Good afternoon, ladies and gentlemen, welcome to Tractor Supply Company's conference call to discuss fourth quarter 2017 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. We ask that all participants limit themselves to one question. Please be advised that reproduction of this call in whole or in part is not permitted without written authorization of Tractor Supply Company. As a reminder, this call is being recorded. I would now like to introduce your host for today's call. This is Mary Winn Pilkington, Vice President of Investor Relations and Public Relations for Tractor Supply Company. Mary Winn, please go ahead.
Thank you, Noah. Good afternoon, everyone. On the call today are Greg Sandfort, our CEO, Steve Barbarick, our President and Chief Merchandising Officer, and Kurt Barton, our CFO. Before we begin, let me reference the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. This call may contain certain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the company. In many cases, these risks and uncertainties are beyond our control. Although the company believes the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct, actual results may differ materially from expectations.
Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included at the end of the press release issued today and the company's filings with the Securities and Exchange Commission. We will also reference certain financial measures not derived in accordance with GAAP. Please see this afternoon's release, which can be found on our website at ir.tractorsupply.com/newsroom. While we believe this information improves comparability to other periods, this information is not a substitute for the GAAP measures and may not be comparable to similarly titled measures of other companies. 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. Tractor Supply undertakes no obligation to update any information discussed in this call.
After our prepared remarks, we will open the call up for your questions. As Noah said, please limit your questions to one and one related follow-up question if necessary. We will keep the call to an hour today. I appreciate your cooperation. Kurt and I will be available after the call for follow-up. Now it is my pleasure to turn the call over to Greg.
Thank you, Mary Winn. Good afternoon, everyone. I will start today's call by providing a review of the operational and financial highlights for Q4 2017 and fiscal 2017, then review our strategic priorities going forward. Kurt will provide additional detail regarding our financial results and review our guidance for fiscal 2018. Following that, we will open the call for questions. We are pleased with our fourth quarter results and the continued progress of our ONETractor strategic initiatives to drive long-term sales growth, a more personalized customer experience, increased market share in all channels, and improved profitability over time. Our fourth quarter comparable store sales increase of 4% was driven by broad-based strength across all of our geographic regions and merchandise categories, as well as increases in both comparable store transactions and average ticket.
We know our customers look to Tractor Supply for their everyday basic needs in living the rural lifestyle. We believe the continued convergence of our physical and digital storefronts and updates to our in-store and online shopping experience are resonating with our customers. I want to thank our Tractor Supply team members across the country for a strong quarter and a solid year. Throughout the year, the team reacted to changing market conditions to optimize our performance while we continued to invest in key initiatives that will drive longer-term growth. The balance between daily execution and investing for the future is critical to the long-term success of any retailer, and our team did an excellent job of this in 2017. Now let me touch on a few financial highlights for the fourth quarter and full year.
Comparable store sales increased a strong 4% in the quarter and 2.7% for the year, with both transaction count and average ticket increasing in the quarter and full year. Net sales reached a record $7.26 billion for the year as we continued our strategy to open new stores to gain market share. The fourth quarter diluted EPS was $0.87 and adjusted EPS was $0.91. For the full year, diluted EPS was $3.30 with adjusted EPS of $3.33. We generated cash from the operations of $631 million while returning $503 million to shareholders through the combination of share repurchases and quarterly cash dividends for the year. This was the seventh consecutive year that we increased our quarterly cash dividend for shareholders. Now, in terms of operational highlights for 2017. We opened 101 new Tractor Supply stores and 25 Petsense locations, increasing our selling square footage by approximately 6%.
We broke ground on a new distribution center in Frankfort, New York, to support our expansion in the Northeast quarter of the country. We saw solid progress with many of our ONETractor initiatives. We rolled out Neighbor's Club, our loyalty program, across all channels. We significantly expanded our buy online pickup in-store capabilities. We began testing our Stockyard and mobile POS technologies, and we invested in store labor hours to ensure we would deliver on our commitment to legendary customer service. The end result was improved sales trends throughout the year and the highest customer satisfaction scores we have seen in the past 10 years. There is no question these two metrics are correlated, and everything we do at Tractor Supply is with our customer in mind. We know there is a large customer base who need our products every day.
We believe that we are uniquely positioned to serve this customer base better than anyone in the market. We see significant opportunities to broaden our customer base and increase our market share as our store base and online presence expands. Looking forward, ONETractor, which we began talking about at our investment community day last year, is our ongoing strategy to leverage our unique positioning with our customers and to drive sustainable growth. What we are accomplishing is more than just growing our e-commerce business. We are providing a convenient, seamless shopping experience for our customers. ONETractor is a broad-based strategy to align the entire organization on how to better serve our customers while improving our supply chain to maximize both our near-term and long-term results.
This strategy is grounded in our foundational strengths of operational efficiency and a culture of team member engagement that ranks among the top in retail. Our ONETractor strategy initiatives are clearly aligned around four key objectives: driving profitable growth, building customer-centric engagement, offering the most relevant products and services, and enhancing our core and foundational infrastructure capabilities. As always, we will continue to take a balanced approach for managing the business and keeping the long-term focus in mind. Given the progress we have made and the positive results we are experiencing from many of our ONETractor initiatives, we are excited about our future investment opportunities. In 2018, our capital spending is prioritized to new stores with an increase of capital dedicated to our store-level initiatives and our supply chain. We believe this is the right focus for the business this coming year.
In 2018, we plan to open approximately 80 Tractor Supply stores. Our pipeline for 2018 for new store openings is robust. We are in the process of working on site selection for 2019 and 2020. Our recent data continues to support the potential for upwards of 2,500 Tractor Supply locations over time. We are continued to be pleased with the new store productivity and their returns. For 2018, we anticipate to open approximately 20 new PetSense stores. We continue to believe that the PetSense format provides us with a unique opportunity to grow our pet business by targeting a different customer with a differentiated preference for products and services not available today in a Tractor Supply store.
2017 was a year of progress and learnings with PetSense. 2018 will be a year of system and process integration as we apply best practices from Tractor Supply to PetSense. In 2018, we anticipate the initial rollout phase of our new point-of-sale system across the Tractor Supply supply chain that will integrate with our mobile POS. The new POS will allow us to improve the customer experience at checkout, integrate our e-commerce order management system, and leverage customer data to ensure a seamless shopping experience across all channels. We will continue to roll out Stockyard, which allows our team members and customers to leverage our digital assets and extend online assortments while they're in the store. This is particularly helpful when a customer is looking for a unique or hard-to-find item that may be make or model specific.
Also in 2018, we will be enhancing our online capabilities, including testing subscription services for recurring purchases of C.U.E. products. Our Neighbor's Club loyalty program is a great example of how we are moving fast to better serve our customers while targeting personalized communication to them. Since our national rollout in April of 2017, we have quadrupled our enrollment to about 7 million members now. With Neighbor's Club, we now have a 360-degree view of our customers' buying behaviors. This is a tremendous tool that should allow us to offer more relevant services and products to our customers as we leverage the data we have collected.
In regards to our supply chain, our largest initiatives in 2018 are the completion of our New York distribution facility, the addition of 2 additional mixing centers, and an East Coast import center that will help the flow of our direct imports. In total, we plan to invest approximately $80 million in these projects, with the majority of the spend falling in 2018. While this will increase our capital spending budget this year, the build-out of our distribution network will improve our delivery to stores and enhance our speed of delivery for direct-to-customer purchases. Our team made great progress in 2017, and we are building a solid foundation for future growth. We will continue to invest in the business across our ONETractor strategy while moving fast but deliberately to capture efficiencies that will in turn drive profitable growth.
I'll now turn the call over to Kurt to review our financial results for the quarter and the year.
Thank you, Greg, good afternoon, everyone. While Greg has taken you through the highlights of 2017, let me provide you with some additional financial details and review our initial outlook for 2018. As a reminder, beginning with the fourth quarter of 2017, PetSense sales are now included in our comparable store sales performance. For the fourth quarter of 2017, we had strong comp store sales growth of 4%, with comp transaction count increasing 2.7% versus an increase of 4% in last year's fourth quarter. Comps were positive across all geographic regions and all major product categories. All months had positive comp sales performance, with November being the strongest month of the quarter. Sales were positively impacted as cold temperatures arrived across our markets and our customers responded favorably to our assortment. PetSense comp store sales were essentially in line with the chain average.
Comp sales average ticket increased 1.3% compared to prior year's reported 90-basis-point decrease. The increase was primarily driven by the mix of goods. For the first time in 17 quarters, deflation was essentially neutral and was not a meaningful drag on comps. For the fourth quarter, gross margin increased 50 basis points to 34.2%. The increase in gross margin was primarily attributable to less promotional activity and improved sell-through rates on seasonal products during the quarter. Partially offsetting these items was an increase in transportation costs driven by higher carrier rates and diesel fuel costs, coupled with a higher mix of freight-intensive products. Including depreciation and amortization, SG&A as a percentage of sales increased by 120 basis points to 24.8% from 23.6% in the prior year's quarter.
The increase was primarily attributable to deleverage of occupancy and other fixed costs resulting from the 53rd week of sales in the fourth quarter of 2016 that did not reoccur this year, and higher store payroll from our continued commitment to customer service. Also impacting SG&A in the fourth quarter were higher store-level incentive compensation resulting from the strong comparable store sales increase and incremental investments in infrastructure and technology related to our ONETractor initiatives. Our effective tax rate was 38.9% in the fourth quarter, which was higher due to a one-time non-cash write-down of our net deferred tax assets of approximately $4.9 million, or $0.04 per diluted share, as a result of our lower effective tax rate going forward. Our balance sheet is strong, and our working capital is in good shape.
For the fourth quarter, our comp store inventory at Tractor Supply stores was essentially flat year-over-year. Exiting the year, we believe our inventory is well-positioned given the sales strength we had in the fourth quarter of 2017. In 2017, we generated cash from operations of $631 million. Total capital expenditures were $250 million, with approximately 40% of this being maintenance-related and the remaining 60% being growth-oriented in areas such as new stores, digital capability investments, and supply chain infrastructure capability. For the quarter, we repurchased about 694,000 shares of our common stock for $42.8 million. We repurchased over $369 million, or about 5.9 million shares of our common stock, in fiscal 2017. Since the inception of our share repurchase program in 2007, we have repurchased $2.1 billion of our common stock. Our remaining share repurchase authorization was approximately $870 million as of year-end.
Turning now to guidance for 2018. We expect net sales in a range of $7.69 billion-$7.77 billion, an increase of 6%-7%. Comp store sales growth is anticipated to be in the range of 2%-3%. As Greg mentioned earlier, we anticipate opening about 80 new Tractor Supply stores and 20 new Petsense locations. Our plans call for approximately half of our new stores to open in the first half of the year. Turning now to costs. As has been well-publicized, the retail industry is facing cost pressures on rising freight rates due to a shortage of drivers and higher diesel fuel prices, along with inflationary wage pressures across retail locations and the supply chain. As I shared with you last quarter, we are not immune to these increases.
The team is working to balance our initiatives and the investments we are making in our stores and at the distribution centers with strict cost disciplines and underlying operational efficiencies. All in, between our investments to grow the business and the external headwinds, we anticipate some pressure in 2018 on our operating margin. The largest items include, first, anticipated higher freight costs driven by rising transportation rates and the higher diesel fuel costs, wage investments for our team members at our stores and distribution centers, as well pre-opening expenses and incremental operating expenses for the ramp-up of our new distribution center in Upstate New York. We are forecasting the distribution center cost to impact the second half of 2018, predominantly in the fourth quarter. Our expectation is that gross margin would be flat to down slightly with the bulk of the pressure on SG&A.
Given the combination of investments we are making in the business and cost headwinds, operating margin at the midpoint of our guidance range is assumed to be about 8.8%. Our outlook includes about 20 basis points of incremental investments to accelerate our priorities as we balance the allocation of benefits from tax reform. More than ever, we are aggressively reviewing our cost structure as we look to strengthen our competitive advantages to better serve our customers. We are committed to ensuring our spending is directed to our highest strategic priorities, all on a sustainable basis. Net income is forecasted in the range of $490 million to $515 million, or $3.95 to $4.15 per diluted share. We would anticipate stronger comp store sales and earnings performance in the first half of the year as compared to the second half.
Given the comparisons for 2017, our comp sales in the first half of the year are forecasted to be at or above our guidance range for the year, with the second half of the year below the range. For the first quarter of 2018, we will have one extra comp day as we were open on New Year's Day for the first time. We estimate this extra day will contribute about 60 to 70 basis points to comparable store sales in the first quarter and about 10 to 15 basis points for the full year. We would also anticipate that the first quarter of 2018 will have the highest comp and the lowest level of operating profit margin compression of the year. Moving to below the line, our effective tax rate is anticipated to be positively impacted by the Tax Cuts and Jobs Act, which was enacted in December 2017.
The Tax Act is expected to reduce our effective tax rate from approximately 36.7% to a range of 23% to 23.5% in 2018. As I mentioned, a portion of the benefits will be allocated to accelerating investments in labor wages at our stores and in our distribution centers and the support of our ONETractor initiatives. We are also modestly increasing our capital spending to a range of $260 million to $300 million, with about 75% of the spending going towards initiatives to support long-term growth. Interest expense is forecasted to be approximately $17 million to $20 million. Depreciation expense is estimated to increase 9% to 10%. For the year, our share repurchases are anticipated to be towards the high end of our target to reduce our weighted average shares outstanding by 2.5% to 3.5%. For modeling purposes, we have assumed weighted average shares outstanding of about 124 million shares in 2018.
We remain committed to a disciplined capital allocation strategy. Our first priority remains investing in the business to support long-term growth through the opening of new stores and our ONETractor initiatives. We also are committed to creating lasting value for our shareholders through anticipated quarterly dividends and consistent share repurchases. That concludes my prepared remarks, and I will now turn the call back to Greg.
Thank you, Kurt. As we mark our 80th anniversary as a company, we are proud of our history and strong heritage of embracing change and leveraging technology to capture growth opportunities. I want to thank the more than 26,000 members of the Tractor Supply family who bring our mission and values to life every day as they serve our customers. Our passionate commitment to provide legendary service and great products at everyday low prices will continue to be the foundation of our growth. With that, Mary Winn, we would now like to open the lines for questions.
Okay. Noah, we'll take our first question.
Thank you. As a reminder, if you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal through to our equipment. Again, that's star one. We'll take our first question from Steve Forbes with Guggenheim Securities.
Good afternoon.
Good afternoon.
Maybe if you could start, I think I heard you right, but can you provide some additional context around the implied margin guidance for next year at the midpoint? As we digested last quarter, the margin headwinds you laid out, I believe you mentioned 20 basis points of incremental pressure as you balance the benefit of Tax Reform. Is that right? Can you just help us understand where those dollars are being spent as you try to accelerate some of the opportunities you see?
Sure, Steven. This is Kurt. I'll first just confirm what you said. Yes, we indicated that about 20 basis points is investment from Tax Reform that's impacting the operating margin. If I step back to the Q3 call, we indicated as to what we saw in regards to our investments and cost pressures. We anticipated operating margin decline in 2018. If you try to bridge that to the guidance that we have, we'd have about 50% of that operating margin implied de-leverage in 2018 specific to investments in the business. I would tell you that with investments from the business that we had related to Tax Reform, as we see that opportunity to invest those resources into labor wages at the stores and distribution centers, as well as ONETractor initiatives. The additional implied into our guidance has more visibility to areas like transportation costs.
I would say that even in the last few months has been widely publicized and indicated about the transportation industry, that we're seeing greater headwinds into that area. The difference in our outlook today as to what was indicated at Q3, principally due to the investments that we're making in the business and stronger cost pressures specific to the transportation industry.
Thank you for that. Then maybe just a quick follow-up on supply chain. Maybe, just a higher level, help us conceptualize how you view the capabilities in the network post New York. You mentioned a few other additions that are hitting this year, but do you envision having to add direct fulfillment points to the network or additional capabilities? Where do you see the evolution of the network going over the next couple of years here?
Yes, Steve, this is Steve Barbarick. I would tell you at this point, once we get that New York distribution center up, we've already got an expansion going on in Waverly, so I feel really good about that. We do have some mixing centers that we believe can continue to add value as we're bringing feed and bulk products through there. We're using 3PLs and trying to get a better sense for that. All of this will be baked into our CapEx guidance as we move forward. As we move forward, you'll see that in the numbers.
Thank you.
We'll take our next question from Peter Benedict with Baird.
Oh, hey, guys. Thanks for taking the question. First question, just around, you mentioned store-level initiatives. I heard talk about the POS. Maybe talk a little bit more about the cost pressures, I guess, around rolling out the POS. Are there other store initiatives, I'm thinking layout changes, things like that, merchandising that you're testing, Steve, that you think could have an impact, if not this year, maybe in 2019?
Yeah. Peter, this is Kurt. I'll start with the first question on your question related to point of sale. We're indicating that we're making investments in our point of sale system. That will be capital that we're investing this year. It has some impact in depreciation in 2017. It's not a significant part of that depreciation, as we'll roll that capital out throughout the year. That's where most of the cost. No other real operating cost impacts specific to a new investment in point of sale. Peter, I think the question, the way I'll respond is less about the expense side, more about the sales and opportunity side. We have a really laid out reset program that we're working toward for the spring and into the summer of this next year that I'm very excited about.
You'll see a lot of newness within the center courts and up and down the aisles. The only other one that I would mention, and I think we've hinted to this in the past, is that we do have a couple concept stores that we're working on right now. They're up and running. The layouts are a little bit different. They're still within the same size box, similar prototype. If we find that they're working well, then what we'll be able to do is retrofit them back into the existing stores should we opt to. It'll also give us an opportunity to put this new format into existing stores as we move forward.
Essentially, that layout is we reduced a number of SKUs that we felt we could accommodate through our fulfillment channels in e-commerce, then giving more space to categories that we believe we have an opportunity to continue to grow share in. The bigger, bulkier products within the inside of the store. We've got a number of pallet drops that we've opened up for our operations team to better manage the labor model. I would say the early read on those two stores has been very positive from both the field as well as from our customers. I would anticipate in the future you'll see more of that concept in a lot of the new stores, then we'll be looking at retrofitting some existing stores to see what the customers' feedback is on that.
No, that's great. That's helpful. I guess my follow-up Looking at turning the online business, I may have missed it, but did you guys give the percentage of sales that were online for the year? As you look out over 2018 and 2019, maybe talk about how you view your pricing online, what type of tools you may have to help optimize that as we go forward. Thank you.
Sure. In Q4, that's usually a heavier time of year for us on the e-com side, and our percent of sales was probably between 2.5% and 3%. That's what it was. For the full year, it was between 1.5% and 2%. As we look forward, we continue to see that as a growth mechanism for us. It's in two ways. It's buy online, pick up in store, as well as some of the ship-to-home product. The vast majority of what we do today is picked up in store. Whether it be shipped to store or picked up in store, our customers still like to come and engage with us in the four walls, but a few would like the convenience of having it shipped to them.
As you look forward, we've done a really nice job, the team has, going out and doing price surveys, looking at where a lot of the major brands are positioned. I feel that we're very competitive today. As we move forward with ONETractor, one of the capabilities that we're adding is a more robust price intelligence tool. We believe that'll give us greater value in the future as well. A number of things at play here, but all very positive as we move forward with our ONETractor strategy.
Okay, great. Thanks, guys.
We'll take our next question from Seth Sigman with Credit Suisse.
Hey, guys. Thanks for taking the question. A couple follow-up questions here. I guess, just first on the investments and the margin outlook. I'm just wondering, have you guys built in any positive offsets within the guidance? In general, if you think about the potential for sales to maybe come in better, would that flow through, or would you offset that with more spending just given the demands and the higher investment requirements that you're basically talking about? Thanks.
Yeah, Seth, this is Kurt. You know what? When we built our outlook, for 2018, we took a pretty rigorous look at all of the costs and all the spend. I would tell you that in an investment mode like this, we certainly have an opportunity, and there are some benefits that we've got that are offsets to these investments that are baked into that outlook. As we're growing the top line and with comp positives in there are areas in the overhead store support center costs, the store and distribution center occupancy costs. Some of the investments we've made in there, as well as leverage, we're seeing the benefits. We're taking a pretty rigorous look at, and we are managing tightly, and there are definitely some benefits that play into the outlook to help offset some of those investments.
Okay.
The second question.
The second part of that was just to the extent that sales do come in better. I realize some of the investments are within your control, some are not, but would better sales flow through, or do you think that you would accelerate spending further just given the investment requirements in the business?
Yeah, Seth, I would say that we've got a pretty good, aggressive investment plan, I think, as you've seen. As those investments start to take hold, and as we believe they will begin to drive the sales, our plan, our strategy is we'll invest to where our capacity and capability is, and I think we've got a realistic capacity in there. You'd see some benefits dropping to the bottom line.
Okay. Thanks very much.
We'll take our next question from Elizabeth Suzuki with Bank of America Merrill Lynch.
Hey, guys. Thanks for taking the question.
Hello.
Oh, hey. On your planned store opening pace, it's slowing a little bit from about 6.6% in 2017 to about 5% in 2018. The first question is, are there still a few stores left to close? Second is, why slow the pace of store growth if you're going to have some extra cash post-tax reform? Obviously, you're making some investments in ONE Tractor that are going to be pretty significant. Is there also maybe a strain on management resources in terms of finding the right people to run new stores?
Liz, hi. This is Greg. There's no limit on how many stores actually we could open from the standpoint of management in the ranks ready. The reason we slowed to 80, if you want to call it that, I see it as a redirection of our capital investments. We've had some tremendous success with some of these ONE Tractor initiatives, and it's a bit of a reallocation of capital in the short term to accelerate those and continue to keep the store opening schedule robust. We don't have anyone that's chasing us for these sites, and we're going through some new data that's demonstrating again to us that there are at least 2,500 as a number of Tractor sites out there. We know that Tractor stores are a great value to the consumer, and they also help us from the standpoint of profitability as a company.
We really are just reallocating some of those dollars to accelerate some of the things in ONETractor that right now are showing us great promise.
All right. Great. Thanks very much.
We'll take our next question from Christopher Horvers with JP Morgan.
Thanks. Good evening, guys.
Good evening.
My first question is, can you talk about the performance of the oil and gas markets, they were a drag as oil prices dropped, then they were more neutral, I think, over the past couple of quarters. How has the performance of those stores changed in the fourth quarter relative to, say, the second and the third?
Yeah. Chris, this is Kurt. I would tell you that, as we've seen it and said that the Texas, Oklahoma oil market and other energy areas, those headwinds have subsided. The last couple of quarters prior to Q4, we said that we saw those areas falling in within chain average. I would tell you, we were pleased in the fourth quarter, in those particular areas, to see some good, strong performance in there in line with chain average. So as you're seeing indicators of that area, I would say that we're pleased to see that no longer really being a headwind for us.
Understood. Also, there's a bit of an earlier Easter this year. I think it's April 1st. It falls right, I guess, at the start of your second quarter. Historically, has an earlier Easter helped you? Is it 50 basis points? Is it 25? Is it 75? Any quantification would be very helpful. Thanks very much.
Sure. It's a good question. I would say that it's not about an early Easter helping or hurting. I think it's a good point to bring up in that the timing of Easter between the halves, where it plays into. This year, we've got Easter on the Sunday right after the end of Q1. The holiday weekend, that Friday and Saturday, will be in Q1. That can shift a little bit between Q1 and Q2. When weather breaks in March has probably more to do about the impact than that weekend. I would say that as you look at that, we anticipate that that weekend falling into Q1 can have some impact, but not of material.
Okay. Thanks very much. Have a great quarter.
Thank you.
We'll take our next question from Michael Lasser with UBS.
Good evening. Thanks a lot for taking my question. My question is on the outlook for comps over the next few quarters. It sounds like deflation's become less of an issue. The oil and gas markets have stabilized. You're providing an optimistic outlook for the next couple of quarters where you said that you expect your comps to be above 3% or near that range. Yet you're in the second half of the year. Admittedly, your comparisons become harder, but you're also talking about sub 2% comp when all of these factors should continue to be benefits, and you'll experience a return on the investments that you've been making. Why would you only be expecting less than a 2% comp in that sort of scenario?
Sure, Michael, this is Kurt. In regards to our outlook, as we looked at the year, I'd say the most significant factor in there is the strength of the second half of 2017 and the compares that are there. We had in Q3 two strong hurricanes that will be cycling, as well as a good, strong performance in fourth quarter with weather and other positive factors. We've got that compare to go up against. When we look at the year, we're taking a good, realistic approach as to what we can actually drive in regards to traffic and sales and aren't making too many wide assumptions about what might happen in the second half there. We're going to drive our strategies that we believe will benefit both the first half and the second half, our guidance is more about our ability to have good, consistent traffic.
It's more about the compares in the second half of the year.
My follow-up question is on the performance of the new stores in the fourth quarter. If we back out the stated contribution from the extra week, it looks like the new store productivity was in the high 50% range. Is that right? Is that what you expect new store productivity to be moving forward?
Michael, I would just say that that percentage would not be consistent with new store productivity as it's calculated. I understand the 53rd week makes this fourth quarter probably the hardest one to calculate for new store productivity. Here's what I'll tell you, is that we continue to be pleased with new store productivity. Fourth quarter had a good, strong new store productivity. Consistent with the last few quarters in 2017, our new store productivity is consistent with 2015 and those years where we saw strength in new store productivity. We're pleased. We look at our new stores and measure against performance to the pro forma and the IRR hurdle, and the 2017s have outperformed both of those. We're pleased with new store productivity.
Thank you very much. Good luck with the year.
Thank you.
Thanks.
We'll take our next question from Ben Bienvenu with Stephens Incorporated.
Good evening. Thanks for taking my questions.
Hey, Ben.
I wanted to ask about operating margins in a little bit different way. You said you expected the midpoint operating margins for this next year to be 8.8%. Is it your expectation that this is sort of a low watermark in the multi-year trajectory for operating margins longer term, and you still think a 10% operating margin goal long term is a realistic goal?
Yeah, Ben, this is Kurt. I would tell you that if I'd step back, talk a little bit about the business and what we see long term in that. I would say the business is strong. The investments are clearly paying off for a lot of the things that Greg mentioned earlier. The investments are having some pressure and had in 2017 and are having pressure as we anticipate in 2018. We're committed to those investments being made, to drive long-term top line, then the overall bottom line, we believe that we're going to grow with those investments, EPS at a low double-digit range. As we manage those investments and our costs, we can grow operating margin. As you look at 2018, we will be focused heavily on the cost and manage those investments.
We believe we have the opportunity in the long term to continue to grow operating margin.
Okay, great. Thanks for that. I wanted to shift as it relates to some of your investments and distribution network changes. Can you talk a little bit about what you're seeing in terms of the impact of the West Coast 3PL transload center and what you think it could mean for your business as you put in place your East Coast import center in 2018?
Yeah, this is Steve. What it's really helped us do is bring product in, house it, and ship it out based on need. In the past, we were shipping container loads to our distribution centers, and it wasn't as effective as it needed to be because we were filling those containers and those DCs with more product than they actually needed. By having these transload centers, what we're able to do is take the over and above, pare them down and ship them to the stores that actually need the product. It should have a benefit in our seasonal inventories and make us more nimble as we move forward rather than having more clearance on the backside.
The last thing I'd tell you is it also allows us to build pallets of product for our stores so that the operations of the business, when it gets to the store, can be more efficient. In the past, it would all come in and have to be sorted out. These transload centers now will allow us to go ahead and pull together a lot of the seasonal product and ship it in one pallet to the stores.
Great. Thanks for all that detail, and best of luck.
Thank you.
We'll take our next question from Alan Rifkin with BTIG.
Certainly appreciated that as a result of the tax legislation, you are making some reinvestments, particularly in the form of higher wages. Yet, if we look at your forecasted operating margin for 2018 of 8.8% at the midpoint, that's lower than where you were even five or six years ago. At what point in time do you believe that all of these reinvestments, not only in wages, but other areas, at what point in time do you think that will result in incrementally higher operating margins? I have a follow-up, please.
Sure, Alan. It's a good question. As we've said, in the last few years, we've been making investments, and you're seeing some of those investments and the impact on the operating margin. Our long-term goal is to grow operating margin annually. We believe that's achievable. As I mentioned previously, our investments that we've been making, we believe we're making them in the right area. They're driving the long-term growth potential. Those sales growth opportunities, typically in our plan that they would lag the initial investments. Those investments over the last few years are generally starting to plateau. When we look at that, we see that the investments and with the top-line benefit, our ability then to grow operating margin. We're very focused on 2018 right now.
I would tell you that, as we see the long term, we're committed to our ability to grow the bottom line profits, and we believe with those investments, the strength of top line, you'll see operating margins improving.
Okay, thank you. A follow-up, if I may. Certainly, if we look at CPI and PPI data and you listen to what the Fed is forecasted to do in 2018, there are certainly greater signs of inflation. As part of your 2%-3% comp guidance, and regardless of what inflation or deflation may be at the product level, are you contemplating perhaps taking prices up to help offset some of these higher costs?
Yeah, this is Steve. I would tell you we're going to be opportunistic. We constantly do a scan of the marketplace, and where we see potential and opportunity, we take advantage of that. That is certainly on the table, and we will adjust accordingly. We also want to make sure that it's balanced with market share, like we've always told you all, and we're making sure that we're doing the right thing for the long term of the business. If that opportunity presents itself, I can pretty much guarantee we will take advantage of it.
Would you be a price leader or would you wait to see what competitors do?
Yeah, I would tell you that there are markets we've got where we will certainly be price leaders. There will be markets that we're at where we'll be watching the market very closely. We are a test and learn company. We've got a price optimization tool that allows us to look at elasticity, and we will do just that.
Okay. Thank you. Best of luck in the new year.
Thank you.
Thank you.
We'll take our next question from Scott Mushkin with Wolfe Research.
Hi, guys. This is Paul Carnahan for Scott. Thanks for taking my question.
Hey, Paul.
I'm curious if you can maybe provide any detail on what you've learned from your core customers through the loyalty program.
Sure. This is Steve. One of the things that we've certainly learned is that they have a keen interest in wanting to build a stronger relationship with us. The enrollment that we've had today has exceeded our expectation and continues to do so. I would also tell you, those folks that are core customers that are part of the program, there's a higher engagement in terms of click-through rates, open rates, redemption of offers. We recently did a study, and this is pretty interesting. These folks have a much higher statistically significant difference in their likelihood to recommend us to others, to return, and their overall satisfaction with Tractor Supply Company is higher. There's a lot here that we're learning. They're coming in more often, and when they do, they spend more.
As we move forward, our focus is on continued enrollment and in continued engagement through personalization to drive more loyalty. If there's one thing that, I guess to me, looking back, is a surprise, I would tell you it's the amount of activity that our core customers are coming to us and how often they come to us to buy their needs and get what they need. It's a much higher frequency rate than we had originally anticipated, now we're able to segment those customers off and talk to them in a more personalized manner.
Great, thank you. Just a quick follow-up. I guess qualitatively, how does the management team look at balancing between growth and improving ROIC, I guess, over the short term and longer term? How important is ROIC as you make these investments through the year? Thank you.
Yep. Paul, this is Kurt. As Greg mentioned, we focus on both of those. We understand the importance of maintaining a good ROIC. The important thing for us as we look at it, and maybe to share in regards to our perspective on it, is that we are making significant investments. These are key investments for the long term. During that time, as those investments may take time to take hold on the top line, you're seeing some pressure on ROIC. We do look at, with each investment, the return on investment and how we balance ROIC. It's part of our overall management, and I would tell you that we believe with the investments we're making today, it'll not only drive the top line, but in the long term, ROIC improvement.
Perfect. Thanks, guys.
We'll take our next question from Matt McClintock with Barclays.
Hi, yes. Good afternoon, everyone, and welcome, Mary Winn. Just on wages, wanted to follow up on that. You guys seem to have been ahead of the curve in addressing this topic last quarter specifically. I just wanted to know, has there been any real change in how you think about wages relative to last quarter now that Tax Reform's been passed? Kind of related to that, it'd be nice to revisit, since you're a high-growth retailer, one of the few that are opening stores, how do you think about finding employees, not store managers, but employees in what is an increasingly a tight labor market? Thanks.
Hey, Matt, this is Greg. Two things. One is changes from maybe a quarter ago till now. I think what we're seeing is we have a unique consumer base. We have a unique team member that wants to work in Tractor Supply. Probably not the average person that would work in some of these other formats. They typically have a love for the lifestyle. They have a passion for living this lifestyle. We attract team members from those local communities because they enjoy the lifestyle and want to participate in it. Guess what? Working for Tractor Supply, they can get a discount on those things that they need. That's the first thing. We're not having a problem attracting those people.
Some of the changes that we are seeing is there are some retail organizations that are making bold statements about, "We're going to have a minimum price guaranteed to our team members of X, Y, and Z." Here's how I look at that, and I've said this to our organization. I said, "We need to be priced very competitively, if not leading the market, in each of the markets where we have stores." We're in 49 states. Those 49 states are not equal. There's different challenges, and there's different, I will call it wage rates, that need to be addressed. Some states are passing state laws that force some of that. Other states are not.
We've taken a very proactive posture and said, even in our 2018 planning, given some of the tax advantages that we have, we're going to stay not only very competitive on wages, but in many cases, we're going to be probably the person maybe leading up in the wages because we need to make sure we've got the best people, period.
Thanks a lot for that, Greg. If I could have a follow-up. Just on buy online, pick up in store, the vast majority of your sales flow through that channel. I was just wondering, you launched that capability impressively just a little bit more than one year ago, and now it's more than half of your sales. Did that mix shift towards buy online, pick up in store cannibalize your existing e-commerce business, or was it largely additive to your existing e-commerce business before?
This is Steve. It's been additive. As a matter of fact, we're seeing growth in both areas. Comp store sales, so to speak, on the ship-to side continues to scale up.
Perfect. Thanks a lot. Best of luck.
Thank you.
We'll take our next question from Matthew Fassler with Goldman Sachs.
Thanks so much. Good afternoon, guys.
Good afternoon.
My first question relates to the investments that you've discussed. Is there a way to apportion how much of them relate to cyclical pressures such as freight and shipping and labor as opposed to what you'd call strategic investments that don't relate at all to the cost backdrop?
Yeah, Matt, this is Kurt. The easiest way I could tell you is about 50% of the additional cost increases that we pointed out, I would bucket as investments, and the other 50% are really more the cost pressures. The transportation piece of that is probably the biggest one of that 50% that's cost pressures, and the majority of the rest is the investments.
Should we think about that 50% that relates to investments basically aligning with the piece of the tax windfall that you're reinvesting? Is that a way to think about that relationship?
About a little over a third, as I mentioned, it's probably 20 basis points.
Yeah
of the operating margin comes from our tax investment. It's not all 50% of it, but it's probably more than a third of that is from our conscious investment on the things we mentioned with the opportunity of the additional resources to invest in a key strategic part of our business, such as our team members. We're investing in those areas. That's probably the right quantification of that.
Got you. Separately, you mentioned in your remarks earlier that you were going to start to test subscription commerce. I'm wondering if the categories that would be most appropriate for subscriptions, presumably large on C.U.E., align with the businesses where you currently have e-commerce penetration, and what the cost, essentially, the logistics and shipping charges or costs associated with those categories would suggest for the return profile if that were to take hold.
It's a great question. One of the things we've got to do is find out whether or not our customers even have an interest in subscription through Tractor Supply Company. This is going to be a slow roll. It's going to be a test and learn. We're going to start with a few categories, see what kind of interest there is. The great thing about the opportunity and the tool is we can geotarget. There's a variety of things that we can do here, so it doesn't get out ahead of us. It's going to be managed. As we continue to scale, if it works, we'll be able to communicate to you along the way what impact that it has.
Steve, would you say that the Neighbor's Club and the data that you've obtained from it has indicated that your customers are purchasing with you with the kind of consistency that would suggest a subscription would be a good fit?
That's a really good question. I would tell you that I think there might be some interest. I think we owe it to our customers, quite frankly. When you look at retail today, you've got to evolve with where the market's going to go. I believe we owe it to our customers through our idea of anytime, anywhere, in any way, that whole idea of being a convenience for them. I think we need to do it based on scale. We need to do it based on our ability to make sure we execute and offer the right customer service along the way, and we need to do it in a way for our shareholders that we don't do it so that it's going to be overly costly.
We will manage this appropriately, but we do believe we owe it to them to at least offer that capability.
Thank you.
Noah, I think we've hit the top of the hour, I think we'll wrap up now. I'm going to turn it back over to Greg for a wrap-up. I know we're leaving some people in the queue, I apologize about that. My number is 615-440-4212, I look forward to speaking to anyone that's interested in calling. Please give me a call, I'll turn it back to Greg.
All right. Well, thank you everyone for being on the call today. I'm excited that we're going to be hosting our upcoming annual sales meeting for over 3,000 of our Tractor Supply team members here in February. During that same time, we're going to be hosting our investment community day. That's scheduled for February the 20th here in Nashville, where we plan to further discuss our strategic growth drivers for the long term with all of you. If you have any questions, as Mary said, please reach out to her. She'll be happy to help you with any further questions. Again, thank you for dialing in today.
That does conclude today's conference. Thank you for your participation, and you may now disconnect.