor Supply Company and Del’s Farm Supply and operate a website under the name TractorSupply.com. References to our website do not constitute incorporation by reference of the information contained on the website. Our stores are located in towns outlying major metropolitan markets and in rural communities and offer the following comprehensive selection of merchandise:
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Equine, pet and animal products, including items necessary for their health, care, growth and containment
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Maintenance products for agricultural and rural use
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Hardware and tool products
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Seasonal products, including lawn and garden power equipment
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Truck and towing products, and
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Work/recreational clothing and footwear for the entire family.
Our Tractor Supply stores typically range in size from 15,500 square feet to 18,500 square feet of inside selling space and additional outside selling space. We are developing stores using one of five standard prototypes as well as existing building structures.
Our wholly-owned subsidiary, Del’s Farm Supply, LLC (“Del’s”), operates 23 stores, primarily in the Pacific Northwest, that offer a wide selection of products (primarily in the equine, pet and animal category) tailored to those who enjoy the rural lifestyle. Del’s stores currently range in size from approximately 1,500 to 5,000 square feet of inside selling space plus additional outside and covered/sheltered selling space.
Tractor Supply Company has one reportable industry segment - farm and ranch retail sales, both at our retail locations and online.
At December 29, 2007, we operated 764 retail farm and ranch stores in 43 states.
Seasonality and Weather
Our business is highly seasonal. Historically, our sales and profits have been the highest in the second and fourth fiscal quarters of each year due to the sale of seasonal products. Unseasonable weather, excessive precipitation, natural disasters, drought, and early or late frosts may also affect our sales. We believe, however, that the impact of severe weather conditions is somewhat mitigated by the geographic dispersion of our stores.
We experience our highest inventory and accounts payable levels during the first fiscal quarter each year for purchases of seasonal products in anticipation of the spring selling season and again during the third fiscal quarter in anticipation of the winter selling season.
Business Strategy
We believe our sales and earnings growth is a result of focused execution of our business strategy, which includes the following key components:
Market Niche
We have identified a specialized market niche: supplying the lifestyle needs of recreational farmers and ranchers and those who enjoy the rural lifestyle (which we refer to as the “Out Here” lifestyle), as well as tradesmen and small businesses. By focusing our product mix on these core customers, we believe we are differentiated from general merchandise, home center and other specialty retailers.
Customer Service
We are committed to providing our customers a high level of in-store service through our motivated, well-trained store employees. We believe the ability of our store employees to provide friendly, responsive and seasoned advice helps to promote strong customer loyalty and repeat shopping. As such, we seek to provide our store employees with decision-making authority, product knowledge and training to enable them to meet our customers’ needs.
We endeavor to staff our stores with courteous, highly motivated employees and devote considerable resources to training store employees, often in cooperation with our vendors. Our training programs include (i) a full management training program which covers all aspects of our operations, (ii) product knowledge modules produced in conjunction with key vendors, (iii) frequent management skills training classes, (iv) semi-annual store manager meetings with vendor product presentations, (v) vendor sponsored in-store training programs and (vi) ongoing product information updates from our management headquarters, the Store Support Center. We seek to hire and train store employees with farming and ranching backgrounds, with particular emphasis on general maintenance, equine and welding.
In fiscal 2007, we established our first online shopping site, TractorSupply.com. The availability of many of our products online provides our customers the ability to purchase products and have them shipped to their homes or offices. This capability further enhances customer service and extends our market to areas where retail stores are not currently located.
We offer proprietary, private label credit cards for individual retail and business customers. In addition, we accept cash, checks, debit cards, Visa, MasterCard and Discover credit cards and gift cards.
Store Environment
Our stores are designed and managed to make shopping an enjoyable experience and to maximize sales and operating efficiencies. Stores utilize several layouts, designed to provide an open environment, optimal product placement and visual display locations. In addition, these layouts allow for departmental space to be easily reallocated and visual displays to be easily changed for seasonal products and promotions. Display and product placement information is sent to stores monthly to ensure quality and uniformity among the stores. Informative signs are located throughout each store to assist customers with purchasing decisions and merchandise location by comparison of “good, better, best” qualities, clear pricing and useful information regarding product benefits and suggestions for appropriate accessories. The general uniformity of our store layouts and visual displays afford our customers a feeling of familiarity and enhances the shopping experience. To further enhance the shopping experience, all of our store employees wear highly visible red vests, aprons or smocks and nametags, and our customer service and checkout counters are conveniently located.
Merchandising
We offer a differentiated assortment of products for our customers. Our broad product assortment is tailored to meet the regional and geographic needs of our markets, as well as the physical store size. Our full line of product offerings is supported by a strong in-stock inventory position with an average of 13,500 to 15,000 unique products per store. No one product accounted for more than 10% of our sales during 2007.
Our stores carry a wide selection of high quality, nationally recognized, name brand merchandise. We also market a growing list of products under our “private-label programs,” i.e. products manufactured by a number of vendors at our direction and specifically for our sole benefit. The trademarks in the private label brand names are owned by us with the exception of a very limited number of brands over which we have sole control but have not yet opted to own. Our private label brands include:
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Masterhand (tools and tool chests)
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Job Smart (hardware and tools)
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Ranch Hand (hand and garden tools)
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Dumor and Producers Pride (livestock feed)
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Retriever and Paws ‘n Claws (pet foods)
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Royal Wing (bird feeding supplies)
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Milepost (Equine Products)
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Groundworks (lawn and garden supplies)
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Harvest Supreme (agricultural products)
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Huskee (outdoor power equipment)
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Minot (lawn and garden tractors)
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Countyline (livestock, farm and ranch equipment)
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Traveller (truck/automotive products)
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C.E. Schmidt (apparel and footwear)
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Red Shed (gifts and collectibles)
Additionally, we have access to control brands which we market. These control brands include Morgan Creek (“lifestyle clothing”) and Farm Hand (air compressors). We believe that the availability of top quality private label products at great prices provides superior value for our customers, a strategic advantage for us, and positions us as a “destination” store.
The following chart indicates the average percentages of sales represented by each of our major product categories during fiscal 2007, 2006 and 2005.
(a)
Reclassified to conform with current year presentation.
Purchasing and Distribution
We offer a differentiated assortment of products for those seeking to enjoy the “Out Here” lifestyle. Our business is not dependent upon any one vendor or particular group of vendors. We purchase our products from a core group of approximately 850 vendors, with no one vendor representing more than 10% of our purchases during fiscal 2007. Approximately 200 vendors accounted for approximately 80% of our purchases during fiscal 2007. We have not experienced any significant difficulty in obtaining satisfactory alternative sources of supply for our products and we believe that adequate sources of supply exist at substantially similar costs for substantially all of our products. We have no material long-term contractual commitments with any of our vendors.
We maintain a dedicated supply chain management team to focus exclusively on all replenishment and forecasting functions. This centralized direction permits our buying teams to focus more strategic attention toward vendor line reviews, assortment planning and testing of new products and programs. Through the combined efforts of these teams, we expect to improve overall inventory productivity and in-stock position.
Over 98% of our purchase orders are transmitted through an electronic data interchange (“EDI”) system, and approximately 91% of merchandise vendor invoices are transmitted through EDI. We are expanding the percentage of vendors who electronically transmit invoices and increasing the amount of sales history transmitted.
We currently operate a distribution network for supplying our stores with merchandise and in fiscal 2007 our stores received approximately 78% of our merchandise through this network. Our six distribution centers are located in Indiana, Georgia, Maryland, Texas, Nebraska, and Washington, representing total distribution capacity of 2.6 million square feet. This capacity increased by approximately 145,000 square feet in 2007 due to an expansion of our Georgia distribution center and relocation of our Washington distribution center. In 2008, we have begun planning a 347,000 square foot expansion of our Waco, Texas distribution facility. As we continue to expand in the western U.S., we expect to establish facilities in that general area to support growth and further leverage transportation and distribution costs.
We manage our inbound and outbound transportation activity in-house through the use of a web-based transportation management system. We outsource the management of our dedicated fleets to two third-party logistics providers and utilize several common carriers as required. The third-party logistics providers are responsible for providing drivers and tractors dedicated to transporting merchandise for us. We endeavor to control our transportation costs through the monitoring of transportation routes, scheduling of deliveries, backhauls and optimal utilization of the dedicated fleet of trucks and trailers.
Marketing
We utilize an “everyday low prices” strategy to consistently offer our products at competitive prices complimented by promotions to enhance peak selling seasons. We regularly monitor prices at competing stores and adjust our prices as we deem appropriate. We believe that by avoiding a “sale-oriented” marketing strategy, we attract customers on a regular basis rather than only in response to promotional sales.
To generate store traffic and position ourselves as a destination store, we promote broad selections of merchandise, primarily advertised at our regular everyday low price, with printed color circulars. We also run periodic special events promoted through circulars and direct mail advertising. We supplement our print marketing programs and further position our brand with national cable and local television advertising in select markets. Due to the geographic dispersion of our stores, the use of national cable advertising is generally more cost-effective and additionally serves to promote our stores prior to entering a new market.
Due to the relatively small size of our stores, increased traffic in the store ensures increased exposure to our products. Our vendors are committed to helping us promote our brand and position ourselves as a destination store. Our vendors provide assistance with product presentation and rack design, brochures, point-of-purchase materials for customers’ education and product education for our employees. We also receive funding through contributions and incentives on purchases to promote new and relocated stores and earn rebates from vendors on product purchases based on volume.
Competition
We operate in a very competitive market. The principal competitive factors include location of stores, price and quality of merchandise, in-stock consistency, merchandise assortment and presentation and customer service. We compete with general merchandise retailers, home center retailers and other specialty and discount retailers, as well as independently owned retail farm and ranch stores, numerous privately-held regional farm store chains and farm cooperatives. Some of these competitors are units of national or regional chains and may have substantially greater resources and financial capacities than we do. However, we believe we have successfully differentiated ourselves from these entities by focusing on our specialized market niche.
Management and Employees
As of December 29, 2007, we employed approximately 6,900 full-time and approximately 4,700 part-time employees. We also employ additional part-time employees during peak periods. We are not party to any collective bargaining agreements.
Our store operations are organized by location into seven regions. Each region is led by a regional manager and the region is further organized into districts, which are led by a district manager. Our regional and district managers, store managers and other distribution and support personnel have contributed significantly to our performance. We have an internal advisory board comprised of store managers. This group brings a grassroots perspective to operational initiatives and generates chain-wide endorsement of proposed “best-practice” solutions. We have implemented numerous best practice teams (comprised of employees from all areas of our operations) to evaluate our key operations and recommend process changes that will both improve efficiency and strengthen controls. Our management encourages the participation of all employees in decision-making, regularly solicits input and suggestions from our employees and responds to the suggestions. Additionally, we are committed to a continuous improvement program called Tractor Value System (“TVS”). TVS is a commitment to provide, through team member engagement, a business management system that emphasizes continuous improvement by embracing change of current practices to reduce cost, shorten lead times, and drive innovation.
All of our employees participate in one of various incentive programs, which provide the opportunity to receive additional compensation based upon team and/or Company performance. We also provide our employees the opportunity to participate in an employee stock purchase plan and a 401(k) retirement plan (we contribute to the 401(k) plan solely through a cash match). Additionally, we share in the cost of health insurance provided to our employees, and employees receive a discount on merchandise purchased at our stores.
We encourage a “promote from within” environment when internal resources permit. We also provide internal leadership development programs designed to mentor our high potential employees for continued progress and believe we have satisfactory relationships with our employees. Our district managers and store managers have an average length of service of approximately five years. Management believes internal promotions, coupled with the hiring of individuals with previous retail experience, will provide the management structure necessary to support our planned store growth.
Management Information and Control Systems
We have invested considerable resources in our management information and control systems to ensure superior customer service, manage the purchase and distribution of our merchandise and improve our operating efficiencies. Our management information and control systems include a point-of-sale system, a supply chain management and replenishment system, a radio frequency picking system in the distribution centers, a vendor purchase order control system and a merchandise presentation system. These systems are integrated through an enterprise resource planning (ERP) system. This ERP system tracks merchandise from initial order through ultimate sale and interfaces with our financial systems.
We continue to evaluate and improve the functionality of our systems to maximize their effectiveness. Such efforts include an ongoing evaluation of the optimal software configuration (including system enhancements and upgrades) as well as the adequacy of the underlying hardware components. These efforts are directed toward constantly improving the overall business processes and achieving the most efficient and effective use of the systems to manage our operations.
Growth Strategy
Our current and long-term growth strategy is to (1) expand geographic market presence through opening new retail stores, (2) enhance financial performance through same-store sales increases, achieved through targeted merchandising programs with an “everyday low prices” philosophy and supported by strong customer service, (3) enhance product margin through assortment management, vendor management, sourcing and optimization of transportation and distribution costs, (4) leverage operating costs, especially occupancy, advertising and distribution, (5) expand market opportunities via internet sales, and (6) expand through selective acquisition, as such opportunities arise, to enhance penetration into new and existing markets as a complementary strategy to organic growth.
We have experienced considerable sales growth over the last five years, with a compounded annual growth rate of approximately 17.4%. We plan to continue our growth strategy, which anticipates an annual increase in our unit count of approximately 13%. This growth has expanded our market presence to 764 retail stores in 43 states. We believe this unit count increase will contribute substantially to our future growth. We have also relocated 83 stores since 2002, which enabled us to keep much of our existing loyal customer base but expand our overall reach to new customers, thereby growing the business. We believe we have developed a proven method for selecting store sites and have identified over 650 potential additional markets for new Tractor Supply stores (excluding Del’s) in the United States. We continue to develop our site selection methodology for the Del’s concept, which includes tests in markets of varying size and demographics.
We expect to open approximately 95 to 100 stores (including eight to 10 Del’s stores) in fiscal 2008.
The average estimated net cash investment required to open a new leased retrofit or prototype store in fiscal 2007 was between $0.8 to $1.4 million and $0.7 to $0.9 million, respectively. A majority of the cash outlay was for initial acquisition of inventory and capital expenditures (principally leasehold improvements, fixtures and equipment), and approximately $95,000 for pre-opening costs.
Additional Information
We file reports with the Securities and Exchange Commission (“SEC”), including Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other reports as required. The public may read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. We are an electronic filer and the SEC maintains an Internet site at sec.gov that contains the reports, proxy and information statements, and other information filed electronically.
We make available free of charge through our Internet website, TractorSupply.com, our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The information provided on our website is not part of this report, and is therefore not incorporated by reference unless such information is otherwise specifically referenced elsewhere in this report.
Our code of ethics, which is applicable to all of our employees, including our Chief Executive Officer, Chief Financial Officer and Controller, along with our Corporate Governance Guidelines and the charters of our Audit, Compensation, Corporate Governance and Nominating Committees of our Board of Directors, is posted on our website.
Item 1A.
Item 1A. Risk Factors
Our business faces many risks. These risks include those described below and may include additional risks and uncertainties not presently known to us or that we currently deem immaterial. If any of the events or circumstances described in the following risk factors occur, our business, financial condition or results of operations may suffer, and the trading price of our common stock could decline. These risk factors should be read in conjunction with the other information in this Form 10-K.
General economic conditions may adversely affect our financial performance.
Our results of operations may be sensitive to changes in overall economic conditions that impact consumer spending, including discretionary spending. Future economic conditions affecting disposable consumer income such as employment levels, business conditions, interest rates, tax rates, fuel and energy costs, higher labor and healthcare costs, the impact of natural disasters or acts of terrorism, and other matters could reduce consumer spending or cause consumers to shift their spending to lower-priced competitors. A general reduction in the level of discretionary spending or shifts in consumer discretionary spending to our competitors could adversely affect our growth and profitability. Additionally, changes in the mix of products sold to a mix with a lower overall gross margin or other increased cost of sales, along with slower inventory turnover and greater markdowns on inventory, could adversely affect our operations and operating results.
Inflationary pressures, including rising energy prices, may adversely affect our financial performance.
Although we cannot determine the full effect of inflation on our operations, we believe our sales and results of operations have been affected by inflation. We are subject to market risk with respect to the pricing of certain products and services, which include, among other items, steel, grain, petroleum, corn, soybean and other commodities as well as transportation services. Moreover, in the last few years, energy prices have risen dramatically, which has resulted in increased fuel costs for our business and utility costs for our stores. We have been successful in reducing or mitigating the effects of inflation, principally through selective buying from the most competitive vendors and by increasing retail prices. However, there is no assurance that we will be successful in reducing or mitigating the effect of inflation in the future.
There is no assurance that we will be able to continue to increase sales at our existing stores.
We experience fluctuations in our same-store sales, which are defined as stores which have completed twelve months of sales, excluding relocated stores. Our success depends, in part, upon our ability to improve sales at our existing stores. Various factors affect same-store sales, including the general retail sales environment, our ability to efficiently source and distribute products, changes in our merchandise mix, competition, current economic conditions, the timing of release of new merchandise and promotional events, the success of marketing programs and weather conditions. These factors may cause our same-store sales results to differ materially from prior periods and from expectations. Past same-store sales are not necessarily an indication of future results, and there can be no assurance that our same-store sales will not decrease in the future. Any failure to meet the same-store sales expectations of investors and security analysts in one or more future periods could adversely affect our results of operations and result in a reduction in the market price of our common stock.
Our failure to effectively manage growth could impair our business.
Even if we are able to implement, to a significant degree, our key business strategy of expanding our store base, we may experience managerial or operational problems, which may prevent any significant increase in profitability or negatively impact our cash flow. To manage our planned expansion, we must ensure the continuing adequacy of our existing systems, controls and procedures, including product distribution facilities, store management, financial controls and information systems. There can be no assurance that we will be able to achieve our planned expansion, that the new stores will be effectively integrated into our existing operations or that such stores will be profitable.
Capital requirements for growth may not be available.
The construction and opening or acquisition of new stores and the development of new production and distribution facilities, along with the remodeling and renovation of existing stores, require significant amounts of capital. In the past, our growth has been funded primarily through bank borrowings and internally generated cash flow.
Failure to open new stores in the manner currently contemplated could adversely affect our financial performance.
An integral part of our business strategy includes the expansion of our base of stores by opening new stores. This expansion strategy is dependent on our ability to find suitable locations, and we face competition from many retailers for such sites. If we are unable to implement this strategy, our ability to increase our sales, profitability, and cash flow could be impaired significantly. To the extent that we are unable to open new stores in the manner we anticipate (due to site approval or unforeseen delays in construction), our sales growth may be impeded.
New stores may negatively impact our results.
There can be no assurance that our new store openings will be successful or result in greater sales and profitability for the Company. New stores build their sales volumes and refine their merchandise selection over time and, as a result, generally have lower gross margins and higher operating expenses as a percentage of sales than our more mature stores. As we accelerate our rate of new store openings, thus increasing the percentage of our sales from new stores and decreasing the average age of our store base, there may be a negative impact on our results from a lower contribution of these new stores, along with the impact of related pre-opening costs.
Competition in our industry may hinder our ability to execute our business strategy and adversely affect our operations.
We operate in a very competitive market. The principal competitive factors include location of stores, price and quality of merchandise, in-stock consistency, merchandise assortment and presentation, and customer service. We believe we have successfully differentiated ourselves from general merchandise, home center retailers and other specialty and discount retailers by focusing on our specialized market niche. However, we do face competition from these entities, as well as competition from independently-owned retail farm and ranch stores, several privately-held regional farm store chains and farm cooperatives. Some of our competitors are units of national or regional chains that have substantially greater financial and other resources.
Weather conditions may have a significant impact on our financial results.
Historically, weather conditions have had a significant impact on our operating results. Weather conditions affect the demand for, and in some cases the supply of, products, which in turn has an impact on prices. In recent years, we have experienced unusually severe weather conditions, including ice storms, floods and wind damage, hurricanes and droughts in some states. Weather conditions also directly affect the demand for petroleum products, particularly during the winter heating season. Accordingly, the weather can have a material effect on our financial condition and results of operations.
There are certain risks associated with the seasonal nature of our business.
Our working capital needs and borrowings generally peak in our first fiscal quarter because lower sales are generated while expenses are incurred in preparation for the spring selling season. If cash on hand and borrowings under existing credit facilities are ever insufficient to meet the seasonal needs or if cash flow generated during the spring and summer is insufficient to repay associated borrowings on a timely basis, this seasonality could have a material adverse effect on our business.
There is no assurance that our merchandising initiatives and marketing emphasis will continue.
We believe our past performance has been based on, and future success will depend upon, in part, the ability to develop and execute merchandising initiatives with effective marketing. There is no assurance that we will be successful, or that new initiatives will be executed in a timely manner to satisfy our customers’ needs or expectations. Failure to execute and promote such initiatives in a timely manner could harm our ability to grow the business and could have a material adverse effect on our results of operations and financial condition. Additionally, our success depends on our ability to anticipate and respond in a timely manner to changing customer demand and preferences for merchandise. If we misjudge the market, we may significantly overstock unpopular products and be forced to take significant inventory markdowns. Shortages of key items could also have a materially adverse impact on operating results.
We face risks associated with vendors from whom our products are sourced.
The products we sell are sourced from a variety of domestic and international vendors. All of our vendors must comply with applicable laws, including labor and environmental laws, and otherwise be certified as meeting required vendor standards of conduct. We rely on foreign manufacturers for various products that we sell. In addition, many of our domestic suppliers purchase a portion of their products from foreign sources. We rely on long-term relationships with our suppliers but have no long-term contracts with such suppliers. Our future success will depend in large measure upon our ability to maintain our existing supplier relationships or to develop new ones. This reliance increases the risk of inadequate and untimely supplies of various products due to local political, economic, social, or environmental conditions, transportation delays, restrictive actions by foreign governments, or changes in United States laws and regulations affecting imports or domestic distribution. As an importer, our business is subject to the risks generally associated with doing business abroad, such as foreign governmental regulations, economic disruptions, delays in shipments, transportation capacity and costs, currency exchange rates and changes in political or economic conditions in countries from which we purchase products. If any such factors were to render the conduct of business in particular countries undesirable or impractical or if additional United States quotas, duties, taxes or other charges or restrictions were imposed upon the importation of our products in the future, our financial condition and results of operations could be materially adversely affected.
Our failure to attract and retain qualified employees could adversely affect our financial performance.
Our ability to continue expanding operations depends on our ability to attract and retain a large and growing number of qualified employees. Our ability to meet labor needs while controlling wage and related labor costs is subject to numerous external factors, including the availability of a sufficient number of qualified persons in the work force, unemployment levels, prevailing wage rates, changing demographics, health and other insurance costs and changes in employment legislation. If we are unable to locate, attract or retain qualified personnel, or if costs of labor or related costs increase significantly, our financial performance could be adversely affected.
We may be subject to product liability and other claims in the ordinary course of business.
Our business involves a risk of product liability and other claims in the ordinary course of business. We maintain general liability insurance with a $250,000 deductible for each occurrence and a $25,000,000 aggregate retention. We also maintain umbrella limits above the primary general liability and product liability cover. In many cases, we have indemnification rights against the manufacturers of the products and their products liability insurance. Our ability to recover under such insurance or indemnification arrangements is subject to the financial viability of the insurers and manufacturers and the specific allegations of a claim. We cannot assure that our insurance coverage or the manufacturers’ indemnity will be available or sufficient in any claims brought against us.
Legal proceedings could materially impact our results.
From time to time, we are party to legal proceedings including matters involving personnel and employment issues, personal injury, intellectual property, and other proceedings arising in the ordinary course of business. Our results could be materially impacted by the decisions and expenses related to pending or future proceedings.
If we experience difficulties with our management information systems, our financial performance may be adversely affected.
We depend on management information systems for many aspects of our business. We could be materially adversely affected if our management information systems are disrupted or if we are unable to improve, upgrade, maintain and expand systems, particularly in light of the contemplated continued store growth.
Effective tax rate changes and results of examinations by taxing authorities could materially impact our results.
Our future effective tax rates could be adversely affected by the earnings mix being lower than historical results in states where we have lower statutory rates and higher than historical results in states where we have higher statutory rates, by changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws or interpretations thereof. In addition, we are subject to periodic audits and examinations by the Internal Revenue Service (“IRS”) and other state and local taxing authorities. Our results could be materially impacted by the determinations and expenses related to these and other proceedings by the IRS and other state and local taxing authorities.
Failure of our internal control over financial reporting could materially impact our business and results.
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. An internal control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all internal control systems, internal control over financial reporting may not prevent or detect misstatements. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report our financial results accurately and timely or to detect and prevent fraud, and could expose us to litigation or adversely affect the market price of our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
At December 29, 2007, we operated 764 stores in 43 states. We lease more than 93% of our stores, two of our six distribution centers and our management headquarters. Store leases typically have initial terms of between 10 and 15 years, with two to four renewal periods of five years each, exercisable at our option. No single lease is material to our operations.
Following is a count of our store locations by state:
Item 3.
Item 3. Legal Proceedings
We are involved in various litigation matters arising in the ordinary course of business. After consultation with legal counsel, we expect these matters will be resolved without material adverse effect on our consolidated financial position or results of operations. Any estimated loss related to such matters has been adequately provided in accrued liabilities to the extent probable and reasonably estimable. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in circumstances relating to these proceedings.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of our stockholders during the fourth quarter of our fiscal year ended December 29, 2007.
Executive Officers
Pursuant to General Instruction G(3) of Form 10-K, the following list is included as an unnumbered item in Part I of this Report in lieu of being included in the Proxy Statement for the Annual Meeting of Stockholders to be held on May 1, 2008.
The following is a list of the names and ages of all executive officers of the registrant, indicating all positions and offices with the registrant held by each such person and each person’s principal occupations and employment during at least the past five years:
James F. Wright has served as Chairman of the Board, President and Chief Executive Officer of the Company since November 2007, and as President and Chief Executive Officer of the Company since October 2004. Mr. Wright previously served as President and Chief Operating Officer of the Company from October 2000 to October 2004. Mr. Wright has served as a director of the Company since 2002.
Anthony F. Crudele has served as Executive Vice President-Chief Financial Officer and Treasurer since January 2007, after having served as Senior Vice President-Chief Financial Officer and Treasurer of the Company since November 2005. Mr. Crudele previously served as Chief Financial Officer at Gibson Guitar from August 2003 to September 2005, as Chief Financial Officer of Xcelerate Corp. from 2000 to January 2003, and at The Sports Authority from 1989 through 1999 (serving as Chief Financial Officer from 1996 through 1999).
Gregory A. Sandfort has served as Executive Vice President-Chief Merchandising Officer of the Company since November 2007. Mr. Sandfort previously served as President and Chief Operating Officer at Michaels Stores, Inc. from March 2006 to August 2007 and as Vice President - General Merchandise Manager at Michaels Stores, Inc. from January 2004 to February 2006. Mr. Sandfort served as Vice Chairman and Co-Chief Executive Officer of Kleinert’s Inc. (d/b/a Buster Brown) from 2002 to 2003 and as a Vice President, General Merchandise Manager for Sears, Roebuck and Co. from 1998 to 2002.
Stanley L. Ruta has served as Executive Vice President-Store Operations since January 2007, after having served as Senior Vice President-Store Operations since June 2000 and as Vice President-Store Operations of the Company since 1994.
Blake A. Fohl has served as Senior Vice President-Marketing of the Company since January 2007, after having served as Vice President-Marketing of the Company since January 1996.
Kimberly D. Vella has served as Senior Vice President-Human Resources of the Company since January 2007, after having served as Vice President-Human Resources of the Company since October 2001.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Tractor Supply Company’s common stock trades on The Nasdaq Global Select Market under the symbol “TSCO”.
The table below sets forth the high and low sales prices of our common stock as reported by The Nasdaq Global Select market since August 1, 2006 and by the Nasdaq National Market for the periods prior to August 1, 2006 for each fiscal quarter of the periods indicated:
As of January 31, 2008, the approximate number of record holders of our common stock was 150 (excluding individual participants in nominee security position listings), and the estimated number of beneficial holders of our common stock was 15,000.
Issuer Purchases of Equity Securities
In February 2007, our Board of Directors authorized a share repurchase program which provides for repurchase of up to $200 million (excluding commissions) of our outstanding common stock over an approximate three-year period. Stock repurchase activity during fiscal 2007 is set forth in the table below:
We expect to implement the balance of the repurchase program through purchases made from time to time either in the open market or through private transactions, in accordance with regulations of the Securities and Exchange Commission.
We have not declared any cash dividends during the two most recent fiscal years. Our Board of Directors authorized a share repurchase strategy, subject to a number of factors, including price, corporate and regulatory requirements, capital availability and other market conditions. Any future declaration of dividends or additional share repurchase programs will be subject to the discretion of our Board of Directors and subject to our results of operations, financial condition, cash requirements and other factors deemed relevant by our Board of Directors.
STOCK PERFORMANCE GRAPH
This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) or otherwise subject to the liabilities under that Section and shall not be deemed to be incorporated by reference into any filing of Tractor Supply Company under the Securities Act of 1933, as amended or the Exchange Act.
The following graph compares the cumulative total stockholder return on our Common Stock from December 28, 2002 to December 29, 2007 (the Company’s fiscal year-end) with the cumulative total returns of the S&P 500 Index and the S&P Retail Index over the same period. The comparison assumes that $100 was invested on December 28, 2002 in our Common Stock and in each of the foregoing indices. The historical stock price performance shown on this graph is not necessarily indicative of future performance.
Item 6.
Item 6. Selected Financial Data
FIVE YEAR SELECTED FINANCIAL AND OPERATING HIGHLIGHTS
The following selected financial data are derived from the consolidated financial statements of Tractor Supply Company. Our fiscal year includes 52 or 53 weeks and ends on the last Saturday of the calendar year. References to fiscal year mean the year in which that fiscal year ended. Fiscal year 2005 consists of 53 weeks while all other fiscal years presented below consist of 52 weeks. The following table provides summary historical financial information for the periods ended and as of the dates indicated (in thousands, except per share and selected operating data):
In fiscal 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) 123(R) which lowered pre-tax income by $10.6 million and $9.7 million for 2007 and 2006, respectively. Net income was lowered by $6.6 million and $6.1 million for 2007 and 2006, respectively.
(a)
The Company adopted Emerging Issues Task Force No. 02-16 (“EITF 02-16”) which changed its method of accounting for consideration received from vendors whereby such consideration is considered a reduction of inventory cost as opposed to a reduction of selling, general and administrative costs. As a result, the Company recorded a non-cash charge of $1.9 million, net of income tax, in the first quarter of fiscal 2003 for the cumulative effect of the change on fiscal years prior to fiscal 2003.
(b)
Basic net income per share is calculated based on the weighted average number of common shares outstanding applied to net income. Diluted net income per share is calculated using the treasury stock method for options and warrants. All share and per share data have been adjusted for stock splits.
(c)
Reflects remodelings costing more than $150,000.
(d)
Includes assets acquired through capital leases.
(e)
Same-store sales increases are calculated on an annual basis, excluding relocations, using all stores open at least one year.
(f)
Average sales per store calculated based on the weighted average number of days open in the applicable period.
(g)
Total assets have been restated to reflect cash held in our bank concentration account as a reduction of book overdraft balances.
(h)
Long-term debt includes borrowings under the Company’s revolving credit agreement and term loan agreement and amounts outstanding under its capital lease obligations, excluding the current portions of each.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Tractor Supply Company is the largest operator of retail farm and ranch stores in the United States and is focused on supplying the lifestyle needs of recreational farmers and ranchers and of those who enjoy the rural lifestyle, as well as tradesmen and small businesses. Our stores are located in towns outlying major metropolitan markets and in rural communities and offer the following comprehensive selection of merchandise:
•
Equine, pet and animal products, including items necessary for their health, care, growth and containment
•
Maintenance products for agricultural and rural use
•
Hardware and tool products
•
Seasonal products, including lawn and garden power equipment
•
Truck and towing products, and
•
Work/recreational clothing and footwear for the entire family.
Tractor Supply Company stores typically range in size from 15,500 to 18,500 square feet of inside selling space plus additional outside selling space. We are developing stores using one of five standard prototypes as well as existing building structures. Our wholly-owned subsidiary, Del’s Farm Supply, LLC (“Del’s”), operates 23 stores, primarily in the Pacific Northwest, that offer a wide selection of products (primarily in the equine, pet and animal category) tailored to those who enjoy the rural lifestyle. Del’s stores currently range in size from approximately 1,500 to 5,000 square feet of inside selling space plus additional outside and covered/sheltered selling space.
Our current and long-term growth strategy is to (1) expand geographic market presence through opening new retail stores, (2) enhance financial performance through same-store sales increases, achieved through aggressive merchandising programs with an “everyday low prices” philosophy and supported by strong customer service, (3) enhance product margin through assortment management, vendor management, sourcing and optimization of transportation and distribution costs, (4) leverage operating costs, especially occupancy, advertising and distribution, (5) expand market opportunities via internet sales, and (6) expand through selective acquisition, as such opportunities arise, to enhance penetration into new and existing markets as a complimentary strategy to organic growth.
We have experienced considerable sales growth over the last five years, with a compounded annual growth rate of approximately 17.4%. We plan to continue this growth strategy with an annual projected increase in our unit count of approximately 13%. This growth has expanded our market presence to 764 stores in 43 states. We believe this unit count increase will contribute substantially to our future growth. The acquisition of Del’s enabled us to establish an initial presence in the Pacific Northwest, primarily in Washington, with three additional stores in Hawaii.
We operated 764 retail farm and ranch stores as of December 29, 2007 and have plans to open 95 to 100 stores (including eight to 10 Del’s stores) in fiscal 2008. We have developed a proven method for selecting store sites and have identified over 650 potential additional markets for new Tractor Supply stores (excluding Del’s) in the United States.
We have placed significant emphasis on our merchandising programs, evaluating the sales and profitability of our products through detailed line reviews, review of vendor performance measures and modification of the overall product offerings. These efforts, coupled with a strong marketing program and in-depth product knowledge training of our store employees, have enhanced our sales and financial performance.
Seasonality and Weather
Our business is highly seasonal. Historically, our sales and profits have been the highest in the second and fourth fiscal quarters of each year due to the sale of seasonal products. Unseasonable weather, excessive precipitation, natural disasters, drought, and early or late frosts may also affect our sales. We believe, however, that the impact of adverse weather conditions is somewhat mitigated by the geographic dispersion of our stores.
We experience our highest inventory and accounts payable levels during our first fiscal quarter each year for purchases of seasonal product in anticipation of the spring selling season and again during our third fiscal quarter in anticipation of the winter selling season.
Inflation
Although we cannot determine the full effect of inflation on our operations, we believe our sales and results of operations are affected by inflation. We are subject to market risk with respect to the pricing of certain products and services, which include, among other items, steel, grain, petroleum, corn, soybean and other commodities as well as transportation services. Moreover, in the last few years, energy prices have risen dramatically, which has resulted in increased fuel costs for our business and utility costs for our stores. We have been successful in reducing or mitigating the effects of inflation, principally through selective buying from the most competitive vendors and by increasing retail prices. However, there is no assurance that we will be successful in reducing or mitigating the effect of inflation in the future.
Significant Accounting Policies and Estimates
Management’s discussion and analysis of our financial position and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. The preparation of these financial statements requires management to make informed estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Our financial position and/or results of operations may be materially different when reported under different conditions or when using different assumptions in the application of such policies. In the event estimates or assumptions prove to be different from actual amounts, adjustments are made in subsequent periods to reflect more current information. Our significant accounting policies are disclosed in Note 1 to our Consolidated Financial Statements. The following discussion addresses our most critical accounting policies, which are those that are both important to the portrayal of our financial condition and results of operations and that require significant judgment or use of complex estimates.
Description
Revenue Recognition and Sales Returns:
We recognize revenue at the time the customer takes possession of merchandise or receives services. If we receive payment before the customer has taken possession of the merchandise (as per our layaway program), the revenue is deferred until the sale is complete. Revenues from the sale of gift cards are deferred and recognized upon redemption.
Judgments and Uncertainties
We estimate a liability for sales returns based on a one-year rolling average of historical return trends and we believe that our estimate for sales returns is an accurate reflection of future returns associated with past sales. Our estimation methodologies have been consistently applied from year to year, however, as with any estimates, refunds activity may vary from estimated amounts.
We recognize a benefit for gift cards when: (i) the gift card or merchandise return card is redeemed by the customer; or (ii) the likelihood of the gift card being redeemed by the customer is remote (referred to as “breakage”) or (iii) the unredeemed merchandise returns cards expire (one year from issuance). The gift card breakage rate is based upon historical redemption patterns and a benefit is recognized for unredeemed gift cards in proportion to those historical redemption patterns.
Effect if Actual Results Differ From
Assumptions
We have not made any material changes in the accounting methodology used to recognize sales returns in the financial periods presented.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate sales returns or gift card breakage. However, if actual consumer return or gift card redemption patterns are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.
A 10% change in our sales return reserve at December 29, 2007, would have affected net earnings by approximately $190,000 in fiscal 2007.
A 10% change in our assumptions regarding gift card breakage would have affected net earnings by approximately $225,000 in fiscal 2007.
Effect if Actual Results Differ From
Description
Judgments and Uncertainties
Assumptions
Inventory Valuation:
Impairment Risk
We identify potentially excess and slow-moving inventory by evaluating turn rates, sales trends, age of merchandise, overall inventory levels and other benchmarks. The estimated inventory valuation reserve to recognize any impairment in value (i.e., an inability to realize the full carrying value) is based on our aggregate assessment of these valuation indicators under prevailing market conditions and current merchandising strategies.
We do not believe our merchandise inventories are subject to significant risk of obsolescence in the near term. However, changes in market conditions or consumer purchasing patterns could result in the need for additional reserves.
Our impairment reserve contains uncertainties because the calculation requires management to make assumptions and to apply judgment regarding forecasted consumer demand, overall aging, the promotional environment, historical results and current inventory loss trends.
We have not made any material changes in the accounting methodology used to recognize impairment reserves in the financial periods presented.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate impairment. However, if assumptions regarding consumer demand or clearance potential for certain products are inaccurate, we may be exposed to losses or gains that could be material.
A 10% change in our impairment reserve at December 29, 2007, would have affected net earnings by approximately $315,000 in fiscal 2007.
Shrinkage
Our stores perform physical inventories at least once a year and we have established reserves for estimating inventory shrinkage between physical inventory counts. This is done 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 shrink rate is based on historical experience. We believe historical rates are a reasonably accurate reflection of future trends.
Our shrinkage reserve contains uncertainties because the calculation requires management to make assumptions and to apply judgment regarding historical trends, loss prevention measures and new merchandising strategies.
We have not made any material changes in the methodology used to recognize shrinkage in the financial periods presented.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our shrinkage reserve. However, if our estimates regarding inventory losses are inaccurate, we may be exposed to losses or gains that could be material.
A 10% change in our shrinkage reserve at December 29, 2007, would have affected net earnings by approximately $810,000 in fiscal 2007.
Effect if Actual Results Differ From
Description
Judgments and Uncertainties
Assumptions
Vendor Support
We receive funding from substantially all of our significant merchandise vendors for the promotion of our brand as well as the sale of their products through a variety of programs and arrangements, including guaranteed funding and volume rebate programs. The amounts received are subject to terms of vendor agreements, which have varying expiration dates ranging in duration from several months to several years. Many agreements are negotiated annually and are based on expected annual purchases of the vendor’s product. Vendor funding is initially deferred as a reduction of the purchase price of inventory and then recognized as a reduction of cost of merchandise as the related inventory is sold, which is in compliance with Emerging Issues Task Force No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” (“EITF 02-16”). The amount of expected funding is estimated based upon initial guaranteed commitments, as well as anticipated purchase levels with applicable vendors.
The estimated purchase volume and related vendor funding is based on our current knowledge of inventory levels, sales trends and expected customer demand, as well as planned new store openings and relocations. Although we believe we can reasonably estimate purchase volume and related vendor funding, it is possible that actual results could significantly differ from estimated amounts.
Our allocation methodology contains uncertainties because the calculation requires management to make assumptions and to apply judgment regarding purchasing activity, target thresholds and vendor attrition.
At the end of each fiscal year, the estimated support is reconciled to the actual amounts earned based upon actual purchase activity.
We do not believe there is a significant collectibility risk related to vendor support amounts due us at the end of fiscal 2007.
Although it is unlikely that there will be any significant reduction in historical levels of vendor support, if such a reduction were to occur, the Company could experience a higher inventory balance and higher cost of sales.
If a 10% reserve had been applied against our outstanding vendor support due as of December 29, 2007, net earnings would have been affected by approximately $1.1 million.
Freight
We incur various types of transportation and delivery costs in connection with inventory purchases. Such costs are included as a component of the overall cost of inventories (on an aggregate basis) and recognized as a component of cost of merchandise sold as the related inventory is sold.
We allocate freight as a component of total cost of sales without regard to inventory mix or unique freight burden of certain categories. This assumption has been consistently applied for all years presented.
If a 10% increase or decrease had been applied against our current inventory capitalized freight balance, net earnings would have been affected by approximately $3.0 million.
Effect if Actual Results Differ From
Description
Judgments and Uncertainties
Assumptions
Stock-Based Compensation:
We have a stock-based compensation plan, which includes incentive and non-qualified stock options, nonvested share awards, and an employee stock purchase plan. See Note 1, Summary of Significant Accounting Policies , and Note 2, Shareholders’ Equity , to the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K, for a complete discussion of our stock-based compensation programs.
We estimate the fair value of our stock option awards at the date of grant utilizing a Black-Scholes option pricing model. We estimate the fair value of our market-based nonvested share awards at the date of grant utilizing average market price of our stock on the date of the related award.
Management reviews its assumptions and the valuations provided by independent third-party valuation advisors to determine the fair value of stock-based compensation awards.
Option-pricing models and generally accepted valuation techniques require management to make subjective assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the future volatility of our stock price, expected dividend yield, future employee turnover rates and future employee stock option exercise behaviors. In addition to the key assumptions used to estimate the fair value, the estimated forfeiture rate of the awarded options is a critical assumption, as it reduces expense ratably over the vesting period. Changes in these assumptions can materially affect the fair value estimate.
While we update our assumptions annually, we do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to determine stock-based compensation expense. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to changes in stock-based compensation expense that could be material. The reported stock-based compensation expense may not be representative of the actual economic cost of the stock-based compensation.
A 10% change in our stock-based compensation expense for the year ended December 29, 2007, would have affected net earnings by approximately $659,000.
Self-Insurance Reserves:
We self-insure a significant portion of our employee medical insurance, workers’ compensation and general liability insurance plans. We have stop-loss insurance policies to protect from individual losses over specified dollar values ($200,000 for employee health insurance claims, $350,000 for workers’ compensation and $250,000 for general liability).
When estimating our self-insured liabilities, we consider a number of factors, including historical claims experience, demographic factors, severity factors and valuations provided by independent third-party actuaries.
Management reviews its assumptions and the valuations provided by independent third-party actuaries to determine the adequacy of our
self-insured liabilities.
The full extent of certain claims, especially workers’ compensation and general liability claims, may not become fully determined for several years.
Our self-insured liabilities contain uncertainties because management is required to make assumptions and to apply judgment to estimate the ultimate cost to settle reported claims and claims incurred but not reported as of the balance sheet date.
We have not made any material changes in the accounting methodology used to establish our self-insurance reserves in the financial periods presented.
We do not believe there is a reasonable likelihood that there will be a material change in the assumptions we use to calculate insurance reserves. However, if we experience a significant increase in the number of claims or the cost associated with these claims, we may be exposed to losses or gains that could be material.
A 10% change in our insurance reserves at December 29, 2007, would have affected net earnings by approximately $1.3 million in fiscal 2007.
Effect if Actual Results Differ From
Description
Judgments and Uncertainties
Assumptions
Sales Tax Audit Reserve:
A portion of our sales are to tax-exempt customers. We obtain exemption information as a necessary part of each tax-exempt transaction. Many of the states in which we conduct business will perform audits to verify our compliance with applicable sales tax laws. The business activities of our customers and the intended use of the unique products sold by us create a challenging and complex environment of compliance. These circumstances also create some risk that we could be challenged as to the propriety of our sales tax compliance.
While we believe we reasonably enforce sales tax compliance with our customers and endeavor to fully comply with all applicable sales tax regulations, there can be no assurance that we, upon final completion of such audits, would not have a significant liability for disallowed exemptions.
We review our past audit experience and assessments with applicable states to determine if we have potential exposure for non-compliance. Any estimated liability is based on an initial assessment of compliance risk and our to-date experience with each audit. As each audit progresses, we quantify the exposure based on preliminary assessments made by the state auditors, adjusted for additional documentation that may be provided to reduce the assessment.
Our sales tax audit reserve contains uncertainties because management is required to make assumptions and to apply judgment regarding the regulatory support for SKU-specific agricultural-based exemptions, ambiguity in state tax regulations, and the level of exemptions support required by applicable states.
We have not made any material changes in the methodology used to recognize the sales tax audit revenue in the financial periods presented.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate the sales tax liability reserve for current audits. However, if our estimates regarding the ultimate sales tax liability are inaccurate, we may be exposed to losses or gains that could be material.
A 10% change in our sales tax liability reserve at December 29, 2007, would have affected net earnings by approximately $350,000 in fiscal 2007.
Tax Contingencies:
Our income tax returns are periodically audited by U.S. federal and state tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any one time, multiple tax years are subject to audit by the various tax authorities. In evaluating the exposures associated with our various tax filing positions, we record reserves for uncertain tax positions. A number of years may elapse before a particular matter, for which we have established a reserve, is audited and fully resolved or clarified. We adjust our tax contingencies reserve and income tax provision in the period in which actual results of a settlement with tax authorities differs from our established reserve, the statute of limitations expires for the relevant tax authority to examine the tax position or when more information becomes available.
Effective December 31, 2006, we adopted FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109. Accordingly, we recognize a liability for certain tax benefits that do not meet the minimum requirements for recognition in the financial statements. See Note 10.
Our tax contingencies reserve contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various filing positions and whether or not the minimum requirements for recognition of tax benefits have been met.
Our effective income tax rate is also affected by changes in tax law, the tax jurisdiction of new stores or business ventures, the level of earnings and the results of tax audits.
We do not believe there is a reasonable likelihood that there will be a material change in the reserves established for tax benefits not recognized.
Although management believes that the judgments and estimates discussed herein are reasonable, actual results could differ, and we may be exposed to losses or gains that could be material.
To the extent we prevail in matters for which reserves have been established, or are required to pay amounts in excess of our reserves, our effective income tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement would require use of our cash and would result in an increase in our effective income tax rate in the period of resolution. A favorable tax settlement would be recognized as a reduction in our effective income tax rate in the period of resolution.
A 10% change in our unrecognized tax benefit reserve at December 29, 2007 would have affected net earnings by approximately $265,000 in fiscal 2007.
Effect if Actual Results Differ From
Description
Judgments and Uncertainties
Assumptions
Goodwill:
We evaluate goodwill for impairment annually and whenever events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable. We complete our impairment evaluation by performing internal valuation analyses, considering other publicly available market information and using an independent valuation firm, as appropriate.
In the fourth quarter of fiscal 2007, we completed our annual impairment testing of goodwill using the methodology described herein, and determined there was no impairment.
We determine fair value using widely accepted valuation techniques, including discounted cash flow and market multiple analyses. These types of analyses contain uncertainties because they require management to make assumptions and to apply judgment to estimate industry economic factors and the profitability of future business strategies. It is our policy to conduct impairment testing based on our current business strategy in light of present industry and economic conditions, as well as future expectations.
We have not made any material changes in our impairment loss assessment methodology in the financial periods presented.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to test for impairment losses on goodwill. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to an impairment charge that could be material.
Long-Lived Assets:
Long-lived assets other than goodwill and indefinite-lived intangible assets, which are separately tested for impairment, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
When evaluating long-lived assets for potential impairment, we first compare the carrying value of the asset to the asset’s estimated future cash flows (undiscounted and without interest charges). If the estimated future cash flows are less than the carrying value of the asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the asset to the asset’s estimated fair value, which may be based on estimated future cash flows (discounted and with interest charges). We recognize an impairment loss if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If we recognize an impairment loss, the adjusted carrying amount of the asset becomes its new cost basis. For a depreciable long-lived asset, the new cost basis will be depreciated (amortized) over the remaining useful life of that asset.
Our impairment loss calculations contain uncertainties because they require management to make assumptions and to apply judgment to estimate future cash flows and asset fair values, including forecasting useful lives of the assets and selecting the discount rate that reflects the risk inherent in future cash flows.
We have not made any material changes in our impairment loss assessment methodology in the financial periods presented.
We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate long-lived asset impairment losses. However, if actual results are not consistent with our estimates and assumptions used in estimating future cash flows and asset fair values, we may be exposed to losses that could be material.
Quarterly Financial Data
Our unaudited quarterly operating results for each fiscal quarter of 2007 and 2006 are shown below (dollars in thousands, except per share amounts):
(1)
Due to the nature of interim earnings per share calculations, the sum of quarterly earnings per share amounts may not equal the reported earnings per share for the year.
Results of Operations
Our fiscal year includes 52 or 53 weeks and ends on the last Saturday of the calendar year. References to fiscal year mean the year in which that fiscal year ended. The fiscal year ended December 31, 2005 contains 53 weeks while the fiscal years ended December 29, 2007 and December 30, 2006 contain 52 weeks.
The following table sets forth, for the periods indicated, certain items in our Consolidated Statements of Income expressed as a percentage of net sales.
Fiscal 2007 Compared to Fiscal 2006
Net sales increased 14.1% to $2,703.2 million in fiscal 2007 from $2,369.6 million in fiscal 2006. This increase resulted from the opening of new stores as well as a same-store sales improvement of 3.4%. Our average transaction value increased 1.1% to $43.60 while same-store transaction value decreased 0.1% for fiscal 2007. Average daily transaction count per store increased 0.6% to 239, and same-store transaction count increased 3.5%.
Same-store sales improvements of 3.4% compared to 1.6% in the prior year were strongest in the livestock/pet and truck/towing categories, but were partially offset by lower than expected performance in seasonal and hardware/tool products.
In fiscal 2007, we opened 89 new stores (compared to 82 new stores in fiscal 2006), relocated 12 stores (compared to 15 in fiscal 2006) and sold our only Del’s store located in Canada (compared to one closed store in fiscal 2006).
As a percent of sales, gross margin was unchanged at 31.5% compared with the prior year. Reductions in direct product costs were achieved through improved sourcing and mix of sales, but were offset by slightly higher transportation costs and increased shrinkage.
As a percent of sales, selling, general and administrative (“SG&A”) expenses increased 20 basis points to 23.7% in fiscal 2007 from 23.5% in fiscal 2006. The increase is primarily attributable to increased occupancy and payroll costs from new stores, which generally have higher costs in relation to sales volume than the chain average. Depreciation and amortization expense increased 20.7% in fiscal 2007 over fiscal 2006 due mainly to costs associated with new stores.
Net interest expense increased 10 basis points as a percent of sales to $5.0 million in fiscal 2007 from $2.7 million in fiscal 2006. This increase is due largely to borrowings related to the stock repurchase program.
Our effective tax rate was 37.9% for fiscal 2007 compared to 37.4% in fiscal 2006, resulting primarily from state taxes relating to the composition of income among the states and the adoption of FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes”, (“FIN 48”) relating to uncertainties in income tax positions. This interpretation prescribes the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Tax positions that meet a “more-likely-than-not” recognition threshold should be measured in order to determine the tax benefit to be recognized. We are no longer subject to federal examination for years before 2005, and state and local income tax examinations for years before 2002.
We adopted the provisions of FIN 48 in fiscal 2007, as required. As a result, we charged approximately $1.9 million to retained earnings for the cumulative effect of adoption including interest. Interest and penalties were immaterial at the date of adoption. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate is $2.3 million. In addition, we recognize current interest accrued related to these uncertain tax positions as interest expense.
As a result of the foregoing factors, net income for fiscal 2007 increased 5.8% to $96.2 million, or $2.40 per diluted share. Compared to net income of $91.0 million, or $2.22 per diluted share, in fiscal 2006. During 2007, the Company repurchased 3.2 million shares of its stock for $150.0 million as part of our previously announced $200 million share repurchase program.
Fiscal 2006 Compared to Fiscal 2005
Net sales increased 14.6% to $2,369.6 million in fiscal 2006 from $2,068.0 million in fiscal 2005. Fiscal 2005 included an additional week of sales which impacted the current year sales increase by 1.5%. This increase resulted from the opening of new stores as well as a same-store sales improvement of 1.6%. Our average transaction value increased 2.6% to $43.12 and same-store transaction value increased 0.8% for fiscal 2006. Average daily transaction count per store decreased 2.9% to 238, while same-store transaction count increased 0.7%.
Same-store sales improvements of 1.6% compared to 5.7% in the prior year were strongest in the clothing/footwear and equine/pet/animal categories, but were partially offset by lower than expected performance in seasonal power equipment, generators and cold weather-related products, including insulated outerwear, snow removal and heating.
In fiscal 2006, we opened 82 new stores (compared to 65 new stores and the acquisition of 16 Del’s stores in fiscal 2005), relocated 15 stores (compared to 18 in fiscal 2005) and closed one store (compared to one closure in fiscal 2005).
As a percent of sales, gross margin increased 80 basis points to 31.7% for fiscal 2006 from 30.9% for fiscal 2005. Gross margin was primarily impacted by a more favorable product mix, increased importing and improved inventory shrinkage.
During the year, we refined our method of estimating the freight cost component of inventory based on changes in our business and operating environment which included a change in mix of goods, an increased level of importing and rapidly increasing fuel costs. This refinement provides a more appropriate matching of freight cost incurred with inventory and cost of merchandise sold. This change in estimate increased the inventory value and reduced the freight component of cost of merchandise sold by approximately $2.9 million for fiscal 2006.
As a percent of sales, selling, general and administrative expenses increased 90 basis points to 23.5% in fiscal 2006 from 22.6% in fiscal 2005. The increase is primarily attributable to increased occupancy costs and a charge of $9.7 million (or 0.4% of sales) related to stock compensation expense.
During the year, we refined our method of estimating the amount of gift cards sold that will ultimately go unredeemed. Our estimate was based on an analysis of gift card sale and redemption patterns across an extended historical timeline. We accordingly recognized a benefit of $2.4 million and $0.3 million in fiscal 2006 and 2005, respectively. Of the $2.4 million recognized in fiscal 2006, $2.1 million (or 0.1% of sales) was due to a modification of the redemption assumptions based on an analysis of historical redemption patterns. This benefit has been included as a reduction in selling, general, and administrative expenses and is reflected as a reduction of other accrued expenses in the accompanying Consolidated Balance Sheets.
Effective January 1, 2006, we adopted SFAS No. 123(R) “Share-Based Payment” (“SFAS 123(R)”) using the modified prospective method and began recognizing compensation expense for share-based payments based on the fair value of the awards. Share-based payments include stock option grants and certain transactions under our other stock plans. SFAS 123(R) requires share-based compensation expense recognized since the beginning of fiscal 2006 to be based on the following: a) grant date fair value estimated in accordance with the original provisions of SFAS 123 for unvested options granted prior to the adoption date; b) grant date fair value estimated in accordance with the provisions of SFAS 123(R) for all share-based payments granted subsequent to the adoption date; and c) the discount on shares sold to employees post-adoption, which represents the difference between the grant date fair value and the employee purchase price.
For fiscal 2006, the adoption of the SFAS 123(R) fair value method resulted in additional compensation expense (a component of selling, general and administrative expenses) related to our stock plans that we would not have recognized had we continued to account for share-based compensation under Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” (“APB 25”). For fiscal 2006, this share-based compensation expense lowered pre-tax income by $9.7 million and net income by $6.1 million.
Depreciation and amortization expense increased 24.3% in fiscal 2006 over fiscal 2005 due mainly to costs associated with new and relocated stores and remodeled existing stores.
Net interest expense increased 64.7% in fiscal 2006 from fiscal 2005. This increase is primarily due to higher average interest rates in fiscal 2006 and interest incurred as the result of federal and sales tax audits; partially offset by a reduction in average long-term borrowings under our revolving credit agreement.
Our effective tax rate was 37.4% for fiscal 2006 compared to 36.5% in fiscal 2005, resulting primarily from a higher effective income tax rate due to the non-deductibility of certain stock compensation expense related to the adoption of SFAS123(R).
As a result of the foregoing factors, net income for fiscal 2006 increased 6.2% to $91.0 million, or $2.22 per diluted share, which includes a $9.7 million charge, or $0.15 per diluted share, in stock compensation expense. This compares to net income of $85.7 million, or $2.09 per diluted share, in fiscal 2005.
Liquidity and Capital Resources
In addition to normal operating expenses, our primary ongoing cash requirements are for expansion, remodeling and relocation programs, including inventory purchases and capital expenditures. Our primary ongoing sources of liquidity are funds provided from operations, commitments available under our revolving credit agreement, capital and operating leases and normal trade credit. Our inventory and accounts payable levels typically build in the first and third fiscal quarters in anticipation of the spring and winter selling seasons, respectively.
Working Capital
At December 29, 2007, we had working capital of $312.1 million, a $4.0 million decrease from December 30, 2006. This decrease was primarily attributable to changes in the following components of current assets and current liabilities (in millions):
The increase in inventories and related increase in accounts payable resulted primarily from the purchase of inventory for new stores. Trade credit arises from our vendors granting extended payment terms for inventory purchases. Payment terms generally vary from 30 days to 180 days depending on the inventory product. We experienced an increase in our financed inventory from approximately 37.3% to 38.3%. (The calculated financed inventory assumes average inventory, excludes in-transit inventories and includes only unopened stores with significant inventory).
While we experienced a seven basis point decrease in inventory turns (approximately 2.60 times per year), we improved our per-store inventory levels through targeted inventory level improvement initiatives. These initiatives included better exit strategies on one-time, special buys; a focused approach on new store inventory levels and less productive inventory; and a more rigorous training program on our E3 inventory management software.
The decrease in the deferred tax assets is a result of changes in temporary differences associated with the accounting for income taxes. Certain items of income and expense such as gift card receipts, inventory costing and depreciation expense may not be recognized in the same accounting period for income tax purposes as they are for financial reporting purposes.
Borrowings and Credit Facilities
In August 2002, we entered into a credit agreement with Bank of America, N.A., as agent for a lender group (the “Credit Agreement”), whereby we were permitted to borrow up to $155 million. The Credit Agreement was subsequently amended on January 28, 2004 and September 30, 2004 (primarily with respect to financial covenants) and replaced on February 22, 2007.
On February 22, 2007 we entered into a new Senior Credit Facility with Bank of America, N.A, as agent for a lender group (the “Credit Agreement”), allowing us to borrow up to $250 million (with sublimits of $75 million and $10 million for letters of credit and swingline loans, respectively). This agreement is unsecured and has a five year term, with proceeds expected to be used for working capital, capital expenditures and share repurchases.
At December 29, 2007, there were $55 million in borrowings outstanding under the Credit Agreement and there were no outstanding borrowings at December 30, 2006. There were an additional $25.0 million and $24.9 million outstanding letters of credit as of December 29, 2007 and December 30, 2006, respectively. Borrowings bear interest at either the bank’s base rate (7.25% at December 29, 2007) or the London Inter-Bank Offer Rate (“LIBOR”) (4.86% at December 29, 2007) plus an additional amount ranging from 0.35% to 0.90% per annum, adjusted quarterly based on our performance (0.50% at December 29, 2007). We are also required to pay, quarterly in arrears, a commitment fee ranging from 0.06% to 0.18% per annum and adjusted quarterly based on our performance, for unused capacity (0.10% at December 29, 2007). There are no compensating balance requirements associated with the Credit Agreement.
The Credit Agreement contains certain restrictions regarding additional indebtedness, capital expenditures, business operations, guarantees, investments, mergers, consolidations and sales of assets, transactions with subsidiaries or affiliates, and liens. The new agreement eliminated the capital expenditures, net worth and current ratio requirements from the previous agreement and requires quarterly compliance with respect to fixed charge coverage and leverage ratios. We were in compliance with all covenants at December 29, 2007.
In February 2008, we exercised the increase option on our Senior Credit Facility increasing the overall capacity from $250 million to $350 million. Each of the nine lenders within our credit facility bank group participated in the increase. Simultaneously, definitions within the existing credit facility were modified as follows: (1) added an additional Increase Option for $150 million; (2) modified the definition of swingline committed amount from $10 million to $20 million; and (3) revised the definition of the fixed charge coverage ratio covenant to remove certain defined fixed charges. All pricing terms and the term of the facility remained the same.
Sources and Uses of Cash
Our primary source of liquidity is cash provided by operations. Principal uses of cash for investing activities are capital expenditures and financing activities are payments on debt and repurchase of the Company’s common stock. The following table presents a summary of cash flows from operating, investing and financing activities for the last three fiscal years (in millions):
Operating Activities
The $67.5 million increase in net cash provided by operations in fiscal 2007 over fiscal 2006 is primarily due to changes in the following operating activities (in millions):
We reclassified cash balances in our bank concentration account against the book overdraft included in accounts payable, resulting in a change in fiscal 2006 and fiscal 2005 net cash provided by operations.
The improvement in net cash provided by operations in fiscal 2007 compared with fiscal 2006 was primarily due to changes in inventory levels and the timing of payments. Inventory levels increased less in 2007 compared to 2006, due to the timing of imports and a focus on inventory management in 2007. Additionally, we achieved a slight increase in financed inventory, resulting in a higher increase in accounts payable relative to inventory. The change in cash used for income taxes relates to the timing of quarterly payments caused by annualized proration requirements.
The $17.0 million decrease in net cash provided by operations in fiscal 2006 over fiscal 2005 is primarily due to changes in the following operating activities (in millions):
The decrease in net cash provided by operations in fiscal 2006 compared with fiscal 2005 is primarily due to the net increase in inventory and accounts payable (as discussed in the Working Capital section), partially offset by an increase in net income adjusted for non-cash items.
Investing Activities
Investing activities used $82.6 million, $80.8 million, and $90.7 million in fiscal 2007, 2006 and 2005, respectively. The majority of this cash requirement relates to our capital expenditures and, in fiscal 2005, the acquisition of the assets of Del’s.
Our significant store expansion, coupled with required investment in infrastructure, required the following capital expenditures, including capital leases (in thousands):
Our long-term growth strategy anticipates continued geographic market expansion and further concentration within existing markets. This growth will also require continuing investment in information technology and people. The costs reflected above are typically building improvements, as we lease the majority of our facilities. We currently estimate that capital expenditures will range between $100 million and $105 million in fiscal 2008.
Financing Activities
Financing activities used $85.1 million, provided $10.1 million, and used $16.2 million in fiscal 2007, 2006 and 2005, respectively. The cash used by financing activities in fiscal 2007 is mainly the result of share repurchase activity partially offset by borrowings and share issuances.
In February 2007, our Board of Directors authorized a share repurchase program which provides for repurchase of up to $200 million (excluding commissions) of our outstanding common stock over an approximate three-year period. 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. The program may be limited or terminated at any time without prior notice.
For fiscal 2007, we repurchased approximately 3.2 million shares at a total cost of $150.0 million. Repurchased shares are accounted for at cost and will be held in treasury for future issuance.
We believe that our cash flow from operations, borrowings available under the Credit Agreement, and normal trade credit will be sufficient to fund our operations and our capital expenditure needs, including store openings, relocations and renovations, over the next several years.
Significant Contractual Obligations and Commercial Commitments
The following table reflects our future obligations and commitments as of December 29, 2007 (in thousands):
(1)
Long-term debt balances represent principal maturities, excluding interest. At December 29, 2007, this entire amount relates to the Company’s Credit Agreement.
(2)
Capital lease obligations include related interest.
(3)
The amounts for purchase obligations include commitments for construction of stores expected to be opened in fiscal 2008 and for acquisition of a store property previously under lease.
The Company had outstanding standby letters of credit of $25.0 million as of December 29, 2007.
Off-Balance Sheet Arrangements
Our off-balance sheet arrangements consist of operating leases and outstanding letters of credit. The balances for these arrangements are discussed above. We typically lease buildings for retail stores and offices rather than acquiring these assets which allows us to utilize financial capital to operate the business rather than invest in fixed assets. Letters of credit allow us to purchase inventory, primarily sourced overseas, and support certain risk management programs in a timely manner.
Known Trends, Events, Demands, Commitments and Uncertainties
Litigation
We are involved in various litigation matters arising in the ordinary course of business. After consultation with legal counsel, we expect these matters will be resolved without material adverse effect on our consolidated financial position or results of operations. Any estimated loss related to such matters has been adequately provided in accrued liabilities to the extent probable and reasonably estimable. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in circumstances relating to these proceedings.
Recent Accounting Pronouncements
How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement
In March 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation)”, which allows companies to adopt a policy of presenting taxes in the income statement on either a gross or net basis. Taxes within the scope of this EITF would include taxes that are imposed on a revenue transaction between a seller and a customer, for example, sales taxes, use taxes, value-added taxes, and some types of excise taxes. EITF 06-3 is effective for interim and annual reporting periods beginning in fiscal 2007. The adoption of EITF 06-3 did not impact the method for recording and reporting these sales taxes in our Consolidated Financial Statements as our policy is to exclude all such taxes from revenue.
Accounting for Uncertainty in Income Taxes
In June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”) to create a single model to address accounting for uncertainty in tax positions. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Tax positions that meet a “more-likely-than-not” recognition threshold should be measured in order to determine the tax benefit to be recognized. We adopted FIN 48 in fiscal 2007, as required. (See Note 10 to the Consolidated Financial Statements for further information.)
Fair Value Measurements
In September 2006, the FASB issued statement No. 157, “Fair Value Measurements”, (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. On December 14, 2007, the FASB issued proposed FASB Staff Position No. FAS 157-b, “Effective Date of FASB Statement No. 157” (the proposed FSP). The proposed FSP would amend FASB Statement No. 157, “Fair Value Measurements” (Statement 157), to delay the effective date of Statement 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually). The proposed FSP defers the effective date of Statement 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of the proposed FSP. The Company is subject to the remaining provisions of SFAS 157 beginning December 30, 2007. The adoption of SFAS 157 did not have a material impact on our financial condition, results of operations, or cash flow.
The Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument by instrument basis, is typically irrevocable once elected. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS 159 did not result in a material impact to our financial condition, results of operations, or cash flow.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to changes in interest rates primarily from the Credit Agreement. The Credit Agreement bears interest at either the bank’s base rate (7.25% and 8.25% at December 29, 2007 and December 30, 2006, respectively) or LIBOR (4.86% and 5.32% at December 29, 2007 and December 30, 2006, respectively) plus an additional amount ranging from 0.35% to 0.90% per annum, adjusted quarterly, based on our performance (0.50% at both December 29, 2007 and December 30, 2006). We are also required to pay (quarterly in arrears) a commitment fee ranging from 0.06% to 0.18% based on the daily average unused portion of the credit line (0.10% at December 29, 2007). A hypothetical 100 basis point adverse move (increase) in interest rates along the entire interest rate yield curve would result in approximately $900,000 of additional annual interest expense and would not impact the fair market value of the long-term debt.
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEX
TRACTOR SUPPLY COMPANY
Report of Independent Registered Public Accounting Firm
on Internal Control Over Financial Reporting
The Board of Directors and Stockholders of
Tractor Supply Company
We have audited Tractor Supply Company’s internal control over financial reporting as of December 29, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Tractor Supply 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 conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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.
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.
In our opinion, Tractor Supply Company maintained, in all material respects, effective internal control over financial reporting as of December 29, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Tractor Supply Company as of December 29, 2007 and December 30, 2006 and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 29, 2007 and our report dated February 25, 2008 expressed an unqualified opinion thereon.
Nashville, Tennessee
February 25, 2008
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Tractor Supply Company
We have audited the accompanying consolidated balance sheets of Tractor Supply Company as of December 29, 2007 and December 30, 2006, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 29, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tractor Supply Company at December 29, 2007 and December 30, 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 29, 2007, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 10 to the consolidated financial statements, in 2007 the Company changed its method of accounting for uncertainty in income taxes.
As discussed in Note 2 to the consolidated financial statements, in 2006 the Company changed its method of accounting for share-based compensation using the modified-prospective method.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Tractor Supply Company’s internal control over financial reporting as of December 29, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2008 expressed an unqualified opinion thereon.
Nashville, Tennessee
February 25, 2008
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
The accompanying notes are an integral part of these financial statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
The accompanying notes are an integral part of these financial statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share amounts)
The accompanying notes are an integral part of these financial statements.
TRACTOR SUPPLY COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral part of these financial statements.
Note 1 - Significant Accounting Policies:
Nature of Business
Tractor Supply Company (the “Company”, “we”, “us” and/or “our”) is the largest operator of retail farm and ranch stores in the United States. We are focused on supplying the lifestyle needs of recreational farmers and ranchers and those who enjoy the rural lifestyle, as well as tradesmen and small businesses. Stores are located in towns outlying major metropolitan markets and in rural communities. At December 29, 2007, we operated 764 retail farm and ranch stores in 43 states and also offered a limited number of products online at TractorSupply.com.
Fiscal Year
Our fiscal year ends on the last Saturday of the calendar year and includes 52 or 53 weeks. The fiscal years ended December 29, 2007 and December 30, 2006 consist of 52 weeks, while the fiscal year ended December 31, 2005 consists of 53 weeks.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated.
Reclassifications
Certain amounts in previously issued financial statements have been reclassified to conform to the fiscal 2007 presentation: (1) Cash balances in our bank concentration account have been reclassified and netted against the related book overdraft included in accounts payable in the Consolidated Balance Sheets; (2) Inventory initially consigned but ultimately purchased has been included in the inventory and accounts payable balances in the Consolidated Balance Sheets; (3) Discount fees on our proprietary credit card have been reclassified from operating expenses into cost of merchandise sold in the Consolidated Statements of Income.
Segment Information
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information,” Tractor Supply Company has one reportable industry segment - the operation of farm and ranch retail stores and also offers a limited number of products online at TractorSupply.com.
Management Estimates
Our preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States inherently requires estimates and assumptions by us 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:
Revenue Recognition and Sales Returns
We recognize revenue at the time the customer takes possession of merchandise or receives services. If we receive payment before the customer has taken possession of the merchandise (as per our layaway program), the revenue is deferred until the sale is complete. Revenues from the sale of gift cards are deferred and recognized upon redemption.
We are required to collect certain taxes and fees from customers on behalf of government agencies and remit these back to the applicable governmental entity on a periodic basis. These taxes are collected from customers at the time of purchase, but are not included in net sales. We record a liability upon collection from the customer and relieve the liability when payments are remitted to the applicable governmental agency.
We estimate a liability for sales returns based on a one-year rolling average of historical return trends, and we believe that our estimate for sales returns is an accurate reflection of future returns associated with past sales. Our estimation methodologies have been consistently applied from year to year; however, as with any estimates, refunds activity may vary from estimated amounts. Estimated sales returns are shown “net”, as a reduction in gross margin in the Consolidated Statements of Income. At December 29, 2007 we had a liability of $3.0 million reserved for sales returns, compared to $3.2 million at December 30, 2006.
We recognize a benefit for gift cards when: (i) the gift card or merchandise return card is redeemed by the customer; or (ii) the likelihood of the gift card being redeemed by the customer is remote (referred to as “breakage”) or (iii) the unredeemed merchandise returns cards expire (one year from issuance). The gift card breakage rate is based upon historical redemption patterns and a benefit is recognized for unredeemed gift cards in proportion to those historical redemption patterns.
We recognized a benefit of $1.2 million and $2.4 million in fiscal 2007 and 2006, respectively. Of the $2.4 million recognized in 2006, $2.1 million (or $.03 per diluted share) was due to a modification of the estimation of redemption assumptions based on an analysis of historical redemption patterns. This benefit has been included as a reduction in selling, general and administrative expenses and is reflected as a reduction of other accrued expenses in the accompanying Consolidated Balance Sheets.
Inventory Valuation
Impairment Risk
We identify potentially excess and slow-moving inventory by evaluating turn rates, sales trends, age of merchandise, overall inventory levels and other benchmarks. The estimated inventory valuation reserve to recognize any impairment in value (i.e. an inability to realize the full carrying value) is based on our aggregate assessment of these valuation indicators under prevailing market conditions and current merchandising strategies. We do not believe our merchandise inventories are subject to significant risk of obsolescence in the near term. However, changes in market conditions or consumer purchasing patterns could result in the need for additional reserves.
Shrinkage
Our stores perform physical inventories once a year and we have established reserves for estimating inventory shrinkage between physical inventory counts. This is done 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 shrink rate is based on historical experience. We believe historical rates are an accurate reflection of future trends.
Vendor Support
We receive funding from substantially all of our significant merchandise vendors for the promotion of our brand as well as the sale of their products through a variety of programs and arrangements, including guaranteed funding and volume rebate programs. The amounts received are subject to terms of vendor agreements, which have varying expiration dates ranging in duration from several months to several years. Many agreements are negotiated annually and are based on expected annual purchase of the vendor’s product. Vendor funding is initially deferred as a reduction of the purchase price of inventory and then recognized as a reduction of cost of merchandise as the related inventory is sold, which is in compliance with Emerging Issues Task Force No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor” (“EITF 02-16”).
The amount of expected funding is estimated based upon initial guaranteed commitments, as well as anticipated purchase levels with applicable vendors. The estimated purchase volume and related vendor funding is based on our current knowledge of inventory levels, sales trends and expected customer demand, as well as planned new store openings and relocations. Although we believe we have the ability to reasonably estimate purchase volume and related vendor funding, it is possible that actual results could significantly differ from the estimated amounts.
Freight
We incur various types of transportation and delivery costs in connection with inventory purchases and distribution. Such costs are included as a component of the overall cost of inventories (on an aggregate basis) and recognized as a component of cost of merchandise sold as inventory is sold.
During 2006, we refined our method of estimating the freight cost component of inventory based on changes in our business and operating environment which included a change in mix of goods, an increased level of importing and rapidly increasing fuel costs. This refinement provides a more appropriate matching of freight cost incurred with inventory and cost of merchandise sold. This change in estimate increased the inventory value and reduced cost of merchandise sold by approximately $2.9 million, (or $.04 per diluted share) for fiscal 2006.
Share-based Payments
We have share-based compensation plans covering certain members of management and non-employee directors. Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123(R), “Share-Based Payments” (“SFAS 123(R)”) using the modified prospective transition method. (See Note 2).
We estimate the fair value of stock option awards on the date of grant utilizing a modified 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 our stock option awards. Option valuation models require the input of subjective assumptions including expected stock price volatility and expected life. We rely on historical volatility trends to estimate future volatility assumptions. Other assumptions required for estimating fair value with the Black-Scholes model are the expected risk-free interest rate and expected life of the option. 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 life of the option on the date of grant was estimated based on our historical experience for similar options.
In addition to the key assumptions used in the Black Scholes model, the estimated forfeiture rate at the time of valuation (which is based on historical experience for similar options) is a critical assumption, as it reduces expense ratably over the vesting period. We adjust this estimate annually, based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate.
We believe our estimates are reasonable in the context of actual (historical) experience. The impact of adopting SFAS No. 123(R) on future results will depend on, among other matters, levels of share-based payments granted in the future, actual forfeiture rates and the timing of option exercises.
Sales Tax Audit Reserve
A portion of our sales are to tax-exempt customers. We obtain exemption information as a necessary part of each tax-exempt transaction. Many of the states in which we conduct business will perform audits to verify our compliance with applicable sales tax laws. The business activities of our customers and the intended use of the unique products sold by us create a challenging and complex environment of compliance. These circumstances also create some risk that we could be challenged as to the propriety of our sales tax compliance. While we believe we reasonably enforce sales tax compliance with our customers and endeavor to fully comply with all applicable sales tax regulations, there can be no assurance that we, upon final completion of such audits, would not have a significant liability for disallowed exemptions.
We review our past audit experience and assessments with applicable states to determine if we have potential exposure for non-compliance. Any estimated liability is based on an initial assessment of compliance risk and our to-date experience with each audit. As each audit progresses, we quantify the exposure based on preliminary assessments made by the state auditors, adjusted for 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, ambiguity in state tax regulations, the number of ongoing audits and the length of time required to settle with the state taxing authorities.
Self-Insurance Reserves
We self-insure a significant portion of our employee medical insurance, workers’ compensation and general liability insurance plans. We have stop-loss insurance policies to protect from individual losses over specified dollar values ($200,000 for employee health insurance claims, $350,000 for workers’ compensation and $250,000 for general liability). The full extent of certain claims, especially workers’ compensation and general liability claims, may not become fully determined for several years. Therefore, we estimate potential obligations for liabilities that have been incurred but not yet reported based upon use of outside actuarial consultants, historical data, and experience. Although we believe the reserves established for these obligations are reasonably estimated, any significant increase in the number of claims or costs associated with claims made under these plans could have a material adverse effect on our financial results. At December 29, 2007, we had recorded net insurance reserves of $21.7 million, compared to $21.9 million at December 30, 2006.
Tax Contingencies
Our income tax returns are periodically audited by U.S. federal and state tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any one time, multiple tax years are subject to audit by the various tax authorities. In evaluating the exposures associated with our various tax filing positions, we record reserves for probable exposures. A number of years may elapse before a particular matter, for which we have established a reserve, is audited and fully resolved or clarified. We adjust our tax contingencies reserve and income tax provision in the period in which actual results of a settlement with tax authorities differs from our established reserve, the statute of limitations expires for the relevant tax authority to examine the tax position or when more information becomes available.
Effective December 31, 2006, we adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (“FIN 48”). Accordingly, we recognize a liability for certain tax benefits that do not meet the minimum requirements for recognition in the financial statements
Our tax contingencies reserve contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various filing positions and whether or not the minimum requirements for recognition of tax benefits have been met.
Our effective income tax rate is also affected by changes in tax law, the tax jurisdiction of new stores or business ventures, the level of earnings and the results of tax audits.
Credit Cards/Accounts Receivable
Sales generated through our private label credit cards are not reflected as accounts receivable. Under an agreement with Citi Commerce Solutions, a division of Citigroup (“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.
Pre-opening Costs
Non-capital expenditures incurred in connection with opening new store and distribution centers, primarily payroll and rent, are expensed as incurred. Preopening costs were approximately $9.4 million, $9.4 million and $7.2 million in 2007, 2006 and 2005, respectively.
Store Closing Costs
We regularly evaluate the performance of our stores and periodically close those that are under-performing. We recognize store closing costs in accordance with the provisions of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, usually in the period the store closes. Store closing costs were not significant to results of operations for any of the fiscal years presented.
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 card transactions process within 24-48 hours and are accordingly classified as cash and cash equivalents.
Fair Value of Financial Instruments
Our financial instruments consist of cash and cash equivalents, short-term receivables and payables and long-term debt instruments, including capital leases. The carrying values of cash and cash equivalents, receivables and trade payables equal current fair value. The terms of our revolving credit agreement (the “Credit Agreement”) include variable interest rates, which approximate current market rates.
Inventories
Inventories are stated using the lower of last-in, first-out (LIFO) cost or market. Inventories are not in excess of market value. Quarterly inventory determinations under LIFO are based on assumptions as to projected inventory levels at the end of the fiscal year, sales for the year and the rate of inflation/deflation for the year. If the first-in, first-out (FIFO) method of accounting for inventory had been used, inventories would have been approximately $25.5 million and $20.3 million higher than reported at December 29, 2007 and December 30, 2006, respectively.
Vendor Concentration
Approximately 200 vendors accounted for 80% of our purchases for fiscal 2007, with no one vendor representing more than 10% of purchases during the year.
Warehousing and Distribution Costs
Costs incurred at our distribution centers for receiving, warehousing and preparing product for delivery are expensed as incurred and are included in selling, general and administrative expenses in the Consolidated Statements of Income.
Property and Equipment
Property and equipment are carried 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 initial term of the lease or the useful life of the improvement, whichever is lesser. Leasehold improvements added late in the lease term are amortized over the term of the lease (including the first renewal option, if the renewal is reasonably assured) or the useful life of the improvement, whichever is lesser. The following estimated useful lives are generally applied:
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 three to five years. These costs are included in Computer software and hardware in the accompanying Consolidated Balance Sheets. Certain software costs not meeting the criteria for capitalization are expensed as incurred.
Leases
Assets under capital leases are amortized in accordance with our normal depreciation policy for owned assets or over the lease term (regardless of renewal options), if shorter, and the related charge to operations included in depreciation expense in the Consolidated Statements of Income.
Certain leases include rent increases during the initial lease term. For these leases, we recognize the related rental expense on a straight-line basis over the term of the lease (which includes the pre-opening period of construction, renovation, fixturing and merchandise placement) and record the difference between the expense charged to operations and amounts paid as a rent liability.
We occasionally receive reimbursements from landlords to be used towards improving the related store to be leased. Reimbursements are primarily for the purpose of performing work required to divide a much larger location into smaller segments, one of which we will use for our store. This work could include the addition of demising walls, separation of plumbing, utilities, electric work, entrances (front and back) and other work as required. Leasehold improvements are recorded at their gross costs including items reimbursed by landlords. Related reimbursements are amortized on a straight-line basis as a reduction of rent expense over the initial lease term.
Impairment of Long-Lived Assets
Long-lived assets other than goodwill and indefinite-lived intangible assets, which are separately tested for impairment, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We apply the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” to assets held for sale.
When evaluating long-lived assets for potential impairment, we first compare the carrying value of the asset to the asset’s estimated future cash flows (undiscounted and without interest charges). If the estimated future cash flows are less than the carrying value of the asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the asset to the asset’s estimated fair value, which may be based on estimated future cash flows (discounted and with interest charges). We recognize an impairment loss if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If we recognize an impairment loss, the adjusted carrying amount of the asset becomes its new cost basis. For a depreciable long-lived asset, the new cost basis will be depreciated (amortized) over the remaining useful life of that asset.
No significant impairment charges were recognized in fiscal years 2007, 2006 and 2005.
Goodwill
Goodwill and intangible assets with indefinite lives are not amortized. We evaluate goodwill for impairment annually and whenever events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable. We complete our impairment evaluation by performing internal valuation analyses, considering other publicly available market information and using an independent valuation firm, as appropriate.
In the fourth quarter of fiscal 2007, we completed our annual impairment testing of goodwill using the methodology described herein, and determined there was no impairment. During the current year, we reduced recorded goodwill by $30,000 upon a final determination of the value related to acquired intangible assets.
Advertising Costs
Advertising costs consist of expenses incurred in connection with newspaper circulars, television and radio, as well as direct mail, newspaper advertisements and other promotions. 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 for fiscal 2007, 2006 and 2005 were approximately $58.6 million, $53.2 million and $47.4 million, respectively. Prepaid advertising costs were approximately $1.3 million and $1.5 million at December 29, 2007 and December 30, 2006, respectively.
Income Taxes
We account for income taxes using the liability method, whereby deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to be recovered or settled.
Net Income Per Share
As provided by SFAS No. 128, “Earnings per Share”, basic earnings per share is calculated by dividing net income by the weighted average number of shares outstanding during the period. Diluted EPS is calculated by dividing net income by the weighted average diluted shares outstanding. Diluted shares are computed using the treasury stock method for options.
Foreign Currency Translation
Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the foreign currency translation adjustment, a component of accumulated other comprehensive loss in shareholders’ equity. The assets and liabilities of our store in British Columbia, which was sold in fiscal 2007, were translated into United States dollars at year-end rates of exchange, while revenues and expense items were translated at average rates for the period.
Note 2 - Share-Based Compensation:
Effective January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payments”, using the modified prospective method and began recognizing compensation expense for share-based payments based on the fair value of the awards. Share-based payments include stock option grants and certain transactions under our other stock plans. SFAS No. 123(R) requires share-based compensation expense recognized the beginning of fiscal 2006 to be based on the following: a) grant date fair value estimated in accordance with the original provisions of SFAS No. 123 for unvested options granted prior to the adoption date; b) grant date fair value estimated in accordance with the provisions of SFAS No. 123(R) for all share-based payments granted subsequent to the adoption date; and c) the discount on shares sold to employees subsequent to the adoption date, which represents the difference between the grant date fair value and the employee purchase price.
For fiscal 2007, the adoption of the SFAS No. 123(R) fair value method resulted in share-based compensation expense (a component of selling and general and administrative expenses) related to our stock plans that we would not have recognized had we continued to account for share-based compensation under APB 25 (defined below). Share-based compensation expense lowered pre-tax income by $10.6 million (including a reduction in expense of approximately $0.5 million related to the modification of certain board members and officers upon resignation) and $9.7 million for fiscal 2007 and 2006, respectively. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow rather than as an operating cash flow, as required prior to adoption of SFAS No. 123(R).
Prior to January 1, 2006, we accounted for share-based payments using the intrinsic-value-based recognition method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”). As options were granted at an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based employee compensation cost was reflected in net income prior to adopting SFAS No. 123(R). As we adopted SFAS No. 123(R) under the modified-prospective-transition method, results from prior periods have not been restated.
The following table illustrates the effect on net income and earnings per share as if we applied the fair value recognition provisions of SFAS No. 123 to options granted under our stock plans in all periods presented (in thousands). For purposes of this pro forma disclosure, the value of the options is estimated using a modified Black-Scholes option pricing model for all option grants.
Under SFAS No. 123(R), forfeitures are estimated at the time of valuation and reduce expense ratably over the vesting period. This estimate is adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate. Under SFAS No. 123 and APB 25, we elected to account for forfeitures at the time of valuation and reduce the pro-forma expense ratably over the period.
Effective May 4, 2006, we adopted the 2006 Stock Incentive Plan, which replaced the 2000 Stock Incentive Plan. Following the adoption of the 2006 Stock Incentive Plan, no further grants may be made under the 2000 Stock Incentive Plan.
Under our 2006 Stock Incentive Plan, options 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 options will expire no later than ten years from the date of grant. In the case of a stockholder owning more than 10% of the outstanding voting stock of the Company, the exercise price of an incentive stock option may not be less than 110% of the fair market value of the stock on the date of grant and such options will expire no later than five years from the date of grant. Also, the aggregate fair market value of the stock with respect to which incentive stock options are exercisable on a tax deferred basis for the first time by an individual in any calendar year may not exceed $100,000. Vesting of options commences at various anniversary dates following the dates of grant.
Under the terms of the 2006 Stock Incentive Plan, a maximum of 2,750,000 shares are available for grant as stock options or other awards. At December 29, 2007, we had 2,189,432 shares available for future equity awards under the Company’s 2006 Stock Incentive Plan.
The fair value of each option grant is separately estimated for each vesting date. The fair value of each option is recognized as compensation expense ratably over the vesting period. We have estimated the fair value of all stock option awards as of the date of the grant by applying a modified 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 weighted averages for key assumptions used in determining the fair value of options granted during fiscal 2007, 2006 and 2005, as well as a summary of the methodology applied to develop each assumption, are as follows:
Expected Price Volatility - This is a measure of the amount by which a price has fluctuated or is expected to fluctuate. We use actual historical changes in the market value of the stock to calculate expected price volatility because we believe that this is the best indicator of future volatility. Prior to July 2006, we calculated weekly market value changes from the date of grant over a past period representative of the expected life of the options to determine volatility. Beginning in July 2006, we calculated 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. 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 life of the option. An increase in the risk-free interest rate will increase compensation expense.
Weighted Average Expected Lives - 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 life will increase compensation expense.
Forfeiture Rate - This is the estimated percentage of options granted that are expected to be forfeited or cancelled before becoming fully vested. This estimate is based on historical experience. An increase in the forfeiture rate will decrease compensation expense.
Dividend Yield - We have not made any dividend payments nor do we plan to pay dividends in the foreseeable future. An increase in the dividend yield will decrease compensation expense.
Stock Options
We issue new shares for options when exercised. A summary of stock option activity is as follows:
The aggregate intrinsic values in the table above represents the total difference between our closing stock price on December 29, 2007 and the option exercise price, multiplied by the number of in-the-money options as of December 29, 2007. As of December 29, 2007, total unrecognized compensation expense related to non-vested stock options is $15,361,000 with a weighted average expense recognition period of 1.4 years.
The following summarizes information concerning stock option grants during fiscal 2007, 2006 and 2005:
(a)
According to the terms of the 2006 Stock Incentive Plan, in the case of a stockholder owning more than 10% of the outstanding voting stock, the exercise price of an incentive stock option may not be less than 110% of the fair market value of the stock on the date of grant and such options will expire no later than five years from the date of grant.
During 2007, certain options were modified to immediately vest and extend the related exercise period, effectively resulting in a cancellation of existing options and grant of new options. The options retained the original exercise price and, as a result, the modified options had exercise prices both above and below the modification date fair value. The following summarizes the activity related to these modifications:
Other information relative to option activity during fiscal 2007, 2006 and 2005 is as follows (in thousands, except per share amounts):
Restricted Stock
We issue shares for restricted stock awards once vesting occurs and related restrictions lapse. We issued 68,889 restricted shares under the 2006 Stock Incentive Plan. The shares vest over a one to three-year term. The status of restricted shares as of December 29, 2007 is presented below:
Employee Stock Purchase Plan
We have an Employee Stock Purchase Plan (the “ESPP”) whereby all our employees have the opportunity to purchase, through payroll deductions, shares of common stock at a 15% discount. Pursuant to the terms of the ESPP, we issued 46,654, 38,354 and 42,065 shares of common stock during fiscal 2007, 2006 and 2005, respectively. The total cost related to the ESPP, including the compensation expense calculation under SFAS 123(R), was approximately $556,000, $430,000 and $247,000 in fiscal 2007, 2006 and 2005, respectively. At December 29, 2007, there were 3,299,403 shares of common stock reserved for future issuance under the ESPP.
There were no significant modifications to the Company’s share-based compensation plans during fiscal 2007.
Note 3 - Acquisition of Del’s Farm Supply:
On November 10, 2005, the Company acquired the assets of privately-held Del’s Farm Supply, Inc. (“Del’s”) for $17.6 million (including 16 stores) and the assumption of certain liabilities. Based in Lakewood, Washington, Del’s now operates 23 stores, primarily in the Pacific Northwest, that offer a wide selection of products tailored to those who enjoy the rural lifestyle. Del’s specializes in the equine, animal and pet category. The purchase price was allocated as follows (in thousands):
Upon completion of the Company’s procedures, the initial estimates related to goodwill were revised to the amounts reflected above (see Note 1).
Note 4 - Credit Agreement:
In August 2002, we entered into a credit agreement with Bank of America, N.A., as agent for a lender group (the “Credit Agreement”), whereby we were permitted to borrow up to $155 million. The Credit Agreement was subsequently amended on January 28, 2004 and September 30, 2004 (primarily with respect to financial covenants) and replaced on February 22, 2007.
On February 22, 2007 we entered into a new Senior Credit Facility with Bank of America, N.A, as agent for a lender group (the “Credit Agreement”), allowing us to borrow up to $250 million (with sublimits of $75 million and $10 million for letters of credit and swingline loans, respectively). This agreement is unsecured and has a five year term, with proceeds expected to be used for working capital, capital expenditures and share repurchases.
At December 29, 2007, there were $55 million in borrowings outstanding under the Credit Agreement and there were no outstanding borrowings at December 30, 2006. There were an additional $25.0 million and $24.9 million outstanding letters of credit as of December 29, 2007 and December 30, 2006, respectively. Borrowings bear interest at either the bank’s base rate (7.25% at December 29, 2007) or the London Inter-Bank Offer Rate (“LIBOR”) (4.86% at December 29, 2007) plus an additional amount ranging from 0.35% to 0.90% per annum, adjusted quarterly based on our performance (0.50% at December 29, 2007). We are also required to pay, quarterly in arrears, a commitment fee ranging from 0.06% to 0.18% per annum and adjusted quarterly based on our performance, for unused capacity (0.10% at December 29, 2007). There are no compensating balance requirements associated with the Credit Agreement.
The Credit Agreement contains certain restrictions regarding additional indebtedness, capital expenditures, business operations, guarantees, investments, mergers, consolidations and sales of assets, transactions with subsidiaries or affiliates, and liens. The new agreement eliminated the capital expenditures, net worth and current ratio requirements from the previous agreement and requires quarterly compliance with respect to fixed charge coverage and leverage ratios. We were in compliance with all covenants at December 29, 2007.
In February 2008, we exercised the Increase Option on our Senior Credit Facility increasing the overall capacity from $250 million to $350 million. Each of the nine lenders within our credit facility bank group participated in the increase. Simultaneously, definitions within the existing credit facility were modified as follows: (1) added an additional Increase Option for $150 million (subject to additional lender group commitments); (2) modified the definition of swingline committed amount from $10 million to $20 million; and (3) revised the definition of the fixed charge coverage ratio covenant to remove certain defined fixed charges. All pricing terms and the term of the facility remained the same.
Note 5 - Leases:
We lease the majority of our office space and retail store locations, certain distribution centers, transportation equipment and other equipment under various noncancellable operating leases. The leases have varying terms and expire at various dates through 2029 and 2025 for capital leases and operating leases, respectively. Store leases typically have initial terms of between 10 and 15 years, with two to four optional renewal periods of five years each. Some leases require the payment of contingent rent that is based upon store sales above agreed upon sales levels for the year. The sales levels vary for each store and are established in the lease agreements. Generally, most of the leases also require that we pay associated taxes, insurance and maintenance costs.
Total rent expense for fiscal 2007, 2006 and 2005 was approximately $124.0 million, $104.3 million and $83.3 million respectively. Total contingent rent expense for fiscal 2007, 2006, and 2005 was insignificant.
Future minimum payments, by year and in the aggregate, under leases with initial or remaining terms of one year or more consist of the following (in thousands):
Assets under capital leases were as follows (in thousands):
Note 6 - Capital Stock:
The authorized capital stock of the Company consists of common stock and preferred stock. The Company is authorized to issue 100,000,000 shares of common stock. The Company is also authorized to issue 40,000 shares of Preferred Stock, with such designations, rights and preferences as may be determined from time to time by the Board of Directors.
Note 7 - Treasury Stock:
In February 2007, our Board of Directors authorized a share repurchase program which provides for repurchase of up to $200 million (excluding commissions) of common stock over an approximate three-year period. 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 will be held in treasury. The program may be limited or terminated at any time without prior notice.
During 2007 we repurchased 3,216,187 shares under the share repurchase program for $150.0 million. As of December 29, 2007, we had remaining authorization under the share repurchase program of $50.0 million.
Note 8 - Comprehensive Income:
Comprehensive income for each fiscal year is as follows (in thousands):
Note 9 - Net Income Per Share:
Net income per share is calculated as follows (in thousands, except per share amounts):
Anti-dilutive stock options excluded from the above calculations totaled 194,455, 217,118 and 19,853 in 2007, 2006 and 2005, respectively.
Note 10 - Income Taxes:
In June 2006, FASB issued FIN 48, to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. This Interpretation prescribes the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Tax positions that meet a “more-likely-than-not” recognition threshold should be measured in order to determine the tax benefit to be recognized. We are no longer subject to federal examination for years before 2005, nor state and local income tax examinations for years before 2002.
We adopted the provisions of FIN 48 in fiscal 2007, as required. As a result, we charged approximately $1.9 million to retained earnings for the cumulative effect of adoption, including interest. Interest and penalties are immaterial at the date of adoption. The total amount of unrecognized tax benefits that, if recognized, would increase the effective tax rate, is $2.3 million. In addition, we will recognize current interest accrued related to these uncertain tax positions as interest expense.
The provision for income taxes consists of the following (in thousands):
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):
We have evaluated the need for a valuation allowance for all or a portion of the deferred tax assets and we believe that all of the deferred tax assets will more likely than not be realized through future earnings.
A reconciliation of the provision for income taxes to the amounts computed at the federal statutory rate is as follows (in thousands):
The Company and its affiliates file income tax returns in the U. S. and various state and local jurisdictions. With few exceptions, we are no longer subject to federal, state and local income tax examinations by tax authorities for years before 2002. Various states have commenced an examination of our income tax returns for 2002 through 2006. We do not anticipate any adjustments would result in a material change to results of operations. However, we anticipate that it is reasonably possible that an additional payment in the approximate range of $900,000 to $1.5 million will be made by the end of 2008.
We adopted the provisions of FIN 48 on December 30, 2006. As a result of the implementation of FIN 48, we recognized a $1.9 million increase (net of applicable federal tax benefit) in the liability for unrecognized tax benefits, which was accounted for as a reduction to the December 30, 2006 balance of retained earnings. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
We recognize interest accrued related to unrecognized tax benefits as interest expense (a component of total operating expenses), and the amount is immaterial to the Consolidated Statements of Income.
Note 11 - Retirement Benefit Plans:
We have a defined contribution benefit plan, the Tractor Supply Company 401(k) Retirement Savings Plan (the “Plan”), which provides retirement and other benefits for our employees. Employees become eligible at the first quarterly entry period following their fulfillment of the eligibility requirements. To be eligible, an employee must be at least 21 years of age, have completed 12 months of employment, and performed 1,000 hours of service in a year of service as defined by the Plan. We match (in cash) 100% of the employee’s elective contributions up to 3% of the employee’s eligible compensation plus 50% of the employee’s elective contributions from 3% to 6% of the employee’s 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 100% vested. Company contributions to the Plan during fiscal 2007, 2006 and 2005, were approximately $2,595,000, $2,278,000 and $1,805,000, respectively.
We offer, through a deferred compensation program, the opportunity for certain qualifying employees to elect a deferral of up to 40% of their annual base salary and up to 100% of their annual incentive bonus under their respective incentive bonus programs. To be eligible for the salary deferral, each participant must contribute the maximum amount of salary to the Tractor Supply Company 401(k) Retirement Savings Plan subject to the Company’s match. Under the deferred compensation program, the participants’ salary deferral is matched by the Company, 100% on the first $3,000 of base salary contributed and 50% on the next $3,000 of base salary contributed limited to a maximum annual matching contribution of $4,500. Each participant’s account earns simple annual interest at the prime rate as in effect on January 1 each year. Each participant is fully vested in all amounts credited to their deferred compensation account. Payments under the program, which are made in cash and paid in ten annual installments or in a single lump sum payment at the election of the participant, are made within 30 days following the earlier of the participant’s (i) death, (ii) retirement, (iii) total and permanent disability, (iv) separation from service, or (v) some other date designated by the participant at the time of the initial deferral. The Company’s contributions, including accrued interest, were $464,902, $403,305 and $257,000 for fiscal 2007, 2006 and 2005, respectively.
Note 12 - Commitments and Contingencies:
Construction and Real Estate Commitments
We had commitments for new store construction projects totaling approximately $8.8 million at December 29, 2007 and a commitment to purchase two stores previously under lease for approximately $8.5 million.
Litigation
We are involved in various litigation matters arising in the ordinary course of business. After consultation with legal counsel, we expect these matters will be resolved without material adverse effect on our consolidated financial position or results of operations. Any estimated loss related to such matters has been adequately provided in accrued liabilities to the extent probable and reasonably estimable. It is possible, however, that future results of operations for any particular quarterly or annual period could be materially affected by changes in circumstances relating to these proceedings.
Note 13 - Subsequent Events:
In January 2008, we signed a construction agreement in the amount of $10.2 million as part of a 347,000 square foot expansion of our Waco, Texas distribution facility.
In February 2008, we exercised the increase option on our Senior Credit Facility increasing the overall capacity from $250 million to $350 million. Each of the nine lenders within our credit facility bank group participated in the increase. Simultaneously, definitions within the existing credit facility were modified as follows: (1) added an additional Increase Option for $150 million (subject to additional lender group commitments); (2) modified the definition of swingline committed amount from $10 million to $20 million; and (3) revised the definition of the fixed charge coverage ratio covenant to remove certain defined fixed charges. All pricing terms and the term of the facility remained the same.
Note 14 - Impact of Recently Issued Accounting Standards:
How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement
In March 2006, the EITF reached a consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation)”, which allows companies to adopt a policy of presenting taxes in the income statement on either a gross or net basis. Taxes within the scope of this EITF would include taxes that are imposed on a revenue transaction between a seller and a customer, for example, sales taxes, use taxes, value-added taxes, and some types of excise taxes. EITF 06-3 is effective for interim and annual reporting periods beginning in fiscal 2007. The adoption of EITF 06-3 did not impact the method for recording and reporting these sales taxes in our Consolidated Financial statements as our policy is to exclude all such taxes from revenue.
Accounting for Uncertainty in Income Taxes
In June 2006, FASB issued FIN 48 to create a single model to address accounting for uncertainty in tax positions. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Tax positions that meet a “more-likely-than-not” recognition threshold should be measured in order to determine the tax benefit to be recognized. We adopted FIN 48 in fiscal 2007, as required (see Note 10).
Fair Value Measurements
In September 2006, the FASB issued statement No. 157, “Fair Value Measurements”, (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. On December 14, 2007, the FASB issued proposed FASB Staff Position No. FAS 157-b, “Effective Date of FASB Statement No. 157” (the proposed FSP). The proposed FSP would amend FASB Statement No. 157, “Fair Value Measurements” (Statement 157), to delay the effective date of Statement 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually). The proposed FSP defers the effective date of Statement 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of the proposed FSP. The Company is subject to the remaining provisions of SFAS 157 beginning December 30, 2007. The adoption of SFAS 157 did not have a material impact on our financial condition, results of operations, or cash flow.
The Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument by instrument basis, is typically irrevocable once elected. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS 159 did not result in a material impact to our financial condition, results of operations, or cash flow.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We carried out an evaluation required by the Securities Exchange Act of 1934, as amended (the “1934 Act”), under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) of the 1934 Act, as of December 29, 2007. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of December 29, 2007, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Management’s Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. 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 29, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on this assessment, management believes that, as of December 29, 2007, 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.
Change in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
In February 2008, we exercised the increase option on our Senior Credit Facility increasing the overall capacity from $250 million to $350 million. Each of the nine lenders within our credit facility bank group participated in the increase. Simultaneously, definitions within the existing credit facility were modified as follows: (1) added an additional Increase Option for $150 million (subject to additional lender group commitments); (2) modified the definition of swingline committed amount from $10 million to $20 million; and (3) revised the definition of the fixed charge coverage ratio covenant to remove certain defined fixed charges. All pricing terms and the term of the facility remained the same.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information set forth under the caption “Executive Officers of the Registrant” in Part I of this Form 10-K is incorporated herein by reference.
The information set forth under the captions “Corporate Governance - Code of Ethics,” “Item 1: Election of Directors,” “Board Meetings and Committees,” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement for our Annual Meeting of Stockholders to be held on May 1, 2008 is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information set forth under the captions “Corporate Governance - Compensation Committee Interlock and Insider Participation,” “Compensation of Directors”, “Executive Compensation”, “Compensation Discussion and Analysis”, “Summary Compensation Table”, “Non-Qualified Deferred Compensation”, “Grants of Plan-Based Awards”, “Outstanding Equity Awards At End of Fiscal Year”, “Option Exercises and Stock Vested”, and “Potential Payments Upon Termination or Change in Control” in our Proxy Statement for our Annual Meeting of Stockholders to be held on May 1, 2008 is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” in our Proxy Statement for our Annual Meeting of Stockholders to be held on May 1, 2008 is incorporated herein by reference.
Following is a summary of our equity compensation plans as of December 29, 2007, under which equity securities are authorized for issuance, aggregated as follows:
The information set forth in Note 2 to the “Notes to Consolidated Financial Statements” contained in this Report, provides further information with respect to the material features of each plan.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information set forth under the captions “Item 1 - Election of Directors”, “Corporate Governance” and “Related-Party Transactions” in our Proxy Statement for our Annual Meeting of Stockholders to be held on May 1, 2008 is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information set forth under the caption “Item 2 - Ratification of Reappointment of Independent Auditor” in our Proxy Statement for our Annual Meeting of Stockholders to be held on May 1, 2008, is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) (1)
Financial Statements
See Consolidated Financial Statements under Item 8 on pages 32 through 56 of this Report.
(a) (2)
Financial Statement Schedules
None
Financial statement schedules have been omitted because they are not applicable or because the required information is otherwise furnished.
(a) (3)
Exhibits
The exhibits listed in the Index to Exhibits, which appears on pages 60 through 64 of this Form 10-K, are incorporated herein by reference or filed as part of this Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
EXHIBIT INDEX
*
Filed herewith
+
Management contract or compensatory plan or arrangement