Afternoon, ladies and gentlemen, and welcome to the Tractor Supply Company's Conference Call to discuss Third Quarter 2012 Results. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. Please be advised 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 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 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 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 Jim Wright, Chairman and Chief Executive Officer.
Jim, please go ahead.
Well, thank you, Jen. Good afternoon, everyone, and thank you for joining us on today's call. I'm here today with Greg Sanford, our President and COO and Tony Cudall, our CFO. We are pleased with our 3rd quarter year to date performance. Each quarter, we continue to build on our momentum, further demonstrating that the structural changes we have made to our business are contributing to our ability to profitably grow Tractor Supply.
Before I turn the call over to Greg, I'd like to comment on our planned leadership transition. As recently announced, I'll be assuming the role of Executive Chairman at the end of the year, at which point Greg will take on the role of Chief Executive Officer in addition to his current role as President. The Board and management have been preparing for Greg's transition as CEO for some time. With the talented team we have in place, the Board and I believe this is the ideal time to complete this transition. Having worked closely with Greg for the past 5 years, I know that we share a deep understanding and belief in the core cultural foundation of Tractor unique niche and a deeply We have a unique niche and a deeply experienced, energized and focused management team in place.
Due largely to Greg's leadership, we are improving our ability to react to and to capitalize on shifts that we see in our business from time to time. Over the last 12 years, it's been honored to serve Tractor Supply's 17,000 plus team members and loyal shareholders through these chapters of successful growth. Director Supply is strongly positioned competitively, operationally and financially, and I believe that will be a seamless transition. I have the utmost confidence in the team's ability to continue executing on Tractor Supply's key strategic initiatives and it continues the company's record of success. I have been privileged to work for an exceptional team and look forward to continuing to work with that team in my new role as Executive Chairman throughout the upcoming year.
And with that, I'll turn the call over to Greg.
Thank you, Jim, and good afternoon, everyone. We are very pleased with our 3rd quarter results, which again underscore the strength of our core business. Our team at Tractor Supply continues to perform exceptionally well, particularly given what remains a challenging retail environment. The progress we continue to make in the areas of new merchandise offerings, management of inventory and our expanded regionalization of assortments have enhanced our overall operational performance. Now let me provide a little more detail on our 3rd quarter results.
As mentioned on our last call, with over 64% of the country in drought conditions as we entered the Q3, weather was not ideal for a strong selling season. Additionally, the lack of cold weather in the North in September contributed to less than ideal weather conditions for sales of cold weather products in that quarter. That being said, we are delighted with the team's ability to successfully manage through these variables and deliver positive comparable sales. Our core businesses had solid increases again in Q3 and within our seasonal categories several big ticket products such as heating and outdoor power equipment were negatively impacted. However, with our ability to recognize and react quickly to sales trends, we turned our focus to other categories that could provide a sales lift.
And now as cooler weather has come at the onset of the 4th quarter, we are experiencing stronger sales trends in fall and cold weather related products. Most importantly, we completed the 3rd quarter ending well positioned with the desired inventory levels to support sales in the all important holiday season. We have often stated in the past that we believe it is most appropriate to look at Tractor Supply's performance by the halves rather than the quarters. Our ability to deliver solid results in the 3rd quarter on top of a very strong comparison from last year positions us well for the Q4. In terms of specific sales drivers, our Q categories consumable, usable, edible remain strong and were key components to driving both traffic and sales, contributing to our 18th consecutive quarter of comp transaction count increase.
We've also experienced solid performance from our exclusive or private brands with mix at roughly 25% of sales, up 1 percentage point from last year's Q3. This slight increase was expected given our focus on growing our penetration of exclusive brands within our stores. Our Forage business continues to build momentum and we continue to expand our program. We are on track to end the year with Forage in over 600 stores compared to just 300 stores at the end of 2011. Equastages, our exclusive brand of equine feed that was introduced about 7 months ago also continues to perform well within our mix of equine feed products.
Our new store performance also contributed to our solid third quarter results. This year we opened 17 new stores in the 3rd quarter as compared to 12 new stores in the Q3 of 2011. We remain very comfortable with our annual square footage growth rate of approximately 8% as we expand our footprint into new regions. So in closing, let me say that we continue to be delighted with our ability to manage our business and drive improved profitability during the Q3 despite the challenging weather and retail environment. The progress we have made on many of our key strategic initiatives continues to provide operational benefits and we are planning, preparing, executing and reacting better than ever before.
We continue to improve our understanding of our customers' changing needs and we regularly refine products in the right regions at the right time. Our business model today is well balanced and will continue to provide sales momentum for Tractor Supply in the coming quarters. I would now like to turn the call over to Tony to review our financial results for the quarter and discuss our outlook. I will return afterwards to share several closing comments. Thanks, Greg,
and good afternoon, everyone. We had another very solid performance in the Q3 to complete an extremely successful 1st 9 months of 2012. The quarter ended September 29, 2012 on a year over year basis, net sales increased 9% to 1,070,000,000 and net income grew by 17.1 percent to $50,000,000 or $0.69 per diluted share. Comp store sales increased 2.9% for Q3 compared to last year's reported increase of 11.5%. Adjusting for the 1 week shift as a result of the 53rd week in fiscal 2011, we were actually cycling comp store sales increase of 11.9 percent resulting in a strong 2 year stacked double digit comp.
Non comp sales were $64,100,000 or 6 percent of sales. As Greg stated, comp transaction count increased for the 18th consecutive quarter, gaining 2.6%. And we are very pleased with the core business as Q Products continue to help drive footsteps, resulting in sustained transaction count increases. The average comp ticket was up 21 basis points compared to the Q3 last year. The benefit to average ticket from inflation was offset by a decrease in big ticket purchases and other mix impacts.
Big ticket sales were hindered in the early part of the quarter by limited riding lawnmower sales as we experienced drought conditions throughout a large portion of the country. There was also limited cold weather in the last few weeks of the quarter, which limited sales of big ticket winter goods, particularly cold weather heating products. Additionally, emergency response sales were less than in the prior year as we cycled Hurricane Irene. Hurricane Irene had a more beneficial impact on sales last year as it affected a significant portion of the East Coast, whereas this year's Hurricane Isaac was more isolated in its impact. Other key notes on the quarter.
The quarter exemplifies the strength of the Q products, which posted a very high single digit growth in both comp sales and units. The strength of these products was consistent throughout the regions. We did an excellent job managing the variable weather conditions throughout the country, including those regions that suffered through prolonged drought. On a regional basis, sales were strongest in the Southwest as we cycled last year's drought conditions in Texas. We also generated incremental sales in the Louisiana area as a result of Hurricane Isaac.
The Southeast also performed very well as we had more moisture in that region than in the prior year that helped to extend the spring seasonal business. Comp sales trends were consistent in the 1st 2 months of the quarter. As expected September's positive comp was the weakest of 3 months as we cycled the sales lift from Hurricane Irene last year. Additionally, we experienced warmer than normal temperatures in the Northeast, which did not benefit from the cold for any of the cold snap to typically signal the start of the fall winter season and entice shoppers to start making cold weather purchases. As the weather cooled in early October, we experienced a notable improvement in some of the key seasonal categories.
The impact of inflation was approximately 185 basis points for the Q3, which was within our projected range of 100 to 200 basis points. Inflation was most evident in livestock feed, lubricant, grass seed and fertilizer categories. Last year inflation in the 3rd quarter was more impactful on comp sales at approximately 4 65 basis points. Turning now to gross margin, which as a percent of sales was essentially flat compared to last year's 33.5%. Direct product margin benefited from product mix as we sold less lower margin big ticket merchandise than last year.
As I noted earlier, as a result of the drought conditions, we sold less power equipment such as riding mowers the early part of the quarter. Also, as I mentioned, lower margin cold weather heating products have shifted into October, which benefited margin in Q3. We also continue to benefit from our price optimization, imports, exclusive brands and markdown initiatives. The favorable gross margin impacts were offset partially by the impact of some of our Q products such as Feed and Pet that have margin rates slightly below chain average. We estimate this at approximately 15 basis points.
Freight increased approximately 10 basis points and also partially offset the product margin benefit we experienced in the quarter. This increase in freight resulted principally as result of the costs related to increased import activity of seasonal goods and the negative impact on freight related to mix shift to freight intensive Q products. Contrary to our historical trend, the year over year reduction in emergency response sales actually had a negative impact on gross margin as a result of the merchandise mix. Lower margin generator sales that we experienced in the early part of the quarter related to storms in the Northeast were comparable to the generator sales from last year's Hurricane Irene. However, this year's decrease in sales of the other ancillary higher margin emergency response categories such as tarps and batteries resulted in a negative impact on gross margin in the current quarter.
Import purchases in the quarter accounted for 13% of total purchases, which represents a 6.9% increase over last year. So overall, we are pleased with our gross margin performance and that our gross margin initiatives provide us the ability to maintain gross margin rate in spite of product mix and freight headwinds, while continuing to provide great value to our customers. For the quarter, SG and A including depreciation and amortization was 26.2 percent of sales, reflecting a 32 basis point improvement from the prior year's quarter. We are very pleased with our ability to leverage SG and A in light of our modest comp store growth with leveraging stemming from lower incentive compensation recorded in the quarter compared to the prior year. We experienced strong payroll control as we continue to better allocate payroll to sales trends and medical expense trends were also favorable in the quarter.
These benefits were partially offset by deleveraging from our distribution costs as we will not begin to cycle last year's opening of our Franklin, Kentucky DC until the Q4. Our effective income tax rate decreased to 35.5 percent in Q3 compared to 36.7% last year. Favorable impact of our provision to return reconciliation and the reversal of tax reserve pursuant to FIN 48. This was partially offset by lower federal tax credits, primarily WOTC and higher credits that expired at the end of 2011. Turning to the balance sheet.
At quarter end, we had $78,600,000 in cash compared to $118,500,000 at
the end of the same period last year.
During the Q3 under our stock repurchase program, we acquired approximately 681,000 shares for $61,300,000 We estimate that the share repurchase program had an insignificant impact on EPS for the quarter. Average inventory levels per store at quarter end were approximately 2.1% higher than last year. Date annualized inventory turns were 3.18 times or 5 basis points better than last year. We are very pleased with our any inventory composition and our overall inventory productivity, especially given the embedded inflation and having 1 more distribution center than at this time last year. We're comfortable with our quarter end inventory level of seasonal merchandise as we exit the summer selling season.
Capital expenditures for the quarter were $45,600,000 as compared to $33,200,000 last year. We opened 17 stores in the Q3 compared to 12 stores in the Q3 of 2011. We closed 1 store in the quarter in both this year and last year. The increase in spend relates to the purchase of the future site for our store support center and costs related to the construction of our new Macon, Georgia distribution center, which is the relocation of our Southeastern DC in Braselton, Georgia. Turning to our outlook.
As a result of our stronger than expected earnings performance in the Q3, we are increasing our net income expectations for the full year 2012. We now expect net income to be in the range of $3.63 to 3.6 $9 per diluted share as compared to our previous guidance of $3.58 to $3.66 per diluted share. We now expect full year sales to range between $4,610,000,000 $4,650,000,000 compared to our previous expectations of $4,580,000,000 to $4,650,000,000 Correspondingly, same store sales for the year are expected to be 4% to 5% compared to our prior expectations for an increase of 3.5% to 5%.
I'd like to quickly discuss a
few of the specific drivers and underlying assumptions for the last quarter embedded in our full year guidance. Our guidance is based on the assumption that the retail environment will be stable. We expect our customers will remain price conscious and value oriented and continue to shop our stores for basic and everyday needs as they did in the 1st 9 months of 2012. On a full year basis, we expect to far exceed our annual EBIT margin improvement target of 20 basis points for the 3rd consecutive year. With respect to the 4th quarter, we are again targeting 20 basis points of year over year EBIT margin improvement principally through our key gross margin initiatives.
We do expect that freight and mix headwinds will continue in the 4th quarter consistent with the Q3 as fuel costs have edged back up and are now slightly higher than last year at this time and we continue to drive queue items that are slightly below chain average margin and freight intensive. As a reminder, we are cycling against the $2,700,000 reserve for welding gas that negatively impacted the commerce assets, it will still be very difficult to leverage SG and A and A last year of $3,200,000 for the write off of certain commerce assets, it will still be very difficult to leverage SG and A in the Q4 based on our forecasted sales range as we are cycling the additional week from last year's 53 week calendar. Therefore, we believe that gross margin improvement will be the majority of the operating margin leverage in the 4th quarter. Overall, we expect inflation impact of 1% to 2 percent in the Q4 and we maintain our inflation forecast of 2% to 3% for the full year. For the full year, we are now forecasting that our effective tax rate will be approximately 36.7 percent, an increase from 36.5% in 2011 and slightly lower than our previous guidance of 37%.
The increase from last year results principally from a reduction in expected federal tax credits reduced ISO disqualifications relative to a higher taxable income base in the current year. The slight improvement in the full year tax rate results from the favorable adjustments I noted earlier that were recorded in the Q3. We have essentially made no changes in our expected store growth rate or plans for capital spend. We expect to open 93 stores, which corresponds to our previously communicated range of 90 to 94 90 to 95 stores for 2012. We project capital expenditures in 2012 will be at the high end of our previous range of 1 $60,000,000 to $170,000,000 in addition to our planned expenditures of $11,000,000 for the initial phase of construction for our Macon, Georgia DC relocation and an incremental $6,000,000 as part of our e commerce replatforming, we will incur approximately $11,000,000 on the land acquisition, initial permitting and grading expenses for our new store support center.
We will continue to make purchases under our share repurchase program as part of our long term objective of reducing cost of capital and maintaining a targeted year end cash balance of $100,000,000 to 150,000,000 dollars We currently project a full year fully diluted shares outstanding calculation exclusive of any additional share repurchases throughout the remainder of the year with approximate 73,000,000 shares. To conclude, we are very pleased with
our performance in the Q3
and the 1st 9 months of 2012 overall, having delivered solid results on top of a very strong comparison. We are proud that our initiatives are driving both top and bottom line And with that, I'd like to turn the call back over to Greg. Thank And with that, I'd like to turn the call back over to Greg.
Thank you, Tony. Regarding the current retail environment, consumers continue to act conservatively and are expecting to find compelling values in our stores during the holidays. Purchases are being driven by necessity and are taking place much closer to the need. We remain committed to our strategy of testing and improving our assortments. We are building a strong stable of exclusive brands across multiple categories to provide our customers with a value driven alternative to branded products without sacrificing quality.
This has been a highly successful strategy for us and we believe this will continue to strengthen customer satisfaction and longer term loyalty to Tractor Supply. Looking at the remainder of 2012 and the holiday selling season, we believe we have the right plans in place for the holiday selling season and we are pleased with our overall inventory position supporting our key categories and initiatives. Before I turn the call over for questions, I would like to take a moment on behalf of the Board and the entire Tractor Supply team to thank Jim Wright for his leadership over the past 12 years. His strategic vision, dedication to our mission and values and unwavering commitment for collaboration among all had been instrumental to Tractor Supply's success and our ability to implement our corporate strategy. As Jim noted earlier, he and I are completely aligned on Tractor Supply's business strategies and priorities for the future.
I look forward to continuing to work with Jim as our Executive Chairman, our Board of Directors and our strong management team. As a team, we will continue to focus on our core strategies to capitalize on the opportunities we see for our business to maintain Tractor Supply's forward momentum. And with that, operator, I'd like to open the call for questions.
Thank And the first question will come from Alan Rifkin with Barclays.
Okay. Thank you very much. Jim, we wish you a very happy and healthy retirement as well. Thank you. With weather between the drought and the lack of cold weather really wreaking havoc on the business, are you at liberty to maybe tell us what the comp was in markets that had no weather impact in the quarter?
That's my first question.
Now generally, we don't get into that detail as far as the regional comps. We would tell you that obviously comps range positive for almost every region and for the most part were below double digits. So you had a span within the single digits for the general categories throughout the nation. Okay. Can you maybe just
tell us where you think you are in that Can you maybe just tell us where you think you are in that program? And what at this point do you think could be the ultimate benefit to the EBIT margin line of that initiative? And then I just have one last follow-up.
Alan, this is Greg. As far as our development within imports and what we see, we're still I would say, if you put it in the baseball terminology like we'd like to use, we're probably in the 3rd, 4th inning. Quite a bit of room yet for us as we move through this cycle of not just conversion of product, but building products that meet the specifications that our customers demand. And then that's probably more important than anything else, is giving them a much better value quality product at a reasonable price point. As far as what it's going to do for overall EBIT margins, we usually don't talk in specifics.
The one thing I will tell you is that on a direct import basis, it's usually somewhere between 600 basis points to 800 basis points of improved margin over, say a comparable national brand.
Okay. And one last one if I may. Any significant change at all to holiday setup this year versus last year? Will you be bringing in the products earlier versus last year? Or how should we look at that?
It's a great question. And I will tell you that from the correction of error process that we have behind each season, last year we noted that our customers were asking us for the decor and the toys segment of holiday product. They wanted it earlier in the stores. They were willing to buy earlier. So we did make that change this year and moved that up 3 weeks.
We also have, I would say, an improved in store environment. We learned from a year ago that the North and the South have to be set a little differently. And what I mean by that is, in the North where we've got a cold weather business, we will move into the center court a lot of the insulated products and ancillary products and heating and such. And we'll use the left hand side of the store for the rest of seasonal and Christmas and holiday. In the South, it's just the opposite.
The center court you'll see is set up with all the seasonal and Christmas and then cold weather has moved to the opposite side of the floor. And some of those changes last year were really test to learn. This year, we were convinced that's going to make a big difference in the ease of shopping and the availability of product for our customers. So just a couple of things that we have done differently.
Okay. Thank you very much.
Thank you.
The next question comes from Peter Benedict with Robert Baird.
Hey, guys. Thanks and congratulations again to Jim. Just can you remind us how last year's Q4 trended kind of by month? Just where were the toughest comparisons as you went through the quarter last year?
Sure. Peter, this is Tony. We generally had a very strong quarter throughout, but we did start off the quarter last year with some nice cool weather, which drove October to be the strongest comp within those 3 months of that quarter.
Okay. When you said, Tony or Greg, I'm not sure you said it, but that October has so far gotten to a trend that's better than what you were seeing before. Is that better than September or better than what you did for the Q2 the Q3 rather?
Well, specifically, we were targeting the winter season program. Generally, what we've seen in the past is in the last couple of weeks of September, we will get cold snaps that will just start to drive those sales. And as I had mentioned earlier, we did not see that type of cold weather. So that did present a drag as we experienced the sales in September. As we moved into October, and we had a nice cold snap during, I would say, the first through the second week, we saw a noticeable improvement in the sales of those winter categories.
So it's really specific to the winter categories that had been a drag in September and we clearly saw them starting to turn around in an accelerated manner in October.
Okay. That's helpful. And then when you think about the feed, can you talk about feed costs and pricing overall? I know your inflation outlook for the Q4 is kind of similar to what you've been seeing. But with the drought and everything, some of our checks have indicated that perhaps there could be some renewed upward pressure on pricing within the feed category.
Can you tell us what you're seeing there?
Yes, Peter, it's Greg. Feed prices and pet food prices have somewhat stabilized for the short term here. There's a little movement in the futures market as we look at corn, but it really hasn't worked its way back yet to our cost as an immediate change. So we're looking at things being fairly stable through the Q4. And again, I don't have the crystal ball to tell you what it's going to look like beyond that point, but pricing is fairly stable right now.
Okay. That's great. And then Greg, just the follow-up on that. Can you talk about the supply chain opportunities? I mean, you mentioned some pressure from moving these bulky feed products around.
Can you talk about the cross docking tests you've got underway? And kind of how you see that as we look out maybe the next year or 2? Is there an opportunity on supply chain for that to turn from a headwind to a tailwind?
Well, on the comment of the crosstox, we have one in operation today and we are pleased with how it is performing. And it is giving us the confidence that it appears this may be a solution for us as we deal with this high bulk, high velocity, but low value product because as we all know, the fewer times you handle it, the more profitable that product is. As far as in the future, we still have some more measurements to take on that. So it will be the early part of next year before I would tell you we are convinced that it's going to work properly. And at that point, we'll be probably at a position to talk on one of the conference calls about the plans to take that forward.
Okay, fair enough. Thanks very much.
Thank you.
The next question will come from Scot Ciccarello from RBC Capital Markets.
Hey, guys. Scot
Ciccarello. Two questions. First of all, there's been a lot of questions recently just regarding the general health of the consumer out there. And I'm just curious if you've noticed any changes in consumer behavior in terms of either how people are shopping or what they're shopping for, etcetera?
Scott, it's Greg Sanford. I would tell you it's very consistent with what we've seen for the last several years, particularly through the 1st three quarters of this year, buying closer to need, being very value conscious and still repairing versus buying new. There's still a big emphasis on trying to extend the life of big ticket.
All right. So no real change from what we've seen already?
No real change.
Okay. And then the second question was, obviously, we've had these drought conditions. It's been a challenging environment. But do you feel like you faced a bigger challenge in the Q2 or Q3 from the drought conditions?
Well, to be honest with you, probably more second than third only because that's the quarter where you have a lot of outdoor power product and such that we would sell. And when there's a drought, typically that business starts to get a little tougher because there's no grass to cut and so on and so forth. But we manage through that and we found other things to sell. And what it does is it helps us understand that we're not reliant. We can we're not reliant on the category.
We can sell other things and this is where the forage piece kicked in and the feed piece kicked in and some other categories that helped us offset. So I would say it's between 2nd and third quarter is probably the most impact on drought, but probably a little bit more in Q2 due to the fact that we need the moisture to drive growth of grass and other things in that for the OPE category.
Understood. Thanks guys.
And we'll move next to Arum Rubinson with Nomura.
Yes. Hi. It's Ed Rachin for Arum. How are you?
We're good.
Good. I had one quick question on purchases. We kind of back into your purchases being up about 13.5% this year versus the same quarter last year. And I was just curious if there's anything behind the scenes that would change with respect to the timing of receipts or anything like that? On a comp store basis, that's up 4.3%, which seems like a reasonable level, but just wondering if there's any extra color there.
Thanks.
Well, there's several things, I guess, we could talk to. 1 is you have another DC in the mix. So you're moving inventory to that DC. You've got the earlier delivery of the core toys and some of the seasonal products, which also would have pushed receipts a little higher. And as we said earlier in the call, in our comments, the Q business continues to drive positive units and positive comps.
So those 3 are probably the primary areas.
Okay, great. And then looking seasonality of the business and we've taken to heart your point that you should look at the halves. But in the past, it looked like about fifty-fifty split between the first and second half. Is there anything you're seeing that would cause this year to move dramatically different from that? Maybe I shouldn't say dramatically.
Is there anything moving it differently?
Yes. Ed, this is
Tony. Just looking at the first half, we really had a tremendous lift in that Q1 and that clearly is rare relative to past historical trends. Now we do understand that there was some shift between the 2 quarters Q1 and Q2, but we do feel that the first half was extremely strong performance. So that may be outside of the norm. But we do feel that the first half was extremely strong performance.
So that may be outside of the norm. Additionally, you have to remember that last year was the 53 week year. So last year was buoyed by that additional week that continued that trend of having the back half a little stronger. So I think coming into this year you would expect the back half to be a little bit less. And as a reminder last year we represented that we believe that last week represented about a $0.09 addition to EPS.
Okay. Thank you.
And we'll go to the next question from Vincent Sinisi with Bank of America.
Thanks for taking my question. And Jim, congratulations to you and best of luck to you and Greg as you move into next year.
Thank you. Thank you.
I wanted to ask on your SG and A, you had some nice leverage on your comp number, especially up against a pretty difficult compare. Was there anything to call out specifically there? I know you mentioned some other personnel costs, incentive comp, anything that's worth calling out for this
We're definitely very pleased with our payroll control and we continue We're definitely very pleased with our payroll control and we continue to leverage that. As well as medical expense has been very favorable and that has been a little choppy throughout the year. However, we have put programs in place over the last year and a half that we have seen overall trend to sort of maintain below our normal SG and A growth. But other than that, really the driver behind it is the incentive comp and that did cause is the reason why we were able to leverage in this quarter. And when we look at SG and A exclusive of the incentive compensation, it has been running relatively flat on a year over year basis when you look at each quarter because each quarter does behave somewhat differently.
So on a per store basis, it's generally flat. And what we've seen is that it will grow again exclusive of incentive comp around the 9% to 10% range on a year over year basis. So the wildcard is the incentive comp and what really drives it is the sales level. So as we looked at last year, since a good portion of our incentive compensation is based on sales for our team members out in the store, you can imagine last year with an 11.5% comp that drove some significant incentive compensation. So there is some variability when it comes to sales level and the amount of incentive comp.
Okay. That's helpful. And then just as a follow-up, are there any updates regarding your CRM efforts? I know that you guys are working on a future loyalty type of program. Can we expect anything with that before we get into really the holiday season?
I know that you said you bring some of the inventory for the holiday specifically in earlier. Any updates there?
Vincent, it's Greg. No additional comments as far as a program being launched this fall. We continue to do a lot of due diligence on what's the right program for Tractor Supply. And I would say that it's our intent that sometime in 2013, it's very possible we could be testing something out there to gain a read, but it's nothing yet for the remainder of this fall. We've got many initiatives in place that I think will carry us through the Q4 adequately.
Great. Thanks very much.
Thank you.
And the next question comes from Dan Wewer from Raymond James.
Thanks. Well, Jim, don't you think you're entirely too young to retire?
I do. My wife does not.
Call us in 6 months and let us know how it's going.
Will do.
I have a question on gross margin rate. You noted that the growing sales contribution from Q items negatively impacted margin by 15 bps. Was the benefit from the declining sales contribution from OPE about the same also 15 bps so they washed each other out?
Yes. The amount there are a few other factors and I lumped all the big ticket together. So there were some other considerations such as generators and all. But it was in that range $15,000,000,000 to $20,000,000
I think there may be some that are surprised that a 10 basis point increase in freight expense would be enough to offset all of the tailwinds that you have on improving gross margin rate. Do you think that we've achieved so much gross margin improvement in the last 3 years that the rate of future gains may begin to slow?
Well, currently, when we look at the potential of the gross margin initiatives, we still think we have a nice runway ahead of us and we can continue to drive that. Obviously, we take into consideration the potential headwinds from the mix as well as from sort of the freight intensiveness of some of the products and weigh that against the potential. But we think that we can continue to drive the sales. As we looked at the potential benefits of the 4 key margin initiatives, we feel that we made substantial progress during this quarter. And again, it gets masked somewhat because of the headwinds that we faced from the freight and the Q items.
Then one other question that I have. There's a thesis that the housing markets are beginning to stabilize or in fact improve. There's our view that there's a portion of your business that's also sensitive to housing activity. Could you just update us how much of your business you think is tied to the housing? And what kind of sensitivity we may see in terms of future sales growth if housing does in fact stage a comeback?
Yes, this is Jim. As we look back to what we experienced in starting in 2008, the only or the most direct correlation we have is Orion lawnmowers and other OPE equipment, obviously, most of it falls into big ticket. And it's not just new housing starts, it's also housing mobility. And while we're hearing that new houses are up a little bit, home sales are up a little bit, mobility has not kicked in to a degree that's going to make a difference in our business. Should it return back to a more normal level of how this starts, we would expect that we would benefit from the increased sales of new mover activity.
I'm not sure we've ever broken out, Tony?
When it comes to the categories that we perceive to be housing related, it represents about 6 percent to 7% of the business.
That's all. Okay.
Okay, great. Thank you.
Sure.
Thank you.
And our next question comes from John Laurence with Stephens.
Good afternoon, guys.
Hey, John.
Yes. Congratulations, Jim, and thanks for all your help all the
years. Thank you, John.
Greg, would you comment just
a little bit if you look at sort of the going into the Q4, particularly private label such as Schmitt and Redstone. If you look at this holiday set compared to last year, would there be a lot more? I know you're always adding products, but compared to what we've seen for the 1st 9 months, would there be an additional sort of a ramp of extending those lines in those private label categories?
John, you will see an expansion first of all on Redstone because we've taken a little over 100 stores and put a much larger heating set into those stores. This is something we tested a year ago called a hearth shop and it did quite well in the stores that was tested. So that's one expansion. You'll also see across the whole category in heating, Redstone being the primary brand and that's a very consistent message for the customer. See in C.
E. Schmidt some additional depth in the insulated categories and in what I would call the everyday use categories, whether it be in denim jeans or flannel shirts, things of that nature. This is kind of workwear related. So yes, we are building out the brand even further and there's been some new footwear that's been placed into the assortments as well. So we are building those 2 brands, yes.
Great. Thanks. And secondly, as you continue to build out the price up sort of modules, any real differences across categories that you could tell us about as time has marched on in that test? And any differences among the processes among categories?
Well, there's no question that hardlines acts a little differently than softlines and feed acts a little differently than let's say lubricants. But let me kind of reiterate that this is a process that's iterative. So it's going to change. You may work through a category today and come back and visit it again a year from now because the dynamics in the market, whether it be cost inputs have changed or consumer preference has shifted, it's going to affect the elasticities and the way that we may price. The other thing you got to consider is the competitive nature in some of these categories.
And as I have said before, there's 3 buckets we work in. There's the bucket for trying to find margin rate, there's the bucket for trying to drive market share and then there's a bucket that has a blend. So in general, what I think I could tell you is that we're very cautious with this test and control methodology here at Tractor Supply. We don't just turn the switch and let the system run. There's always a test and control group that we work with to ensure that we're going to get the kind of result we expected before we roll this to the chain.
Secondly, there's going to be differences between the regions, no question. You can imagine the Northeast right now acting a little different than the South because we haven't had some of the weather situations in the North just yet. So more specific than that, John, I could vary with detail and I don't think it would add any value.
Great. Congratulations and thanks for your
help. Thank you.
We'll go next to Matt Fassler from Goldman Sachs.
Thanks a lot. And Jim, all the best to you as you move on. And Greg, I look forward to continuing to work with you. Thanks, Matt. Two questions really focused on gross margin.
Tony, you cited the impact of the Q products and their impact on mix as one of the factors keeping gross margin level among many others I guess. Is that mix shift element and the consumables business and its strength any different than it's been in prior quarters? Or should we just view this as a continuation of that long run trend?
Matt, I would look at it as a continuation. We've experienced this headwind as we've accelerated our business in those lines. And we would expect again each quarter varies slightly, But as we continue to drive that business, we'll continue to have that very similar headline.
If I were to take a step back and look at the past four quarters from a gross margin perspective, 3 of them have been essentially flat. And there have been, I guess, some kind of freakish events that or weather circumstances that have contributed to that. If you thought about the next 4 quarters in aggregate, the initiatives you have taking weather out of the picture and knowing what your drivers are, would you think that the gross margin would probably have a better year on year trajectory? Or is this the kind of I guess 20 basis points, 25 basis point run rate on an annualized basis that you would anticipate?
Yes. Matt, we generally, we
the base at 8% and drive EBIT margin of 20 basis points. So that's really our goal. We understand that the years in which sales are very strong, we're going to get some leverage on SG and A. But for the most part, we expect to drive 20 basis point improvement in EBIT margin with the majority of that coming from the gross margin initiatives.
Got it. And then just one final follow-up. Once you start to leverage the Kentucky D. C, how much of a weight does that take off margins as you think about whatever pressure it is it's driven year to date?
Well, Matt, the impact on margin is going to be in the stem mile savings because of where that DC is located and its capabilities. So it's going to fall on that side of the house. The building is still not at full capacity yet and that's a good thing because we built it large enough and it's got enough stores to be pushed through it. So there'll be some advantages yet, but it'll be more on I think on a when we look at the distributiontransportation
side.
Got it.
Thank you, guys.
Thank you.
We'll move next to Adam Sindler with Deutsche Bank.
Yes. Good evening, guys. So I guess no one has said congratulations to Steve Barbarick. Yes, I'll do that right now.
He's exactly incredible.
There you go. Okay. So just go back to the gross margin question for a minute. And relative, I guess, to Scott's question about the impact of drought in the Q2 and Q3. Would you say that the change in gross margin trajectory between the second and third was due to the fact that one, you have more consumable business in this quarter and then secondly, the favorable impact of the higher margin drought was not as beneficial this quarter than last quarter?
Because it just seems that the impact of Q is not too dissimilar and yet the margin slowed pretty significantly sequentially?
We definitely have an increase in the mix of the freight intensive queue items in Q3. So that really was one of the biggest drivers. Also the pull forward in Q1 as we move some of the big ticket riding lawnmowers into Q1 helped Q2 when it came to its margin. So yes, there's always going to be some pluses and minuses as we go through each quarter. But those two explanations probably drive the majority of the difference in performance between Q2 and Q3.
Okay. And then as you look back over the last 9 months, would you safe say that, I mean, from my perspective, you guys really only had 1 month of favorable weather and that being March and then the other months were pretty much actually very unfavorable?
Well, they were challenging, I'll say that. We haven't had this has not been a typical year, but regardless of weather, we still have to find a way to do business, right? And we do. We find to sell the products that our consumers continue to want. So, yes, it's been a tough year from a weather standpoint.
Okay. And then just lastly, could we just go back over the I know there was a couple of puts and takes on the gross margin in the Q4. Last year, you had the welding gas charge and then also some early discounting on winter merchandise. Can you remind us what the basis points impact was of the discounting?
That I don't have handy. I want to say that it's going to be probably less than 20 basis points when it comes to management. And we did have significant freight expense increase last year that I think was I want to recollect it was close to 40 basis points. So we would not expect that type of a headwind from freight as the freight expenses and diesel is similar to last year. So net net between the 2, there was clearly an offset freight as we talked about earlier as well as the mix.
But I don't think it will be quite as dramatic as the freight impact from last year.
Okay. Very good. Thanks guys.
Thank you.
We'll move next to Mark Miller with William Blair.
Hi, good afternoon. The benefits you had in lower incentive comp, Tony, I think
you were suggesting that maybe that was the majority of the
really
about $0.04 to EPS? It represented
it was a little bit less than that. It was probably more in the $0.02 to $0.03 range.
Okay. And then how about the other one time items you called out lower medical costs? And then were those considered in your prior EPS outlook and also the tax rate? So in other words, as you raise the EPS outlook, how much of that is coming from any of these items?
When we look at the quarter, the payroll management and the medical expense were not as significant. And when we look at the entire year, a little bit of a driver from the payroll performance throughout the entire year, probably not as significant in Q3. The main driver of the SG and A improvement and I say main driver, I would say significantly the entire portion of the SG and A leverage came from the incentive compensation. So as we look at the forecast, we really felt very good about the sales level that we anticipated because we understood that we were going up against an extremely strong comp in Q3 from last year. So, we felt very good about that as well as margin.
In fact, as we went through it, we had we were ahead in probably each category slightly above performance in sales, slightly above performance in margin, slightly above performance on the SG and A. So it was a combination of several factors that drove us to raise our full year expectations.
And the tax rate as well or had you contemplate
that? The tax rate was a benefit that was above our expectations that was expectations by at a minimum excluding the tax impact by the increase in our guidance.
Okay, great. And then I was hoping to get some perspective around the increase in the import orders. So I think if my numbers are right in the second quarter, those were up 16% and then the 3rd quarter up 7%. And I imagine that can be impacted by the timing of when you want to inventory certain items. But was there any timing there that impacted that?
Or I guess can you broadly comment on sell through of import items versus your plan? And are there any items that are just maybe not moving as quickly as you thought perhaps due to weather?
Well, this is it's a good question. I would tell you a couple of things on imports. Depending upon the category, the lead times are what you have to consider here. But thus far, the fall season, we're very pleased with what we're seeing as far as sales in the direct import products. Now remember, I mentioned earlier that we delivered a lot of these products in early to mid third, many of these pushing into the Q4 for the all important holiday season and gift giving.
But at this point, I can't tell there's anything that we're displeased with. We understand the weather impact right now and we're very patient with that because the weather will come. I'm not concerned. It will come and we're not at this point in time at any risk to say that we've got more inventory in the stores than we need at this point. We're waiting for those allocations based upon sales.
So as sales come, we'll allocate the product and push it out of the distribution centers. But the big shift, I guess, from 3rd or Q4 as far as sales is yet to come.
And I would tell you that we're basically dealing with a little bit bigger base when we go into the Q3. As we in the past have had relatively high imports as we go into Q4. And so that is one of the reasons why you probably don't see as significant of an increase year over year.
Okay. Thanks so much.
And we'll move next to Brad Thomas with KeyBanc Capital Markets.
Thanks. Good afternoon. Let me add my best as well to you Greg and you Jim. Hi, Mike. I wanted to just ask about performance
of new stores. It's kind
of an imperfect perfect metric for us to grade from the outside, but our calculation suggests a little bit of a slowdown in that metric for the Q3. Anything in particular going on with timing or maybe the mix of stores in terms of the smaller market smaller format that might have affected that?
Well, this is Greg. Let me just quickly say that the new store performance is on par with what we've seen through the first two quarters and actually in the Q3 of this year. So we're not seeing any deceleration in the performance. And I think I mentioned this in the last call that we developed a new launch platform for the new stores with the marketing area that is really helping us accelerate the business and get those stores off to a much faster start. So we're very pleased with those performances right now.
Great. And as we think about the contribution and that delta between your comp and your top line,
would you expect that to start
to shrink a little bit as you start to open stores that are in the smaller format over the next few years?
Not really. The mix between the format, there might be a 10% of the base maybe in smaller markets, but it shouldn't be significant. And again, as Greg has mentioned, it's the performance of the new stores has done very well. And I want to say almost in every case exceed the target sales levels that we had laid out for each one of those stores.
Perfect. I appreciate the clarification. Thanks so much.
You're welcome.
The next question comes from Simeon Gutman with Credit Suisse.
Thanks and congratulations Jim and Greg.
Thanks.
Just a quick question on Q area. Can you talk about how the product margin in that category has trended? Has there been any meaningful changes within it? And then besides private label, is The product
The product margin in Q has remained fairly stable. It moves with some of the commodity shifts that we'll see. But in general, we manage those shifts with inflation and deflation. As far as any advantage going forward based upon scale and size that we may be able to have some influence, There's no question we're always working with our manufacturers and suppliers to talk about size and usage product. And in many cases, we can gain some benefit.
But it's highly it can be highly volatile when there's inflation and deflation is all I can tell you. And we have a very concise program how we manage that. So we take every advantage, believe me, of using our size and scale to try to drive costs out.
But I guess to your point before of it being, I guess, high touch but low value, I mean is there a lot to really extract out of it? Is it an area that you're really focused on? Or it's sort of a minor it might be a minor benefit if you see something over
time? Well, the place that we're focusing on today is the crosstalk center earlier. Your largest expense is really is your freight. And so we are working diligently to find a better solution to bring to tractor supply in handling that piece of business. And at the same time, as we are gaining and growing market share, our cost should probably be a little more advantageous than say a much smaller three tow that's purchasing quite a bit less.
Okay. And then one follow on I guess regarding Q. You mentioned the forage program. My apologies if someone asked this. I missed I didn't get every question.
Can you just talk about, I guess, the traditional cube pay versus some of the bags? I'm curious how each are performing. And then is it bringing new customers into the store? Or is it adding to the basket of existing?
There's two parts of the forage program. There's the outside piece that we've been talking a lot about recently and that's the 2 string, 3 string and the rolled hay bale. That's one piece. There's also an inside piece that is the packaged product that we sell. It's compressed product that sells inside the store.
The in store piece does carry a little higher margin than the outside store piece. And I would say to you that what it's done is it's helped us round out the ticket for the consumer. See, in the past, when we didn't have these programs in place, they may have come to us for their feed, but they didn't buy the other components. They'd have to still go to some other place, some other store. Today, we have become that one stop destination where they can fulfill all those needs And we are seeing the market basket growing as the customers buying in the feed product.
We're seeing some of the other forge products accompanying that and that was the whole goal behind that.
Okay. Thank you.
We'll take the next question from Matt Niemeyer with Wells Fargo Securities.
Afternoon. I just had a quick question on the gross margin in the Q4. Assuming that the 25 basis point headwind for mix and freight is fairly persistent. How would you rank the offsets to that that take gross margin up enough to drive EBIT margin expansion? For example, how much benefit do you think you'll see from the Franklin cycling the Franklin opening?
The Franklin opening would be down in SG and A and because we do not allocate the distribution center operating costs to gross margin. And we would anticipate there's a potential for possibly 5 basis points of improvement there. So it's fairly limited when it comes to the Q4 because as Greg had mentioned earlier, we really need to drive the productivity in that new facility. And then of course, we can get a positive contribution from the mix depending on the big ticket sales. And generally, we would anticipate some increase there.
And then when it comes to the 4 key gross margin initiatives, we feel very good about how we've been driving that business. The markdown management, we really were the main one of the main drivers in this Q3 and we expect to as we enter in to the Q4 that our inventory position is in very good shape. So we expect to be able to manage through that. Price optimization contributed very nicely in Q3 as well. And we have a really nice import line, which we had brought in relatively early this quarter and expect to have some benefit there as well.
So it's difficult to rate all 3 or 4 of those gross margin initiatives and then combining with the mix performance and exceed any of the margin headwinds that we would encounter.
No, that's helpful. It helps lay it out for us. And then secondly, given the drought that we've had and you may have already hit on this, but what's your outlook for inflation over the next couple of quarters into mid beginning of 2013?
We haven't looked out into Q1 quite yet. We usually like to reserve that as we get a little bit closer. But this last quarter, we were at 185 basis points and we expect to range between the 102 100 basis points again this quarter.
Okay, great. Thank you.
And our next question will come from Joe Feldman with Telsey Advisory Group.
Yeah. Hi. Good afternoon, guys. Thanks for taking my questions. Most of mine have been answered, but I did want to ask you about, as you think about the Q4 and I know you sort of addressed it different chunks of the call, but I guess where do you guys worry about the potential pitfalls in the quarter or potential upside in the quarter that could come out of this?
Well, there's a couple of things we don't worry about. 1 is Q. Q continues to drive, continues to perform and we believe that we have our hands around that business. I think the biggest issue we're to have for Q4, if there's an issue at all, is when the weather might come and help us in the seasonal products. It's going to come.
It's just Is it middle of November? I mean we had for example Halloween a year ago in the Northeast we had a snowstorm. That was a wonderful thing. It helped kick the business off, but I can't predict that this year. So what I've done is I've kept my inventories very tight, very pointed, very focused.
My vendor community is sitting out there with product waiting if I need it. And if I don't need it, then I don't need it. But I think that's probably the only thing that I it's not even a concern because we manage our inventory so differently today than we did in the past. There's an upside and the upside is if the water breaks and if we get some opportunities, we can push inventory into the stores very quickly. We're very good at that.
Our supply chain is well it's a well oiled machine at this point from that standpoint and we can take advantage of it and drive sales. So it's a little bit of a waiting game.
Got it. That's helpful. Thank you. And then, if I could just ask one other question. I guess where you sort of addressed it in the prepared remarks, but I guess where weather was a little more seasonal, were the trends dramatically different in sales?
Or was it just moderately different in sales? Like I don't know if you could size it at all for us.
It's tough to come to some conclusions because of the different weather patterns. For example, as we cycled the drought in Texas from last year, we had a significant comp. We were high single digits in that region. As we cycled against Hurricane Irene up in the Northeast, we experienced the weakest comp. So the weather variables were so dramatic that it's difficult to sort of isolate it and encapsulate it into sort of one generalization across the nation.
But we do feel very strongly that in particular as we enter Q4, if the cold weather comes, we'll be very well positioned. As well as last year was one of the warmest winters December through February that we had experienced in many, many years. So we're optimistic that the cooler weather will take over. The forecast show a relatively warm winter again, but potentially cooler than last year.
Joe, the other thing that we have an advantage is with the composition of stores now across the country, this is how weather kind of dissipates. We may have ideal weather in one part of the country and less favorable in another, but the mix of all is what we've been able to really to use as a strength of ours because of our ability to move within the supply chain and push products where they're needed. Example, the drought a year ago. We took advantage of that. This year, we didn't have we have drought in many other parts of the country and we continue to shift.
Last year, it was kind of consolidated, as Tony said, into Texas. So because of the dispersion of stores, we have a little bit of an advantage and a little bit, I guess, of some, I would say a little bit of an offset to what might happen in one particular region or another.
Got it. That's helpful guys. Thanks and good luck with this quarter.
Thank
you. And we'll move next to Chris Horvers with JPMorgan.
Thanks. Good evening. So I was just trying to a little bit more on the monthly trend side, not to beat a dead horse, but thinking about last year and you mentioned Irene, how did the comparisons play out in 3Q last year? On an adjusted basis, you did a 7.1% in 2Q and then 11.9 and then we fell off and went back to a lower trend. So kind of when did we come over that hump?
Did that show up in September because of Irene? Or how should we think about that?
Last year in Q3, September was the strongest comp, although all 3 months were double digit comps last year with September being the strongest. So as we entered this quarter, we expected that September would be the weakest. We also mentioned last year on the conference call that Irene represented about a 1% impact overall to the comp for the quarter. So you can imagine that it had a fairly significant impact on the September numbers.
That's very helpful. And then as you think about how that math would play out, I mean, did you was September still positive? And then related to that, did Q did the Q category show any variability on any significant variability on a monthly basis as well?
Yes. Q was very consistent throughout the quarter. And again, as I had mentioned earlier, it was really high single digits both in sales and units. So we're very pleased with the performance. And again, it drives the footsteps and is one of the key reasons why we have 18 consecutive quarters of transaction growth.
When you look at September, it was a positive comp. And the other thing that I would like to reiterate is that last year we had some significant inflation as we moved into the back half of the year. And in particular Q3 was impacted almost 500 basis points of inflation, whereas this year was down to 185. So between the hurricane and the inflation, we understood that coming into the quarter that it would be a very tough comparison. And that's why we come away very pleased and actually exceeded our internal expectations and gave us the opportunity to increase our outlook for the year.
Thanks very much and good luck Jim and Greg. Take care.
Thank you. Thank you.
And we have a follow-up from Peter Benedict.
Hey, guys. Just one more, sorry, a drag call going on here. Just, Tony, on the 20 basis points of the margin plan for the Q4, is that off of last year's reported 9%? Or is it or are you thinking about that off of like an adjusted 13 week number from last year? Thanks.
That is off of last year's reported number. So that's what we're targeting. And our merchandise group is test and have put a plan together that can get us there. And also we're hopeful as much as we think it will be a struggle to drive some SG and A benefit. We're hopeful that we can drive some SG and A leverage as we manage the expenses and some of the expense trends that we see as we enter the quarter.
But we really do think that the majority of the EBIT margin improvement will come from gross margin.
Okay, perfect. Thank you.
And there are no further questions. Please continue with any closing comments.
Okay. Thank you, operator. Thank you all very much for participating in today's call. Let me just make a few comments here that in the past few years, Tractor Supply has operated more effectively than at any time in its history. This is best demonstrated by the fact that we've had 18 consecutive quarters of comp transaction catincreases, 15 consecutive quarters of double digit EPS growth, 12 consecutive quarters of comp sales increases and 11 consecutive quarters of expense leverage.
We know and we understand our customer and our more than 17,000 knowledgeable and very motivated Tractor Supply team members work very hard every day to provide exceptional customer service. Surveys indicate that our customers appreciate the level and consistency of our service and that we are honored that they continue to reward us with their increased loyalty. We continue to demonstrate our ability to manage the controllable and operate our business effectively despite the uncontrollable, whether it's the economy, inflation or its weather. We appreciate your continued interest and support of Tractor Supply and we look forward to speaking to you again after the holidays.
Ladies and gentlemen, that does conclude our conference call for today. You may all disconnect and thank you for participating.