Tractor Supply Co (TSCO) 2008 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Tractor Supply Company's conference call to discuss fourth quarter and full year results. At this time, all participants are in a listen-only mode. (Operator Instructions).

Please be advised that reproduction of this call in whole or in part is not permitted without prior written authorization of the Tractor Supply Company. And as a reminder, ladies and gentlemen, this conference is being recorded. I would now like to introduce your host for today's conference, Miss Erica Pettit of FD. Please go ahead, Erica.

Thank you, operator. Good afternoon, everyone, and thank you for joining us. Before we begin, we would like to take a moment to reference the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. This conference call may contain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the Company. Although the Company believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.

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

Now I am pleased to introduce Jim Wright, Chairman, President and Chief Executive Officer. Jim, please go ahead.

Thank you, Erica. Good afternoon, everyone.

I'm here today with Tony Crudele, our Chief Financial Officer; Stan Ruta, EVP of Stores; and Greg Sandfort, EVP of Merchandising.

Before reviewing our performance during 2008, I'll discuss the fourth quarter briefly. As we all know, the fourth quarter of 2008 was extremely challenging for the retail industry, as the consumer stayed home, traded down, and in some cases in some categories simply stopped buying. In the face of these headwinds, our team continued to take the necessary actions to change the merchandise offering, intensify customer engagement, and tightly control costs. As a result of these efforts, we produced solid operating earnings.

For the Holiday season of 2008, we refined our strategy as we planned for purchasing less giftable inventory, and focused our gift assortment on items and supported our customers' basic lifestyle needs at compelling value prices. We're pleased with our ability to navigate through the quarter by properly managing our upfront buying, and highlighting more everyday basics, thus reducing the exposure to markdowns and improving inventory productivity. Throughout the year, we saw consumers shifting purchases from wants to needs, and from style to value, and the fourth quarter was no different. While the Holiday season was challenging, our team correctly anticipated consumer buying patterns and executed very well.

As I mentioned last week, we believe our operating performance of 2008 represented one of our strongest periods ever for the Company. I want to thank our team members for their hard work and consistent execution this year. We remain committed to offering great prices and merchandise assortments that are core to our customers' rural lifestyle needs, and we successfully executed the fundamentals of our business model. Early in the year, our team recognized the external challenges, and we adjusted our strategies accordingly. Overall, I'm proud of our steadfast efforts to grow and to improve our business.

To provide more detail behind our growth drivers for 2008, I'll discuss some operational highlights. First, we grew our business, with sales increasing 11.3% and comps by 1.4%. Further, we expanded the chain by 12%. We opened 91 new stores, and ended the year with 855 stores. We're very encouraged by the performance of our new stores, and we are pleased to reduce the cost of stores opened in 2008, and also those that we have proved during the year. To further support our growth, we added 250,000 square feet of capacity to our our distribution center in Waco, Texas.

Second, we refined our merchandising selection and focused on core non-discretionary basic products. Our core [consumable] business remained strong, as our customers continue to purchase items that are relevant to their every day needs for their land, their animals and their pets. This helped to drive traffic to our stores throughout the year. We also made progress on our integrated multi-channel strategy, by enhancing our e-commerce offering with a more robust website. And we've seen a marked increase in the number of consumers who shop online prior to visiting one of our stores.

Throughout the year we challenged the paradigm, and rigorously worked towards improving various areas of our business. First, we implemented an aggressive expense management program early in the year. Through this, we tightly managed costs at the store support center and in our stores, without compromising customer service. Our team responded well to this initiative, and we believe we are better positioned to operate as a leaner organization going forward.

Now second, we made progress in our merchandising initiatives. Specifically, we navigated the extreme volatility in grain, steel and petroleum costs, by successfully balancing the inflation and cost of goods against our moving average cost, the prevailing market retail price, our margin targets and our market share goals. The smart and diligent work of our merchants and finance teams allowed us to hold or gain share, while improving merchandise margin.

Furthermore, the transportation team did a great job of managing the unexpected and unprecedented spike in fuel costs. Additionally we made improvements in inventory management. As planned, we significantly reduced the clutter in our stores by moving through discontinued and aged inventory, and refocused our mix more towards basic categories. With that in mind, I'm very pleased that we ended the year with cleaner inventory, particularly for our core and seasonal items. Further, we exceeded our goal to improve our inventory terms by 15 basis points this last year.

Third, we made significant progress in customer satisfaction. The fourth quarter of 2007 was our first full year of collecting CSI data, and at the time we were proud to find ourselves in the top quartile of hardline retail. We are very pleased that our store teams raised our top box score another 4% in Q3 -- in Q4 of '08. Once again, we lowered our store manager and store team member turnover. These two significant achievements were produced while we asked our store team members to do more with less.

Finally, we have made substantial progress on our [CRM] strategy. We are now positioned to leverage our customer database going forward. We'll pursue comp -- profitable comp sales, and hold all media costs to a high ROI standard.

Taken together, our actions this year allowed us to maintain a strong capital structure. Our balance sheet is solid, with essentially no long-term debt at the end of the year. We have maintained ample liquidity to continue to invest in our business for the long term, while strategically repurchasing shares to maximize shareholder value.

In conclusion, our team attacked the [functional] areas of retailing, Including strong merchandising, superior customer service, and sound operational procedures. These efforts, combined with the resiliency of our business model and the leadership of our management team, allowed us to remain relevant to our customers throughout the year and to generate positive results.

Now I would like to turn the call over to Tony, would will review our financial performance and discuss our full year outlook. He will also address some of the questions we received regarding the LIFO provision call last week.

Thanks, Jim, and good afternoon everyone.

As we've said, we were very pleased with the operating performance for the quarter. We achieved double-digit sales growth, and continued to manage our clearance process and inventory levels. For the fourth quarter ended December 27th, 2008, sales were $799.5 million, and net income was $24.7 million or $0.67 per diluted share. Excluding LIFO, net income was $37.2 million or $1.01 per diluted share, compared to $31.6 million or $0.81 per diluted share in the same period last year. As discussed last week, the Company will restate its financial results for the first three quarters of fiscal quarter 2008 to reflect an adjustment to the Company's LIFO provision. All figures discussed here have taken the effect of the restatement into account. For comparative purposes we are providing gross margin and net income metrics, both including and excluding LIFO.

I'll review some of the drivers of each P&L line item, but please note that gross margin improvement, excluding LIFO, expense management and lower pre-opening expenses were all drivers of our substantially stronger than expected performance in the quarter. Total comp sales in the period increased 1.3%, and non-comp sales were approximately $65.6 million or 8.2% of sales. The comp transaction account increased 1%, and we are pleased that we continued to drive footsteps into the store. The average comp ticket increased 0.3%, due to the inflation on commodity-related items, offset by a decrease in big ticket item sales.

Our core consumable category continue to be the key driver of the business. We also had strong sales in our heating consumable, but had some difficulty obtaining enough product from suppliers, as many customers made advance purchases in the third quarter. While some discretionary and big-ticket items categories performed well, such as alternative heating stoves and chainsaws, we saw that consumers are still electing to postpone big ticket purchases when they have discretion. We experienced that in categories such as recreational vehicles and trailers. We also had lower emergency response equipment sales, such as generators and portable heaters, because there were several severe storms in the prior year. We continued to show a slight comp decline in our housing-related categories, but the decline continues to be narrow compared to the prior year's decline. Weather did not play a significant factor on a year-over-year comparable basis. Although temperatures overall were just slightly cooler on average for each month, there was less severe storm activity during the quarter.

With respect to regional sales trends, comp sales were the strongest in the southwest and the north, and weakest in the southeast. Year-over-year the southeast had more moisture in the second half of the year, which has an inverse relationship to seed sales. Of note, California and Michigan had an above average comp, while the Florida economy continues to struggle. Comp sales in our Del's stores were negative, significantly higher hay prices and compressed demand for discretionary items continued to have a negative impact on the consumer in the quarter. Jim will discuss Del's later in the call.

Turning now to gross margin, compared to the prior year quarter we experienced a decline of approximately 191 basis points. Excluding the 219 basis point impact of LIFO, we had an improvement of 28 basis points, as decreased freight costs were offset by improved shrink, vendor allowances and markdown management. Freight expense increased by 33 basis points. Although fuel costs declined significantly as we moved through the fourth quarter, the lower fuel costs pushed down the moving average costs slowly. Therefore, the benefit is somewhat delayed. Our LIFO allowance increased by 219 basis points over the prior year quarter, driven by a significant change change in product mix caused by our aggressive clearance activity and commodity-driven price increases experienced throughout the year. On last week's conference call, we discussed more detailed information about the LIFO calculation, and additional supplemental schedules are in today's press release. We continued our phased markdown strategy for seasonal product and certain non-go-forward inventory, as part of our efforts to keep the inventory fresh.

We are pleased with the support we received from our vendors. We are also continued to focus on buying efficiencies and inventory management to offset a portion of the margin impact of seasonal clearance activity. Imports as a percentage of purchases in the quarter decreased 284 basis points from the prior year quarter, and 100 basis points for the full year period, as part of our strategy to limit import Holiday gifts and utilize more everyday basics. More importantly, we saw our sales from import goods increase almost 15 basis points for the year, and they now represent approximately 7.4% of our sales.

For the quarter, SG&A, including depreciation and amortization as a percent of sales, was 25.6%, which was flat compared to the same quarter in the prior year. Overall, we are pleased with the SG&A leverage we achieved, especially in light of the limited comp store sales increase. Store occupancy costs continue to be our biggest opportunity, but it is beginning to moderate, and the expense was offset by other SG&A categories that we did leverage. We leveraged our advertising costs from the prior year quarter, we focused more of our marketing efforts on direct mail and less on television media, allowing us a more targeted approach to drive business with existing and prospective customers. The pre-opening expenses for new stores were approximately $1.7 million, compared to $2.7 million in the prior year quarter. In the fourth quarter we opened 21 stores, compared to 26 store openings last year. For the year we opened 91 stores, compared to 89 store openings last year.

Turning to the balance sheet. As we have discussed, we were very diligent with our inventory management program in 2008. At quarter end, inventory levels per store were down approximately 8.2% compared to the prior year. Our calculation is based on average cost of inventory, and excludes in-transit inventory and inventory held in unopened stores. Inventory turns were 2.79 for the year, a 19 basis point improvement. We anticipate our improved inventory management will continue into next year. We also improved accounts payable financing of inventory from approximately 38.3% up to 43%, driven by the improved turns and our merchants' negotiations with our vendors.

Capital expenditures for the quarter were approximately $22.9 million. As anticipated, the majority of the spend relates to our store opening program. For 2008, CapEx came in as expected at $91.8 million, which includes $2.5 million for the acquisition of two store properties in the first quarter. CapEx for the full year of 2007 totaled $83.5 million.

During the fourth quarter we continued to make purchases under our stock repurchase program. We bought approximately 318,000 shares for $11.4 million, for a cumulative total of approximately $204 million since the inception of the program in February of 2007. The share repurchase program impact on EPS for the quarter was not significant. We are pleased that we ended the year in a net investment position. This is a substantial accomplishment, as we have offset over $53 million of stock repurchases and paid down $55 million in debt during the year through our inventory and vendor financing initiatives.

We would like to reiterate our confidence in our liquidity position. We are very comfortable with our position, as our revolving credit facility is $350 million and does not expire until 2012. Including our restated results, we were still well within our covenants. We generated cash flow from operations of $217.5 million, more than in any other year, and net of capital expenditures we had free cash flow for the full year of $3.35 per share.

Now turning our attention to 2009, first let me provide you with our outlook for a few key metrics. We expect full year sales to range from approximately $3.2 billion to $3.3 billion. We have forecasted comp sales to be in the range of a decline of 1.5% to an increase of 1.5%. We expect EBIT margin to increase around 50 basis points for 2009, and excluding LIFO, we expect EBIT margin to decrease approximately 45 basis points. We anticipate net income to range from approximately $95 million to $101 million, or $2.58 to $2.74 per diluted share. Net income includes a LIFO projection of approximately $9.6 million after tax, or $0.26 per diluted share. Excluding LIFO, we anticipate net income to range from $2.84 to $3 per diluted share.

Let me discuss some of the more specific drivers and assumptions that helped us form our expectations for 2009. We anticipate a tough retail environment that will be less tolerant of retail price increases and, in a potentially deflationary environment, a retail consumer would expect retail price decreases. While this could impact sales, we would expect to mitigate margin impact by carefully managing gross margin, as we did in 2008. We anticipate expansion of gross margin profit from our merchandise initiatives, and a more favorable trend in freight costs. We anticipate gross margin will benefit from price optimization, assortment planning, improved product allocation, private label offering, better strategic sourcing and less clearance activity. Additionally, we expect fuel prices to be lower on average throughout the year. We anticipate our pre-tax LIFO provision will be approximately $15.7 million.

With comp sales anticipated to be less robust within this retail environment, we believe it will be more difficult to leverage our SG&A expenses, as we continue our commitment to grow our store base. Occupancy costs have historically had a deleveraging impact, and we expect this will continue until the new stores reach maturity. We have successfully executed several initiatives to drive down the occupancy costs as part of our efforts to be more efficient with our capital. For marketing, field management and distribution center expenses in 2009, we expect that they will roughly be flat as a percent of sales. We anticipate higher store expenses, as we incur rollout costs of the new POS beginning in the third quarter, and anticipate slightly higher store incentive compensation compared to 2008. We have planned that our store support center costs will deleverage slightly, as we cycle the prior year's staff additions. As we demonstrated in 2008, there are several levers that we can control when managing the expense line items. We will judiciously allocate resources based on the Company's performance throughout the year.

We forecast that our effective tax rate will increase to 38.9% from 38.6%. This results principally from a FIN 48 reversal arising from a state tax settlement realized in 2008, which is not anticipated in 2009, and expected increases in state taxes. Total capital expenditures are expected to range between $85 million and $95 million, which is in line with 2008.

As we said on our third quarter call, we plan to open approximately 70 to 80 stores in 2009, and don't expect to open any Del's stores. Similar to the store opening strategy executed in 2008, we expect to open approximately 60% of the stores in the first half of the year. We expect to relocate one store in 2009. We'll update you throughout the year if market conditions dictate a change in our approach.

Comparing our CapEx spending for 2009 with last year, in 2008 we opened 10 to 20 more stores than we anticipate opening in 2009, and we spent $11 million on our Waco distribution facility expansion. However, we anticipate replacing those investments with store refurbishment, an upgrade in IT hardware, and other efficient-driving system enhancements in 2009. Although we believe it is likely we will make further purchases under our stock repurchase program as part of our long-term objective of reducing our cost of capital, we do not include potential future repurchases in our forecast. As always, this will be subject to prevailing market conditions and overall market volatility.

As we emphasized in the past, we believe our business can be more accurately assessed by looking at the halves, not the quarters, as the weather can significantly change and shift the timing of our sales. Some key points with respect to the quarters. As you know, Q1 is our get-ready quarter for the spring, and results can vary significantly depending on an early or late Spring. We expect that we will have a slight loss in the first quarter. Additionally, we expect to open up to 30 stores in Q1, with the corresponding pre-opening expense. Further, keep in mind that we have one more comp day in the first quarter, as we are closed on Easter, which shifts to April this year from March. We estimate this could increase comps by approximately 1.5% in Q1, and an approximate 1% reduction in Q2.

From a weather perspective, we expect the quarter to be relatively consistent with the prior year, with the prospect of a slightly warmer March in the northern states. For the back half of the year, keep in mind that the third quarter sales in 2008 were bolstered by hurricane activity and heating-related sales that were pulled forward from the fourth quarter. At the same time, we did experience a lower margin from the mix of emergency response equipment, and we also took an additional reserve for clearance merchandise.

We also expect to incur additional payroll in Q3, as we anticipate to be in full swing of the POS rollout. We believe the fourth quarter has less gross margin upside potential, because we will be cycling positive [shrink], vendor allowances and discounts, and clearance markdown management. However, this is also the quarter that we believe has the most opportunity for earnings improvement, due to the softer comp comparison. As in the past, we will provide more color on our expectations for the subsequent period at each quarterly conference call.

Now I would like to turn the call back over to Jim for more details on our plans for 2009.

Thanks, Tony.

We're excited about our opportunities this year. While we believe our plans realistic for the existing economic outlook, we will continue to monitor the underlying trends to remain nimble and adjust our plans quickly, if there are any significant positive or negative changes. Throughout '09, we will continue differentiating Tractor Supply Company in the market, and executing our retail strategy to win in the current environment and beyond. Let me go into more detail on both of these priorities.

We serve an attractive niche. We will remain committed to supporting the functional needs of those living the rural lifestyle. While we are not immune to the challenges in the macro environment, we continue to see relative strength in both the consumers and the markets we serve. Our customers are fiscally conservative. They have proven to be more resilient, and less reliant on credit than the average. Further, the initial approval rate for new applicants on our Tractor Supply consumer credit card remains strong.

As you know, our unique mix of merchandise is the foundation of our business. I am pleased with our efforts to ensure that we continuously offer a variety of products that are relevant to our customers' lifestyle, and make our stores a destination. We will continue to refine our merchandise assortment, and expect to direct more of our mix towards consumable products and basic lifestyle items that we can offer at compelling values. We expect these categories, such as animal health and pet-related products, will drive sales growth and repeat business, especially in a difficult economy. Throughout the year we'll also be focused on further reducing our dependency on discretionary and big-ticket items, by significantly scaling back this inventory. We did well with this strategy in 2008, and expect that applying those learnings will allow us to produce more gross margin and further improve working capital this year.

We continue to focus on strategic direct sourcing and increasing our private label business, which allows us to offer the best products for our customers from both a quality and value perspective, and attractive margins. Over the long term, we target 13% of sales from strategic direct sourcing and 25% from private label sales. Our customers' shopping experience in our stores and our website helps define Tractor Supply Company, and is critical in shaping their impression of the brand. In this environment, it is even more important to identify opportunities for attracting and retaining customers. Our associates allow us to deliver a differentiated level of service, because they understand and live the rural lifestyle. We are maintaining our associate development and training programs, because we know our customers benefit from their in-depth expertise.

Our marketing efforts will remain an important way to drive traffic, and to a somewhat lesser degree, strengthen the brand. We believe there are opportunities to refine our marketing efforts this year. John Wendler, who joined us as Senior Vice President of Marketing at the end of 2008, will be instrumental in enhancing customer relationship management, customer loyalty and private label brand programs this year. We believe reallocating more of our advertising spend to our CRM program will provide us with the most efficient way to reach current and prospective customers. Today, we can identify the needs of many of our customers, Tractor purchasing behavior, and target their future purchases.

Over the long term, we continue to believe our CRM program will position us to grow profitability per household by increasing market share of our targeted customers, and provide insight to our customers' shopping behaviors across all channels. Our merchants and marketers are rigorously using the margin dollars net of advertising metric in their decisions and planning. The retail marketplace today is very noisy, and media is becoming increasingly inefficient. We believe that every dollar spent on media must produce a dollar -- a margin dollar lift above the cost of that media. We will use media to continue gaining market share in those categories we intend to dominate. We will also continue to offer our customers great day-in and day-out pricing, while concurrently improving our comp margin dollars.

We view 2009 as another year of learning for Del's. We continue to see the consumer responding well to non-discretionary merchandise, such as heating and pet food. However, spending on discretionary items such as clothing and gifts has declined. While we made some adjustments to the operating structure in 2008, we are still working to improve this business and to increase the productivity of the new stores in the non-core markets for Del's. We will be monitoring this progress very closely in the first three quarters of this year. At the same time, we have applied some of the learnings from Del's to our Tractor Supply Company stores. We've started selling hay in some stores, and are testing bulk propane, with good success in others.

Turning to our second primary effort for 2009, we are executing our retail strategy centered on store expansion, rigorous inventory management, and expense management programs. As planned, we'll be more cautious with the store expansion program in the near term, due to the current economic backdrop. Importantly, though, we'll remain a growth Company. As such, we'll continue to capitalize on opportunities to expand the chain. The success of our store model is evident, both by the outstanding performance of our existing stores and the ramp-up of our new stores, which continue to exceed our expectations.

We expect to make further progress on the inventory management program, and we have recently added some additional resources to improve forecasting and replenishment. The same team will also allow us to take the next steps in price optimization. We'll carefully manage our inventory levels, while ensuring that we have excellent in-stocks on key items at all times. We also expect more timely and cleaner exits from seasonal inventory. We'll continue to work on improving inventory turnover. We believe it is important to maintain our aggressive expense management program, given the uncertainty in the economy. We'll continue to evaluate additional leverage we can pull, if needed, by reducing incremental discretionary costs, without sacrificing customer service.

While there is no doubt the American consumer has changed, we believe that we are well positioned to win in any environment. Simply put, the priorities we have defined for this year have been communicated to our store support center and our field management team. We are aligned, we are confident, and we are well prepared for 2009 and the future.

This will conclude our prepared remarks. Operator, we would like to open the call to questions at this time.

(Operator Instructions) Our first question comes from Mitch Kaiser from Piper Jaffray.

Hello?

Hey, thanks guys. I'm sorry about that. You know, one of the things I really liked about the prepared remarks is that you're assuming a northern March in the northern states. We'd really appreciate that.

We do what we can. You have to buy something, though, if it's warmer.

That is true. Hey, just want to understand, I know that there is a lot of noise around the margins and things like that, but you had said EBIT margin was going to up 50 basis points inclusive of LIFO, but down 45 if we exclude that. Is that purely a function of the -- you know, roughly flat comp on the -- at the mid-point of the guidance? Or could you just kind of take us through your overall thinking on that? I know you gave a lot of detail on that, but if you could help us on that, that would help.

Well, Mitch, you're asking about the relatively -- the impact of LIFO within the range itself?

I think, Tony, you said your EBIT margin guidance was up 50 basis points, but ex-LIFO would be down 45, right? So the down 45, is that a function of, you know, basically being a flat comp at the mid-point of the guidance range? The deleverage on the SG&A?

The deleverage on the SG&A is clearly as a result of the limited comp that we're projecting for the full year. So -- in an -- excluding the LIFO adjustment, we will have some margin improvement that will not fully offset the SG&A deleverage. If that is where -- if that is where you're going?

No, that is exactly -- that is very helpful.

That is absolutely the case.

And then with CapEx roughly at $90 million, what would you -- and I know that there is going to be some working capital improvements, you guys have done a very good job on that. What would you expect free cash to be, if you were to assume kind of the mid-point of the guidance range on EPS?

On EPS, we're looking for it to be in a similar range as we put together this year. So we finished at about the $3.35 in the prepared remarks, so we expect to be in that range as well.

Okay, okay, sounds good guys. Thank you, good luck.

Your next question comes from Jack Murphy from William Blair.

Just on a gross margin in the quarter, on the components of the improvement of shrink and then allowances on management, are those roughly equal contributors? And then secondly, could you just give us a sense of what you're absolute shrink ratio is at this point, and what you think the risks are of that going in -- backing up and going against you next year?

Yes, let me speak to the shrink. We don't give out the detail. All year we have been expecting to see an increase in shrink on a year-over-year basis due, to the number of unemployed and so forth. Thus far we have not seen that, so shrink has actually been marginally better year-over-year, and we have not seen any increase in the shrink factor as we have gone throughout the four quarters of '08. Greg, could you do that question on the margin?

In relationship to gross margin performance --

Vendor allowances.

Vendor allowances were slightly ahead of a year ago, but they were in relationship to the mix of products that -- to be honest with you, performed better or worse from a year ago. Secondly, we really managed the seasonal transition from Fall to Christmas to Spring far better this year than last year. And I think that is -- one of the issues that saved us a ton of dollars in markdowns. So we really -- the exchange there was fewer markdowns, acting faster on slow-selling products, transitioning faster to Spring. If you were in our stores, you would have seen some Spring products in our stores in the late fourth quarter, where in the years past it would have been first quarter. So it was just kind of a shift in momentum, but it worked very, very well for us.

To answer your question, I would break those three into fairly equal components.

Okay, great. And then one follow-up just on the SG&A, if you were to do something below the negative 1.5, does the deleverage in the model become much greater? I assume that you can't do a lot more with staffing levels in the store, you know, given you need sort of minimum coverage in terms of keeping the service levels high. So can you talk a little bit about that? In the event that you do worse in the comp line, just how much greater the leverage becomes?

Jack, the -- there are -- a couple of different levers as we move down that continuum in the model. Obviously, there is the incentive compensation piece that tends to be a little bit of a trigger as well. So there is not a significant fall-off. So I would model it more in a -- a ratable manner as opposed to sort of a steep decline after that -- after the negative 1.5.

Okay. That is helpful. Thanks.

Your next question comes from the line of Peter Benedict from Wachovia.

Hey guys, thanks. First of all on the POS system, can you talk a little bit about the cost there? What is the magnitude? What should we be thinking about in the second half of '09, and what kind of benefits do you guys expect to get from the new system?

Yes -- we'll take it in two parts. When it comes to the expense side, we have had -- outfitted the stores with any type of hardware that is required in the previous year, but we are really looking at some additional software expenses. It ranges in the -- sort of the $2 million to $3 million range. So it is a sizeable investment, but not overly significant. And then as it relates to the benefits that we expect to inure from the system itself, let me turn that one over to Stan to give you some highlights.

Yes, Peter the benefits of the POS, really two big areas. Number one, the customer experience, and secondly what the system is going to help us learn about our customer. In terms of the customer experience, it is speed of checkout. The transactions are going to be faster, notably faster, on the specialty transactions like return transactions, layaways and special orders will be much faster for our customer. The new system is going to be giving us the ability to take checks electronically, so that will not only speed up the process at the point of sale, but it will also eliminate us from having to process checks at night because it is all going to be electronic. So we'll save some labor there, while increasing transaction speed.

The system is going to be much easier for our team members to learn, it's a touch-screen system, it's much more intuitive than what we currently have. And it will give us real time inventory, so we'll have better inventory accuracy in the store to speed up our customer service. The information capture is significantly more than what we have today. It will increase our ability to understand the market basket, and what our customers are buying at the SKU level, as well as how often they're buying that merchandise, and we'll get that information whenever we get their name on check transactions, bank card transactions or tax exempt transactions. And this information will really be used by the marketing department and our direct mail programs, and the CRM program that Jim talked about earlier.

We'll also get some significant LP controls and information that will help our LP department measure fraud and refunds and other areas. And then lastly, we will get a little bit of cost savings out of it. The new system will help us eliminate counter tickets in our store. It will help us remove some equipment that we're leasing today, and it will probably save $300,000 to $400,000 a year when those things go away. But overall the new system is better, faster, it is more efficient, and it is going to improve our customer shopping experience while helping us become a little smarter about our customer.

Okay great, thanks for that. Switching over, Tony, I guess, or -- on the free cash flow front. I mean if you guys are going to generate another $100 million-plus in free cash flow next year, I know you're not assuming some buybacks, I assume there will be some there. What other uses of the free cash flow would you guys consider for '09?

Good question, Peter. When we look at it, obviously we look at the stock repurchase program first. But secondly, our real estate program -- we're going to be -- we're going to assess it as part of what assistance developers may need, and as far as acquiring really grade-A sites as we move forward. We'll have to make an assessment as to how we're going to utilize our balance sheet to make those deals work. At this point in time it has not become an issue, but it is one area that we targeted potentially in 2009 where we can utilize that additional free cash flow.

Okay, fair enough, then one last question. Just on the pre-opening cost trend down nicely in the back half of '08, down about 20% to 30%, I guess, year-over-year on a per-store basis. How should we be thinking about the pre-opening costs for the stores that you've got on tap for '09?

Yes, generally it is going to be a similar spread based on the number of stores that I have provided. As far as the rollout, about 60% of the stores in the first half. The one thing that we focused on at the end of 2008 was to reduce the number of store openings in January. That reduced the pre-opening that we would normally incur in the December month as well as, you know, January is -- is really our weakest sales month, as well. So if you -- it behooves us on two fronts to push January openings into more the February-March timeframe. Other than that, the rollout and the approximate cost to open a store remain about the same.

Okay, thanks so much.

Your next question comes from the line of Matt Nemer from Thomas Weisel Partners. Please go ahead.

Good afternoon, everyone. My first question is in a less inflationary environment, how are you thinking about balancing maybe the capture of some incremental gross margins as your costs come down, versus market share? Is that by category, or maybe give us a little bit of color on how you're going to balance those two?

As we looked at last year, obviously we had to maintain margin and market share on the way up, and frankly as we experienced some deflation in steel, petroleum and grain, we have managed it on the way down, with really an eye towards maintaining margin dollars, not necessarily rate but margin dollars. And we view it as, we think, a significant opportunity to gain share in some categories that are most important to us.

Okay. And then the second question I had is, can you give us any detail on -- on customer behavior in the pet category? Have you seen any evidence that, you know, it seems like if somebody is getting a pink slip it is only intuitive to me that they may not decide to buy the highest quality of Nutro, and maybe trade into one of your private label brands. But just curious as to what you're seeing there?

We have seen some grade down with some customers. But in the general context of how our business is operating, we're very pleased that we haven't seen any massive moves yet. We are very cautious on how we price both our private brand and the national brands, to keep those spreads very consistent. And as inflation rose, both of those followed soon, and as deflation comes in play, it will be the same. There's not going to be less feeding of animals or pets, but there could be some additional trade-off and we have actually planned for that, we anticipate some of that.

Do you have any data that would, you know, sort of explain how if somebody is trading down and perhaps trading out, is there any way to determine, you know, where they're going? If they would be going to a Wal-Mart or Target or Petsmart or kind of what channel they would -- if they were migrating away from your store, is there any way to determine where they're going?

Actually, we've seen -- not seen, we believe we're taking share in pet food particularly, and frankly the pet category continues to be one of our very best comp performing categories. The trading down within the categories -- I really don't believe there is any trading out going on. The trading down within the categories, if someone trades from grocery to our private brand, they win and we win. They save five bucks a bag, and we make a little more margin dollars. So we are fine with that one. We have not seen a lot of trade down premium brand of grocery thus far. We've seen some trade down within premium, but again the yield on all of those brands is fairly comparable to us, and frankly in a couple of cases, if the consumer goes down, the price continuum, they win and we do as well.

Got it. Okay. Then lastly on the expense side, is there an opportunity to renegotiate occupancy expense? How many leases do you have coming due this year, you know, or next year? And do you have any issues where a co-tenancy change or an occupancy change maybe allows you to go back in and renegotiate?

Yes, we -- on all the leases that are coming up, they come through the real estate committee, first of all, and we take a look at them, and on each of them we are going back to the landlord. And if we want to stay in that location, which most of them we do, we go to the landlord at that time and we renegotiate to our existing rent, without wanting to pay the additional increase that is due. And we've just started that over the last -- the last four months or so, and we're having some success. And it is early, and we'll probably report more on it as time goes on, but we are having some success as landlords realize that the environment is a little bit different.

Great. Very helpful. Thanks so much.

Your next question comes from Dan Wewer from Raymond James. Please go ahead, sir.

Do I [guess] correctly that you anticipate fourth quarter of '09 would be your best same-store sales opportunity?

Yes, that is correct. We anticipate that -- we saw some softer comps in Q4, as well as in Q1. In Q1, though, I just want to caution, as in my notes, that there is a shift of the comp date.

I was thinking that with inflation benefiting fourth quarter '08 store sales by four percentage points, and a chance that we could be seeing deflation in the fourth quarter of '09, that it could actually be a challenging quarter from that perspective?

That is absolutely a possibility, and I think you could make that statement about all four quarters. In looking at the sales in the -- the type of sales that we had in Q4 by category, we believe that there is some upside that would offset some of that deflationary pressure if it does occur. And also, as we noted, we felt that there was a shift of the heating sales into Q3 that, normalized, would translate back into Q4 in 2009.

Okay. Second question is on the real estate. I know that your unit expansion rate is slower than you were running a few years ago, but nevertheless it is still one of the fastest in hardline retail. Other retailers are telling us that the properties are not developing as quickly as they wanted, due to financing issues. Could you tell us on the 70 to 80 that you're planning to open, how many of those have actually been secured and the leases are signed?

Stan, we're about there?

There might be one or two for '09 that haven't been signed, the rest have been.

And we're into '10 with some commitments already.

And with the silver mile strategy, can you remind me how the prices on these leases compare with the openings, say, a year or two years ago?

Yes, I guess the most significant thing, if we looked at -- the metric I have on hand is if we look at the new stores, all of them combined, prototype and second-use real estate, that we approved in 2006 versus those that we approved in 2008, our rent and depreciation, whichever it is, is 120 basis points lower for the stores that we approved in '08 as a percent of sales when compared to '06. So we have been very successful in those initiatives, and we continue to test and push and take costs out.

And then I think that was the last question I had, Jim, was on your comments on Del's, make sure I understand, the issue that the new store productivity in the non-core markets is not where you want it to be, is that correct?

Yes, that is correct. Again the markets are really very different from -- in eastern Washington and western Washington, and that impacted the merchandise mix much more significantly than we anticipated. We are recasting that merchandise mix right now, and we'll need, we think through Q3, to fully understand what the potential of those markets is.

When do you think you will be able to make a decision long term on Del's?

I would think in the next three to five quarters, we'll have a good idea of -- of how fast we're going to grow it and where we're going to grow it, if we're going to grow it.

Great, I appreciate it, thanks.

You're welcome.

Your next question comes from John Lawrence from Morgan Keegan. Please go ahead.

Jim or Greg, either one, on merchandise mix for 2009 as it relates to private label, give us a little breakdown. You mentioned pets and feed-related consumables. But how would the breakdown go between, say, CE Schmidt, Master Hand and Red Shed, looking to '09 as far as your expansion of those SKUs?

Let's -- let me kind of break them up a little bit. CE Schmidt will expand with the worker strategy and the focus we have in that category business, so we are going to be adding more components, probably a female component quarter by the end of the third quarter. It's performed well, and it continues to be a good -- I would call it stair step to the [Carhar] brand, which of course we do a wonderful job with here at Tractor.

As far as Red Shed in the gift category, a very, very cautious approach. We have had to retrench, pull back, and really kind of assort based upon what the consumer would expect to pay, number one, and number two, the kind of and type of items that are more day-in and day-out, not driven so much and solely towards holiday-type purchasing. Our consumer looks at that as very discretionary, and so we've really kind of refocused our efforts there. We think that we've got that on a very positive [note] as we go into the Spring and into the Fall, so pretty comfortable with that.

As far as the Master Hand, that's the tool category, we are working through right now, reestablishing the brand in, first, the hand tool segment. If you think about Craftsman, it took them many, many years to develop the Craftsman brand, and they started with hand tools. You've got to get the tools in customers' hands and used. From there, we'll move the brand back in again under the power tool category, but be very cautious. We probably over-stepped our bounds in 2007 and early 2008 there. And then I think what we have to understand is where we play off on the tool mix, and for us there is an opening price, and there is probably then the Master Hand, which is a step up. So we feel very good about it. We are probably in the early stages of that relaunch. You will see more in the stores the latter part of second and third quarter.

Any new brands you're thinking about?

Actually, no, not at this time. It is more of editing what we have. I think that, you know, there is nothing out there that I see today, except for maybe some acquisition on the feeder food side, and I'll leave it at that, but nothing in the private label sector that we have it in the hopper right now.

Great, thanks a lot.

This concludes our conference call today. Please continue with any closing comments.

Okay, well thanks again for your support. Great to talk to you on the call. While we are in a very volatile environment, and there is lots of things around the corner that we may not be fully able to anticipate, when I look at the issues of our business within the control of this management team, I have never been more confident in -- in our ability to plan correctly, to execute crisply, and to continue to build a great team of merchants and operating executives. So I look forward to '09 with great confidence on those things that we can control, and also our ability to react quickly to those things that we cannot control. Thank you very much. We'll talk to you next quarter.

Ladies and gentlemen, you may all disconnect, and thank you for participating.