Tractor Supply Co (TSCO) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Tractor Supply conference call to discuss third-quarter results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will follow at the 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. Melissa Myron of Financial Dynamics. Please go ahead, Melissa.

Thank you. Good afternoon. Thank you for joining us for Tractor Supply's conference call to discuss third-quarter results.

Before we begin, let may 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. The Tractor Supply Company undertakes no obligation to update any information discussed in this call.

And now, I would like to turn the call over to Jim Wright, President and CEO. Jim, please go ahead.

Thank you, Melissa, and good afternoon, everyone. I'm here today with our chairman, Joe Scarlett; Cal Massmann, our Chief Financial Officer. We also have Stan Ruta from Store Operations, Gerry Brase from Merchandising, as well as Tony Crudele with us today.

Tony, as you know, joined Tractor Supply on September 26, and will officially assume the CFO position on November 4. Since joining our Company, Tony has been touring our stores and distribution centers, meeting our people, familiarizing himself with our business, our products, and our culture. We're pleased to have Tony join our team, and are confident that he will contribute greatly to our future growth and success.

We are pleased to also have the benefit of Cal's counsel for the past five years, and looking forward to having Cal with us through May of next year, which will ensure a smooth transition and provide additional support to the senior management team as we continue to execute against our growth strategy.

Now onto the results. We delivered another very strong performance in the quarter, in an external environment that was characterized by record gas prices, severe weather conditions, and general consumer caution. We were able to generate positive comp sales against a difficult comparison, as well as significantly grow our margins and our bottom line.

While we did have a hiccup in the third quarter of last year on the margin site, I would like to point out that our operating margin improved not just over Q3 of last year, but also over the third quarter of 2003 which was a more normalized quarter. I believe our solid results are a testament to the various initiatives we have instituted over the past year, the unique niche that we serve, and the strength and the commitment of our team.

In planning the quarter of this year, we focused on managing the margin line as opposed to driving high comps on top of the very strong comps we had in the third quarter the past two years. This included rethinking how we advertised, what we advertised, what we merchandised, and how we set our prices. This year's management of seasonal goods allow us to reduce clearance markdown exposure. Circulars were reduced, both in number and in duration. And the efficiency of direct-mail was improved. We were impacted by four hurricanes last year versus one this year. As a result, we sold fewer low-margin generators this year compared to last.

During the quarter, our traffic was down 2.9%. Our ticket, however, was up 4.8%, highlighting the macrotrend in retailing today that is skewed towards lower traffic and higher ticket. We have seen this evolve over the past six quarters, and have factored it into the way we do business. As I discussed last quarter, we continue to focus on shifting our consumers up the purchasing scale to more premium products.

We have enjoyed a $500 increase in the average riding lawnmower retail price over the last five years, and more than $200 in Q3 of this year versus Q3 of last year. Premium horse and dog foods continue to outgrow the good and better brands, and we are enjoying strong sales of Carhartt and Colombia apparel in our clothing superset stores.

In addition, we benefited from improved inventory management during the quarter. We ended Q1 of this year $100,000 per average store over the prior year. We ended Q3 flat with the prior year -- so tremendous improvement. And while we did that, we also increased our in-stock position to the best level over the last several years. So we continue to work through the learning curve of E3, which is substantially implemented. And we are already beginning to see some early benefits from this new technology and the processes and team that we have installed concurrent with the technology.

After some delay at our new stores, we are on schedule for the year, and anticipates opening 65 stores versus the previously announced 63. Our newest distribution center in Waverley, Nebraska is progressing well, and we anticipate it to be online in January as scheduled.

We are extremely proud of our store teams who were impacted by the hurricanes. At the peak, we had 16 stores closed, and in total, we lost 50 store days of full productivity. Our teams took great care of our customers, serving them with flashlights and without the support of any systems. We were frequently the last store to close, and also frequently the first store to reopen.

It is important to note that in the third quarter, a key aspect of our business was highlighted -- that Tractor Supply is unlike any other store. Specifically, we have certain unique characteristics that cause our business not to be impacted by the macrotrends in the retail environment the same way as other retailers. While we are in the pet business, we are not a pet retailer. And while we sell apparel, we're not a clothing to store. We cater to a unique customer and to a unique niche.

At Tractor Supply, we exist to meet the needs of those who live the rural lifestyle, and our experience has shown that the items needed to live this lifestyle are much closer to needs than they are to wants or desires. Our customers are committed to living the "out here" lifestyle and need the products we supply to maintain and protect that lifestyle. Therefore, in a downturn, while not fully protected, we tend not to be as severely impacted as other retailers.

Now I would like to turn the call over to Cal, who will review our financial results for the quarter. Cal?

Thanks, Jim. First of all, on income, in the context of the overall retail environment and our strong same-store sales growth in 2003 and 2004 for the third quarter, our third-quarter net sales and comps were strong, increasing 12.5% and 1.8%, respectively. Seasonal products showed the greatest strength, as we enjoyed both strong sales of riding mowers and early sales of fall heating products. Clothing and footwear were also strong, partially as a result of our expanded workwear department currently being tested in every 50 stores.

Geographically, Florida and the Southeast continue to exceed our expectations on the sales line. Our gross margin improved significantly to 30.6% from 28% last year. This improvement was the result of several factors, including improved mix of sales, increased selling prices on selected merchandise, lower freight costs, and a lower LIFO charge. When you compare it to the 2003 third quarter, as Jim had earlier mentioned, we're still 20 basis points ahead of that third quarter '03 number. So we're continuing to make progress on our gross margins and compared to not only the prior year, but the year before that.

Selling, general, and administrative expenses have improved 90 basis points to 22.7% of sales compared to 23.6% last year. You might recall that last year in the third quarter, we moved our store support center. That was at a cost of about $2.9 million on a pre-tax basis, and if you take that out, the selling, general, and administrative expenses decreased by 20 basis points in the quarter. This is primarily due to reduced advertising expense compared to the prior year. Lower personnel costs, as a result of a favorable benefits cost, offset somewhat by higher occupancy cost, driven by heating and property taxes.

Depreciation and amortization increased approximately $2 million from 1.6% of sales in the third quarter in '04 to 1.9% of sales as a result of the approximately $85 million in capital expenditures that we've made in the past 12 months, primarily for distribution capacity, for new stores, and for technology. We continue to grow toward that 1,300-store target that we have, while at the same time delivering excellent EBIT margins.

For the third quarter, our EBIT margin was 6% compared to 2.8% last year. On a year-to-date basis, our EBIT margin was 5.9% compared to 5.2% last year. The tax rate for the quarter was unchanged from the prior year. On a year-to-date basis, that effective rate is approximately 36.25% compared to about 36.75% in the prior year, primarily as a result of the change in the mix of business among states that have different rates.

Now turning to the balance sheet, our average inventory per store has decreased slightly from about $870,000 per store last year to about 867,000 this year, reversing a trend that we have had for the last several quarters. And that is in spite of inflation-driven higher costs. After several quarters of slower inventory turns and lower gross margin return on inventory investment, we're starting to see improvements as E3 becomes more fully implemented.

Accounts Payable is approximately 46.1% of inventory this year compared to about 45.8% last year. So we continue to have the leverage of our vendors. Property and equipment has increased about $85 million, as we added that distribution capacity and increased our store count, relocated stores, and developed our technology infrastructure. Our revolving credit loan has decreased by about $24 million to a mere 20 million even as we continue to build infrastructure and increase our new store growth from internally generated cash.

Now turning to our guidance and our outlook for the remainder of the year, we are constantly monitoring how these macrotrends may impact our business. We haven't faced a similar environment with our current mix of customers and geography. So we believe it's prudent to maintain a healthy dose of caution.

However, given what we know today about our customers and how our business has performed thus far this year, we're optimistic about our full year bottom-line performance. We're up against some pretty tough comps going into the first quarter, and we do not expect to achieve the same level of comp store sales improvement that we had in the fourth quarter last year. We do expect the full-year of approximately 4.2% to 4.5%, and currently anticipate net sales will range from 2.012 billion to 2.020 billion, and for that full year, EBIT margins to range in the 6.3 to 6.4% level.

Our guidance is for fully diluted earnings per share in the $1.95 to $1.97 range, with net income to range between approximately 80.5 million and $81 million. And this compares to a 2004 full-year net income of 64.1 million and $1.57 per share per diluted share.

During the balance of the year, we plan to open approximately 18 additional new stores and have approximately six more store relocations. This will result in 65 new stores and 19 store relocations for the year compared to the 63 new stores and approximately 20 relocations that we forecast at the beginning of the year. Additionally, we're currently rolling out an energy management system to our stores, and we now expect the total 2005 capital expenditures to be just shy of $90 million. With that, I'll turn it back to Jim.

Thanks, Cal. Our consistent progress and steady growth are the result of our team's solid execution, our passion to serve those customers who live the rural lifestyle, and our ability to adapt and take advantage of an ever-changing marketplace. We are pleased with our 6% EBIT margin for the quarter, given that we were able to achieve this in the type of environment we faced during the quarter bodes well for our ability to effectively run our business in good times and bad.

Our third-quarter results also reflect our ability to deliver strong performance in the current period while simultaneously investing in our long-term potential. Our new store openings are on track, and we continue to invest in training, store remodels, infrastructure, and technology that will ensure our longer-term success.

We remain confident that there's a market for at least 1,300 Tractor Supply stores in the U.S., representing a significant growth for our current 562 stores. And we are on the path to reach that opportunity.

Before I turn the call over to Joe for his closing remarks, I would like to update you on Del's Farm Supply. We announced this summer a letter of intent to acquire this privately held company that would provide us with a second retail concept and an entry into the northwestern United States. We are on track to complete this transaction, and are currently working towards a close in the month of November. We think it will be a great strategic fit for our Company, and we are excited to begin working with their management team. Now I would like to turn the call over to Joe Scarlett.

Thanks, Jim. I'd like to tell a little story about people development. As we all know, business unit leadership makes a real difference. Simply put, in our business, good store managers make a big difference. Good district managers make a huge difference. And we believe in developing -- in our leaders. And it all starts with the selection process. And we have become more and more rigorous about the selection of new people, and we're equally tough on internal promotions. We treat the selection process very seriously.

Once we have good people in position, we work hard to educate those folks, both for their current position and for their future growth. We founded Tractor Supply University in 2002, and that's our umbrella for education.

Our Tractor Supply Leadership II (ph) program is for high-performing and high-potential store managers. Last year at this time, we had about 90 applications of those folks who were running stores who wanted to come to class to learn how to be better managers and to prepare themselves for the future. We chose 22 of the best for that group. And those folks came to class for four separate three-day classes over the first nine months of the year.

We focused on the skills they needed to move forward. And the classes were done by our executives, by our HR people, and by some of the folks from Belmont University. They went through classes on leadership, communication, effective writing, conducting meetings, public speaking, personnel management of all kinds. We worked with them even on their computer skills, and certainly on financial accountability. We worked with them very closely, preparing them for their next step. And the skills we know as a multiunit manager are much more difficult than the skills of running an individual store.

Well, in September, we proudly graduated all 22 students. And of those 22, nine have already been promoted to multiunit management, running a group of stores. And I am confident that many more will be in the months ahead. At Tractor Supply, we believe in investing in our people because in the long-term, that's what will pay the greatest results. With that, I'll turn it back to Jim.

We are ready for your questions, and look forward to discussion.

(OPERATOR INSTRUCTIONS). David Cumberland, Robert W. Baird.

On the Q3 earnings, how did your performance compare to your internal plan?

The bottom line -- it was very close to our internal plan. The comp store sales were a little softer than we expected. But overall, we are pleased.

Jim, do you expect to continue to manage a bit more to margin in the near-term as you mentioned you did in the third quarter?

Actually, no. We had a unique situation. If your recall, a year ago, David, we had about -- if I recall, a 360-basis-point margin shortfall year over year driven by mix and discounts and the hurricanes and also freight. So that was a very deliberate effort in Q3. And while we always pay attention to the margin line, and we certainly expect to increase it (multiple speakers) over term, no; we will continue to drive topline sales.

And one other topic -- Jim, you mentioned that severe weather in Q3 -- what was the impact, at least directionally, of weather on your results in the third quarter?

A couple of things. First of all, it was very hot and dry. So the weather was unfavorable in July and August across many parts of our 44 states we do business in. It was slightly positive in September. But on a year over year basis, we actually did less business in the emergency response, which would be severe-weather related goods. So the weather, I guess, would be a net negative for us on a year-over-year basis.

Cal noted strong sales of heating equipment. Can you elaborate on that, and perhaps, are you seeing any supply issues with certain products that might be more in demand with the high energy prices?

David, this is Gerry. And just to comment on your question specifically, basically, the heating sales were fairly lackluster, given that heat and the dry conditions in both July and August. With the rapid run-up of fuel costs at the end of August specifically as a result of Hurricane Katrina, there was a lot of attention focused on alternative heating products, if you will. And for us, that means wood heating, specifically. We saw a significant increase year over year in wood heating products and pellet stoves and wood pellets and the like. The industry right now is strapped keeping up with demand, as there has been a lot of focus on behalf of the customers on alternative heating products. But I can assure you with our sizable market share in this industry, we're getting a disproportionate share of the available product that's out there today.

Vivian Ma, CIBC World Markets.

I am interested in any insight you may have regarding the factors on the sort of somewhat slower comps in the July and August months apart from the weather factors. And whether you think looking out, how temporary or how longer-lasting that is, and whether you saw anything like a share shift or a channel shift to other types of retailers -- just sort of in general, any more color on the region differences or differences in the category sales trends?

I'll speak to that first. First of all, we must bear in mind in that we are cycling 10.1 comps last year on top of (multiple speakers) 13 4 in the quarter the prior year. So we have a very, very significant sales to overcomp.

Secondly, if we look back, particularly to the earlier part of Q3 last year, we had terrific rain and very favorable weather in the South, Texas, and the Southwest -- Southeastern United States. Very favorable for the sale of lawnmowers and other outboard (ph) power equipment a year ago. This year, that reversed on us. And it was really quite dry in that same geography.

So beyond that, we saw in early parts of the quarter no significant shift that couldn't be really explained by a weather cycle year over year. Of course, then, in late August and through September, consumer dynamics became very evident as energy prices went up. And beyond that now, we saw really a very good -- very consistent results across most all categories and across all of our geography.

Has the sort of traffic slowed down from -- was there a big difference between August and September?

Gerry, do you have a --

Yes, Vivian, just as an update, the trends that Jim reported on for the quarter was pretty consistent across all three months of the third quarter, which -- again, this has been a continuing trend roughly over the last 12 months that we have observed.

Okay. Was there any difference between categories, or was it broadly based?

I'm not sure that we track traffic counts by category. And Vivian, Jim has already commented on some of the categories that performed well. And relative to the weakest-performing categories that we had, a lot of it can be attributed to the very strong emergency response sales we said last year in both generators as well as woodcutting supplies -- chainsaws, chainsaw accessories, and the like. That was where we saw our biggest decreases year-over-year.

Okay. Just one more questions. On the SG&A, I'm wondering about the reduction in the advertising expense. Was that -- is it correct to assume that was a planned reduction?

Absolutely. You may recall again in the third quarter of last year, we were attempting to build on comps that were strong from the prior year. And as Jim mentioned in his comments, we have taken a different approach when it comes to the advertising and promotion. And we definitely had planned advertising down for the third quarter.

Okay. So for the coming quarter, for the fourth quarter, I should expect this is a permanent step (ph) down. Is that correct or --

In advertising? No.

Oh, so in the fourth quarter, it's going to be -- I guess year over year, it's going to be -- you're back to whatever the normalized level is.

That would be correct.

Okay. Got it. So overall, basically, if I'm looking at the fourth-quarter SG&A, you are probably expecting similar to maybe up a bit year over year --?

We've giving guidance on top line and EBIT, and that's about as far as we usually like to discuss it in detail. We see some cost pressures on occupancy costs as a result of heating and cooling buildings. And because of additional taxes that we are paying on real estate. But other than that, we don't see any significant items in the fourth quarter that would be different than the fourth quarter of last year.

Edward Yruma, J.P. Morgan.

Question regarding your clothing test. It sounds like you're seeing some real success. I know it's very early, and it's only 50 stores. What learnings can you take from those stores across chain, and have you kind of developed a more broad rollout?

And Jim mentioned the super clothing departments that we have rolled out to -- we actually went in and retrofitted during the third quarter this year a total of 51 of our existing stores. And we've also made the strategic decision that we will roll them out in virtually all new stores going forward. And that began back in June.

So as of today, we have approximately 90 stores that have the super clothing sets. And we have seen significant growth, and we are just delighted with the performance of our basic workwear and what I would consider to be our lifestyle clothing that's been introduced as a result of our new, expanded clothing set.

We did see a little bit of softness in the third quarter in what I would consider to be insulated outerwear, which -- again, as hot and dry as it was, there was just no preseason selling in those categories. But overall, we are delighted with the performance of our expanding clothing sets.

John Lawrence, Morgan Keegan.

Just to quick follow-on that quickly -- Gerry, I would assume that the new stores -- the 50 or so stores that have been opened new in our models, that would be -- the difference in how those stores are opening would be the apparel sets are doing pretty good volumes?

That's correct, John.

A couple of other questions. First of all, on the -- if you look forward -- I mean, if you look back, Gerry, a year ago, when you did the reset in the third quarter and those were some of the problems, now you've had a year and worked through, basically, I guess five quarters of that -- what can you tell us about that reset now that -- it started off a little slow. Obviously, it was the right thing to do. Can you talk a little bit more strategically about that -- why it was done and really what you gained from that?

Yes, it afforded us the opportunity to invest and see if we could accelerate change within our store environment and our products base on that, John. And a lot of what we rolled out in the third quarter of last year were really expansions of test programs. And we basically tested several new categories at the same time.

I would tell you, we've analyzed the results of that. And overall, we've been delighted with the topline performance in aggregate. I will tell you there are some categories that have been disappointing to us, and we won't be expanding beyond the test that we did. And there are others that we will be accelerating and rolling out to additional stores as we go forward based on the last four quarters of their performance.

And can you give us an idea -- and you might not say it here, but how much further will the Schmidt line be expanded for the fourth quarter?

John, our goal with the CE Schmidt clothing line, which is what you're referring to -- it's our private-label line of clothing -- is that every six months, we will have new introductions into the product line. And we're delighted this year with the expansion of what we're doing with CE Schmidt into additional categories, most notably, several new lines of shirts within the clothing category, and we've also expanded substantially the men's bottoms. These are men's jeans and workwear pants that have been in the stores since August. And today, we are delighted with the way they're performing, John.

And to follow on the last question, no announcement yet as to when the super apparel will be rolled out to the chain?

As I mentioned earlier, we are testing it in 51 existing stores that we converted at this point. We will monitor and measure the results. And then we will make a decision as we go forward as to how quickly we want to expand it beyond where we are.

(multiple speakers) John, that wouldn't be before Q3 of next year.

Congratulations.

Wayne Hood, Prudential.

I had a couple of questions. I guess on the traffic being down almost 3% -- given your outlook for the fourth quarter, you would expect that to reverse it, and also given the fact I guess you're going to go back to normal amortizing program, the traffic trends would be flat or positive in the fourth quarter?

Wayne, the traffic has been -- if you look back into '01, '02, most of '03, the vast majority of our comps came as a result of traffic. Then began a mix of traffic and ticket. And the last several quarters, it has been predominantly ticket.

We would suspect that trend to continue. Whether we will have negative traffic or not, I can't really say. I think we will continue to see ticket drive more of our comp store sales. And I think we're seeing a fundamental shift across all of retail in the number of shopping trips that consumers are making. And when they get to the store, I think most all retailers are reporting a larger market -- a larger average purchase.

Right. I was also wondering, Jim, were you able to leverage your comparable store expenses in the quarter on a 1.8% increase in comps? Are you going to tighten down that much, or is that number flat or up?

There was a lot of chatter in our SG&A compared to last year's third quarter that you would have to take into consideration. I would say that certain aspects of it we were certainly able to leverage at that level, especially in the personnel cost. Occupancy cost is a little more of a challenge, given some of the increases that we're having in occupancy cost.

But you think it would be leverage because of the spending that went on last year in the third-quarter -- right with the reset?

Correct.

Okay. And another maintenance question. The pre-tax LIFO charge last year was 3.1 million. What was that this year?

About 2.4 -- slightly less.

Okay. And then, one measure that we look at is new store productivity. And that was about 73% versus about 75 a year ago. Were those 15 openings -- were they late in the quarter that might have caused some erosion in that, year over year?

(multiple speakers) They were later in the quarter -- absolutely, Wayne.

Matthew Nemer, Thomas Weisel Partners.

First question is on the commodity price increases that you mentioned, can you give us a sense of what the initial margin was on those products? Were you able to pass that on?

For the most part, we have been able to pass along these increases to the consumer. Obviously, we stay in touch with what's happening in the marketplace. And predominantly, what was driving the differences this year were less steel, which was a big factor last year. And as you might imagine, petroleum and plastics and the like are expected to play a significant role out there.

Okay. Next question, on your holiday merchandise, just wondering if you can give us some more detail on what you're planning there. How much are you rolling out to the stores, and what percentage of the mix or contribution should that provide in the fourth quarter?

We have been delighted with the growth of our fourth-quarter holiday gift sales. And we're going to see if we can't capitalize on the growth that we've seen in the last couple of years. And as you might imagine, we'll be focusing on categories such as tools, toys, and we have a very unique offering in what we call equine gifts that are arriving at our stores right now. And I would tell you as a percentage of the total, it will play a higher percentage of the total this year than it has in past years, because we're going to be more aggressive in those areas.

Okay. And then lastly, on the distribution side, and I guess on the store management side, can you give us a sense of what impact higher energy prices are having, both on diesel fuel and potentially on heating this winter?

On the distribution center side, certainly higher fuel costs -- diesel fuel costs have been a real challenge. And we anticipated higher fuel costs throughout most of the year, and have really done a nice job leveraging it through additional efficiencies through the end of August.

In September, it just became runaway. And we are implementing plans right now to do everything possible to contain the expense associated with diesel fuel costs. Regardless, it will play a more significant factor in our fourth quarter. We've already anticipated what that is, and have put together contingency plans to offset that.

Is that -- are you going to put any hedging in place for fuel costs?

Not at the present time.

Okay. And then on the heating, is that related to the energy management system that Cal mentioned?

Yes, obviously we have a -- at this point now, we're installing an energy management system in the chain. It's now in about 80 stores or so. We expect that is going to perform at a three-year payback. And it's going to be very efficient for us. Unfortunately -- I guess fortunately for us, we have it in place, and we'll be fully rolled out by midyear next year. Unfortunately, on a year-over-year basis, we will not see the gains, because were going to essentially be deferring increases as opposed to gaining traction against one of the expenses in the past. But we are rolling out very, very quickly.

And in addition to that, we are working on energy management policies with regard to the temperature at which we set our stores and door openings and closings and so forth. So we will do everything we can to mitigate increased energy cost to heat our stores and our distribution centers. But it will continue to be a challenge until we are fully rolled out with this energy management system.

Reed Anderson, Miller Johnson.

Good quarter, guys. A couple of questions. In terms of working capital improvements, inventory in particular -- nice improvement there. To what extent is that sustainable? Can you expand on a little bit?

Reed, this is Gerry. And when it comes to leveraging our inventory position, as Jim mentioned in his remarks, we have fully implemented the E3 system at this point. We are going through a shakedown period with that. But we are already starting to see benefits in that regard through both improved in-stocks as well as improved inventory productivity. And we anticipate that what you see in terms of turnaround is just the start of what will be a continuing pattern going forward into the future. So we think we're at the beginning of acceleration of our inventory productivity going forward.

Gerry, can you share with us what your in-stock rates are and what they were, or is that something you don't want to share?

Something we'd prefer not to share at the present time on that, Reed.

Could you give us an order of magnitude of what the improvement might have been?

The magnitude of improvement year over year third quarter -- and we do track that -- is between 2 and 3% improvement from last year to this year in the third quarter.

Good. Then in terms of -- you talked about holiday a couple of questions ago and your focus on gift items and stuff. To what extent is your timing of your sets going to be a little bit earlier this year than last year, or is it about the same?

Toys were set a little bit earlier this year. Tools were set about the same. And our holiday gift program is not yet fully set in the stores -- the equine gift program I referred to. But that will be set by about the 1st of November. So we are geared up. We've had no difficulties arriving product into the system on that, Reed. And we're excited about the opportunities in Q4.

(multiple speakers) take a look at those, Reed, but don't take your wife with you unless take your (ph) credit card.

So that would explain why I saw that one empty endcap, but I know that it must be filled now. (laughter)

Which store was that?

You know the one I go to. That's that Mankato (ph) store. The other question I had -- probably a Cal question is you mentioned that you were able to leverage benefit costs, which just struck me as kind of counter to what you're seeing out there. Is that a onetime, or did you implement a change or something? What happened there?

It's probably a onetime. Both the frequency and severity have declined compared to last year on a year-to-date basis. I guess you could say we've been lucky, because we anticipated that it was going to be higher than it's turned out to be this year.

Well, nice job. Congratulations.

It's not that things are cheaper. It's the severity and the frequency, not the rate.

Good job.

Michael Cox, Piper Jaffray.

My first question is a follow up on Reed's question on the personnel costs. I just wanted to make sure that this was entirely on the benefit side, or was there something from a store labor perspective or on the corporate side that changed this year versus last year?

We were able to leverage our payroll expenses pretty well in the third quarter. And again, as Cal indicated a little earlier, last year we did have some personnel charges -- costs in there for the heavy SDIs that we did not cycle this year. Although we did have some, it wasn't to the extent that we had in 2004.

SDI is sales driving initiative, just to take it out of Tractor Supply lingo.

In terms of the commodity prices, I knew you guys started raising prices late 3Q or in fourth quarter of last year. Will we continue to see this type of comp lift that you have had over the past couple of quarters from commodity costs?

And if you've noticed the trending, basically, this is as thin an increase coming off of inflation as we have reported in the last four quarters as we've been tracking this. The fact is that we've been thrown a little bit of a curveball now with petroleum products and petroleum and expenses. So we're going to have to monitor this fairly closely. But it should wind up contributing somewhere between 0.5 and 1.5% of our comp increases if pattern follows based on what I'm seeing today.

And then my last question is on the direct product sourcing. You've talked about that in the past couple of calls. I was wondering if you could give us an update on that, please.

You must be talking about import sourcing of products. And is that what you were referring to, Michael?

Yes it is. Thank you.

Import sourcing of products -- this will be a high water mark for a Tractor Supply this year. We will have imported more containers of freight than ever before. We're expecting next year to increase that by 20% or thereabouts, and have put a lot of steps in place process and procedures to continue to accelerate the growth of our imports as a percentage of our total cost of goods sold as we go forward.

And are there specific categories there that you're targeting within your four walls?

Each of our 10 buying teams has been given a target list of categories for sourcing offshore or overseas. And they're working arduously against that right now. So it's really not focused in any one category.

Thanks a lot and congratulations.

R.J. Hottovy, Next Generation.

Great quarter. Really, most of my questions have been answered here. But the one question I wanted to see if I could have you answer was if you could break out the margin improvement among the supply chain improvements and the sourcing?

We don't really report on that in a public forum from the standpoint of how that breaks out. I can tell you that there are many different contributing factors. And Jim touched on several when he mentioned improved seasonal inventory management coming out of spring and summer, thus less of a requirement to take markdowns in the third quarter this year. We had an improved mix of sales that has benefited our margin. And clearly, our importing initiatives are continuing to benefit our margin, although I think it's important to mention that as a result of some of our lower cost of goods from our importing initiatives, we are passing a chunk of that savings along to the customer, with the intent of seeing how much product we can sell and what should we drive the topline on that.

And while it improves the landed cost, it does cause the freight cost to increase. So there are a lot of moving parts to margin, and it's pretty dynamic.

But you can't break it out between the balance -- it was weighted either one way or another -- it's just in general?

It was balanced between those several initiatives that I just mentioned on that.

Okay. I guess my last question is, there has been some talk out there among some of the pet feed and supply -- I mean animal feeding supply vendors out there about raising prices over the next quarter or two. Are you guys seeing that kind of impact, or is that something that you're not seeing at the premium level?

Well, if the talk is about raising retail price, we're in favor of it. If you are talking to manufacturers, we haven't heard that.

Okay.

Actually, quite the opposite. We're expecting costs may moderate a little bit given the record harvests that have occurred across the country this year.

Anthony Lebiedzinski, Sidoti & Company.

A couple of questions. First, can you perhaps discuss what factors do you think have driven the better sales performance in the southern states versus the rest of the country?

Well, you're talking about areas that were impacted by the hurricane last year. And they have maintenance things that they need to do. It also has insurance proceeds that's in their pockets. And those stores down there are at a good place on the maturation curves, and have typically higher comps than chain average because of the relative youth of those stores compared to the chain as a whole.

Got it, okay. Now in terms of the product sourcing, you talked about it a little bit. How much of your sales is actually tied to direct imports at this point?

Currently, Anthony, we're at 6% of our total cost of goods sold are bought on direct import by Tractor Supply.

Okay. And you plan to increase that 20% next year, right?

20% increase in containers -- it won't grow from 20% on top of the 6% because it will accelerate. Our longer-term goal is to get that to about 15%. But that's going to take probably five years to get us there.

And where is private-label now in terms of your overall product mix? And then how do you see that expanding over the next few years?

We're currently at -- 17% of our product mix is in private label. And we expect to grow that over next three to five years from 17% to 25% of our mix.

Okay. I was also wondering if because of Katrina, if you had any disruptions in terms of getting supply -- and really, my question is whether or not you had a lot of products that were shipping through the port of New Orleans and if there was any disruption there in terms of getting products.

Nothing significant. If we've experienced any challenges at all, it's been with trucking and making sure that there was ample enough trucking to acquire the products that we were buying.

Joe Randy (ph), Wedbush Morgan.

I'm not sure if you guys gave this or not -- the Q4 comp guidance?

We gave full-year comp guidance. That's what our guidance is tending to be. We encourage people to look at halves and not quarters. You may be able to back into it, but I don't want to start giving quarterly comp guidance.

I understand. And then the stores with the expanded clothing -- that's expanded clothing and expanded equine as well. Is that correct?

That is correct -- not necessarily in the same stores, however.

Okay. And then lastly, how are the California stores doing?

We remain pleased. We've had the first three of them cycle. And all three of them have cycled -- the first 12 months have been substantially above the chain average. And four-wall (ph) profitability is terrific. It's a long freight line out there. So it's really not altogether that accretive to the Company. But as we said before, we wanted to get to California, establish a beachhead, figure it out, test products and mix, price points, and then we'll continue to slowly expand California, preparing ourselves for a significant expansion in a couple of years.

We opened a store near Davis here a couple of weeks ago. So if you're up in that area, stop by and see us.

Yes, I'm down here in Southern California.

I know where you are. But you might get to Sacramento.

Okay. Will do. Thanks a lot.

Barbara Allen, Avondale Partners.

Thanks. I just wanted to add my congratulations to you guys for being great retail managers and, actually, executing the concept of managing the margin as well as sales. It's a pleasure to watch you.

I did have a couple of questions. One is, can you get us updated on what you are seeing in price competition in pet foods?

The pet food environment out there is highly competitive right now. And I will tell you that lots of different channels recognize the opportunity in pet food, and are chasing it aggressively. We continue to see comp store sales growth in pet food, most notably in the high-end of the pet food business for Tractor Supply. But I can tell you that it's become fiercely competitive out there as people are vying for marketshare.

Have you had to match those prices in any of your offerings?

No different than we do across the broad spectrum of products that we carry at Tractor Supply, Barbara. We stay in touch with the marketplace through an aggressive comp shop program, and adjust up or down as the opportunity presents itself.

You have been able to hold your premium pricing, it sounds like.

For the most part, that is correct.

Good. And could you remind me of how many Del's stores there are? And just to clarify, this would not be included in your 65 new openings, of course --?

It is not. There are a total of 17 stores -- 13 in the state of Washington, one in British Columbia, and three in Hawaii.

Keep up the good work.

Andrew Wolf, BB&T Capital.

Thank you. Most of my questions also were addressed. I did want to ask one follow-up. On freight, I though you said earlier you leveraged freight in gross margin. And I assume that was maybe due to a maturation of distribution infrastructure. Did you, A, address whether freight helped or not the gross margin, and (multiple speakers)

In the quarter, Andrew, freight hurt us because we had unusually high freight in the third quarter of last year -- I'm sorry I interrupted you. What was the second part of your question?

I'm sorry -- I'm still not clear. It hurt you last year in the third quarter and this year?

So on a comparative basis, it was favorable this year.

Okay, great. And was that due more to just last year -- I guess it was the port of L.A. at that time, or whatever it was -- or is it more due to what's happening internally with your distribution getting more efficient?

It's more internal and some things that we've changed in how we order our freight. And we've gone from having a third-party freight management system to bringing it in-house. And we did that primarily in the third quarter of last year. And that transition resulted in some higher freight costs. We also had some unusual freight costs because of the response that we had to the many hurricanes that were going on in the third quarter of last year.

Thank you. On shrink -- I think -- you didn't mention it so far about this quarter. But from the last few quarters or so, I guess it's been a bit of a negative to the margin. Has that changed at all?

It continues to be a bit of a negative, not a significant item. But yes, our shrink year over year is maybe 10 basis points higher than it had been. We've taken some pretty aggressive moves to improve that at the store level. And we will see -- we believe we'll see some improvement. The improvement takes time because of the time between physical inventories.

Lastly, on sales, I think geographically, this year's third quarter, the two hurricanes I believe affected completely different geography than the four in the year ago. And clearly, the four in the year ago boosted sales. What was the effect of the two hurricane that obviously hit a lot less stores this year -- but on those stores, or overall?

Andrew, the hurricanes that hit this year -- one was Katrina. And that fell fully into our third quarter. And we saw a little bit of a spillover in our Northern Mississippi, Alabama, and even some of our East Texas stores. We don't specifically have stores today in Louisiana. So there was nothing that was immediately impacted. It was really more perimeter stores there.

Rita, which came in the very end of our third quarter and actually spilled over a little bit into Q4, was much more impactful on the overall business. And that impacted predominately the East Texas stores for Tractor Supply.

But even though you called out that you had -- the stores had to be closed for a certain period of time, which I'm sure happened in the year-ago quarter, on a net basis, it helped sales because of the emergency equipment and the other things?

We had a net negative -- totally -- gross emergency response compared to prior year due to the fact that prior year, we had 4 hurricane in stores well-populated by Tractor Supply. This year, we did have a lift in Texas. But the net of the two events was several million dollars less business.

Fair enough. And lastly, you were asked about this, Jim, by another analyst. But I still have sort of basically the same question. It looked like in the second quarter, I think you called out that same-store traffic was up 1.5 points. And in the prior quarters, you didn't say exactly, but it sounds like it's been flattish to slightly up. And in this quarter, it was down.

When I look at it compared to last year's third quarter, you had all this traffic due to these hurricanes. So it strikes me that I would hope that you guys are not looking for down traffic at same stores in the Q4. You must be looking for something slightly better than that trend. Is that the right way to think about it?

If we look, again, across the last six or eight quarters, this has been a -- I think this is the first time we've actually had down traffic. But again, we were also against some very unusual and very high comps last year. So we have been trending from what was 5% traffic gains three years ago down to 2, 3, 1, and now negative. But bottom line, we are not planning for flat traffic.

At the same point in time, we think that ticket will have a whole lot more to do with our production of comp store sales than it has in the past. And (technical difficulty) again, consumers respond to the fact that the 20-mile trip to Tractor Supply on average used to cost $3. Now, it costs 6 one way.

Got it. Thank you.

Okay. We'll take one more question. And then -- we've already been at this an hour. It's been a great hour. But we do try to keep our calls to an hour. So final question, please?

We have no further questions. Please (multiple speakers).

Well, look at that. We're really in sync.

Thank you all. I appreciate your questions and the dialogue. And we are just great shape for Q4. There's a lot of dynamics out there in the marketplace right now. But I'm just proud as I can be of our merchants and our marketers and the field. They are executing very well. We are as ready as we can be. And if our customers show up, we're going to sell them a lot of product. And we're in great shape. I look forward to speaking to all of you in February. Thanks for being on the trip with us. Goodbye.

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