Tractor Supply Co (TSCO) 2005 Q2 法說會逐字稿

Good afternoon ladies and gentlemen, and welcome to the Tractor Supply's conference call to discuss second quarter results.

(Operator Instructions)

I would now like to introduce your host for today's conference, Cara O'Brien of Financial Dynamics. Please go ahead Cara.

Thank you operator. Good afternoon everyone, and thank you for joining us for Tractor Supply's conference call to discuss second quarter results. 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 SEC. 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. The Tractor Supply Company undertakes no obligation to update any information discussed in this call. And now with that out of the way, I'm pleased to introduce Jim Wright, President and Chief Executive Officer of Tractor Supply. Jim, please go ahead.

Thank you, Cara, and good afternoon, everyone. I'm here this afternoon with Joe Scarlett, our Chairman; Cal Massmann, our CFO; Stan Ruta for Store Operations and Jerry Brase for Merchandising. Our team delivered yet another strong quarter and I'm frankly delighted with our results.

Our consistent progress and steady growth are the result of our team's solid execution, our passion to serve those consumers who live the rural life-style, and our ability to adapt and take advantage of a very rapidly changing marketplace. I believe it's also important to note that the second quarter results reflect our ability to deliver strong performance in the current period while preparing and investing in our long-term potential. Our strategy has been and remains a straightforward approach to value creation, and we continue to make progress on each of our key initiatives during Q2 of this year.

We are focused on driving comp store sales and comp store margins. We aim to accomplish this through superior merchandising as well as compelling and targeted advertising messages. We seek to develop and sustain long-term relationships with our customers based on solution selling and providing seasoned advice. We look to work with progressive vendor partners who understand our customers' lifestyle and we are constantly testing new products and categories that further differentiate Tractor Supply. We embrace vendors who have the wherewithal to improve their efficiency and deliver more value at lower costs as our volume grows.

Our merchants completed this quarter, their first trip in a number of years, to China and sourced out a number of unique merchandise. We're very encouraged by our future potential to deliver compelling value at a reduced landed cost. As I previously stated, our current mix of direct import product is 5 or 6% and we see that growing to 15% over the next several years. And see a wonderful opportunity to differentiate ourselves and provide our consumers with just great, great value.

Our sales driving initiatives during the quarter that were launched rather in Q3 and 4 of last year contributed solidly to our comp store sales for the quarter. Comps for the quarter were 5.9%, principally driven by ticket average of which 2% was inflation, driven mostly by steel and petroleum pricing. The remainder of our ticket average came from mix shifts - a mix shift to premium product. Our traffic was up 1.5% comp in the quarter.

During June, we cycled our first year anniversary of our first store in California. You've asked us several times and we said we needed to wait for 12 months. Well, 12 months have passed and our first store in California set an all-time record of $5.7 million first full year. We are pleased with the sales mix. We are delighted with our learning. The learning we achieved and experienced in clothing and equine has been rolled now to two stores in Texas where it is also performing well and we'll be rolling that expanded concept out to about 50 stores throughout Q3 of this year. Testing further for possible expansion into many other stores in the future.

We remain focused on expanding our geographic footprint. As I've stated in the past we're confident there's a market for at least 1,300 Tractor Supply stores throughout the U.S. and we've made progress on this goal in the second quarter by opening 19 new stores and relocating two stores. Our newest DC, where I'm calling from today in Hagerstown, Maryland, ended the quarter on plan for efficiency and is currently supporting 111 stores. The construction of our new Waverly, Nebraska, distribution center scheduled to open at year's end is absolutely on schedule and progressing very, very well. Our implementation of E3 forecast in replenishment software is on schedule and is gaining momentum. We look forward to capturing value there in the months and years to come.

While we are constantly striving to improve our top line, we also take a very disciplined and methodical approach to ensuring that we deliver solid margins of profitability to you our shareholders and we're always looking to take work out. I believe we had a capacity to gain efficiency in supply chain as a result of technology, of process, and leadership. I believe very strongly that we in order to create a stable foundation for a long-term growth we must develop a deep leadership team and that we all work diligently. We continue to nurture top talent, provide skilled building programs to all our team members. Last quarter was no different. We had several training conferences in the store support center. I'm delighted with the enthusiasm, the quality of the folks who are joining our team today.

I'm very optimistic about our future and believe that we are executing well. We are running on all cylinders, our proven strategy and solid business model. We have experienced a dedicated management team and a very favorable long-term consumer trend that frankly has been getting quite a bit of press lately as folks around the country begin to recognize that there is a population migration as folks escape the urban and suburban areas and move to what we call the out here rural life-style. We remain on track to meet our 2005 goals as well as our long-term objectives. And look forward to reporting a progress to you next quarter. With that I'll turn the call over to Cal who will review our financial results.

Thanks Jim. Good afternoon, everyone. First on the income statement our comps were strong. Increasing 5.9% with same store sales gains in all geographic regions. The Southeastern markets were the strongest with comps above chain average while the Mid-Atlantic, Midwest, and Northeastern portions of our trade area had the weakest comp performance.

The farm products division had a solid 3.5% comp sales increase. That was on top of last year's 12.4% comp increase for the quarter. The equine animal and pet category was up 5.4%. Agricultural maintenance products were up 5.8%. And clothing and footwear were up 4.9%.

Going to the consumer products division, it had a 6.5% comp sales increase with hardware and tools having a very strong 7% comp increase. Seasonal products 7.8% comp increase. While truck trailer and towing had a 2.2% comp increase.

Our gross margin improved to -- from last year, a combination of several factors. The gross margin performance versus last year resulted from a neutral mix but a strong gross margin run rate offset somewhat by higher freight costs and higher shrink expense. We also reduced our promotional discounting during the quarter and the LIFO charge which was nearly $2 million last year was about $600,000 this year.

SG&A expense as a percent of sales was 50 basis points higher this year than last year for the quarter, consistent with what we've been talking about starting in the last year as well as on into this year. The majority of that increase was the result of the growth over last year and our distribution capacity, technology infrastructure, and our new store support facilities.

The depreciation and amortization expense was 1.3% of sales in both periods. The increase from $8.1 million in this year versus $6.7 million last year was a result of capital expenditures for new and relocated stores, the new distribution facilities, and our continuing technology investments. Our effective tax rate this year was 6.2% compared to 6.8% in last year's second quarter resulting primarily from the mix of business by state.

Now going to our balance sheet, inventory is the major factor there. At the end of the second quarter our inventory was approximately $67 million above the prior year. The average inventory per store, including the DC inventory increased approximately $45,000 or 5.5%. $865,000 per store this year compared to about $825,000 per store last year. Accounts payable as a percent of inventory decreased from 58% of inventory last year to 54% this year.

Our capital expenditures for the first half were $26.2 million compared to $38.5 million for the first half last year. At the end of the first half in both 2004 and 2005 we had nothing drawn on our line of credit. Our cash position was approximately $66 million at the end of both periods demonstrating our ability to fund growth from operating cash flow.

Now turning to our guidance, well we continue to guide to our previous outlook for the second half of the year. We're up against some tough comp comparisons, so we do not expect to achieve the level of comp store sales improvement that we did in the second half of last year. We currently expect full-year comps in the 4.5 to 5 range. However, we do expect the EBIT margins for the last half of the year to improve versus a weak comparison in the prior year.

As always we encourage you to look at the full six-months period and not individual quarters. Additionally, keep in mind that we continue to manage the business for the long-term. Based upon a slightly stronger than expected performance in the first half, combined with our unchanged expectations for the second half, we currently anticipate net sales for the year 2005 will range between $2.023 billion and $2.033 billion. Full year EBIT margins are expected to be approximately 6.3%.

Net income is expected to a range between approximately $80.7 million and $81.3 million or $1.93 to $1.97 per fully diluted share. This compares to 2004 full-year net income of $64.1 million or $1.57 per diluted share. During the balance of the year we plan to open approximately 31 additional new stores and relocate approximately 14 stores. Now turning it over to Joe for some closing comments before we go to Q and A.

Thanks, Cal. I just want to tell you a same little story. Back in June I was headed up to the William Blair conference in Chicago and decided instead of flying that I would drive and visit a group of our stores in Kentucky and Illinois. And I wound up going to about a dozen stores over two and a half days. Four of those stores were actually building at markets that we've been in for more than 30 years. And all four of those stores we've recently relocated.

Paducah, Kentucky, we had been on, not only the wrong side of the tracks but the wrong side of the interstate and we moved to a great retail location in Mount Vernon, Illinois and Bloomington, Illinois we were actually in the wrong side of town. We moved to the right side of town with new locations and right in the heart of the retail and in Princeton, Illinois, which is a fairly small town, we just jumped across the interstate from a non-retail location into a retail location.

And those stores are just doing great. And it's -- what's so rewarding here is to see the increase in the pride and confidence of our teams in the stores. And it's not just a stores, it's the whole district where people just step up to the plate and they say wow, company's investing in us and we're doing well. And we get great returns out of these stores. We see on these four, for example, we're seeing about 25% sales increases during the first year they're opened as a new location and by the way, those are not in our comp numbers. So our comps are very clean.

We've relocated about 50 stores in the last three years and had tremendous results out of it. I guess the takeaway from this story is that we're investing in the upgrades of our older facilities. We're not letting them sit there and deteriorate. We're making long-term decision for the long-term growth of the company. And as we're doing that we're building the confidence and building the spirit of our organization to continue to grow our business going forward. And when you look at the growth curve of these relocated stores, well, they're certainly headed in the right direction. That's my story for this time and at this point, let's open it up for questions.

Thank you. [Operator Instructions] One moment please for the first question. Our first question is coming from John Lawrence of Morgan Keegan.

Good afternoon, guys.

Good afternoon, John.

Good afternoon, John.

Would you comment a little bit more, Jim? I mean you gave us a little, I guess a teaser on the $5 million store in California. Can you go to the next level of detail and tell us obviously apparel is in more of those baskets than in most of the other stores, but what else can we look at out there? What does the sales mix look like, etc.?

All right. I think John, as you know we don't get too granular, but we have talked about the fact that we had doubled the space roughly to apparel, I would say that we're pleased with that investment. We are also added other categories substantially increasing equine, some of it has worked, some of it has not that's being rationalized soon. We've added unique categories unique to California, drip irrigation, orchard supplies, vineyard supplies. Those are not huge categories, for us but we are pleased. And as always we test the very broad assortment and then rationalize down to the SKU level as we go on. The four wall profitability looks pretty good. It's a long way out there and it's not accretive to the company, just yet but we are learning. This continues to be an experiment. We believe we'll end this year with probably six stores in California.

Great thanks. And obviously we know you started the quarter if you can just give us some kind of sense of obviously, you started the quarter very strong and just sort of by month how did that track, Cal?

Last, the last quarter, we were pretty excited on the first two weeks of April.

Right.

We were less excited in May and we got excited again in June. So it, was cool and if you look at the weather it was cool and dry in May. And that had some impact on the business.

We were able to come out at the high end of the revenue guidance that we gave for the quarter and our performance was just slightly better than the high end of guidance. So, I guess when you take the pluses and the minuses for the quarter, it worked out fairly well.

And the last question, Jerry, when would you assume that you get some real benefit from further importing activity?

John, right now we expect that we will see meaningful benefit from our import activity beginning Q2 of 2006 and then accelerating from that point going forward.

Thanks, guys.

Thank you. Our next question is coming from Reed Anderson of Friedman Billings.

Good afternoon.

Hi, Reid.

Hi.

First, Cal, could you just repeat what you said, the seasonal category comp was that also if someone could follow up maybe give some color on how you felt kind of the more category did relate to your expectations?

Okay. Jerry, maybe you could take the lower while I flip through my notes.

Yeah. Overall, Reed, the outdoor power equipment business, we executed a notable change in our strategy this year, which was really centered around trade-up selling as an organization. And we were very pleased with the shift towards trade-up units that we saw in our overall mix and that was really propelled by the expansion of the Cub Cadet initiative here at Tractor Supply this year. So I would tell you we were very pleased with the strategy shift that we executed in the riding mower category.

Also driven by the kind of the zero turn riders as well?

Zero turns played a significant piece. But that was certainly only a portion of the success that we enjoyed as part of that trade-up strategy on that, Reed.

Both seasonal products on a comp basis improved 7.8% for the quarter.

Okay good. And then in terms of, Jim you commented a little bit in your remarks about inventory management and E3 being rolled out, that sort of thing. Are you still on track with that to maybe add 10 or 20 basis points to the turn this year, or is that by the end of the year or what are your thoughts on that?

I think, Reed, this year the first thing we're seeing, from E3 as you know we are over on a year-over-year basis our inventory comp stores is up at the end of Q2, although it was up less than it was at the end of Q1. So, we're managing that pretty well. But the first thing that happens when you implement an inventory forecast - demand forecast or replenish an engine is that your inventory gets deeper in B and C level SKU's and then over time the C, D, and E SKU's bleed off. We are beginning already to see some gains on our best selling inventory, which was terrific. Obviously that should translate to sales. But in the interim, I think we'll more or likely to be flat, maybe flat at best in inventory turn for the year.

So and then with the benefit really coming in the first half of next year? Would you...

I would see the benefit coming, as we said before, at the beginning of next year we believe we'll see something between 10 and 20 basis points of inventory improvement year-on-year until we're someplace north of 3.3 or 3.4 turns.

Okay and then, one last question on just promotional activity. I got in my mailbox I got a direct mailer from you guys around the 4th of July and I didn't recall getting one last year. I'm just curious about something new you're trying, are you experimenting with different marketing or did I just miss it last year.

No, you obviously had a compensation change year-over-year and our research indicated that -- no. Yes, that is something that we did do last year but for some reason we may have missed you. We did that as an event. We're a little broader in mailing this year than last due to the fact that we had more print activity a little broader basis last year in the month of July than this.

Okay. Good. Good quarter. We'll see you in a couple of days.

Thank you.

Thank you. Our next question is coming from Jack Murphy of William Blair.

Good afternoon.

Good afternoon, Jack.

Could you just talk a little bit about the merchandising initiatives and where we're at on anniversarying the tool reset. If there's any, you know, additional lift you'll see beyond the point of anniversarying that and what other kind of merchandising initiatives of that size or, you know, that type, that kind of come in behind that? Could you give us an update on that?

Jack, this is Jerry and to your point, we basically implemented a significant number of initiatives in the third quarter of 2004. And have been benefiting really since the completion of those resets starting with the -- probably the early to middle part of Q4 of last year. We expect we'll continue to benefit with those initiatives as we roll into the back half of this year. The tool initiatives have been particularly successful and I think Cal touched on the comps that we experienced in the tool and hardware categories. And a lot of that was a buy product of the reset activities we undertook in the third quarter of last year.

I would tell you in terms of additional initiatives beyond what we've worked on previously, you heard the dialogue and the discussion of taking some of our learning from California as it applies to clothing and as it applies to equine and we're beginning to roll that out and bring that back through the rest of the chain. Initially we're looking at approximately 50 stores. We're going to kind of ping it and watch very closely. Once we're satisfied with the results, we expect to have significant opportunities to grow those two very important pieces of our business, Jack.

Okay. Thanks. And also on the CapEx guidance for this year, I'm not sure if you mentioned it, but I think you initially had a number out there --

82 million as our CapEx guidance, down from about 93 the year before. We don't have any change in that guidance at this time.

Okay. And in terms of the spending on the distribution centers, just over 20, that's a number that also looks to be pretty much on track?

That's correct.

Okay. And then last question is just you mentioned about some of the opportunities to take work out. What are some of the bigger opportunities that, you know, you see in front of you for the next call it four, six quarters.

Jack, Stan Ruta at that here. We recently had a meeting with our management advisory board and they delivered to us a list of opportunities regarding process, taking work out. Mainly in our day-to-day work process that we have in our stores. That's to move our freight, to get it on the shelves, to do price changes, and in a timely and efficient manner. You know, no huge, huge initiative there that's going to just mean tons of stuff. It's really just refining the details and adjusting our business process to make process fast and efficient in our stores.

We are currently in Store Operations we're getting ready to go to our summer meetings starting in August and meet with all of our entire management team, our store managers and assistant managers to review not only product knowledge training but also management skills training as we continuously do at Tractor Supply. But in regards to efficiencies, just continuous process so we become more efficient with every business transaction and with every task we do.

Thank you.

Thank you. Our next question is coming from David Cumberland of Robert Baird.

Hi, thanks good afternoon. Did the Florida sales tax holiday on hurricane related items have a meaningful impact on comps in the Southeast region, which you mentioned as the strongest and also on your overall comps?

That area has been strong prior to and after that sales tax or that initiative that they had in Florida. We got some incremental sales there. Tends to be lower margin type sales. Probably less than $2 million of incremental sales. Jerry's putting up one finger and saying that it's closer to 1 than it is to 2.

Thanks. And then, what is your outlook for weather conditions in the second half? Are you starting to go see drier conditions in some of your markets and does that affect how you manage some of your categories?

David, based on our anticipation of the weather patterns, number one, yes, we are seeing drier conditions in a significant number of markets, particularly down in Texas, up through Oklahoma, up through Illinois and actually into some of the areas of northern Indiana and Michigan. We would characterize those as being drought areas right now. We've reacted. We've substantially built inventory in our drought responsive categories. The fact that there's a drought doesn't always mean that we don't have the opportunity to sell something. In fact, we've got a whole drought initiative out there from that standpoint.

One of the things that we are expecting is that September sales on cool weather products that were somewhat blunted last year by the havoc that was wreaked with all the hurricanes that came through Florida, we expect we will see an early burst of business when it comes to some of the cool weather categories in the month of September this year which will give us a little bit of a boost towards the end of the third quarter. Again, it's still early and the dollars are relatively small, but we are expecting a lift on those categories early in autumn this year.

Last question, the SG&A ratio was higher in the first half related to investments in growth. Which of those investments would also apply to the second half or the E3 rollout, any others we should have this mind.

Most of the others will have been anniversarised in the second half. In other words, we were incurring similar costs so on a year-over-year basis or they should be neutralized.

Great. Thank you.

Thank you. Our next question is coming from Michael Cox of Piper Jaffray.

Hi, Michael.

Good afternoon. Congratulations on a great quarter.

Thank you.

And congrats to Reid Anderson out there for his competition increase as well. My first question is on the commodity cost front. I was wondering with commodity costs, particularly steel items starting to come down a little bit. How quickly are your vendors to react to that? Do you see any type of relief or do they maintain their prices as they were?

First of all, steel was coming down in scrap steel. Cold and hot rolled steel is very, very flat compared to last year and I'll let our merchant talk about how quickly our costs are coming down?

Michael, we have seen some cost reductions, specifically in a couple of key categories, steel categories, most notably in the fencing areas. Again a lot of that product is derived from scrap. I would tell you at this point it's turning a corner because a lot of the suppliers had forward bought product at higher pricing. Some of that is still working its way through the supply chain itself.

I would caution the fact that there is some rumbling that scrap prices in July and August are starting to turn back up again. Even though they had come down during the past four to six months, in that timeframe. So we are making a very targeted effort right now to go after those ****suppliers where we had seen cost increases as a by-product of steel and we're starting to extract that through the process of reviews with the suppliers. Again, it's not across the board. This is very targeted at the vendors that came to us and asked for support during a rising tide. We'd like support when it goes the other way.

Okay. Great. And in terms of Joe, you mentioned some of the relocations that you've made recently. As you look at your store bases there, is there a targeted number of stores that you are looking at to relocate over the next, say, two to three years?

We've been doing about 20 stores a year now for the last several years. And we've eliminated most of our really bad, old stores. We've got a few left to go. But our long-term strategy is to continue in numbers of about that amount, 2 to 3% unit each year we will look at replacing and making sure we keep our stores up to date. What we talk about internally is not winding up where Kmart was but following the path of Wal-Mart of continuing to upgrade and improve and keep ourselves up to date.

Okay, great. One last final question and I'll turn it over to some other folks. Any new markets to speak of what you'll be entering into in the back half of the year?

I don't believe there's any new states that we'll be entering based on current plans.

Okay. Great. Thanks a lot, guys.

Thank you. Our next question is coming from Anthony Lebiedzinski of Sidoti & Company.

Good afternoon. Couple of questions. Any color you can provide about the comps that are running quarter to date so far for you?

No.

Okay. Now this year is a 53-week year. I was wondering how much extra is that in terms of the top line and bottom line that you expect out of that additional week?

Less than the average week, that's about as granular as I can get at this time. Probably about 60% or so of an average week. That tends to be the week between Christmas and New Year's, there's at least two selling days that you're down. It's probably really only a five-day extension, and it's at a time when it's not - it's more like January than it is like December.

Okay. A few months ago you talked about making some changes to your clearance section. I was wondering about the progress in that, in that area.

Anthony, this is Jerry on that. We have rolled out a complete new process in our stores for handling discontinued and clearance merchandise that is much more granular in nature and at this stage much more consistent in terms of our execution across the stores. We have identified specific areas within the stores themselves for stores or stores to merchandise clearance goods. We've also made some changes to our technology that allow for in-store printing of yellow and black clearance signing that makes it much more obvious to the consumer what's on markdown. Our goal and our hope, and it's a little too early to give you an assessment at this point, our goal is we will sell more merchandise on the first markdown as opposed to waiting until it gets to 40, 60, and 80% off.

Okay. And as far as the comments about the gaining better distribution efficiencies, maybe you could just add some more color to that.

Anthony, the distribution efficiencies that we are seeing today are as a by-product of the maturation of our distribution center network. A year ago we opened the Brazelton, Georgia center and as a start-up facility we had a level of expectation, which they met in terms of productivity and efficiency. This year they've significantly ramped that up in terms of their efficiency. Again, they're maturing.

The Hagerstown facility here in Hagerstown, Maryland, has really jumped out of the chutes very quickly at a level of efficiency that has exceeded our expectations. We continue to gain efficiency within the Waco and the Pendleton distribution centers which is really allowed us to bring additional categories of merchandise to the distribution center that were previously going store direct or cross dock through the distribution centers which is having a favorable benefit on the landed cost to goods as an organization.

Could you also comment about the availability of real estate as well as store managers for your future stores?

Sure, Anthony. Stan Ruta here. Real estate, we're moving right along on the real estate front. We've got for 2006 we already have 55 sites that are approved and to our real estate committee. Our goal next year is going to be well over 70 stores. So we're moving along okay on the real estate front. It's a continuous challenge but the real estate team is very aggressive and doing a great job.

In terms of managers, again, this is an area where we always want to do better. We don't work on managers once a quarter. We work on them every single day at Tractor Supply. Today we have more managers in training to become store managers than any other time in our company's history. Between assistant managers and manager trainees, our numbers are terrific and we're doing very well there and our manager turnover continues to be solid and declining slightly.

Okay. Thank you.

Thank you. Once again the floor is open for questions.

[Operator Instructions]

We have a question coming from Frank Brown of SunTrust Robinson.

Good afternoon.

Hi Frank.

I was curious if you could give a little more color on the trade-up selling. And specifically I am interested is that good, better, best, or is that a higher mix shift towards the higher end in terms of assortments.

Frank, it's a combination of both. The first thing that had to occur is as merchants we had to tailor the assortments to include trade up goods, where they didn't exist previously in our overall mix. We had to revisit our in-store presentation for the point were we made certain we displayed what we wanted to sell to the customer first and foremost. We've altered our presentation within our stores significantly.

It was then also a matter for us collectively of training to what we wanted to sell as an organization. So we put a heavy focus on trade-up selling in our recently completed managers meeting back in February. Our store operators as a team have really rallied behind this initiative and we've basically rolled it out in several key areas. We've mentioned outdoor power equipment. We're also looking at this today in clothing, in tools, and most recently in the feed business we've introduced a high-end line of equine feeds that have been met with some very pleasing success initially out there. So it's really a total company initiative across all disciplines at this point, Frank.

Okay. Just on a different tack promotional financing, could you comment kind of on the promotional environment that you face from other retailers out there and things you might have to match in the marketplace?

There's a lot of noise out there right now, a lot of use of 12 months no interest, no pay on sales above $300, above $500. A lot of six months no, no as well. And frankly we're seeing some retailers in the home products business who are becoming much more aggressive with high-low and my observation is there's more print on the street than there was a year ago. A lot of noise out there right now.

Okay. And just a final question, I think Cal mentioned that shrink was up a little bit as one of the factors on gross margin rate. Is there anything specific, you know, related to that?

There's been slightly more shrink as a result of some of the initiatives that we took in the third quarter of last year. A lot of the power tool-type categories have a higher risk of shrink. However, we have taken some actions to better control that inventory and we believe that we have plans in place to bring that back into our historic lows. Compared to most retailers we've typically had a very favorable shrink rate and even with the slight increase over what our historical rate has been, we're still well in line with what you would see similar retailers having.

Great. Thanks very much. We'll see y'all on Friday.

Thank you.

Thank you. Our next question is coming from Vivian Ma of CIBC World Market.

Good afternoon. I was wondering about the drivers of your gross margin gain because you mentioned your mix is neutral during the quarter but the run rate was higher. And so I just was wondering what were the reasons behind the higher run rate.

Vivian, this is Jerry and when you look at the higher run rate that we experienced on margins in the second quarter, a key piece of that whole initiative came as a by-product of the trade-up selling posture that we've taken as an organization. Typically, as I'm sure you understand, trade-up goods carry higher gross margins than do opening price point or good product in a good, better, best continuum from that perspective.

In addition, we've put forth a significant effort on cross merchandising within the stores, taking advantage of some of the discretionary merchandising display space that we have to generate additional impulse sales. And again a lot of the impulse sale categories that we're talking about have significantly higher margins than most of the core merchandise categories we have within the stores. So without necessarily wanting to sell less, low margin product, we have been fortunate enough to accentuate those sales with higher margin trade-up goods as well as impulse sale items that have complemented the overall margin on the basket itself.

Okay. I see. So it wasn't like the - your category percentage breakdowns stayed the same but within the category you were selling more of the higher end, more of the best products.

Yes. As a senior merchant, Vivian, I was most pleased throughout the quarter with the balance of growth across each of our six major categories. This has been as balanced a quarter in terms of overall growth that we've seen probably in the last two years, which I think speaks volumes about the strength of our individual businesses today.

Can -- my next question is on shrink. Can you comment on the shrink sequentially versus the first quarter? Was there an improvement or not?

It was about at the same level but it was in the first quarter. You might recall in the first quarter we had some shrink as a result of inventory taking subsequent to the Florida hurricanes. The period of time that was covered by those inventories included the time that right after those hurricane related disruptions to our stores. So on a first quarter and second quarter had approximately the same shrink rate.

Okay. And what is the outlook for the third quarter? Do you think it's going to be, you know, more or less the same or do you expect improvement?

It may be close to the same again because we've put actions in place to stem that tide but you still have the period of time that hasn't been covered by inventories yet that as we take inventories of stores, it's been a year since we took them, so there's some period of time this in there when those stores had that line of merchandise that is subject to higher shrink until we put some of the additional controls in place.

Okay. For your pet category, have you noticed any changes in the pricing or the competitive environment?

Vivian, there's more and more people that are entering the pet supplies category from our perception out there. I think they are recognizing some of the same opportunities that Tractor Supply has recognized. That not withstanding, when you look at our overall market share as a company today in pet food and in pet supplies, it's a very insignificant total market share. We believe we have significant opportunities to continue to grow that, even though it's becoming an increasingly crowded retail environment.

Okay. My last question is, do you have some more color on the variance in sales trends from month to month during the quarter as it -- you know, specifically as it relates to weather changes?

No, I said earlier that we -- that April came out strong, May softened, and June came back.

Okay.

Vivian, as usual, we encourage people to look at our business not on a quarterly basis, let alone on a monthly basis. So we like to look at sales over two distinct cycles. We have that spring selling season that sometimes it starts in March, sometimes it starts in April. It goes through till May, June, and sometimes on into July. And we have a similar phenomenon in the last half. So you can get bad conclusions out of information on a specific month basis. So we're reluctant to give people information that may not be beneficial to their evaluation of our true business results.

Okay. Great. Thanks very much.

Thank you. Our final question is coming from Andrew Wolf of BB & T Capital Markets.

I'd like to start with a couple of housekeeping questions for you. Could you tell us what your D&A expectations are and your effective tax rate expectation.

Effective tax rate to be consistent with what it's been on a year to date basis. It will depend on where our business occurs for the balance of the year and other factors. We don't know of anything that would change it from what we've experienced in the first half. Let's see, what was your second portion of that question?

The D&A side of it.

About on a percent to sales basis comparable to what it's been the first half, we have been constantly increasing our investment in new stores and in distribution facilities and other things that result in depreciation and amortization. The second half is likely to be slightly higher on a dollar basis than the first half, but then we would anticipate that sales are going to be slightly higher as well.

Thanks, Cal. And lastly, I've noticed that each of the last four quarters the company has called out that the Southern stores have done better on same-store sales basis. To what do you attribute that? Is that the legs on rebuilding Florida post hurricane or is there something, you know, different or more structural that we should be thinking about?

I guess two things. Principally there certainly was some acceleration and continuing momentum as a result of the hurricanes and the fact that as we said before, we were the last stores to close, the first stores to open and did business to serve our customers with flashlights. Put mine in a cigar box 11, 12 months ago. We think that creates tremendous goodwill. Next is there's obviously an inflow of insurance money to Florida. It's probably helping all retailers in our categories in Florida. And next could be that those stores as a group tend to be a little less mature. We just entered Florida for the first time five years ago. There's a natural comp momentum in the first, you know, two to five years of comp store growth.

When you refer to the southern stores as you have in your releases does that include two regions, like southeast and the southwest and Texas or could you help me?

It would be not only Florida but also Georgia and Alabama. So it's -- our regions are not static, for one thing. So we don't usually refer to regions. We usually refer to geographical areas. What we were referring to on the southeast was Florida and Georgia. That's where the higher comps came from primarily.

Okay. So we shouldn't think of Texas, the biggest state as being part of that?

Texas was not intended to be included in that comment.

Thank you.

Thank you. Thank you everyone. We are having a webcast on investor day on Friday, 7:30 Eastern Time. I look forward to listening in at that time. Thanks for your support. We're off to creating some more value in next quarter and we'll talk to you soon. Bye-bye.

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