Good afternoon, ladies and gentlemen, welcome to the Tractor Supply Company's conference call to discuss first quarter 2013 results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If anyone should require assistance during the conference, please press the star and zero on your touch-tone phone. Please be advised that reproduction of this call in whole or in part is not permitted without prior written authorization of Tractor Supply Company. As a reminder, ladies and gentlemen, this conference is being recorded. I would now like to introduce your host for today's conference, Ms. Jennifer Milian of FTI Consulting. Please go ahead, Jen.
Thank you, operator. Good afternoon, everyone, thank you for joining us. Before we begin, let me take a moment to reference the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. This conference 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 that 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's 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 the statements will remain operative at a later time. Lastly, Tractor Supply Company undertakes no obligation to update any information discussed in this call. Now, I'm pleased to introduce Greg Sandfort, President and Chief Executive Officer. Greg, please go ahead.
Thank you, Jen, good afternoon, everyone. Thank you for joining us on today's call. With me today is Tony Crudele, our Chief Financial Officer. We are pleased with our first-quarter performance, given the variables we faced during the quarter. Our Q1 performance demonstrates the continued underlying strength of our core business and our ability to adapt to challenging weather conditions. As we have said in the past, it is important to assess our performance by the halves and not by the quarters. While we now expect a slower ramp into spring, we believe we are well-positioned to take full advantage of the selling season ahead.
Tractor Supply remains committed to our strategic initiatives. We are making positive strides in the areas of new exclusive brand offerings, expansion of our regional assortments, and further supply chain capability, all of which are contributing to our capture of market share, sales growth, and longer-term profitability. On our last call, we discussed that the first quarter of 2012 benefited greatly from the early spring weather, and as we had anticipated, weather was not as favorable in the first quarter of 2013. We planned conservatively for the first quarter. We were delighted with the team's ability to deliver positive comparable store sales despite the extended winter selling season. While specific big-ticket products within our seasonal categories, such as riding lawn mowers, were negatively impacted by the colder weather, we experienced very strong sell-through of winter product and winter-related CUE items.
Most importantly, we ended the first quarter well-positioned with current, high-quality forward inventory to support our spring business. Now let me discuss in more detail some particulars regarding our first-quarter results. In terms of specific sales drivers, CUE categories, the consumable, usable, and edible part of our business remained very strong. Pet food and animal feed experienced unit sales growth versus a year ago, and more importantly, drove increased foot traffic to our stores. Another area of focus is our drive-on merchandising, which has proven to increase the basket size and enhance the treasure hunt experience for our customers. One such example is our Dollar Day event, which provides great values on everyday commodities, and another is our poultry event, labeled Chick Days, that drives sales of live birds and the necessary items you would need to raise poultry.
Both events performed above last year results. These type of in-store events provide Tractor Supply with a great opportunity to grow sales in our center court space while enhancing our relevance in the eyes of our customers. Our focus on providing newness with product innovation across the store has kept our assortments fresh and our customers highly engaged with our brand. In this regard, we continue to see growth within our exclusive brands through brand extensions and new product introductions. During the first quarter, exclusive brands accounted for roughly 30% of our mix of sales. Exclusive brands enable TSC to differentiate our products from that of our competition in both the offline and online channels and remains another important area for improving our profitability and customer loyalty.
During the quarter, we expanded our 4health exclusive dog food brand by adding new SKUs in grain-free formulas, and we're very pleased with the initial reception by our customers' purchase of the product. CUE remains a solid foundational piece of our key sales-driving strategies, and we are pleased that we are experiencing market share growth here. Through our growth in sales, it is clear that our customers choose Tractor Supply as their most dependable supplier of these need-based products. Another great example of our commitment to providing product newness is our live goods category, which we started testing about three years ago in select stores. Our spring live goods program is now in approximately 500 stores, and we are very optimistic about the sales potential for the company. Already in our southern regions, we've experienced solid sell-through on many of the early receipts of vegetables, herbs, and fruit-bearing trees.
I'm delighted with our team's ability to manage through a wide array of variables. The diligent work of our teams to adjust merchandise offerings and flow of inventory to meet customer demand in Q1 was exceptional, and this resulted in comparable store sales growth against very difficult comparisons from the prior year. I'll now turn the call over to Tony to review our financial results and discuss our outlook for the remainder of 2013. I'll return following his remarks to share my closing comments.
Thanks, Greg, and good afternoon, everyone. For the quarter ended March 30th, 2013, on a year-over-year basis, net sales increased 6.4% to $1.09 billion, and net income grew by approximately 9% to $44 million, or $0.62 per diluted share. As Greg discussed, we prepared for weather that would not be as favorable as we experienced in the first quarter of last year, where we benefited meaningfully from early spring weather in March. As a reminder, we had estimated that approximately $38 million in sales, which translates to approximately $0.10 impact on EPS, was pulled forward into Q1 from Q2 last year as a result of the early spring. We planned for this shift accordingly and managed through to deliver another solid performance in the first quarter. We tracked well to our internal plan, although it was really a tale of two seasons.
The winter season was very strong in the first quarter and exceeded our expectations as the cold weather drove solid sales performance and clearance of winter product. This resulted in a solid mid-single-digit comp gain through February. As we head into March, the colder-than-average temperatures resulted in softer sales than anticipated. Temperatures in our markets were 13 degrees colder than last year on average and almost four degrees colder than historical averages. Some days were actually colder by as much as 50 degrees compared to last year's warm spring weather. This dampened sales of big-ticket riding lawn mowers as well as higher-margin spring seasonal categories and resulted in very difficult comparisons to last year.
Although the second quarter has gotten off to a colder-than-expected start, we have seen that our consumer respond as the weather's warmed to more typical spring conditions, and we are hopeful that this will result in a strong spring selling season. Also, as we head into May, we begin to see softer sales comparisons to last year. As Greg stated earlier, we believe it is more appropriate to look at our performance by the halves rather than the quarters, and we believe that this year's spring variation relative to last year will be reallocated between the first two quarters. Comp store sales increased 0.5% for the first quarter compared to last year's very strong increase of 11.5%. Comp transaction count increased for the twentieth consecutive quarter, gaining 2.2% on top of a 4% increase last year.
We remain very pleased with our core business, as CUE products continue to serve our customers' basic and functional needs and drive transaction count increases. Specifically, pet food and animal feed were particularly strong and delivered comp increases in dollars and units across the chain, driven in part by the extended winter season. Average comp ticket decreased by 1.7% versus last year's strong 7.1% increase. We estimate that the softness in riding lawn mower sales had a negative 220 basis points impact on average ticket, resulting from the shift in spring weather just discussed. Average ticket was also impacted by the increase in CUE transactions, which generally carry a lower average ticket than the chain average. This was partially offset by inflation, which we estimate was approximately 140 basis points and within our projected range of 100-200 basis points, but significantly less than last year's 400 basis points benefit.
On a regional basis, the Western region performed the best, and comps were positive in all regions except the Midwest, where our winter seasonal goods did not offset the soft spring sales. Turning now to gross margin, which as a percent of sales decreased by 19 basis points to 32.4%. This was consistent with our outlook, as we anticipated that gross margin would be flat to slightly down in the first half of the year. Mix had the most significant impact on margin, which we estimate at approximately 53 basis points. This was primarily related to CUE, which, as we mentioned, performed exceptionally well in the first quarter and made up a larger percentage of the first quarter sales compared to the prior year. Q1 generally has the largest mix of CUE sales, and this was further exaggerated with the cold weather trends in the quarter.
We continue to manage gross margin dollars per unit, and again, we increased margin dollars per unit in key CUE categories this quarter. Strong sales of heating-related products, which carry margins below the chain average, also negatively impact gross margin in Q1. We did receive a slight benefit from the softness in riding lawnmower sales, as riders carry a lower-than-chain average margin. However, this was more than offset by the softness in the sales of higher full-margin spring merchandise. Freight increased approximately 31 basis points, principally as a result of the continued mix shift to freight-intensive CUE products and costs related to increased import activity of seasonal goods as we had a mix shift in the quarter to merchandise that is duty-intensive. Import purchases in the quarter increased 16.2% year-over-year and represented 8.6% of the total purchases.
Also, exclusive brand sales increased over 20% compared to last year's Q1 and were close to 30% of sales. Although we always strive to deliver gross margin improvement, we are pleased with our ability to manage gross margin rate in spite of the product mix and freight headwinds, while continuing to provide great values to our customers. In turn, this allows us to increase our market share, drive gross margin dollars, and deliver solid operating margin performance and a healthy growth in earnings per share. For the quarter, SG&A, including depreciation and amortization, was 26.1% of sales, reflecting 13 basis points of improvement from the prior year's quarter. The improvement resulted from the reduced incentive compensation relative to last year's strong first quarter performance. This demonstrates the alignment of our incentive structure with our sales and operating performance.
We are pleased with our ability to control costs, particularly as we cycled against below-normal store costs in the first quarter last year due to the mild winter, and the leverage provided by last year's strong comp sales in the quarter. Our effective tax rate decreased to 35% in Q1 compared to 36.8% last year, which was consistent with the guidance that we provided in our fourth-quarter conference call. The decrease was principally due to the favorable impact of the reversal of certain tax reserves pursuant to FIN 48 and the reinstatement of the WOTC federal incentive tax credits that were approved by Congress in the early part of our first quarter, and as such, treated as a discrete item in the quarter. Turning to the balance sheet.
We have managed well against our capital allocation strategy over the past year, utilizing our dividend and share repurchase program to move us into a borrow position at quarter end, which is one of our peak seasonal inventory periods. At the end of Q1, we had a cash balance of $57 million and borrowings of $105 million, compared to a cash balance of $126.7 million last year and no debt. During the first quarter, under our stock repurchase program, we acquired approximately 522,500 shares for $49.9 million. We estimate the share repurchase program did not have a material impact on EPS for the quarter. Average inventory levels per store at quarter end were 2.3% higher than last year, which was in line with our expectation and is related to the spring inventory build and the impact of inflation.
Excluding key spring seasonal categories, average inventory levels per store would have been down relative to last year. We exited the winter season in great shape, as the extended winter season allowed us to effectively clear through winter merchandise. Capital expenditures for the quarter were $49.3 million, compared to $31.8 million last year. We opened 22 stores this quarter, compared to 33 stores in the first quarter of 2012. The increase in capital spend relates to the construction of our new Macon, Georgia, distribution center, which is the relocation of our Braselton, Georgia, facility. Turning our attention to the full-year outlook. With respect to our financial expectations for the full year 2013, as noted in today's press release, we have confirmed our previous guidance for net sales, comp store sales, and earnings per share. As a reminder, we still expect full-year sales to range from $5.07 billion to $5.17 billion.
We continue to forecast comp store sales to increase between 3% and 5%. We are targeting improvement of approximately 10 to 20 basis points in EBIT margin compared to 2012. We anticipate net income to range from approximately $304 million to $310 million, or $4.32 to $4.40 per diluted share. Capital expenditures will range between $240 million and $250 million. The new store pipeline is full, and we continue to track very well to our full-year goal of 100 to 105 new stores. We have not seen any significant change in our customers' behavior, even with concerns about the economy or the impact of the higher payroll tax on their take-home pay. Our customer continues to purchase their basic and everyday needs, spending on larger ticket items only when it is essential.
Inflation is tracked as expected, and we continue to estimate that it will be approximately 1%-2% for the full year, with our expectation that it will likely be at the middle of that range in the first half of the year and slightly less than that in the second half of the year. As we stated in the fourth quarter press release, we expect a drag of approximately $6.5 million-$8 million or $0.06-$0.07 in EPS related to the relocation of our Southeast distribution center and our corporate data center. These costs include duplicate occupancy expense and temporary labor during the transition, freight movement costs between facilities, and equipment depreciation. These costs will be principally reflected in SG&A, with the majority occurring in Q2 and Q3. With respect to margin, gross margin.
For the full year, we expect to achieve a slight gross margin rate improvement through the execution of our key gross margin initiatives. We expect this will not be realized until the back half of the year. We will continue to have a headwind from the mix shift to CUE products, which carry a margin below the chain average. We also expect freight costs to remain a headwind due primarily to continued merchandise mix shift to more freight-intensive CUE product and increased import container volume. We estimate that the impact of the mix shift and the transportation expenses discussed will prevent us from realizing gross margin rate improvement in the first half of the year. We will continue to focus on driving market share and growing gross margin dollars.
With respect to inventory, we may experience slightly higher levels at the end of Q2 as we transition to the Southeast distribution center. With respect to SG&A, excluding DC and data center charges, as I discussed previously, we continue to target SG&A growth to leverage at a 3% comp. Store support and store payroll is expected to leverage slightly as we grow our comp sales base and cycle a more normalized level of incentive compensation, which should offset wage and healthcare increases. Based on the above, we anticipate that our EBIT margin target improvement will be weighted more towards SG&A leverage than gross margin rate improvement. For the full year, we continue to forecast our effective tax rate will be approximately 36.5%.
To conclude, weather trends in the first quarter were essentially the opposite of last year and therefore not as favorable to our business in the first quarter of this year. However, we again executed very well, successfully managing through the things that we were able to control in our business to produce solid financial results for the first quarter and position ourselves for a healthy spring selling season overall. With that, I'll turn it back over to Greg.
Thank you, Tony. Regarding the current retail environment, our customer shopping patterns have remained consistent with recent quarters. They seek compelling values, and they purchase based upon need. At the same time, we are nimble and capable to react quickly to the trends that are developing in our business, which has enabled us to capture market share. Before I close, I'd like to provide a brief update on some of our current company initiatives. We're pleased to report that we remain on schedule with the construction of our new distribution center in Macon, Georgia, which is the relocation of our Southeastern distribution center in Braselton. In April, we completed the necessary upgrades to our website, which will provide us with the infrastructure to accommodate drop ship, and we now have fulfillment capabilities from our own distribution center in Franklin, Kentucky.
While very early, we're executing well and very pleased with our results thus far. The new store support center is well underway, and construction is on schedule for completion in mid to late 2014. This will enable the company to operate together again in one complex and will further our culture of mission and values. In the area of strategic sourcing, we recently hosted a vendor conference in Shanghai, China. We do this about every two years. We reiterated our commitment to the factory base there and their need to be in compliance with all U.S. laws, FCPA in particular. The attendance was very strong, and through this event, we were able to strengthen not only our factory relationships, which we believe will advance our sourcing capabilities over time.
Looking ahead to spring, I am excited about our plans and the people and the process we have in place to drive our results. Our balance sheet remains very strong, allowing us to invest in capital initiatives to ensure our growth for the longer term. We continue to implement newness throughout the store, which will enable us to grow our sales. We continue to expand our footprint in key growth regions and remain very committed to our annual square footage growth rate of approximately 8%. In closing, I'd like to thank every Tractor Supply team member for their ongoing hard work, passion for our customers, and commitment to our company. Because of their efforts, TSC is well-positioned today for growth, and we all look forward to a successful 2013. Operator, I would now like to open the call for questions.
Thank you. Ladies and gentlemen, at this time, if you have a question, you will need to press the star key followed by the digit one. If your question has already been answered, you may remove yourself from the queue by pressing the star key followed by the digit two. Also, if you are using a speakerphone, please pick up the handset before pressing the buttons. One moment, please, for our first question. Our first question comes from David Magee from SunTrust Robinson Humphrey.
Yeah. Hi, guys. Good afternoon.
Hi, David.
Can you tell us how the business seems to be trending in the parts of the country that have sort of resumed more normal temperature seasonally?
What I can share with you is, as what Tony had mentioned in his script, where we've had a typical spring season, or at least the warming trends of a spring season, very pleased with how the business is responding. That's across the categories of live products, our outdoor power equipment, and other categories that we typically see movement in once there's weather.
Is there a danger that in other parts of the country that have not experienced the spring yet, that we get too deep and people would just defer and not buy the seasonal products?
I've been with the company now six years, and I have yet to see that really happen. What typically you'll find is even though the season has pushed back a bit, this is actually more of a typical spring season. We haven't seen this in five or six years, but typically spring comes about this time if you go back and you look at probably historical data. No, I believe, and I think we believe as a company that, as the warming trends occur, and they will come in the north and in the upper Midwest, our business should return to normal there, and we have every expectation that we'll have a strong finish to the spring season.
And David, this is Tony. I think really the best way to look at it is to look at last year as being the aberration in the season, which actually generated such an early season that it was a little bit slower as the season went through. That's why, as I commented earlier, we'll start to go up against much easier compares as we enter into May and even slightly into June.
Great. Thanks, Tony.
We'll now go to Michael Lasser from UBS.
Thanks a lot for taking my question. You did a good job last year of sizing the amount of sales that you thought were pulled forward due to the weather. Do you have some estimate of what you think the weather impacted your first quarter all in this year?
Well, Michael, this is Tony again. We really like to sort of cycle back and say that last year had the impact. As we looked at this current year, the winter trend was favorable, but again, relatively consistent to what we would think a normal winter condition would be. Really the difficulty is in the comparison to last year when it comes to the March and the springtime. Really, the best way to look at it is not so much what the impact was with weather this year, but it was more of what the impact was last year. That's the easiest way to quantify it, and that's why we feel very comfortable with the $38 million estimate.
Okay. Traffic remained very strong in the first quarter this year. Do you have a sense, is that coming from greater frequency of existing customers, or are you starting to attract new customers as they gain awareness of the different product offerings?
It's absolutely a combination of both. We continue to grow our store base. As our newer stores continue to mature, we continue to drive comps and get new traffic and new customers. It's definitely a combination of both because when we look at each of the age of the stores, we see improved comp sales in all of the ages of the stores. We're really pleased with attracting the new customers and then continuing to have additional shopping transactions or shopping visits from our current customers.
Okay. That's very helpful. Thank you very much.
We'll now move to Brad Thomas with KeyBanc Capital Markets.
Yeah. Thanks. Just another follow-up on the weather impact here. Will we see any additional markdown pressure because of the later spring that we're seeing this year versus last year? Is that something you don't need to do, it's just a matter of waiting for people to come in the doors and buy this product?
Brad, this is Greg. We are very cognizant of our flow of product and the demand that sits in front of us. We do a lot of estimating and forecasting of production. We feel very comfortable right now that our inventories are well-positioned, both south as we move all the way to north, and we're not concerned with any, I'll call it outsized lumps of product or anything at this point. We're in great shape. As those customers start to come through, as weather warms, we think we'll convert that into sales. If we see anything that's changing, because we are nimble and we have the capabilities, we'll make the adjustments. So far, no need to adjust.
Great. As a quick housekeeping item, could you just remind us, were all of your stores closed on Easter Day this year? Would that have been a drag in the first quarter that provides a little bit of benefit then in the second quarter?
We were closed on Easter. Easter fell in our same quarter, so there was no impact there. There was a slight shift. Obviously, the earlier the Easter, generally, the better. That was somewhat negated by the cold weather. When we look at it, we don't see it being a significant impact one way or the other.
Great. Thanks.
We'll now go to Peter Benedict from Robert W. Baird.
Oh, hey, guys, couple questions. Tony, the second quarter, it sounds like gross margin expected to be down again. Should we think in terms of magnitude that down more than the first quarter or kind of a similar rate? Related to that, as you look to the back half of the year, your view for improved gross margins, is that going to be driven in your view by less of a mix headwind, less of a freight headwind, or how do you expect to achieve that?
Sure. When it comes to Q2, as we do a build and take a look at Q2 from a detailed level, we still expect to have that mix headwind. However, we do expect that to moderate some because in Q1, the CUE items had a significant increase in the % of total business. As we move into Q2 with the spring business, we expected that to be a smaller %. At the same time, we still expect to have that as a headwind. With that moderating somewhat, but with the addition of what we would anticipate additional riding lawnmower sales, which again, have a lower than chain average margin, there's going to be an offset.
We're looking generally in the same range, but what we do anticipate or are hopeful of as we continue to drive sales in Q2, that we will be able to offset any gross margin rate reduction with SG&A leverage. Again, what we're trying to communicate is that we believe that we'll be able to drive more of an SG&A leverage than improvement in gross margin in Q2, and be able to wind up overall with an EBIT margin somewhere flat to slightly down.
Okay. That's helpful. As you think to the second half and getting the gross margin up year-over-year, the components driving that, is it just less of a mix headwind or less freight?
Yeah. When we look at it, because there is less imports, and that obviously with the buildup this time in Q1 and the release of the freight, there was an impact when it came to transportation. That's a little bit less of a headwind. We think that the CUE mix will be a little bit less of a headwind as well as we move into the back half. We do get some margin lift as we get into some of our giftables as we get back into Q2. That's what gives us the optimism that the gross margin rate will have more of an improvement in the back half of the year than in the first half of the year.
Okay, thanks. Maybe for Greg, can you just talk a little bit about the ground moisture levels you see across the chain right now, how they compare to where you've been in the past? Related to that, I recognize you guys haven't seen this in a bit, but at what point do delayed seasonal sales become lost sales? At what point would that occur? Thank you.
Okay, let's take the first question, the ground moisture. Right now, Peter, as you well know, we've had a lot of moisture in the North and Northeast and Midwest, and that's in the accumulation of snow. When snow melt happens, that puts more ground moisture in. Versus a year ago, much more moisture right now. We are seeing a little bit of drought in the West Texas region. That hasn't changed much in the last several years. If you look at the drought monitor across the country, there's a lot more green than there is brown. We're in better shape today than we were a year ago, and we believe with the snow melt that the Northeast and the upper Midwest is going to be more moisture there for a longer period of time in the spring.
When you talk about lost sales, it really isn't so much lost as I believe it'll be more delayed. I actually had a conversation this morning with one of our large outdoor power equipment vendors. We were talking about, is this a more normalized spring or is this another aberration?
His comment was, he's been doing this for 30 years. He said, "We've finally gotten back to what I believe is more of a normalized spring period." He said, "The longer the season extends, the higher propensity we'll have of selling more units because these units have to go a little longer into the season and so on." He says, "We're hoping for a turnaround here and being able to sell new units and replacement units versus them repairing and extending." I think in my opinion, it is too early to say that there's been any real missed sales. I believe these sales have shifted. I think we'll capture much of this as we get into late April, May. It is our hope that the season will extend in and through possibly June, which is more typical.
Now, we haven't seen that in many years. This could be a more typical year.
All right. Terrific. That makes sense. Thanks very much.
Yep.
Good.
We'll now go to Alan Rifkin from Barclays.
Hi. Good afternoon. Just a couple of quick questions. There was a step up in your buyback activity for the quarter. Is this a level that we can expect going forward from you?
Hi, Alan. This is Tony. We have a target as we begin the year. Again, I'd like to refer you back to our Analyst Day presentation that's still available out on the web where we talked about what our goals are over the next five years. Each quarter, we will set a matrix under a 10b5-1, and it'll be based on our internal calculation of what we believe the intrinsic value of the stock is over the next couple of years, and we'll set our buying targets based on that. Depending on how the stock moves within that quarter will dictate how much we buy. We are somewhat fortunate this quarter that in the early part of the quarter, the matrix was buying at a relatively large clip, principally prior to our fourth quarter announcement where we announced earnings.
As the stock rose, it again went outside of our matrix. We can't adjust it during our quiet periods, so there was a lot less buying in the second part of the first quarter. As much as we sit out there with a target generally somewhere between $100 million-$200 million. It's very dependent on how the stock price moves within a particular quarter. As we move forward, $50 million in a quarter generally would be at the high end of our target for a particular quarter.
Okay. That makes sense. A question on your marketing. Can you just update us on your initiatives to continue to drive traffic, especially with new customers and increasing awareness with people who might not be as aware of the Tractor Supply brand?
Yeah, Alan. Hi, this is Greg. In the first quarter of the year, there really wasn't much of a change from what we did in last year. We continued with our circular program. We continued with some CRM products and direct mail. What we're finding is we're getting more and more efficiency as we gain more information on these customers. We're starting now to use the web quite a bit more to talk to these specific customers about things that they're interested in and the information that we've now gathered on them. If you're referring in specific to the aware non-shopper comment that we made, and we've talked about a few times, that customer base continues to be more difficult to target.
Although we know that we're gaining some new customers on a day-to-day basis as we hear the commentary from our stores talking about customers making the first trip into Tractor Supply and saying, "Wow, I didn't realize you had all these things to sell." We continue to work that side of the business as well. In the first quarter, there's probably less of that than you'll see as we move forward into second quarter because the apex of our business starts to move here towards second quarter, and we'll ramp up some of those activities as this quarter develops.
Great. Thank you.
We'll now go to Vincent Sinisi from Bank of America.
Hi, good afternoon. Thanks very much for taking my question. We appreciate all the color around the gross margin headwinds. I also, though, just wanted to ask, you did mention within your gross margin commentary that exclusives were around 30% of sales, clearly a nice step up. If you guys could just give us some further input in terms of where you potentially see that going throughout this year in terms of product expansions. It was pretty evident at your investor day that is certainly a focus.
Vince, this is Greg Sandfort. No question, what we saw in the first quarter in exclusive brands, particularly in the CUE categories, we saw a large acceleration. As you know, some of those CUE products, whether it's our private brand or our exclusive brand feeds and pet foods and things, don't carry the same margin as some of the products maybe on the left-hand side of the store that are more hard lines driven and such. We're thrilled with the market share growth that we saw. It did put a little pressure on margin. As we move forward through the balance of the year, Steve Barbarick and the team have put together some really, I think, some terrific programs that are continuing to build out categories or line extensions within existing categories in exclusive brands.
Whether if you look in our spring assortments, whether it's long-handled tools in the garden area or heating in the fall or clothing and apparel and footwear. We just had some new products that are now coming through the pipeline there. I'm comfortable that we're going to see continued movement and growth. Again, I must caution everybody, this is really driven by how the consumer responds. As the consumer gives us the green light to move ahead and take categories further, we move those categories forward. There will be a point in time when in a certain category, we'll say we're already penetrated X% and it's enough, and we still need to have a balance of brands that are recognized on the national level and so on. By no means are we well-developed here, and we're excited about what we're seeing.
We haven't had any real setbacks yet. We're pleased with the progress we've made.
Thank you, Greg. That's helpful. Just a follow-up question, if I may. Regarding the replacement cycle, I believe last you had said you haven't really seen a true tick-up from that pent-up demand. Just wondering, and maybe using markets that have seen more spring weather to date at least, have you seen any signs that are making more or less positive that we could potentially see an uptick in that replacement cycle?
Vince, that's a great question. It's very early in the season. I think anyone who's selling outdoor power equipment would give you the same answer. It's very early. What I can tell you is that our replacement parts, maintenance businesses are still running very strong, which leads me to believe that consumers are still looking to extend the life on the current products. As I said earlier in talking with some of the experts in the outdoor power equipment category, if we have an extended spring and it goes in and carries through June into July, some of these units that have had an extended life, let's call it that, are probably going to start having failure. That could be a sign that we could start seeing some movement. We just haven't seen it yet. We just really haven't.
It's still a replacement cycle and it's out of need when they need to. The days five, six, seven years ago when we were seeing new units being sold preferably versus repairing and maintenancing the one they had, I just don't see it yet.
Okay. Good to know. Best of luck in the second quarter.
Thank you.
We'll now go to Scot Ciccarelli from RBC Capital Markets.
Hey, guys. How are you?
We're good.
Good. Excellent. You guys talked about being able to leverage SG&A at a 3% comp and did a little bit better than that this quarter. I guess the question is, if we stay in the low single-digit kind of comp rate here, does that change the complexion of, kind of SG&A going forward, just given the commentary you made on incentive comp?
I think as you move forward, and we cycle up against last year, our incentive compensation program is designed to continuously raise the bar each year. If we were riding it down in a lower single digit, and I'm talking more of sort of the 1%-3% range, I think that you'll be able to see us manage through and lever SG&A. However, as we move into the spring season and our discussions about the sales shift between quarters, we believe that we have a significant opportunity to leverage SG&A as we potentially drive sales at a little bit higher clip than that 3% comp. That's what gives us the optimism. Again, as we cycle some of the incentive comp from last year, as well as some of the enhancements that we've made in our cost structure, we believe that we can drive SG&A efficiency in Q2.
All right. That's helpful, Tony. Then a follow-up would be, it's been a while since you guys dipped into your revolver, and I guess what I'm wondering is that any kind of change on the capital structure you talked about in the past, or is it just a combination, sales were a little bit slower, slightly higher inventory levels, and that's what you need for the balance sheet to reconcile? Thanks.
As we entered the year, we did anticipate that we would be in a borrowing position at the end of the first quarter. Again, our other heavy inventory period would be at the end of the third quarter. As we looked at this year, I would expect to be in a borrowing position throughout the year, and I do anticipate having a cash balance in our targeted range of $100 million-$150 million at the end of the year. I would cast it as being pretty much where we had planned, and that the ongoing share repurchase program and dividend program that we've had in place for the last couple of years, we've been able to allocate that out to our shareholders and return value in that capacity.
Got it. Thanks, guys.
I will now take a question from Aram Rubinson from Nomura Securities.
Thank you, and God bless. Good afternoon, guys. Couple things, just housekeeping. Can you give us a sense of the gross margin benefit that private label gave you? And also order of magnitude of CUE, how much that increases in the mix? Just curious order of magnitude, because it sounds bigger than normal.
Generally, we would not disclose the gross margin benefit of the private label and/or the CUE. I would tell you that the impact relative on the quarter was close to mid-single digits as far as the mix of the CUE and the increase in CUE relative to the sales in Q1. That was a significant movement of those CUE categories and obviously what put pressure on the gross margin rate. Now, again, as we emphasized earlier, as much as there was pressure on gross margin rate, we were still making the same gross margin dollars per unit or gross margin per bag that was sold. That's really what drove the results and continued to drive EBIT performance and EPS improvement over last year.
On the private label side, if you had, I think it was a 50 some odd basis point hit from mix, then there was a hit from freight, but you only ended up down 20. Is it possible that private label would have helped you by 30, 40?
I would say it would not be that large of a number because, again, a lot of our private label brands are used as sort of entry price point. They're not going to carry as significant of a mix. When we look at the CUE and some of the drivers within CUE , as much as private label was up, the CUE mix really was what was driving the margin rate down. There was a slight offset. It was positive, it was not overly significant.
Would you guys also mind updating us on kind of the cross-dock function? I wasn't sure if Greg kind of hit on this a little bit at the end of his prepared remarks. Just in terms of flowing goods differently throughout the supply chain, can you update us where you are and kind of when and where you'd like to be with that? Thanks.
Yeah, Aram, I can tell you. We have completed our test of the mixing center out of the back of one of our distribution centers, and it has given us confidence that this model can work. We are now planning and looking forward and saying, "Okay, how do we make this work within the mix of the supply chain that we have? How do we take this high velocity, low value, and really fast turn product and move it into this sector?" We haven't got all the plans finalized. We just got the results, honestly, and have dug through them, but it looks like it could be an option for us
We'll speak more to that probably as we get to the next call or two. There are plans to move forward in some shape or form with looking for sites and trying to put this into play over time.
Mm-hmm. All right. Well, we'll wait for that. Thanks again. Good luck in the quarter.
We'll now go to Matthew Fassler from Goldman Sachs.
Thanks a lot. Good afternoon. I have two questions that relate to gross margin. The first, you alluded to some higher-margin spring product that did not sell through particularly well, I guess because of the weather. Can you just kind of refresh our memory on what product you were speaking to?
Matt, this is Greg. The products we will talk about would be things like long-handled tools, seed packets, mulches, products like three-point equipment that would be used for tillage. Things that work across that when the snow's gone and the ground thaws, people start to use. Those types of things, to be honest with you, we delivered in the latter part of the first quarter anticipating we may see a little movement. We did not see much movement in those categories. Subsequent to that, though, the weather's starting to change now, and now we are starting to see movement in those categories. It really is a delayed effect is what we are seeing here, particularly in the Midwest and the North.
Got it. My second question related to gross margin. The 31 basis point impact that you saw from freight, substantially higher than you saw a year ago. Diesel, which I know this typically tracks to some degree, did not do very much over the course of the quarter based on our measurements, and I know that you alluded to the mix shift to CUE as a driver of freight. Now that the CUE mix shift, I guess, will not be quite as pronounced over the remainder of the year, but it looks to be persistent. What kind of structural freight impact do you expect us to see in kind of a level fuel price environment?
Matt, this is Tony. When we look out, we believe that the transportation impact should moderate. You are correct. When we look at diesel, less of an impact. We have increased some of the stem miles in which we have to deliver to our stores, especially as we open out our West, a lot of the stores out West, and I think you will see some significant expansion as we move into Colorado and Arizona. There is some additional expense relative to that. When we isolate the transportation piece, we break it out for the conference calls, but obviously, there's a component that is part of our import initiative, and that creates a positive effect net between the two. As much as we do focus on the transportation and that being a headwind overall, the major driver in that headwind is CUE product being much more freight-intensive.
As we continue to allocate and match our freight expense as we bring down the cost of goods sold and expense it, we'll continue to match that up, and that tends to moderate as well as we go through the season and begin to sell the more margin-fruitful product of spring. As we look forward, we expect it to moderate, but we still expect it to be a significant headwind throughout the year.
Understood. Thank you so much.
We'll now take a question from Peter Keith from Piper Jaffray.
Hi. Thanks, everyone. Thanks for taking the question. Just a couple of puts and takes on the gross margin line for you, Tony. Previously, I guess with the full-year guidance, you thought that you'd get EBIT expansion of 10-20 basis points, largely from gross margin. Did that dynamic change? Should I hear you correct, it's more SG&A, and if so, why did the gross margin outlook change?
That's correct. As we looked at the year in the first conference call, our view is to increase EBIT margin 20 basis points. We said that we anticipated that 10 to 15 would come from gross margin rate improvement and that five to 10 could possibly come from SG&A. As we went through this quarter, we see the increase in the CUE items, and we look at the mix. We anticipate that would actually level off and that it'd be more of a 50/50 mix and potentially SG&A on a full-year basis actually could contribute more. The key to the operations as we look at it is as the CUE items become a larger percentage of the mix, we're going to have an impact on gross margin rate. However, that should continue to drive market share, continue to drive sales expansion.
As we drive that sales expansion, that's where we believe that we will get the SG&A leverage. Absolutely, the outlook has changed when it comes to the relationship and the impact of gross margin rate and SG&A leverage. We think that, as we demonstrated in the past, our model will work as we continue to drive customer loyalty and market share.
Okay. That's helpful. I guess that it sounds like it's mostly the dynamic around Q. The drivers with Q, or I guess the performance there, that's been strong for a couple of years, but it really seems to have accelerated here in the last few quarters, where now it's become a more meaningful gross margin headwind. What's been causing that acceleration within the mix?
Dave, this is Greg. I can tell you that it's market share. We are very conscious of gaining market share in categories that are meaningful to us as a company and to our customers. There's been some adjustments down, Peter, there's been some adjustments down with amount of independent feed stores. That's dropped off. We believe we picked up share there. We believe in the pet food categories, as we've enhanced our assortments, the buying teams have brought really a lot of newness into those categories. We're seeing acceleration there, and we believe that, again, is market share gain. It really is coming back. It's market share. That's what we believe and what we see in our numbers.
Peter, when it comes to the first quarter, the weather had a significant impact on the CUE items because, just for example, when it's cold and as it was cold this winter, you have to think that you don't have the animals out grazing. They're in and they're buying feed. That was, I don't want to say an aberration, but that was a strong driver of transactions in the quarter. Additionally, for another example would be when it comes to heating. In the winter, people that have wood-burning stoves are going to be buying a lot of wood pellets. Another CUE type of transaction that's a consumable that will drive footsteps. We had a very heavy base this first quarter, again, obviously, it had an impact on the gross margin rate.
To get through this first quarter and have a transaction increase of 2.2%, that was huge. That's why when we look back on the quarter, we think it was a very successful quarter and are very optimistic as we roll into Q2.
Okay. That's helpful, guys. Actually, I just want to sneak in one more clarifying question around the margin dynamics. It sounds like Q2 operating margin would be flattish, myself and others would expect a sort of meaningful comp acceleration in Q1. You're talking about sort of EBIT margin expansion performance similar with Q1 on a better comp. Is that simply due to some of the extra SG&A around the DC and the support centers or something else we're missing?
There's definitely an impact. When we talk about the $0.06-$0.07, the majority will come in Q2 and Q3, you'll see an impact in Q2. That is a part of it. A lot of it will have to do as we work through the quarter and continue to manage the SG&A. Just currently, our model might be a little bit more conservative relative to entering the quarter when it comes to the expense structure. Again, we're very optimistic when it comes to the SG&A leverage as we move into the quarter.
Okay. Thanks for all that detail, good luck this coming quarter.
Thank you.
Thank you.
Our next question comes from Brian Nagel from Oppenheimer.
Hi, good afternoon. My first question, I just wanted to follow up on the answer to the question before me a bit. As you look at the strength in sales in this CUE category and the presumed market share gains you're getting from that, is that increased wallet share with your existing customers, or is there potentially a new customer coming to your store for some of these products?
Brian, this is Greg. I would tell you, again, I think it's a combination of both. We look across our sales and we say, if we've got a consumer that's buying feed and they have horses, let's say, and we say they're not buying in our category of dog food or whatever, we start to talk to them. We start to get them to buy the dog food category. That's a new customer now that we've acquired now for that category of business. We do a lot of that. At the same time, I think we have a very compelling offer in our store. Our balance of offer, good, better, best in these categories is as good as anything that's out there, and our values on a day-to-day basis are better than most. We're not a high-low retailer. We price right every day with some promotion.
I think I would say that's part of the secret sauce and the word's out, and I believe customers are starting to recognize that. It's a combination of both.
Got it. The second question I had, most of us are focused now in the Q&A here on the shift in sales Q1 to Q2 with the weather and such. Greg, you made a comment in your prepared remarks about your consumer holding up well despite such things as higher taxes. Maybe just expand a little further. Given the results, it looks like indeed your consumer is holding up well. As you look at the data, is there anything to suggest maybe the consumer is even getting better from here? Many of us are focused right now on the improving housing environment and what impact that's having on spending. Do you guys see any evidence in your sales trends that housing's starting to have a positive impact with your business?
I'd say that there's nothing from a direct correlation that we've seen yet. However, we know that when housing starts are robust, it seems to flow over and people seem to buy outdoor power equipment, the new lawnmower for the new house and so on and so forth. I don't think it's robust enough yet for us to make a call. I will tell you though, that from what we can see in our mix of spend from our consumer, it's very similar to what we've seen from past quarters. I would say that because they're conservative and the way that they have smaller mortgages and the fact that they don't have large amounts of debt, they pay with a lot of cash. They're holding up well. Our traffic is, like Tony said, it's up 2.2%. What else can you ask for?
That's a good sign and good health for the business.
Well, thank you.
I'll next move to Christopher Horvers from J.P. Morgan.
Thanks. Good evening. Couple random follow-ups. The CUE categories, can you share with us what the units in dollars were up? I think last year it was low double digits in Q1 and mid to high singles for the balance of the year. Can you share what that category did in Q1?
It was really the strength, and I can tell you that it was significant and a major driver of the transactions and the volume in Q1. We don't provide specific guidance as far as the CUE categories and how they performed.
Okay. Maybe it came out in the Q&A or commentary in previous.
We're pretty tight-lipped around here.
I'm not so sure. Okay, anyway.
Yeah. All right. Well. Fair enough. Can you share with us also, I don't know, did you share with us how much the incentive comp actually helped SG&A rate in the second quarter on a basis point level?
We haven't given the specifics. I will tell you that it exceeded the amount of improvement. It was clearly the main driver, and obviously, there were obvious other pluses and minuses. The incentive comp was greater than the total improvement in the SG&A. Again, I would stress to you that the incentive compensation, which primarily consists of the annual bonus compensation, is structured around sales performance targets for the stores and an operating performance target for the stores, as well as, obviously, a corporate or store support center bonus structure. It's tied to how we drive the business and that we believe that will provide leverage in times in which there might be some softness in sales, as well as we believe that it really returns well to the shareholders as sales increase significantly in a particular quarter or throughout the year.
I think that's a key component in how we can manage the business and drive the operating model.
Thanks very much.
You're welcome.
We'll now go to Adam Sindler from Deutsche Bank.
Yes, good afternoon, guys. I wanted to turn back to gross margins for a second here. When you look at your CUE products, would you say that the combination of the merchandise margin including and then freight, so it's sort of the all-in gross margin, is that still better than outdoor power equipment?
It all depends what category.
Oh, someplace.
Generally, it is better than the outdoor power equipment.
Okay. Secondly, on the CUE, it seems like, just with the amount of turn in this business, not too dissimilar from what goes on in the auto parts space. Have you guys ever looked at sort of a hub-and-spoke model so that you didn't have to distribute from your distribution centers all the time, especially, things like Texas and Northeast, where stores are clustered a lot closer together, or even in some of your emerging markets?
Adam, this is Greg. The answer to that question is what we're doing with these mixing centers. That gives us the ability to be close to the manufacturer as well as closer to the stores. Should keep this type of product primarily out of the large DCs, which are used more for individual pick and so on and so forth. If it's palletized product, the key there is to move it with the least amount of touches to the store. That's really our solution longer term.
Okay. I guess just lastly on outdoor power equipment, at what point in the season, or just on that product specifically, would you start to mark down? How significant is the markdown? Because I know that it's a low-margin item to begin with.
Well, the first thing is, before you take the markdown, you want to control what's coming through the pipeline. As I said earlier, we have a very rigorous production planning process that we work with our OPE vendors on. For example, we already know that because of the drought situation in the west part of Texas, we're already starting to trim deliveries to that part of our supply chain because the demand's just not going to be there. In other parts of the chain where we see demand is in front of us, we'll continue to flow product.
When you talk about markdowns, OPE is a category that you try to avoid the markdown if you can because what you want to try to do is sell it at either the regular price or some type of maybe gift with purchase scenario so that you don't have to go through the markdown process. We have very little markdown, honestly, in our OPE equipment from year to year. We manage that business very effectively, and a lot of that is the partnership between us and our manufacturers.
Okay, great. I appreciate it. Thank you.
We'll now go to Joe Feldman from Telsey Advisory Group.
Yeah. Hi, guys.
Hi.
Good afternoon. Nice job on the quarter.
Thanks.
Most of my questions were answered. I just wanted to go back to more of a bigger picture topic, though, that we talked about at the Analyst Day, which was on regionalization, and you guys touched on it, I think, in the prepared remarks. Just wanted to get kind of the latest update on where things stand as far as regionalizing the assortments and more store clustering. I remember the example you've given us before about even in your home market, where you could have four or five different types of assortments within a 30, 40-mile radius of the home office.
Right.
Just wanted an update on that. Thanks.
Well, Joe, what do I said? Improvement. We're improving all the time in the process. It's ever-changing. One of the things we're learning as we move stores further west is these assortments have to be different. We may have elevation of store. I'll give you an example in New Mexico. Higher elevation, lower elevation, valley-type stores, very different mixes. In some cases, we can model sister store off of that. In some cases, we have to do a little bit of trial and error. Regionalization is ongoing, and we work at it every day. We're looking at our demand forecasting opportunities as we go forward. We take a lot of input from the field. I would tell you that we're still in the early stages. We're fairly good, but we're not great at this just yet, and so there's more to do.
Got it. Thanks very much, guys. Good luck with this second quarter.
Thank you.
Our next question will come from Simeon Gutman from Credit Suisse.
Hey, thanks for keeping this going. Quick question on Q. We know the impact, I guess, from a freight perspective. What about on the store labor model? Does it change, or can you just reallocate? I don't know if it takes more time to get this merchandise onto shelves, et cetera.
It really has little impact. The stores are structured with their labor model to handle this type of product. Particularly at the velocity that we're selling some of this product at full pallet type sell-off, it actually can make it a little easier sometimes for the stores as they roll it out to the floor. It's kind of almost like just-in-time inventory. As they're selling down to the last four or five bags, they bring in another pallet, drop it down, and convert and go. Really no impact.
Okay. Then on live goods, I think we discussed at the Investor Day, a lot of that is on recourse, if I'm not mistaken. To the extent there is shrink or spoilage, if the season just takes later to happen. Most of it is recourse, but is there still some impact that the company bears, whether it is, I guess, some transportation piece of it or some other piece that's in the numbers, at least now or going forward?
No, not for this year. Our structure is set up so that it's scan-based. We were more cautious than maybe some others as far as how we would flow that product. I was actually traveling stores in the Florida region several weeks ago, and we were fully set there. I traveled some stores in the upper Midwest, and we had yet to set because there was still a threat of frost and so on. For us, it's a new business. It's a business we're being cautious about and trying to do it the right way. We're listening very closely to our partners out there because the people that grow the product and that have worked with larger-based retailers on the product will tell you that being early is probably not good. Being at the right timing is what you need in the product.
Really no issues. We're very happy again with sell-throughs and very pleased with the partnerships we have with our growers right now.
Okay. Last, competition in OPE category. Are you seeing anything different from a pricing perspective from either big box or from independents?
Again, it's early in the season. I would tell you, I haven't seen anything that's worrisome at this point, but we kind of run our own program. Our units are a bit unique. The features and benefits and what we build and what we need for our consumers who have more land and don't need a small deck, small type of riding lawnmower. They need something that's more durable, that's more industrial kind of in strength. It really gives us the point of differentiation, and there's not a lot of crossover between our assortments and the others that are out there that we would compete with.
All right. Thanks. Appreciate it.
There are no further questions. Please continue with any closing comments.
All right. Thank you, operator, and thank you all for being on the call today. As we've said, we're very pleased with the recent performance, given the weather impacts and such from a year ago, and we are a company that operates with a sense of relentless dissatisfaction. We are always looking to improve, and we're a continuous improvement organization. Remember, we're a growth company. We're committed to 8% square footage growth, and we're still looking at a domestic store target of 2,100. We have, and will continue to have, a pipeline of sales drivers for the company. Our store team members are doing a fantastic job serving our customers, and that reflects in our improvement in our customer loyalty scores, which we track weekly, monthly, and quarterly. We plan to continue returning value to our shareholders through earnings growth, as well as our dividend and share repurchase programs.
Needless to say, we are and continue to be excited about our business and about the opportunities that lie in front of us. Thank you today for your continued interest and support of Tractor Supply, and we all look forward to speaking with you again on our next earnings call in about 90 days.
Ladies and gentlemen, that does conclude our conference call for today. You may now all disconnect. Thank you for your participation.