Good afternoon, ladies and gentlemen, and welcome to the Tractor Supply Company's conference call to discuss third quarter 2014 results. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. Please note each participant will be permitted to ask one question with a follow-up. Please be advised that the reproduction of this call, in whole or in part, is not permitted without written authorization of Tractor Supply Company. As a reminder, this call is being recorded. I would now like to introduce your host for today's call, Christine Skold of Tractor Supply Company. Christine, please go ahead.
Thank you, operator. Good afternoon, and thank you for joining us for Tractor Supply Company's quarterly earnings conference call. Before we begin, let me reference the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. This call may contain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the company. Although the company believes the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in the company filings with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed.
Investors should not assume that statements will remain operative at a later time. Lastly, Tractor Supply Company undertakes no obligation to update any information discussed in this call. I am now pleased to introduce Greg Sandfort, Tractor Supply Company's President and Chief Executive Officer. Greg, please go ahead.
Thank you, Christine. Good afternoon, everyone, and thank you for joining us. On the call with me today are Tony Crudele, our EVP and CFO, Steve Barbarick, our EVP of Merchandising and Marketing, and Lee Downing, our EVP of Store Operations and Real Estate. The team here at Tractor Supply delivered a solid third quarter performance, and we are very pleased with our results. Sales were strong across the board and benefited from an extended spring-summer selling season and the early sales of fall cold weather products. Our business performed consistently from month to month and region to region, with each of the regions delivering mid-single-digit comp increases for the quarter. Comparable store sales increased 5.6% versus an increase of 7.5% in last year's third quarter, which was our most difficult quarterly comparison for the year.
The comp increase was driven by a strong performance in both traffic and ticket. Comp store transaction count increased 3.3% and average ticket increased 2.2%. This represents our 26th consecutive quarter of positive comp transaction counts. With the delayed beginning of the spring selling season in many of our markets this year, I felt the team did a terrific job managing product assortments and inventory levels to capitalize on the shift in the weather. We experienced strong sell-throughs of seasonal categories such as lawn and garden supplies, live goods, outdoor power equipment, fencing, and agricultural chemicals for the quarter. We also saw strength on the left-hand side of our store in categories such as hardware, truck, and tool. We updated a number of these planograms, during the earlier part of the year, and these changes clearly contributed to our increase in comparable store sales.
Also, big-ticket sales increased for the quarter, driven by both late summer and early fall seasonal product sales in such categories as outdoor power equipment and heating. Based on our experience that a cold, extended winter season, like we had earlier this year, can result in early fall buying, we delivered our heating and cold weather items earlier this year, and we experienced a solid sales response from our customers without any additional major promotions to our existing event calendar. There were a number of other achievements in the quarter, and let me highlight those. Our annual Pet Appreciation Week, our PAW event, as we call it, occurred in the third quarter again this year, and we again experienced a great response.
Just as a reminder for those of you who are not familiar with this is a week-long event that promotes pet adoption and pet health awareness. We partner with local pet adoption agencies and community groups to promote pet adoptions, and we offer exceptional values on pet products throughout all our stores. Year after year, the PAW event continues to position us as an authority for pet food and pet care. The opening of our new store support center on time and on budget was another highlight. The new building, which was designed to be LEED certified, consolidated our three previous store support center locations into one facility, bringing all of our dedicated team members into a single-campus setting. Separate from the new store support center, we also opened our new planogram facility, which we call our Merchandise Innovation Center, or MIC.
This now gives us the ability to review, analyze, and approve multiple planograms and floor sets in a full-size store environment before the proposed rollout to our stores. This will also prove to be a big time saver for our merchant and visual display teams. Turning to the fourth quarter. We plan to open our first Tractor Supply store in Utah, which will be the 49th state for Tractor Supply. We recently opened our first Tractor Supply store in the state of Washington, and we're excited about the opportunity to grow our market share in the Washington markets as we introduce Tractor Supply store as a format to our loyal Del's customers. Additionally, we continue to remain very pleased with the overall performance of all our new stores that are opening in the West.
In late 2015, we will open a new distribution center to support store growth in the West and the Southwest regions. While we have not announced the exact location yet, we are in the process of finalizing the agreements and acquiring the land for the new building, and we expect to be in a position to provide more information shortly. We also recently leased a second distribution facility in Hagerstown, Maryland, and we plan to be shipping products from this facility in early 2015. This new facility will support our continued plans for growth in the Northeast. Finally, in mid-November, we plan to open two HomeTown Pet stores near our store support center here in Brentwood, Tennessee.
HomeTown Pet is a new and unique pet supply store that will offer high-quality products and services in an inviting and welcoming atmosphere for a large variety of pets and animals, including dogs, cats, poultry, wild bird, horses and more. With our test and learn philosophy as a company, we believe these two stores will serve as great vehicles for us to improve our customer insights and product selections in the local markets we serve. As you know, pet has been a growing and important category for Tractor Supply for some time, and we think these stores will help us further develop our pet business. We have not determined our future expansion plans for this concept, but we'll apply the initial earnings back into our Tractor Supply stores to grow our sales. Tractor Supply sells products that people need and use every day.
Our goal is to sell these products at great prices, keep them in stock, and make it very easy for our customers to shop in our stores. Customers trust us to have what they need and when they need it. It doesn't matter if it's relatively cool in May or unusually warm in November. It's our job to anticipate these needs and to have the merchandise our customers want. Improved tools and analytics in areas such as price management, demand planning, and inventory allocation will help us meet our customers' needs, and we believe by doing so, this will benefit our sales and margin growth over the longer term. In closing, I'd like to thank all of our dedicated team members out there who work so hard to meet our customers' needs each and every day, whether it be in our stores, distribution centers, or at the store support center.
They delivered a strong third quarter, and we as a company continue to believe that the underlying trends and fundamentals of our business are solid. We all know that retailing is a challenging but exciting business that is always changing, and I believe we have the right people and tools in place to deliver long-term growth and shareholder value creation for many years to come. We appreciate your time today, and I'll now turn the call over to Tony for additional commentary on the third quarter financials and our full year outlook. Tony?
Thanks, Greg, good afternoon, everyone. For the quarter ended September 27, 2014, on a year-over-year basis, net sales increased 12.6% to $1.36 billion, net income grew by approximately 18.3% to $76.6 million, or $0.55 per diluted share. Comparable store sales increased 5.6% for the third quarter compared to last year's increase of 7.5%. Similar to last year, we experienced a late spring as ground moisture and mild temperatures extended the spring selling season, resulting in strong sales and favorable seasonal sell-through. The animal and pet categories continued to perform well with solid comps despite deflationary pressure. Seasonal categories such as gardening and live goods, outdoor recreation, fencing, riding lawn mowers, and repair all performed very well. Additionally, the third quarter sales benefited from early fall-winter purchases as the cooler weather later in the quarter served as a reminder of last year's harsh winter.
Comp transaction count increased for the 26th consecutive quarter, gaining 3.3% on top of a 6.7% increase last year. Comparable transactions were driven by continued strength of Consumable, Usable, and Edible products, and the strong performance of the seasonal categories. Average comp ticket increased 2.2% compared to last year's 0.8%. The increase was driven by the mix of goods and the strength of big-ticket sales, partially offset by deflation. A few key points about the quarter. We had a solid comp sales trend in July and August against a very tough sales comparison from last year, when we also had a similar late spring. Comp sales were relatively consistent throughout the quarter, with all three months having positive mid-single-digit comp sales. All regions performed well as both the North and the South benefited from the extended spring season, and the North, in particular, benefited from the early fall seasonal sales.
Big-ticket had a positive impact on the average ticket as the overall big-ticket comp was above chain average, and big-ticket transactions count remained consistent as a percent of the total sales. Strength in our seasonal categories such as outdoor power equipment drove the positive big-ticket comp sales increase despite the continued headwind in the safe category. Deflation was approximately 90 basis points. Last year's third quarter had approximately 100 basis points of inflation, a swing of 190 basis points. Turning now to gross margin, which declined 29 basis points. Our initial direct margin improved as a result of our initiatives around price management and strategic sourcing. Import purchases in the quarter increased 26.9% and represented 11.4% of the sales mix. Also, exclusive brand sales increased 13.2% compared to last year's Q3 and were approximately 30.7% of sales. Deflation was the most significant favorable factor impacting margin.
As we focus on maintaining margin dollars per unit, this typically will result in an improvement in gross margin rate in deflationary periods. Offsetting the benefits from deflation and our margin-enhancing initiatives was merchandise mix, which we estimate had a negative impact of approximately 12 basis points. The mix impact resulted from the strength in sales in live goods, power equipment, and the heating categories, which all have lower than chain average margin and had solid year-over-year increases. Freight increased approximately 23 basis points as we had higher transportation costs from the mix of merchandise in the quarter and the increase in stem miles to the new western store base. As Greg had mentioned, our promotional cadence was similar to last year and had only a slight negative impact on margin.
For the quarter, SG&A, including depreciation and amortization, was 25.2% of sales, an improvement of 84 basis points over the prior quarter. We were pleased with our expense control in the quarter, which, coupled with the strong comp sales, provided significant leverage. Incentive compensation had a favorable impact on the expense leverage and represented over a third of the leverage benefit. The prior year quarter had a substantial bonus accrual based on the strength of that quarter relative to the full year. Additionally, we saw employee medical and workers' comp expense moderate from Q2 levels and was more in line with our expectations. This leverage was achieved despite incurring the majority of our new store support center transition costs, which included lease write-offs for two properties. We estimate that this had a drag on the P&L of approximately $0.01.
Our effective income tax rate in Q3 was 37%, compared to 36.1% last year. The rate was consistent with our expectation. The year-over-year increase was due principally to the reduction in the federal WOTC tax credit. Turning to the balance sheet. At the end of Q3, we had cash balance of $48 million, compared to $46 million last year. We had an outstanding short-term debt of $150 million, compared to $40 million last year, as we had a higher fall seasonal inventory build at the end of the quarter and made significant purchases in our stock repurchase program during the quarter. During the third quarter, under our stock repurchase program, we acquired approximately 1,574,000 shares for a total of $97.4 million. We estimate that the share repurchase program did not have a material impact on EPS for the quarter.
Average inventory levels per store at quarter end were 3.7% higher than last year, while annualized inventory turns increased by nine basis points for the quarter. We are pleased with the productivity of inventory during the quarter, as the team did an excellent job allocating inventory to key categories and making sure we restocked for the extended spring season. Additionally, we brought several key fall/winter categories in early and are well prepared for the upcoming season. As a result of the prolonged spring season, we do not have significant markdown exposure as we move into the fourth quarter. Capital expenditures for the quarter were $43.3 million, compared to $58.2 million last year. We opened 30 stores this quarter, compared to 23 stores in the third quarter of 2013. The decrease in capital expenditure relates to cycling expenditures for the construction of our Southeast distribution center last year.
Turning to our outlook. Based upon the third quarter results, the company has increased its fiscal 2014 guidance from the low end of the previously provided ranges to the high end of the ranges, which were net sales of $5.62 billion-$5.7 billion, comparable store sales of 2.5%-4%, and net income of $2.54-$2.62 per diluted share. We have reduced our estimate for capital expenditures to range between $190 million-$200 million, as we have better visibility to the timing of some of our larger projects, such as the Southwest Distribution Center and our Northeast Distribution Center expansion project, and we do not anticipate any purchases of leased stores in the fourth quarter. Although some of these projects will move into 2015, we will not raise our target of $250 million of CapEx in 2015, which is consistent with our capital expenditure long-term plan.
New store pipeline is tracking to our full-year goal of 102 to 106 new stores. Based on the volume of our share repurchase year to date, we believe that our year-end cash balance will be about $25 million-$50 million, compared to our previously stated target of $100 million-$150 million. We are also adjusting our estimate for full-year diluted shares outstanding to approximately $139.5 million. In the fourth quarter, we now expect deflation to moderate down just slightly from the Q3 levels and range between 60 and 90 basis points. This would put deflation at the high end of our original full-year guidance of flat to 100 basis points. We expect gross margin to be down slightly in fourth quarter, as the fourth quarter is our toughest quarterly comparison due to the strong seasonal sell-through and minimal markdowns last year.
We expect to have continued freight and mix headwinds to offset some of the benefits of our key gross margin initiatives. We have been very disciplined in our management of SG&A expense in the back half of the year. We expect to leverage SG&A in the fourth quarter. We have begun to cycle some of the investments we made in the back half of last year, making the comparisons a little easier. We forecast that our effective tax rate for the full year will be approximately 37%, consistent with our previous guidance. Although I will provide full guidance at year-end conference call, consistent with our past practices, I wanted to highlight some of the larger capital projects and incremental expenses for 2015.
The construction of our Southwest distribution center and the related pre-opening expenses, expansion of the capabilities of our Northeast distribution facility by adding additional lease space close to the current facility in the first quarter of next year, the building of two to three mixing centers next year, system improvements in our omni-channel platform, enhanced IT security, and demand planning and forecasting tools. Higher transportation costs from additional stem miles resulting from our continued expansion in the West. Over the past two years, the company has invested in many initiatives to position itself for long-term growth. We have managed the business and related investment spending to absorb these costs in our financial model while delivering strong bottom-line growth.
Therefore, as we continue to invest in the long-term growth of the company, our goal is to execute these incremental investments, such as those I just mentioned, while managing the financial impact to enable us to deliver against our annual EPS target of mid-teens growth. To conclude, we are very pleased with our results and execution in the third quarter. We believe that we took advantage of the extended spring-summer selling season and are well-positioned to finish the year strong and deliver another solid growth year. This concludes our prepared remarks. Operator, we will now turn the call over for questions.
Thank you. If you'd like to ask a question, please signal by pressing *1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press *1 to ask a question, we'll pause for just a moment to assemble the queue. We'll take our first question from Peter Benedict with Robert W. Baird.
Hey, guys. Thanks for taking the question. Good job, thanks for the color on the call. That was helpful. First, Greg, for you, I know you said that the performance of the stores across the region is pretty consistent. That's obviously encouraging to hear. Can you dig down a little bit into that, though? There's some fear out there about ag-related markets. Can you talk about, to the degree that you guys look at that, how those specific markets perform? Are you seeing any kind of stress in those markets?
Hey, Peter. It's Greg. I'll give you a brief comment, let Lee comment as well. We are not seeing any real difference in the business in the upper Midwest and in the Midwest, where you just mentioned a lot of these "fears" of the ag business being difficult have occurred. Our business was very consistent across those regions as well as it was in the South, the North, and the West. No, we're not seeing any real impact. Lee, you have anything to say?
Peter, up in the Midwest, the issue you have there is that you're up in the North, you can imagine you got the most of the late spring season in that area, you also would have got a little more of the early winter season. That held that area up. I agree with Greg. I think we had a good even keel across all regions, including the Midwest.
Okay, thank you. Then, talk about new store productivity looked good again. Just curious, comment, I know you're pleased with what's going on so far in the West, but what kind of competitive response are you seeing from the competitors as you move into these markets? Anything worth calling out?
Peter, we haven't seen anything out West that would indicate that they're really reacting. Their prices have stayed where they are, and we're entering the market. People seem to like where we are, and we're enjoying the business.
Okay, great. Last one for Tony, just the decline in fuel costs or gas prices that we've seen here in recent months. Should we think of that as being a potential positive on the freight front going forward? Help us understand how that works through the P&L over the next few quarters. Thank you.
We definitely had a positive, but it was not significant relative to the total transportation expense. We're optimistic that go forward, that it will prove to be a tailwind, but at the same time, we are concerned that there will be some additional transportation costs that we're going to have to manage. For the most part, we believe that it can serve as a positive as we move forward.
Okay, fair enough. Thanks, guys.
Thanks, Peter.
We'll take our next question from David Magee with SunTrust.
Hey, guys, this is Linda in for David. Just in regards to the new stores out West, since they're a little bit larger, just how's the new store productivity performing out there? Is it in line with the company or a little bit higher?
This is Tony. Depending on how you measure the productivity, from a sales perspective, they are much stronger sales stores than the average stores, and we really like the volume that we get from the stores out West. The expense structure is a little bit heavier as well, net-net, from a
long-term return perspective, they are at or slightly above our normal approval rate.
What about on the per foot basis? Would you say it's the same thing?
Yeah. On a per foot basis, they are not significantly larger on a square foot basis, the incremental sales obviously makes them more productive.
Okay. How is e-commerce growing at the rate you'd expect right now?
I'll answer that. This is Greg. Our e-commerce business is very robust right now. It's still very small, and we have some more investment spending in the early part of 2015 to really get the platform where we'd like it, then we believe it'll really start to accelerate. It is running well ahead of the comps that the overall company is running, but it's still at a very small contribution rate. We like what we see. All the enhancements we've given that piece of the business so far are working. We just have a few more things to dial in, then I think by the early part of next year, we're going to start to see this thing really start to ramp.
Okay, just lastly, how would you guys prefer winter to play out? What would be the best scenario?
Well, I'll take that one. Certainly cooler weather early bodes well. You heard Greg talk a little bit about some early cool season weather impacting Q3. I will tell you, credit to the team. We talked about getting product in early. We made some strategic investments in inventory, and that's paid off for us. We'd like to see it stay cold, quite frankly. Heating is a good business for us. We sell outerwear and apparel. I would say the colder, the better.
Okay, great. Thank you.
Thank you.
We'll take our next question from Michael Lasser with UBS.
Good evening. Thanks a lot for taking my question. First, Tony, I wanted to follow up on a comment you made towards the end of your remarks about making investments while still maintaining the mid-teens earnings growth. This year, at the high end of the range, if you hit it, you're going to grow earnings maybe 13%. We could argue whether that's mid-teens or not. The suggestion would be that this year would be an aberration out of the mid-teens earnings growth, and even if you make a similar number of investments next year, we should expect a similar to better growth rate. Is that fair?
Well, yeah, I guess we could argue a little bit as to whether 13 was considered to be mid-teens. The comment represents that we know that we're a growth company. We know that to continue to grow, we need to make investments in the business. We believe that those investments have been included in our modeling. The last two years, we've talked about the last two years being investment years. We think that now that it's sort of embedded in our model go forward, that we can continue to grow the company in mid-teens and be able to continue to make those type of investments, to build out our infrastructure. There just always seems to be concerns that every year is going to be an investment year, and we need to shave something off our earnings.
We believe as we go forward, that it's already embedded in our modeling, and that we can deliver our long-term target. Having that been said, as in the past, we've always talked about growing the chain at 8%, having some comp sales increase, looking at 25 basis points of EBIT margin improvement. With the share repurchase, we think that we can get to the mid-teens level.
Okay. My follow-up is on the gross margin. You outlined freight was up 23, mix was up 12. That's 35 basis points. Your gross margin was down 28. You should have seen a little bit of a benefit from deflation. You've outlined all the factors that are margin drivers that you've continued to benefit from. Is there something else going on? I know Greg mentioned that promotions weren't really part of the picture this quarter, or at least throughout most of the quarter. Is there something else going on? Then as part of that, should we expect to see gross margin accelerate over time as you build out more distribution centers and you're going to, in turn, lower the number of step miles that you have?
That clearly is one objective that we have as far as using the distribution network. When it comes to the gross profit drivers, I try to highlight some of the larger impacts. When you look at all the variables involved in looking at gross profit, there's probably about 10 or 15 different levers. There's shrink. It was slightly up this period. There's special events that we have. There's vendor-funded programs that have impacts. The marketing and the benefits of the programs that we have in place may impact margin in certain ways. What we try to communicate relative to the marketing was that we did not have significant numbers of programs out there that we were trying to buy the sales. We feel it was a very normal year for us from a marketing standpoint.
When you look at some of the other factors, there were some other negatives that brought it down as an offset. The two that I mentioned between mix and freight, those are the largest drivers, and we believe that those go forward are the sort of the key headwinds that we're going to be facing. Obviously, with our initiatives to drive EBIT margin performance, either through gross margin or SG&A leverage, we want to try to deliver that 25 basis points of improvement each year.
Okay. That's helpful. Let me sneak one last in. Greg, there's a lot of discussion on the commodity price complex and grain prices and the potential impact it could have on your customer base. That's probably anyone's guess, and at least your performance would suggest that it's not having an impact. Does it have an impact on the way you run the business? Are you thinking about changing up the product mix if corn stays at $3-$4 a bushel for an extended period of time? Does that influence in any way the shape or manner in which you run the business? I'll turn it over from there. Thank you.
All right. Michael, I'm going to let Steve address this. I would tell you that it would not change the way that we run the mix of the business because we are a needs-based company. There are certain things our customers need. I think, Steve, why don't you give some highlights on that?
Yeah. I'll tell you, Michael. You can look at it being deflationary. Yeah, there may be some top-line headwinds. We're still continuing to see unit growth. The way I sit back and I look at it is there's a lot of folks have an opportunity now to get into animal ownership where they may have not done so before. Whether it be getting into bird feeding when it comes to a lot of bird products that we sell on the seed side. Whether it be herd size. We've seen a decline over time in herd size. You may see that come back. I don't necessarily see deflation in some of these commodities as a bad thing. If anything, it's putting money back into the pockets of folks that were spending a lot more on it.
I think there's two different ways to look at that, and I tend to look at it from that perspective.
As a reminder, please limit yourself to one question and one follow-up. We will take our next question from John Lawrence with Stephens.
Yeah. Good afternoon, guys.
Hey, John.
Hey, John.
Steve, just following on a mix issue. Can you talk a little bit about, you mentioned some of the positive surprises from the test or good sell-through on the left-hand side of the store. Can you tell us what really worked there and what you're excited about?
It's interesting, John. We talked a little bit about deflation and overcoming some of the top-line headwinds that might cause, and we experienced some of that in the last couple of quarters. The team did a really nice job looking out, working with our store operations partners. We updated the planograms. We did a number of resets. Not to get into too much specifics, but the departments where we have product in line, every single department had a positive comp store sales performance. I have not seen that in a long time with Tractor Supply Company. The team's really worked hard. We've worked with our vendor partners. We've switched out some product lines. I would tell you, I feel very good about the strength of that side of the business. We just need to keep the momentum going.
Great. Thanks. Just another, you mentioned a little bit more on the mixing centers for next year. Greg, can you comment a little bit more about the thought process on that and where we stand and what you're seeing out of that?
Yeah. The mixing center concept is really an attempt on our part to replenish the stores in a more rapid response methodology, I guess I would call it, on high bulk, high velocity, low-value product. It also takes some steps out of us moving the product the distance from the manufacturer all the way to the DC and back to the stores. Mixing center sits in between all of that and deals with full palletized, high velocity, high bulk products that we can push to the stores daily, every other day, once a week. It really depends upon the need.
It's to help cut down on stem miles at the same time, though, to be able to pull inventory back out of the store from the standpoint that we were putting a week or 10 days worth of supply in the back room of these types of products because we only had once or twice a week deliveries. The mixing centers will help us push that inventory to those stores as they're selling it. We think it'll speed our term. We think overall it'll bring our inventory levels down over time and again, keep us in better stock position. We've got two facilities that we will have operational in 2015. We are moving out of the back of the Waco DC with the one facility, and we'll be switching off with another facility that'll be a freestanding close to that distribution network.
We're excited about the idea of it, and we believe that it will serve us well. We tested the process in Waco over the last year. It worked. Now we're going to go into two freestanding units and see how that operates. If it works the way we think, we'll take it out to more.
Great. Congrats. Good luck in the fourth.
Thank you, John.
We'll take our next question from Chuck Cerankosky with Northcoast Research.
Good afternoon, everyone. Nice quarter.
Thank you, Chuck.
Tony, could you just repeat one number before I ask my question? You said what private label or corporate brands was as a % of sales.
Yes, I can give you that number. It was 30.7%.
All right. Thank you. It sounds like most categories did well. Is there anything you'd like to point out that was a little weak in terms of the merchandise categories and what kind of headwind were the safes this quarter?
Yeah. Overall, like the regional performances, we saw pretty consistent strength across the board on the merchandising side. I will say that we continue to face some headwinds when it comes to safes and storage. We saw that the last couple quarters. We continue to see that in Q3. We're doing a lot to offset that, but that's where I would say some of the softness was.
Okay. Any other retail R&D going on besides HomeTown Pet?
Well, Chuck, we're always trying and testing new ideas. I would say no, there's no other large-scale things in relative respect to what you heard from us about HomeTown Pet. Any given time, you'll be in our stores, and you'll see us testing 60-70 different ideas throughout the chain. That's just a testament or mentality that we have.
All right, thank you.
Thank you.
We'll take our next question from Chris Horvers with J.P. Morgan.
Thanks. Good evening.
Hi.
A couple questions. Can you talk about your thoughts on deflation next year, and how that might proceed throughout the year? You're starting to lap the deflation in the fourth quarter here. Obviously, corn prices are way down, any thoughts there would be very helpful.
Sure. Chris, this is Tony. When it comes to our estimates of deflation, we really do it sort of as a spot calculation and look as to where we are today and compare it to the upcoming quarters or the upcoming year. I would prefer to push that calculation out until we come through to our next conference call and give full year guidance. In general terms, we do expect to experience some form of deflation next year. As much as we do see some of the prices decreasing in some of the farm categories, we're hopeful that it will moderate somewhat over what we experienced this year.
Yeah, understood. I mean, the comparisons pretty much are straight lines over the next four quarters. There's been a lot of discussion and debate in the investment community around the correlation to farming income. I know you mentioned specifically that all regions comped in the mid-single-digit range, but can you talk about any evidence in either direction to support or refute that argument?
Chris, this is Greg. The only evidence I can give you is our performance. It is totally inconsistent with what has been stated out there, I think it's overplayed that farm income has a direct correlation to our business. We can't see it. We've been watching it for years. It has a slight, if any, impact. I think our third quarter performance kind of stands out as a factor that would say that it's not anything that is correlated to our business.
Okay. Understood. The last question is, the DC investments next year. Last year, you had a DC opening that caused some margin pressures. You have a couple things going on in the West and the Northeast. Any thoughts there in terms of maybe how these DC openings compare to the one that you did in 2013? Thanks.
Sure. Chris, Tony again. Last year was a little bit different because last year's distribution center in the Southeast was a relocation. We incurred probably more cost than opening up a new one because we had a team, we had to relocate, we had some exit costs on the lease. There was more transition costs required. Also, as we move into next year, that's why I didn't give specifics as to any numbers and what we're lapping this year versus next year. We obviously have the relocation of the store support center. As we move into the distribution center next year, what's different is we would expect to have a decrease in the stem miles and obviously have a benefit in transportation.
The only thing that would hold us back next year that would be incremental would be the pre-opening related to the distribution center. Other than that, once it's open and it gets to full capacity, the transportation benefits should offset the additional cost. We do expect to have some pre-opening related to that facility. Again, we believe that over the last two years, we have incorporated those type of expenses into our operating model and can continue to deliver our EPS target despite some of the additional infrastructure build that we'll have.
Thanks very much.
We'll take our next question from Scot Ciccarelli with RBC Capital Markets.
Hey, guys. Scot Ciccarelli. Another follow-up on the planograms and resets. Can you give us a specific example of some changes you've been made so we can better understand why customers had the positive reaction that they did? Could that lead to further resets in the store given the success of the initiative?
Yeah, absolutely. First of all, we're always looking to do different resets, adjusting and modifying our product assortments based on customer demand and trend. When you look at the left-hand side, I'll give you just one example. We were looking at the performance of cargo management. We've got an Intactix system, and we talk a lot about the systems that we use today and how the refining done. It suggested that our profitability per square foot wasn't real strong. We looked across at what opportunities we might see, and we saw an opportunity, for example, with our winch set. We reduced cargo management by four feet, added that four feet onto the winch program, and we've seen the numbers just exceed our expectations in a pretty significant way.
You could take that bit of learning right there and apply that across a lot of different areas.
We have done that on the left-hand side. In addition to that, I would tell you, we have done a better job refining our assortments both locally, like we've talked a lot about in the past, and then taken the inventory and reapplied it back to markets where we think that there's more investment, where there's more demand. Again, credit to the team, working collaboratively as an organization. We really pulled off some nice things, and it should give us a tailwind for another quarter or so.
That's very helpful. Just a follow-up. It's actually a balance sheet question. Your payables inventory were actually up a bit this quarter. I've always thought, given the leverage you guys should have with your vendors, given how big you are in your space, that's something that could continue to rise over time. I would think you'd be able to take a lot of working capital out over time. Anthony or Greg, can you just give us your perspective on that? Thanks a lot.
Sure, Scot. This is an area where we clearly would like to focus a little bit more. We believe that as we work with our vendors, that we look at the entire relationship. When we look at the type of terms that we're going to get as far as sort of finance inventory versus the cost of the goods, and the other programs that they work with us on, it's been an area where we believe that we come up with sort of the best working relationship with the vendors. Having said that, it's definitely, as we move forward, is an area that we will continue to focus on as far as driving that. Over the last couple of years, we have used our financing ability to provide anticipation for our vendors when they needed cash infusions. We've utilized that.
Generally, as we came out of the recession, that's one of the reasons why that number sort of had continued to drop down, but as business has improved, obviously it's an area that we will take a hard look at.
Got it. Thanks a lot, guys.
Thank you.
We'll take our next question from Matthew Fassler with Goldman Sachs.
Hi, guys. This is actually Chandni Luthra on behalf of Matthew Fassler. Congratulations on the quarter. I just have a couple of questions. Could you please contextualize the cost or CapEx implications for the new DC next year?
We have, as far as the capital around the DC, is that the question?
We've targeted about $70 million-$75 million for the facility. It will be a little bit larger than some of our other facilities, obviously, due to the span and the number of stores that we anticipate that it will serve.
Perfect. You guys talked about strengths that you saw in big-ticket items. Could you please frame this trend versus what it has been in the last five years? Is this a particularly standout period, or was this cyclically driven, and do you think this is sustainable going forward?
Yeah. As far as the big-ticket items, what we've seen over the past couple years is that our customer is really need-based. It has been very difficult for us to read relative to the big ticket. For example, included in our big ticket is gun safes. Last year or the last two years, there's been significant activity around that. There are some cyclical business, like our riding lawnmower business. That's been somewhat stagnant or down over the last seven years, but we've seen some fairly positive activity this year. It's very difficult to judge whether it's cyclical or it's just sort of need-based, or if it's economy-based and people are just feeling a little bit better and feel that they have the opportunity to go out and spend on some of the larger items.
At this point in time, we're still not willing to commit that big ticket is back, that people are willing to spend right now. It is something that we're watching, and we did like what we saw as we moved through the quarter and in some of the larger ticket sales, like riding lawnmowers, some of the power equipment, heating, and items like log splitters.
Got it. Thank you. One final quick question. I know this has been talked about already, but if you could just contextualize the implications of the recent commodity price declines for inflation or deflation going forward and in terms of its margins, and what would it do so where do you see the impact from this current commodity price action on a go-forward basis?
Right. Chandni, we had talked about it just recently on another question. We tend to really try to wait and do it more on a quarter-by-quarter basis because the prices do tend to move. I prefer to provide more specific guidance until we give our full-year guidance on the January conference call. Generally speaking, we believe that there will be some deflation next year. We expect it to hopefully moderate from what we saw this year, which was approximately 90 to 100 basis points of impact. When we do have deflation, it obviously hurts the top line, but at the same time, it generally will benefit gross margin rate. We can have a little pickup there. Again, it is our position as a management team that we are expected to manage deflation and inflation as we continue to manage the business sales and margin.
Perfect. Thank you.
Thank you.
We'll take our next question from Simeon Gutman with Morgan Stanley.
Thanks. Good results. You mentioned, Greg, last quarter that you'd be less promotional in the third quarter, and it sounds like the business stayed true to that. Last quarter, traffic was not as good, and I think some of the promos were to get people in or spend a little more. This quarter, the traffic seemed better. The weather was more seasonal. I don't know. Is there any second thoughts on whether putting promos onto better traffic environments would have even gotten a better result? I have a follow-up for Tony.
All right. I would tell you, Simeon, that our customers are need-based, and we're a destination store. We knew that as the weather would improve, and it always does, it's just a matter of timing. We had the tale of two stories here in the third quarter. You had a continuation of spring, summer, which we were able to chase, and the merchants did a wonderful job of pulling product into that and feed that trend. At the same time, in the northern part of the country, we started seeing a really strong reaction to the early selling and heating and other fall-type products, as Tony has mentioned. When you start seeing those two collide, there's no reason to step up the promotional base. As a matter of fact, we only run 15, 16 rotations a year. We like that strategy.
We don't want to get caught up in a strategy longer term of saying it's got to be a coupon to buy something at Tractor, or I got to wait till the next ad or so on and so forth. That's what a lot of the people we compete with do. That's just not our business model. No, I don't think we would have driven any more business, really, to any great extent by layering on more promotion.
You mentioned you avoided doing any major promotions, and I think it sounds like also the lesson learned from last quarter. Is that something that we're not going to see repeated, whether it's a few quarters down the road or a couple of years down the road? Is that fair?
I think that's fair, I would also tell you that if we were starting to see foot traffic slow, that'd be a different story. We continue to see good, solid foot traffic, and that's an indicator for us that we've still got customers coming through the front doors. As long as that stays solid, we're going to stick with our plans.
Okay. Then my follow-up on the guidance for comp, and not to get too cute with the guidance, but I think the implied for the year backs you into the fourth quarter anywhere between slightly positive to somewhere 6, so maybe a midpoint of 3. I think that's just the plain math. The lower end of that would seem overly conservative for you based on history. Is there a purpose behind keeping it that wide ex the weather, or is that just simple conservatism?
When we set the guidance, it is sort of difficult. One area where we have the three different sales, comp sales, and the earnings. On a full-year basis, the comp guidance is a little bit wide. We just felt that we didn't want to try to narrow it specifically. We assume that you all will sort of work off of what you think the reasonable comp is, given the context around the directions that we've given you for the fourth quarter and sort of come up with a reasonable comp. We did state that we believe that the comp will be at the higher end of the range. That, in our mind, sort of puts you somewhere between the 3.3 and 3.8 for the full year. Somewhere in that area, and then obviously whatever the math works out to get into that range.
We don't think that it's relatively conservative, and I don't believe if you do the math, you come out to a 3 for the quarter.
No, that's helpful. One more to sneak in back for Greg. I know you mentioned the hometown stores, and it sounds like you don't want to answer a whole lot of questions on them, but I'll try one.
That's okay.
Franklin and Fairview.
Yeah.
Franklin and Fairview, we can look at the demographics from using the internet here. Anything specific about those towns to tell you about, at least geographically, what you're thinking about with strategy? Is it going to be more of a rural concept the way that Tractor is, or are you thinking more suburban?
Well, you're correct on the location selection. It was done purposely. The Franklin location sits equidistant between two Tractor stores that sit in rural environments, maybe a little bit more on the edge of suburbia. The unit that sits out in Fairview sits literally a quarter mile away in the rural environment from a current Tractor. This is going to give us a pretty good read of the type of customers that we'll attract to this store format.
Okay, thanks. Good luck.
Thank you.
Again, please limit yourself to one question and one follow-up. We'll take our next question from Gary Balter with Credit Suisse.
Hi, this is Gary. I'll ask only one question, unlike Simeon and everybody else who's asked three. First of all, congratulations on a great quarter. That doesn't count as a question.
Thanks, Gary.
The question is, if you look back over the last few years, Q, and specifically some of the feed categories have been by far your strongest areas that you've been growing significantly in that area, including hay. What are you seeing competitively, like whether it's Rural King or Orscheln or Mills, are any of these companies starting to expand their feed offerings to try to compete more directly with you? What have you seen in that regard? Thank you.
Yeah. This is Steve. They're all formidable competitors. They do a very nice job with their assortments. They recognize there's need in the marketplace. As Greg mentioned, we'll be in 49 states here shortly. We continue to see momentum in C.U.E.. We're growing our units. We think we're picking up share. We talk a lot about independence as well, and where we're picking up some of that share. I would tell you in general, I think we're out in front of the marketplace. I think we're continuing to grow and expand what we're doing in this area. Really the focus for us in C.U.E. is three key things. We're constantly looking at refining our assortments. Two, we're making strategic investments, so we're better in stock, and we're a better dependable supplier of basic maintenance needs.
three, we've done a really nice job using our price optimization system, so we're right and we're priced locally, making sure that we're taking care of those customers. We think that there's continued growth here using those three tactics.
Do we see the other more direct competitors change their mix at all to try to do what you're doing with your stream?
I would tell you there's a lot of folks out there that are doing a lot of different things, we try to stay focused on what we're doing rather than chasing a lot of the competitors. I would tell you that by copying, if that's the case, that's the way they want to go, that's a fine form of flattery. We're continuing to pick up share, we're going to stay true to what we're focused on.
That's great. Thank you very much.
Thank you, Gary.
We'll take our next question from Alan Rifkin with Barclays.
Thank you very much. Greg, with respect to the two HomeTown Pet stores, can you just give a little bit more color on the impetus for testing those concepts now? More importantly, what does that speak to your conviction level of your core concept as well as the smaller format? Thank you.
I'll only give you this, Alan, that we have a very robust pet business in general in the company. We believe that we can do more pet business, but we don't want to distort the interior of the Tractor Supply format because it's many stores inside a store. That format works well. It continues to perform well. Our thought process was, if we believe we're owed more pet business, how would we go about maybe achieving that? How do we understand how to still grow the pet business inside of Tractor? Are there pieces and parts that maybe we're missing that we don't understand? That was the impetus of putting these two test concepts out there.
Okay. Do you still believe that you can have the same number, 22, 2,300 of the core concept?
Absolutely. Without question.
One correction there.
Thank you.
We're still at 2,100 right now, we're very confident in that number, we'll obviously continue to look at sites up over and above that. Right now we feel that 2,100, we're very confident with that number.
We'll take our next question from Seth Basham with Wedbush Securities.
Nice quarter, guys.
Great.
Thank you.
My first question is just around your customers. You guys have pretty good information on your customers now. You bucket them in a few different categories. Do you have any sense of how they've been reacting to the various macro and farm income forces over the last few quarters? Has there been any difference in trends?
I'll try to answer that. What I can tell you is this. They continue to buy the way they've been buying for the last three to four years. They're credit-averse. They're paying with cash and with debit about the same rate as they have been. They continue to repair and not replace, although we did see a little bit of movement this year because of the elongated spring-summer season and just some big-ticket transactions that I would say were new units in outdoor power equipment. No, they're very consistent, and that's what we like about this customer base. They're fairly predictable. They have not shown us any indication that they want to take on any type of short-term debt to do something out of the ordinary. No, very consistent performance, very consistent behavior.
Got you. No major differences in rate of sales contribution from the hobby farmers or production farmers or lifestylers or anything like that?
No.
Got it. Okay, my follow-up is just around thinking about the fourth quarter. Given the terrible weather trends in September particular, you had good cold weather gear-oriented sales. Do you feel like you may have pulled forward some sales from the fourth quarter?
Yeah, I'll answer that question. At this point, we don't anticipate that. Like I mentioned, we do like cold weather, while October temperatures are what they are, November and December are very important months for us.
Very good. Thank you very much.
We'll take our next question from Denise Chai with Bank of America Merrill Lynch.
Okay. Thank you very much. Congratulations on a great quarter.
Thank you, Denise.
You said that southern regions were comping mid-single digit, I think that going into the quarter, you had expected that in the Northeast and Upper Midwest, the delayed onset of summer would lead to some demand destruction because of the very short gardening season. Looking at categories in those markets, did you actually see that?
I would tell you up north, we talked about the extended season, our ag products performance, lawn and garden, everything did pretty well. That is comping the prior year where we had a very strong Q3. Year-over-year, we saw nice, consistent growth.
Thanks. In terms of SG&A leverage, you said that, which was much better than we had expected. You said that about a third of that was coming from incentive comp. Was the rest from just the higher comp, or were there some other factors?
Yeah. Denise, this is Tony. As we moved into the back half of the year coming off Q2, we were very focused on managing the SG&A. We believe that we were aggressive when it came to the expense control, and that combined with the strong comp sales really gave us that significant leverage. The one key thing that I had mentioned on the prepared remarks was that in Q2, medical and workers' comp were very high, and they moderated. That gave us some additional leverage as well.
Okay. Got it. Thanks. Just lastly, to kind of go back to this nearly dead horse. Actually, how much have feed costs declined? We've talked about deflation in very broad terms in terms of your total comp, but how much has feed gone down? I'm just wondering, for the person who's got a couple of horses, what are they saving? It just doesn't seem to square with the strength in big ticket, for example, in small agricultural equipment like mowers that you were talking about.
Just to give you an indication, we always use corn as sort of the main factor as the component in the feed category. Year-over-year, it was around $4.50 last year. We're down to a little bit below $3.50 this year. You can see that there was a significant impact on a year-over-year basis. Directionally, that should give you an idea of the impact.
Okay. All right. Thank you very much.
We'll take our next question from Mark Miller with William Blair.
Hi. Good afternoon or good evening at this point. I appreciate the call-out that the weather helped the business, not just talking about when it's negative. Is there a way to estimate what that benefit was in the period as grow light conditions fell further year-on-year? I think, Tony, your guidance for 4Q looks like about a 4 comp. Would that be sort of taking an ex weather benefit run rate of around 4 in the third quarter and continuing it on, or was the weather impact bigger than that?
Mark, it's definitely difficult to make that assessment. We do look at some of the spring categories, what the lift was overall. The other complexity when you get into some of the cold winter products, selling log splitters in August seems to be counterintuitive. Between the extended and the winter, I would say it would be an injustice to try to quantify exactly what the weather impact was. As we move forward, we look at the weather as having a nice, cold, wintry December, but we believe there's opportunities last year, it was a cold, wintry December. This year, as we move forward, we believe there's some opportunity in October and November with a potentially cooler October, November.
Generally, as we move into the fourth quarter, we are optimistic that people will recant last year's harsh winter and get out and do a little shopping earlier in the quarter.
Okay. Then can you just share with us your updated thoughts for store growth a little bit longer term? You did mention the 8% footage or store growth. I thought there was some consideration being given to potentially going to a constant number of openings per store. Is that something you're reflecting on, or do you think you can continue to drive the 8% over a number of years?
Yeah. Currently, our position is the 8% growth. We will take a look at that growth on an annual basis and make determination as to what we believe is the most beneficial for the company and for the shareholder. We'll take a look at that as we sort of cycle into the new year. Potentially we can address that as we move into the Analyst Day.
Okay. Thanks a lot.
Thank you.
We'll take our next question from Brian Nagel with Oppenheimer.
Hi, good evening. Congrats on a very nice quarter.
Thank you.
I just have a couple quick questions here since we're towards the end of the queue. First, on the SG&A expense, Tony, you spoke about this a bit in your prepared remarks, but we saw a nice leverage or actually, I guess, reduced SG&A growth here in the quarter. If you look at that 80 basis points on leverage, how much of that you think reflected more or less one time or one-time benefits here that we should probably not expect as we go into Q4 or even into 2015?
The first thing that I would generally carve out, and it's a little bit difficult to predict, is really the incentive compensation. Right off the bat, I'd say carve out the one-third and then look at the comp and the comp increase. When we look at our leverage points, depending on the quarter, it can range from usually about 3% to even potentially 4%. That could be an indication that as we get above 3% on a comp, you're going to start to see some more leverage. The main driver will be the sales comp.
We will be able to manage some of the expenses, and I think we've done a good job in the back half, but again, being a growth company, we will continue to grow the SG&A, and our goal is to do it at a lesser amount than we grow our sales base.
That's very helpful. The follow-up question, again, which is a quick one, and I apologize if you already addressed this, but you've taken your CapEx guidance down, and there hasn't been any real adjustment to store openings. What's the reason behind that?
Yeah, I had stated in the prepared remarks some of the larger initiatives that now we have a little bit more visibility on have been pushed out during the course of the year. Specifically, the Southwest Distribution Center, we expected to have some capital expenditures this year, and we do project to still have a few in the fourth quarter, in particular, some land purchase. We also expected to have additional lease space for our Northeast Facility. We have identified some space very close to our current distribution center in Hagerstown, and we expected some additional expense related to that and some capital as well. Those projects got pushed back. We usually maintain some CapEx dollars for the potential purchase of some of our leased stores, in acquiring those properties. We do not anticipate doing any this year in actuality. That was a significant savings.
What I would reiterate, and I think that is important as we move forward into next year, we have set a goal that we do not want to exceed CapEx of $250 million a year. Even with a portion of these projects being pushed into 2015, we will still maintain our CapEx at no higher than $250 million for 2015.
Thank you very much. Congrats again.
Thank you.
Thank you.
We'll take our next question from Daniel Wewer with Raymond James.
Greg, just a quick question about HomeTown Pet. If the two test stores do prove to be successful
Yeah
would it ideally become a new growth platform for Tractor Supply? Or is it to convince some of the channel-exclusive brands that currently are not selling to Tractor, that you could responsibly and effectively carry those brands in your full line stores and therefore not need to roll out Hometown Pet?
As I stated before, Dan, Hometown is a test of two stores. You hit on it that there's gonna be some mix of products in those stores that we currently do not carry in Tractor. We've got some learning here between these two locations. I think that's about as much as I'm willing to tell you at this point. We haven't got the first store open yet. That's gonna be in a couple of weeks, and there'll be more to talk about sometime in the other part of next year, I think.
Okay, great. Thank you.
We'll take our next question from Adam Sindler with Deutsche Bank.
Yes. Hi, good afternoon, guys. I will add my congratulations as well.
Thank you.
I was wondering if we could talk a little bit more about the mixing centers. I think this is a very important development, especially given the growth in C.U.E. If you could maybe tell us just a little bit more, the size of these things, the CapEx requirements relative to a DC, how quickly you can get them open. Then how that might change your views on growing the distribution capacity and network going forward.
Well, Adam, I'll give you what I'm comfortable to tell you. How about that?
Oh, great.
That is that this is not going to displace distribution centers, but what it actually does is it allows us to improve our ability to service stores and also to take some pressure off the supply chain. We'll have two operations opening in the South next spring. Average CapEx is about $8 million. We like to look at these as lease facilities first and build or purchase facilities second. They're anywhere between 50,000-70,000 sq ft. Think of it as an elongated H. A lot of doors on both sides where product comes in one side is quickly moved and sorted and pushed across into trucks on the other side of the building. This is kind of a rapid response methodology in a way. What will it do long term? Long term, it helps us move high velocity, high bulk, low-value product more cost effectively.
That's the bottom line. That's what we're trying to do.
Okay. Given just lease first, build second, if you saw these two really help drive productivity, how quickly would you be able to ramp this going forward?
Great question. I don't have a direct answer for you on that. We've already got some target markets where we believe if this works well, we would go, but we have not worked on any additional leases or properties at this point.
All right, great. Thank you so much.
We'll take our next question from Aram Rubinson with Wolfe Research.
Hi, guys. This is Cody Ross filling in for Aram. A quick question, I'll make it brief. You had previously called out that localization of products is a big focus, especially out West, where the stores are farther apart. Can you just provide an update on that front? Thank you.
Yeah, absolutely. This is Steve. We're making great strides out there. I would tell you that the stores out in Arizona, New Mexico, Colorado, Nevada have different assortments than what you're gonna find out East. Even the store in Utah that we're gonna open will be carrying beekeeping supplies. Yeah, you heard me right. That is beekeeping supplies. We went out there, we researched the market, we saw it in a lot of our competitors and thought, "You know what? We better put our best foot forward out there when we move out there." You're going to see a lot of localized products. We're continuing to refine what we're doing. We have ongoing conference calls with our store operators out there because they're really leading us down the path of what those customers are asking for. We're tweaking our assortments as we move forward.
That was in Utah, you said you'll have the beekeeping supply?
Yeah. That's accurate.
Okay.
What's interesting about that is you pick up, you learn little things here and there, then you find over time that there may be more opportunities in other existing stores. Again, these are all test and learn type formats and product categories, and we'll see how they do.
Great. Thank you very much.
We'll take our next question from Joe Feldman with Telsey Advisory Group.
Hi, guys. Thanks for taking the question and congratulations on the quarter. I wanted to ask, I know it's still very small, but, like, with online purchases, are you seeing any different behavior? Like, are what people buying online, is it different? Is it, like, skew towards more consumable or more big ticket or anything? Are you also seeing more pickup in store or desire to pick up in store than just a delivery? Just curious, just initial learnings that you're finding.
This is Greg. What we're finding is that our customers are looking for products either in what I would consider to be not standard in a typical Tractor, in other words, a long tail aspect of SKUs that maybe we don't carry in Tractor but are available online, and a category of product that we have to keep more narrow because of the store. We've only got X amount of space. We're seeing people do that. I'll give you an example in the business with portable buildings. We have an assortment inside the store for that, but online, we have this elongated, broad, long tail, and they're buying out of the long tail, larger buildings, different sized buildings, custom buildings and so on. That's what we're seeing a lot on our online business.
There are some customers that are buying some dog food products that we sell in the stores. I'm not going to tell you they're not. They're doing it for convenience. It's primarily the things that would be out of a long tail that you wouldn't find in our store.
Got it. That's helpful. Thanks. One more, and I apologize if I missed it before. Did you guys address? We always ask about where you might stand with an affinity type of program. I know you've been testing some different things. Just wanted to get an update there.
Yeah, I'll go ahead and take that. This is Steve Barbarick. We brought on a director of customer marketing earlier this year because we felt like we needed to add to our expertise. He's come in, he's done a lot of very interesting things. He's targeted email and made us more relevant. We're getting better click-through rates and page opening rates. When it comes to affinity, we've had a number of cross-functional meetings. We're right now in the process of building some business requirements for it. You won't see anything as far as a pilot until the very back half of 2015, and even then it'll be just a test.
Got it. That's helpful. Thanks, and good luck with this fourth quarter.
Thank you.
We'll take our next question from Mark Montagna with Avondale Partners.
Hi. Question about planograms. Based on one of your answers during Q&A, it sounds like you have one more quarter of a big benefit from the planogram resets. I just want to make sure that's accurate. If that's true, have you cycled through the entire square footage of the store, but with the new planogram center, I would assume it's fair to assume you can take that to another higher meaningful level of effectiveness. I just want to make sure I'm interpreting that all correct.
Yeah, for the most part, you are. I may have misspoken when I just said one quarter, and I don't want to overbuild it. I would say that we had a very solid Q3. We saw performance we hadn't seen in the past. You would anticipate that to continue forward, but again, things can change, customer habits can change. I feel very good about the progress we've made on that side of the store. The new planogram center will allow us to be more effective in what we're looking at. I would tell you we're constantly in a test and learn mode, and that's where I'll leave it.
Okay. Thank you.
We'll take our next question from Matt Nemer with Wells Fargo Securities.
Good afternoon. I've just got one follow-up question, which is distribution related. Is there a way to quantify the impact of sort of an ideal distribution network when you roll out the new facility in the Southwest and the West, and the expansion in the Northeast? Obviously, there's a trade-off between CapEx and the P&L, but do you think that the benefit to gross margin is in the tens of basis points or on lower stem miles or potentially a lot better than that?
Yeah. When we look at it, we look at the distribution network or a distribution center as we build them at full capacity. The cost of the buildings will net against the transportation costs. We look at them generally as neutral, depending on when we eventually push to two to three shifts, we do expect some benefit that would outweigh the cost. From a modeling perspective, I would tend to show the increase in SG&A with a comparable offset in gross margin transportation.
Okay, I guess just as a follow-up to that, after you have these new facilities that you've discussed up and running, what's your total capacity in terms of the number of units you can serve, post these new facilities?
Relative to the distribution centers, our long-term plan is obviously 2015 to do a facility in the Southwest. We target about two years after that, looking at the Northwest. Then eventually, depending on the added capacity from the additional leased space in the Northeast, we'll eventually be looking at the Northeast as well. Once we're there, we would expect that we would be able to exceed the 2,100 that we currently have. We anticipate that from a distribution center capacity, we would be able to exceed that number as well as have some additional capacity through the mixing center network as well.
Okay, great. Thanks so much.
We'll take our final question from Brent Rystrom from Feltl & Company.
Thank you, and good morning. Quick couple of thoughts for you. I was thinking about all the questions on the farm economy. As an observation of somebody who is a farmer and lives in the Midwest, the 2012 crop, which was the drought crop that became so valuable, was worth about $64 billion, the corn crop. From a simplistic perspective, as production rebounded in 2013, the realized value of that crop was about $54 billion. When you look at the futures curve right now, and you look at the projections for yields, it looks like the current crop is valued at about $53 billion. It would seem to me that if there is indeed a risk or an impact from a slowing farm economy, it would've hit you on the $64 billion-$54 billion drop, not the $54 billion-$53 billion. Does that make sense?
It definitely makes sense. Again, we don't believe that there's that direct correlation.
I understand that.
I can appreciate.
I understand that, but everybody seems to be fixated on this from a simplistic perspective.
Right. It would've already come, is what you're saying. Right.
Yes.
Yeah.
If it even is an impact, wouldn't it imply the impact was in the second half of 2013 and the first half of 2014, when those prices that dropped was realized at that point, which coincidentally coincided with some very poor comps for you guys?
Yes. We agree with you.
Whether related or not, it happened already.
Right.
Right now, it doesn't look like there's pricing in any significant change. The current crop, which started getting harvested right now, compared to last year's. I just want to say that seems reasonable, right?
Yes.
All right. I was at the Pellet Fuels Institute Conference in Miami earlier this month. There were dozens of small retailers from New England and the Midwest there, and all of them saying that they're having a very difficult time finding wood pellets for this season. You guys were cited as a reason, which I view as a positive for you, in that as you guys grow your business in the wood pellet business, and as a couple of your other big box competitors do as well, it's getting more difficult for these smaller players to buy wood pellets, particularly as the export market for wood pellets heats up. You guys appear to be really well-positioned for this. I'm just sensing this could be a very big opportunity this fall in the wood pellet business for you guys seasonally. Would you care to comment on that?
Yeah. This is Steve. I would tell you that heating is a big business for us. We did make some strategic investments across all lines of heating, and I think we're well-positioned as we go into November, December.
Thanks, guys.
Thank you, Brent.
It appears there are no further questions at this time. Ms. Skold, I would like to turn the conference back to you for additional or closing remarks.
This is Greg. Let me just close by saying thank you all for your interest and support of Tractor Supply. We look forward to speaking to all of you again on our fourth quarter performance in January of 2015, and this will end the call.
This now concludes the presentation. Thank you for your participation.