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Tractor Supply Company (NASDAQ:TSCO)

Q1 2009 Earnings Call

April 22, 2009 5:00 pm ET

Executives

Cara O’Brien – Financial Dynamics

James F. Wright - Chairman of the Board & Chief Executive Officer

Anthony F. Crudele - Chief Financial Officer, Executive Vice President & Treasurer

Gregory A. Sandfort – President & Chief Merchandising Officer

Stanley L. Ruta - Chief Operating Officer & Executive Vice President

Analysts

Dan Wewer – Raymond James

Jack Murphy – William Blair & Company

Peter Benedict – Robert W. Baird

Mitch Kaiser – Piper Jaffray

John Lawrence – Morgan Keegan

Matt Nemer – Thomas Weisel Partners

David Magee – SunTrust Robinson Humphery

[Peter Benedict – Robert W. Baird & Co.]

Operator

Welcome to Tractor Supply Company’s conference call to discuss first quarter 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 reproductions 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, Miss Cara O’Brien of Financial Dynamics.

Cara O’Brien

Before we begin we would like to 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 am pleased to introduce Mr. Jim Wright, Chairman and CEO.

James F. Wright

I’m joined today by Tony Crudele, our Chief Financial Officer; Greg Sandfort, our President and Chief Merchandising Officer; and Stan Ruta, our Chief Operating Officer. As you know the first quarter represents a get ready quarter for us as we prepare for the important spring selling season. Though the first quarter is always the smallest quarter for us we are pleased with our performance and believe we’re off to a good start for the year.

During the quarter we made solid progress on our key priorities for 2009 which are to continue differentiating our business and executing our retail strategy to win in the current environment and beyond. Let me briefly discuss some of the highlights. First we grew the business as we increased total sales by nearly 13% to $650 million, improved gross margin by 40 basis points to 30.9%.

As a result we were able to improve our bottom line on a year-over-year basis by $0.06 per diluted share to a profit of $0.01 per diluted share. Second our team did a great job of ensuring their stores remain a destination and as a result our customers continued to respond positively and have increased their visits.

Although average ticket was done which Tony will discuss later we experienced a marked improvement in traffic during the quarter which we attribute primarily to the focus we’ve placed on having the right mix of everyday and advertised merchandise to keep our customers coming back. Let me go into more detail on both of these items.

Starting with our merchandise as you heard us mention we believe there’s been a fundamental shift in consumer shopping habits from wants to needs and from style to value. Due to our response to these trends we’ve not seen any real deterioration in our customers’ willingness or ability to shop for products that fit the everyday needs for their rural lifestyle.

We continue to emphasize and appropriate stock our CUE items which stands for consumables, usables and edibles. These products are also highly represented in what we call our 20 to 50 which represents our focus on being in stock on products in the top 20 categories ad the top 250 skews within those categories. We’ve also built a strong reputation with our communities for being a reliable source for emergency preparation and response items.

During the quarter we experienced demand for product such as generators and emergency pumps as a result of the impact of ice storms in the South and flooding in the upper Midwest. Turning to our marketing program we are benefiting from our efforts to improve our marketing while leveraging advertising dollars.

Our emphasis on value, less clutter and more education is working well and our advertising campaigns, marketing and merchandising remain important elements of our strategy to differentiate our business. Additionally we are closely monitoring gross margin dollars net of advertising on an internal basis to measure the effectiveness and efficiency of each event. I’ll talk more about these major components on our business later in the call.

Third as part of our effort to reduce costs in the business and to improve margin I am pleased with the progress we made with transportation and freight. We’ve increased the efficiency of our distribution centers by in-sourcing the management of freight movement from our DCs to our stores. We are also utilizing our trailers more productively by improving our CUE utilization and reducing empty miles by using common carriers more frequently.

The benefits of these actions are beginning to gain traction. At a recent investment community day we announced that we’ve increased our long term store target to 1,800 domestic TSC stores. We evaluated metrics such as county and state demographics, known competition, distance from our distribution centers.

We calculated in depth sales and RLI projections and we further examined the characteristics of the world population with 20 and 40 minute drives times of our desired locations. We’re excited about this growth opportunity and confident that we’ll be able to achieve this target based on the success of our site selection model and the performance of the nearly 400 new stores we’ve opened in the last five years.

Overall in our first quarter we continued to execute on our initiatives which are centered on strong merchandising, sound operational procedures and superior service. These are driven by our commitments to connect with our customers and offer them a complete and compelling assortment of the basic item they need for their rural lifestyles.

We continue to benefit from the strength of our business model, our unique niche and our customers’ and team’s ability to continue to win in this challenging retail environment. I’d now like to turn the call over to Tony to review our financial performance and discuss our full year outlook.

Anthony F. Crudele

Although Q1 is the quarter with the lowest sales volume we are pleased with the results as Jim said. On a year-over-year basis we achieved double digit sales growth for the quarter and reduced our per store inventory levels for the sixth consecutive quarter. We believe this continues to validate the resiliency of our business model as we work through these tough economic times.

For the first quarter ended March 28th, 2009 sales were $650 million and net income was $470,000 or $0.01 per diluted share. The LIFO provision was approximately $0.05 per share in the first quarter of 2009 and $0.04 in the first quarter of 2008. Total comp store sales in the period increased 4.2% and non-comp sales were approximately $49.7 million or 7.6% of sales.

Comp transaction count increased 5.8% and we are pleased that we continue to drive footsteps into the store. The average comp ticket decreased 1.5% resulting from the softness in the sale of large ticket items. Although the consumer is making more frequent trips to the store for their essentials we believe they are not adding non-essential purchases to their basket. I’ll go into a little more detail on some of the other sales drives and trends.

Our stores are not open on Easter and with the Easter shift to April this year we had an additional comp store day in the first quarter. We estimate that this resulted in an increase to comp store sales of approximately 160 basis points. Our core consumable, usable and edible categories including livestock and pet supplies and feed continued to be the key drivers of the business.

It’s important to note that we estimate that inflation which is prevalent in these categories increased comp sales by approximately five to six percentage points. I’ll further address inflation impact in a moment. Overall weather did not play a significant factor on a year-over-year comparable basis.

Recycling a negative comp from the first quarter of 2008 which resulted from extremely favorable weather conditions in 2007 this year the year-over-year comparisons were much more normalized although there was some variability on a regional basis. While January is colder in most regions February was a few degrees warmer which can negatively impact our sales.

However there was some storm activity in February that favorably impacted sales in the Northeast and upper Midwest regions where comp sales were the strongest. Additionally although March was slightly warmer than the prior year in the same regions the anticipation of an early spring was tempered by periodic cold snaps throughout these regions.

Comp sales in our Del’s stores were lower than chain average as the Northwest suffered through some extremely cold temperatures which hampered spring sales. Overall we were pleased with Del’s gross margin improvement and their ability to exceed plans under less than favorable climatic conditions. Jim will discuss Del’s in more detail later in the call.

Comp sales were the weakest in the Southeast resulting from soft big ticket sales as we entered the spring selling season combined with the persistent weakness in the Florida economy. Turning to gross margin compared to the prior year quarter we experienced an increase of approximately 40 basis points. Lower freight expense compared to the prior year was the primary driver of this improvement.

As we had anticipated we began to realize the favorable impact of fuel price decreases over the last several months that were capitalized as part of our inventory costs. Additionally we are seeing some of the benefits of our transportation cost savings initiatives as Jim discussed earlier. Our LIFO provision was essentially flat with last year at approximately $2.8 million. This allowed us to slightly leverage this expense on the higher sales we achieved during the quarter.

Before turning to SG&A let me comment on the inflationary impact for the first quarter. As I mentioned we estimate that inflation had a favorable impact on comp sales. Despite deflation in several categories over the past several months we expected retail price increase in the first quarter of 2009 would still exceed the first quarter of 2008 which was not characterized by high inflation.

The more significant inflation we experienced last year began to accelerate in the second quarter. at the same time as we have discussed in the past we actively seek to manage inflation by maintaining our gross margin rate and per unit profit and we achieved this successfully during the quarter.

We will start to see the year-over-year inflation impact moderate as we move forward in the year and I’ll discuss this more during my comments on our outlook for the remainder of the year. For the quarter SG&A including depreciation and amortization was 30.7% of sales a 10 basis point improvement over the prior quarter. We are pleased with the SG&A leverage we achieved especially in our lowest sales volume quarter.

The main driver was leveraging our advertising costs as we focused more of our marketing effort on circulars and direct mail and less on television media. As Jim mentioned we have found that our focus on driving gross margin dollars net of marketing expense has been effective. The pre-opening expenses for new stores were approximately $2.9 million compared to $2.4 million in the prior year quarter.

In the first quarter we opened 28 stores compared to 27 store openings last year. Pre-opening expense per store was flat on a year-over-year basis. We have strategically opened fewer new stores during January ’09 than in past years since it is low sales volume period in between seasons. By opening these stores later in the quarter pre-opening expense that normally would have been incurred in the previous December actually shifted to the first quarter this year.

Further last year’s openings included three Del’s stores which require less pre-opening expense. We also closed one Del’s store in the quarter when we opted not to renew an expiring lease. Turning to the balance sheet we continued to improve our inventory productivity. At quarter end inventory levels per store were down approximately 6.9% that on top of an 8.2% decrease at the end of Q1 last year.

Our calculation is based on average cost of inventory and excludes in transit inventory and inventory held in unopened stores. Annualized inventory turns for the quarter were 2.39 nearly a 20 basis point improvement over last year’s first quarter. We also had a slight increase in inventory financing to 47.8% up 80 basis points principally as a result of the improved turns.

We believe that we have created a true business partner relationship with our vendors and believe that we are at the top of the vendors’ list when it comes to allocation of merchandise if production limitations occur. Capital expenditures for the quarter were approximately $18.9 million related principally to our new store opening program. This is a decrease compared to last year’s spend of $26.5 million which included the acquisition of two stores for $8.5 million.

During the first quarter we continued to make purchases under our stock repurchase program. We bought approximately 281,000 shares for $9.1 million or a cumulative total of approximately $213 million since the inception of the program in February of 2007. The share repurchase program did not have a significant impact on EPS for the quarter. We are extremely confident in our cash flow and liquidity position.

Generally our peak borrowings will occur during the first quarter as we prepare for the busy spring season. This quarter our peak borrowings were cut in half as we were below $75 million and our average borrowings were cut by two thirds from the prior year. This provides us significant flexibility as our revolving credit facility is $350 million.

We believe it is important to maintain our prudent balance sheet management in the current environment. Turning to our outlook for the full year, with respect to our financial expectations for the full year 2009 as noted in today’s press release we have confirmed our previous expectation for sales, comp sales and earnings per share.

As a reminder we expect full year sales to range between $3.2 billion and $3.3 billion and full year comp sales ranging between a decrease of 1.5% and an increase of 1.5% and earnings per share to range between $2.58 and $2.74. While we believe it is difficult to draw conclusions or extrapolate performance to the next three quarters based on our small get ready first quarter let me discuss a few of the underlying assumptions included in our estimate.

With respect to sales consumer spending remains in line with our expectations outlined at the beginning of the year. As I mentioned we continue to see our customers shopping our stores for a wide variety of functional nondiscretionary items that are very relevant to their lifestyle. In April we are losing one selling day related to the Easter shift. Early spring sales this month have also been softer than expected as cold weather has stalled sales of seasonal merchandise.

However we expect overall that weather will be neutral for the quarter as the cold start of the spring season will be offset by more moisture in some areas of the country. Consistent with our expectations at the beginning of the year we have seen prices moderate in several key categories that were highly inflationary last year. This will provide a difficult sales comparison particularly in the second and third quarters.

With respect to margin we expect some margin pressures as we move forward in the year. As I mentioned we had anticipated the inflationary impact experienced in Q1. As we move forward during the year we do not expect the inflation tailwinds we experienced in 2008 or in Q1 of 2009 to repeat as cost have been more stable.

We have demonstrated that we can successfully margin pressures with respect to the deflationary impacts due to sticker retail prices than we had originally anticipated at the beginning of the year. We expect the firmness in the retail prices will buy us the opportunity to realize the beneficial impact of cost reductions on our moving average inventory costing.

Additionally freight and LIFO at our current projection levels could provide a favorable offset to any incremental margin pressures. Fuel prices are running substantially below last year prices and as Jim mentioned we believe that our freight initiatives will continue to gain traction. With respect to LIFO based on our expectations for year end inventory levels and mix we are currently estimating a full year LIFO provision of $14.1 million which is essentially in line with our original guidance of $15.7 million.

We continue to project the LIFO provision by ongoing cost reductions and concessions in several of the key product categories. We expect this given that our mix continues to shift to fresh fast turning goods especially in light of our 20 to 50 in stock merchandise initiative and as we continue to clear merchandise.

Also as we expand our store base we will have a net increase in aggregate total inventory. This results in adding merchandise that has higher indices in the current company average and therefore a higher LIFO provision even as inflation moderates. Let me remind you that provides us the opportunity to realize a substantial income tax deferral.

We were pleased with our SG&A leverage in the first quarter. As we indicated in our original guidance SG&A leverage will be difficult on a low comp sales increase especially as we cycle some of our cost saving initiatives implemented last year.

However as I mentioned we believe the more efficient advertising spend should provide us some benefit particularly in the spring selling season before we begin cycling some of the shifts we implemented for the fall and winter 2008 season.

Overall we believe if our sales are somewhat softer and/or we experience gross margin pressure we will be able to offset this through the related freight and LIFO benefits and additional expense management levers that we are planning such as to reduce TV advertising spend in favor of more efficient direct marketing spend. We continue to expect to open 70 to 80 new stores this year although we now expect our openings in the first and second halves of the year will be split evenly.

We have not changed our expectations that cap ex will range between $85 million and $95 million. Overall we believe our ability to execute and serve the functional needs of the out here customer will be the key differentiators as we manage through the remainder of the year. With that I’ll turn the call back to Jim.

James F. Wright

As I mentioned earlier we’ll continue to differentiate our business in executing our retail strategy to win in the current environment and beyond. At the same time we believe we are well positioned to react quickly should any changes in consumer buying patterns occur. That said we’re enthusiastic about the opportunities ahead for our company. As you know our merchandise mix is the cornerstone of our business.

We continue to provide our customers with basic and key items that support their lifestyle. As previously mentioned we’ve intensified the assortment and promotion of our CUE categories. We continue to see an increasing trend towards grow it yourself hobbies like gardening and patch farming and we’ve adjusted our merchandising plans accordingly. The customer is spending more time attending to their gardens for personal consumption.

We expand the depth and breadth of spring seasonal goods by adding more seed packets and vegetable plants and tillers to our store assortment. Additionally we expect consumers will continue to defer big ticket items a trend that we began to see nearly three years ago. Accordingly we’ve shifted our focus to meet our customers’ growing replacement part needs as they are increasing the repair and maintenance of their existing equipment. We’ve been tightly managing inventory levels on many big ticket items by narrowing the assortment while simultaneously ensuring that we have the depth to support peak season demand.

We’re also pleased with our refined marketing strategy. The marketing team has stepped up to the challenge to do more with less as we adjust our advertising dollars to focus more on or CRM program. We continue to reinforce the value proposition and our position as the authority on the rural lifestyle. Additionally we are leveraging our advertising to drive repeat business and customer loyalty efficiently.

In Q1 we generated significant savings from our advertising expense and we expect this trend to continue. This is primarily the result of shifting ad spend away from television towards more direct marketing which allows us to offer the right products to the right customer at the right time. Also we’ve improved the look and shoppability of our print ads. I’m also very pleased with the continued improvement in our customer loyalty scores.

While we currently rank in the top quartile of hard land retailers we are committed to further strengthening the bond that we have earned with our customers. With respect to new stores we made a few changes that have generated increased sales earlier in the life of new stores. We have reduced the timing gap between soft opening and grand opening. Previously we had scheduled most of our grand openings to be during the peak season of selling weeks.

Initially it appears that this change has driven stronger out of the gate sales at many of our new stores. We’ve also developed new grand opening print ads to introduce a broad merchandise assortment for greater impact. As you are aware we held our store managers meeting in Nashville last month which provides our vendors with the opportunity to showcase their products and discuss their products with our store managers.

We also held our first ever Vendor Conference in Asia last week. In the current environment we find that it’s more important than ever to ensure that we consistently work with our vendors to quickly translate the benefit of their decreased raw material costs for our mutual end users resulting in win/win solutions which ultimately drive the best outcomes for our vendors, ourselves and our shareholders.

As we previously stated we view 2009 as another year of learning for Del’s and we continue to closely monitor our progress. That said we are continuing to better position this business. This began several quarters ago when we initiated an organizational shift by aligning the merchandise and store operations under Greg and Stan respectively. We refocused the product categories in which Del’s has historically been most successful and have added only modest line extensions.

The stores are well staffed, energized and we are ready for the upcoming spring selling season. Before we turn the call over to questions I’d like to reiterate that we have a very solid capital structure, a very strong balance sheet, we’re generating significant cash flow from operations and have minimal debt.

Though we continue to be conservative and anticipate persistent challenges in the macro environment in the near term we remain a growth company and we expect Tractor Supply Company will continue to deliver on our expectations to win both now and in the future. This concludes our prepared remarks. Operator, we’d like to now open the call for questions.

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from Dan Wewer – Raymond James.

Dan Wewer – Raymond James

Jim or Tony when you were commenting on the April sales trends, can you determine if the weakness is due to a smaller contribution from inflation that we’re beginning to see or is it related more to traffic?

James F. Wright

It’s really weather. When we look at our business in the month of April by day and by region the ground moisture first of all with the exception of Texas is very, very good and we have a combination of a nice weather on a Friday or weekend we do see a response in the business and a response frankly in mowers. But Dan we simply have not had consistently spring like weather across most of the chain.

Dan Wewer – Raymond James

That would be impacting traffic I would assume and not the ticket size?

James F. Wright

No actually traffic, while not as robust perhaps as Q1 has been much better than the average ticket.

Dan Wewer – Raymond James

I guess I’m a bit confused then. At what point during the period will the inflation benefit, the same store sales, begin to taper off?

James F. Wright

Most of our inflation benefit last year came to us late Q2 and then through 3 and 4.

Dan Wewer – Raymond James

One other question related to sales, you had noted that consumers are shifting away from style to focus on value and from wants to needs. I’m curious as to what those implications are for your apparel business which I know you’ve been expanding the last couple years.

James F. Wright

The good news is that very few people ever state that we have any style in our apparel or very much of it. The vast majority of our business in really Q3, 4 and it’s heavyweight outerwear. Our boots are principally work boots and it’s very much a replacement business as it is an aspirational business. I see frankly very little risk in the clothing business. If consumers do trade down to our private brands, that’s fine. We maintain equal gross margin dollars per unit.

It’d be obviously soft on a comp store sales side but will weigh on the margin side, Dan.

Operator

Your next question comes from Jack Murphy – William Blair & Company.

Jack Murphy – William Blair & Company

I just want to go back to the inflation question for a minute. Tony, did you say that you thought you had a 500 or a 600 basis points inflation in those consumable related categories? Is that what you said earlier?

Anthony F. Crudele

Yes, that’s correct.

Jack Murphy – William Blair & Company

So help us scale this a little bit. When you’re talking about those categories in particular that are inflation impacted what percent of the mix were we talking about in the quarter? And then on a related note given the fact that you saw some deflation or the beginning of deflation in other categories, if you look at the mix as a whole, how much do you think the comp was impacted by inflation?

Anthony F. Crudele

Let me correct the question as you stated. Overall we were looking at a 500 to 600 basis point increase not necessarily specific to those categories. Directionally we see that as far as quantifying between the categories we wouldn’t provide that level of detail because again it’s really just an estimate trying to look at the retail prices and what the increases are year-over-year and there’s obviously a lot of factors that go into that, not just inflation.

Again we want to keep it more at a higher level. Directionally we feel that year-over-year we understood that based on the inflationary impact in the prices throughout 2008 we knew that we had a significant increase in the first quarter and that will continue to moderate as we move through the year when we really go up against comparable numbers that had significant inflation in it.

Jack Murphy – William Blair & Company

So the 500 to 600 is versus the total company comp?

Anthony F. Crudele

Correct.

Jack Murphy – William Blair & Company

On the transaction count, obviously a pretty big number, best in about two years I guess. Given the calendar was Easter much of a factor in that and also how do you think traffic should progress as you move throughout the year given these other factors?

Anthony F. Crudele

If you want to break down to just generally on the 160 basis point impact on Easter about 140 would be attributable to the transaction side and 20 basis points attributable to the average ticket. So that’s how it would break down. Again we would anticipate to maintain relatively firm traffic patterns and that has been consistent over the last couple quarters.

It really truly is driven by the consumer and trying to satisfy their basic needs, continues to drive footsteps into the store. We’re looking forward to a continued increase in traffic.

Operator

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

Peter Benedict – Robert W. Baird

What was the inflation benefit last year in the first quarter? I know you said it wasn’t much but was it 1% to 2%? Is that a fair estimate?

Anthony F. Crudele

I would say it ran in that range and probably more the 2% to 3% range last year.

Peter Benedict – Robert W. Baird

Can you quantify the fuel impact benefit to gross margin in the first quarter? Was it somewhere in the neighborhood of 10 basis points or so?

Anthony F. Crudele

Of the freight increase we attribute about 70% of it related to fuel. So you can break it down that way. We had just total 40 basis points so I’d say about 30 basis points related to the fuel increase.

Peter Benedict – Robert W. Baird

On the ad spend, I think last year advertising was just under 2% of sales. It improved by about 24 basis points year over. Can we expect a similar level of improvement this year in terms of the basis point improvement given what you guys are doing on the ad front?

Anthony F. Crudele

I would think throughout the year, in particular in Q2 we anticipate a similar run rate. As we move forward into the second half of the year we’ll continue to assess the program and make sure that we are not trading off marketing dollars in lieu of driving sales. But generally we do expect to have a leverage of marketing but probably not to that extent as we work through the remainder of the year.

Peter Benedict – Robert W. Baird

One last question, on the softer start to the spring seasonal business can you talk about our maybe break it down between the OPE business and the lower ticket lawn and garden? Is it across the board or is it more weighted in one versus the other?

James F. Wright

Again it is mostly in big tickets and mostly in riders, walk behind mowers, really the whole category of cutting grass is the vast majority of the weakness.

Operator

Your next question comes from Mitch Kaiser – Piper Jaffray.

Mitch Kaiser – Piper Jaffray

Could you talk a little bit on the food deflation or the deflation, what impact do you think that might have on transaction? Because I know transaction becomes bigger in the second quarter relative to the first. What should we be thinking about there on average transaction size in the second quarter?

James F. Wright

With regard to feed and pet food?

Mitch Kaiser – Piper Jaffray

Yes.

James F. Wright

The closer we buy to the commodity which would be for example large animal feed, we’re much more closely linked in our purchasing agreements to commodities that across are coming down and that retail is somewhat sticky. On the pet food side it’s a bit of a mixed bag with the brands attempting to hold costs and as a result retails are staying and there’s another tier of brands where across are beginning to come down.

Retails again seem to be fairly sticky and generally because private brand is pegged to the national brands, private brand retails are staying a little stickier than private brand costs. Is that correct, Greg?

Gregory A. Sandfort

Yes.

James F. Wright

I would not to suspect to see a lot of ticket inflation on food and feed and the good news is that we continue to gain unit share in those categories.

Anthony F. Crudele

As far as the average ticket goes, as we move into Q2 I would suspect that the sale or the softness in large ticket items would probably be more impactful than the inflation/deflation impact. Since we have obviously the riders are a large portion of the sales and they’re a large unit ticket. That will have an impact.

Mitch Kaiser – Piper Jaffray

So you’re not seeing the benefits of DIY then that people are maybe foregoing lawn service care and doing it on their own? That benefit hasn’t really come through yet I guess at this point?

Anthony F. Crudele

Relative to riding lawn mower sales, not necessarily. Obviously it has a significant impact when it comes to the repair and maintenance of those items which again tend to be a much higher gross margin category for us.

Mitch Kaiser – Piper Jaffray

I know you did a recap on the lawn and garden area. Could you talk a little bit about the results that you’re seeing there?

Gregory A. Sandfort

We are very pleased with the set this year and we’ve had a tremendous amount of learnings about our customer particularly in the categories that Jim mentioned in his comments about them wanting to grow their own foods and really tend to their own property.

It’s a little early right now for us to draw any conclusions on all of OPE but when we redirected the business and decided that other parts of the outdoor power equipment category could play a larger role this year, i.e., maintenance, the parts business, push more blowers and other types of categories, we’ve been very pleased with those initial results. A little disappointed as Tony mentioned and Jim mentioned on the rider category at this point.

We have confidence that we’ve got it planned correctly and it’s just a matter of time.

We need a little weather, that’s all we need.

Mitch Kaiser – Piper Jaffray

Lastly, I know there’s some change in legislation or tax credits associated with alternative heating an I know this was a very strong category for you last year and often had some stock outs and back orders. Could you just talk about what you’re seeing or how you think you’re positioned for the alternative heating category especially in light of these tax credits that might be coming through?

James F. Wright

Obviously the tax credits as they materialize and get communicated would be a benefit. We expect that the full year will not be too much unlike last year although the timing of that business is likely to change. Last year you recall we accelerated normal Q4 business into Q3. Then we got into Q4 and we in the industry had sporadic out of stocks on both stoves and fuel.

The consumer exited last year saying boy there’s a shortage of both the whole goods and the fuel, perhaps we ought to buy earlier. Bear in mind that as the consumer went into the season last year they were looking at alternative heating being much, much cheaper than electrical, natural gas and in our case most importantly propane and fuel oil.

So to a degree we are expecting some moderation demand as it is unlikely that we’ll see fuel oil and propane prices a year ago. That said we think that the fact that we’ll be in stock during actual peak season will probably offset that but we will shift from Q3 to Q4.

Gregory A. Sandfort

One follow up on that will be the essence of the pellet business, the fuel actually for the units. Because we had such increase last year in the installed base we believe there is still room for us to grow in fulfilling the needs of that customer as it comes to the fuel itself.

Operator

Your next question comes from John Lawrence – Morgan Keegan.

John Lawrence – Morgan Keegan

Greg would you comment a little bit to take it one step further on lawn and garden. I know a lot of those products you just sort of reset and brought in to the category. Was some of those products that you’ve been selling for a long time still that have seen some increase because of the reset and the way that you put them together in that front left part of the store?

Gregory A. Sandfort

You are correct. By putting that together in one area to create a destination in the store and it has paid off very, very well for us.

John Lawrence – Morgan Keegan

If you take that obviously as you look at things down the road, other categories, other parts of the stores do you think maybe you can play that again?

Gregory A. Sandfort

I would tell you that we have plans to do things similarly as we move forward yes, John you are absolutely correct.

John Lawrence – Morgan Keegan

The last question, any comments Jim on the labor profile in the store? Economic environment, turnover down, attracting better talent, anything going on there?

James F. Wright

Store turnover is actually modestly up but that is the fact that we are upgrading the team and we have a wonderful opportunity to higher some very strong talent so we’re really in very, very good shape right now.

Operator

Your next question comes from Matt Nemer – Thomas Weisel Partners.

Matt Nemer – Thomas Weisel Partners

My first question is not to harp on the softness in April in some large ticket items but you sound very comfortable that this more of a weather impact than an economic impact and I’m wondering if you’ve seen any consumer studies that confirm that or is there any chance that it is potentially the other way around?

James F. Wright

I certainly couldn’t rule that out but the greatest data we have is the response we see when we get a bright sunny warm day. Matt, it is very, very significant. We can see our business move several, several points of comp just due to the fact that we have a combination – it’s very wet, everyplace but Texas and as soon as we get a sunny day when people are out in their yards and they’re out shopping we see an immediate pickup. So, while we realize that there is certainly a persistent big ticket problems for all the reasons that we all understand, we think that because that has been the case for a while now and certainly recycling that, that at this point in time we believe it is predominately the weather.

Matt Nemer – Thomas Weisel Partners

Then secondly, in terms of the OPE category, what are you forecasting this year in terms of year-over-year I guess it would probably be a decline, maybe slight growth, just what is the industry saying this year?

Gregory A. Sandfort

That’s a real interesting question and Matt I don’t think there is any one real answer. The industry OPEI has said that shipments, and I’ll refer to that are going to be down double digit. So, taking that in light I am sure that many retailers have planned their business accordingly. We went through a real rationalization of skews, we looked at our store base, we looked at the mix of our skews and we feel still very comfortable that we have a very compelling offer.

We’ve assorted it by store and it’s really, I agree with Jim, this is a matter of when the weather breaks and we believe it will be shortly and I think we’re well positioned. So, OPEI data would tell you that it’s going to be tough. I guess we’re betting against the odds a little bit.

Matt Nemer – Thomas Weisel Partners

I guess just digging a little deeper that does that mean you’re going to have your inventory in that category will still be down year-over-year but not down as much as double digits?

Gregory A. Sandfort

We have planned the inventory down to last year. I can’t go any further than that to tell you but its appropriate to our sales potential that we believe is out there for us.

James F. Wright

Also, we’ve narrowed the line so we have fewer choices of riders that allows us to have more depth so we can be in stock at the price points that have proven to be most important. Again, this is where we’re sorted this year not just by region but by store based upon their two year history by future benefit price point. The other thing to recall is that riders have over the last really four years now have become a less significant portion of our business and the plan that we shared, the data that we used in our planning which we have shared with you all is that a good rider year would be beneficial to our results but we don’t need one to achieve our objectives.

Matt Nemer – Thomas Weisel Partners

Part of the narrowed line, it sounds like from something you said earlier that there will be more push mowers, more sort of accessories and parts and perhaps that takes your ticket down in the category this year versus last year?

James F. Wright

Within the category yes but, bear in mind we have a $45 ticket average so every string trimmer on average is double that. So, as we can gain share in walks, in string trimmers, blowers, we’ve already had a very good tiller season, I expect more of that up North year, we have the opportunity to offset many of the sales dollars but most significantly the margin dollars.

Matt Nemer – Thomas Weisel Partners

Then lastly, in terms of the price moderation that you’ve talked about, can you get more specific on which categories are starting to moderate? It sounds like it’s potentially not the feed and the pet food categories from what you said earlier?

Gregory A. Sandfort

When we look at the three main categories, when you look at the grain prices, we look at oil and we look at steel, we’ve already experienced a significant decrease in those raw material prices. So, it’s a matter relative to each one of those categories and how they impact our merchandise categories as we work with the vendors for us to realize those savings as well.

So, we believe that we have worked through a lot of the price decreases and again, as we relate back to some of our comments that we feel that the retail price has been sticky in many of the categories to the extent that as we receive those cost reductions which we believe has already been experienced by many of the vendors and manufacturers in the raw materials, as we receive those prices decreases and they work through our average costs, we’ll be able to maintain reasonable margins during that time period.

So, we think obviously it’s our responsibility to work through that. It’s part of our business to manage the margins and we think that we’ve been successful and that we have seen a stabilization of the prices over the last couple of months.

Matt Nemer – Thomas Weisel Partners

Of those three in response to another question that was asked earlier it sounds like on the pet food side specifically maybe you haven’t seen as much of a decrease as you’d like?

James F. Wright

We have not seen as much of a decrease as we would expect, that would be correct.

Operator

Your next question comes from David Magee – SunTrust Robinson Humphery.

David Magee – SunTrust Robinson Humphery

Just a question going back to the inflation impact on the comp, you had said it was 500 or 600 bips, I guess does that mean then that I guess ex that then the average transaction size was really down about 8% coming on a FIFO basis year-to-year?

Gregory A. Sandfort

When you say the average?

David Magee – SunTrust Robinson Humphery

You said the average basket size was down a couple of points earlier. If you ex’d out the impact of inflation as a positive influence there in terms of just taking price out of the equation mean that the basket size would be much less?

Gregory A. Sandfort

Right. You would allocate inflation more to the average ticket. It would have less of an impact on the transaction size, correct.

David Magee – SunTrust Robinson Humphery

So I guess what I’m getting to is as inflation, the positive impact there begins to lesson as the quarter goes on, the second quarter and your traffic probably moderates certainly from the strong first quarter performance. I guess the second quarter comp, although you didn’t give the guidance, would be it looks like to me is going to be roughly offsetting what you did in the first quarter. Is my logic I guess correct in that regard?

Gregory A. Sandfort

Not necessarily and obviously we don’t give specific guidance to the second quarter. We do agree that generally we will not have the tailwind that we’ve had in the past in 2008. However, as we look at it and we become focused on the margin rate and the margin per unit, as much as it may have an impact on the comp sales, we think what’s critical is to drive the [inaudible] and that’s where we feel that we’ve been successful as we analyze categories that have already experienced that type of deflation.

James F. Wright

Two things to remember, one in Q2 we’re going to have a 100 basis point negative comp because Easter is in the quarter versus not being in the quarter last year and secondly, for the next three quarters with us reaffirming our revenue guidance, our projections are comps of -29 to a positive 80 basis points. That’s the range we are planning and yet we fully anticipate landing the EPS of $2.50 to $2.74 with that range of comp sales performance.

David Magee – SunTrust Robinson Humphery

Also could you talk a little bit about what the competition might be doing this spring in the mower business? Is that having an impact different than expectations of any sort?

James F. Wright

Frankly, thus far we have not seen any new tricks or any real strengthening by any of our competitors. Obviously, the next six weeks will be the flurry of activity but we’ve seen nothing out there that we think something else will win at our cost.

Operator

Your next question comes from [Peter Benedict – Robert W. Baird & Co.]

[Peter Benedict – Robert W. Baird & Co.]

If I could was the inflation impact in the first quarter the highest you’ve seen in the cycle so far? I think it was, it was higher than what you saw in the fourth quarter, correct?

Anthony F. Crudele

That’s correct. Generally for the year last year we were in the slightly above four range for the whole year and the fourth quarter was the highest quarter in 2008 that was sort of in the 4.5 to 5 range. So yes.

[Peter Benedict – Robert W. Baird & Co.]

Tony, what type of impact are you guys assuming in the full year comp plan in terms of inflation for that down 1.5 to plus 1.5?

Anthony F. Crudele

We really don’t break out the inflation component when it comes to the comp sales. Obviously we do sensitivities around that number and try to understand what the potential impact is and again, that’s how we come up with the ranges but we have not disclosed any specific inflation guidance.

[Peter Benedict – Robert W. Baird & Co.]

Is it fair to say it’s not a negative number? The impact for the full year?

Anthony F. Crudele

Not necessarily but it’s generally closer to the mid range of the comp.

[Peter Benedict – Robert W. Baird & Co.]

Then on the expectations for your SG&A leverage plan over the balance of the year, what type of comp do you think you guys need to get leverage on SG&A over the balance of the year?

Anthony F. Crudele

Generally as we stated in the past we’re still look at the 2 to 2.25 range. I’d like to sort of stay in the 2.5 but I think 2 to 2.25 potentially. I think given the marketing spend we anticipate I think we have a good opportunity to leverage at that comp range.

Operator

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

James F. Wright

Thank you all very much. I’m glad you’re on this journey with us. We are glad that we have confirmed the opportunity to open 1,800 stores. Those of you who have known us for a long time recognize that we run the business against the long term opportunity. We are diligent by the day, week and certainly by the quarter but we run the business to deliver value and continue to build the brand and relationship with our customers in this sort of aspirational lifestyle that we call this wonderful place out here. We look forward to speaking to you next quarter.

Operator

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

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Source: Tractor Supply Company Q1 2009 Earnings Call Transcript
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