Tractor Supply Co (TSCO) 2009 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to Tractor Supply Company's conference call to discuss third quarter results. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. (Operator Instructions). Please be advised that reproduction of this call in whole or part is not permitted without prior written authorization of Tractor Supply Company. And as a reminder, ladies and gentlemen, this conference is being recorded.

I would now like to introduce your host for today's conference, Ms. Erica Pettit, of [FD]. Please go ahead, Erica.

Thank you. Good afternoon, everyone, and thank you for joining us. Before we begin, let me take a moment to reference the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. This conference call may contain forward-looking statements that are subject to significant risks and uncertainties. Including the future operating and financial performance of the Company. Although the Company believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in the Company's filings with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time. Lastly, Tractor Supply Company undertakes no obligation to update any information discussed in this call.

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

Thanks, Erica. Good afternoon, everyone. I'm here today with Tony Crudele, our Chief Financial Officer; Greg Sanfort, our President and Chief Merchandising Officer; and Stan Ruta, our Chief Operating Officer. Our team did an outstanding job as we again delivered higher than expected net income driven by significant improvement in gross margin and modest topline growth. As you recall, we are cycling against a number of factors that benefited our performance from last year, including landfall hurricanes of both Louisiana and Texas, which created high demand for emergency preparation and response items, volatile fuel prices that created early sell through of heating products and high inflation levels which provided tailwinds for our sales. We recognize this will be a challenging corridor, and I'm even more pleased with our achievements in light of the headwinds that we faced. We took a proactive approach toward planning and go we executed our strategies very well. Let me go into more detail about the strategies that allowed us to win in the third quarter and are continuing to position as for success for the remainder of this year and beyond.

First our merchandise assortment supports our customers' everyday life style needs. We have a thorough understanding of what is relevant to our customers, our core consumable, usable, edible, are cue categories are very attractive to consumers looking for a one stop destination for products that fit their rural lifestyle at a compelling value. These items include animal and pet related products, repair and maintenance parts for machinery, and lubricants are continuing to drive footsteps into our stores. We are pleased that we delivered positive comp trends action growth from the sixth consecutive quarter. We continue to explore opportunities that build upon the strength of our cue categories. In the last few weeks, we have introduced a select equine and livestock feeds from Purina and Nutrina to our stores nationwide. Early response to these prominent brands has been positive. We believe that adding nationally recognized best selling feed brands for the first time will drive category expansion and attract new customers. Secondly, we intensified our focus on managing gross margin net of advertising.

One of the key metrics that we are using to both plan and to gauge our team's performance. In doing so we planned our our inventory to manage markdowns carefully to ensure that inventory was fresh and selling at optimal price points. For the eighth consecutive quarter, we reduced total personal or inventory levels on a year over year basis. Concurrently, we improved our instock position on key items. Our strategy to focus on the top 20 merchandise categories and the top 250 SKUs continues to serve us well by ensuring the products our customers need the most are in stock and in quantity. The benefit of eliminating television advertising in favor of direct marketing was not as substantial as it was in Q2, since we have not historically used television during the third quarter. Third, we are maintaining disciplined expense control. We successfully kept our costs down and improved the shopping experience for our customers. We continue to emphasize and invest in the training of our team to ensure that store execution is a leading competitive advantage for us.

We are proud that we continue to improve upon our customer loyalty scores. Our customers are recognizing that we have the products they need and are giving our stores high marks for organization and friendly, knowledgeable service. Overall, we are pleased with the performance in the third quarter and the first nine months of 2009. Throughout the year, we have maintained our focus on continuing to differentiate our stores and executing our retail strategy. Our ability to perform well consistently is a testament to our working as one cohesive and cross functional team. We are using the breadth and depth of information across the organization, as well as individual and collective expertise to work toward the best outcomes for our customers, our business, and our shareholders.

Now, I would like to turn the call over to Tony to review our financial performance and to discuss the outlook for the year.

Thanks, Jim. And good afternoon, everyone. As Jim noted, we are very pleased with our results for the quarter, as we continued to proactively navigate through a number of headwinds. On a year over year basis we grew sales and EPS, effectively managed our margins, generated an increase in customer traffic, and reduced our per store inventory levels for the eighth consecutive quarter. For the third quarter ended September 26, 2009, net sales grew by 1.9% to $747.7 million. Net income grew by 38.5% to $22.0 million or $0.60 per diluted share. Total comp store sales in the period decreased 5.1% compared to last year's 6.2% increase, and noncomp sales were $51 million or 6.8% of sales. We estimated that comp sales were negatively impacted by approximately 110 basis points as a result of the cycling last year's emergency preparation and response sales related to the two Gulf hurricanes. We estimate inflation was approximately flat and had no significant impact on comps on a year over year basis in Q3. While we have seen some deflationary pressure in certain categories such as livestock feed and fencing, there has also been some retail price increases in areas such as pet food and finished steel products.

We continue to gain customers, and our customers are continuing to shop more frequently, primarily for essentials, that support their rural lifestyle. The comp transaction count increased 5.9%, and we are very pleased that we continue to drive footsteps into the store. This is even more favorable when considering the traffic generated last year from the hurricane activity, and preselling of heating fuel. The average comp ticket decreased 10.4%, resulting principally from softness in the sale of big ticket items such as stoves and furnaces. Our core consumable, usable, and edible categories, including animal and pet related products continue to be the key merchandise drivers of our sales. Additionally all repair and replacement part categories continue to perform well as the consumer are extending the life of their assets in an effort to postpone big ticket purchases. Seasonal items such as heating and hurricane related emergency preparation and response merchandise faced difficult year over year comparisons and comped below chain average.

Weather, with the exception of no hurricane activity, was neutral year over year. Sales were the strongest in the Midsouth and Southeast as we cycled against drought conditions in the prior year. Sales were the weakest in the Southwest, as areas of Texas had an expanse of drought compared to much more favorable conditions in the year before. Comp sales in our Del stores were better than chain average. Feed and hay makeup a significant mix of Del's product mix. While we are pleased with Del's transaction count increase in these categories, these gains were partially offset by deflation in these categories. Overall, we are pleased with Del's gross margin improvement and their ability to exceed plan.

Turning now to gross margin, compared to the prior year quarter, we increased gross margin by 317 basis points to 32.9% of sales. The favorable LIPO provision relative to last year's abnormally large provision accounted for 11 basis points of the improvement. The LIPO provision was approximately $0.03 per share in the third quarter of 2009, compared to $0.17 in the third quarter of 2008. Three other components contributed to gross margin improvement. First, lower freight expense, compared to the prior year was a strong driver of this improvement. Resulting from fuel price decreases relative to last year and benefit from our transportation costs savings initiatives. Reduction in freight expense was 73 basis points of the gross margin improvement. Second, lower markdown impact, as we have kept inventories fresh and achieved a good markdown cadence. We minimized exposure to margin erosion for the markdown. And third, continued vendor support of our merchandise initiatives and promotions.

For the quarter, SG&A, including depreciation and amortization, was 28.1% of sales, which was 194 basis point increase over the prior year quarter. Although we did not leverage SG&A expense due to the decline in comp sales, we are still pleased with the SG&A expense control. In addition to the deleveraging impact from the comp sales decrease, the following attributed to the deleveraging. The incentive plan accrual was higher as a percent of sales compared to last year's quarter. We increased our sales tax reserve as several states have initiated or have notified us of their intent to conduct sales audits, and lastly, we experienced the expected deleveraging from new store growth relative to the mature store base. With respect to marketing, our expense was flat as a percent of sales, compared to Q3 last year. As we noted in our last conference call, we generally do not spend TV dollars in Q3 and therefore did not benefit as significantly as we did in Q2. Importantly, we continue to drive comp transaction increase without increasing our advertising spend, thus effectively managing gross margin dollars net of advertising expense. Opening expenses for the new stores were $1.9 million compared to $2.1 million in the prior year quarter. In the third quarter we opened 17 stores, compared to 20 store openings last year. Preopening expense per store was consistent on a year-over-year basis.

Turning to the balance sheet. We are pleased with the inventory productivity. At quarter ends, inventory levels per store were down approximately 4.8%. On top of an 8.5 % decrease at the end of Q3 last year. Our calculations based on average cost of inventory and excludes in transit, and inventory held in unopened stores. It is important to note that we achieved a decrease in per store inventory while simultaneously increasing our in stock percentage. Annualized inventory turns for the quarter were 2.7 times. A four basis point decrease over last year's third quarter. We are pleased with our inventory productivity, given the comp store sales decrease, while also improving our in stock position on our key 20, 250 SKUs and improving receipt flow for winter purchases. On a year to date basis, inventory turns have improved seven basis points. We did have a decrease in inventory financing to 44.9% down 350 basis points. As we have been more aggressive in working with our vendors to ensure we captured discounts.

Capital expenditures for the quarter were $15.3 million related principally to our new store opening program. This compares to $15.4 million in last year's third quarter. During the third quarter, we made limited purchases under our stock repurchase program. We purchased approximately 19,400 shares for $915,000 for a cumulative total of $214.7 million since the inception of the program in February of 2007. The share repurchase program did not have a significant impact on EPS for the quarter or year to date. We are extremely confident in our cash flow and liquidity position. We had no revolver debt as we moved into what has generally been one of our peak borrowing periods as we build inventory for the winter holiday season. We had $95 million in cash compared to a net borrowed position of $6.8 million last year at quarter end. We have demonstrated an ongoing commitment to carry higher cash and more liquidity to ensure we are managing our balance sheet prudently in the current environment.

Turning to our outlook for the full year. In our business update release earlier this month, we raised our previous financial expectations for full year net income to a range of $2.88 to $2.98 per diluted share, compared to our previous guidance of $2.78 to $2.92 per diluted share. We have narrowed our full year sales range to between $3.17 billion and $3.2 billion compared to our previous guidance of $3.15 billion to $3.25 billion. Correspondingly, we have narrowed our guidance for same store sales for the year to range between a decline of 1% to 2%, compared to our previous expectations of flat to a decrease of 2%. Let me discuss a few of the underlying assumptions for the remainder of the year included in our full year guidance. With respect to sales, we have balanced our full year guidance to reflect a combination of current economic trends and our performance for the year to date period. As we look ahead to the fall, winter, and holiday season, we have taken a cautious perspective that we believe is appropriate. Our approach considers the following factors.

Customer spending has remained generally in line with our expectations in the first nine months of the year. Our customers have continued to shop our stores for functional, nondiscretionary items that supports their lifestyle while maintaining their focus on compelling values. We have not altered our view on the consumer's hesitancy to make big ticket discretionary purchases as we head into the fall, winter, and holiday season. Although our performance is least dependent on big ticket items in the fourth quarter, we have a variety of big ticket items throughout all seasons. Unemployment is still at a very high level, and economic forecasters are projecting that unemployment will increase as we move into the fourth quarter. While our customers appear to have some resiliency to this, we are not immune to the negative impact that unemployment has on consumer spending. We will be cycling a 1.3% comparable sales increase in Q4 last year. Initially ,this may not appear to be a tough comparison; however, this was a strong performance, given the economic turmoil last year and the benefits we received from high inflation levels. As we expected, the inflationary pressures subsided in the second half of 2009, and we now estimate that deflation could provide a headwind of approximately 2% in the fourth quarter.

From a weather perspective, as most of you are aware, harsh cold winters generally will have a positive impact on sales when our insulated workwear, heating products, snow removal, and emergency response equipment are essential for our customers. In the fourth quarter, our weather analytics provider forecasted that weather will be only slightly colder in October and slightly warmer in November and December. We did have some storm activity at the end of last year's quarter. We believe that the weather impact will be neutral to slightly negative. Overall, we anticipate that we will continue to benefit from freight savings and reduced LIPO compared to the prior year. However ,we expect gross margin exclusive of the year-over-year favorable LIPO comparison to be flat to slightly down compared to the prior year. More specifically, with respect to gross margin, we expect some margin pressure as we move into Q4, although it would be cycling against a very heavy inflationary period last year. We believe that the most significant cost reductions that we have negotiated have cycled through our moving average copy. While we expect deflation in the 2% range in the quarter, and we have proven that we can maintain retail prices and manage gross margin effectively in the current environment. We believe that this will limit our ability to obtain the margin expansion exclusive of the LIPO impact that we experience during the first three quarters of 2009. We believe that the pressure on the margin will be partially offset by a favorable mix as big ticket sales will continue to be soft and generally big ticket items have a lower than chain average margin.

We anticipate freight will continue to have a favorable impact on margins but less than we experienced in Q3. Fuel prices remain well below last year's prices, and although fuel prices began to decline in the latter part of 2008, the P&L benefit was delayed as freight costs are capitalized into inventory. Additionally, we believe that our initiative to increase the efficiency of transportation and freight will continue to gain traction. We are cycling our fourth quarter of strong [shrink] performance, and we do not anticipate a benefit in Q4, as we had very strong results last year. With respect to LIPO, based on our expectations per year and inventory levels and mix, we are currently estimating a full year LIPO provision of $11.6 million, a reduction compared to our full year estimate of $13.1 million at the end of Q2. As you'll recall, the LIPO provision is dependent upon the combination of year end inventory levels and mix of product, as well as the inflation rate for various product categories. As inflation has subsided, we have continued to reduce our LIPO estimates throughout the year.

To date, we have been please with our SG&A expense management, but given our comp sales forecast, we expect SG&A we delever in the fourth quarter. Consistent with our approach in the second quarter, we will benefit in Q4 from negligible intelligent costs and continued efficiency in our advertising spend. However, we do not expect our benefits to be near the same extent as in Q2, because our fourth quarter spend historically has been significantly less than Q2. We have begun our roll-out of POS system, and have installed approximately 150 stores. We will continue to incur additional payroll through early November to support implementation. Additionally, at the earnings level implied in our guidance, we will continue to have incentive compensation above prior year's expense, consistent with the year to date trend.

We expect to open 76 new stores in 2009, and we have opened 58 stores year to date. Additionally we have targeted 70 to 80 stores for 2010, as we continue to believe that expanding the chain at 8% to 9% is appropriate in this environment. As you all know, earlier this year we increased our long-term store count to 1,800. We have been able to increase the ultimate potential store count, due to our research based on our knowledge of cannibalization trends, drive time distances, and further research about the Tractor Supply Company household. While new stores sales levels have been impacted by the economic downturn, similar to the comp stores, our new stores in aggregate continue to meet our pro forma and internal rate of return hurdle. We expect that capital expenditures will approximate $70 million to $75 million.

In closing, we remain very pleased with our performance in a very difficult retail environment. We are confident that our ability to execute our retail strategy and serve the functional needs of the out here customer, will be the key differentiators as we manage through the fourth quarter and head into 2010. Now, I would like to turn the call back to Jim.

Thanks, Tony. As we enter the final quarter of 2009, I would like to review the tremendous strides we have made throughout this recessionary period to both grow and to improve our business. We recognize down turn very early in the cycle and adjusted to a near term realities of our business without losing sight of our long-term outlook for Tractor Supply Company.

Now, more than ever, this environment has accentuated the value of our relationships with our customers. Significance of swift execution and the critical role of our team members. Early in 2008, we developed a plan to proactively address a challenging macro environment, and we then enlisted and lined their team around that plan. We refined their merchandising strategy as we observed their customers' changing spending behaviors. With a more conservative mind set, consumers have dedicated their spend to nondiscretionary and to essential merchandise, deferred items that did not fit that criteria, and reduced their credit card purchases. We saw a shift away from big ticket items while sales of basics continue down their growth trajectory. We believe our emphasis on key items and the compelling value proposition has helped to offset this pressure. At the same time, we have controlled the reduced expenses across the organization. We recognized it would be important to find ways to cut costs as far away from the consumer as possible. In many cases, we have discovered we can do more with less. We optimized our marketing program to ensure that we are driving profitable traffic and sales with every event and frankly, every cut in every event. In doing so, we eliminated TV costs in favor of more efficient and productive direct marketing. We are able to track the success of this effort, and ensure that it is producing the way we planned by measuring our gross margin lift, net of advertising. As I mentioned earlier, we reduced year over year inventory for eight consecutive quarters, while improving our in stock level.

We recognized that one key component of our retail engine is our people. We did not implement a hiring freeze but instead implemented a frost to ensure that we could continue to add talent and critical roles and replace key positions. Our team members worked hard and generated and we granted raises and paid bonuses commensurate with their performance. We also improved our healthcare program while holding costs to our team members. We maintained our 401K match. Through our store opening program, we created 1,600 jobs since the beginning of 2008. We managed our balance sheet very prudently to ensure that our capital structure was solid. We reduced our long-term debt to zero, and increased cash flow from operations to fund working capital needs as we approach the peak borrowing season. Additionally, we expanded our credit facility. At the same time, we returned approximately $65 million to our shareholders since the beginning of 2008 through our share repurchase program. Although we have slowed store expansion, we remain a growth Company and I'm delighted that we will have opened more than 140 stores since the beginning of 2008.

Overall, we believe our business has improved through this recession. We are pleased with our earnings growth at this time. In sum, our combination of great people and prices along with unique merchandising mix has served us well. We continue to manage our business effectively for both near and long-term. Through very deliberate actions and intelligent planning, we have achieved a great deal during this recession, but most critically we have made the investments to assure success when the economy normalizes. As we approach the holiday season, we are confident that we have the right plan in place. We believe the conservative but nimble posture is appropriate given the level of uncertainty in consumer spending. As such, our gift assortment for the season will again be focused on key basics and compelling values. This includes offering a range of gift items at mid and lower price points. This approach was well received this year, and we also believe we'll continue to produce sales while allowing us to limit markdown on carryover risks as we move forward.

Looking beyond 2009, we'll continue to leverage the merchandise and operational strategies that have served us well during the recession. While we anticipate that pressure on big ticket will persist, we believe that the repair cycle will gradually swing to replacement, as eventually the economics of replacement versus continue to repair will shift. The rural customer will continue to be needs-based and value-driven for some time to come. Nonetheless, as the authority on the rural lifestyle, we are confident that our consumers will continue to rely on Tractor Supply Company.

Operator, with that, we conclude our prepared remarks and would like to open the call for questions.

(Operator instructions). Our first question comes from the line of Jack Murphy with William Blair.

Good afternoon. Just a couple of questions. Jim, I wonder if you can give us a little insight into how you get the sustainability of the traffic trends that you have seen so far? Obviously, a nice job through the downturn, but what initiatives you have in place for fourth quarter and beyond that could give us a sense of the sustainability of the traffic gains.

Sure, Jack. A couple of things. Probably a couple of key factors. One is as we look at the knowledge we continue to gain and refine on customer segmentation, the number of households that we attribute customer name and address to, and our increasing ability to refine our direct response marketing efforts, we believe that we will be able to drive increased frequency of visit with existing customers, as well as begin to use that media to prospect for new customers. I feel very good about the advertising reach.

Also, as we reported several times our pet food, which is a high frequency business, and our large animal feed, have grown now for several years at a rate exceeding that of the overall chain, yet when we look at our relative market share, it's lower. We are pleased with our growth. Our market share was frankly rather diminimus, compared with our opportunity, and we are confident that we can continue to grow those businesses. And now that we have added to the two most significant major brands of large animal feed, we are very confident that we can grow that, also recognizing that those customers are amongst our most valuable.

Great. Just one last question. I wonder if you could just update us on your thinking in terms of the timing or potential timing of acceleration and square footage growth? How you are seeing the retail real estate market out there right now, and how it might factor into your square footage plans, as you look a few quarters out here?

You bet, Jack. We have not seen a significant change in space availability or pricing. Some on our pricing side, not significant. Not a lot of change on the price of construction, however. So the overall availability of retail sites through rural America has not changed significantly. Obviously, we are committed at this time for 2010, and our number will be in the 75 to 80 stores for next year. We have a little bit of time before we have to begin filling the pipeline for 2011, and at this point in time, I would suggest we are probably going to be at 9% growth again, but reserve the right to accelerate that if we see a turn in consumer behavior and consumer confidence in the next, let's say five to six months.

Great. Thank you.

Your next question from the line of Dan Wewer with Raymond James.

Thanks. Tony a few years ago, you guys were talking a lot about the silver mile strategy. An approach to reduce your occupancy costs. In your prepared comments, you did note your new store volumes are running in line with your plan. Could you remind us how you are budgeting first year sales with the silver model strategy with compared to the gold model strategy? Also, in terms of -- are we seeing the benefits in reducing occupancy expenses that you were anticipating?

A couple points on that, Dan. Then I can turn it over to Stan for any other additional comments. But generally when it comes to sales, the differential between the golden mile and the silver mile is not significant. So we did not anticipate either a decline or an increase in the sales level per store. The sales level per store generally is driven by the location of the stores. And in some areas of the country there are going to be lower sales volumes and other areas will be higher sales volumes. So that really is more the driver than the silver and the gold mile. Relative to the silver/gold mile, the silver mile we would expect to have lower costs, and we have seen that as we have had a shift to the silver mile. From I believe -- we were up to about 60%. Or lower I guess, when it came to the siller mile and shifting to the silver miles. We have seen an expense reduction. Stan, if you wanted to add any points to that.

I think you covered very well, Tony. We did quite a bit of analysis before we really started focusing on the silver mile. At that time, Dan, we really didn't see any significant difference in store volumes. In the markets we served. And of course, usually they are smaller markets, so the distance between the golden mile and silver mile is just across town or down the road. I continues to be a good strategy for us. It is helping us maintain good store growth at a reduced cost.

One follow-up question if I could? I think that you noted that something the pet food prices were actually increasing year over year? Was that at the wholesale level to you? Or Tractor being able to push through price increases on pet food?

Hi, this is Greg, Dan. It is a combination of really the prices holding in some cases, or slightly becoming elevated. And us. literally, as we have always done, kind of move with the market as the costs would increase. We are not seeing a real deflation yet in pet food. And that's something that we are watching closely. But there have been some slight increases. We have taken advantage of those and moved with the market. To be honest with you, anticipating the first of the year possibly some prices coming in, but we really just don't know at this point.

Okay. Great. Thank you.

Your next question comes from the line of Robert Higginbotham with Goldman Sachs.

Thank you. I wanted to dig into gross margin a little bit and Tony touched on much of this. I'm hoping for some incremental color. When you talked to the third quarter performance, you broke out the 70 bits of impact from freight, certainly a big number. The overall fit for margin that was up nearly 200 basis points. I'm wondering if you can help us quantify or at least sort of bucket those other two factors between better markdown performance and vendor supply?

Yes, Robert. Basically what we have seen from our internal reporting, we break these out. I try not to get too granular when it comes to the specific breakouts because a lot of times, you'll allocate either vendor support or promotions or discount as part of the direct margin. So I try not to get too granular as far as how we break that out. Generally the initial margin, purchase price margin, was probably about 20 basis points less. And we saw generally in those categories of volume support or rebates, again, improvements in sort of the 10 to 20 basis point range. As far as we can best quantify markdown management, there is probably somewhere between the 70 to 80 basis point improvement there. So hopefully that gives you some sense of the magnitude of the various categories that we are talking about. But again, between freight and the management markdowns, how you allocate that to your direct margin can be a little bit subjective. But for the most part, those are your three key components.

I understand that. That is actually very helpful. On mixed shift, was there no positive mix impact? I would have thought to the extent that you had lower sales of your alternative heating products, which I imagined would have lower margins that you would have seen some positive impact there. Is that correct?

Yes. Interesting -- as far as mix goes, we actually had a negative impact, and a lot of that is a result of the shift to some of our consumables and the feed line that has just a slightly lower than chain average margin. But we were doing some significantly higher volumes. So in this case, we had a negative impact when it came to mix. Which I would agree with you, it is a little counterintuitive to the impact that normally the slowness and the large ticket items would prevail.

Got you. That is helpful. And lastly, on your comments around 4Q margins, did I understand you correctly to say that you are expecting a net decline in LIPO gross margins in the fourth quarter?

I said yes. I said flat to slightly negative.

Okay. And fair enough.

On x-LIPO basis or FIFO basis, we are looking at flat to slightly down.

I understand that you may have cycled through your average cost inventory from your biggest price negotiations. It still seems like year over year though, that you would see some further benefit from that. I might be missing something.

Again, a lot of it has to with the mix and the way it's been trending, as well as the management of those price decreases that we have obtained and how much we passed onto the customer, etc. But based on our forecasting, we are looking at a FIFO basis of flat to slightly down.

Got you. Okay. Thank you very much.

Next question from [Vincent Cinice] from Bank of America.

Thanks very much for taking my question. First question regarding your outlook for the 4Q deflation, you said potentially there could be 2% worth of deflationary headwinds in the quarter. Just wondering if you can give, Tony, a breakdown there by category, if that is strictly taking into account the livestock feed and the fencing you mentioned, or if there is anything else in there?

The categories I mentioned initially that were deflationinary are two of the larger categories that would drive that deflation for the most part. Other than that, we don't provide too much guidance and some of it is speculative as to direction. Directionally where it could be headed. Basically we'll look at where our current pricing is and try to extrapolate that as to where we see the pricing going at year end. We believe overall, given where prices were last year, looking at it on a year over year basis, that we would expect to have and deflationary pressure.

Just one quick follow-up if I may? Your CapEx came down minimally, only about $5 million. Is that strictly timing, or is there anything else in there?

A combination of timing and obviously a good portion relates to our store expansion program. Those expenses have come in a little bit less than we had anticipated as well. The majority relates to timing of some projects getting pushed into 2010.

Great, thanks very much.

Your next question Matt Nemer with Wells Fargo.

Good afternoon, everyone.

Hi, Matt.

My first question is around the branded feed product introduction. When did that actually find its way into the stores? And does that increase margin per bag? Or is it designed to drive new customers? What is the thinking behind that? Sure. Greg, why don't you take that?

Matt it went in the early part of October, officially around the 10th would be the day. To be honest with you, as we went in with the pricing structure with this it would be very similar to what you would find at local markets, so there wasn't really any what I'll call margin gain out of this. It was pretty much typical what you would find in our relative margins across other feed. So, no great margin gain here. This was a strategy to go acquire new customers.

Got it. Maybe you can give us a quick update on additional product launches or merchandising initiatives we can look for toward the end of this year early next year?

Well, first of all the wrap around of branded feed as it goes into the first part of next year is going to be a big plus. And secondly, I would say that the fourth quarter, from a merchandise execution strategy on gifting and on positioning of product throughout the store targeted toward, I'll call usable gift, is -- we have taken a much stronger stance this year than we did last year. Jim mentioned earlier it worked well for us. This year we believe it will work even better. I would tell you that we have also repositioned the location if the store where this product is going to be found. It is now down the center court where a year ago it was up in the left hand corner in what we call the seasonal area. This year that positioning is for all heating and for what we call warm wear products. So we are feeling very good about how the fourth quarter should translate to sales on seasonal products.

Then turning to your balance sheet, quickly. Your cash balance I think is at or close to a record high. You didn't draw down on your revolver which would be sort of typical for this time of year. What should we expect in terms of cash build and your philosophy around redeploying that back in a shared purchase?

Currently, we looked at the share repurchase program and each quarter will look at the matrix, and we will fine tune the matrix relative to some internal calculations that we do around the share pricing. As you made sense, stock price had a nice movement throughout the quarter and therefore, moved away from the matrix that we had established. The purchases were minimal. We will continue to look at how to deploy the cash. We have set targets internally as far as what we like to maintain as our cash balances. We are slowly approaching those targets. As we move into 2010, we will continue to look at alternatives, as far as returning cash either to our shareholders or deploying it in what we believe are the most efficient growth potentials. And we'll be able to provide more clarity as we move into 2010 and give guidance on the 2010 forecast P&L and balance sheet.

Okay, if I could sneak one more quick one in. Can you give us an update on the point of sale system rollout?

Yes. Matt. Point of sale, as Tony mentioned earlier, right now we have it in about 174 stores. These are going to be -- we are going to stop at 174 for this year. We are going to focus on fourth quarter business, and right after the first of the year, we are going to start rolling the POS out to the rest of the Company. The feedback from our stores has been extremely favorable on the system in the 174 stores that we've rolled it out to. In all phases. Its initial feedback is a big win for the stores and for our customers. And we plan on having full rollout completed by the end of Q1 2010.

Right. Thanks for taking my questions.

Your next question comes from the line of [Peter Keith] with Piper Jaffray.

Hey guys, thanks for taking my question. Calling in for Mitch. I wanted to follow-up a little bit on Robert's gross margin question. I apologize if it is a little bit repetitive, but for Q4 to make sure I fully understand, on those -- on the FIFO margins, you do expect, I take it, some small benefit from freight and mix. But then is it the impact from the average inventory costing will more than offset that? Being you think it could be flat to slightly down?

Yes, that's why the drivers, and I also mentioned we do not anticipate having the same performance in shrink we had on a year over year basis last year. So that will be a tough comparison for us. And again, as we move in, and some of the promotional -- we are a little uncertain as to the promotional environment. So we look at that, as far as the fourth quarter. So -- but we feel that on the direct margin, again, you have to look at the year over year comparison and look at some of the categories and the mix. But potentially that would be one of the drivers as far as pulling down the margin. Relative to the two anticipated drivers as far as improvement in the margin, which is -- freight obviously being the leading candidate there.

Okay. Since that dynamic is now starting in Q4, is that something that we might continue to expect in some of the quarters in early 2010?

Well, we feel very confident that we can continue to manage in a low inflationary or low deflationary environment. Again, it's a matter of how those costs cycle through. When we get to cost savings in a deflationary period, and how we can manage our pricing. Clearly, if the retail price is maintained and have a certain stickiness to it, it give us an opportunity for those costs to move through our costing an therefore, we have a better matching of the cost and the retail price and can better maintain the margin. Again, several variables. But we believe that as we have shown in the first three quarters, that we can manage through low inflationary and to certain extent a deflationary period as well.

Okay. All right. That helps. And then one unrelated question. We haven't heard much about apparel. I know you are moving into more apparel heavy Q4 with some of the outerwear. Could you update us on any trends you are seeing there at this point?

Yes, Peter, I failed to mention in some of the fourth quarter initiatives the rollout that we started in third quarter of [CE Smith] for her, which has been very, very positive. We also are seeing some early, solid indications that the cold weather products, insulated, and the boots and such, cold weather gear, is going to perform well. We have our inventories in great shape. We are fresh inventories, no carryover from a year ago, so we are very bullish on that. I think we really structured in apparel, more of a price point program for this Fall. And that is also benefiting us. The consumer really relates to, I hate to say this, but item price. We are very much a key item set on the floor right now, and it is working very well for us.

Okay. Thanks for the feedback and good luck.

Thank you.

Your next question comes from the line of [Christine Rapedo] with SunTrust Robinson.

Hi there. You said earlier that you expect the big ticket items to remain under pressure? And I was wondering if you expect the recovery there? The shift from repair back to replace to basically be in line with whatever happens in the macroeconomy?

I think we have to recognize that there is that consumer behavior and the declared end to the recession are likely to be decoupled. Consumers continue to deleverage their balance sheets. They continue to be credit adverse. They continue to save. And as we know ,every dollar that goes into debt reduction or savings is a dollar that does not go into retail. So, I think we are going to have to wait and see. But I do think that the discretionary spend or big ticket spend will probably lag the official end of the recession. Eventually it will come back, eventually the consumers -- repair capital goods cannot be repaired forever. At some point in time it actually becomes more economical to replace over term.

Okay. Thanks very much.

Sure.

Next question comes from the line of Jay McCanless with FTN Equity.

Thanks. Two questions. First one -- on the 5.9% transaction increase year over year, could you all talk about how much of that is actually boots coming into the store versus people ordering online? I wanted to see if you are actually pulling people in, or if they are taking advantage of all the internet promotions and e-mail promotions I have seen.

That is all store traffic. That is the same store foot traffic -- actually same store transactions, not traffic. Transactions.

Okay. Then my other question -- with the increases we have seen since the beginning of the quarter in oil prices and some of the other commodities, am I reading it correctly with the way you are capitalizing those input costs now that we won't see any effect in Q4, if oil prices and grain prices started to keep going up. But we might see some pressure in fiscal 2010, is that the right way to think about it?

Generally, since our turns are close to three, it could take four months on average for the cost to cycle through the inventory costing, so the freight costs matching up with the turns, obviously, the turns are different for various categories. So some may be accelerated through. So some of it could impact a little bit earlier, but generally, on average, you are looking at sort of a three to four month lag, when if comes to the oil prices impacting freight and subsequently the P&L to inventory capitalization.

Okay. Have you all seen anything? I know you talked a little bit about deflation. I'm guessing that is lagging from earlier this year. Have you all seen any new recent price increases from any of your vendors or anything you didn't expect in the way of coming price increases?

No, we have not, to be honest with you. We continue to challenge the vendor community to bring prices back down, and we have been for the most part successful at it it's been -- they have been receptive.

Okay. Great. Thank you.

Your next question comes from the line of David Strasser with Janney Montgomery.

I was calling a little bit looking at sort of the mix of sales as it relates debit versus credit. Are you seeing any incremental, I guess, refusals at the register? Is that having an impact on the bigger ticket? And how are you thinking about that going forward?

Generally, what we are seeing is that the applications themselves have declined. And that is because the consumer just isn't looking to make that big ticket purchase. The decline that we are actually getting from the credit company generally is just slightly less, but it is not something that is overly significant. So what we are seeing is that people just generally are not applying for the credit.

So they are not, okay. So when they are -- the people who are applying -- but inside the story guess as it relates to the credit card, you are not seeing anything incremental or mix toward cash? It is more just people not buying the stuff or applying as opposed to a mix towards cash away from credit? Or --

When we look at sort of the cash/debit mix, we see the cash debit check has increased year to date about 130 basis points.

How significant of a number is that? Is that something you step back and say wow? Or is that something this's more just kind of not a dramatic, not a big deal to you and.

It's not overly dramatic. Especially in light of the trend that debit had prior to the economic situation. We saw significant movement toward debit, and that continued. However, the movement to cash and check has increased. And that had gone in the other direction prior to. So we definitely see the consumer being more conservative and only spending what he has in his pockets.

One other clarification, I'm sorry. But when you were talking about some new brands on the pet side, I think Purina --

Purina and Nutrina, they are both within the livestock side.

Okay. Thank you. I kind of went a little off when you were saying it. Thank you.

Next question comes from the line of Christian Buss with Thomas Weisel.

Hi there. You mentioned the deleverage impact from newer stores on SG&A. Could you help us quantify what that was?

I could probably help you quantify it. But we generally don't give that type of directional information. As in the past few years, we know that the real estate, and to a certain extent some of the payroll new stores, until those stores reach maturity, those stores will have a deleveraging impact. We felt that through -- as we moved into 2010, that that would become a much, that difference would moderate and probably be in the 20 to 25 basis point range. And that we could eventually overcome that with our other SG&A management. With negative comp sales, that obviously becomes more exaggerated. So -- in a range you are probably looking somewhere between sort of the 15 for 40 basis range at any given time, depending on the comp sales volume.

That is very helpful. And maybe a follow-up there. Is there any way you can help us gauge the hurdle for new stores as a percent of revenue at that 9% store growth rate that you guys have slowed to? Sort of what the hurdle is there to hit the inner targets?

I'm having a hard time translating the question. When we look at a particular store, it doesn't necessarily matter what the sales level is. It is obviously the whole economics of the box itself. So we'll be looking at it over a ten year period and we'll do a discounted cash flow for that ten year period. So a store, depending on its cost structure, could be very successful at $2.2 million or very successful at $4.4 million.

Okay. Fair enough.

(Operator instructions) Next question comes from the line of Chris Horvers with JPMorgan.

Thanks, good afternoon. Tony, can you talk about how that, the markdown management benefit trended over the past four quarters? You mentioned it was roughly 70, 80 basis points this quarter. I'm curious if 4Q is just a tough compare, in spite of it sounding like being stronger on seasonal, it is more of a comparison issue versus the execution?

Well, it's probably a little of both. It has built throughout the course of the year. Some of it, again, I think we need to go back to some of the history. But Greg joined us near the end of 2007, so his first year coming through in 2008. We started to experience the improved inventory management, and obviously cycling through some of our older goods and moving those out. So the freshness of the inventory really had a significant impact. As we have continued to cycle that, is really when we started to show the benefit. So obviously, the cycle year over year, 2009 compared to his first quarter 2008 had less of an impact. And as we've continued to show that improvement throughout his tenure, we have continued to be able to improve that markdown management focus. So there has been a slight improvement of sustainability standpoint, I believe that we can continue, but not necessarily at the pace that we saw in the third quarter. But we believe that there will be some benefit as we move into Q4.

So that 70 to 80 basis point sticks, it is just that some of the shrink -- the cycling shrink of a year ago and and some of the vendor allowance dollars, that is the tough compare? Not necessarily the markdown management, is that fair?

I think as we move into Q4, that's a fair statement.. The benefit on the markdown management may not be to the extent that it was in Q3. But we do believe that we will be able to have enhanced performance on a year over year basis.

Okay. Thank you. And then on the freight side, you turned inventories three times a year, so for freight to have a 70 basis point improvement in the quarter, being the biggest of the year, that is a little counter intuitive. Perhaps what is the driver there, and is it some of the supply chain effort coming through and driving that, and why is that not sustainable in the 4Q?

Clearly we'll have a benefit in Q4, we just don't think it will be to the extent of the 73 basis points, but we believe it will be substantial. As we cycle through and compare to last year, we did have very high costs in the summertime months and the majority of that did cycle through in the fourth quarter. So we believe that we'll have some significant benefit there, and then -- but as gas prices have increased obviously throughout this year, we may not have the benefit that we had in Q3. But you are correct on a year over year basis, freight expense was very high last year, coming in to the fourth quarter, so we will have some substantial benefit, we just believe it will be slightly less than the 73 basis points we experienced in Q3.

And then all told, you are thinking the direct margins are going to be down kind of 60-70 basis points and freight comes in plus 50. Ballpark, directionally?

I don't believe the initial will be down as significantly as that. I think it will be less than that as far as initial margins. And again, it is a matter of how you allocate the promotional dollars as well. But net-net, the biggest hurdle will be the shrink, and we believe that obviously the markdown managements will be a positive contributor. But when it comes to the initial margin, net of the discounts, we are probably looking at more of the 20 or 30 basis point level.

Down?

Down. Correct.

And then finally, if I could just sneak one in. Are you hearing a lot of like the apparel retailers, even home furnishings guys seeing some renewed maybe spent up demand on big ticket? Just curious as the quarter progressed or even into October, if you saw any signs of life on the big ticket side of the mix?

I think we have to temper what we are hearing on certain retail sectors against how far they fell last year. They are seeing improvement on a year over year basis. Their rate of decline I guess in Q3, certainly Q4 last year is much more severe than ours was. So I guess the answer was no, we are not anticipating a significant improvement on trend for ourselves.

Thank you very much.

You are welcome. We have time for one more call.

There are no further questions. Please continue with any closing commence.

Great. Well thank you all very much. Delighted with our results. Glad that you are with us on our growth journey and look forward to talking to you with final year results. Thank you.