Afternoon, ladies and gentlemen, and 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. Please be advised that reproduction of this call in whole or in part is not permitted without prior written authorization of Tractor Supply Company. And 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 Millan of FTI Consulting. Please go ahead, Jen.
Thank you, operator. Good afternoon, everyone, and 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 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 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 Sanford, President and Chief Executive Officer. Greg, please go ahead.
Thank you, Jen, and good afternoon, everyone. Thank you for joining us on today's call. With me today is Tony Crudell, our Chief Financial Officer. We are pleased with our Q1 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. And 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 and 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 Q1 of 2012 benefited greatly from the early spring weather and as we had anticipated, weather was not as favorable in the Q1 of 2013. We planned conservatively for the Q1 and 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 lawnmowers 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 Q1 results. In terms of specific sales drivers, 2 categories, the consumable, usable and inedible 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 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 and these type of in store events provide Tractor Supply with a great opportunity to grow sales in our CenterCourt 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 Q1, exclusive brands accounted for roughly 30% of our mix of sales. Exclusive brands enabled 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 experienced our 4 Health we expanded our 4 Health 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. Q 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 testing about 3 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. Then I'll return following his remarks to share my closing comments. Thanks, Greg, and good afternoon, everyone.
For the quarter ended March 30, 2013, on a year over year basis, net sales increased 6.4 percent to $1,090,000,000 and net income grew by approximately 9% to $44,000,000 or $0.62 per diluted share. As Greg discussed, we prepared for weather that would not be as favorable as we experienced in the Q1 of last year, where we benefited meaningfully from early spring weather in March. As a reminder, we had estimated that approximately $38,000,000 in sales, which translates to approximately $0.10 impact on EPS, with pull forward into Q1 from Q2 last year as a result of the early spring. We plan for this shift accordingly and manage through to deliver another solid performance in the Q1. We tracked well to our internal plan, although it was really a tale of 2 seasons.
The winter season was very strong in the Q1 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 4 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 lawnmowers as well as higher margin spring seasonal categories and resulted in very difficult comparisons to last year. Although the Q2 has gotten off to a colder than expected start, we have seen that our consumer respond as the weather has warmed to more typical spring conditions. And we are hopeful that this will result in a strong spring selling season. Also 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 2 the first two quarters. Comp store sales increased 0.5% for the Q1 compared to last year's very strong increase of 11.5%. Comp transaction count increased for the 20th consecutive quarter, gaining 2.2% on top of a 4% increase last year. We remain very pleased with our core business as Q product continue to serve our customers' basic and functional needs 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 lawnmower sales had a negative 220 basis point impact on average ticket, resulting from the shift in spring weather just discussed. Average tick was also impacted by the increase in queue 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 to 200 basis points, but significantly less than last year's 400 basis points benefit. On a regional basis, the Western regions performed the best and comps were positive in all regions except the Midwest, where our winter seasonal good 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 Q, which as we mentioned performed exceptionally well in the Q1 and made up a larger percentage of the first quarter sales compared to the prior year. Q1 generally has the largest mix of Q 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 Q 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 incentive skew 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 and 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 Q1 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 Q1 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 Q4 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 WATC federal incentive tax credits that were approved by Congress in the early part of our Q1 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 borrowed position at quarter end, which is one of our peak seasonal inventory periods. At the end of Q1, we had a cash balance of $57,000,000 and borrowings of $105,000,000 compared to a cash balance of $126,700,000 last year and no debt. During the Q1, under our stock repurchase program, we acquired approximately 522,500 shares for $49,900,000 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 we the extended winter season allowed us to effectively clear through winter merchandise. Capital expenditures for the quarter were $49,300,000 compared to $31,800,000 last year and we opened 22 stores this quarter compared to 33 stores in the Q1 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 $700,000,000 to $5,170,000,000 We continue to forecast comp store sales to increase between 3% 5%. We are targeting improvement of approximately 10 20 basis points in EBIT margin compared to 2012. We anticipate net income to range from approximately $304,000,000 to 310,000,000 dollars or $4.32 to $4.40 per diluted share.
Capital expenditures will range between $240,000,000 $250,000,000 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've 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 the 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% to 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 Q4 press release, we expect a drag of approximately $6,500,000 to $8,000,000 or 0.06 dollars to $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 and A with the majority occurring in Q2 and Q3. With respect to margin, gross margin. 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 Q products, which carry a margin below chain average. We also expect freight costs to remain a headwind due primarily due to continued merchandise mix shift to more freight intensive Q 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 experience slightly higher levels at the end of Q2 as we transition to the Southeast distribution center. With respect to SG and A, excluding DC and data center charges, as I discussed previously, we continue to target SG and A growth to leverage at 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 and 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 Q1 were essentially the opposite of last year and therefore not as favorable to our business in the Q1 this year. However, we again executed very well, successfully managing through the things that we are able to control in our business to produce solid financial results for the Q1 and position ourselves for a healthy spring selling season overall. And with that, I'll turn it back over to Greg.
Thank you, Tony. Now 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 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 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.
Lastly, in the area of strategic sourcing, we recently hosted a vendor conference in Shanghai, China. We do this about every 2 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
Yes. 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 spring season, very pleased with how the business is responding. And 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.
And is there a danger that in other parts of the country that have not experienced 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 6 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 of a typical spring season. Now we haven't seen this in 5 or 6 years, but typically spring comes about this time if you go back and you look at probably historical data. So 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 season, 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. And that's why as I commented earlier, we'll start to go up against much easier compares as we enter into May and even in slightly into June.
Great. Thanks, Tony.
And 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 Q1 all in this year?
Well, Michael, this is Tony again. We really like to 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. So really the difficulty is in the comparison to last year when it comes to the March in the springtime. So 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.
And that's the easiest way to quantify it and that's why we feel very comfortable with the $38,000,000 estimate.
Okay. And traffic remained very strong in the Q1 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. And so 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. So 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.
And we'll now move to Brad Thomas with KeyBanc Capital Markets.
Yes, 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? Or 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. So 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. And if we see anything that's changing, because we are nimble and we have the capabilities, we'll make the adjustments. But so far, no need to adjust.
Great. And as a quick housekeeping item, could you just remind us, were all of your stores closed on Easter Day this year? And would that have been a drag in the Q1 that provides a little bit of a benefit than 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 Easter generally the better. That was somewhat negated by the cold weather.
But when we look at it, we don't see it being a significant impact one way or the other.
Great. Thanks.
And we'll now go to Peter Benedict from Robert W. Baird.
Hey, guys. A couple of questions. Tony, so the second quarter Celtic gross margin expected to be down again. Should we think in terms of magnitude that down more than the Q1 or kind of a similar rate? And then 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 Q items had a significant increase in the percent of total business. So as we move into Q2 with the spring business, we expected that to be a smaller percentage. But at the same time, we still expect to have that as a headwind.
So 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. So we're looking generally in the same range. But what we do anticipate or hopeful of as we continue to drive sales in Q2 that we will be able to offset any gross margin rate reduction with SG and A leverage. So and that's again what we're trying to communicate is that we believe that we'll be able to drive more of an SG and A leverage than improvement in gross margin in Q2 and be able to wind up overall with the EBIT margin somewhere flat to slightly down. Okay.
That's helpful. And then
as you think 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?
Yes. 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. So that's a little bit less of a headwind. We think that the Q mix
will be
a little bit less of a headwind as well as we move into the back half. Then we do get some margin lift as we get into some of our giftables as we get back into Q2. So 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
the year. Okay. Thanks. And then maybe for Greg,
could 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? And then 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. And when snow melt happens, that puts more ground moisture in. So 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. But if you look at the drought monitor across the country, there's a lot more green than there is brown. So 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 will be more delayed.
I actually was on a conversation I had a conversation this morning with one of our large outdoor power equipment vendors and we were talking about is this a more normalized spring or is this another aberration? And his comment was he's been doing this for 30 years and he said we've finally gotten back to what I believe is more of a normalized spring period. And 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. And he says, we're hoping for a turnaround here and being able to sell new units and replacement units versus them repairing and extending. So 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 and it is our hope that the season will extend in and through possibly June, which is more
much. Yes.
And we'll now go to Helen Pan 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 target we have a target as we begin the year. And again, I'd like to refer you back to our Analyst Day presentation that's still available on the web where we talked about what our goals are over the next 5 years. Each quarter, we will set a matrix under a 10b5 and it will 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, we'll 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 4th quarter announcement where we announced earnings. As the stock rose, it again went outside of our matrix. We can adjust it during our quiet periods. And so there was a lot less buying in the 2nd part of the Q1.
So as much as we sit out there with a target generally somewhere between $100,000,000 to $200,000,000 it's very dependent on how the stock price moves within a particular quarter. If as we move forward, dollars 50,000,000 in a quarter generally would be at the high end of our target for a particular quarter.
Okay. That makes sense. And then 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 of people who might not be as aware of the Tractor Supply brand?
Helen, hi, this is Greg. In the Q1 of the year, there really wasn't much of a change from what we did in last year. We continue with our circular program. We continue with some CRM products and direct mail. And what we're finding is more 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. So, 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. But we continue to work that side of the business as well. But in the Q1, there's probably less of that than you'll see as we move forward into Q2 because the apex of our business starts to move here towards apex of our business starts to move here towards Q2 and we'll ramp up some of those activities as this quarter develops.
Great. Thank you.
And 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 that is certainly a focus.
Vince, this is Greg. No question what we saw in the Q1 in exclusive brands particularly in the Q categories, we saw a large acceleration. And as you know, some of those Q 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. So we're thrilled with the market share growth that we saw. It did put a little pressure on margin.
Now as we move forward and through the balance of the year, Steve 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 and exclusive brands. Whether if you look at our spring assortments, whether it's long handled tools in the garden area, where our heating in the fall, our 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 in growth. But again, I must caution everybody, this is really driven by how the consumer responds. And 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 percentage and it's enough and we still need to have a balance of brands that are recognized on national level and so on. But 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. So we're pleased with the progress we've made.
Thank you, Craig. That's helpful. And then just a follow-up question if I may. Regarding the replacement cycle, I believe last you hadn't had said you haven't really seen a true tick up from that pent up demand. Just wondering and maybe using markets that are 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, it's a great question. It's very early in the season. And I think anyone who's selling out their part 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 and talking with the experts in the outdoor power equipment category, if we have this if we have an extended spring and it goes in and carries through June into July, some of these units that have been have an extended life, let's call it that, are probably going to start having failure. And that could be a sign that we could start seeing some movement. But we just haven't seen it yet. We just really haven't. Still a replacement cycle and it's out of need when they need to.
And the days 5, 6, 7 years ago when we were seeing new units being sold preferably versus repairing and maintenance in the one they had I just don't see it yet.
Okay. Good to know. Best of luck in the Q2.
Thank you.
And we'll now go to Scot Ciccarelli from RBC Capital Markets.
Hey, guys. How are you?
Good. Good. Excellent. You guys talked about being able to leverage SG and 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 kind of change the complexion of kind of SG and 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. So if we were writing it down in the lower single digit and I'm talking more of sort of the 1% to 3% range, I think that you'll be able to see us manage through and lever SG and 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 and A as we potentially drive sales at a little bit higher clip than that 3% comp. So 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 and A efficiency in Q2.
All right. That's helpful, Tony. And then a follow-up would be, it's been a while since you guys dipped into your revolver. I guess what I'm wondering is, is that any kind of change on kind of 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 kind of 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 Q1. And again, our heavy our other heavy inventory period would be at the end of the Q3. So 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 $100,000,000 to $150,000,000 at the end of the year. So, I would say 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.
And we'll now take a question from Aram Rubinson from Nomura Securities.
Thank you and God bless. Good afternoon guys. Couple of things, just a housekeeping. Can you give us a sense of the gross margin benefit that private label gave you? And also order of magnitude of Q, how much that increases in the mix?
Just curious order magnitude because it sounds bigger than normal.
Generally, we would not disclose the gross margin benefit of the private label and or the Q. I would tell you that the impact relative on the quarter was close to mid single digits as far as the mix of the Q and the increase in Q relative to the sales in Q1. So that was a significant movement of those Q categories and obviously what put pressure on the gross margin rate. Now again as we emphasized earlier, the 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. And that's really what drove the results and continue to drive EBIT performance and EPS improvement over last year.
And then on the private label side, if
you had, I think it
was a 50 some odd basis point hit from mix and then there was a hit from freight, which 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. So they're not going to carry as significant of a mix. And when we look at the Q and some of the drivers within Q as much as private label was up, the Q mix really was what was driving the margin rate down. So there was a slight offset. It was positive, but it was not overly significant.
And would you
guys also mind updating us on kind of the cross stock function? I wasn't sure if Greg kind of hit on this a little bit at the end of his prepared remarks. But just in terms of kind 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.
Yes. 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 term product and move it into this sector?
And 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 2. But there are plans to move forward in some shape or form with looking for sites and trying to put this into play over time.
All right. Well, we'll wait for that. But thanks again and good luck in the quarter.
And we'll now go to Matthew Thesler from Goldman Sachs.
Thanks a lot and good afternoon. I have two questions that relate to gross margin. The first, you alluded to some higher margin spring product that didn't sell through particularly well, I guess, because of the weather. Can you just kind of refresh our memory and what product you were speaking to?
Matt, this is Greg. With the products we'll talk about would be things like long handled tools, seed packets, mulches, products like 3 point equipment that will be used for tillage, things that work across that when you have when the snow is gone and the ground thaws, people start to use. And those types of things, be honest with you, we delivered in the latter part of the Q1, anticipating we may see a little movement. We did not see much movement in those categories. Subsequent to that, though, the weather is starting to change now and now we're starting to see movement in those categories.
So it really is a delayed effect is what we're seeing here, particularly in the Midwest and the North.
Got it. And then my second question related to gross margin. So 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 didn't do very much over the course of the quarter based on our measurements. And I know that you alluded to the mix shift to Q as a driver of freight.
So now that the Q mix shift, I guess, won't be quite as pronounced over the remainder of the year, but it looks to be persistent. What kind of Yeah, Matt.
Yeah, Matt. This is Tony. When we look out, we believe that the transportation impact should moderate. You're 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'll see some expansion significant expansion as we move into Colorado and Arizona. So there is some additional expense relative to that. But 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 2. So as much as we do focus on the transportation and that being a headwind overall, the major driver in that headwind is Q product being much more freight intensive.
So and then as we continue to allocate and match our freight expenses as we bring down the cost of goods sold and expenses, 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. So again, as we look forward, we expect it to moderate and but we still expect it to be a significant headwind throughout the year. Understood. Thank you so much.
And 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. So previously, I guess, with the full year guidance, you thought that you'd get EBIT expansion of 10 to 20 basis points largely from gross margin.
Did that dynamic change? Should I hear you correct, it's more SG and 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 5% to 10% could possibly come from SG and A. As we went through this quarter, we see the increase in the Q items and we look at the mix.
We anticipate that that would actually level off and that it'd be more of a fifty-fifty mix and potentially SG and A on a full year basis actually could contribute more. Because the key to the operations as we look at it is as the Q items become much more become a larger percentage of the mix, we're going to have an impact on rate, gross margin rate. However, that should continue to drive market share, continue to drive sales expansion. And as we drive that sales expansion, that's where we believe that we will get the SG and A leverage. So absolutely, the outlook has changed when it comes to the relationship and the impact of gross margin rate and SG and A leverage.
But 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. So I guess it sounds like it's mostly the dynamic around Q. Now 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. And 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 and 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. So it really is coming back, it's market share.
That's what we believe and what we see in our numbers. And Peter, when it comes to
the Q1, the weather had a significant impact on the Q items. Because just for example, when it's cold and as long 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. So that was I don't want to say 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. So another type of transaction that's a consumable that will drive footsteps. So we had a very, very heavy base this Q1. And again, obviously, you had an impact on the gross margin rate. But to get through this Q1 and have a transaction increase of 2.2% that was huge.
And that's why when we look back on the quarter, we think it was a very, very successful quarter and are very optimistic as we roll into Q2.
Okay. That's helpful guys. And I just want to sneak in one more clarifying question around the margin dynamics. So it sounds like Q2 operating margin would be flattish, but myself and others would expect a sort of meaningful comp acceleration in Q1. So 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 and A around the DC and the support centers or something else we're missing?
There's definitely an impact. And when we look at we talk about the $0.06 to $0.07 the majority will come in Q2 and Q3. So you'll see an impact in Q2. So that is a part of it. And a lot of it will have to do as we work through the quarter and continue to manage the SG and A.
Just currently our model might be a little bit more conservative relative to entering the quarter when it comes to the expense structure. But again, we're very optimistic when it comes to the SG and A leverage as we move into the quarter.
Okay. Thanks for all that detail and good luck this coming quarter.
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. But as you look at the strength in sales in this Q category and the more the presumed market share gains you're getting from that, Do you think that is that increased wallet share with your existing customers or are you bringing 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 level retailer.
We price right every day with some promotion. And I think I would say that that's part of the secret sauce and the words out. And I believe customers are starting to recognize that. So it's a combination of both.
Got it. And second question I had, most of us are focused in the Q and A here on kind of the shift in sales Q1 to Q2 with the weather and such. But Greg, you made a comment in your prepared remarks about your consumer holding up well despite such things as higher taxes. Maybe just expandable for me. If you given the results, I mean, it looks like you're indeed your consumer is holding up well.
Is there anything as you look at the data, is there anything to suggest maybe the consumers even getting better from here? And so many of our us are focused right now with improving housing environment and what impact that's having on spending. Do you guys see any evidence in your sales that housing start 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. But I will tell you though that from what we can see and 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.
And our traffic is like Tony said, it's up 2.2%. So what else can you ask for? I mean, that's a good sign, a good health of the business.
Well, thank you.
We'll next move to Chris Horvers from JPMorgan.
Thanks. Good evening. Couple of random follow ups. So the queue categories, was that can you share with us what the units and dollars were up? I think last year it was low double digits in the Q1 and high single mid to high singles for the balance of the year.
Can you share what that category did in the 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 the Q1. But we don't provide specific guidance as far as the Q categories and how they performed.
Okay. Maybe it came out in the Q and A or commentary in previous. So
We're pretty tight lipped.
My mouth is mature. Okay.
Yes. All right. Well, fair enough. Then I guess the can you share with us also I don't know, did you share with us how much the incentive comp actually helped SG and A rate in the 2nd quarter on a basis point
level? Again, we haven't given the specifics. I will tell you that it exceeded the amount of improvement. So it was clearly the main driver. And obviously there were obvious other pluses and minuses, but the incentive comp was greater than the total improvement in the SG and A.
But again, I would stress to you that the incentive compensation, which primarily consists of the annual bonus compensation. It's 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. And so it's tied to how we drive the business and that we believe that 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. So 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 Sandler from Deutsche Bank.
Yes. Good afternoon, guys. Wanted
to turn
it back to gross margins for a second here. When you look at your Q 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 only depends what category.
Some
place. But generally, it is better than the outdoor power equipment.
Okay. And then secondly, on the Q, 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. And if it's palletized product, the key there is to move it with the least amount of touches to the store. And so that's really our solution longer term.
Okay.
And then I guess just lastly on Outdoor Power Equipment. At what point in the seasonal just on that product specifically, would you start to mark down? And then is it anything that's how significant is the markdown? Because I know 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. And 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 silver chain because the demand is just not going to be there. But in other parts of the chain where we see demand is in front of we'll continue to flow product. So 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.
But we have very little markdown honestly in our OP 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.
And we'll now go to Joe Feldman from Advisors Group.
Yes. Hi, guys.
Hi, Joe.
Good afternoon. Nice job on the quarter. 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.
But just wanted to get kind of the latest update on where things stand as far as regionalizing the assortments and more store clustering. And I remember the example you've given us before about like even in your home market where you could have 4 or 5 different types of assortments within a 30, 40 mile radius of home office. And just wanted an update on that. Thanks.
Well, Joel, it's an ever what 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.
And 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. But 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. So I would tell you that we're still in the early stages.
I mean, 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 Q2.
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 etcetera.
It really has little impact. The stores are structured with their label model to handle this type of product and particularly at the velocity that we're selling some of this product, a 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 we're selling down the last 4 or 5 bags, they bring in another pallet, drop it down and convert and go. So really no impact.
Okay. And then on live goods, I think we discussed at the Investor Day, a lot of that is on recourse, if I'm not mistaken. If to the extent there is shrink or spoilage, if the season just takes later to happen, is there 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. And we were more cautious than maybe some others as far as how we would flow that product. I was actually traveling stores in Florida region several weeks ago and we were fully set there. And then 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.
So for us, it's a new business. It's a business we're being cautious about and trying to do it the right way. And 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. So no really no issues. We're very happy again with the sell throughs and very pleased with the partnerships we have with our growers right now.
Okay. And then last competition in OP category, are you seeing anything different from a pricing perspective from either big box 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. I mean, 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 rotting lawnmower.
They need something that's more durable, that's more industrial kind of in strength. So 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. Well, 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 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.