ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This discussion and analysis should be read with, and is qualified in its entirety by, the Consolidated Financial Statements and the notes thereto. It also should be read in conjunction with the Cautionary Disclosure Regarding Forward‑Looking Statements and the Risk Factors disclosures set forth in the Introduction and in Item 1A of this report, respectively.
Executive Overview
We are among the largest discount retailers in the United States by number of stores, with 13,429 stores located in 44 states as of March 3, 2017, with the greatest concentration of stores in the southern, southwestern, midwestern and eastern United States. We offer a broad selection of merchandise, including consumable products such as food, paper and cleaning products, health and beauty products and pet supplies, and non-consumable products such as seasonal merchandise, home decor and domestics, and basic apparel. Our merchandise includes high-quality national brands from leading manufacturers, as well as our own value and comparable quality private brand selections with prices at substantial discounts to national brands. We offer our customers these national brand and private brand products at everyday low prices (typically $10 or less) in our convenient small-box locations.
Because the customers we serve are value-conscious, many with low or fixed incomes, we are intensely focused on helping them make the most of their spending dollars. We believe our convenient store format and broad selection of high-quality products at compelling values have driven our substantial growth and financial success over the years. Like other retailers, we have been operating for several years in an environment with ongoing macroeconomic challenges and uncertainties. Our core customers are often among the first to be affected by negative or uncertain economic conditions, and are among the last to feel the effects of improving economic conditions particularly when, as in the recent past, trends are inconsistent and their duration unknown. The primary macroeconomic factors that affect our core customers include the unemployment rate, the underemployment rate, wage growth, fuel prices, and changes to certain government assistance programs, such as the 2016 changes to the Supplemental Nutrition Assistance Program, which had the effect of not only reducing benefit levels but also eliminating benefit eligibility for certain individuals. Additionally, our customers are impacted by increases in those expenses that generally comprise a large portion of their budget, such as rent and healthcare, and during 2016, these expenses increased at a rate that was greater than many of our core customers’ growth in income. We believe the overall effect of the factors listed above have negatively affected our traffic and, along with deflationary pressures, including both lower commodity costs and pricing actions on our products, have negatively affected same-store sales.
During 2016, we undertook a strategic review of our business and the retail environment that was designed to help identify additional long-term growth opportunities. This strategic review resulted in prioritizing those growth opportunities that we believe are most important for the business, such as leveraging digital tools and technology, while ensuring that we maintain our brand heritage and build upon our organizational capabilities.
Following this strategic review, we remain committed to the following long-term operating priorities as we consistently strive to improve our performance while retaining our customer-centric focus: 1) driving profitable sales growth, 2) capturing growth opportunities, 3) enhancing our position as a low-cost operator, and 4) investing in our people as a competitive advantage.
We seek to drive profitable sales growth through initiatives aimed at increasing customer traffic and average transaction amount, as well as an ongoing focus on enhancing our margins while maintaining both everyday low price and affordability.
Historically, our sales of consumables, which tend to have lower gross margins, have been the key drivers of net sales and customer traffic, while sales of non-consumables, which tend to have higher gross
margins, have contributed to profitable sales growth and an increase in average transaction amount. We expect these trends to continue in 2017. Same-store sales growth is key to achieving our objectives. As noted above, in recent periods economic and competitive deflationary pressures resulting in lower commodity costs and prices has negatively affected our net and same store sales performance, and the continuation, if any, of these deflationary pressures could negatively impact sales of certain items going forward. Additionally, we have made certain pricing adjustments and marketing investments in designated geographies with a focus on the consumables category to drive customer traffic. These pricing adjustments and marketing investments are performing well in the majority of stores that received them with improvements in transactions, units, and same-store sales. We expect to continue to evaluate and refresh these pricing adjustments across various items, categories and markets as needed.
During 2016, we made significant progress with the rollout of other initiatives designed to increase customer traffic and sales, such as the expansion of coolers in existing stores, the expansion of certain product classes including health and beauty care, party and stationery, and improvement in our in-stock position. We plan to further this progress in 2017 with the continued expansion of coolers, the rollout of additional merchandising initiatives across all merchandise categories, a continued focus on improving our in-stock position, and the addition of a queue line, similar to that in our DG16 layout stores discussed below, in a portion of our existing store base. We will continue to utilize our updated customer segmentation information, which has provided us with deeper insights into the spending habits for each of our core customer segments, to refine these initiatives and drive our category management process, as we optimize our assortment and expand into those products that are most likely to drive customer traffic to our stores. We plan to enhance our advertising effectiveness in 2017 by further integrating our traditional and digital media mix, designed to ensure that we reach our target customers where, when and how they decide to engage with us while also targeting a higher return on investment. We also plan to continue investing in our existing store base through many of these targeted merchandising initiatives, with a goal to drive increased customer traffic, average transaction amount and same-store sales.
We demonstrate our commitment to the affordability needs of our core customer by pricing more than 80% of our stock-keeping units at $5 or less at the end of 2016. However, as we work to provide everyday low prices and meet our customers’ affordability needs, we also remain focused on enhancing our margins through effective category management, inventory shrink reduction initiatives, private brands penetration, efforts to improve distribution and transportation efficiencies, global sourcing, and pricing and markdown optimization. With respect to category management, we strive to maintain an appropriate mix of consumables and non-consumables sales because, as noted above, the mix of sales affects profitability due to the varying gross margins between, and even within, the consumables and non-consumables categories. To support our efforts to reduce inventory shrink, we continue to implement additional in-store defensive merchandising and technology-based tools, such as Electronic Article Surveillance and video-enabled exception-based reporting in select stores. We strive to balance these and other shrink reduction efforts with our efforts to improve our in-stock position. We seek to reduce our stem miles and optimize loads to improve distribution and transportation efficiencies.
To support our other operating priorities, we remain focused on capturing growth opportunities and innovating within our channel. In 2016, we continued to expand our store count, opening 900 stores and remodeling or relocating 906 stores. In 2017, we intend to open approximately 1,000 stores and to relocate or remodel approximately 900 stores.
We continue to innovate within our channel, and during 2016 we began implementing the DG16 store layout for all new stores, relocations and remodels. In addition, we also began testing a smaller format store (less than 6,000 square feet) which we believe could allow us to capture growth opportunities in metropolitan areas as well as rural areas with a low number of households. In 2017, we plan to incorporate into a portion of our existing store base certain lessons learned from the DG16 layout and smaller format stores, as well those learned in connection with the conversion of the larger format former Walmart Express stores we acquired during 2016. To support our new store growth and drive productivity, we continue to make investments in our distribution center network. During 2016, we opened new distribution centers in Texas and Wisconsin. Our fifteenth distribution center in Jackson, Georgia is under construction with a goal to begin shipping from this facility in late 2017. We
expect to break ground on our sixteenth distribution center in Amsterdam, New York in mid-2017 to support our northeast growth.
We have established a position as a low-cost operator, continuously seeking ways to reduce or control costs that do not affect our customers’ shopping experience. We continued to enhance this position during 2016 through our zero-based budgeting initiative, streamlining our business while also reducing certain expenses as a percentage of sales. This initiative was successful in 2016, as evidenced by reductions in administrative payroll, advertising and certain other costs, and we believe this initiative has the momentum to assist in leveraging SG&A expenses at a lower same-store sales growth percentage over the long term. In addition, we remain committed to simplifying or eliminating store-level tasks and processes so that those time savings can be reinvested by our Store Managers and their teams in important areas such as enhanced customer service, higher in-stock levels, and improved store standards.
Our employees are a competitive advantage, and we are always searching for ways to continue investing in them. We invest in our employees in an effort to create an environment that attracts and retains talented personnel, as we believe that, particularly at the store level, employees who are promoted from within generally have longer tenures and are greater contributors to improvements in our financial performance. During 2016, these efforts helped to achieve our lowest level of store manager turnover in four years. During 2017, we will build upon this foundation by investing approximately $70 million, primarily for increased compensation and training for our store managers, as well as strategic initiatives. Our store managers play a critical role in our customer experience, and we anticipate this investment in their compensation will contribute to improved customer experience scores, higher sales, lower shrink and improved turnover metrics. The proposed changes to the overtime exemption regulations under the Fair Labor Standards Act (“FLSA”) are subject to an injunction by a federal court and if such regulations were to be implemented, we likely will incur incremental SG&A expenses.
To further enhance shareholder return in 2017, we plan to continue to repurchase shares of our common stock, although we expect to do so in a lower amount than in 2016, and pay quarterly cash dividends, subject to Board discretion.
A continued focus on our four operating priorities as discussed above, coupled with strong cash flow management and share repurchases resulted in solid overall operating and financial performance in 2016 as compared to 2015, as set forth below. Basis points, as referred to below, are equal to 0.01% as a percentage of net sales.
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Net sales in 2016 increased 7.9% over 2015. Sales in same-stores increased 0.9%, primarily due to an increase in average transaction amount accompanied by traffic that was essentially unchanged from the prior year. Average sales per square foot in 2016 were $229, including a $4 contribution from the 53
rd
week, as compared to $226 per square foot in 2015.
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Operating profit increased 6.3% to $2.06 billion, or 9.4% of sales, compared to $1.94 billion, or 9.5% of sales in 2015. The decrease in our operating profit rate reflects an 11 basis-point decrease in our gross profit rate and a 3 basis-point increase in SG&A.
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Our gross profit rate decreased by 11 basis points due primarily to higher markdowns, a greater proportion of sales of consumables, and a higher rate of inventory shrinkage.
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The increase in SG&A, as a percentage of sales, was due primarily to increases in retail labor costs. For other factors, see the detailed discussion that follows.
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Interest expense increased by $10.9 million in 2016 to $97.8 million due primarily to greater average debt outstanding and higher average interest rates.
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The decrease in the effective income tax rate to 36.3% in 2016 from 37.1% in 2015 was due primarily to an accounting change related to share-based compensation.
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We reported net income of $1.25 billion, or $4.43 per diluted share, for 2016, compared to net income of $1.17 billion, or $3.95 per diluted share, for 2015. Stock repurchase activity during 2015 and 2016 contributed to the increase in diluted earnings per share.
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We generated approximately $1.61 billion of cash flows from operating activities in 2016, an increase of 15.3% compared to 2015. We primarily utilized our cash flows from operating activities to invest in the growth of our business, repurchase our common stock, and pay quarterly cash dividends.
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Inventory turnover was 4.7 times on a rolling four-quarter basis. Inventories decreased 0.7% on a per store basis compared to 2015.
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We opened 900 new stores, remodeled or relocated 906 stores, and closed 63 stores.
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We repurchased approximately 12.4 million shares of our outstanding common stock for $990 million.
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Readers should refer to the detailed discussion of our operating results below for additional comments on financial performance in the current year periods as compared with the prior year periods.
Results of Operations
Accounting Periods.
The following text contains references to years 2016, 2015, and 2014, which represent fiscal years ended February 3, 2017, January 29, 2016, and January 30, 2015, respectively. Our fiscal year ends on the Friday closest to January 31. Fiscal year 2016 was a 53-week accounting period and fiscal years 2015 and 2014 were 52-week accounting periods.
Seasonality
. The nature of our business is somewhat seasonal. Primarily because of sales of Christmas-related merchandise, sales in our fourth quarter (November, December and January) have historically been higher than sales achieved in each of the first three quarters of the fiscal year. Expenses, and to a greater extent operating profit, vary by quarter. Results of a period shorter than a full year may not be indicative of results expected for the entire year. Furthermore, the seasonal nature of our business may affect comparisons between periods. For more information about the seasonality of our business, see “Seasonality” included in Part 1, Item 1 of this report.
The following table contains results of operations data for fiscal years 2016, 2015 and 2014, and the dollar and percentage variances among those years.
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2016 vs. 2015
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2015 vs. 2014
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(amounts in millions, except per share
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Amount
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%
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Amount
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%
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amounts)
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2016
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2015
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2014
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Change
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Change
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Change
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Change
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Net sales by category:
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Consumables
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$
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16,798.9
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$
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15,457.6
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$
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14,321.1
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$
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1,341.3
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8.7
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%
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$
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1,136.5
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7.9
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%
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% of net sales
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76.41
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%
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75.89
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%
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75.73
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%
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Seasonal
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2,674.3
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2,522.7
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2,345.0
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151.6
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6.0
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177.7
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7.6
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% of net sales
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12.16
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%
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12.39
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%
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12.40
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%
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Home products
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1,373.4
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1,289.4
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1,205.4
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84.0
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6.5
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84.1
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7.0
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% of net sales
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6.25
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%
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6.33
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%
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6.37
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%
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Apparel
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1,140.0
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1,098.8
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1,038.1
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41.2
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3.7
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60.7
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5.8
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% of net sales
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5.18
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%
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5.39
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%
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5.49
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%
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Net sales
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$
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21,986.6
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$
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20,368.6
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$
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18,909.6
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$
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1,618.0
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7.9
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%
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$
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1,459.0
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7.7
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%
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Cost of goods sold
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15,204.0
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14,062.5
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13,107.1
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1,141.5
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8.1
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955.4
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7.3
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% of net sales
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69.15
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%
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69.04
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%
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69.31
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%
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Gross profit
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6,782.6
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6,306.1
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5,802.5
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476.5
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7.6
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503.6
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8.7
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% of net sales
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30.85
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%
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30.96
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%
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30.69
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%
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Selling, general and administrative expenses
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4,719.2
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4,365.8
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4,033.4
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353.4
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8.1
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332.4
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8.2
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% of net sales
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21.46
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%
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21.43
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%
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21.33
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%
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Operating profit
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2,063.4
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1,940.3
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1,769.1
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123.2
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6.3
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171.2
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9.7
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% of net sales
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9.39
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%
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9.53
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%
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9.36
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%
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Interest expense
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97.8
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86.9
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88.2
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10.9
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12.5
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(1.3)
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(1.5)
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% of net sales
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0.44
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%
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0.43
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%
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0.47
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%
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Other (income) expense
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—
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0.3
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—
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(0.3)
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(100.0)
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0.3
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—
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% of net sales
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0.00
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%
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0.00
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%
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0.00
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%
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Income before income taxes
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1,965.6
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1,853.0
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1,680.9
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112.6
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6.1
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172.2
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10.2
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% of net sales
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8.94
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%
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9.10
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%
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8.89
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%
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Income tax expense
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714.5
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687.9
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615.5
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26.6
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3.9
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72.4
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11.8
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% of net sales
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3.25
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%
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3.38
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%
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3.26
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%
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Net income
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$
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1,251.1
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$
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1,165.1
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$
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1,065.3
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$
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86.1
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7.4
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%
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$
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99.7
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9.4
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%
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% of net sales
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5.69
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%
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5.72
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%
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5.63
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%
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Diluted earnings per share
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$
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4.43
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$
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3.95
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$
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3.49
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$
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0.48
|
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12.2
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%
|
$
|
0.46
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|
13.2
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%
|
Net Sales
. The net sales increase in 2016 reflects a same-store sales increase of 0.9% compared to 2015, primarily due to an increase in average transaction amount accompanied by traffic that was essentially unchanged as compared to the prior year. Same-store sales were affected by the factors discussed in the Executive Overview above. For 2016, there were 12,383 same-stores, which accounted for sales of $20.3 billion. Same-stores include stores that have been open for at least 13 months and remain open at the end of the reporting period. Changes in same-store sales are calculated based on the comparable calendar weeks in the prior year, and include stores that have been remodeled, expanded or relocated. Same-store sales results reflect positive results in the consumables and home products categories, partially offset by negative results in our apparel and seasonal categories. Net sales for the 53
rd
week of 2016 totaled $398.7 million. The remainder of the increase in sales in 2016 was attributable to new stores, partially offset by sales from closed stores.
The net sales increase in 2015 reflects a same-store sales increase of 2.8% compared to 2014. For 2015, there were 11,706 same-stores, which accounted for sales of $19.25 billion. The increase in sales reflects increases in both customer traffic and average transaction amounts. Same-store sales results reflect positive results in all four of our product categories, with the greatest increases in sales of consumables and seasonal, followed by home products and apparel. The remainder of the increase in sales in 2015 was attributable to new stores, partially offset by sales from closed stores.
Of our four major merchandise categories, the consumables category, which generally has a lower gross profit rate than the other three categories, has grown most significantly over the past several years. Because of the impact of sales mix on gross profit, we continually review our merchandise mix and strive to adjust it when appropriate.
Gross Profit.
The gross profit rate as a percentage of sales was 30.8% in 2016. Gross profit increased by 7.6% in 2016 as compared to 2015, and as a percentage of sales, declined by 11 basis points over the same period. The gross profit rate decrease in 2016 as compared to 2015 primarily reflects increased markdowns which were driven by promotional and inventory clearance activity, sales of lower-margin consumables comprising a greater proportion of net sales, and increased inventory shrink, partially offset by higher initial inventory markups and lower transportation costs. We recorded a LIFO benefit of $12.2 million in 2016 compared to a LIFO benefit of $2.3 million in 2015.
The gross profit rate as a percentage of sales was 31.0% in 2015 compared to 30.7% in 2014. Gross profit increased by 8.7% in 2015, and as a percentage of sales, increased by 27 basis points. The gross profit rate increase in 2015 as compared to 2014 primarily reflects lower transportation costs and an improved rate of inventory shrinkage, partially offset by increased markdowns. We recorded a LIFO benefit of $2.3 million in 2015 compared to a LIFO provision of $4.2 million in 2014.
SG&A.
SG&A was 21.5% as a percentage of sales in 2016, increasing by 3 basis points over 2015. The 2016 results reflect increases in retail labor costs, which increased at a rate greater than the increase in net sales, partially offset by reductions in administrative payroll costs, incentive compensation expenses, and advertising costs. The 2016 results also reflect an increase in disaster-related expenses of $12.2 million over 2015, much of which was hurricane-related.
SG&A was 21.4% as a percentage of sales in 2015 compared to 21.3% in 2014, an increase of 10 basis points. The 2015 results reflect increases in incentive compensation expenses, repairs and maintenance expenses, occupancy costs, and fees associated with an increase in debit card transactions. Partially offsetting these items was a higher volume of cash back transactions resulting in increased convenience fees collected from customers. The 2014 results reflect expenses of $14.3 million, or 8 basis points as a percentage of sales, related to an acquisition that was not completed.
Interest Expense
. Interest expense increased $10.9 million to $97.8 million in 2016 compared to 2015 primarily due to an increase in average debt outstanding and higher average interest rates. See the detailed discussion under “Liquidity and Capital Resources” regarding the financing of various long-term obligations. Interest expense decreased $1.3 million to $86.9 million in 2015 compared to 2014.
We had outstanding variable-rate debt of $924.3 million and $686.6 million as of February 3, 2017 and January 29, 2016, respectively. The remainder of our outstanding indebtedness at February 3, 2017 and January 29, 2016 was fixed rate debt.
Income Taxes
. The effective income tax rates for 2016, 2015 and 2014 were expenses of 36.3%, 37.1% and 36.6%, respectively.
The effective income tax rate for 2016 was 36.3% compared to a rate of 37.1% for 2015 which represents a net decrease of 0.8 percentage points. The effective income tax rate was lower in 2016 due principally to the early adoption of a change in accounting guidance related to employee share-based payments requiring the recognition of excess tax benefits in the statement of income rather than in the balance sheet, as reported in prior years.
The effective income tax rate for 2015 was 37.1% compared to a rate of 36.6% for 2014 which represents a net increase of 0.5 percentage points. The effective income tax rate was lower in 2014 due principally to federal and state reserve releases in 2014 that did not reoccur, to the same extent, in 2015. As in prior years, we receive a
significant income tax benefit related to wages paid to certain newly hired employees that qualify for federal jobs credits (principally the Work Opportunity Tax Credit or “WOTC”). In December 2015, Congress retroactively extended the federal law authorizing the WOTC for the period from January 1, 2015 through December 31, 2019.
Off Balance Sheet Arrangements
We are not party to any material off balance sheet arrangements.
Effects of Inflation
In 2016, we experienced product cost deflation reflecting reductions in commodity costs primarily related to food products. We experienced minimal overall commodity cost inflation or deflation in 2015 and 2014.
Liquidity and Capital Resources
Current Financial Condition and Recent Developments
During the past three years, we have generated an aggregate of approximately $4.3 billion in cash flows from operating activities and incurred approximately $1.4 billion in capital expenditures. During that period, we expanded the number of stores we operate by 2,188, representing growth of approximately 20%, and we remodeled or relocated 2,702 stores, or approximately 20% of the stores we operated as of February 3, 2017. In 2017, we intend to continue our current strategy of pursuing store growth, remodels and relocations.
At February 3, 2017, we had a five-year $1.425 billion unsecured credit agreement, and we had outstanding $2.3 billion aggregate principal amount of senior notes. As further discussed below, during the third quarter of 2016, we established a commercial paper program that may provide borrowing availability of up to $1.0 billion. At February 3, 2017, we had total outstanding debt (including the current portion of long-term obligations) of $3.2 billion, which includes balances under the 2015 Term Facility and 2015 Revolving Facility (each as defined below), commercial paper, and senior notes, all of which are described in greater detail below. We had $986.2 million available for borrowing under the unsecured credit agreement that, due to our intention to maintain borrowing availability related to the commercial paper program as described below, could contribute incremental liquidity of $495.7 million at February 3, 2017. We entered into an amended and restated credit agreement on February 22, 2017 as described further below. The information contained in Note 5 to the consolidated financial statements contained in Part II, Item 8 of this report is incorporated herein by reference.
We believe our cash flow from operations and existing cash balances, combined with availability under the Facilities (as defined below), the commercial paper program and access to the debt markets will provide sufficient liquidity to fund our current obligations, projected working capital requirements, capital spending and anticipated dividend payments for a period that includes the next twelve months as well as the next several years. However, our ability to maintain sufficient liquidity may be affected by numerous factors, many of which are outside of our control. Depending on our liquidity levels, conditions in the capital markets and other factors, we may from time to time consider the issuance of debt, equity or other securities, the proceeds of which could provide additional liquidity for our operations.
For the remainder of fiscal 2017, we anticipate potential borrowings under the unsecured revolving credit facility described below and our commercial paper program to be a maximum of approximately $750 million outstanding at any one time, including any anticipated borrowings to fund repurchases of common stock.
Credit Facilities
On February 22, 2017, we entered into an unsecured amended and restated credit agreement (the “Facilities”), which consists of a $175.0 million senior unsecured term loan facility (the “Term Facility”) and a $1.25 billion senior unsecured revolving credit facility (the “Revolving Facility”) which provides for the issuance
of letters of credit up to $175.0 million. The Term Facility is scheduled to mature on October 20, 2020 and the Revolving Facility is scheduled to mature on February 22, 2022. The Facilities replaced our previous unsecured credit agreement which consisted of a $425.0 million senior unsecured term loan facility (the “2015 Term Facility”) and a $1.0 billion senior unsecured revolving credit facility (the “2015 Revolving Facility”).
Borrowings under the Facilities bear interest at a rate equal to an applicable interest rate margin plus, at our option, either (a) LIBOR or (b) a base rate (which is usually equal to the prime rate). The applicable interest rate margin for borrowings as of March 3, 2017 was 1.10% for LIBOR borrowings and 0.10% for base-rate borrowings and the commitment fee rate is 0.15%. We also must pay a facility fee, payable on any used and unused commitment amounts of the Facilities, and customary fees on letters of credit issued under the Revolving Facility. The applicable interest rate margins for borrowings, the facility fees and the letter of credit fees under the Facilities are subject to adjustment from time to time based on our long-term senior unsecured debt ratings. The weighted average all-in interest rate for borrowings under the Facilities was 1.88% as of March 3, 2017.
The Facilities can be voluntarily prepaid in whole or in part at any time without penalty. There is no required amortization under the Facilities. The Facilities contain a number of customary affirmative and negative covenants that, among other things, restrict, subject to certain exceptions, our (including our subsidiaries’) ability to: incur additional liens; sell all or substantially all of our assets; consummate certain fundamental changes or change in our lines of business; and incur additional subsidiary indebtedness. The Facilities also contain financial covenants that require the maintenance of a minimum fixed charge coverage ratio and a maximum leverage ratio. As of March 3, 2017, we were in compliance with all such covenants. The Facilities also contain customary events of default. The terms of the Term Facility and the Revolving Facility are substantially similar to the terms of the 2015 Term Facility and the 2015 Revolving Facility, respectively, including financial covenants and events of default.
As of February 3, 2017, under the 2015 Revolving Facility, we had no outstanding borrowings and outstanding letters of credit of $13.8 million. In addition, as of February 3, 2017 we had outstanding letters of credit of $29.4 million which were issued pursuant to separate agreements.
Commercial Paper
On August 1, 2016, we established a commercial paper program under which we may issue unsecured commercial paper notes (the “CP Notes”). Under this program, we may issue the CP Notes from time to time in an aggregate amount not to exceed $1.0 billion outstanding at any time. The CP Notes have maturities of up to 364 days from the date of issue and rank equal in right of payment with all of our other unsecured and unsubordinated indebtedness. We intend to maintain available commitments under the Revolving Facility in an amount at least equal to the amount of CP Notes outstanding at any time. We had $490.5 million of CP Notes outstanding at February 3, 2017 that were classified as long-term obligations in the consolidated balance sheet due to our intent and ability to refinance these obligations as long-term debt, at a weighted average borrowing rate of 1.0%.
Senior Notes
We have $500.0 million aggregate principal amount of 4.125% senior notes due 2017 (the “2017 Senior Notes”) which are scheduled to mature on July 15, 2017; $400.0 million aggregate principal amount of 1.875% senior notes due 2018 (the “2018 Senior Notes”), net of discount of $0.1 million, which are scheduled to mature on April 15, 2018; $900.0 million aggregate principal amount of 3.25% senior notes due 2023 (the “2023 Senior Notes”), net of discount of $1.6 million, which are scheduled to mature on April 15, 2023; and $500.0 million aggregate principal amount of 4.150% senior notes due 2025 (the “2025 Senior Notes”), net of discount of $0.7 million, which are scheduled to mature on November 1, 2025. Collectively, the 2017 Senior Notes, the 2018 Senior Notes, the 2023 Senior Notes and the 2025 Senior Notes comprise the “Senior Notes”, each of which were issued pursuant to an indenture as supplemented and amended by supplemental indentures relating to each series of Senior Notes (as so supplemented and amended, the “Senior Indenture”). Interest on the 2017 Senior Notes is
payable in cash on January 15 and July 15 of each year. Interest on the 2018 Senior Notes and the 2023 Senior Notes is payable in cash on April 15 and October 15 of each year. Interest on the 2025 Senior Notes is payable in cash on May 1 and November 1 of each year. We expect to refinance the 2017 Senior Notes prior to their maturity utilizing proceeds from one or more of the issuance of additional senior notes, revolver borrowings or issuance of CP Notes.
We may redeem some or all of the Senior Notes at any time at redemption prices set forth in the Senior Indenture. Upon the occurrence of a change of control triggering event, which is defined in the Senior Indenture, each holder of our Senior Notes has the right to require us to repurchase some or all of such holder’s Senior Notes at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date.
The Senior Indenture contains covenants limiting, among other things, our ability (subject to certain exceptions) to consolidate, merge, or sell or otherwise dispose of all or substantially all of our assets; and our ability and the ability of our subsidiaries to incur or guarantee indebtedness secured by liens on any shares of voting stock of significant subsidiaries.
The Senior Indenture also provides for events of default which, if any of them occurs, would permit or require the principal of and accrued interest on our Senior Notes to become or to be declared due and payable, as applicable.
Rating Agencies
On June 1, 2016, Moody’s Investors Service upgraded our senior unsecured debt rating to Baa2 from Baa3, and on August 3, 2016, assigned to us a commercial paper rating of P-2 and affirmed our existing senior unsecured debt rating of Baa2, both with a stable outlook. On August 4, 2016, Standard & Poor’s assigned to us a short-term corporate credit and commercial paper rating of A-2 and affirmed our existing long-term corporate credit and senior unsecured rating of BBB, all with a stable outlook. Our current credit ratings, as well as future rating agency actions, could (i) impact our ability to finance our operations on satisfactory terms; (ii) affect our financing costs; and (iii) affect our insurance premiums and collateral requirements necessary for our self-insured programs. There can be no assurance that we will maintain or improve our current credit ratings.
Interest Rate Swaps
From time to time, we use interest rate swaps to minimize the risk of adverse changes in interest rates. These swaps are intended to reduce risk by hedging an underlying economic exposure. Because of high correlation between the derivative financial instrument and the underlying exposure being hedged, fluctuations in the value of the financial instruments are generally offset by reciprocal changes in the value of the underlying economic exposure. Our principal interest rate exposure relates to outstanding amounts under our Facilities and the CP Notes. At February 3, 2017 and January 29, 2016, we had no outstanding interest rate swaps. For more information see Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” below.
Contractual Obligations
The following table summarizes our significant contractual obligations and commercial commitments as of February 3, 2017 (in thousands):
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Payments Due by Period
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Contractual obligations
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Total
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< 1 year
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1 - 3 years
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3 - 5 years
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5+ years
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Long-term debt obligations
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$
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3,224,340
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$
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990,500
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$
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400,955
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$
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426,135
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$
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1,406,750
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Capital lease obligations
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3,643
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950
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957
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|
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728
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1,008
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Interest(a)
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417,750
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80,120
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117,991
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106,093
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113,546
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Self-insurance liabilities(b)
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224,614
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86,349
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93,455
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30,031
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14,779
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Operating lease obligations(c)
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8,123,628
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961,786
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1,794,920
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1,510,735
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3,856,187
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Subtotal
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$
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11,993,975
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$
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2,119,705
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$
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2,408,278
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$
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2,073,722
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$
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5,392,270
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Commitments Expiring by Period
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Commercial commitments(d)
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Total
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< 1 year
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1 - 3 years
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3 - 5 years
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5+ years
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Letters of credit
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$
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11,028
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$
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11,028
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$
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—
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$
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—
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$
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—
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Purchase obligations(e)
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1,303,163
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1,179,122
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124,041
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—
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—
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Subtotal
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$
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1,314,191
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$
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1,190,150
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$
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124,041
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$
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—
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$
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—
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Total contractual obligations and commercial commitments
(f)
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$
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13,308,166
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$
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3,309,855
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$
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2,532,319
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$
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2,073,722
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$
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5,392,270
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(a)
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Represents obligations for interest payments on long‑term debt and capital lease obligations, and includes projected interest on variable rate long‑term debt, using 2016 year end rates and balances. Variable rate long‑term debt includes the 2015 Revolving Facility (although such facility had a balance of zero as of February 3, 2017), the CP Notes (which had a balance of $490.5 million as of February 3, 2017), the balance of an outstanding tax increment financing of $8.8 million, and the balance of the 2015 Term Facility of $425 million.
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(b)
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We retain a significant portion of the risk for our workers’ compensation, employee health insurance, general liability, property loss and automobile insurance. As these obligations do not have scheduled maturities, these amounts represent undiscounted estimates based upon actuarial assumptions. Reserves for workers’ compensation and general liability which existed as of the date of a merger transaction in 2007 were discounted in order to arrive at estimated fair value. All other amounts are reflected on an undiscounted basis in our consolidated balance sheets.
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(c)
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Operating lease obligations are inclusive of amounts included in deferred rent in our consolidated balance sheets.
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(d)
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Commercial commitments include information technology license and support agreements, supplies, fixtures, letters of credit for import merchandise, and other inventory purchase obligations.
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(e)
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Purchase obligations include legally binding agreements for software licenses and support, supplies, fixtures, and merchandise purchases (excluding such purchases subject to letters of credit).
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(f)
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We have potential payment obligations associated with uncertain tax positions that are not reflected in these totals. We are currently unable to make reasonably reliable estimates of the period of cash settlement with the taxing authorities for the $4.8 million of reserves for uncertain tax positions.
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Share Repurchase Program
On August 24, 2016, our Board of Directors authorized a $1.0 billion increase to our existing common stock repurchase program, which had a total remaining authorization of approximately $933 million at February 3,
2017. Under the authorization, purchases may be made in the open market or in privately negotiated transactions from time to time subject to market and other conditions. The authorization has no expiration date and may be modified or terminated from time to time at the discretion of our Board of Directors. For more detail about our share repurchase program, see Note 11 to the consolidated financial statements.
Other Considerations
On March 15, 2017, the Board of Directors approved a quarterly cash dividend to shareholders of $0.26 per share which is payable on April 25, 2017 to shareholders of record on April 11, 2017, an increase of $0.01 per share over quarterly dividends paid in 2016. Although the Board currently intends to continue regular quarterly cash dividends, the payment of future cash dividends, and the amounts of any such dividends, are subject to the Board’s discretion and will depend upon, among other factors, our results of operations, cash requirements, financial condition, contractual restrictions and other factors that our Board may deem relevant.
Our inventory balance represented approximately 53% of our total assets exclusive of goodwill and other intangible assets as of February 3, 2017. Our ability to effectively manage our inventory balances can have a significant impact on our cash flows from operations during a given fiscal year. Inventory purchases are often somewhat seasonal in nature, such as the purchase of warm-weather or Christmas-related merchandise. Efficient management of our inventory has been and continues to be an area of focus for us.
As described in Note 7 to the consolidated financial statements, we are involved in a number of legal actions and claims, some of which could potentially result in material cash payments. Adverse developments in those actions could materially and adversely affect our liquidity. We also have certain income tax-related contingencies as disclosed in Note 4 to the consolidated financial statements. Future negative developments could have a material adverse effect on our liquidity.
Cash Flows
Cash flows from operating activities.
Cash flows from operating activities were $1.6 billion in 2016, an increase of $213.4 million compared to 2015. Significant components of the increase in cash flows from operating activities in 2016 compared to 2015 include increased net income due primarily to increased sales and operating profit in 2016 as described in more detail above under “Results of Operations.” Changes in merchandise inventories resulted in a reduction in working capital usage in 2016 compared to 2015 as described in greater detail below. Accounts payable increased by $56.5 million in 2016 compared to a $105.6 million increase in 2015, due primarily to the timing of merchandise receipts and related payments which were impacted by increases in payment terms.
Cash flows from operating activities were $1.4 billion in 2015, an increase of $64.8 million compared to 2014. Significant components of the increase in cash flows from operating activities in 2015 compared to 2014 include increased net income due primarily to increased sales and operating profit in 2015 as described in more detail above under “Results of Operations.” Changes in merchandise inventories resulted in an increased use of working capital, growing by a greater amount in 2015 compared to 2014 as described in greater detail below. Accounts payable increased by $105.6 million in 2015 compared to a $97.2 million increase in 2014, due primarily to the timing of merchandise receipts and related payments.
On an ongoing basis, we closely monitor and manage our inventory balances, and they may fluctuate from period to period based on new store openings, the timing of purchases, and other factors. Merchandise inventories increased by 6% in 2016, by 10% in 2015, and by 9% in 2014. Inventory levels in the consumables category increased by $54.5 million, or 3% in 2016, by $218.4 million, or 13%, in 2015, and by $178.4 million, or 12%, in 2014. The seasonal category increased by $79.5 million, or 15%, in 2016, by $63.2 million, or 13%, in 2015, and by $13.8 million, or 3%, in 2014. The home products category increased by $40.8 million, or 14%, in 2016, by $12.8 million, or 5%, in 2015, and was essentially unchanged in 2014. The apparel category increased by
$9.9 million, or 3%, in 2016, decreased by $2.7 million, or 1%, in 2015, and increased by $37.1 million, or 13%, in 2014.
Cash flows from investing activities
. Significant components of property and equipment purchases in 2016 included the following approximate amounts: $201 million for distribution and transportation-related projects; $168 million for improvements, upgrades, remodels and relocations of existing stores; $120 million for new leased stores; $38 million for stores purchased or built by us; and $26 million for information systems upgrades and technology-related projects. The timing of new, remodeled and relocated store openings along with other factors may affect the relationship between such openings and the related property and equipment purchases in any given period. During 2016, we opened 900 new stores and remodeled or relocated 906 stores.
Significant components of property and equipment purchases in 2015 included the following approximate amounts: $168 million for improvements, upgrades, remodels and relocations of existing stores; $144 million for distribution and transportation-related projects; $99 million for new leased stores; $53 million for stores built by us; and $34 million for information systems upgrades and technology-related projects. During 2015, we opened 730 new stores and remodeled or relocated 881 stores.
Significant components of property and equipment purchases in 2014 included the following approximate amounts: $127 million for improvements, upgrades, remodels and relocations of existing stores; $102 million for new leased stores; $64 million for distribution and transportation-related projects; $38 million for stores built by us; and $35 million for information systems upgrades and technology-related projects. During 2014, we opened 700 new stores and remodeled or relocated 915 stores.
Capital expenditures during 2017 are projected to be in the range of $650 to $700 million. We anticipate funding 2017 capital requirements with existing cash balances, cash flows from operations, availability under our Revolving Facility and the issuance of CP Notes. We plan to continue to invest in store growth and development of approximately 1,000 new stores and approximately 900 stores to be remodeled or relocated. Capital expenditures in 2017 are anticipated to support our store growth as well as our remodel and relocation initiatives, including capital outlays for leasehold improvements, fixtures and equipment; the construction of new stores; costs to support and enhance our supply chain initiatives including new and existing distribution center facilities; technology initiatives; as well as routine and ongoing capital requirements.
Cash flows from financing activities
. In 2016, we repurchased 12.4 million outstanding shares of our common stock at a total cost of $990.5 million. Net repayments under the 2015 Revolving Facility during 2016 were $251.0 million. We had net commercial paper borrowings during 2016 of $490.5 million. We also paid cash dividends of $281.1 million.
In 2015, we repurchased 17.6 million outstanding shares of our common stock at a total cost of $1.3 billion. We made repayments of $500.0 million on our term loan facilities, and had proceeds of $499.2 million from the issuance of senior notes. Net borrowings under our revolving credit facilities during 2015 were $251.0 million. We also paid cash dividends of $258.3 million.
In 2014, we repurchased 14.1 million outstanding shares of our common stock at a total cost of $800.1 million. We made repayments of $75.0 million on our term loan facility. Borrowings and repayments under our revolving credit facilities during the 2014 period were the same amount, resulting in no net increase to amounts outstanding under our revolving credit facility during 2014.
Accounting Standards
In May 2014, the Financial Accounting Standards Board (“FASB”) issued comprehensive new accounting standards related to the recognition of revenue, which specified an effective date for annual reporting periods beginning after December 15, 2016, with early adoption not permitted. In August 2015, the FASB deferred the effective date to annual reporting periods beginning after December 15, 2017, with earlier adoption
permitted only for annual reporting periods beginning after December 15, 2016. The new guidance allows companies to use either a full retrospective or a modified retrospective approach in the adoption of this guidance. We have formed a project team to assess and implement the standard by compiling a list of the applicable revenue streams, evaluating relevant contracts and comparing our current accounting policies to the new standard. As a result of the efforts of this project team, we have identified customer incentives and gross versus net considerations as the areas in which we could most likely be affected by the new guidance. We are continuing to assess all the impacts of the new standard and the design of internal control over financial reporting, but based upon the terms of our agreements and the materiality of the transactions related to customer incentives and gross versus net considerations, we do not expect the adoption to have a material effect on our consolidated results of operations, financial position or cash flows. We expect to complete this work in 2017 and to adopt this guidance on February 3, 2018.
In February 2016, the FASB issued new guidance related to lease accounting, which when effective will require a dual approach for lessee accounting under which a lessee will account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability on its balance sheet, with differing methodology for income statement recognition. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. A modified retrospective approach is required for all leases existing or entered into after the beginning of the earliest comparative period in the consolidated financial statements. We are currently assessing the impact that adoption of this guidance will have on our consolidated financial statements and we are anticipating a material impact because we are party to a significant number of lease contracts.
In October 2016, the FASB issued amendments to existing guidance related to accounting for intra-entity transfers of assets other than inventory. These amendments require an entity to recognize the income tax consequences of such transfers when the transfer occurs and affects our historical accounting for intra-entity transfers of certain intangible assets. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted subject to certain guidelines. The amendments should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We are currently assessing the impact that adoption of this guidance will have on our consolidated financial statements, but expect such adoption will result in an increase in deferred income tax liabilities and a decrease in retained earnings.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect reported amounts and related disclosures. In addition to the estimates presented below, there are other items within our financial statements that require estimation, but are not deemed critical as defined below. We believe these estimates are reasonable and appropriate. However, if actual experience differs from the assumptions and other considerations used, the resulting changes could have a material effect on the financial statements taken as a whole.
Management believes the following policies and estimates are critical because they involve significant judgments, assumptions, and estimates. Management has discussed the development and selection of the critical accounting estimates with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed the disclosures presented below relating to those policies and estimates. See Note 1 to the consolidated financial statements for a detailed discussion of our principal accounting policies.
Merchandise Inventories
. Merchandise inventories are stated at the lower of cost or market (“LCM”) with cost determined using the retail last in, first out (“LIFO”) method. We use the retail inventory method (“RIM”) to calculate gross profit and the resulting valuation of inventories at cost, which are computed utilizing a calculated cost-to-retail inventory ratio at an inventory department level. We apply the RIM to these departments,
which are groups of products that are fairly uniform in terms of cost, selling price relationship and turnover. The RIM will result in valuing inventories at LCM if permanent markdowns are currently taken as a reduction of the retail value of inventories. Inherent in the retail inventory method calculation are certain management judgments and estimates that may impact the ending inventory valuation at cost, as well as the gross profit recognized. These judgments include ensuring departments consist of uniform products, recording estimated shrinkage between physical inventories, and timely recording of markdowns needed to sell inventory.
We perform an annual LIFO analysis whereby all merchandise units are considered for inclusion in the index formulation. An actual valuation of inventory under the LIFO method is made at the end of each year based on the inventory levels and costs at that time. In contrast, interim LIFO calculations are based on management’s annual estimates of sales, the rate of inflation or deflation, and year-end inventory levels. We also perform analyses for determining obsolete inventory, adjusting inventory on a quarterly basis to an LCM value based on various management assumptions including estimated below cost markdowns not yet recorded, but required to liquidate such inventory in future periods.
Factors considered in the determination of markdowns include current and anticipated demand based on changes in competitors’ practices, consumer preferences, consumer spending and unseasonable weather patterns. Certain of these factors are outside of our control and may result in greater than estimated markdowns to entice consumer purchases of excess inventory. The amount and timing of markdowns may vary significantly from year to year.
We perform physical inventories in virtually all of our stores on an annual basis. We calculate our shrink provision based on actual physical inventory results during the fiscal period and an accrual for estimated shrink occurring subsequent to a physical inventory through the end of the fiscal reporting period. This accrual is calculated as a percentage of sales at each retail store, at a department level, based on the store’s most recent historical shrink rate. To the extent that subsequent physical inventories yield different results than the estimated accrual, our effective shrink rate for a given reporting period will include the impact of adjusting to the actual results.
We believe our estimates and assumptions related to the application of the RIM results in a merchandise inventory valuation that reasonably approximates cost on a consistent basis.
Goodwill and Other Intangible Assets.
The qualitative and quantitative assessments related to the valuation and any potential impairment of goodwill and other intangible assets are each subject to judgments and/or assumptions. The analysis of qualitative factors may include determining the appropriate factors to consider and the relative importance of those factors along with other assumptions. If required, judgments in the quantitative testing process may include projecting future cash flows, determining appropriate discount rates, correctly applying valuation techniques, correctly computing the implied fair value of goodwill if necessary, and other assumptions. Future cash flow projections are based on management’s projections and represent best estimates taking into account recent financial performance, market trends, strategic plans and other available information, which in recent years have been materially accurate. Changes in these estimates and assumptions could materially affect the determination of fair value or impairment, however, such a conclusion is not indicated by recent analyses. Future indicators of impairment could result in an asset impairment charge. If these judgments or assumptions are incorrect or flawed, the analysis could be negatively impacted.
Our most recent evaluation of our goodwill and indefinite lived trade name intangible assets was completed during the third quarter of 2016. No indicators of impairment were evident and no assessment of or adjustment to these assets was required. We are not currently projecting a decline in cash flows that could be expected to have an adverse effect such as a violation of debt covenants or future impairment charges.
Property and Equipment
. Property and equipment are recorded at cost. We group our assets into relatively homogeneous classes and generally provide for depreciation on a straight-line basis over the estimated average useful life of each asset class, except for leasehold improvements, which are amortized over the lesser of
the applicable lease term or the estimated useful life of the asset. Certain store and warehouse fixtures, when fully depreciated, are removed from the cost and related accumulated depreciation and amortization accounts. The valuation and classification of these assets and the assignment of depreciable lives involves judgments and the use of estimates, which we believe have been materially accurate in recent years.
Impairment of Long-lived Assets.
Impairment of long-lived assets results when the carrying value of the assets exceeds the estimated undiscounted future cash flows generated by the assets. Our estimate of undiscounted future store cash flows is based upon historical operations of the stores and estimates of future profitability which encompasses many factors that are subject to variability and are difficult to predict. If our estimates of future cash flows are not materially accurate, our impairment analysis could be impacted accordingly. If a long-lived asset is found to be impaired, the amount recognized for impairment is equal to the difference between the carrying value and the asset’s estimated fair value. The fair value is estimated based primarily upon projected future cash flows (discounted at our credit adjusted risk-free rate) or other reasonable estimates of fair market value. Although not currently anticipated, changes in these estimates, assumptions or projections could materially affect the determination of fair value or impairment.
Insurance Liabilities
. We retain a significant portion of the risk for our workers’ compensation, employee health, property loss, automobile and general liability claims. These represent significant costs primarily due to our large employee base and number of stores. Provisions are made for these liabilities on an undiscounted basis. Certain of these liabilities are based on actual claim data and estimates of incurred but not reported claims developed using actuarial methodologies based on historical claim trends, which have been and are anticipated to continue to be materially accurate. If future claim trends deviate from recent historical patterns, or other unanticipated events affect the number and significance of future claims, we may be required to record additional expenses or expense reductions, which could be material to our future financial results.
Contingent Liabilities – Income Taxes.
Income tax reserves are determined using the methodology established by accounting standards relating to uncertainty in income taxes. These standards require companies to assess each income tax position taken using a two-step process. A determination is first made as to whether it is more likely than not that the position will be sustained, based upon the technical merits, upon examination by the taxing authorities. If the tax position is expected to meet the more likely than not criteria, the benefit recorded for the tax position equals the largest amount that is greater than 50% likely to be realized upon ultimate settlement of the respective tax position. Uncertain tax positions require determinations and liabilities to be estimated based on provisions of the tax law which may be subject to change or varying interpretation. If our determinations and estimates prove to be inaccurate, the resulting adjustments could be material to our future financial results.
Contingent Liabilities - Legal Matters
.
We are subject to legal, regulatory and other proceedings and claims. We establish liabilities as appropriate for these claims and proceedings based upon the probability and estimability of losses and to fairly present, in conjunction with the disclosures of these matters in our financial statements and SEC filings, management’s view of our exposure. We review outstanding claims and proceedings with external counsel to assess probability and estimates of loss, which includes an analysis of whether such loss estimates are probable, reasonably possible, or remote. We re-evaluate these assessments on a quarterly basis or as new and significant information becomes available to determine whether a liability should be established or if any existing liability should be adjusted. The actual cost of resolving a claim or proceeding ultimately may be substantially different than the amount of the recorded liability. In addition, because it is not permissible under U.S. GAAP to establish a litigation liability until the loss is both probable and estimable, in some cases there may be insufficient time to establish a liability prior to the actual incurrence of the loss (upon verdict and judgment at trial, for example, or in the case of a quickly negotiated settlement).
Lease Accounting and Excess Facilities
. Many of our stores are subject to build-to-suit arrangements with landlords, which typically carry a primary lease term of up to 15 years with multiple renewal options. We also have stores subject to shorter-term leases and many of these leases have renewal options. Certain of our stores have provisions for contingent rentals based upon a percentage of defined sales volume. We recognize contingent rental expense when the achievement of specified sales targets is considered probable. We record minimum rental
expense on a straight-line basis over the base, non-cancelable lease term commencing on the date that we take physical possession of the property from the landlord, which normally includes a period prior to store opening to make necessary leasehold improvements and install store fixtures. When a lease contains a predetermined fixed escalation of the minimum rent, we recognize the related rent expense on a straight-line basis and record the difference between the recognized rental expense and the amounts payable under the lease as deferred rent. Tenant allowances, to the extent received, are recorded as deferred incentive rent and amortized as a reduction to rent expense over the term of the lease. We reflect as a liability any difference between the calculated expense and the amounts actually paid. Improvements of leased properties are amortized over the shorter of the life of the applicable lease term or the estimated useful life of the asset.
Share-Based Payments
. Our stock option awards are valued on an individual grant basis using the Black-Scholes-Merton closed form option pricing model. We believe that this model fairly estimates the value of our stock option awards. The application of this valuation model involves assumptions that are judgmental in the valuation of stock options, which affects compensation expense related to these options. These assumptions include the term that the options are expected to be outstanding, the historical volatility of our stock price, applicable interest rates and the dividend yield of our stock. Other factors involving judgments that affect the expensing of share-based payments include estimated forfeiture rates of share-based awards. Historically, these estimates have been materially accurate; however, if our estimates differ materially from actual experience, we may be required to record additional expense or reductions of expense, which could be material to our future financial results.
Fair Value Measurements.
Accounting standards for the measurement of fair value of assets and liabilities establish a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). Therefore, Level 3 inputs are typically based on an entity’s own assumptions, as there is little, if any, related market activity, and thus require the use of significant judgment and estimates. Currently, we have no assets or liabilities that are valued based solely on Level 3 inputs.
Our fair value measurements are primarily associated with our outstanding debt instruments. We use various valuation models in determining the values of these liabilities. We believe that in recent years these methodologies have produced materially accurate valuations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Fir
m
The Board of Directors and Shareholders of
Dollar General Corporation
We have audited the accompanying consolidated balance sheets of Dollar General Corporation and subsidiaries as of February 3, 2017 and January 29, 2016, and the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended February 3, 2017. 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 Dollar General Corporation and subsidiaries at February 3, 2017 and January 29, 2016, and the consolidated results of their operations and their cash flows for each of the three years in the period ended February 3, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Dollar General Corporation and subsidiaries’ internal control over financial reporting as of February 3, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 24, 2017 expressed an unqualified opinion thereon.
Nashville, Tennessee
March 24, 2017
DOLLAR GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
February 3,
|
|
January 29,
|
|
|
|
2017
|
|
2016
|
|
ASSETS
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
187,915
|
|
$
|
157,947
|
|
Merchandise inventories
|
|
|
3,258,785
|
|
|
3,074,153
|
|
Income taxes receivable
|
|
|
11,050
|
|
|
6,843
|
|
Prepaid expenses and other current assets
|
|
|
220,021
|
|
|
193,467
|
|
Total current assets
|
|
|
3,677,771
|
|
|
3,432,410
|
|
Net property and equipment
|
|
|
2,434,456
|
|
|
2,264,062
|
|
Goodwill
|
|
|
4,338,589
|
|
|
4,338,589
|
|
Other intangible assets, net
|
|
|
1,200,659
|
|
|
1,200,994
|
|
Other assets, net
|
|
|
20,823
|
|
|
21,830
|
|
Total assets
|
|
$
|
11,672,298
|
|
$
|
11,257,885
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
Current portion of long-term obligations
|
|
$
|
500,950
|
|
$
|
1,379
|
|
Accounts payable
|
|
|
1,557,596
|
|
|
1,494,225
|
|
Accrued expenses and other
|
|
|
500,866
|
|
|
467,122
|
|
Income taxes payable
|
|
|
63,393
|
|
|
32,870
|
|
Total current liabilities
|
|
|
2,622,805
|
|
|
1,995,596
|
|
Long-term obligations
|
|
|
2,710,576
|
|
|
2,969,175
|
|
Deferred income taxes
|
|
|
652,841
|
|
|
639,955
|
|
Other liabilities
|
|
|
279,782
|
|
|
275,283
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
Shareholders’ equity:
|
|
|
|
|
|
|
|
Preferred stock, 1,000 shares authorized
|
|
|
—
|
|
|
—
|
|
Common stock; $0.875 par value, 1,000,000 shares authorized, 275,212 and 286,694 shares issued and outstanding at February 3, 2017 and January 29, 2016, respectively
|
|
|
240,811
|
|
|
250,855
|
|
Additional paid-in capital
|
|
|
3,154,606
|
|
|
3,107,283
|
|
Retained earnings
|
|
|
2,015,867
|
|
|
2,025,545
|
|
Accumulated other comprehensive loss
|
|
|
(4,990)
|
|
|
(5,807)
|
|
Total shareholders’ equity
|
|
|
5,406,294
|
|
|
5,377,876
|
|
Total liabilities and shareholders’ equity
|
|
$
|
11,672,298
|
|
$
|
11,257,885
|
|
The accompanying notes are an integral part of the consolidated financial statements.
DOLLAR GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
|
|
|
|
|
February 3,
|
|
January 29,
|
|
January 30,
|
|
|
|
|
2017
|
|
2016
|
|
2015
|
|
Net sales
|
|
|
$
|
21,986,598
|
|
$
|
20,368,562
|
|
$
|
18,909,588
|
|
Cost of goods sold
|
|
|
|
15,203,960
|
|
|
14,062,471
|
|
|
13,107,081
|
|
Gross profit
|
|
|
|
6,782,638
|
|
|
6,306,091
|
|
|
5,802,507
|
|
Selling, general and administrative expenses
|
|
|
|
4,719,189
|
|
|
4,365,797
|
|
|
4,033,414
|
|
Operating profit
|
|
|
|
2,063,449
|
|
|
1,940,294
|
|
|
1,769,093
|
|
Interest expense
|
|
|
|
97,821
|
|
|
86,944
|
|
|
88,232
|
|
Other (income) expense
|
|
|
|
—
|
|
|
326
|
|
|
—
|
|
Income before income taxes
|
|
|
|
1,965,628
|
|
|
1,853,024
|
|
|
1,680,861
|
|
Income tax expense
|
|
|
|
714,495
|
|
|
687,944
|
|
|
615,516
|
|
Net income
|
|
|
$
|
1,251,133
|
|
$
|
1,165,080
|
|
$
|
1,065,345
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
$
|
4.45
|
|
$
|
3.96
|
|
$
|
3.50
|
|
Diluted
|
|
|
$
|
4.43
|
|
$
|
3.95
|
|
$
|
3.49
|
|
Weighted average shares outstanding:
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
|
281,317
|
|
|
294,330
|
|
|
304,633
|
|
Diluted
|
|
|
|
282,261
|
|
|
295,211
|
|
|
305,681
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividends per share
|
|
|
$
|
1.00
|
|
$
|
0.88
|
|
$
|
—
|
|
The accompanying notes are an integral part of the consolidated financial statements.
DOLLAR GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
|
|
|
|
February 3,
|
|
January 29,
|
|
January 30,
|
|
|
|
2017
|
|
2016
|
|
2015
|
|
Net income
|
|
$
|
1,251,133
|
|
$
|
1,165,080
|
|
$
|
1,065,345
|
|
Unrealized net gain (loss) on hedged transactions, net of related income tax expense (benefit) of $527, $971, and $1,671, respectively
|
|
|
817
|
|
|
1,520
|
|
|
2,583
|
|
Comprehensive income
|
|
$
|
1,251,950
|
|
$
|
1,166,600
|
|
$
|
1,067,928
|
|
The accompanying notes are an integral part of the consolidated financial statements.
DOLLAR GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In thousands except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
Common
|
|
|
|
|
Additional
|
|
|
|
|
Other
|
|
|
|
|
|
|
Stock
|
|
Common
|
|
Paid-in
|
|
Retained
|
|
Comprehensive
|
|
|
|
|
|
|
Shares
|
|
Stock
|
|
Capital
|
|
Earnings
|
|
Loss
|
|
Total
|
|
Balances, January 31, 2014
|
|
317,058
|
|
$
|
277,424
|
|
$
|
3,009,226
|
|
$
|
2,125,453
|
|
$
|
(9,910)
|
|
$
|
5,402,193
|
|
Net income
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1,065,345
|
|
|
—
|
|
|
1,065,345
|
|
Unrealized net gain (loss) on hedged transactions
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
2,583
|
|
|
2,583
|
|
Share-based compensation expense
|
|
—
|
|
|
—
|
|
|
37,338
|
|
|
—
|
|
|
—
|
|
|
37,338
|
|
Repurchases of common stock
|
|
(14,106)
|
|
|
(12,342)
|
|
|
—
|
|
|
(787,753)
|
|
|
—
|
|
|
(800,095)
|
|
Tax benefit from stock option exercises
|
|
—
|
|
|
—
|
|
|
5,047
|
|
|
—
|
|
|
—
|
|
|
5,047
|
|
Other equity and related transactions
|
|
495
|
|
|
432
|
|
|
(2,805)
|
|
|
—
|
|
|
—
|
|
|
(2,373)
|
|
Balances, January 30, 2015
|
|
303,447
|
|
$
|
265,514
|
|
$
|
3,048,806
|
|
$
|
2,403,045
|
|
$
|
(7,327)
|
|
$
|
5,710,038
|
|
Net income
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1,165,080
|
|
|
—
|
|
|
1,165,080
|
|
Dividends paid, $0.88 per common share
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(258,328)
|
|
|
—
|
|
|
(258,328)
|
|
Unrealized net gain (loss) on hedged transactions
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1,520
|
|
|
1,520
|
|
Share-based compensation expense
|
|
—
|
|
|
—
|
|
|
38,547
|
|
|
—
|
|
|
—
|
|
|
38,547
|
|
Repurchases of common stock
|
|
(17,556)
|
|
|
(15,361)
|
|
|
—
|
|
|
(1,284,252)
|
|
|
—
|
|
|
(1,299,613)
|
|
Tax benefit from stock option exercises
|
|
—
|
|
|
—
|
|
|
13,698
|
|
|
—
|
|
|
—
|
|
|
13,698
|
|
Other equity and related transactions
|
|
803
|
|
|
702
|
|
|
6,232
|
|
|
—
|
|
|
—
|
|
|
6,934
|
|
Balances, January 29, 2016
|
|
286,694
|
|
$
|
250,855
|
|
$
|
3,107,283
|
|
$
|
2,025,545
|
|
$
|
(5,807)
|
|
$
|
5,377,876
|
|
Net income
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1,251,133
|
|
|
—
|
|
|
1,251,133
|
|
Dividends paid, $1.00 per common share
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(281,147)
|
|
|
—
|
|
|
(281,147)
|
|
Unrealized net gain (loss) on hedged transactions
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
817
|
|
|
817
|
|
Share-based compensation expense
|
|
—
|
|
|
—
|
|
|
36,967
|
|
|
—
|
|
|
—
|
|
|
36,967
|
|
Repurchases of common stock
|
|
(12,354)
|
|
|
(10,810)
|
|
|
—
|
|
|
(979,664)
|
|
|
—
|
|
|
(990,474)
|
|
Other equity and related transactions
|
|
872
|
|
|
766
|
|
|
10,356
|
|
|
—
|
|
|
—
|
|
|
11,122
|
|
Balances, February 3, 2017
|
|
275,212
|
|
$
|
240,811
|
|
$
|
3,154,606
|
|
$
|
2,015,867
|
|
$
|
(4,990)
|
|
$
|
5,406,294
|
|
The accompanying notes are an integral part of the consolidated financial statements.
DOLLAR GENERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended
|
|
|
|
February 3,
|
|
January 29,
|
|
January 30,
|
|
|
|
2017
|
|
2016
|
|
2015
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,251,133
|
|
$
|
1,165,080
|
|
$
|
1,065,345
|
|
Adjustments to reconcile net income to net cash from operating activities:
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
379,931
|
|
|
352,431
|
|
|
342,353
|
|
Deferred income taxes
|
|
|
12,359
|
|
|
12,126
|
|
|
(17,734)
|
|
Loss on debt retirement, net
|
|
|
—
|
|
|
326
|
|
|
—
|
|
Noncash share-based compensation
|
|
|
36,967
|
|
|
38,547
|
|
|
37,338
|
|
Other noncash (gains) and losses
|
|
|
(3,625)
|
|
|
7,797
|
|
|
8,551
|
|
Change in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
Merchandise inventories
|
|
|
(171,908)
|
|
|
(290,001)
|
|
|
(233,559)
|
|
Prepaid expenses and other current assets
|
|
|
(25,046)
|
|
|
(24,626)
|
|
|
(25,048)
|
|
Accounts payable
|
|
|
56,477
|
|
|
105,637
|
|
|
97,166
|
|
Accrued expenses and other liabilities
|
|
|
42,937
|
|
|
44,949
|
|
|
41,635
|
|
Income taxes
|
|
|
26,316
|
|
|
(19,675)
|
|
|
12,399
|
|
Other
|
|
|
(500)
|
|
|
(905)
|
|
|
(1,555)
|
|
Net cash provided by (used in) operating activities
|
|
|
1,605,041
|
|
|
1,391,686
|
|
|
1,326,891
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
Purchases of property and equipment
|
|
|
(560,296)
|
|
|
(504,806)
|
|
|
(373,967)
|
|
Proceeds from sales of property and equipment
|
|
|
9,360
|
|
|
1,423
|
|
|
2,268
|
|
Net cash provided by (used in) investing activities
|
|
|
(550,936)
|
|
|
(503,383)
|
|
|
(371,699)
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
Issuance of long-term obligations
|
|
|
—
|
|
|
499,220
|
|
|
—
|
|
Repayments of long-term obligations
|
|
|
(3,138)
|
|
|
(502,401)
|
|
|
(78,467)
|
|
Net increase in commercial paper outstanding
|
|
|
490,500
|
|
|
—
|
|
|
—
|
|
Borrowings under revolving credit facilities
|
|
|
1,584,000
|
|
|
2,034,100
|
|
|
1,023,000
|
|
Repayments of borrowings under revolving credit facilities
|
|
|
(1,835,000)
|
|
|
(1,783,100)
|
|
|
(1,023,000)
|
|
Debt issuance costs
|
|
|
—
|
|
|
(6,991)
|
|
|
—
|
|
Repurchases of common stock
|
|
|
(990,474)
|
|
|
(1,299,613)
|
|
|
(800,095)
|
|
Payments of cash dividends
|
|
|
(281,135)
|
|
|
(258,328)
|
|
|
—
|
|
Other equity and related transactions
|
|
|
11,110
|
|
|
6,934
|
|
|
(2,373)
|
|
Net cash provided by (used in) financing activities
|
|
|
(1,024,137)
|
|
|
(1,310,179)
|
|
|
(880,935)
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
29,968
|
|
|
(421,876)
|
|
|
74,257
|
|
Cash and cash equivalents, beginning of period
|
|
|
157,947
|
|
|
579,823
|
|
|
505,566
|
|
Cash and cash equivalents, end of period
|
|
$
|
187,915
|
|
$
|
157,947
|
|
$
|
579,823
|
|
Supplemental cash flow information:
|
|
|
|
|
|
|
|
|
|
|
Cash paid for:
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
92,952
|
|
$
|
76,354
|
|
$
|
82,447
|
|
Income taxes
|
|
$
|
679,633
|
|
$
|
697,357
|
|
$
|
631,483
|
|
Supplemental schedule of noncash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
Purchases of property and equipment awaiting processing for payment, included in Accounts payable
|
|
$
|
38,914
|
|
$
|
32,020
|
|
$
|
31,586
|
|
The accompanying notes are an integral part of the consolidated financial statements.
DOLLAR GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of presentation and accounting policies
Basis of presentation
These notes contain references to the years 2016, 2015, and 2014, which represent fiscal years ended February 3, 2017, January 29, 2016, and January 30, 2015, respectively. The Company had a 53-week accounting period in 2016, while 2015 and 2014 were each 52-week accounting periods. The Company’s fiscal year ends on the Friday closest to January 31. The consolidated financial statements include all subsidiaries of the Company, except for its not-for-profit subsidiary which the Company does not control. Intercompany transactions have been eliminated.
The Company sells general merchandise on a retail basis through 13,320 stores (as of February 3, 2017) in 43 states with the greatest concentration of stores in the southern, southwestern, midwestern and eastern United States. The Company has owned distribution centers (“DCs”) in Scottsville, Kentucky; South Boston, Virginia; Alachua, Florida; Zanesville, Ohio; Jonesville, South Carolina; Marion, Indiana; Bessemer, Alabama; Bethel, Pennsylvania; San Antonio, Texas; and Janesville, Wisconsin, and leased DCs in Ardmore, Oklahoma; Fulton, Missouri; Indianola, Mississippi; and Lebec, California.
Cash and cash equivalents
Cash and cash equivalents include highly liquid investments with insignificant interest rate risk and original maturities of three months or less when purchased. Such investments primarily consist of money market funds, bank deposits, certificates of deposit, and commercial paper. The carrying amounts of these items are a reasonable estimate of their fair value due to the short maturity of these investments.
Payments due from processors for electronic tender transactions classified as cash and cash equivalents totaled approximately $73.9 million and $59.5 million at February 3, 2017 and January 29, 2016, respectively.
At February 3, 2017, the Company maintained cash balances to meet a $20 million minimum threshold set by insurance regulators, as further described below under “Insurance liabilities.”
Investments in debt and equity securities
The Company accounts for investments in debt and marketable equity securities as held‑to‑maturity, available‑for‑sale, or trading, depending on their classification. Debt securities categorized as held‑to‑maturity are stated at amortized cost. Debt and equity securities categorized as available‑for‑sale are stated at fair value, with any unrealized gains and losses, net of deferred income taxes, reported as a component of Accumulated other comprehensive loss. Trading securities are stated at fair value, with changes in fair value recorded as a component of Selling, general and administrative (“SG&A”) expense. The cost of securities sold is based upon the specific identification method.
Merchandise inventories
Inventories are stated at the lower of cost or market with cost determined using the retail last‑in, first‑out (“LIFO”) method as this method results in a better matching of costs and revenues. Under the Company’s retail inventory method (“RIM”), the calculation of gross profit and the resulting valuation of inventories at cost are computed by applying a calculated cost‑to‑retail inventory ratio to the retail value of sales at a department level. The use of the RIM will result in valuing inventories at the lower of cost or market (“LCM”) if markdowns are
currently taken as a reduction of the retail value of inventories. Costs directly associated with warehousing and distribution are capitalized into inventory.
The excess of current cost over LIFO cost was approximately $80.7 million and $92.9 million at February 3, 2017 and January 29, 2016, respectively. Current cost is determined using the RIM on a first‑in, first‑out basis. Under the LIFO inventory method, the impacts of rising or falling market price changes increase or decrease cost of sales (the LIFO provision or benefit). The Company recorded a LIFO provision (benefit) of $(12.2) million in 2016, $(2.3) million in 2015, and $4.2 million in 2014, which is included in cost of goods sold in the consolidated statements of income.
The Company purchases its merchandise from a wide variety of suppliers. The Company’s largest and second largest suppliers each accounted for approximately 8% of the Company’s purchases in 2016.
Vendor rebates
The Company accounts for all cash consideration received from vendors in accordance with applicable accounting standards pertaining to such arrangements. Cash consideration received from a vendor is generally presumed to be a rebate or an allowance and is accounted for as a reduction of merchandise purchase costs as earned. However, certain specific, incremental and otherwise qualifying SG&A expenses related to the promotion or sale of vendor products may be offset by cash consideration received from vendors, in accordance with arrangements such as cooperative advertising, when earned for dollar amounts up to but not exceeding actual incremental costs.
Prepaid expenses and other current assets
Prepaid expenses and other current assets include prepaid amounts for rent, maintenance, business licenses, advertising, and insurance, and amounts receivable for certain vendor rebates (primarily those expected to be collected in cash) and coupons.
Property and equipment
In 2007, the Company’s property and equipment was recorded at estimated fair values as the result of a merger transaction. Property and equipment acquired subsequent to the merger has been recorded at cost. The Company records depreciation and amortization on a straight-line basis over the assets’ estimated useful lives. The Company’s property and equipment balances and depreciable lives are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciable
|
|
February 3,
|
|
January 29,
|
|
(In thousands)
|
|
Life
|
|
2017
|
|
2016
|
|
Land
|
|
Indefinite
|
|
$
|
199,171
|
|
$
|
188,532
|
|
Land improvements
|
|
|
|
20
|
|
|
74,209
|
|
|
66,955
|
|
Buildings
|
|
39
|
-
|
40
|
|
|
1,013,227
|
|
|
834,884
|
|
Leasehold improvements
|
|
|
|
(a)
|
|
|
438,711
|
|
|
402,997
|
|
Furniture, fixtures and equipment
|
|
3
|
-
|
10
|
|
|
2,797,144
|
|
|
2,526,843
|
|
Construction in progress
|
|
|
|
|
|
|
72,540
|
|
|
150,275
|
|
|
|
|
|
|
|
|
4,595,002
|
|
|
4,170,486
|
|
Less accumulated depreciation and amortization
|
|
|
|
|
|
|
2,160,546
|
|
|
1,906,424
|
|
Net property and equipment
|
|
|
|
|
|
$
|
2,434,456
|
|
$
|
2,264,062
|
|
|
(a)
|
|
Amortized over the lesser of the life of the applicable lease term or the estimated useful life of the asset.
|
Depreciation expense related to property and equipment was approximately $378.3 million, $350.6 million and $335.9 million for 2016, 2015 and 2014, respectively. Amortization of capital lease assets is included in depreciation expense. Interest on borrowed funds during the construction of property and equipment is
capitalized where applicable. Interest costs of $1.4 million, $1.4 million and $0.2 million were capitalized in 2016, 2015 and 2014, respectively.
Impairment of long‑lived assets
When indicators of impairment are present, the Company evaluates the carrying value of long‑lived assets, excluding goodwill and other indefinite-lived intangible assets, in relation to the operating performance and future cash flows or the appraised values of the underlying assets. Generally, the Company’s policy is to review for impairment stores open more than three years for which current cash flows from operations are negative. Impairment results when the carrying value of the assets exceeds the undiscounted future cash flows expected to be generated by the assets. The Company’s estimate of undiscounted future cash flows is based upon historical operations of the stores and estimates of future store profitability which encompasses many factors that are subject to variability and difficult to predict. If a long‑lived asset is found to be impaired, the amount recognized for impairment is equal to the difference between the carrying value and the asset’s estimated fair value. The fair value is estimated based primarily upon estimated future cash flows over the asset’s remaining useful life (discounted at the Company’s credit adjusted risk‑free rate) or other reasonable estimates of fair market value. Assets to be disposed of are adjusted to the fair value less the cost to sell if less than the book value.
The Company recorded impairment charges included in SG&A expense of approximately $6.3 million in 2016, $5.9 million in 2015 and $1.9 million in 2014, to reduce the carrying value of certain of its stores’ assets. Such action was deemed necessary based on the Company’s evaluation that such amounts would not be recoverable primarily due to insufficient sales or excessive costs resulting in the carrying value of the assets exceeding the estimated undiscounted future cash flows generated by the assets at these locations.
Goodwill and other intangible assets
The Company amortizes intangible assets over their estimated useful lives unless such lives are deemed indefinite. Goodwill and intangible assets with indefinite lives are tested for impairment annually or more frequently if indicators of impairment are present. Definite lived intangible assets are tested for impairment if indicators of impairment are present. Impaired assets are written down to fair value as required. No impairment of intangible assets has been identified during any of the periods presented.
In accordance with accounting standards for goodwill and indefinite‑lived intangible assets, an entity has the option first to assess qualitative factors to determine whether events and circumstances indicate that it is more likely than not that goodwill or an indefinite‑lived intangible asset is impaired. If after such assessment an entity concludes that the asset is not impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the asset using a quantitative impairment test, and if impaired, the associated assets must be written down to fair value as described in further detail below.
The quantitative goodwill impairment test is a two-step process that would require management to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of an entity’s reporting units based on valuation techniques (including a discounted cash flow model using revenue and profit forecasts) and comparing that estimated fair value with the recorded carrying value, which includes goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment by determining an “implied fair value” of goodwill. The determination of the implied fair value of goodwill would require the entity to allocate the estimated fair value of its reporting unit to its assets and liabilities. Any unallocated fair value would represent the implied fair value of goodwill, which would be compared to its corresponding carrying value.
The quantitative impairment test for intangible assets compares the fair value of the intangible asset with its carrying amount. If the carrying amount of an intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
Other assets
Noncurrent Other assets consist primarily of qualifying prepaid expenses for maintenance, beer and wine licenses, and utility, security and other deposits.
Accrued expenses and other liabilities
Accrued expenses and other consist of the following:
|
|
|
|
|
|
|
|
|
|
February 3,
|
|
January 29,
|
|
(In thousands)
|
|
2017
|
|
2016
|
|
Compensation and benefits
|
|
$
|
91,243
|
|
$
|
111,191
|
|
Insurance
|
|
|
85,240
|
|
|
82,182
|
|
Taxes (other than taxes on income)
|
|
|
175,099
|
|
|
136,762
|
|
Other
|
|
|
149,284
|
|
|
136,987
|
|
|
|
$
|
500,866
|
|
$
|
467,122
|
|
Included in other accrued expenses are liabilities for maintenance, utilities, interest, credit card processing fees and freight expense. Certain increases in accrued expenses and other reflect the 53
rd
week in 2016.
Insurance liabilities
The Company retains a significant portion of risk for its workers’ compensation, employee health, general liability, property and automobile claim exposures. Accordingly, provisions are made for the Company’s estimates of such risks. The undiscounted future claim costs for the workers’ compensation, general liability, and health claim risks are derived using actuarial methods and are recorded as self‑insurance reserves pursuant to Company policy. To the extent that subsequent claim costs vary from those estimates, future results of operations will be affected as the reserves are adjusted.
Ashley River Insurance Company (“ARIC”), a South Carolina-based wholly owned captive insurance subsidiary of the Company, charges the operating subsidiary companies premiums to insure the retained workers’ compensation and non-property general liability exposures. Pursuant to South Carolina insurance regulations, ARIC maintains certain levels of cash and cash equivalents related to its self-insured exposures.
Operating leases and related liabilities
Rent expense is recognized over the term of the lease. The Company records minimum rental expense on a straight‑line basis over the base, non‑cancelable lease term commencing on the date that the Company takes physical possession of the property from the landlord, which normally includes a period prior to the store opening to make necessary leasehold improvements and install store fixtures. When a lease contains a predetermined fixed escalation of the minimum rent, the Company recognizes the related rent expense on a straight‑line basis and records the difference between the recognized rental expense and the amounts payable under the lease as deferred rent. Tenant allowances, to the extent received, are recorded as deferred incentive rent and are amortized as a reduction to rent expense over the term of the lease. The difference between the calculated expense and the amounts paid result in a liability, with the current portion in Accrued expenses and other and the long‑term portion in Other liabilities in the consolidated balance sheets, and totaled approximately $61.1 million and $57.9 million at February 3, 2017 and January 29, 2016, respectively.
The Company recognizes contingent rental expense when the achievement of specified sales targets is considered probable. The amount expensed but not paid as of February 3, 2017 and January 29, 2016 was approximately $3.5 million and $4.0 million, respectively, and is included in Accrued expenses and other in the consolidated balance sheets.
Other liabilities
Noncurrent Other liabilities consist of the following:
|
|
|
|
|
|
|
|
|
|
February 3,
|
|
January 29,
|
|
(In thousands)
|
|
2017
|
|
2016
|
|
Insurance
|
|
$
|
137,743
|
|
$
|
137,798
|
|
Deferred rent
|
|
|
61,082
|
|
|
57,017
|
|
Deferred gain on sale leaseback
|
|
|
49,259
|
|
|
53,737
|
|
Other
|
|
|
31,698
|
|
|
26,731
|
|
|
|
$
|
279,782
|
|
$
|
275,283
|
|
Fair value accounting
The Company utilizes accounting standards for fair value, which include the definition of fair value, the framework for measuring fair value, and disclosures about fair value measurements. Fair value is a market‑based measurement, not an entity‑specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, fair value accounting standards establish a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are directly or indirectly observable for the asset or liability. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which are based on an entity’s own assumptions, as there is little, if any, observable market activity. In instances where the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
The valuation of derivative financial instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis takes into account the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments (or receipts) and the discounted expected variable cash receipts (or payments). The variable cash receipts (or payments) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.
The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. The Company considers the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees, to adjust the fair value of outstanding derivative contracts for the effect of nonperformance risk. In connection with accounting standards for fair value measurement, the Company has made an accounting policy election to measure the credit risk of outstanding derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.
Derivative financial instruments
The Company accounts for derivative financial instruments in accordance with applicable accounting standards for such instruments and hedging activities, which require that all derivatives are recorded on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting.
Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge a certain portion of its risk, even though hedge accounting does not apply or the Company elects not to apply the hedge accounting standards.
The Company previously recorded a loss on the settlement of treasury locks associated with the issuance of long-term debt which was deferred to other comprehensive income and is being amortized as an increase to interest expense over the period of the debt’s maturity in 2023.
Revenue and gain recognition
The Company recognizes retail sales in its stores at the time the customer takes possession of merchandise. All sales are net of discounts and estimated returns and are presented net of taxes assessed by governmental authorities that are imposed concurrent with those sales. The liability for retail merchandise returns is based on the Company’s prior experience. The Company records gain contingencies when realized.
The Company recognizes gift card sales revenue at the time of redemption. The liability for the gift cards is established for the cash value at the time of purchase of the gift card. The liability for outstanding gift cards was approximately $3.4 million and $2.8 million at February 3, 2017 and January 29, 2016, respectively, and is recorded in Accrued expenses and other liabilities. Estimated breakage revenue, a percentage of gift cards that will never be redeemed based on historical redemption rates, is recognized over time in proportion to actual gift card redemptions. The Company recorded breakage revenue of $0.5 million and $0.6 million in 2016 and 2015, respectively.
Advertising costs
Advertising costs are expensed upon performance, “first showing” or distribution, and are reflected in SG&A expenses net of earned cooperative advertising amounts provided by vendors which are specific, incremental and otherwise qualifying expenses related to the promotion or sale of vendor products for dollar amounts up to but not exceeding actual incremental costs. Advertising costs were $82.7 million, $89.3 million and $77.3 million in 2016, 2015 and 2014, respectively. These costs primarily include promotional circulars, targeted circulars supporting new stores, television and radio advertising, in‑store signage, and costs associated with the sponsorships of certain automobile racing activities in 2016. Vendor funding for cooperative advertising offset reported expenses by $35.9 million, $36.7 million and $35.0 million in 2016, 2015 and 2014, respectively.
Share‑based payments
The Company recognizes compensation expense for share‑based compensation based on the fair value of the awards on the grant date. Forfeitures are estimated at the time of valuation and reduce expense ratably over the vesting period. This estimate may be adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the prior estimate. The forfeiture rate is the estimated percentage of share-based awards granted that are expected to be forfeited or canceled before becoming fully vested. The Company bases this estimate on historical experience or estimates of future trends, as applicable. An increase in the forfeiture rate will decrease compensation expense.
The fair value of each option grant is separately estimated and amortized into compensation expense on a straight‑line basis between the applicable grant date and each vesting date. The Company has estimated the fair value of all stock option awards as of the grant date by applying the Black‑Scholes‑Merton option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense.
The Company calculates compensation expense for restricted stock, share units and similar awards as the difference between the market price of the underlying stock or similar award on the grant date and the purchase price, if any. Such expense is recognized on a straight‑line basis for time-based awards or an accelerated basis for performance awards over the period in which the recipient earns the awards.
Store pre‑opening costs
Pre‑opening costs related to new store openings and the related construction periods are expensed as incurred.
Income taxes
Under the accounting standards for income taxes, the asset and liability method is used for computing the future income tax consequences of events that have been recognized in the Company’s consolidated financial statements or income tax returns. Deferred income tax expense or benefit is the net change during the year in the Company’s deferred income tax assets and liabilities.
The Company includes income tax related interest and penalties as a component of the provision for income tax expense.
Income tax reserves are determined using a methodology which requires companies to assess each income tax position taken using a two‑step process. A determination is first made as to whether it is more likely than not that the position will be sustained, based upon the technical merits, upon examination by the taxing authorities. If the tax position is expected to meet the more likely than not criteria, the benefit recorded for the tax position equals the largest amount that is greater than 50% likely to be realized upon ultimate settlement of the respective tax position. Uncertain tax positions require determinations and estimated liabilities to be made based on provisions of the tax law which may be subject to change or varying interpretation. If the Company’s determinations and estimates prove to be inaccurate, the resulting adjustments could be material to the Company’s future financial results.
Management estimates
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Accounting standards
In May 2014, the Financial Accounting Standards Board (“FASB”) issued comprehensive new accounting standards related to the recognition of revenue, which specified an effective date for annual reporting periods beginning after December 15, 2016, with early adoption not permitted. In August 2015, the FASB deferred the effective date to annual reporting periods beginning after December 15, 2017, with earlier adoption permitted only for annual reporting periods beginning after December 15, 2016. The new guidance allows companies to use either a full retrospective or a modified retrospective approach in the adoption of this guidance. The Company formed a project team to assess and implement the standard by compiling a list of the applicable revenue streams, evaluating relevant contracts and comparing the Company’s current accounting policies to the new standard. As a result of the efforts of this project team, the Company has identified customer incentives and gross versus net considerations as the areas in which it would most likely be affected by the new guidance. The Company is continuing to assess all the impacts of the new standard and the design of internal control over financial reporting, but based upon the terms of the Company’s agreements and the materiality of these transactions related to customer incentives and gross versus net considerations, the Company does not expect the effect of adoption to have a material effect on the Company’s consolidated results of operations, financial position or cash flows. The Company expects to complete this work in 2017 and to adopt this guidance on February 3, 2018.
In February 2016, the FASB issued new guidance related to lease accounting, which when effective will require a dual approach for lessee accounting under which a lessee will account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability on its balance sheet, with differing methodology for income statement recognition. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. A modified retrospective approach is required for all leases existing or entered into after the beginning of the earliest comparative period in the consolidated financial statements. The Company is currently assessing the impact that adoption of this guidance will have on its consolidated financial statements and is anticipating a material impact because the Company is party to a significant number of lease contracts.
In March 2016, the FASB issued amendments to existing guidance related to accounting for employee share-based payment affecting the income tax consequences of awards, classification of awards as equity or liabilities, and classification on the statement of cash flows. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is permitted. The Company early adopted this guidance in the first quarter of 2016. The Company has elected to continue estimating forfeitures of share-based awards. The amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement were applied prospectively resulting in a benefit for the year ended February 3, 2017 of approximately $11.0 million, or $0.04 per diluted share. The Company has elected to apply the amendments related to the presentation of excess tax benefits on the statement of cash flows using a retrospective transition method, and as a result, $13.7 million and $12.1 million of excess tax benefits related to share-based awards which were previously classified as cash flows from financing activities for the years ended January 29, 2016 and January 30, 2015, respectively, have been reclassified as cash flows from operating activities.
In October 2016, the FASB issued amendments to existing guidance related to accounting for intra-entity transfers of assets other than inventory. These amendments require an entity to recognize the income tax consequences of such transfers when the transfer occurs and affects the Company’s historical accounting for intra-entity transfers of certain intangible assets. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted subject to certain guidelines. The amendments should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently assessing the impact that adoption of this guidance will have on its consolidated financial
statements, but expects such adoption will result in an increase in deferred income tax liabilities and a decrease in retained earnings.
Reclassifications
Certain financial disclosures relating to prior periods have been reclassified to conform to the current year presentation where applicable.
2. Goodwill and other intangible assets
As of February 3, 2017 and January 29, 2016, the balances of the Company’s intangible assets were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of February 3, 2017
|
|
|
Remaining
|
|
|
|
|
Accumulated
|
|
|
|
|
(In thousands)
|
|
Life
|
|
Amount
|
|
Amortization
|
|
Net
|
|
Goodwill
|
|
Indefinite
|
|
$
|
4,338,589
|
|
$
|
—
|
|
$
|
4,338,589
|
|
Other intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Leasehold interests
|
|
1-6 years
|
|
$
|
3,658
|
|
$
|
2,699
|
|
$
|
959
|
|
Trade names and trademarks
|
|
Indefinite
|
|
|
1,199,700
|
|
|
—
|
|
|
1,199,700
|
|
|
|
|
|
$
|
1,203,358
|
|
$
|
2,699
|
|
$
|
1,200,659
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of January 29, 2016
|
|
|
|
Remaining
|
|
|
|
|
Accumulated
|
|
|
|
|
(In thousands)
|
|
Life
|
|
Amount
|
|
Amortization
|
|
Net
|
|
Goodwill
|
|
Indefinite
|
|
$
|
4,338,589
|
|
$
|
—
|
|
$
|
4,338,589
|
|
Other intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Leasehold interests
|
|
1-7 years
|
|
$
|
4,379
|
|
$
|
3,085
|
|
$
|
1,294
|
|
Trade names and trademarks
|
|
Indefinite
|
|
|
1,199,700
|
|
|
—
|
|
|
1,199,700
|
|
|
|
|
|
$
|
1,204,079
|
|
$
|
3,085
|
|
$
|
1,200,994
|
|
The Company recorded amortization expense related to amortizable intangible assets for 2016, 2015 and 2014 of $0.3 million, $0.9 million and $5.8 million, respectively, all of which is included in rent expense. Expected future cash flows associated with the Company’s intangible assets are not expected to be materially affected by the Company’s intent or ability to renew or extend the arrangements. The Company’s goodwill balance is not expected to be deductible for tax purposes.
3. Earnings per share
Earnings per share is computed as follows (in thousands except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Net
|
|
Average
|
|
Per Share
|
|
|
|
Income
|
|
Shares
|
|
Amount
|
|
Basic earnings per share
|
|
$
|
1,251,133
|
|
281,317
|
|
$
|
4.45
|
|
Effect of dilutive share-based awards
|
|
|
|
|
944
|
|
|
|
|
Diluted earnings per share
|
|
$
|
1,251,133
|
|
282,261
|
|
$
|
4.43
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2015
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Net
|
|
Average
|
|
Per Share
|
|
|
|
Income
|
|
Shares
|
|
Amount
|
|
Basic earnings per share
|
|
$
|
1,165,080
|
|
294,330
|
|
$
|
3.96
|
|
Effect of dilutive share-based awards
|
|
|
|
|
881
|
|
|
|
|
Diluted earnings per share
|
|
$
|
1,165,080
|
|
295,211
|
|
$
|
3.95
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2014
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Net
|
|
Average
|
|
Per Share
|
|
|
|
Income
|
|
Shares
|
|
Amount
|
|
Basic earnings per share
|
|
$
|
1,065,345
|
|
304,633
|
|
$
|
3.50
|
|
Effect of dilutive share-based awards
|
|
|
|
|
1,048
|
|
|
|
|
Diluted earnings per share
|
|
$
|
1,065,345
|
|
305,681
|
|
$
|
3.49
|
|
Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per share is determined based on the dilutive effect of share‑based awards using the treasury stock method.
Share-based awards that were outstanding at the end of the respective periods, but were not included in the computation of diluted earnings per share because the effect of exercising such options would be antidilutive, were 1.7 million, 1.3 million, and 1.2 million in 2016, 2015 and 2014, respectively.
4. Income taxes
The provision (benefit) for income taxes consists of the following:
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
2016
|
|
2015
|
|
2014
|
|
Current:
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
613,009
|
|
$
|
590,120
|
|
$
|
543,089
|
|
Foreign
|
|
|
135
|
|
|
1,678
|
|
|
1,245
|
|
State
|
|
|
88,990
|
|
|
84,021
|
|
|
81,816
|
|
|
|
|
702,134
|
|
|
675,819
|
|
|
626,150
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
11,053
|
|
|
6,410
|
|
|
(7,697)
|
|
State
|
|
|
1,308
|
|
|
5,715
|
|
|
(2,937)
|
|
|
|
|
12,361
|
|
|
12,125
|
|
|
(10,634)
|
|
|
|
$
|
714,495
|
|
$
|
687,944
|
|
$
|
615,516
|
|
A reconciliation between actual income taxes and amounts computed by applying the federal statutory rate to income before income taxes is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
2016
|
|
2015
|
|
2014
|
|
U.S. federal statutory rate on earnings before income taxes
|
|
$
|
687,969
|
|
35.0
|
%
|
$
|
648,558
|
|
35.0
|
%
|
$
|
588,303
|
|
35.0
|
%
|
State income taxes, net of federal income tax benefit
|
|
|
60,168
|
|
3.1
|
|
|
59,700
|
|
3.2
|
|
|
49,819
|
|
3.0
|
|
Jobs credits, net of federal income taxes
|
|
|
(18,952)
|
|
(1.0)
|
|
|
(21,366)
|
|
(1.2)
|
|
|
(18,961)
|
|
(1.1)
|
|
Increase (decrease) in valuation allowances
|
|
|
(1,474)
|
|
(0.1)
|
|
|
(1,371)
|
|
(0.1)
|
|
|
1,453
|
|
0.1
|
|
Stock-based compensation programs
|
|
|
(9,915)
|
|
(0.5)
|
|
|
—
|
|
—
|
|
|
—
|
|
—
|
|
Decrease in income tax reserves
|
|
|
(2,161)
|
|
(0.1)
|
|
|
(2,037)
|
|
(0.1)
|
|
|
(6,449)
|
|
(0.4)
|
|
Other, net
|
|
|
(1,140)
|
|
(0.1)
|
|
|
4,460
|
|
0.3
|
|
|
1,351
|
|
—
|
|
|
|
$
|
714,495
|
|
36.3
|
%
|
$
|
687,944
|
|
37.1
|
%
|
$
|
615,516
|
|
36.6
|
%
|
The 2016 effective tax rate was an expense of 36.3%. This expense was greater than the federal statutory tax rate of 35% due primarily to the inclusion of state income taxes in the total effective tax rate. The effective income tax rate was lower in 2016 due principally to the adoption of a change in accounting guidance related to employee share-based payments, as further discussed in Note 1, requiring the recognition of excess tax benefits in the statement of income rather than in the balance sheet, as reported in prior years.
The 2015 effective tax rate was an expense of 37.1%. This expense was greater than the federal statutory tax rate of 35% due primarily to the inclusion of state income taxes in the total effective tax rate. The 2015 effective income tax rate increased from 2014 due principally to federal and state reserve releases in 2014 that did not reoccur, to the same extent, in 2015.
The 2014 effective tax rate was an expense of 36.6%. This expense was greater than the federal statutory tax rate of 35% due primarily to the inclusion of state income taxes in the total effective tax rate.
Deferred taxes reflect the effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows:
|
|
|
|
|
|
|
|
|
|
February 3,
|
|
January 29,
|
|
(In thousands)
|
|
2017
|
|
2016
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
Deferred compensation expense
|
|
$
|
7,626
|
|
$
|
8,200
|
|
Accrued expenses
|
|
|
6,958
|
|
|
8,139
|
|
Accrued rent
|
|
|
24,077
|
|
|
20,793
|
|
Accrued insurance
|
|
|
72,990
|
|
|
72,676
|
|
Accrued incentive compensation
|
|
|
15,170
|
|
|
19,902
|
|
Share based compensation
|
|
|
18,908
|
|
|
17,988
|
|
Interest rate hedges
|
|
|
3,175
|
|
|
3,702
|
|
Tax benefit of income tax and interest reserves related to uncertain tax positions
|
|
|
746
|
|
|
1,371
|
|
Deferred gain on sale-leaseback
|
|
|
20,872
|
|
|
22,637
|
|
Other
|
|
|
12,591
|
|
|
9,440
|
|
State tax credit carry forwards, net of federal tax
|
|
|
8,765
|
|
|
10,711
|
|
|
|
|
191,878
|
|
|
195,559
|
|
Less valuation allowances
|
|
|
—
|
|
|
(1,474)
|
|
Total deferred tax assets
|
|
|
191,878
|
|
|
194,085
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
(334,430)
|
|
|
(320,619)
|
|
Inventories
|
|
|
(65,844)
|
|
|
(72,456)
|
|
Trademarks
|
|
|
(434,045)
|
|
|
(433,548)
|
|
Other
|
|
|
(10,400)
|
|
|
(7,417)
|
|
Total deferred tax liabilities
|
|
|
(844,719)
|
|
|
(834,040)
|
|
Net deferred tax liabilities
|
|
$
|
(652,841)
|
|
$
|
(639,955)
|
|
The Company has state tax credit carry forwards of approximately $13.5 million that will expire beginning in 2022 through 2026.
The Company reversed the remaining valuation allowance for state tax credit carry forwards in the amount of $1.5 million, which was recorded as a reduction in income tax expense in 2016. Based upon expected future income, management believes that it is more likely than not that the results of operations will generate sufficient taxable income to realize the deferred tax assets. The 2015 decrease of $1.4 million and 2014 increase of $1.5 million were recorded as a reduction and an increase in income tax expense, respectively.
The Company’s 2012 and earlier tax years are not open for further examination by the Internal Revenue Service (“IRS”). The IRS, at its discretion, may choose to examine the Company’s 2013 through 2015 fiscal year income tax filings. The Company has various state income tax examinations that are currently in progress. Generally, the Company’s 2012 and later tax years remain open for examination by the various state taxing authorities.
As of February 3, 2017, accruals for uncertain tax benefits, interest expense related to income taxes and potential income tax penalties were $3.1 million, $0.8 million and $0.9 million, respectively, for a total of $4.8 million. This total amount is reflected in noncurrent Other liabilities in the consolidated balance sheet.
As of January 29, 2016, accruals for uncertain tax benefits, interest expense related to income taxes and potential income tax penalties were $7.0 million, $0.9 million and $0.8 million, respectively, for a total of $8.7 million. This total amount is reflected in noncurrent Other liabilities in the consolidated balance sheet.
The Company believes that it is reasonably possible that the reserve for uncertain tax positions may be reduced by approximately $2.2 million in the coming twelve months principally as a result of the expiration of applicable statutes of limitations. Also, as of February 3, 2017, approximately $3.1 million of the uncertain tax positions would impact the Company’s effective income tax rate if the Company were to recognize the tax benefit for these positions.
The amounts associated with uncertain tax positions included in income tax expense consists of the following:
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
2016
|
|
2015
|
|
2014
|
|
Income tax expense (benefit)
|
|
$
|
(3,795)
|
|
$
|
(2,379)
|
|
$
|
(9,497)
|
|
Income tax related interest expense (benefit)
|
|
|
(31)
|
|
|
(23)
|
|
|
(1,445)
|
|
Income tax related penalty expense (benefit)
|
|
|
50
|
|
|
373
|
|
|
51
|
|
A reconciliation of the uncertain income tax positions from January 31, 2014 through February 3, 2017 is as follows:
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
2016
|
|
2015
|
|
2014
|
|
Beginning balance
|
|
$
|
6,964
|
|
$
|
9,343
|
|
$
|
19,583
|
|
Increases—tax positions taken in the current year
|
|
|
41
|
|
|
214
|
|
|
198
|
|
Increases—tax positions taken in prior years
|
|
|
52
|
|
|
17
|
|
|
62
|
|
Decreases—tax positions taken in prior years
|
|
|
(1,435)
|
|
|
(106)
|
|
|
(8,636)
|
|
Statute expirations
|
|
|
(2,453)
|
|
|
(2,504)
|
|
|
(1,121)
|
|
Settlements
|
|
|
(52)
|
|
|
—
|
|
|
(743)
|
|
Ending balance
|
|
$
|
3,117
|
|
$
|
6,964
|
|
$
|
9,343
|
|
5. Current and long‑term obligations
Current and long‑term obligations consist of the following:
|
|
|
|
|
|
|
|
|
|
February 3,
|
|
January 29,
|
|
(In thousands)
|
|
2017
|
|
2016
|
|
Senior unsecured credit facilities
|
|
|
|
|
|
|
|
Term Facility
|
|
$
|
425,000
|
|
$
|
425,000
|
|
Revolving Facility
|
|
|
—
|
|
|
251,000
|
|
4.125% Senior Notes due July 15, 2017
|
|
|
500,000
|
|
|
500,000
|
|
1.875% Senior Notes due April 15, 2018 (net of discount of $111 and $203)
|
|
|
399,889
|
|
|
399,797
|
|
3.250% Senior Notes due April 15, 2023 (net of discount of $1,552 and $1,775)
|
|
|
898,448
|
|
|
898,225
|
|
4.150% Senior Notes due November 1, 2025 (net of discount of $700 and $764)
|
|
|
499,300
|
|
|
499,236
|
|
Unsecured commercial paper notes
|
|
|
490,500
|
|
|
—
|
|
Capital lease obligations
|
|
|
3,643
|
|
|
4,806
|
|
Tax increment financing due February 1, 2035
|
|
|
8,840
|
|
|
10,590
|
|
Debt issuance costs, net
|
|
|
(14,094)
|
|
|
(18,100)
|
|
|
|
|
3,211,526
|
|
|
2,970,554
|
|
Less: current portion
|
|
|
(500,950)
|
|
|
(1,379)
|
|
Long-term portion
|
|
$
|
2,710,576
|
|
$
|
2,969,175
|
|
At February 3, 2017, the Company’s senior unsecured credit facilities (the “2015 Facilities”) consisted of a $425.0 million senior unsecured term loan facility (the “2015 Term Facility”) and a $1.0 billion senior unsecured revolving credit facility (the “2015 Revolving Facility”) which provided for the issuance of letters of credit up to $175.0 million. The 2015 Facilities were scheduled to mature on October 20, 2020, but were replaced by an amended and restated credit facility on February 22, 2017 as described below.
Borrowings under the 2015 Facilities bore interest at a rate equal to an applicable interest rate margin plus, at the Company’s option, either (a) LIBOR or (b) a base rate (which is usually equal to the prime rate). The applicable interest rate margin for borrowings as of February 3, 2017 was 1.10% for LIBOR borrowings and 0.10% for base-rate borrowings. The Company was also required to pay a facility fee, payable on any used and unused commitment amounts of the 2015 Facilities, and customary fees on letters of credit issued under the 2015 Revolving Facility. As of February 3, 2017, the commitment fee rate was 0.15%. The applicable interest rate margins for borrowings, the facility fees and the letter of credit fees under the 2015 Facilities were subject to adjustment from time to time based on the Company’s long‑term senior unsecured debt ratings. The weighted average all-in interest rate for borrowings under the 2015 Facilities was 1.9% as of February 3, 2017.
The 2015 Facilities could be voluntarily prepaid in whole or in part at any time without penalty. There was no required principal amortization under the 2015 Facilities. The 2015 Facilities contained a number of customary affirmative and negative covenants that, among other things, restricted, subject to certain exceptions, the Company’s and its subsidiaries’ ability to: incur additional liens; sell all or substantially all of the Company’s assets; consummate certain fundamental changes or change in the Company’s lines of business; and incur additional subsidiary indebtedness. The 2015 Facilities also contained financial covenants which required the maintenance of a minimum fixed charge coverage ratio and a maximum leverage ratio. As of February 3, 2017, the Company was in compliance with all such covenants. The 2015 Facilities also contained customary events of default.
As of February 3, 2017, under the 2015 Revolving Facility, the Company had borrowing availability of $986.2 million that, due to its intention to maintain borrowing availability under such facility related to the commercial paper program described below, could contribute incremental liquidity of $495.7 million. In addition,
the Company had outstanding letters of credit of $13.8 million which were issued under the 2015 Revolving Facility and $29.4 million which were issued pursuant to separate agreements.
On February 22, 2017, the Company entered into an unsecured amended and restated credit agreement for a $175.0 million senior unsecured term loan facility and a $1.25 billion senior unsecured revolving credit facility that provides for the issuance of letters of credit up to $175.0 million. The amended and restated credit facilities replaced the 2015 Facilities, and have terms similar to the 2015 Facilities, but the revolving credit facility maturity date was extended to February 22, 2022.
On August 1, 2016, the Company established a commercial paper program under which the Company may issue unsecured commercial paper notes (the “CP Notes”). Under this program, the Company may issue the CP Notes from time to time in an aggregate amount not to exceed $1.0 billion outstanding at any time. The CP Notes have maturities of up to 364 days from the date of issue and rank equal in right of payment with all of the Company’s other unsecured and unsubordinated indebtedness. The Company intends to maintain available commitments under the amended and restated revolving credit facilities in an amount at least equal to the amount of CP Notes outstanding at any time. As of February 3, 2017, the Company had outstanding CP notes of $490.5 million classified as long-term obligations on the consolidated balance sheet due to its intent and ability to refinance these obligations as long-term debt. The weighted average interest rate for borrowings under the commercial paper program was 1.0% as of February 3, 2017.
On October 20, 2015, the Company issued $500.0 million aggregate principal amount of 4.150% senior notes due 2025 (the “2025 Senior Notes”), net of discount of $0.8 million, which are scheduled to mature on November 1, 2025. Interest on the 2025 Senior Notes is payable in cash on May 1 and November 1 of each year, commencing on May 1, 2016. The Company incurred $4.4 million of debt issuance costs associated with the issuance of the 2025 Senior Notes. The net proceeds from the sale of the 2025 Senior Notes were used, together with borrowings under the 2015 Facilities, to repay all of the outstanding borrowings under a previous credit agreement and for general corporate purposes. Collectively, the 2025 Senior Notes and the Company’s other Senior Notes due 2017, 2018 and 2023 as reflected in the table above comprise the “Senior Notes”, each of which were issued pursuant to an indenture as supplemented and amended by supplemental indentures relating to each series of Senior Notes (as so supplemented and amended, the “Senior Indenture”).
The Company may redeem some or all of its Senior Notes at any time at redemption prices set forth in the Senior Indenture. Upon the occurrence of a change of control triggering event, which is defined in the Senior Indenture, each holder of the Senior Notes has the right to require the Company to repurchase some or all of such holder’s Senior Notes at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date.
The Senior Indenture contains covenants limiting, among other things, the ability of the Company and its subsidiaries to (subject to certain exceptions): consolidate, merge, sell or otherwise dispose of all or substantially all of the Company’s assets; and to incur or guarantee indebtedness secured by liens on any shares of voting stock of significant subsidiaries.
The Senior Indenture also provides for events of default which, if any of them occurs, would permit or require the principal of and accrued interest on the Senior Notes to become or to be declared due and payable, as applicable.
Scheduled debt maturities at February 3, 2017, including capital lease obligations, for the Company’s fiscal years listed below are as follows (in thousands): 2017 - $991,450; 2018 - $400,892; 2019 - $1,020; 2020 - $425,980; 2021 - $883; thereafter - $1,407,758.
6. Assets and liabilities measured at fair value
The following table presents the Company’s assets and liabilities required to be measured at fair value as of February 3, 2017, aggregated by the level in the fair value hierarchy within which those measurements are classified.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
in Active
|
|
|
|
|
|
|
|
|
|
|
|
|
Markets
|
|
Significant
|
|
|
|
|
|
|
|
|
|
for Identical
|
|
Other
|
|
Significant
|
|
Total Fair
|
|
|
|
Assets and
|
|
Observable
|
|
Unobservable
|
|
Value at
|
|
|
|
Liabilities
|
|
Inputs
|
|
Inputs
|
|
February 3,
|
|
(In thousands)
|
|
(Level 1)
|
|
(Level 2)
|
|
(Level 3)
|
|
2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term obligations (a)
|
|
$
|
2,315,204
|
|
$
|
929,845
|
|
$
|
—
|
|
$
|
3,245,049
|
|
Deferred compensation (b)
|
|
|
19,612
|
|
|
—
|
|
|
—
|
|
|
19,612
|
|
|
(a)
|
|
Included in the consolidated balance sheet at book value as Current portion of long‑term obligations of $500,950 and Long‑term obligations of $2,710,576.
|
|
(b)
|
|
Reflected at fair value in the consolidated balance sheet as a component of Accrued expenses and other current liabilities of $905 and a component of noncurrent Other liabilities of $18,707.
|
The carrying amounts reflected in the consolidated balance sheets for cash, cash equivalents, short‑term investments, receivables and payables approximate their respective fair values. The Company does not have any recurring fair value measurements using significant unobservable inputs (Level 3) as of February 3, 2017.
7. Commitments and contingencies
Leases
As of February 3, 2017, the Company was committed under operating lease agreements for most of its retail stores. Many of the Company’s stores are subject to build‑to‑suit arrangements with landlords which typically carry a primary lease term of up to 15 years with multiple renewal options. The Company also has stores subject to shorter‑term leases and many of these leases have renewal options. Certain of the Company’s leased stores have provisions for contingent rent based upon a specified percentage of defined sales volume.
The land and buildings of the Company’s DCs in Missouri, Mississippi and California are subject to operating lease agreements and the leased Oklahoma DC is subject to a financing arrangement. Certain leases contain restrictive covenants, and as of February 3, 2017, the Company is not aware of any material violations of such covenants.
The Company is accounting for the Oklahoma DC as a financing obligation as a result of, among other things, the lessor’s ability to put the property back to the Company under certain circumstances. The property and equipment, along with the related lease obligation associated with this transaction are recorded in the consolidated balance sheets. The Company is the owner of a secured promissory note (the “Ardmore Note”) which represents debt issued by the third party entity from which the Company leases the Oklahoma DC and therefore the Company holds the debt instrument pertaining to its lease financing obligation. Because a legal right of offset exists, the Company is accounting for the Ardmore Note as a reduction of its outstanding financing obligation in its consolidated balance sheets.
Future minimum payments as of February 3, 2017 for operating leases are as follows:
|
|
|
|
|
(In thousands)
|
|
|
|
|
2017
|
|
$
|
961,786
|
|
2018
|
|
|
924,169
|
|
2019
|
|
|
870,751
|
|
2020
|
|
|
792,435
|
|
2021
|
|
|
718,300
|
|
Thereafter
|
|
|
3,856,187
|
|
Total minimum payments
|
|
$
|
8,123,628
|
|
Total future minimum payments for capital leases were $4.5 million, with a present value of $3.6 million, as of February 3, 2017. The gross amount of property and equipment recorded under capital leases and financing obligations at both February 3, 2017 and January 29, 2016, was $29.8 million. Accumulated depreciation on property and equipment under capital leases and financing obligations at February 3, 2017 and January 29, 2016, was $14.3 million and $12.4 million, respectively.
Rent expense under all operating leases is as follows:
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
2016
|
|
2015
|
|
2014
|
|
Minimum rentals (a)
|
|
$
|
935,663
|
|
$
|
849,115
|
|
$
|
776,103
|
|
Contingent rentals
|
|
|
6,748
|
|
|
7,793
|
|
|
9,099
|
|
|
|
$
|
942,411
|
|
$
|
856,908
|
|
$
|
785,202
|
|
|
(a)
|
|
Excludes amortization of leasehold interests of $0.3 million, $0.9 million and $5.8 million included in rent expense for the years ended February 3, 2017, January 29, 2016, and January 30, 2015, respectively.
|
Legal proceedings
From time to time, the Company is a party to various legal matters involving claims incidental to the conduct of its business, including actions by employees, consumers, suppliers, government agencies, or others. The Company has recorded accruals with respect to these matters, where appropriate, which are reflected in the Company’s consolidated financial statements. For some matters, a liability is not probable or the amount cannot be reasonably estimated and therefore an accrual has not been made.
Except as described below, the Company believes, based upon information currently available, that such matters, both individually and in the aggregate, will be resolved without a material adverse effect on the Company’s consolidated financial statements as a whole. However, litigation and other legal matters involve an element of uncertainty. Future developments could cause these actions or claims to have a material adverse effect on the Company’s results of operations, cash flows, or financial position. In addition, certain of these matters, if decided adversely to the Company or settled by the Company, may result in liability material to the Company’s financial position or may negatively affect operating results if changes to the Company’s business operation are required.
Employment Litigation
The Company is defending a lawsuit filed by the Equal Employment Opportunity Commission (the “Commission”) in which the Commission alleges that the Company’s criminal background check policy has a disparate impact on “Black Applicants” in violation of Title VII and seeks to recover monetary damages and injunctive relief on behalf of a class of “Black Applicants.” The Company believes that its background check process is both lawful and necessary to a safe environment for its employees and customers and the protection of its assets. The Company is vigorously defending this matter, which has been tendered to, and accepted by, the Company’s Employment Practices Liability Insurance carrier. The Company has met its self-insured retention, and does not expect a material loss at this time.
The Company also is defending litigation in California (the “California Wage/Hour Litigation”) in which the plaintiffs allege that they and a putative statewide class of other “key carriers” were not provided with meal and rest periods and were provided inaccurate wage statements and termination pay in violation of California law, including California’s Private Attorney General Act (the “PAGA”). The plaintiffs in the California Wage/Hour Litigation seek to recover alleged unpaid wages, injunctive relief, consequential damages, pre-judgment interest, statutory penalties and attorneys’ fees and costs.
The Company is vigorously defending the California Wage/Hour Litigation and believes that its policies and practices comply with California law and that these actions are not appropriate for class or similar treatment. At this time, however, it is not possible to predict whether any of the actions comprising the California Wage/Hour Litigation ultimately will be permitted to proceed as a class, and no assurances can be given that the Company will be successful in its defense of these actions on the merits or otherwise. Similarly, at this time the Company cannot estimate either the size of any potential class or the value of the claims asserted in these actions and consequently is unable to estimate any potential loss or range of loss in these matters. If the Company is not successful in its defense efforts, the resolution of these actions could have a material adverse effect on the Company’s consolidated financial statements as a whole.
The Company also is defending a lawsuit in which the plaintiff alleges that she and other similarly situated California Dollar General Market store managers were improperly classified as exempt employees and were not provided with meal and rest breaks and accurate and appropriate wage statements in violation of California law, including the PAGA. The plaintiff in this matter seeks to recover unpaid wages, including overtime pay, civil and statutory penalties, interest, injunctive relief, restitution, and attorneys’ fees and costs. The parties reached an agreement to settle this matter for an amount not material to the Company’s consolidated financial statements as a whole, and the settlement has received final approval by the Court.
Consumer/Product Litigation
In December 2015 and February, March, May and June 2016, the Company was notified of several lawsuits in which the plaintiffs allege violation of state consumer protection laws relating to the labeling, marketing and sale of Dollar General private-label motor oil. Each of the 22 lawsuits was filed in, or removed to, various federal district courts of the United States (collectively “the Motor Oil Lawsuits”).
On June 2, 2016, the United States Judicial Panel on Multidistrict Litigation granted the Company’s motion to centralize the Motor Oil Lawsuits in a matter styled
In re Dollar General Corp. Motor Oil Litigation
, Case MDL No. 2709, before the United States District Court for the Western District of Missouri (“Motor Oil MDL”). Subsequently, the plaintiffs in the Motor Oil MDL filed a consolidated amended complaint, in which they seek to certify two nationwide classes and 16 statewide sub-classes and for each putative class member some or all of the following relief: compensatory damages, injunctive relief, statutory damages, punitive damages and attorneys’ fees. The Company’s motion to dismiss the allegations raised in the consolidated amended complaint remains pending.
The Company believes that the labeling, marketing and sale of its private-label motor oil comply with applicable federal and state requirements and are not misleading. The Company further believes that this matter is not appropriate for class or similar treatment. The Company intends to vigorously defend this action; however, at this time, it is not possible to predict whether the Motor Oil MDL will be permitted to proceed as a class or the size of any putative class or classes. Likewise, at this time, it is not possible to estimate the value of the claims asserted, and no assurances can be given that the Company will be successful in its defense of this action on the merits or otherwise. For these reasons, the Company is unable to estimate the potential loss or range of loss in this matter; however if the Company is not successful in its defense efforts, the resolution of the Motor Oil MDL could have a material adverse effect on the Company’s consolidated financial statements as a whole.
Shareholder Litigation
The Company is defending litigation filed in January and February 2017 in which the plaintiffs, on behalf of themselves and a putative class of shareholders, allege that between March 10, 2016 and December 1, 2016, the
Company violated federal securities laws by misrepresenting the impact to sales of changes to certain federal programs that provide supplemental nutritional assistance to individuals. (
Iron Workers Local Union No. 405 Annuity Fund v. Dollar General Corporation, et al.
, M.D. Tenn. Case No. 3:17-cv-00063;
Julia Askins v. Dollar General Corporation, et al
., M.D. Tenn., Case No. 3:17-cv-00276;
Bruce Velan v. Dollar General Corporation, et al
., M.D. Tenn., Case No. 3:17-cv-00275)(collectively “the Shareholder Litigation”). Applications for lead plaintiff designation in the Shareholder Litigation must be filed on or before March 20, 2017, after which time the court is expected to designate a lead plaintiff and counsel for the putative class. Until such designation, neither the plaintiffs nor the Company is expected to make additional substantive filings in this matter.
The Company believes that the statements at issue in the Shareholder Litigation complied with federal securities laws and intends to vigorously defend this matter. At this time, it is not possible to predict whether this matter will be permitted to proceed as a class or the size of any putative class. Likewise, at this time, it is not possible to estimate the value of the claims asserted, and no assurances can be given that the Company will be successful in its defense of this action on the merits or otherwise. For these reasons, the Company is unable to estimate the potential loss or range of loss in this matter; however if the Company is not successful in its defense efforts, the resolution of this matter could have a material adverse effect on the Company’s consolidated financial statements as a whole.
Environmental Matter
In February 2014, certain California District Attorneys’ Offices (“California DAs”), representing California’s county environmental authorities, informed the Company that they were investigating the Company’s hazardous waste handling and disposal practices in certain of its California stores and its California distribution center. On September 22, 2016, the California DAs provided a settlement demand to the Company that included a proposed civil penalty and certain injunctive relief. The Company continues to work with the California DAs towards a resolution of this matter and does not believe that any possible loss or the range of any possible loss that may be incurred in connection with this matter will be material to the Company’s financial condition or results of operations. Nonetheless, SEC regulations require disclosures of certain environmental matters when a governmental authority is a party to the proceeding unless the Company reasonably believes the proceeding will result in no monetary sanctions or in monetary sanctions, exclusive of interest and costs, of less than $100,000. As noted above, it now appears that this matter is likely to result in monetary sanctions, which the Company expects to exceed $100,000.
8. Benefit plans
The Dollar General Corporation 401(k) Savings and Retirement Plan, which became effective on January 1, 1998, is a safe harbor defined contribution plan and is subject to the Employee Retirement and Income Security Act (“ERISA”).
A participant’s right to claim a distribution of his or her account balance is dependent on the plan, ERISA guidelines and Internal Revenue Service regulations. All active participants are fully vested in all contributions to the 401(k) plan. During 2016, 2015 and 2014, the Company expensed approximately $16.0 million, $15.0 million and $13.7 million, respectively, for matching contributions.
The Company also has a nonqualified supplemental retirement plan (“SERP”) and compensation deferral plan (“CDP”), known as the Dollar General Corporation CDP/SERP Plan, for a select group of management and other key employees. The Company incurred compensation expense for these plans of approximately $0.7 million, $1.1 million and $0.8 million in 2016, 2015 and 2014, respectively.
The CDP/SERP Plan assets are invested in accounts selected by the Company’s Compensation Committee or its delegate, and the associated deferred compensation liability is reflected in the consolidated balance sheets as further disclosed in Note 6.
9. Share‑based payments
The Company accounts for share‑based payments in accordance with applicable accounting standards, under which the fair value of each award is separately estimated and amortized into compensation expense over the service period. The fair value of the Company’s stock option grants are estimated on the grant date using the Black‑Scholes‑Merton valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense. The fair value of the Company’s other share-based awards discussed below are estimated using the Company’s closing stock price on the grant date. Forfeitures are estimated at the time of valuation and reduce expense ratably over the vesting period.
On July 6, 2007, the Company’s Board of Directors adopted the 2007 Stock Incentive Plan, which plan was subsequently amended and restated on several occasions (as so amended and restated, the “Plan”). The Plan allows the granting of stock options, stock appreciation rights, and other stock‑based awards or dividend equivalent rights to key employees, directors, consultants or other persons having a service relationship with the Company, its subsidiaries and certain of its affiliates. The number of shares of Company common stock authorized for grant under the Plan is 31,142,858. As of February 3, 2017, 17,691,607 of such shares are available for future grants.
Since May 2011, most of the share-based awards issued by the Company have been in the form of stock options, restricted stock, restricted stock units and performance share units. With limited exceptions, stock options and restricted stock units granted to employees generally vest ratably on an annual basis over four-year and three-year periods, respectively. Awards granted to board members generally vest over a one-year period. Performance share units generally vest ratably over a three-year period, provided that certain minimum performance criteria are met in the year of grant. With limited exceptions, the performance share unit and restricted stock unit awards are payable in shares of common stock on the vesting date.
From July 2007 through May 2011, a significant majority of the Company’s share-based awards were a combination of stock options that vested solely upon the continued employment of the recipient (“MSA Time Options”) and options that vested upon the achievement of predetermined annual or cumulative financial-based targets (“MSA Performance Options”) (collectively, the “MSA Options”). MSA Options generally vested ratably on an annual basis over a period of approximately five years, with limited exceptions. The MSA Options have a contractual term of 10 years and an exercise price equal to the fair value of the underlying common stock on the date of grant.
The weighted average for key assumptions used in determining the fair value of all stock options granted in the years ended February 3, 2017, January 29, 2016, and January 30, 2015, and a summary of the methodology applied to develop each assumption, are as follows:
|
|
|
|
|
|
|
|
|
|
February 3,
|
|
January 29,
|
|
January 30,
|
|
|
|
2017
|
|
2016
|
|
2015
|
|
Expected dividend yield
|
|
1.3
|
%
|
1.2
|
%
|
0
|
%
|
Expected stock price volatility
|
|
25.4
|
%
|
25.3
|
%
|
25.6
|
%
|
Weighted average risk-free interest rate
|
|
1.6
|
%
|
1.8
|
%
|
1.9
|
%
|
Expected term of options (years)
|
|
6.3
|
|
6.4
|
|
6.3
|
|
Expected dividend yield - This is an estimate of the expected dividend yield on the Company’s stock. An increase in the dividend yield will decrease compensation expense.
Expected stock price volatility - This is a measure of the amount by which the price of the Company’s common stock has fluctuated or is expected to fluctuate. An increase in the expected volatility will increase compensation expense.
Weighted average risk‑free interest rate - This is the U.S. Treasury rate for the week of the grant having a term approximating the expected life of the option. An increase in the risk‑free interest rate will increase compensation expense.
Expected term of options - This is the period of time over which the options granted are expected to remain outstanding. The Company has estimated the expected term as the mid‑point between the vesting date and the contractual term of the option. An increase in the expected term will increase compensation expense.
A summary of the Company’s stock option activity, exclusive of MSA Options, during the year ended February 3, 2017 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
Remaining
|
|
|
|
|
|
|
Options
|
|
Exercise
|
|
Contractual
|
|
Intrinsic
|
|
(Intrinsic value amounts reflected in thousands)
|
|
Issued
|
|
Price
|
|
Term in Years
|
|
Value
|
|
Balance, January 29, 2016
|
|
2,429,965
|
|
$
|
61.19
|
|
|
|
|
|
|
Granted
|
|
996,984
|
|
|
84.73
|
|
|
|
|
|
|
Exercised
|
|
(524,129)
|
|
|
51.64
|
|
|
|
|
|
|
Canceled
|
|
(204,162)
|
|
|
75.69
|
|
|
|
|
|
|
Balance, February 3, 2017
|
|
2,698,658
|
|
$
|
70.64
|
|
7.9
|
|
$
|
18,842
|
|
Exercisable at February 3, 2017
|
|
675,234
|
|
$
|
54.40
|
|
6.4
|
|
$
|
12,849
|
|
The weighted average grant date fair value per share of non-MSA options granted was $20.06, $18.48, and $17.26 during 2016, 2015 and 2014, respectively. The intrinsic value of non-MSA options exercised during 2016, 2015, and 2014 was $17.3 million, $20.8 million and $2.5 million, respectively.
The number of performance share unit awards earned is based upon the Company’s annual financial performance in the year of grant as specified in the award agreement. A summary of performance share unit award activity during the year ended February 3, 2017 is as follows:
|
|
|
|
|
|
|
|
|
Units
|
|
Intrinsic
|
|
(Intrinsic value amounts reflected in thousands)
|
|
Issued
|
|
Value
|
|
Balance, January 29, 2016
|
|
144,097
|
|
|
|
|
Granted
|
|
121,246
|
|
|
|
|
Converted to common stock
|
|
(69,393)
|
|
|
|
|
Canceled
|
|
(21,567)
|
|
|
|
|
Balance, February 3, 2017
|
|
174,383
|
|
$
|
12,754
|
|
The weighted average grant date fair value per share of performance share units granted was $84.67, $74.72 and $57.91 during 2016, 2015, and 2014, respectively.
A summary of restricted stock unit award activity during the year ended February 3, 2017 is as follows:
|
|
|
|
|
|
|
|
|
Units
|
|
Intrinsic
|
|
(Intrinsic value amounts reflected in thousands)
|
|
Issued
|
|
Value
|
|
Balance, January 29, 2016
|
|
640,910
|
|
|
|
|
Granted
|
|
282,828
|
|
|
|
|
Converted to common stock
|
|
(340,916)
|
|
|
|
|
Canceled
|
|
(80,861)
|
|
|
|
|
Balance, February 3, 2017
|
|
501,961
|
|
$
|
36,713
|
|
The weighted average grant date fair value per share of restricted stock units granted was $84.56, $74.67, and $57.87 during 2016, 2015 and 2014, respectively.
At February 3, 2017, 90,467 MSA Time Options were outstanding, all of which were exercisable, with an average exercise price of $19.06, an average remaining contractual term of 2.7 years, and an aggregate intrinsic value of $4.9 million. The intrinsic value of MSA Time Options exercised during 2016, 2015, and 2014 was $5.3 million, $6.6 million and $6.8 million, respectively.
At February 3, 2017, 66,290 MSA Performance Options were outstanding, all of which were exercisable, with an average exercise price of $19.15, an average remaining contractual term of 2.7 years, and an aggregate intrinsic value of $3.6 million. The intrinsic value of MSA Performance Options exercised during 2016, 2015 and 2014 was $5.5 million, $4.9 million and $4.9 million, respectively.
At February 3, 2017, the total unrecognized compensation cost related to unvested stock‑based awards was $53.7 million with an expected weighted average expense recognition period of 1.6 years.
The fair value method of accounting for share‑based awards resulted in share‑based compensation expense (a component of SG&A expenses) and a corresponding reduction in income before and net of income taxes as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
|
|
Performance
|
|
Restricted
|
|
Restricted
|
|
|
|
|
(In thousands)
|
|
Options
|
|
Share Units
|
|
Stock Units
|
|
Stock
|
|
Total
|
|
Year ended February 3, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax
|
|
$
|
12,008
|
|
$
|
7,258
|
|
$
|
17,701
|
|
$
|
—
|
|
$
|
36,967
|
|
Net of tax
|
|
$
|
7,325
|
|
$
|
4,427
|
|
$
|
10,798
|
|
$
|
—
|
|
$
|
22,550
|
|
Year ended January 29, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax
|
|
$
|
11,113
|
|
$
|
4,856
|
|
$
|
22,578
|
|
$
|
—
|
|
$
|
38,547
|
|
Net of tax
|
|
$
|
6,779
|
|
$
|
2,962
|
|
$
|
13,772
|
|
$
|
—
|
|
$
|
23,513
|
|
Year ended January 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-tax
|
|
$
|
8,533
|
|
$
|
5,461
|
|
$
|
15,968
|
|
$
|
7,376
|
|
$
|
37,338
|
|
Net of tax
|
|
$
|
5,206
|
|
$
|
3,332
|
|
$
|
9,742
|
|
$
|
4,500
|
|
$
|
22,780
|
|
10. Segment reporting
The Company manages its business on the basis of one reportable operating segment. See Note 1 for a brief description of the Company’s business. As of February 3, 2017, all of the Company’s operations were located within the United States with the exception of certain subsidiaries in Hong Kong and China and a liaison office in India, which collectively are not material with regard to assets, results of operations or otherwise, to the consolidated financial statements. The following net sales data is presented in accordance with accounting standards related to disclosures about segments of an enterprise.
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
2016
|
|
2015
|
|
2014
|
|
Classes of similar products:
|
|
|
|
|
|
|
|
|
|
|
Consumables
|
|
$
|
16,798,881
|
|
$
|
15,457,611
|
|
$
|
14,321,080
|
|
Seasonal
|
|
|
2,674,319
|
|
|
2,522,701
|
|
|
2,344,993
|
|
Home products
|
|
|
1,373,397
|
|
|
1,289,423
|
|
|
1,205,373
|
|
Apparel
|
|
|
1,140,001
|
|
|
1,098,827
|
|
|
1,038,142
|
|
Net sales
|
|
$
|
21,986,598
|
|
$
|
20,368,562
|
|
$
|
18,909,588
|
|
11. Common stock transactions
On August 29, 2012, the Company’s Board of Directors authorized a common stock repurchase program, which the Board has since increased on several occasions. Most recently, on August 24, 2016, the Company’s Board of Directors authorized a $1.0 billion increase to the existing common stock repurchase program. As of February 3, 2017, a cumulative total of $5.0 billion had been authorized under the program since its inception and approximately $933.3 million remained available for repurchase. The repurchase authorization has no expiration date and allows repurchases from time to time in the open market or in privately negotiated transactions. The timing and number of shares purchased depends on a variety of factors, such as price, market conditions, compliance with the covenants and restrictions under the Company’s debt agreements and other factors. Repurchases under the program may be funded from available cash or borrowings including under the Company’s amended and restated credit facilities and issuance of CP Notes discussed in further detail in Note 5.
During the years ended February 3, 2017, January 29, 2016, and January 30, 2015, the Company repurchased approximately 12.4 million shares of its common stock at a total cost of $1.0 billion, approximately 17.6 million shares of its common stock at a total cost of $1.3 billion and approximately 14.1 million shares of its common stock at a total cost of $0.8 billion, respectively, pursuant to its common stock repurchase programs.
The Company paid quarterly cash dividends of $0.25 per share during each of the four quarters of 2016. On March 15, 2017, the Company’s Board of Directors approved a quarterly cash dividend of $0.26 per share, which is payable on April 25, 2017 to shareholders of record as of April 11, 2017. The amount and declaration of future cash dividends is subject to the discretion of the Company’s Board of Directors and will depend upon, among other things, the Company’s results of operations, cash requirements, financial condition, contractual restrictions and other factors that the Board may deem relevant in its sole discretion.
12. Quarterly financial data (unaudited)
The following is selected unaudited quarterly financial data for the fiscal years ended February 3, 2017 and January 29, 2016. Each quarterly period listed below was a 13-week accounting period, with the exception of the fourth quarter of 2016, which was a 14‑week accounting period. The sum of the four quarters for any given year may not equal annual totals due to rounding.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
Second
|
|
Third
|
|
Fourth
|
|
(In thousands)
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
5,265,432
|
|
$
|
5,391,891
|
|
$
|
5,320,029
|
|
$
|
6,009,246
|
|
Gross profit
|
|
|
1,612,614
|
|
|
1,681,767
|
|
|
1,587,510
|
|
|
1,900,747
|
|
Operating profit
|
|
|
480,743
|
|
|
509,097
|
|
|
392,991
|
|
|
680,618
|
|
Net income
|
|
|
295,124
|
|
|
306,518
|
|
|
235,315
|
|
|
414,176
|
|
Basic earnings per share
|
|
|
1.03
|
|
|
1.08
|
|
|
0.84
|
|
|
1.50
|
|
Diluted earnings per share
|
|
|
1.03
|
|
|
1.08
|
|
|
0.84
|
|
|
1.49
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First
|
|
Second
|
|
Third
|
|
Fourth
|
|
(In thousands)
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
Quarter
|
|
2015:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
4,918,672
|
|
$
|
5,095,904
|
|
$
|
5,067,048
|
|
$
|
5,286,938
|
|
Gross profit
|
|
|
1,498,705
|
|
|
1,588,155
|
|
|
1,536,962
|
|
|
1,682,269
|
|
Operating profit
|
|
|
428,194
|
|
|
475,812
|
|
|
423,859
|
|
|
612,429
|
|
Net income
|
|
|
253,235
|
|
|
282,349
|
|
|
253,321
|
|
|
376,175
|
|
Basic earnings per share
|
|
|
0.84
|
|
|
0.95
|
|
|
0.87
|
|
|
1.30
|
|
Diluted earnings per share
|
|
|
0.84
|
|
|
0.95
|
|
|
0.86
|
|
|
1.30
|
|
In 2016, the Company acquired 42 former Walmart Express locations and closed 40 of its own locations as part of relocating stores to the purchased locations. As a result, the Company incurred expenses, primarily related to lease termination costs, of $11.0 million ($6.7 million net of tax, or $0.02 per diluted share), which was recognized in Selling, general, and administrative expense in the third quarter of 2016.
In the fourth quarter of 2016, the Company sold or assigned the leases for 12 of its own locations which were closed as part of the relocation process to the Walmart Express locations. As a result, the Company incurred a reduction of expenses of $4.5 million ($2.8 million net of tax, or $0.01 per diluted share), which was recognized in Selling, general, and administrative expense.
In the third quarter of 2015, the Company implemented a restructuring of its corporate support functions. As a result, the Company incurred expenses, primarily related to severance-related benefits, of $6.1 million ($3.7 million net of tax, or $0.01 per diluted share), which was recognized in Selling, general, and administrative expense.