Tractor Supply Co (TSCO) 2006 Q4 法說會逐字稿

Good evening, ladies and gentlemen, and welcome to the Tractor Supply's conference call to discuss fourth quarter and full year results. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and the instructions will follow at that time. [OPERATOR INSTRUCTIONS.]

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

Thank you, operator. Good afternoon, everyone, and thank you for joining us on today's conference call.

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 they can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.

Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in the company's filings with the SEC. The information contained in this call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time. Lastly, Tractor Supply Company undertakes no obligation to update any information discussed in this call.

Now, I'm pleased to introduce Jim Wright, President and CEO. Jim, please go ahead.

Thank you, Carol, and good afternoon, everyone, and thanks for joining us. I'm here today with Tony Crudele, our Chief Financial Officer. Also, Stan Ruta from Store Operations, and [Gerry Brase] from Merchandising are on the call with us.

Our chain faced significant challenges in driving sales in Q4. The early weeks in the quarter were weather neutral to last year, however, we were cycling the sales benefits from the Texas hurricanes and the Katrina effect which increased demand for heating, emergency response, and fuel storage products last year. The second half of the quarter was marked with record high temperatures and the almost complete lack of snow and ice storms.

On our last call, we communicated our confidence in our comp store sales assumptions for the fourth quarter, but also noted the critical role of a normal winter and our plans to cycle last year's shortage of alternative heat inventory in the latter part of the quarter. The weather did not materialize and the demand for alternative heating proved less than we expected, primarily due to the moderating fuel costs and reduced consumption due to the record high December temperatures.

Now, with that said, I'm very proud of the proactive efforts of our team during the quarter to help mitigate the impact of the unusual weather conditions. We recognized the top line softness, took the appropriate actions to maximize our productivity on a lower sales base. Through our operational responsiveness, including being very deliberate in our promotional strategy, we were able to protect gross margins for the quarter while also generating positive comps against a very strong comparable period last year.

Specifically, our 5.3% sales increase or 13.3% net of the 14th week last year of sales increase in the fourth quarter was driven by our core merchandise and holiday products, which remained strong throughout the quarter. We were particularly pleased with the sales margin and sell through of our toy and gift assortments. Core pet and animal categories also produced solid sales gains. Comp store traffic and comp store ticket were both up slightly in the quarter.

Reviewing 2006, we faced many challenges, notably a record warm January to start the year, drought in the southwest markets, no landfall hurricanes, and industry-wide decline in riding lawnmowers, and then at the end of the year record-high December temperatures. That said, we continued to drive our performance by successfully executing the many important initiatives we outlined at the beginning of the year.

Looking at some of those, more specifically, on the store opening front we hit our new store target with the opening of 82 stores. Included in these new stores were two Del's, four Tractor Supply Stores in California, bringing our total California to eight. We opened 60% of our new stores in the first half of the year. In total, our 2006 new stores are hitting their sales at profit proforma.

Store initiatives, we're always working hard to keep the look and feel of our entire store base exciting and engaging. During the year we focused on two major initiatives, rolling out the expanded clothing set to 169 stores, bringing our year-end total to 279, and introducing the expanded pet and animal set to test stores.

As we reported all year, the non-seasonal apparel sales in the expanded stores have been quite strong, as our customers have responded positively to the enhanced merchandise assortment. We began rolling out our expanded pet resets in the third quarter of 2006, and completed the year with 37 of our stores having this new enhanced offering. As we've previously mentioned, the resets are designed to give the pet department a softer feel and ultimately attract a wider range of customers. These sets improve our very important pet category through the addition of new products in each pet department. While the sales response to date has been very positive, we have significant opportunity to refine the allocation of space and inventory before we expand this test in the third quarter of this year.

On the merchandising side, we work hard to keep our merchandise mix compelling and fresh and relevant to folks who live the [out here] lifestyle. During the year we maintained our focus on this initiative and introduced many new products for our customers who live that lifestyle, including Husqvarna chainsaws, string trimmers, and riding lawnmowers, premium zero turn riders by Dixon and Bad Boy, Stetson brand hats, high-end dog food by Royal Canin, Biljak and Nutro Ultra, pet accessories from Harley-Davidson, Remington, and the AKC licensed chemicals. We also made marked progress in developing our private label brands with the C.E. Schmidt footwear line and the Master Hand tool and tool storage line.

The Del's integration went really quite well. We converted most all of the Del's stores to the new, updated format. The new format adds a breadth and depth to pet, equine, clothing, and footwear, as well as seasonal categories. Our results in these Del's stores have been encouraging thus far, and we're pleased with our execution of these resets. Overall, continuing to be very happy with Del's and the Del's concept, and Del's was accretive to our earnings for the year.

On the people side, we continued to build on our leadership team this year. As we focus our long-term growth initiatives, we recognize there are areas within our team that need to be enhanced to support our growth. Specifically, we welcomed [Alex Stanton] to our finance team, [Steve Braun] to spearhead our multi-channel initiative, [Roger Hartley] to our merchandising team as a Divisional Merchandise Manager, and [Melody Alford] as a new Director of Imports.

In addition to expanding the breadth of our store support team, we have also continued to emphasize the importance of our people through our training programs. During 2006 we delivered 758 person weeks of Tractor University training here at the Store Support Center, including 250 one-weeks of store manager and store manager candidate training. We also met with the entire store management team at both our spring and fall/winter sales conferences.

Throughout 2006 we maintained a strict focus on building on past successes and laying the foundation for long-term growth. Though the last year was not without its challenges, we were pleased with our ability to address them, continue to make progress on our strategic initiatives, and generate a strong year-over-year growth.

We learned a great deal last year and plan to leverage this knowledge in 2007. I'll go into further details in a few minutes, after Tony reviews our financial results for the quarter and 2006. And, now, I would like to turn the call over to Tony.

Thank you, Jim. Good afternoon, everyone.

As Jim indicated, we navigated through a tough selling environment and delivered $0.72 per share for the quarter. This compares to $0.75 in the prior year. As a reminder, this Q4 2006 compares to a 14-week quarter last year. We estimate that the additional week represented approximately $0.06 to $0.08 of EPS for the previous year.

The quarter results also include approximately $2.8 million or $0.045 per share of stock option expense reported pursuant to FAS 123(R). Excluding the 53rd week in 2005 and the stock comp expense in 2006 we calculate the quarter-over-quarter increase to be closer to a 12% increase. Adjusted for these items, on a full year basis, net income and EPS increased approximately 16%.

In the quarter, sales increased 5.3%. Adjusted for the additional week sales increased 13.3%. Total comp sales for the period were 0.5%. The unseasonably warm weather took its toll on the comps, and comps excluding the cold weather categories would have been approximately 4.15%.

With respect to regional sales trends, comp sales were above company average in the south and southwest, and below company average in the northern regions. The Del's comp sales continue to perform well above the company average.

With the warm weather during the quarter, sales of winter related merchandise were generally difficult throughout the quarter. However, we saw a pick-up in sales as we approached the Christmas holiday, especially during the additional weekend selling day. All in, we were generally pleased with the sell through of our toys and holiday season gift program.

We had a slight percent increase in both average ticket and transaction count for the quarter. We had a solid gross margin performance for the quarter as overall margins improved 70 basis points. This resulted principally from freight and shrink improvement, offset by an increase in our LIFO reserve. With fuel prices easing and a better availability of trucks, the transportation environment was much more favorable. The change in our method of estimating freight, which we made in the third quarter, did not have a material impact on freight expense for the fourth quarter. Our initial purchase margin continued to improve as a result of better buying and increased importing, but this was offset by higher than planned markdowns due to the unseasonably warm weather.

We managed SG&A below our internal plan with tight payroll management. Excluding the $2.8 million of FAS 123(R) stock comp expense, SG&A, including depreciation, as a percent of sales increased compared to the prior year by 90 basis points. We estimate that a majority of the de-leveraging resulted from the leverage created by the 53rd week last year. The remaining increase is attributed to the increase in occupancy expense as a percent of sales.

We also had a shift in marketing expense into the fourth quarter for television and production of approximately 600,000, which we expect will shift back to Q3 next year. The occupancy and marketing increase was partially offset by leveraging our Store Support Center and field management, resulting from a decrease in the field and corporate incentive compensation expense. The reduction year-over-year in incentive compensation was approximately $3.4 million pretax. We also had a pretax gain from sales of real estate of $1.2 million during the quarter, which is comparable to the fourth quarter last year, when we also had a real estate gain of $1.2 million.

The effective tax rate in the fourth quarter was 37.9 versus 36.8. The year-over-year increase is attributable to the non-deductibility of certain option expense related to FAS 123(R). It is also an increase over the full year tax rate. Although our estimate of nondeductible stock option expense did not change, it was a larger portion of the tax base as a result of the lower than expected earnings in the fourth quarter.

For the fiscal year net sales increased 14.6% to 2.37 billion. Excluding the sales for the additional week in fiscal 2005 the total sales increase for the year would have been approximately 16.1%. Same-store sales increased 1.6% after last year's 5.7% gain. We were pleased with our gross profit performance for the fiscal year, as it increased 17.5% to $751.4 million or 31.7% of sales, compared to 30.9% of sales last year, or an 80-basis point improvement for the year.

Now, looking at the balance sheet, our inventory levels on a per-store basis increased 11% or approximately 89,000 per store. This calculation excludes Del's and in-transit inventory, and the store base includes unopened stores that were carrying inventory at the end of the quarter.

Several factors contributed to the increase in inventory. Shortfall in sales in the quarter clearly contributed. We managed the categories that we believe have potential markdown risk, and we're very--we were very deliberate with our inventory management in those categories that represented good go-forward, in-line merchandise.

Our general growth initiatives include expanded growth in in-store square footage and a roll-out of expanded clothing. Additionally, beginning in the third quarter we made a concerted effort to improve service levels by raising the minimum stocking levels for certain SKUs as we better stratified our inventory into high-turn and core inventory items as part of our E3 refinement. We planned early arrival of Q1 seasonal merchandise, as well as certain freight, shrink, and evaluation reserves now represent a smaller percent of the inventory balances as the inventories have increased.

On a full year basis we experienced a 15 basis point decrease in inventory turns. We've identified the key factors that drove the high inventory levels at year-end, and we're actively working towards driving greater inventory productivity, and Jim will go into more detail shortly.

Accounts payable financing of inventory decreased 2 percentage points year-over-year. We're confident that we're able to secure better financing, and we'll focus on improving this metric in 2007.

CapEx for the year was approximately 90 million, including assets under capital leases. This is consistent with the $96 million guidance that we provided, as approximately 6 million of the CapEx that we contemplated spending for our POS rollout was pushed into 2007.

Looking at 2007, the full year, we anticipate sales to range between 2.7 and 2.74 billion, a 14 to 15.6% increase over 2006. Our top line guidance reflects an expected comp store sales increase of approximately 3 to 4%. We expect the impact of cannibalization to increase slightly above the 40 basis points we ran in 2006, and estimate the range to be about 50 to 70 basis points.

We expect full year 2007 net income to be in the range of approximately 101 million to 104 million or $2.45 to $2.52 per diluted share. Two accounting pronouncements, FAS 123(R) and FIN 48, will have a significant impact on 2007. Taking these two pronouncements into consideration, our earnings growth guidance is more consistent with our targeted mid to upper-teens earnings growth.

Stock comp expense, we anticipate that stock compensation expense will approximate $12.1 million or $0.18 a share. This represents an increase of approximately $2.4 million or $0.03 to $0.04 a share over last year. This results principally from the forecasted expense of the 2007 stock option awards with a less impactful roll-out for prior year grants.

Our forecast also assumes the adoption of FAS Interpretation No. 48, accounting for uncertainty in income taxes, which is referred to as FIN 48. This pronouncement requires us to reserve where probable the potential disallowance of certain tax positions. This will increase our effective tax rate. Additionally, we will be impacted by new changes in certain state tax regulations. We estimate that these changes and the tax impact of stock option non-deductibility will increase our effective tax rate by approximately 56 basis points. Approximately a third of this change is related to the adoption of FIN 48. We estimate the change in the tax rate to have an approximate $0.02 impact.

We expect EBIT margin to be flat for 2007. Consistent with our performance in 2006, we expect continued expansion of gross profit margin and a de-leveraging of SG&A expenses. We anticipate that gross margin will continue to increase, but not at the same level of acceleration as 2006. We believe that our gross margin initiatives will continue to be beneficial, and we will anticipate a more favorable transportation environment. However, we do not anticipate having our shrink improve at the same rate as 2006.

The de-leveraging of SG&A occurs principally for three reasons. First, our investment in the future includes Ecommerce, Del's, and new stores. E-commerce, although the majority of our investment this year will be capitalized, we expect a net expense for the year of approximately $0.02 to $0.03. Given the timing of the Ecommerce initiative, we have planned these startup expenses with limited sales forecasted for late in the year.

At Del's, we continue to make technology enhancements and increase staffing as we prepare to grow Del's, once we obtain the proper learning in 2007 with respect to the new store ramps.

And the new stores, as we previously discussed on past conference calls, in connection with our 13% annual new-store expansion since 2004, occupancy costs and to a certain extent payroll has had a de-leveraging impact that will continue until the stores reach maturity. We have identified several factors that have exaggerated the impact of the de-leveraging, and we have initiated several initiatives to drive-down the occupancy costs as part of our capital efficiency target, which Jim will outline further. We expect these initiatives to bear fruit over the two years of store openings beginning in the second half of this year. We expect the de-leveraging to continue through 2008.

Secondly, as previously discussed, stock option expense is expected to increase and provide an SG&A headwind.

Third, we will continue to leverage our marketing, distribution centers, field management, and corporate overhead. However, we will cycle against 2006, a year in which we fell short of our internal plan, and the incentive compensation payout was limited. Therefore, there will be little leveraging obtained from these areas as we forecast a more normalized incentive compensation expense for 2007.

In 2007 we plan to open approximately 85 to 90 stores, including 4 to 8 Del's, with approximately 60% of the stores being opened in the first half of the year, which is consistent with the store opening strategy that we implemented in 2006.

Total CapEx expenditures are expected to range between $95 and $100 million. As we've emphasized in the past, we believe our business can be more accurately assessed by looking at half's and not quarters, given that the weather can significantly shift and shift the timing of our sales.

We refer to our first quarter as a "get ready quarter", and expect the quarter to be approximately flat with last year. Consistent with prior years, we look at the second and fourth quarters as our most productive quarters, as well as where we anticipate having the most opportunity for earnings improvement versus the prior year. As in the past, at each quarterly conference call we will provide more clarity on the going forward period.

Now, I would like to turn the call back over to Jim for more details on our plans for 2007.

Thanks, Tony.

We are proud of our ability to respond to a challenging retail market and drive our performance in 2006. We were able to deliver results while also executing important initiatives that will keep us well positioned and prepared for our future growth. We look to remain as focused and successful in our execution of our long-term strategy in 2007. I would like to walk you through a few of our plans for 2007, which incorporate the learning we acquired in evaluating last year's challenges.

First, on sales growth, growing our top line has always been the key objective for Tractor Supply over the years. Looking at the years ahead, we'll remain steadfast in our efforts to expand and to be innovative with our merchandise mix. Specifically, we'll continue to roll-out apparel resets and expansions. We expect to reset 170 stores, bringing our total expanded stores to over 500 at year's end, including the new stores that we'll open this next year. We continue to evaluate and refine the expanded pet set, and expect to roll the set out to approximately 100 stores in the third quarter of this year.

We have a team of merchants reviewing several [Plan-o-grams] on the left-hand side of our store for category and SKU rationalization, expansion, and a possible addition of new categories. Our store managers and district managers will review this thinking during our spring sales meeting next month. We plan to test and revise assortments in Q3 of this year.

Our print and advertising is undergoing a significant review, and I fully expect we will improve our return on advertising going forward. We'll also have fresh television creative for the spring campaign, also developed to drive sales. We have launched a CRM initiative to allow us a single view of our customers across our multi-channel marketing efforts. Our [GURA] program, which stands for greet, uncover, recommend, and ask, was launched at the fall and winter store managers meeting, and it continues to gain traction. This program emphasizes customer engagement and selling activity over non-selling activity.

Operating efficiencies, we're pleased with the early results of LEAN, or as we call it, tractor value system initiatives, and expect that by 2008 this rigorous process of review, along with other initiatives, will allow us to moderate the growth of SG&A and position us to leverage going forward from that date.

Customer service initiatives, we anticipate making great strides with regard to customer initiatives in 2007. Perhaps our greatest is launching our Ecommerce objective. Currently, our customers can use our website for information and for store location. The new website, which we anticipate going live late in the year, will enable our customers to not only browse for products online but purchase them, as well. We believe this effort will strengthen the relationship with and the loyalty from our customers, while further developing our capacity to market each household when they're most likely to respond, using the media they prefer, presenting the categories and the products that have most interest, while using the offer they are most likely to respond to.

Capital efficiencies, turning to inventory. Today our stores look great. We have the best in-stock in our history. We have fresh goods and we have no abnormal markdown risk. That said, we ended 2006 with an 11% increase in average store inventory, and while we're not satisfied with our inventory productivity, we have identified the reasons for this increase, and are actively addressing them as we speak.

In late Q2 we hired an E3 consultant to assess our implementation. In Q4 I reorganized the supply chain, giving the replenishment responsibilities to Stan Ruta, our SVP of Operations. His team will capture efficiency from E3 and implement the plans we developed with the consultants. As the field also reports to Stan, we'll have a heightened awareness of inventory accountability at the store and field model. The merchants, of course, will continue to be the primary owner of inventory, investment levels, terms, and GMROI.

Specific elements of inventory optimization plans include improved seasonal and regional assortment timing, more accurate linking of store demographics to initial buys, a focus to reduce slow moving and heavy SKUs at the store level, and a structured program to reach an appropriate level of accounts payable leverage.

During the last quarter we completed a deep review of new store productivity. We evaluated the performance of stores opened over the last four years relative to their location, that be on [The Golden Mile] or [The Silver Mile], are they retrofit or prototypical, 15,500 or 18,500 square feet. We reviewed our design spec for every major building component. As a result of this study, we've cancelled a few stores for 2007, we've revised others in the pipeline and confirmed that we can reduce CapEx and occupancy costs on future projects. That said, while new stores will continue to cost more than the base, we see the de-leveraging of occupancy expense beginning to moderate in 2008.

Our ability to successfully serve our customers and achieve improved financial results in a very dynamic external environment last year is a testament to Tractor Supply's proven business model and the strength of our people. Our team remains motivated and focused on executing against our set initiatives. Our challenges in 2006 only fuel our enthusiasm and determination to execute our important initiatives and long-run strategy, which will drive our performance and profitability in the future. We have very clear objectives for 2007 and the years ahead. Our opportunity remains tremendous, our team capable, and our future very bright.

And I would now like to open the call for questions.

[OPERATOR INSTRUCTIONS.]

Our first question comes from Bill Sims from Citigroup. Please go ahead.

Hello, Bill?

Hi, sorry about that. A couple quick questions. First, Jim, when you expanded the pet category in 2006 what is it that you learned that really led you to put the brakes on the expansion in terms of the reallocation of space? Can you just delve into that reallocation a little bit more?

Are you talking about--I didn't quite catch all of it, Bill, you're a little cloudy at this end. I think the question was as we began to see sales softening we took action with regard to--?

--Let me rephrase the question, if I can. As you expanded the pet category in 2006, it appears like you're putting the brakes on the expansion in 2007 as you expand and the need to reallocate the space in the category.

Actually, no. We had planned this as a test, as we did with the clothing test, we normally test a group of 30 to 50 stores, let them percolate and appraise and refine in Q1 and Q2 as we prepare for a more significant roll-out in Q3. So, actually, Bill, we're following the same methodology that we followed when we went to the super clothing expansion.

Okay. So when you refresh the reallocation of space in the category, there's nothing structurally that we need to be concerned about there?

No, we were very aggressive. We added like 900 new SKUs to really fill the shelves and find out where the winners were and where the losers were. And we recognize that we'll not need 900 SKUS going forward to delight our customers.

The second question is in regards to the LIFO impact of 2006, can you remind us if that was a net benefit or a net drag on margins in '06, and actually from a gross margin perspective what--how should we think of gross margins in '07?

With respect to LIFO, it was a slight increase over the prior year, and we would expect that it would be consistent in 2007 with the 2006 [in the] reserve. But net, net it should have limited impact relative to margin year-over-year.

And then, final question, if you could just comment with the drop in temperatures throughout the country, can you just give any direction? Have you started to see a pick-up in traffic in sales in the store during the first quarter, or is too early to tell?

Winter is always good for us.

Very good. Appreciate it. Thank you.

Thank you. Our next question comes from Dan Wewer from Raymond James. Please go ahead.

Hi, good afternoon.

Hi, Dan.

Jim, you'd noted the prospects of a 3% to 4% comp sales gain during 2007. Could you tell us why you think the business reaccelerates? It looks like for the last six quarters it went below that level.

Sure. Well, one thing, the old metric of retailers, you begin to lap yourself, so we do have that going on. If you look at the external influences last year, there simply was not a favorable weather pattern, there was no landfall hurricanes. We know that the power equipment industry is seeing another soft year, but a change year-over-year it is expected to be much less deceleration in riding lawnmowers '07 compared to '06, versus '06 compared to '05.

And, in addition to that, we are now six months into the sales focus program, that we call "GURA", and, frankly, are getting traction from that. We're changing print, we're changing television, and we also believe there will be a general, hopefully, a continued moderation in the cost of gasoline, which should in time free-up some discretionary spend at the lower end of our demographics.

Most hard line retailers with a 3% to 4% comp can maintain a flat expense rate or even get some leverage. Is there anything unique or inherent about the Tractor Supply model that requires a higher level of comp sales growth to keep the expense rate flat?

Well, I think, Dan, the issue really is a little bit on the history side, as we've had some--part of our store base is much older, and had some very favorable rents, as well as our acquisition in 2002 of the Quality Stores, we had obtained some locations with very favorable rents. So as we've expanded since 2004, that--the rent increase on the newer locations has provided a significant headwind. So really that's the driving force within the SG&A and has probably caused a little bit greater de-leveraging than you normally would expect. But, as we've stated before, we expect that to moderate as we move into 2008 and then position us to start to get that leverage that you would expect.

And then the last question I had revolved around E3 and the work with the consultants. Have they put together a timeframe as to when inventory turns could begin to improve? And then, also, trying to figure out how we can increase gross margin rate in 2007 while simultaneously working down these excess inventory levels. Thanks.

Sure. Yes, good question, Dan. We--they have given us an insight into how to make the E3 engine run better. We have set our turnover acceleration target for this year at, I believe, about 15 basis points--is that right, Gerry?

Right.

Yes, so we have an internal goal of 15-basis point acceleration in turnover. I think that, frankly, that's very doable. And the third part of your question is how can we do that while concurrently maintaining or improving gross margins, is due to the relative freshness of our inventory and the fact that we are not in the position--while we are heavy, we are heavy in good go-forward SKUs of products.

All right. Great. Thank you.

You're welcome.

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

Thanks. Good afternoon.

Hi, David.

Hi, Jim. With incentive compensation down in '06 have you seen an increase in turnover at the field level?

No, the--at this point in time, no. As a matter of fact, I--I'm delighted with the enthusiasm of the organization. We had our leaders meeting, which was the top--all of the top field management, district manager, top--every manager is included in that, as well as the top 40 or so team members from the Store Support Center. And the energy was just, just terrific.

We've got a--we're very much blessed with a management force, and I'm speaking of store management and up, that understand what incentive, incentive compensation and leverage is all about. They have a plan that they believe in. They see their numbers on a daily/weekly basis. They understand the key categories that prevented them from making their plans this year. I think, clearly, they saw the effort that we all expended trying to support them. And I think, as I would not want to be having this conversation after three years like last year, but I think, frankly, they're very energized and looking forward to earning some money in '07.

Thanks. And my other question is on outdoor power equipment. Can you talk about some of your merchandise initiatives in outdoor power equipment, including riding mowers? And related to that, do you expect your comps in this category to increase in '07?

David, this is Gerry, and I'll field that one. Last year was a very tough year in outdoor power equipment across the industry, and we certainly felt the effects of that. We saw most of the deceleration in sales in outdoor power equipment, David, on the lower to mid-price points of our rider program here at Tractor Supply. The premium riders and the zero turn riders held their own in a challenging marketplace.

So for 2008 we put a very concerted effort about delivering exceptional value throughout the program for the really renewed focus and emphasis on the low to mid-tier price points to see if we can't grab back some of that market share that we felt went away last year, while still focusing on being innovative and the market share leader when it comes to new products, in particular, zero turns and some of the other categories that have really propelled our growth the last couple of years.

Gerry, if I could follow-up on that. At the lower price points how do you reinforce the value? Is it lowering prices, is it adding features? And then at the higher price points, is there still a lot of innovation going on with the high-end riders?

David, we've really focused on, call it the mid-tier price points, between $1,000 and $1,500, on delivering additional features that the customers will be delighted to see. In our private brand offering, and I'm talking Huskee and Huskee Supreme, and we believe that we've done a lot to really power that up for the year 2007. On the higher end there is new innovation coming to marketplace this year, and Tractor Supply will be first to market with some of the newest and what we believe is really innovative features in some of the premium riders and, particularly, on some of the zero turns.

Sounds good. Thanks.

Thank you. Our next question comes from Jack Murphy from William Blair. Please go ahead.

Okay. Good afternoon.

Hi, Jack.

Just a quick, just a clarification on the guidance before, a big picture question. So on the two things that Tony carved out, the incremental options, that's you said $0.03 to $0.04, is that right?

Yes.

Now, is that a number that's going to continue to grow or is that just part of the transition and now that sort of flattens out, or is that just sort of an ongoing expense that's going to grow every year?

No, we expect that next year's increase will be a little bit higher than we would anticipate go forward, and we expect that to flatten out in the subsequent years.

Okay. As a percent of earnings or in an absolute sense?

As a percent of earnings, not necessarily in an absolute sense.

Okay. And then the [1048] was $0.02, you said?

Yes.

Okay. All right. And on the occupancy, in the real estate study that you did, could you just talk a little bit more specifically about what you found--some examples of where occupancy, the reasons why occupancy has been higher on newer stores? And can you distinguish the--that issue with new store productivity from a sales perspective? So, in other words, you know, can you continue to get good sales productivity on new stores while managing down occupancy expense?

Yes, we can, Jack. And the analysis we did, the components of building prototype buildings are land cost and building. And build--first, of all, let's assume building is pretty much the same wherever you place it, land costs can be several hundred thousand dollars a half mile away from Wal-Mart, as opposed to adjacent to Wal-Mart, or adjacent to another big box, or adjacent to a retail epicenter.

So part of our analysis was to break our stores into those different buckets which we called The Golden Mile and The Silver Mile. And, frankly, after the first 60 to 90 days we found the volume ramp-up and the absolute volume to be virtually the same. The stores closest to a traffic generator may have come out of the box the first 90 days a little faster, but their terminal value after six months or 12 months was exactly the same, and that's I think to a degree logical because we are a unique concept and a destination store. So land value is one piece.

The next piece is as we began to look at the composition of our building costs, we recognized that over the last several years we had made a series of independently good decisions, this is a case of [what we want on]--we were in some new stores back in 2002, 2003 where we were not delighted with the cement finish. So we said, well, by gosh, go fix that. Well, that's an $8,000 fix times the number of new stores we've built. We've also been building permanent docks, recessed truck docks in our stores.

We've discovered that we can go to a fabricated steel dock and save $50,000 a store. In some parts of the climate--of the country, where we have warmer climates, we can go out, we can eliminate the double airlock vestibule and save $30,000 a store. Now, we kind of like the vestibules, and as we began to add all these things up we said, boy, there's significant dollars here that will only compound as we open several hundred stores over the next several years.

Okay. So it's really a series of things that you just engineer out that doesn't have anything to do with the productivity of selling?

That's correct, yes, exactly. And we've found--again, when we look at the productivity in some of our previously occupied buildings, you know, they may have a second--we may be the second occupancy on that--occupant on that tile floor. We may not have a vestibule, and yet we will do our average of $3.8 million in the third year.

All right, that helps. Thanks a lot.

Thank you. Our next question comes from Matt Nemer from Thomas Weisel Partners. Please go ahead.

Hi, everybody, good afternoon. The first question is on the spring selling season, I'm just wondering what your plans are from an ordering standpoint? Some vendors that have--that are public have reported that they're seeing smaller orders from retailers that are perhaps waiting to order later in the season. Can you give us any insight to that?

Yes, I read that report, as well, [although I'm] not in that business. We have--if you look at power equipment, we decided this year to present our categories, a very solid category presentation early on, so we are not actually managing that on the front, front end. We will manage inventory very arduously starting when the season begins, forward. But, frankly, most of our stores today from, I guess, I-70 south would appear to be in the lawn and garden business, not the way they're going to look in late March or April, but we are in business right now. So I cannot say that we have delayed shipments, delayed purchases, at all.

Okay. And just a follow-up on that same topic. Do you think that if you look at the second quarter that the slowdown--can you give us some more color about the slowdown in the outdoor power equipment category? I know that you think that the deceleration changes. Do we still comp negative in that category in the second quarter, or does it start to--does it take a few years to unwind out of that category?

Well, our plan is at this point--I think the industry is saying that 3 on top of the 9, 3 on top of 9 down. We are not planning for that, we're planning for very, very modest comps at the unit and dollar level, mainly due to the strength, or what we believe is the strength of our offering and our marketing efforts. There is some linkage to housing turnover, so we have the seven-year cycle of the power equipment business. We also think there is some linkage to housing turnover.

The other thing that is very favorable for Tractor Supply is the fact that it really appears that the southwest of our--what we call our southwest, is going to be green this year due to rainfall and current groundwater levels, so we have some optimism there, recognizing that a big piece of our drag last year in that category was that geography.

Got it. Next question is just to follow-up on the change in new store investment. Is it possible to quantify the change in either the building costs or even the fixtures expense?

I think each situation probably is a little bit unique and different, and we have to make that assessment. So I would say at this time we would not get that granular.

And Matt, we're also, we're taking this action now, but will not have a demonstrated net effect until late this year and really into '08 on some projects, because you understand the real estate pipeline.

Yes, fair enough. And then last question is just on the point of sale roll-out, can you explain why there was a delay and at what point does that--what quarter does that roll-out in in '07?

Right. Actually, there was no delay. In the guidance that we gave last year at the beginning of the year, we anticipated CapEx to be about $80 million, with approximately $16 million for POS that we were not sure if we would spend it at the end of the year or not. We actually anticipated rolling that out in early '07. So we actually are a little bit ahead of schedule. It relates mostly to the hardware, and we felt as some of our POS is coming off lease that it would serve us best to roll that out at the end of '06.

With the hardware rollout, we anticipate rolling out software in mid to late summer, and then try to hit a majority of the stores in that time period, and then subsequently rolling out the remainder in early '08 after the busy selling season.

Okay. So just to be clear, the hardware is fully installed and the software is coming, starting in mid to late summer of '07?

That--that is correct. We still, as indicated, we still have about $6 million of anticipated cost. Some of that is hardware, but some of it also relates to the software that we'll be rolling out this year.

Okay. That's all I've got. Thank you very much.

Thank you.

Thank you. Our next question comes from David Magee from SunTrust Robinson. Please go ahead.

Hi, David.

Yes, hi, good afternoon. Just really a question on the advertising spend. You mentioned in your remarks that you saw opportunity there. I'm just curious what you're happy with, what you're unhappy with, and what you might see changing in that area for you?

Sure. On the print side we have--we use an internal metric here at Tractor Supply, which we call ROAD, which is return on advertising dollar, and we measure gross margin lift on a trend line against the cost of the print ad. We have now taken that--we've actually had a value stream and a rapid improvement event around circular item selection, circular design, and circular process.

We will be becoming much more granular, down to the item level, looking at the absolute gross margin dollar lift, if that was the strategy for the item. In some cases the strategy might be traffic. So I guess my point is we have a lot more rigor around our print. The timing of print, the number of circulars will remain unchanged, so we'll be plus or minus a week to [LY] and the same number of circular events in '07 as in '06.

With regard to television, we launched a new campaign last year, and television, of course, has two primary objectives. One is the ad must break-through the noise in the living room and grab the consumer's attention, and then, hopefully, there's a call to action that gets them to come on down. I believe our campaign last year was very good on the first part of that. I think it broke through the clutter. It was very, very creative. Pretty much on strategy. But the time we allowed with that creative was only seven--there was only seven seconds left after the creative piece for the sell message, and we felt that did not work well in most cases. So, as a result, we've gone to a--we're developing now a new campaign that we hope will also break-through the clutter but will allow a little more time and have a little more impactful sell message.

But you anticipate the spend this year to be about the same and [inaudible]?

Spend, yes, our spend as a percent of sales will be flat with LY.

Great, thanks a lot.

Thank you. Our next question comes from John Lawrence with Morgan Keegan. Please go ahead.

[Good afternoon], guys.

Hi, John.

Jim, would you go a step further, and maybe Gerry wants to talk about the left-hand of the store? Obviously, gifts, toys were good. The second year in a row that that category has really, I guess, the RED SHED performed well. Talk a little bit about that and just sort of the approach to looking at things, like Master Hand, et cetera, going forward?

John, just to pick-up a little bit on your comments. We were very pleased with the performance of our toy business. We very much differentiate our toy offering from that which you will find in the discount stores and the toy store specialty channel during the fourth quarter and had a fabulous year this year. Our holiday gift product offering, and we private label a lot of it under the brand name RED SHED, came into the stores a little bit later, on import this year, than we would have liked. It got out into the stores a little bit later. But we were extremely pleased with the sell through.

And, again, the predominance of those sales occur between Thanksgiving and Christmas, and we were able to successfully maximize those sales. And this business has gone from a standing start at zero four years ago to a very significant portion of our fourth quarter sales and an even more significant portion of our fourth quarter profit.

As Jim alluded to and Tony, in their remarks, the challenges that we faced in the fourth quarter were principally in the seasonal categories, and most of those categories of merchandise that were related to cold weather or the lack of cold weather from that perspective on that, John.

Would you exceed--would you expect that category to be expanded a little more next fall?

It will be, both categories will be expanded, and we're anticipating an earlier arrival and earlier set of those categories, which should give us some very profitable early season sales on both of those categories.

Okay. And just sorry for the repetition, but as far as your plans for the rest of the left-hand, when would we--did you say within the next couple of months we'll know more about what you're trying to do with some of those areas on that--of space?

John, to Jim's point, we are in the final stages right now of building a prototype and building a model in an offsite warehouse here, and we'll very shortly be tearing that down and taking it with us to our annual store manager sales meeting that occurs in late February. And we'll be previewing it with our managers, getting a lot of their feedback, and then we will come back, we will refine it.

And we have targeted some number of test stores, probably between 30 and 50 test stores in the third quarter so that we can get a good benchmark on fourth quarter sales, which most of those categories peak for us in annual sales during the fourth quarter. And we'll do a similar analysis after the first of the year, next year, not unlike what we're going through right now on the expanded pet program that both Jim and Tony spoke about.

John, let me elaborate on that a little bit. We're going to [show] our store managers, I think at about 84 feet more than we have room for, and they're going to walk it with clipboards, we'll get their comments. We'll come back, we'll debate. And I--actually, at this point, [I've not even] walked the set. We've set our buyers loose, and the guidance we've given them is that we are a farm and ranch store that serves consumers who live the out here lifestyle, show us what you've got. And some of it may be silly, but we're going to take a look.

We've also--a website is a wonderful thing. We were able in a matter of just a couple hours to get 1,500 customer responses back with verbatims on--we asked the [five] questions, "Should Tractor Supply carry more of this or more of this or more of this?" And then an open-ended question, "What else should we carry?" And in a couple of hours, or I guess a couple of days, we had 1,500 people tell us what they want to see. So we're taking--working through that. And we think we have a tremendous opportunity on the left-hand side of our store. You've seen over the years, the acceleration in animal, animal related, animal feed, pet, pet related, clothing on the right-hand side of the store. And we're now getting around to attacking the left-hand side with the same level of commitment.

John, just a follow-up comment. Randy just confirmed for me that we have announced our upcoming investor meeting that we'll have at our annual store managers meeting, so if you're there this year, John, I would encourage you to take a look at it and you'll get an early preview of some of the things that we're looking at related to that left side.

Will we give him a clipboard?

Of course, really, [inaudible].

[Assign you a clipboard], Jim.

I understand. Thanks, guys.

Thank you.

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

Hi, Peter.

Yes, hey, guys. Thanks for taking my question. Just two things. First, Jim, you talked a little bit about the pet food category and, we're hearing costs going up in the space. Have you guys been attempting to pass that along, and what level of success have you had? And then I have one follow-up.

Peter, two comments there. This is Gerry. We have seen significant acceleration in costs related to grain pricing in livestock feed, and we have been successfully able to pass that along, because all of our competition is seeing that pressure right now on the cost side. Most of it's being driven by the higher pricing on corn due to the demand for corn in the ethanol industry.

As it relates to pet food, it's a very interesting circumstance. We have been able to successfully hold-off cost increases in pet food up to this particular point. That industry is very tight, and typically with so many competitors and so many big players in that business, no one wants to be the first one to blink in that business and, thus far, any hints of price, price changes to date we've been able to push back on. Although in all candor if the prices of corn stay where they are right now I expect at some point it will work its way through the supply chain.

Sure. No, that makes sense. Thank you. And then maybe, Tony or Jim, on the timing of the openings in '07 for the new stores, if you could give us kind of a sense maybe first half, second half? And then for the stores that you did let--you cancelled out for '07, Jim, was it just a Golden Mile decision or were there any other factors that led you to chop a few off for the '07 plan? Thanks.

You bet. We will have over half our stores open in the first half of the year, maybe not quite 60% but more than half of our stores will be front loaded. Secondly, the stores that we cancelled did not meet--we've introduced a new--a new metric. We've had a very rigorous review, and there are several of us that sit on the real estate committeeA primary driver of our decisions have been--has been an [IRR] rate, which is a ten-year look. We now are using a 50-year occupancy as a percent of sales and 50-year store level for overall profitability as another look.

And when we looked at some stores that, frankly, had hit our internal rate of return target, due to the acceleration in years five through 10, we recognized a significant drag they would have on earningson margin, rather, earnings margin in years one through five. Went back, took a look, and said that the Golden Mile, they're prototyped, we can move a little further out, maybe replace them with a previously occupied building that has a significantly faster profit ramp.

Great. Thanks so much for your comments.

You're welcome.

Thank you. Our next question comes from Edward Yruma from J.P. Morgan. Please go ahead.

Hi, Edward.

Thank you very much for taking my question. I wanted to ask a little bit--I know you had [pack-away] inventory at the end of the first quarter of '06. Have you sold through that inventory?

Ed, this is Gerry, and in response to that, as Jim indicated earlier, cold weather in January is a good thing. And it has certainly helped Tractor Supply with its inventory levels when it comes to fall and winter merchandise, which, well, quite frankly, we're not in bad shape coming out of the month of December.

But your question, Ed, was with regard to '06?

Right, for the pack-away inventory that you had?

Yes, that was digested early, early in Q4. We bought around that, and the good thing about our business is that the merchandise we pack-away has no style, function, or fashion risk.

Got you. Now, did that actually help your gross margins then in the fourth quarter, if you reserved against that last year?

We wouldn't have reserved against that.

No, yes, we would not reserve against it, unless we felt that the margin, the value of the merchandise would be below cost.

Got you.

Right.

And I guess my final question is more of a high level, and I know that you've kind of addressed some of the initiatives you're taking in the zero turn lawnmower market, but do you kind of view the upgrade cycle as having played out? And are you really transitioning now more toward a replacement cycle for these units? Thank you.

The replacement business is always the key driver. I think, frankly, the upgrade cycle for the most part comes concurrently with the replacement cycle. So a consumer has a need, they decide to upgrade. There's also a little bit of keeping up with the Jones. The neighbor has a zero turn, I want one, too. Obviously, that's more susceptible to a tight economy. But I think, frankly, Edward, we'll continue to see a benefit from both. The baby boomers have continued to, at least to a degree, understanding our customers, these are tools and they're also toys, so they do, they do spend when they have the money to spend on the premium product.

Great. Thank you very much.

You're welcome.

Thank you. Our next question comes from Joan Storms from Wedbush Morgan. Please go ahead.

Good afternoon.

Hi, Joan.

Hi. Could you characterize, it seems like you've got some of these one-time issues going on in '07 that you should see some alleviation on in '08, including occupancies, stock option, anniversary, the higher tax rate. For '08 then do you think you could return to a more normal, what we would call sort of mid to high-teens growth rate on the earnings side?

Yes, Joan. Tony--this is Tony. We think that a lot of that will normalize. We clearly don't want to be in a position to forecast.

Right.

So, but we think that those issues that you've hit on generally will moderate. We don't look at '08 necessarily as being one where SG&A will leverage, but we are optimistic that we can return to our goal of 20 basis points improvement in EBIT margin.

So, basically, the '08 numbers--I guess, well, maybe I should put it this way, on operating margin have you updated us? Could you remind me if you've updated us on sort of what maybe a three-year target might be on operating margin?

Again, generally, next year we've guided that EBIT margin will be flat, and then we'd like to return to the 20 basis point improvement on an annual basis.

Okay. Great. Thank you.

Thank you.

Thank you. Our next question comes from Anthony Lebiedzinski from Sidoti & Company. Please go ahead.

Good afternoon.

Hi, Anthony.

Thanks for taking the questions. Just wanted to verify, did you guys say earlier that the comp sales in the fourth quarter excluding the weather sensitive products, that that was up around 4%?

Yes, that's correct.

Okay. Can you also give us an update on the private label product and the direct sourcing?

Anthony, private label products this past year achieved close to 19% of Tractor Supply's total sales, and we've successfully expanded several of our key programs. And I believe we mentioned the C.E. Schmidt clothing program. One of the big homeruns we had there was the introduction in the second half of our leather footwear program, which was manufactured for us exclusively by Timberland Footwear. And, in addition, we expanded the RED SHED program, which was our holiday gift program, and that was very successful in the fourth quarter.

We also launched in the fourth quarter Master Hand as Tractor Supply's exclusive line of premium portable power tools and tool storage cabinets. And we were pleased with the initial results that we had on both of those categories and look to make a long-term commitment to the expansion of the Master Hand brand throughout the entire tool category here at Tractor Supply.

Relative to imports, imports were up significantly from the previous year and Tractor Supply did close to 5% of its retail sales in 2006 on direct import merchandise, for us as an organization. As you might imagine, it represented a significantly higher percentage of our gross profit dollars because it does carry a higher gross margin percent for Tractor Supply.

We hired in August of last year Melody Alford, as our Director of Global Sourcing, and she is significantly experienced in global sourcing and direct importing, all with the intention and the goal of accelerating Tractor Supply's growth on the import side, so that has already begun and I anticipate an accelerated rate of growth over what we've seen in the last couple of years on the import side as we go forward.

And do you also expect to see a higher number of private label products, as well, going forward?

We're currently partnering with the marketing department on several additional initiatives. Over time we expect to be able to grow private label products at Tractor Supply, Anthony, to about 25% of our top line sales.

Got it. And then what kind of comp sales do you guys need to leverage SG&A?

That's generally a difficult question to answer because there's several factors that are involved. We run several different scenarios relative to stock compensation, and how that moderates--how the occupancy moderates. So, you know, generally what we'd say is in a steady state environment we look--on a mature store base we look at leverage around 2, 2.5. To maintain our growth we believe that we need to be in the 4 to 5% range as we roll-out our 13% store growth and try to leverage that increased SG&A that we experienced. So when you break it into those two pieces, we look at a mature store base of about 2 to 2.5, and to leverage to newer stores we need an overall company comp of about 4 to 5%.

Okay. That's helpful. And what was the expected tax rate, again, for '07?

The tax rate for--we just said that there's a 56 basis point increase.

From '06?

Right, from '06.

So, okay, so, all right. And then, and, lastly, do you guys have any early expectations for your Ecommerce sales for--in 2008?

It'll be--it'll be very, very modest sales, because we'll be launching in Q4. We may have a few products in Q3, and our expectation is that it will be--initially it will be a drag on earnings in '07.

Okay. Thank you.

You're welcome.

Thank you. Our next question comes from [Ryan Ritheria] from [Carrs Capital]. Please go ahead.

Hi. Thanks a lot. I just wanted to clarify, on the new store productivity is it correct that the sales productivity is still running on plan with what your model shows and it's just the rent that's an issue?

That is correct.

Got you. Thanks. And then the second question was given the fact that you did a 4% comp ex the weather categories in Q4, are you feeling any better about sort of the macro environment that tends to affect you?

Well, I--we certainly lapped fuel costs. If we look at that, we lapped fuel costs. We--it's very hard--we know we are more linked to housing turnover perhaps than we thought, but that is such a nebulous linkage that we can't say we're at it or beyond it. I'm not sure the--even the people that are more closely linked with housing know if we're halfway through or three-quarters of the way through this readjustment in housing and the velocity. So I guess on the overall we feel comfortable at 3 to 4 comps next year, all things considered.

Uh-huh. And I guess the third question is if you could elaborate on efforts to improve upon return on capital in the coming year, whether that's E3 on the inventory side or something else?

We clearly believe that the inventory productivity is a key component. And I think a lot of what Jim outlined relative to our new store growth and the capital efficiencies that we anticipate there, those would be the two leading efforts as we try to improve our return on capital.

And CapEx in the coming year should be 95 millionish, is that correct?

Right, 95 to 100.

Okay. Great. Thanks so much.

Thank you.

Okay. Let me take one more question, if there's one out there.

Yes, our final question comes from R.J. Hottovy from Next Generation. Please go ahead.

Good afternoon, guys.

Hi, R.J.

A couple quick questions here. One, bookkeeping, and then just one quickly on some growth initiatives. First of all, I just wanted to see if we could get a--quantify the amount of SG&A expense that was shifted as a part of that advertising shift this year, from the third to the fourth quarter?

It was about $600,000 or $0.01.

Okay. And essentially that's going to be the same amount that's going to be shifted again in '07?

Yes, it should remain in the third quarter in '07.

Okay. And then I guess my last question has to do with just the multi-channel development in general. Obviously, you've talked about your plans for the Ecommerce segment, but you've discussed other channels, possibly a catalog and other initiatives that might be on the table. Just some thoughts, longer term, where those might develop?

Yes, our thinking is that we are uniquely positioned for both to deliver value to consumers outside of our store trading areas through Ecommerce and eventually--so phase one will be Ecommerce. Phase two, the platform for Ecommerce will allow us to become much more powerful and efficient at special order within our stores, so that's kind of within this whole business plan, as well. And then, third, would become a series, probably not a master catalog, but a series of specialty catalogs aimed at customers who live our lifestyle, but participate in one sector of the lifestyle more than others. That would be an '08 initiative.

All right. Well, thank you very much.

You're welcome. Well, thank you all very much. We have over the last several years had a very consistent focus and [stated] focus on managing the company for the long term. Tractor Supply will be a 1,400-store chain, plus Del's. We will improve our EBIT margin over time. While we remain intensely focused on the day-to-day optimization of sales and profits, we have not and will not place our long-term opportunity at risk to meet short-term hurdles.

In hindsight, last year there were some things that we could have anticipated. There were some things that we could have and probably should have done better. That said, I'm really very proud of our team's performance in what proved to be a very challenging year. We have a competitive opportunity, a clear strategy to capture that opportunity, and we have the team to get the job done. So, with that, I thank you for your support and look forward to our next call.

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