Tractor Supply Co (TSCO) 2006 Q3 法說會逐字稿

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

[OPERATOR INSTRUCTIONS.]

I would now like to introduce your host for today's call, Ms. 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 third 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 and investors should not assume that the statements will remain operative at a later time. Lastly, Tractor Supply undertakes no obligation to update any information discussed in this call.

Now, with that out of the way, I'm pleased to introduce Jim Wright, President and Chief Executive Officer, and Tony Crudele, Chief Financial Officer of Tractor Supply Company.

Jim, please go ahead.

Thanks, Cara. Good afternoon, everyone. And thank you for joining us. I'm here today with Tony, our CFO, [Gerry] Brase, SVP of Merchandising, is also in the room with me. And [Stan Ruda], our SVP of Store Operations is calling in from the road and will be available for q and a later.

We are pleased with our performance for the third quarter. We effectively addressed the sales challenges that we faced in the second quarter, and we were able to deliver solid top line sales increase, as well as a 90 basis point improvement in margin.

As we've discussed previously, our sales in the second half are not as dependent on big ticket items as we are in the second quarter. This helped us alleviate some of the affects of a macro environment during the third quarter. We were able to deliver results during the quarter, while also executing on important initiatives that will keep us well positioned and prepared for growth.

We were steadfast in our efforts to generate sales in the third quarter, and so a marked improvement over last quarter's top line results, as well as a return to more normalized comp levels. We generated 2.4% comp in the third quarter, and excluding seasonal merchandise, namely hurricane related products and riding lawnmowers, our comp for the quarter was a solid 5.7%.

Same store sales were strongest in livestock and pet, clothing and footwear. Seasonal sales were mixed, with the exception of power equipment, summer categories actually performed quite well. Fall categories, with the exception of emergency and response, also performed very well. Overall, we experienced solid results in our core lifestyle categories.

Our key to driving our sales is our ability to offer compelling merchandise, compelling assortments. For the second half of the year we focused on developing and optimizing our new product pipeline, and successfully executed on that goal during the quarter.

In addition to keeping our overall product assortment updated and relevant for our customers and the rural lifestyle they live, we continued to expand on the successful C. Schmidt private label line. In addition to expanding into new apparel categories during the quarter, we introduced a five style lineup of C. Schmidt footwear in August. While still relatively new, the initial response of our customers has been strong.

Our traffic was up 3.6% in the quarter for comp stores, and that marked a shift in the trends we've been witnessing over the last several quarters. While we're pleased with this change in consumer shopping patterns, we are not assuming that traffic will now be trending consistently upward. We will continue to monitor our traffic trends. We will work vigorously on conversion. We're going to optimize advertising, and always will focus on exceeding our customers' expectations to drive both repeat business and referral.

In addition to opening 18 stores, tractor supply stores during the quarter, our store teams worked diligently to prepare the chain for the fall and winter selling seasons. With that in mind, we continued to roll-out the expanded clothing sets in 86 stores during the quarter. Our overall clothing sales are strong for the third quarter as a result of the improved assortments across the chain, as all stores benefited from the experience we gained last year in the expanded set stores.

On top of the apparel super sets we also rolled out the first wave of our pet reset in 29 stores. These resets enhanced the presentation of our products in the pet department, which as you may know is a key category for us. Based on the feedback from our customers, vendors, market research we designed the resets to give a softer feel to the department, which will help create, attract a wider range of customers.

Additionally, when each of these resets we're adding more than 900 new products in each pet department. The initial response to these pet sets, these resets has also been very positive. We continue to convert [Dell] stores to a new and updated format. This activity added breadth and depth to the pet, equine, clothing, and footwear, as well as seasonal categories.

The early results for the nine stores which have been converted are very encouraging. We are pleased with the execution of these rollouts, and nine of the thirteen Dell stores in Washington are now converted to the new format and are very well prepared for the upcoming holiday season.

This summer we had a great third quarter. We are proud of the execution of our long-term initiatives. However, the macroeconomic environment continued to impact our business, mostly in the front half of the quarter and began to, continued to push shopping patterns. We're pleased with our ability to, nonetheless, generate strong comp store sales.

I believe our results for the quarter are a testament to the various initiatives we've instituted over the last few years, the unique niche we serve, and the strength and the commitment of our team.

I would now like to turn the call over to Tony, who will review the financial results.

Thanks, Jim. Good afternoon, everyone. As Jim indicated, we are pleased with our third quarter performance, and we are on track to achieve full year EPS in the range of 2.29 to 2.30, which is in line with what we discussed last quarter.

During Q3 EPS was $0.44 compared to $0.45 in the prior year. As a reminder, this year's results include approximately $2.4 million or $0.04 a share of the stock option expense reported pursuant to FAS 123R. Total comp sales for the period were 2.4%.

As planned, our emergency response equipment comps principal generators were down as we were comping against Katrina and Rita sales in the prior year. With the one-week shift in the calendar following our 53-week year, Rita's comparable period shifted into the third quarter. Excluding hurricane impact in September, comp sales were firmly in the mid single digits increase for all three months of the quarter.

Also, as we saw in the second quarter, the riders category continued to show softness. As Jim mentioned, excluding seasonal items, which includes the riders and emergency response, our comps would have been approximately 5.7%. Excluding hurricane activity we estimated the impact from cannibalization was approximately 40 basis points as we brought on 18 stores in the third quarter.

Non comp sales were approximately 66 million or 11.9% of the quarter's sales. This does not include relocated stores which are excluded from the comp store base until they stock hold a full year.

With respect to regional sales trends, comp sales were above company average in the north and mid east. Comps were below company average in the southwest and the southeast, principally as a result of comping against the hurricane related activity in the prior year.

We had a 3.6% increase in transaction count, reversing the trend from Q2, and generally the trend from the first half of the year. Average ticket was approximately $41.10, which was a comp decrease of 1.2%. We believe that the consumer footsteps were strong but they were still focused on consumables and smaller ticket items. We had particularly strong sales in our livestock and pet, and clothing department. The decrease in average ticket is consistent with shortfall in large ticket purchases, specifically the riders and generators. Exclusive of these categories, average comp ticket increased close to 2%.

We had a solid gross margin performance for the quarter as overall margin improved 90 basis points. This was the result of improved initial margins, increased importing, and improved shrink results, offset partially by freight costs which increased 15 basis points over the prior year and 30 basis points from Q2.

Our initial margins improved based on improved buying, better managed markdowns, and increased importing over prior year. Additionally, we had a favorable sales mix among our categories, principally as a result of the shortfall in emergency response categories, which tend to have gross margin at below chain average.

Also, during the quarter we changed our method of estimating the freight cost component of inventory expense. As our business changes and evolves, such as increased imports and, or the environment changes, such as escalating gas prices, we are constantly working to review our accounting practices to ensure we are utilizing the most appropriate methods.

As part of our ongoing review we determined that our previous method for estimating freight no longer provided the best method to match freight costs with the movement of inventory due to the increasing level of imports, change in mix of goods, rapid increase in fuel costs to flat turns.

The prior estimation method inaccurately accelerated the recognition of freight expense. This change in estimate, which will be disclosed in our Q, resulted in freight expense being lowered by approximately 3.2 million on an after-tax basis, or $0.05 a share, and it would have been under the previous method of estimation which, again, I know provides a better matching of freight and costs of sales. Of course, this was reviewed by the auditors as part of their quarterly review.

I'd also like to note that the level of freight expense recorded in Q3 was in line with the amount we had initially incorporated into our annual forecast at the beginning of the year and is consistent with our seasonal inventories flow.

SG&A net of the 2.4 million FAS 123R stock option expense as a percent of sales was unfavorable compared to the prior year by 130 basis points. We did not leverage SG&A but we did perform consistent with our internal plan. As discussed in the past, this lack of leverage results principally from store personnel and occupancy as we continue to grow our store base.

Also, personnel costs at both the stores and the store support center included incentive compensation accruals in excess of prior years' accruals totaling 1.2 million or $0.02 per share. This was the result of a more consistent performance relative to our bonus incentive metrics during the year, compared to prior year. Additionally, we were comping against very favorable employee benefits in the prior year that resulted from a significant decrease in medical claims incurred in Q3 of 2005. We also had expensed real estate related costs and fixture write-offs that aggregated approximately $0.01 in the quarter.

Pre-opening expense was consistent on a YOY basis as we opened 18 stores and relocated 4 stores, compared to 15 new stores and 8 relocated stores in the prior year. Pre-opening costs were approximately 2.2 million on a per store basis, including the unopened stores and excluding any lease expiration costs, pre-opening was approximately 83,000 per store, which is consistent with our new store opening program.

Interest expense for the quarter is up YOY primarily developed additional borrowings for seasonal build-up of inventory and increased borrowing rate over last year. Our effective tax rate was 37.1 compared to 36.2 in the prior year. The increase in tax rate resulted primarily from the non-deductibility of certain stock option expense pursuant to FAS 123R.

Now, looking at the balance sheet, our inventory levels on a per store basis, excluding Dells and including some unopened stores that were carrying inventory at the end of the quarter, increased approximately 3.1%. Net of freight, shrink, and valuation reserves, our FIFO inventories grew at only 1.9%. This is in line with our internal goal and is a decrease from the previous quarter's YOY growth.

Taking into consideration the growth of square footage, the roll-out of expanded clothing, additional freight allocation, the absorption of inventory through the distribution network, inventories actually were flat. So we were pleased with our inventory management in the quarter.

Also in this quarter we began booking in transit inventory, which added approximately $28 million to the balance sheet inventory. As we have begun to increase our imports, the amount of inventory that is on the water has increased, and it was prudent to begin recognizing inventory carry at the point in time title changes hands. There's no income statement impact from this adjustment.

Based on our internal inventory turns calculation on a cost basis we had a slight increase in YTD turns of 8 basis points. We did experience a decrease in accounts payable financing of inventory from approximately 46% down to 40%. This reduction is a result of the reduced turns and increased direct import supported by letters of credit. Now, having said that, we are disappointed in the results of our [better] financing and our focus on improving this metric.

The YOY increase in net property and equipment principally results from investment in new stores. The capital expenditures for the first three quarters were approximately 59 million. Full year estimates for CapEx is 96 million which includes the majority of POS capital for POS rollout initiative. This is consistent with the guidance from our last conference call. We plan to open 17 new stores and relocate none in the fourth quarter, for a total of 81 new stores, and we have relocated 15 stores and closed one store.

Now, turning to full year guidance, we've narrowed the projected sales range to between 2.370 billion to 2.390 billion. Our full year sales projection assumes a full year comp store sales increase of approximately 2 to 3%. We expect EPS to be in the range of 2.9 to 2.30 to diluted share, which included the stock option expense of $0.14 per share for the full year.

And, with that, I'll turn it back over to Jim.

Great. Thanks, Tony.

We are, again, pleased with our third quarter results and believe we are on track to meet our goals for the year. As we begin the all important holiday selling season our team remains motivated, focused on executing our stated initiatives.

Specifically, for the fourth quarter we're excited about equine and gift merchandise assortments. These were very strong sales drivers last year, and we'll be offering another compelling program in this area in 2006.

Our print ad program, for the holiday season our ads will feature a higher mix of consumable products, tools, and gifts in each ad. We feel this program is very strong for the season, and are confident it will help drive traffic and sales.

Our heating products, although gas prices have come down a bit recently, heating continues to perform well in our stores, and we will be cycling a very light inventory position from Q4 last year. So we look forward to highlighting this category during the fourth quarter and reporting on it when we talk next.

The apparel sets, as I mentioned before, our apparel sales at stores that have the expanded apparel sets are generating very strong results, and based on our current rollout schedule we are on track to have expanded sets in 286 of our stores by the end of the year.

On the new product front, we need to always be innovative and dynamic with our new product, and in assortments we try to be first to market wherever we can be. With that in mind, we're currently introducing the [master hand] portable power tools and toolboxes to all of our stores in time for the holiday selling season. We believe this premium private label brand will be a strong seller in the fourth quarter, and over the next several quarters it will develop into a respected brand known for durability and functionality. Following the initial launch in Q4 we'll roll-out additional categories with our exclusive master hand brand next year.

For several years now our stores have been operating under the motto you can buy everything we carry someplace else, but you can't find someplace else that sells everything we carry. This has been a driving force not only in our merchandising strategy, but also in the way we differentiate our business overall, and will continue to be as we move towards our goal of reaching 1,300 plus tractor supply stores. Overall, we are happy with the condition of our stores and believe that we're well merchandised in the important holiday selling season.

We just held our annual event, a vendor conference, and are excited about the pipeline of new products that we'll be offering in the coming season and next year. Our new store openings are on track, and we continue to emphasize and invest in the training of our team, as well as our infrastructure and our technology.

Before we turn the call over to questions, I'd like to highlight although our fundamental long-term strategy remains consistent, we are tirelessly working to refine our business model to maximize our performance. For example, beginning in the late Q2 and continuing in Q3 our top management was engaged in five one-day offsite strategic planning meetings. With the help of an outside team we took a most rigorous look at the external drivers of our business over the next five years, with equal rigor we reviewed our current state across all of our functions and assessed our opportunities, our change readiness, and our face of value capture.

Following the last meeting, the six of us rented a van, drove 1,100 miles, visited 12 of our stores and 9 competitors stores. While on the road we debated and refined our objectives for the future, and are excited about the opportunities that lie ahead.

In summary, the lifestyle that we serve will continue to grow. The markets we serve and intend to locate into are growing. Our opportunities are prioritized, our teams are aligned, and our future remains very bright.

I would like to thank you for your continued support, and open the call for q and a.

[OPERATOR INSTRUCTIONS.]

Our first question comes from Matt Nemer from Thomas Weisel Partners. Please go ahead.

Hi, Matt. Hello?

Hey, sorry about that. I was on mute. First question is your guidance implies that comps will be up 2 to 6% in the fourth quarter which is a pretty big acceleration. What makes you comfortable with that, given that we're only three weeks into the fourth quarter?

Well, we look at the plans we have in place, the categories, the fact that we have an additional 150 clothing super sets this time last year?

That's correct, Jim. 86 of which are new.

86 are brand-new.

Comps.

So we're right into that quarter. We've really, Matt, looked at it by category. As I mentioned last year, we sold out of heating fairly early, about halfway through the quarter, we were really out of the heating business. While we recognize that some of our markets, that the demand has been sated in the last year, we feel pretty strong on the clothing side.

Matt, this is Gerry Brase. Just jumping in to piggyback on what Jim said, one of the things that gives us a lot of confidence looking at the fourth quarter is that the categories that performed best in the third quarter and, frankly, have all year long are peaking in terms of their contribution to our overall sales mix in the fourth quarter. So, again, we will see a natural acceleration as a result of maintaining that trend going through the fourth quarter.

Okay, that's helpful. Secondly, on the gross margin change in freight accounting, was that a change that you made in both years? In other words, did you make that change in Q3 last year?

Matt, this is Tony. It's really not a change in accounting. It's just a change in how we estimate actually the freight burden that is carried with the inventory, so it's not required for a change in the prior period. And that's why I wanted to highlight specifically that the freight expense in the current quarter is very comparable, obviously an increase over the prior year. And also it's very consistent with the trend that we've seen YTD, so we feel that it's a very, I want to say appropriate, not only estimation process, but we feel that the quarter is properly burdened as far as the freight expense.

Okay, but is it fair to assume that if that change had not taken place and we backed that out of cost of sales that your margins would only be up about 35 basis points?

No, I don't believe that that would be a fair assumption, because the drivers that required the change which really was a lot to do with the mix of the merchandise and the timing of the receipts did not necessarily apply last year, as well as the escalating gas prices. And sort of in a nutshell, as you work through it, we were recognizing the freight expense probably closer to more of a LIFO type method and incurring at a faster pace than was required.

And so you really have to look at the mix of goods, as well as the mix of imports, as well as the gas price increase, to try to calculate what the exact difference was. What we're required to disclose and the reason why we put in the press release is that when you do have a change in estimate you have to quantify the distance between the two methods, and that is what we're doing. But in no means are we implying that the change was X percent over last year, one method to the other, because in this case we believe that the current quarter is properly burdened as far as the freight expense.

Okay, I think I understand. And then, lastly, on the SG&A expense side, what is exactly driving the incremental increase? If your new store opening cost is 83,000 per store and your rent is somewhere in probably the $30,000 to $40,000 a quarter range, can you help us understand what's driving the bulk of that percentage increase? It doesn't seem like those two move the needle.

Well, generally, if you look at just the lesser volume stores, and in fairness we can always also go back to the comp sales, we – the newer stores will historically run at a fairly large comp increase, you know, low double digits. And, obviously, from our comp performance that is not the case on some of the newer stores. So the ramp-up has been a little bit slower, and until they get to maturity they will overall bring down the company performance from a percent to sale standpoint.

So that's the main driver in the SG&A. However, as I discussed in the conference call comments and alluded to some in the press release, that last year we had what I refer to as compensation incentive. But our bonus plan, the way that it played out throughout the year there was less of a burden placed in the third quarter. This year the bonus expense was spread more ratably throughout the year and that accounted for 1.2 million impact. Last year in the third quarter we also have very favorable fringe benefits related to medical claims, which was very, fairly significant, probably in the 800 to million dollar range, as well, that we were up comping again. We took the real estate and fixture charge expense of approximately $900,000.

So there were some elements in this quarter, and what's interesting is that we had visibility to that and, again, I wanted to point out that it was very consistent with our model in what we expected to achieve in the quarter, but because of some of the variance to the prior year it wasn't necessarily reflected in the analyst models.

Okay, that's helpful. Thanks very much.

Thank you. Our next question is coming from Mr. [Dan Moore] from Raymond James. Please go ahead.

Thank you. Tony, curious as to when you all made the decision to change the way you estimate the freight expense?

Well, we actually, we were looking at it mid to late second quarter, as we continued to refine our forecast for the second half of the year. And we understood that the freight expense as we projected it was running much higher or was less than what was actually what our actual calculation would be.

So we started to try to fully understand the seasonality of the mix of goods, because generally the change in the estimate doesn't, isn't highlighted until the third quarter. So as we reviewed it in the second quarter and understood the impact in the third quarter we felt that it was the appropriate time to make the change.

As we move forward YOY, quarter over quarter, it should not have a significant impact. I think potentially the second quarter might have a little bit higher freight burden, but slightly, I wouldn't, I don't estimate more than 10 basis points. And, again, it's affected by how fast the gas prices move in one direction or the other.

So to make sure I understand, we had a $0.05 per share contribution in 3Q. Is there going to be a $0.05 offset during the other three quarters of the year so that this is a push when it's all said and done?

No, it should not be a significant change to any of the quarters go-forward. Again, as I have mentioned, what we were doing previously accelerated the rate in which we expensed freight. It did not necessarily burden the inventory from a matching standpoint.

Going forward you would see that, there'll be a very similar YOY comparison, and a lot of the burden that's been captured, because of the rate and the relationships of the inventory it shouldn't have a significant impact throughout the quarters. We did review if we had implemented or changed the estimate at the beginning of the year, and it would not have had a significant impact on the first half of the year.

So it sounds like this is a onetime benefit to earnings? Then the fourth quarter, your estimate, your procedure for the fourth quarter will be the same as last year?

I think from a modeling standpoint you should not see a significant difference as you move forward to model, and I would hesitate to characterize it the way that you just did, saying that a $0.05 benefit. I and we do not perceive it as a benefit in the third quarter. We said it's the appropriate freight burden and it should have been allocated for the fourth.

Then just the last question, and I'll let somebody else take the line. On the, in the news release, it talks about the $0.05 benefits or earnings. Is this is a cash or a non-cash benefit?

Again, it is not a benefit to earnings, it is only the difference between the way we were estimating and the change in the estimate.

Okay.

It's very – and, you know, I know it's a fine line, but it's very important that we emphasize that, that the proper amount that needed to be expensed and was very consistent with our models was what was expensed and, again, was a significant increase over the prior year and a significant increase over the Q2.

But from an accounting standpoint we're required to disclose what the difference in the estimation was. And, again, not to say that what we were doing was incorrect, we just felt that it was not a proper match. So we have to disclose that amount, so, again, we're not disclosing the amount of benefits in the third quarter, we're only disclosing the amount of the difference between the two methods of estimation.

Great. Thank you.

Your next question comes from Mr. Ed Yruma from JP Morgan. Please go ahead.

Thank you very much.

Hi, Ed.

Hi. Thank you very much. Can you talk a little bit about the composition of your inventory? I know that you saw a weaker than expected sales in OPE and generators. Does that comply as a large slug of some of that inventory build?

I'll let Gerry take that.

Ed, in looking at a breakdown of the inventory levels that we have today, the fact is is that we're slightly over our original inventory plan when it comes to spring and summer merchandise. It is not a burden from the standpoint of the inventory that we have. The inventory that we are carrying today, most of it is forward bought for fourth quarter sales and anticipated growth in sales, and the investment that we've made in the major resets that we've done in the clothing business and the recent expansion of our pet sets. So there's no exposure that we feel at all uncomfortable with relative to the inventory we're carrying today.

Great. And I think this kind of dovetails with I believe Matt's question, and I think you said something to the effect that your new store ramp has begun to slow a little bit and that was kind of burdening the comp a little bit. What's caused that slowdown? And kind of how recent is that?

Well, I think the point really is is that all comps across every – we look at stores, you know, more than six years old and five years old, and stores that opened in '01, '02, and '03, and across the entire universe of every category, every age of store, comps were slower. The difference being, though, that with the higher occupancy costs of new stores that when you don't get the sales there they have, you know, a more significant effect on SG&A rates.

Great.

Do not interpret the fact that new stores – new stores are performing relative to the base as well as they ever did.

Great. And I guess my final, well, housekeeping question, just wanted to verify that the guidance still includes that $0.02 onetime benefit from gift card breakage in the second quarter? Thank you.

Yes, it does. The second quarter, obviously, actual results are incorporated into our full year estimate.

Great. Thank you.

Thank you. Our next question comes from Mr. David Cumberland from Robert Baird. Please go ahead.

Hi, David.

Hi, good afternoon. Jim, you mentioned inventory in the heating category being light last Q4, I believe, also, demand for heating was very high last Q4, how did that category perform for you last Q4? Or maybe asking it another way, do you have a tough comparison in that category due to the high demand last Q4?

For the quarter, no. Actually sales for the quarter, if I recall, were fairly normal, but they happened in the first half of the quarter. So we missed – my point was we missed opportunity in the back half of Q4 last year due to the fact that we and the industry sold out and we were unable, for the most part unable to replenish. So our comp, while it's fairly tough, it's certainly not a hill we can't climb in that category.

Any important merchandising changes in that category for Q4?

David, this is Gerry. And the one thing I would tell you is that in the wood heating category this year we knew pellet stoves would be in strong demand. But there's a product out there this year called a multi fuel stove that has been very popular with our customers. It burns wood pellets, as well as other sources of fuel, such as cherry pits and corn, and that's been very popular thus far.

And then you mentioned, also, that comps for generators were planned to be down in Q3. Are those also planned to be down in Q4? And is the impact of generators on your overall business much smaller in Q4 than Q3?

Yes and yes. We planned them down and it's much less important to us in Q4, both from planning purposes and in cycling comps than it would have been in Q3.

And my last question for Tony, did the one-week calendar shift have much impact on the total sales comparison?

No, I didn't mention that, actually we thought about it and calculated it, and it was very nominal.

Thank you.

Thank you. Our next question comes from Mr. Michael Cox from Piper Jaffray. Please go ahead.

Good afternoon. Thanks for taking my call.

Hi, Michael.

My first question, I hate to go back on this issue, but this freight adjustment, I was wondering if this was included in the full year EPS guidance that you provided at the end of the second quarter, considering that you had contemplated this change at that point?

Yes. The simple answer is yes. As we looked at Q3 and our expectations of freight, which was the basis of our guidance, it was included in that, and that is again the freight burden that is included in the income statement for Q3 including what we had anticipated should be expensed for that, for Q3.

So just to make sure I'm clear, that the earnings guidance is essentially unchanged relative to that second quarter expectation?

Correct.

Okay. In terms of the new merchandise that is being rolled out, I was wondering if you could provide a little more color in the pet segment? You've been very strong in the equine category, historically. Just curious as to what areas you're targeting specifically in the pet segment?

Sure. We mentioned, it's just about 900 SKUs. We're addressing what, I guess, we and the industry are calling is a humanization of pets, so we've reset it to be a softer look, more inviting shopping experience. We've expanded the treat category significantly, gone to branded treats, in different sized bags of private brand treats. We've expanded life cycle food, pet food, we've expanded pet containment, training, and generally -- Gerry, any other categories significant beyond that?

No. That's -- pet containment.

Pet containment, as well.

Okay. In terms of the softness that you've experienced, along with the rest of the industry, and the outdoor power equipment segment and the summer months, I was wondering if you could comment on how that shaped your view of outdoor power equipment through the winter months and the snow thrower category?

Well, I think they're decoupled. Gerry, any…

Yes. Michael, the snow thrower business is, to Jim's point, completely decoupled from the spring and summer outdoor power equipment business. Last year with the extremely mild winter was a very soft selling season for tractor supply and for the industry when it came to snow throwers from that perspective, and preseason sales have been soft to this point. So we're all waiting at this point for some action in season. Certainly, what we saw in the northeast a week or two ago was a refreshing start to the season.

But could it be a function of just a softer environment for big ticket spending that's driving this as opposed to a comparison issue?

It could be, although we don't see that in some of the other categories. You know, we talked about the fall, the larger ticket categories in the fall, ex the hurricane relief supplies, are not performing nearly as softly as we saw along the [lawn and garden] perform. But, again, we are really not into snow blower season because for the most part they're not bought in advance of, they're bought because of snowstorms.

Sure, that makes sense. And my last question is on the performance of your California stores, if you could provide a little color there? And if maybe the timeframe of having a DC out on the west coast?

Yes, California continues to perform well above the chain average. Our new stores are hitting their model, and it was a little dry out there, on a YOY basis because -- this Q3 than last, so we saw some impact from that. We're still planning '08 for a distribution center, more likely in Nevada.

Great. Thank you very much.

You're welcome.

Thank you. Our next question is coming from Mr. Jack Murphy from William Blair. Please go ahead.

Hello, Jack.

I had a couple of quick questions. I'm wondering if you could give some color on the expanded apparel reset in terms of the type of comps you're getting, on the trips mentioned? And if you can give us a similar read on the performance in the pet category, after you've done pet resets?

On the super clothing sets, in the past I reported, the delta in comp trends, control stores versus the super set stores, and it has -- last quarter it was around 30 delta. And I think the difference between Q1 in non-seasonal clothing was maybe mid-30s, if I recall. This time it was around 10.

A couple of reasons for that delta change. One is that we are now cycling some of the super clothing sets. Two, we have very, very strong comps in the entire chain, so the control group benefited from the learning that we had in the super set stores from a year ago. So the controlled group is no longer as pure as it was when we were getting as large a delta.

But when I mix it all up we were really delighted with the return on the additional space and the return on the additional inventory. And we will know really a lot more, probably take this time next year I think we'll have a real, real good handle on how well that is actually performing on a GROI basis.

And similar read, I know it's really early, but on pets?

It's very early. We only converted them during the quarter, and so a couple of weeks' worth of data. But what we see, we like.

And the outdoor power equipment, did you mention how you felt about the category from a market share perspective, particularly on the riding mower category?

Gerry, you want to take that?

Sure. Jack, the industry reports on an annual basis what they call their model year, which is their shipping season for outdoor power equipment. And riders, which is the vast majority of the outdoor power equipment business that we do, as an industry was down 8.5% from September of last year through August of this year, which they consider that to be the 2006 model year from that perspective.

On the basis of everything that we can determine right now, we basically maintained our market share in the outdoor power equipment industry. We tried to get a bead on, you know, who was growing and who was losing market share, and it was a tough year across the industry in outdoor power equipment from all data points that we've been able to ascertain at this particular point.

Okay. And a couple quick questions for Tony. On the CapEx this year, the 96 million, given that the POS spending is in there, do you expect that CapEx for the following year will be flatter or down, or is there an early read you can give us on that?

Yes, I would expect it to be flat or down. I don't see it getting close. I'd like it to be more of an $80 million run rate, but I would expect it to probably be around a $90 to $95 million market.

Then the final question is on, I understand that the comp weeks were matched, so the shift with Katrina doesn't really affect the comp. But from a total sales perspective what's the comparable sales growth number, third and fourth quarter? What kind of negative impact we'd have in the third? And, you know, positive affect on the fourth in terms of comparison?

Well, again, the hurricane or Rita was included in the comp base, so but YOY the weeks do not correspond from a financial reporting standpoint. So the hurricane impact did impact the third quarter. So I don't know if that clarified that.

And, you know, relative to the entire, to the YOY, the impact from the weak shift was not significant as far as say picking up, dropping off the first week, picking up the last week. That did not change, so the two weeks that shifted from a financial reporting standpoint were matched up. However, on a comp basis, as we reported, there was significant impact from the hurricane activity.

Okay. Thanks.

Your next question is coming from Mr. Anthony Lebiedzinski from Sidoti & Company. Please go ahead.

Good afternoon.

Good afternoon. A couple of questions. Did sales trends get better throughout the quarter and, if so, has this continued so far into Q4?

Actually, each of the months, when we factor out the hurricane related emergency response sales all three months were about even.

Got it. Okay.

Some acceleration as we went through the quarter.

All right. And as far as the issues surrounding the, again, the gross margin impact because of the change in freight allocations, is it safe to say that going forward this will not have much of an affect on your earnings?

Yes.

Okay.

And if it does, it would probably have a slight improvement as we move through – again, our turns, you know, approximately four months. So as you cycle through the change in estimate you should see no impact after the fourth or fifth month.

Uh-huh. And regarding your expenses, is there any way you could tell us what your same store SG&A expenses were as a percent of sales this quarter versus the year ago period?

No, we don't disclose that information. We do look at it internally, but it is information that we don't disclose.

Okay. And, lastly, at the second quarter conference where you talked about revising your advertising strategy, could you give us an update as to what you've done and what you expected to be done in the fourth quarter?

Sure. We've changed our prints as we get back into our cycle. You'll see a broader apparel, more consumables on the front and back cover. And our television ads that will begin in a few weeks and run for five weeks in Q4, the 15-second tag or the 7-second tag on the back, 7 seconds or a 30-second spot are going to have what we feel is a much more compelling products value offer than what we did in the spring. And now we're also doing a very thorough review of our advertising of all media and product selection for next year.

Okay. Thank you.

Thank you. Our next question comes from Mr. Peter Benedict from Wachovia. Please go ahead.

Hi, guys. Thanks so much. A quick question on the riding mower business. I understand the penetration diminishes here as we move into the fourth quarter. Can you maybe speak either quantitatively or qualitatively, how does the penetration of rider mowers change as you move through your fiscal year?

Peter, the fourth quarter is a very small percentage of our annual sales in the rider business. I would tell you that it's somewhere in the neighborhood of approximately 10% of our annual sales of riders come in the fourth quarter. It peaks in the second quarter, with the third quarter being the second strongest quarter for the rider business. First quarter, not unlike the fourth quarter, is similarly soft as a percentage of total sales.

Perfect, that's helpful. In the second quarter conference call you guys had mentioned some softness at the entry level price point for those type of products, do you see that again here in the third quarter?

Yes, in riders we saw exactly the same thing. The zero turn riders and the premium front engine riders continued to perform at a better level than the $1,000 and $1,500 price points.

Excellent. And then last question, maybe for Tony. Could you quantify the impact of this freight allocation change on the inventory number, that 606 million inventory number at the end of the year? Thanks.

Yes, there's a lot of factors. You know I would estimate it to be about 5 million.

Perfect. Thanks, Tony.

Thank you. Our next question comes from [Adrian Maley] from [Farley Capital]. Please go ahead.

Hi, guys. Can you explain to me exactly what you estimate in terms of freight expense? I'm not sure how it works, I'm not sure I understand how it works, and why do you not know your exact freight expenses?

Well, we know the exact freight expense, the question is a matter of how much of it should be capitalized with the inventory. We do not have freight at the SKU level, so we must use a methodology to match that freight expense with the inventory flow. I guess that's sort of the simplistic version of what we go through.

Okay. And with respect to, I mean can you explain to me again why you don't view it as a – in terms of comparing it to the third quarter of last year, why you don't view it as a, whether it's a – maybe it's not a onetime gain but in terms of comparing the two quarters that it was a, whether you look at it as last quarter should have been 50 basis points higher or lower in terms of the gross margin? I guess I don't – why don't you view it as – why aren't you viewing it as a onetime gain versus last year? I mean I don't understand?

Well, because I think things have changed since last year. In a static environment I think you might better make that case. However, you know, with the escalating freight costs, specifically over the third quarter of last year and, again, taking a hard look, and we took a deep dive into the movement of goods, how items turn, and our allocation process really was at a very high level and still is.

And as we continue to refine it and drill it down, and understand how each department or each category of goods move through the systems, and how we should properly allocate freight, you know, we would be better able to determine exactly what the YOY lift would be.

I wouldn't say that there is no benefit, but I believe that if you look at our freight burden this quarter and then rationalize that on 3.2 million, I think it's another 60 basis points. Our freight and the way we move freight, we've actually become more efficient in the manner that we do that. And to the extent that we have price increases I can understand freight increasing YOY. But as we become more efficient it clearly required us to take a look at how the goods moved through the system and making sure that we properly burden that inventory to capitalize the freight.

So I think when you look at it that way, it's easy to make the argument that it really is not a matter of the hit or the increase or the improvement over YOY, it's really just the difference between the estimations. We felt it was best to disclose it in the press release so we could talk about it on the conference call rather than just have it appear in the Q.

Okay, so when you calculate what's the general formula, when you calculate how to allocate it, what to capitalize, what factors are you looking at? Is it just – I guess I just don't understand, what are the – can you give me the basic formula that you're looking at?

Yes, you know, again, I prefer not to get into the details. But it really is a matter of trying to understand how the goods turn, but we captured all the freight dollars. It's not an issue of, you know, have we not accrued the freight properly or haven't captured all the expenses. It's just a matter of understanding the movement of goods and how we're going to apply that freight rate to the inventory. So as we determine what that estimate is based on the frequency of the turns for the categories, that's how we would allocate it to the inventory.

Okay. Finally, do you – your pre-opening expenses, are those capitalized?

Pre-openings, no, they're expensed.

Okay. Thank you.

Okay, we have about three minutes left on our 60-minute call, so we have time for a few more questions.

Thank you. Our next question is coming from Mr. [Yasmine Insada] from [Clovis Capital]. Please go ahead.

Hi. It's actually [Jasmine Nyne] today, with Clovis Capital.

Hi.

Hi. How are you guys? I was actually wondering, so I hate to belabor this topic on the comps, just for just one last second. So you guys basically capitalize the expenses, the 3.2 million? In other words, where did that go?

Again, basically, yes.

Okay.

That winds up being capitalized, but again it's, 3.2 is just the difference in the estimate.

Okay, okay. And then and looking forward into your business, as far as business trends are concerned, on the business outlook for the fourth quarter is it mostly the benefit due to apparel and pets that's doing so well? Like looking versus seasonal?

Well, we expect to have a very strong performance in our equine Christmas gifts, lifestyle Christmas gifts. We do expect heating on a YOY basis to be solid for the quarter.

Okay.

They're launching a private brand master hand tools, portable hand tools, and tool storage cabinets. So there's really several categories that we feel we are going to market in a very, very improved plan to prior year.

Okay. Great. Thank you very much.

You're welcome.

Your last question is coming from Mr. [John Emerich] from [Ironworks]. Please go ahead, sir.

Thanks.

Hi, John.

Thanks. Hi. Hate to end it on essentially a silly question, but why does goodwill seem to bounce around from quarter to quarter, the last few quarters, down from December to the last quarter and then up sequentially to this quarter?

Yes, it's a fair question.

Are you still doing purchase price allocations from Dell, or?

Yes. We took a look at the allocation. We made our initial pass, I want to say at the end of the first quarter, and then we revised it. And that's the only thing that's giving rise to the change.

I mean if it's one thing then I'll ask for the answer, if it's a million little things then I'll let it go, but the million dollar increase sequentially, did it come from one other line item in particular? Because if it went up by a million, obviously some other asset class went down.

Yes, it was our decision to use the brand for an extended period of time. We were wondering if we should co-brand it, and at one point in time change the name to co-brand retractor or, three, go to market in perpetuity with the Dells brand, which has been our decision, and that had the impact I think. Is that right?

Correct.

Another million dollars to, a different intangible, the name, the name brand.

Thank you very much.

You're welcome. Thank you, all, for the call. Thank you for joining us on this terrific growth story, we call Tractor Supply. Again, we spent an entire day looking at the, looking five years out at the key drivers of our business. As the baby boomers age what will their participation be, what's happening with [Jet Xers]? What's happening with people moving, this wonderful place we call out here? And we remain very excited. We continue to work hard to execute at an ever increasing level. We're aligned. And look forward to talking to you after a terrific Q4. Thank you very much.

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