Tractor Supply's CEO Discusses Q4 2012 Results - Earnings Call Transcript

| About: Tractor Supply (TSCO)

Tractor Supply Company (NASDAQ:TSCO)

Q4 2012 Earnings Call

January 30, 2013, 5:00 pm ET


Jennifer Milan – FTI Consulting

Greg Sandfort – President, CEO

Tony Crudele – EVP, CFO


Mark Miller – William Blair

John Lawrence – Stephens

Vincent Sinisi – Bank of America

Peter Benedict – Robert W Baird

Matthew Fassler – Goldman Sachs

David Magee – SunTrust

Matt Nemer – Wells Fargo Securities

Brian Nagel – Oppenheimer

Chris Horvers – JPMorgan

Adam Sindler – Deutsche Bank

Simeon Gutman – Credit Suisse

Eric Bosshard – Cleveland Research


Good afternoon, ladies and gentlemen, and welcome to the Tractor Supply Company’s conference call to discuss fourth 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. (Operator Instructions)

Please be advised that reproduction of this call in whole or in part is not permitted without prior written authorization of Tractor Supply Company. And as a reminder, ladies and gentlemen, this conference is being recorded.

I would now like to introduce your host for today’s conference, Ms. Jennifer Milan of FTI Consulting. Please go ahead, Jen.

Jennifer Milan

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-looking statements will prove to be correct.

Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in the company’s filings with the Securities and Exchange Commission.

The information contained in this call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time. Lastly, Tractor Supply Company undertakes no obligation to update any information discussed in this call.

Now, I’m pleased to introduce Greg Sandfort, President and Chief Executive Officer. Greg, please go ahead.

Greg Sandfort

Thank you, Jen, and good afternoon, everyone. I’m delighted to be speaking with you today in my new role as Chief Executive Officer after what has been a very smooth transition between Jim Wright and myself. With me today is Tony Crudele, our CFO.

We are very pleased with our fourth quarter and full-year performance, which underscores the continued strengths of our business. Our teams are performing exceptionally well in what remains a very challenging retail environment. And our attention to our customers’ changing needs has never been more focused.

Each quarter in 2012 we made progress in the areas of new merchandise offerings, refinement of our regional assortments, supply chain efficiencies and management of our inventory, all of which are contributing to our continued growth and profitability.

Now let me discuss in little more detail some particulars regarding our fourth quarter results. In terms of specific sales drivers, two categories – the consumable, usable, edible part of our business – remains very strong and was a key component in driving both traffic and sales.

We are increasing our market share in these categories and are becoming in the minds of our customers the most dependable supplier for their need-based products. We also remain very focused on keeping our customers highly engaged with the Tractor Supply brand by providing newness to product innovation.

We continue to see a high level of sales and profit performance from our exclusive brands with mix at roughly 24% of sales, up 150 basis points from last year’s fourth quarter.

Our immediate plans are to continue expansion of these exclusive brands through brand extension. And because these brands can only be purchased at Tractor Supply, this will ensure Tractor Supply will achieve the product differentiation from other farm store competition and internet retailers.

Pet food and animal feed continue to generate solid results in the fourth quarter and remain important drivers of repeat footsteps in our stores. As an example, EquiStages, our exclusive brand of equine feed introduced about 10 months ago, continues to perform well within our mix of feed due to number one brand positioning, secondly, quality of ingredient and, third, the value price proposition it offers versus the national brand comparative.

Our forage business continues to build momentum as we expanded the program to more stores this past year. We exceeded our goal of 600 stores by year-end, ending the year with 750 stores with forage product.

This effort required a tremendous amount of hard work and diligence on the part of our buying teams and is another excellent example of how TSC is meeting our customers’ core needs through extension of offerings within an established category, this namely being feed.

In the quarter, we experienced a small sales benefit from Hurricane Sandy, which directly drove sales of emergency related merchandise. But more importantly, we are extremely proud of our Northeastern store teams, our distribution team members at our (Hagerstown), Maryland facility and across our entire distribution center network who worked selflessly and tirelessly to support their communities in their time of need.

I also want to express my sincere appreciation to those in our vendor community who worked side by side with our teams in our store support center to obtain inventory quickly so that we could assist those most in need following the storm.

Such efforts as these to go above and beyond to meet our customers’ needs in a crisis exemplify the teamwork culture at Tractor Supply. I believe this is one of many reasons for our continued improvement in our customer loyalty scores and, in fact, on a year-over-year basis we improved our scores every month in 2012 and ended the year with a record customer loyalty score across all regions within the company.

Weather conditions for the quarter for sales of cold weather products remained less than ideal, however. And as in the past, our team again successfully managed through these unfavorable variables and delivered growth in comp store sales and another double digit increase in profitability on top of a strong fourth quarter a year ago.

Our effective management of inventory through the quarter is another milestone achievement. I’m convinced this was accomplished in part because of the many structural changes we now have embedded into our daily operation.

Our team has done an outstanding job managing inventory levels and, most importantly, we ended 2012 with our fall winter carryover inventory well below a year ago.

So let me conclude my remarks by stating that I am delighted with our team’s ability to adapt our business to changing conditions while still driving improved profitability.

Operationally, we made great strides on our key strategic initiatives and this progress has yielded sustainable improvement for our business.

As we look to 2013, we have never been more excited about the opportunities that lie ahead. I’ll now turn the call over to Tony to review our financial results and discuss our 2013 outlook. I will return following his remarks to share my closing comments.

Tony Crudele

Thanks, Greg, and good afternoon, everyone. For the quarter ended December 29, 2012, on a year-over-year basis, net sales increased 10.8% to $1.29 billion when you adjust for the one additional week we had in our fourth quarter last year.

Correspondingly, net income grew by approximately 24% to $79.5 million or $1.11 per diluted share adjusted for that additional week.

As a reminder, this year’s fourth quarter consisted of 13 sales weeks compared to 14 weeks last year as our fiscal 2011 was a 53-week year.

We achieved these strong results despite a warm winter season and being up against robust sales growth last year. Comp store sales, which is the more relevant measure, increased 4.7% for the fourth quarter compared to last year’s increase to 7.1% adjusted for the one-week calendar shift.

Comp transaction count increased for the 19th consecutive quarter gaining 2.7% on top of a 3.6% increase last year. We are very pleased with the core business as two products, specifically animal feed and pet, continued to serve our customers’ basic and functional needs and drive transaction count increases.

The trended average comp ticket continued to be positive at 1.8% versus last year’s 3.8% increase. The impact of this inflation was approximately 165 basis points for the quarter, which was within our projected range of 100 to 200 basis points but significantly less of a benefit than last year’s estimated 500 basis points.

Big ticket merchandise performed consistent with company’s overall comp sales increase and had a favorable impact on comp ticket of approximately 30 basis points. Big ticket was bolstered by Hurricane Sandy emergency response sales, such as generators, but this benefit was moderated by negative trends in sales of winter goods such as snow blowers and log splitters due to the unseasonably warm winter.

Other key notes regarding the quarter, we did an excellent job of managing through the variable weather conditions throughout the country, particularly those impacted by Hurricane Sandy.

On a regional basis, all regions had positive comp sales. Sales were the strongest in the southwest and southeast as moisture conditions were favorable in these regions and the seasonal business was less impacted by the warm weather.

Comp sales trends were generally consistent by month throughout the quarter. We did end the quarter on a very strong note as holiday sales kicked in and comp sales benefitted this year from the additional holiday shopping weekend between Thanksgiving and Christmas.

Emergency response, including Hurricane Sandy, had a modestly positive impact on comp sales, which we estimate to be approximately 30 basis points for the quarter. We did not suffer a significant number of lost sales days and we are proud of our team members for showing tremendous dedication in supporting their communities with many sacrificing to open stores and going above and beyond to serve customers in their time of need.

Turning now to gross margin, which as a percent of sales increased by 50 basis points to 33%, we continued to benefit from our key gross margin initiatives, which are price optimization, strategic sourcing, exclusive brands and mark down management. These initiatives combined with strong merchandise leadership yielded significant improvement in direct product margin rate.

This improvement more than compensated for the negative impact of the continued mix shift to key products which have a margin rate lower than chain average.

Freight increased approximately 13 basis points partially offsetting the product margin benefit we experienced in the quarter. This increase in freight is principally as a result of the cost related to increased import activity of seasonal goods and the mix shift to freight intensive key products.

Big ticket sales did not have a significant impact on gross margin rate during the fourth quarter. Although the sales of lower margin emergency response products were higher due to Hurricane Sandy, the unfavorable margin impact was offset by softness in sales of other winter related merchandise such as snow blowers and log splitters, which also carry lower than chain average margin.

We did have an easier margin comparison in the fourth quarter as we took a $2.7 million charge last year for the exit of our welding gas program from several hundred stores. This represented 20 basis points of the year-over-year improvement.

Import purchases in the quarter accounted for 9.6% of total purchases, which represents 11.7% increase year-over-year. Overall, we’re pleased with the gross margin performance during the fourth quarter and that our gross margin initiatives provide us with the ability to maintain gross margin rate in spite of product mix and freight headwinds while continuing to provide great values to our customers.

For the quarter, SG&A, including depreciation and amortization, was 23.3% of sales reflecting 20 basis points of improvement for the prior year’s quarter. We are extremely pleased with our field and store payroll cost controls and ability to leverage SG&A in the quarter, especially since last year’s quarter had an additional selling week as a result of the 53-week year in 2011.

We had estimated that the additional week last year had a favorable impact of approximately 15 basis points.

We did book adjustments last year in Q4 related to the write down of certain ecommerce assets which made the comparison easier by 26 basis points. Incentive compensation was less than last year as well.

Turning to the balance sheet, we ended the year with $147 million in cash, meeting our year-end target of $100 million to $150 million.

During the fourth quarter under a stock repurchase program, we acquired approximately 1.21 million shares for $108 million. We estimated the share repurchase program had a slightly less than $0.01 impact on EPS for the quarter.

Average inventory levels per store at year-end increased just under 1% compared to last year. The rate of increase was well below our estimated inflation rate and we are comfortable with our year-end inventory levels of seasonal merchandise.

As a result of our strong inventory management, inventory turns for the year improved to 3.28 times, or five basis points better than last year.

Capital expenditures for the year were $153 million as compared to $166 million last year. We opened 25 stores in the fourth quarter compared to 31 stores in the fourth quarter of 2011.

Our capital spend is generally consistent with the prior year but below our expectations that would be at the high end of our forecasted range of $160 million to $170 million.

While our projects remain on target, anticipated expenditures around our southeast DC relocation, the construction of our new store support center and certain IT projects shifted into 2013.

So turning our attention to 2013, we expect full-year sales to range from $5.07 billion to $5.17 billion. We have forecasted comp sales to increase between 3% and 5%. We are targeting improvement approximately 10 to 20 basis points in EBIT margin compared to 2012 with the majority coming from gross margin as a result of several of our key merchandising initiatives.

We anticipate net income to range from approximately $304 million to $310 million or $4.32 to $4.40 per diluted share and we expect to open 100 to 105 new stores with approximately 50% to 55% opened in the first half of the year.

As we’ve emphasized in the past, we believe our business can be more accurately assessed by focusing on the halves, not the quarters, as weather patterns can change significantly from year to year and shift the timing of the sales.

It is particularly important to keep this in mind as you look at the first half of 2013 as we had an early spring last year and we estimated we pulled approximately $38 million forward into Q1 from Q2.

Let me discuss some of the more specific drivers and assumptions that helped us form our projections for 2013.

Although the consumer will continue to be concerned about the ongoing high unemployment and the impact of higher payroll tax on their take-home pay, we do not expect that the current retail environment will change dramatically.

Although there was some positive and negative weather events in 2012, such as the hurricane activity and the drought in the Midwest, we believe it was a net neutral year from a weather perspective, therefore, we do not anticipate the cycling against last year’s weather trends will have a significant impact on a year-over-year results in 2013 other than the potential shift to sales between Q1 and Q2 as I previously mentioned.

We expected the inflationary impact will be approximately 1% to 2% for the year and that we’ll be at the higher end of the range in the first half of the year and slightly less in the second half of the year.

The increase in EBIT margin is net of an approximate $6.5 million to $8 million headwind or $0.06 to $0.07 EPS drag that we anticipate to incur as we relocate our southeast distribution center and our store support data center.

These costs include duplicate occupancy expense while we transition facilities, temporary labor during the transition, freight movement costs between facilities and equipment depreciation.

These costs will be principally reflected in SG&A with the majority of the expense occurring in Q2 and Q3.

For the full year, we expect net gross margin rate expansion of approximately 10 to 15 basis points. We expect to achieve our gross margin rate improvement through the execution of our key gross margin initiatives.

These initiatives will provide us the ability to overcome an estimated gross margin headwind of approximately 10 to 15 basis points from the continuing mix shift to our key products which carry a below chain average margin rate.

We also expect freight costs to remain a headwind as we experience deleverage from the merchandise mix shift to more freight intensive key products. Additionally, (stem) miles per store will increase slightly as we continue to open new stores in the west.

In terms of cadence, we expect gross margin percent will be flat to slightly down in the first half of the year with improvement weighted more to the second half based on our forecasted merchandise mix, our initiatives continue to drive value and cycling softer margin comparison in Q3.

Inventory turns are expected to improve slightly. We would expect per-store inventories to increase modestly, consistent with investments and key merchandise categories and inflation.

We may experience slightly higher inventory levels at the end of Q2 as we transition to our southeast distribution center.

With respect to SG&A, exclusive of DC and datacenter charges I discussed previously, we continue to target our SG&A growth to leverage at 3% comp and to manage our business accordingly.

Store support center and store payroll is expected to leverage slightly as we grow our comp sales base and cycle a more normalized level of incentive compensation which should offset wage and healthcare increases.

Some key points with respect to the quarters, remember that Q1 last year was unseasonably warm, which resulted in reduced expenses of approximately $1.5 million related to snow removal and utilities.

With respect to the datacenter – the distribution center and datacenter relocation, we estimate that the majority of the expense will be incurred in Q2 and Q3. We’ll be cycling Hurricane Sandy in Q4 and, as in the past, we will provide more color regarding our expectations for the subsequent periods at each quarterly conference call.

For the full year, we forecasted our effective tax rate will be approximately 36.5%, consistent with 2012. Due to the timing of certain tax incentives that were reinstated on January 1, 2013, these incentives will be treated as a discrete tax item in Q1 and we have estimated a favorable impact on Q1 tax rate of approximately 100 to 120 basis points.

We plan to have a significant increase in capital expenditures in 2013 with a range of approximately $240 million to $250 million for the full year as we complete the construction of our southeast distribution center and begin construction on our new store support center scheduled to be completed in 2014.

We expect store growth and general maintenance capital to increase slightly to approximately $110 million to $112 million. We also have allocated approximately $130 million as a place holder for our elite store acquisition program and potentially four self-developed store projects.

We will continue to make purchases under our share repurchase program as part of our long-term objective of reducing our cost of capital and maintaining a target cash balance of $100 million to $150 million.

For modeling purposes, we estimate that the diluted shares outstanding inclusive of option grant and share repurchase activity will approximate $71 million for the full year. Now I’d like to turn it over to Greg for more details on our plans for 2013.

Greg Sandfort

Thank you, Tony. Regarding the retail environment, we have seen very little change from recent quarters regarding our customers’ purchasing behaviors. Our consumers are spending conservatively and are seeking out compelling values.

Purchases are being driven by necessity and are taking place much closer to need. Today, Tractor Supply is responding more quickly to the opportunities within our business and we make an effort every day to understand and anticipate the changing needs and wants of our customers.

Our ability to respond quickly to shifting customer demand has contributed to our performance and will continue to drive our sales in the coming year.

Looking ahead to the spring selling season, although there could be a shift in sales between the quarters, as Tony commented earlier, we are confident that we have the right plans in place to drive improved results and are pleased with our overall inventory position as we enter spring.

Our customers will see newness across the store, which we believe they expect from us and will, in turn, will purchase from us. The teams remain relentlessly focused on improved execution throughout the business and believe we have considerable opportunity ahead to increase our market share.

As we continue to expand our footprint in key regions, we remain very comfortable with our annual square footage growth rate of approximately 8% and with our strong balance sheet, we are investing in strategic capital initiatives that will ensure our growth for longer term.

In closing, I would like to thank every Tractor Supply team member for their ongoing hard work and commitment to our company. I want to thank Jim Wright, our Executive Chairman, and our Board of Directors for their support and our shareholders for your ongoing investment and confidence in Tractor Supply as a growth company.

I’m delighted to be working with such a seasoned and talented executive team and acknowledge the opportunity to serve you, our shareholders, in my new role as Chief Executive Officer.

Operator, I would now like to open the call for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Mark Miller – William Blair.

Mark Miller – William Blair

Given the strong outlook for 2013, could you provide updated perspective on where you see the margin potential of the business? I think your prior objective around 9.5% looks, if our math is correct, as if you can be there in ’13. So what is the upside potential and should we think about that more along the lines of gross margin?

Tony Crudele

I’d like to remind you that the 9.5% EBIT target is really set as an interim goal and we have not yet hit the 9.5%. We will continue to evaluate that position. It’s much easier for us to stay in that long-term perspective of growing the business at the 10 to 20 basis points of EBIT margin improvement each year.

We’ll continue to reassess and we’ll definitely get back to the marketplace as we approach and exceed the 9.5%.

Mark Miller – William Blair

Let me maybe ask a follow-up. If there were to be areas that you would look to invest at a more aggressive rate, what would those areas that you would consider as tradeoffs?

Greg Sandfort

Mark, if you’re asking what parts of the business potentially could drive sales but could be a bit of a drag on margin – is that what you’re asking?

Mark Miller – William Blair

Exactly and to what degree might that play out as we go through the year into next year.

Greg Sandfort

Well, one of the things that we talked about earlier in our comments was the driving force of Q. And we’ve stated many times that it works at a less than company average margin rate but the dollars it throws off are considerable.

It helps us leverage on the SG&A side and also we’re looking right now at our business a little differently from a mix standpoint because Q is growing but we’re also finding that in the box other components of that box are starting to grow.

We’ve got a business on the outside of the store with a lot of product that Steve and the team has been working on. The left hand side, being more the hard lines business with a mix of the products are higher margin, so I guess the blend is what I’m saying to you we think we can control and we do believe as we move forward we’ll still see some growth in our EBIT margins but it’s hard to say when we’ll hit the 9.5% and when we’ll go beyond but we still believe that there is tremendous momentum behind Q and that is going to be one of the things we have to just monitor and watch from a mix standpoint.


Your next question comes from the line of John Lawrence – Stephens.

John Lawrence – Stephens

Greg, would you mention a little bit – you talked about the newness in the spring season a little bit, what we expect there and if you split that out and take it another step with the regional product and just how far do we have to go there and maybe some examples of success there on that regional brand?

Greg Sandfort

Well, on newness factor, John, you know that we talk about changes in the store every year and in the first part of the year we make most of our plannogram, hard plannogram changes.

And we’ll touch between 30% and 40% of the store updating plannograms and bringing in newness there. The second piece is about what we do in the center cord and on the outside of the store.

And Steve and the team have done a wonderful job of bringing literally probably 50% to 60% of new product into those spaces year after year. You’ll see that again this year as you walk into our stores. You’ll notice new things that are either brand extensions or maybe we’ll be testing and trying some new products.

And we have a lot of confidence that through the testing of the last two years and our live product categories and this whole garden concept of our consumer being sustainable and growing their own vegetables and so on and so forth and foods that this is going to be a business that is going to serve us well for some time.

So there’s movement inside; there’s movement outside. You’ll see more of this as we use our advertising to talk to it. But quite a bit of newness, quite a bit of newness.

John Lawrence - Stephens

Do we have to wait a few weeks to hear more about the crawl stop?

Greg Sandfort

Yes. We’re analyzing that right now.


Your next question comes from the line of Vincent Sinisi – Bank of America.

Vincent Sinisi – Bank of America

Wanted to ask first about your gross margin initiative. Obviously you had some nice continued progress this quarter. But can you guys just give us an update in terms of where you are and specifically maybe where we are from the price optimization standpoint?

I know now it’s been quite a while since all the items have been loaded into the software. Can you just give us an update in terms of where you are today with that?

Greg Sandfort

Yes, Vince, I’ll talk a little bit about some of the initiatives and we’re start with price op. As we now are into year two of price optimization. What we’re finding is that it’s a very iterative process and that changes we’ll make within the testing module that we have and I’ll remind you that we don’t just turn this system on and let it run. We do test and then we have against control stores to make sure that we’re getting the right results, our anticipated result that we thought.

But once we do that, we put that into play and we look at sets of SKUs, it changes the dynamics of the sales. We see it sometimes, some sales moving to other SKUs and vice versa.

So what this helped us do longer term is look at our overall assortments and say do we need to change the depth within X, Y, Z SKUs and maybe we don’t need to carry these other SKUs in the assortment any longer because there’s been a transferrable demand.

And that’s the learnings that we’re now starting to see along with the fact that making sure that we’ve got our prices right by district, by store and sometimes across region on a lot of our Q products and the high velocity products.

So we’re still, in my opinion, as I see how this is developing and I see the kind of results that we’re starting to measure against, it’s a much longer-term journey than I think I initially anticipated.

We mentioned a little earlier about the other things in gross margin, the direct sourcing of product and our exclusive brand. I mentioned one earlier about EquiStages. The team continues to find opportunities within our assortments where we can build and place into the assortment a very competitive product under our own brand that our customers will accept and embrace and they’ll purchase.

And in many cases, it’s not cannibalizing. It’s actually additive to what we have in our assortment because we recognize the gap that either the national brands can’t serve or the generic (inaudible) can’t.

So those businesses continue to grow and we are developing some sophistication now that in this now almost two years, almost going into three, with our product development side and with our direct sourcing side.

And I’m very pleased with those teams and what products they’re developing and we’re bringing to market. And the advantage there is, of course, that it’s exclusive to Tractor. You can only buy it here, so it gives us that exclusivity and that uniqueness and that also is going to feed the margin rate over the longer term.

Vincent Sinisi – Bank of America

Just one follow-up question, if I may, for your CapEx outlook for ’13, I know you mentioned that largely the increase is due to just the several timing shifts from this year into next. Any other color or discussion that you guys can provide specifically around your store locations, further western states that you may be entering?

I know you mentioned Colorado from last year, of course, was a new state and then any other color around those four potential self-develop projects you mentioned.

Tony Crudele

When it comes to our expansions, Colorado was as key state in 2012 and will continue to expand there as we move into 2013. And then our next state that’s targeted is Arizona and we’ve been looking at some sites there and some sites in our real estate committees already.

So we’ll be looking at Arizona in 2013. So those will be the two key states as we move west.

When it comes to CapEx and the drivers really the only point of note would be that the southeast distribution center will come online in most likely mid to late third quarter and that’s when you would recognize some depreciation around that facility, which is in the $40 million range.

And then the capital that’s allocated towards the store support center, our corporate headquarter, since that does not come on until 2014, you should see very limited depreciation around approximately $40 million there that we’ve targeted to spend in 2013, so we would not expect to have any depreciation as that stays in construction in progress.

When it comes to self development, we have a small team on staff where when we identify sites that might not be cost effective to go in with a developer, we have obviously the financing capabilities and now the in house capabilities to be able to develop that site and either land bank that site and/or just develop that site for store locations.

So it’s a small team. We’ve been developing the expertise over the last couple years and so we expect to continue to accelerate that so that at some point in time we’ll be in the four to maybe 15 new stores would be developed by our own team in house.


Your next question comes from the line of Peter Benedict – Robert W Baird.

Peter Benedict – Robert W Baird

First, Tony, just to follow up on the last question there, can you give us anything just where you think the DEI is going to come in in aggregate in 2013? I know there’s a lot of moving parts there but is there a range that you can help us with in terms of what the DEI will be next year?

Tony Crudele

DEI, we haven’t specifically given that but I would say it’s consistent with the growth that we’ve had and very similar to the prior years. So you’re looking at I want to see we’re close to $88 million $90 million range for 2012 and I would expect that to increase by about 10%.

Peter Benedict – Robert W Baird

And then just the small stores or the smaller market store format, how many did you guys get opened in ’12 and then what’s the plan as you look out to ’13? Of those 105 stores, how many do you think will be in that smaller market footprint?

Greg Sandfort

We don’t – probably won’t comment (to that money). We (open end specific). It’s part of the overall mix of stores. But we’re really pleased with our performance and the thing about these small stores, it’s really not a different concept.

All it is is a store that’s right size for the size of the market and what we’ve done in these stores is modified some depth and breadth of assortment to match the market. In fact, I think you’ve probably been in a couple of these where you can’t tell the difference when you go in. The typical customer thinks this is the same Tractor Supply. It just is a smaller box.

So what I would tell you is plans are to continue with those backfill or those small market stores. We still believe that it’s in the run rate of the 2100 and so far so good.

Peter Benedict – Robert W Baird

Then just lastly, any sense of how many stores you think you could get forage into by the end of this year? I think you said you were at 750 at the end of ’12.

Greg Sandfort

That won’t be a specific number either and here is why. You have some restrictions with forage. There are some landlords that we have stores leased with that will not let us place trailers on the lots and many of those we’re in negotiation with trying to figure out is there another way of doing this. Can we put it maybe in our side lot or the back lot?

So 750 is not the end number. There will be more but I really can’t give you a target yet because we were surprised we could get it as far as we did this year. The team’s still working on it. But it won’t be all stores. I can tell you that because there will be some restrictions.


Your next question comes from the line of Scott Ciccarelli – RBC Capital Markets.

Scott Ciccarelli – RBC Capital Markets

When you’re looking at SG&A per store, it was down in almost every quarter of the year and obviously it was – there was an outside impact in the fourth quarter due to incentive comp. But was there any other call outs during the course of the year that helped that metric? And then when we think about 2013, any other factors we should be considering?

Tony Crudele

Well, when we look at the quarters, the only thing that jumped out last year really was the warm Q1 that we had, so we didn’t have the standard expenses that we normally would have in Q1.

Then obviously in Q4, we were up against a period that had additional sales in 2011 so we had additional week of sales in 2011, so that made it a little bit more difficult to leverage against the SG&A. So those would be the two things that jump out relative to 2012.

Scott Ciccarelli – RBC Capital Markets

So when you think about 2013, whether it’s healthcare costs or anything else that you have top of mind as tougher cost save control?

Tony Crudele

We do. Where we’ve been getting the leverage is really in – the demand has been in the store payroll. We had really a terrific year this past year. And as we grow the comp sales, we have seen leverage on the occupancy and so that’s given us the ability to absorb some of the additional expense that we would have in medical, although medical in 2012 did not exceed what we had originally forecasted.

So our in house program has done very well. We’re self-insured and so we’ve been – had some fairly good results when it comes to medical. But we have planned as we move into 2013 that we will have an increase in that area and anticipate that to be offset by a normalized incentive compensation for 2013.


Your next question comes from the line of Matthew Fassler – Goldman Sachs.

Matthew Fassler – Goldman Sachs

You quantified the anticipated impact of the mix shift to Q on your gross margin guidance for next year. I think you said 10 to 15 basis points of mix headwind. Is that similar to where it’s been in each of the past couple years?

Tony Crudele

Relatively consistent; it has run in that range and it will vary quarter to quarter but overall for the full year we’ll look at it somewhere between 8% to 12% or, in this case, 10% to 15%. So it’s about consistent with prior year.

Matthew Fassler – Goldman Sachs

And then second question, is it possible to quantify the impact of the incentive comp swing in the fourth quarter? And obviously you had a very good fourth quarter a year ago, so maybe on a two-year basis, does that come out in the wash or is this a below average quarter from the incentive comp perspective?

Tony Crudele

Yes, usually we will identify – if it’s a significant amount, we’ll highlight it as one of the main drivers. This quarter was a very strong quarter, as was last year. The way it was – the incentive comp was accrued throughout the year, it did have less in this Q4 than in the prior year but I do not have exactly what the biggest point impact was. But it definitely was favorable.

Matthew Fassler – Goldman Sachs

And third and finally, just you essentially spoke about very little change in consumer behavior and presumably that pertains to big ticket as well. Any color you could offer on the signs of life perhaps or new signs of life in the big ticket arena. The ticket (x) inflation was a bit better than it was the prior couple quarters. I know that the hurricane might have had something to do with that but any sign of inflection there would be helpful to hear about.

Tony Crudele

Yes, right now we’re not anticipating a significant change. We’ve yet to declare victory when it comes to big ticket. When we do see an increase it tends to be spotty and unsustained but at times we do see a pickup relatively well, especially obviously when we run into the emergency response categories in the fourth quarter.

Hard to assess the fourth quarter because the warm winter impacted a lot of the sales of our larger ticket items but there does not seem to be a resistance when there is a need by the retail community. They will make that purchase, so we believe it will be consistent throughout 2013.


Your next question comes from the line of David Magee – SunTrust.

David Magee – SunTrust

On the forage business, is that expected to comp well? Was the startup such that you could still see growth from those 750 stores this year? And I’m just also curious about the margins of that category right now.

Greg Sandfort

Yes, we do still see a ramp in forage and the reason being is that we had a number of customers that once they start to see that we carry the full assortment now maybe there were some customers – at least what we see in our numbers that were shopping in other places. We’re in the early stages of ramping that business.

Secondly, on the margin side, it’s very similar to what we do in our sales and margin dollars and feed. It’s not robust but at the same time it’s a completer and it’s a footstep driver, so it runs around the feed margins.

David Magee - SunTrust

How does the live plant category compare to that in terms of potential and is that now in all the stores?

Greg Sandfort

The live plant and what we consider will be – we’ll just call it live goods – will not be in all stores but is from a margin standpoint can be a bit more robust than forage and it really is how we manage our business.

We’re not going to run it like the big boxes. We’re going to run it basically into the season early and then probably exit the season a bit early so that we can transition.

Our need for these types of products are plant, harvest and can and so on and so forth. There’s a stage to ours. So as we get through that, there’s no need for us to continue to try to extend that season. So we’re going to get in, set it, take our sales and make sure that we stay profitable and move on and we’ve got some tremendous partners who have chosen to work with us. It will be in a substantial number of stores but not all stores for spring.

David Magee - SunTrust

That’s versus a limited number of stores last year.

Greg Sandfort

Yes, very limited numbers last year.

David Magee - SunTrust

And then lastly – and I apologize if I missed this – but Tony, I think you had said that the gross margins would be weighted to the second half and I’m just curious as to what’s causing maybe the first half to be a little bit weaker on a year-to-year basis.

Tony Crudele

Some of it is the way in which we cycle through some of the seasonal goods from the winter and also some of – the back half of the year generally will have less of the lower margin type products and some of the big ticket.

And the way we’re looking at the mix and the impact of say the (rider) season on spring can have an impact as well.

So a lot of it is really mix oriented and, again, it’s very difficult when you have 77 different departments and 340 different categories to develop that merchandising plan. And the mix can obviously impact margin significantly.

So and as we look at the second half of the year we think we have a little bit easier compare in Q3 where we obviously had a lot conversations on that call about margins as well, so we think we had a little bit easier compare when we look at Q3 as well.


Your next question comes from the line of Peter Keith – Piper Jaffray.

Peter Keith – Piper Jaffray

I wanted to ask a question about the gross margin. The performance in Q4 was pretty impressive and I just wanted to compare it against what you saw in Q3. Now, certainly we know there was the easier mark down compare you (inaudible) but it still looked like you saw some sequential acceleration in the drivers.

I’m wondering if you have any color on what some of your key drivers that may have picked up in Q4 relative to Q3.

Greg Sandfort

As we looked at the business as it was developing, we had to stay patient and I guess that’s the word I’ll use. Merchant team tried to understand what was happening and we saw a lot of our products out of need.

So when you look at need-based products, if you don’t have the need, you don’t have the demand like weather and such, that can cause you to do some things sometimes, if your inventories are too heavy, to start overreacting.

There’s a couple things here. Inventory management did a great job of keeping our inventories tight and then as we said earlier the business really opened up toward the end of the quarter and we were in position and we were still at what I would call robust retails.

The other thing is our management of clearance. We are a different company today than we were five years ago. We take that – when we move the clearance and we start to see products not selling to the degree that we’d like, we’ll take those first initial markdowns understanding that that 20% markdown gets me $0.80 on the dollar today versus if I wait until January or February when I get $0.20 on the dollar, I’m at 80% off.

So we’re fairly aggressive on moving through inventory when we see issues and I would tell you that’s the other component, really tight management of any clearance as we’re moving through the season and then the overall management of our inventory and being patient, not pulling the trigger and overreacting.

Tony Crudele

And then a couple other real quick points, when we look at the impact of big ticket in Q4, we had less of a drag than we would have anticipated because of the softness of some of the larger big tickets, as I mentioned earlier, on the log splitters and snow blowers.

As well as, as in the past, the import and strategic sourcing products that we have had a big impact in Q4 as well and they’re a little bit obviously stronger margin items and that tends to benefit Q4 as well.

Peter Keith – Piper Jaffray

Just to follow up, as we think about all of your key drivers – I guess there’s four of them – looking out to 2013, are there any that you think actually have the potential to accelerate as a benefit and then conversely anything that you think may have already played itself out that probably diminishes as a benefit?

Greg Sandfort

Well, I would comment to this. I said earlier that price optimization has got a much longer horizon. It’s teaching us a lot more about how to price our products and it’s also teaching us, in some cases, how to sort our products. So that’s got a much longer horizon.

I think I know that we’ve got more opportunity to take the (cusa) brand mix of our products and accelerate that in the areas where it makes sense. And we’re starting to find those gaps.

The other thing I will tell you is when we look at management of clearance and the seasonal conversions, I mentioned earlier that we did a wonderful job of that. But I think it’s all about – truthfully, it’s a balanced equation between all of these and some things drive sales, some things drive margin, some things as they blend together can be an offset to SG&A.

So from the standpoint of how the margins in those four buckets are working, they’re all still working hard. I would say the one that we are probably most developed on is the seasonal conversion piece. We’ve been working on that the longest. Quite a bit of room ahead of us for price op and as well as deeper exclusive brand development and then more opportunity yet to bring product from overseas in a direct sourcing capacity.


Your next question comes from the line of Matt Nemer – Wells Fargo Securities.

Matt Nemer – Wells Fargo Securities

One, could you talk about how you’re planning for the timing of receipts this spring and just category change overs given the unique weather we had last year? Are you going to try to go back to normal or do you maybe (set) a little bit earlier?

Greg Sandfort

Actually, Matt, it’s about the same time. Last year we somewhat went south to north in three ways and then that’s what we’re going to be doing again this year. So if you’re in our southern stores right now, you’ll see that. You’ll see we’re relatively set for spring. And Midwest is beginning and north will be quite a bit later yet.

Matt Nemer – Wells Fargo Securities

Then secondly, earlier in the year you talked about spending more on marketing to convert aware non-shoppers. Do you think that you’ve made progress on this goal this year and is there any way that you could quantify the increase in new customers?

Tony Crudele

What I would tell you is that we’re still trying to find the right mix of marketing vehicles to reach this consumer base. We had some success in the second test. We will be doing some more testing this year but we’re not convinced yet that we’ve – we’re hitting all eight cylinders as far as understanding how to get to these people.

They’re still coming into our stores but they’re coming in sporadically on a test basis. We want to be able to talk to them directly, so more work to be done.

Matt Nemer – Wells Fargo Securities

And marketing expense as a percent of sales for 2013?

Tony Crudele

Slightly up and the majority of that really is how we’re now using our marketing dollars across the company. We’re now looking at more of what I’ll call a cross channel marketing effort.

You will see us do more things and things that tie back throughout the web and print and in store and all that as really one voice to the consumer. So that’s – the spend will be raised a bit in the – I’ll call it the multi channel or the web side of our marketing.


Your next question comes from the line of Brian Nagel – Oppenheimer.

Brian Nagel – Oppenheimer

The question I had – there is a lot of chatter lately, over the last few months within the investment community regarding inflation or maybe deflation in some of your input costs and that any impact you may see on margin sales. From – maybe an update there. Where are we right now with respect to the inflation, deflation as you’re making your way through cost of sales? How should we think about it as we’re modeling out 2013?

Tony Crudele

Brian, we’re at the point where the majority of the inflation has moderated and so as we look at the upcoming year and compare it to the pricing of last year, that’s how we come up with our inflation expectations of 1% to 2%. So it’s clearly moderated. The majority of the inflation we saw last year has worked its way through our costs and it’s really going to come down to how does 2013 play out?

Brian Nagel - Oppenheimer

So is it fair to say then that going – as we sit right now it’s much less of a factor going forward?

Tony Crudele

It should be. As we see the numbers on a year-over-year basis – now, again, as we work through the year that can change. But it should be less of a factor. As we noted in Q4 last year, it was almost 500 basis points. So it really has moderated.

We currently don’t anticipate seeing a downturn towards deflation and it will just continue at a very low or moderate pace.

Brian Nagel - Oppenheimer

The second question – it’ll be a quick one – you called out in your prepared comments I think the benefit of Sandy on your comps in Q4. How should we think about the ongoing, maybe an ongoing benefit to Tractor Supply as people prepare their land and such from the hurricane?

Tony Crudele

We’ve commented before that a lot of times there is a much longer tail for some of the home centers because it relates to home building and repair. But it really is much less of an impact for us and so we don’t look at it as a tail. We look at it more as hurricane preparedness and then the short response following and the recovery area efforts.

The one category that does benefit is more the fencing category. (There’s usually) some damaged fencing and we’ll be able to repair that and that might be extended. But we generally have confined the impacts of Sandy just to the fourth quarter.


Your next question comes from the line of Chris Horvers – JPMorgan.

Chris Horvers – JPMorgan

I was just curious if you could talk about incremental margins in the business. As we model out the first quarter, $38 million of pull forward and the $1.5 million in savings last year, if you use, let’s say, a 20% incremental margin on sales, do we start in the high 40s as an EPS base versus the 55 that you did last year?

Tony Crudele

Well, hopefully the information that we provided gives you enough to populate your models. I will give you a little bit of guidance saying that our goal – and we believe that we have the plans in place to drive an EPS increase and we expect to drive a comp increase as well.

And so I think if you put that together with the $38 million, adjust for the $38 million sales impact I think you can come to those same outcomes when it comes to the first quarter as well as the first half.

Chris Horvers - JPMorgan

And a couple random follow ups, can you talk about what Q did in terms of comp in the quarter? It had been running in I guess the high-single digits recently. And then also on the live product side, is that going to be a consignment basis or do you take ownership of the inventory?

Greg Sandfort

On the Q side, we typically don’t talk to what kind of sales increases. But I can tell you that there was an increase in our overall mix because of Qs impact on sales. So Q did actually help us drive some additional sales. It was a larger percentage, not a great number, not a very large number but some tailwind.

On the live goods side of the business, you’re right. (You’ll probably) value a lot of this is on consignment or scan based, which helps us on the downside risk. We have a number of stores we’ll be having true service of a product by the manufacturers and then some stores we’ll be managing ourselves. So we’re testing it both ways to see what seems to work best.


Your next question comes from the line of Adam Sindler – Deutsche Bank.

Adam Sindler – Deutsche Bank

Just wanted to ask a couple questions about some of the merchandising programs in the quarter, there are two questions. First about the heating program, just given the impact of the warm weather, I know you guys rolled out a couple of new stoves and things like that. And I just wanted to see how the (gift) program went as well.

And then the follow-up question would be when generators, we did check a significant number of stores. Was there any negative impact from a lack of supply of generators? We heard that even people like Briggs had actually run out at the supplier end. Was that – did that impact you guys in the quarter?

Greg Sandfort

Well, let’s just talk about heating first. Heating was, as I said earlier, some of the seasonal businesses weren’t as robust but it did come late and it came as the weather changed. This is one of those demand businesses again that unless you have the demand, you can overreact and really burn margin with no result of sales.

So we sat tight, kept our inventories tight and we did see our last minute push on the heating side of the business particularly in the fuel side.

On the generator question, there weren’t enough generators in the country when this storm hit to be able to service the need. And that would be my overall statement. From what we knew, we were continuing to pull generators from all four corners of the US with our suppliers and there was probably some missed business.

I think what we’re going to see from the northeastern quadrant is individuals wanting to put what I’ll call standby generators, not the portables but standbys, in their homes because this is the second year now that they’ve been without power.

So we’re – I can’t tell you that we’ve seen a real major uptick there yet but I think as the rebuilding occurs I think (Generac) and companies like that might see a nice push in their business.


Your next question comes from the line of Simeon Gutman – Credit Suisse.

Simeon Gutman – Credit Suisse

Will you talk about gross margin maybe in a little different perspective? I guess if we’re sitting a year from now and gross margin ends up being better than the 15 basis points, 20, 30 basis points, do you think that will be more a result of mix issue meaning Q growing slower than the rest of the house or is it maybe due to some of the initiatives being bigger contributors than you expected?

Greg Sandfort

I would tell you that we like what we’re seeing in the growth of Q. There will be no plans to slow Q. What we’re working diligently on is how we can grow at a faster pace, the mixes of our business.

And some of that is going to be with some high velocity products but the other side of that coin is going to be what we’re doing with an exclusive brand, what we – we should be able to gain some additional margin and then our ability to source product internationally or really just strategically source product and gain better cost.

And all those mixes combined – we track, we monitor and I think that’s going to help us continue to better predict as well as keep our hands around the gross margin equation.

Simeon Gutman – Credit Suisse

And with regard to the product acquisition cost in Q, given that you’re taking more market share and you’re becoming a bigger customer probably for some of these vendors, are you seeing an improvement in margin in that category?

Greg Sandfort

Well, here’s how we do that. To be honest with you, yes, size and scale does matter. It does help. But oen of the things that we’ve done over the last few years is we’ve multisourced products, particular categories that are high velocity and low value, so we are able to use multiple vendors and through that prospect in between we’re able to find advantages to bringing our supply chain cost down because we’re getting closer to where the manufacturing is and that’s the biggest cost in most of that product is the transportation side. So that’s how we’re doing it.

Simeon Gutman – Credit Suisse

And then my follow-up is can you talk about new space productivity? It looks like it’s still very strong, maybe our math just took a step back. The way we look at it could be very skewed. So curious what your thoughts on new stores are.

Tony Crudele

Yes, the new stores have been extremely productive in 2013. And some of that has to do with as we move into new territories where there might be a little bit less cannibalization, maybe some areas where it’s a little bit less competitive.

But as we look at the stores, we believe that there’s not a significant variation in how we’ve approved the store or looked at the stores. And we just believe that as the Tractor Supply name becomes much better known throughout, it’s easier to open those stores and be able to penetrate the marketplace a little bit more rapidly than in the past.

So again, we’re very pleased with the new stores and the program and the marketing around it and that’s helped to drive the business as well.


Your next question comes from the line of Eric Bosshard – Cleveland Research.

Eric Bosshard – Cleveland Research

One question, in terms of 2013, the competitive pricing environment and what you’re thinking about in terms of promotions, I’m interested in how you’re thinking about that form a competitive standpoint and how you’re thinking about that balancing that relative to the pursuit of gaining market share and driving sales.

Greg Sandfort

We look at this constantly. Again, in our gross margin equation, there’s really three things we look at: are we trying to grow this business from a market share standpoint; if we do, we understand there will be some compression on margin.

When we look at it from a mix business and saying, listen, if this is a project complete tour, probably don’t need to be as competitive because they’ve got to have it to make the project work and then there’s that blend of a little bit of both.

So we’re going to stay very aggressive on growing market share. What we find is that with the price optimization tool that we are now using, it’s giving us some insights to where we need to be priced and it’s not always about being the lowest priced. It’s about being the right price by market and that’s why – another reason why we had to have this system.

We’ve got in the range of 1200 stores in many, many – 46 states and you’ve got to have some type of tool to help you work through that. And we’re very confident that we run our advertising based upon regional need and regional price, sometimes even down to the district level. So it’s not about just driving it by price. There’s a mixture of things that we do and we’re learning as we go. I’ll be honest.

We’re not – we’ve still got things that we can do to improve our performance.

Tony Crudele

Philosophically, though, we will not come into a marketplace and drive price down. But we will be extremely competitive in some situations and what we’ve learned is – and what the tool has given us is the ability to be able to better manage the price so in the event that we focus on market share and drive increased sales, then we will get the leverage that we would expect from leveraging SG&A versus improved gross margin rate.

So that’s where we see the tradeoff and it gives us great flexibility in determining whether we increase EBIT margin through gross margin or leverage SG&A.

Eric Bosshard – Cleveland Research

And then as a follow up, as you think about ’13 in this realm, does the behavior to your actions, you do anything materially different in ’13 than ’12 with the learnings you experienced and the environment?

Greg Sandfort

Well, I would tell you from what we see now, the customer is still responding very similarly to what they did back in 12 with the exception of the weather patterns. Again, our business is a need-based business and if you have animals, you have property and you have equipment, you’re going to shop Tractor Supply.

There are other things we carry in our assortments that are more seasonally sensitive and if we see movement in seasonal, we seem to see more of an uptick but we’re less sensitive today than we’ve been.

We’ve somewhat been able to moderate that by really bringing the business across all four walls of the store. So I think right now we feel very comfortable from a mix standpoint and there’s some upside, of course, if the weather plays in our favor. And moisture in the spring is a good thing and cold in the fall is a good thing.


There are no further questions. Please continue with any closing remarks.

Greg Sandfort

Thank you, operator. Well, thank you all for joining us on today’s call. While we are very pleased with the progress we’ve made in the past few years, we are more committed today than ever to continue growing Tractor Supply to be a more profitable retailer and returning greater value to our shareholders.

Our teams are planning, preparing and executing and reacting better than ever before. We’re committed to provide the right merchandise in the right regions at the right time to our customers while bringing quality products and great values.

Our business model is solid and we continue to build momentum in our business. Thank you for your continued support of Tractor Supply Company and we look forward to speaking with all of you again in about 90 days.


Ladies and gentlemen, that does conclude our conference call for today. You may all disconnect. Thank you for participating.

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