Tractor Supply Co (TSCO) 2010 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Tractor Supply Company's conference call to discuss the second-quarter 2010 results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will follow at that time. (Operator Instructions).

Please be advised that reproduction of this call, in whole or in part, without permitted or prior written authorization of Tractor Supply Company (sic). 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.

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

Thank you, Erica. Good afternoon, everyone. I am here today with Tony Crudele, our Chief Financial Officer, Greg Sandfort, our President and Chief Merchandising Officer, and Stan Ruta, our Chief Operating Officer.

The second quarter and the first half of this year have been exceptional. Our customers have continued to respond to our compelling value propositions, they continue to increase their store visit as they have for the last nine quarters, and they continue to prove that their economic resilience and dedication to the rural lifestyle is strong.

As a result of this, combined with terrific planning, strong execution across the organization, we achieved double-digit sales and earnings growth in the second quarter. At the same time, we experienced significant margin expansion and SG&A leverage.

Let me go into a bit more detail about what we experienced in the second quarter, the drivers of our performance and the clearly differentiated results when comparing Tractor Supply Company to general retail trends. We serve a unique and resilient customer, who is generally more fiscally conservative, and has been less impacted by the economic downturn.

We sell a mix of goods that is critical to the lifestyle, which are assorted regionally and seasonally. Our team has both anticipated and responded to the changing needs of our customers correctly.

We offer them the right merchandise, at the right price, and at the right time. As a result, they have increased their reliance on our stores for their everyday needs and we are enjoying their loyalty.

We have also achieved success broadly across categories, geography, and price points. As expected, our core consumable usable and edible or CCUE categories such as pet food and animal feed continue to be solid as sales drivers, and contributed to our 6.9% comp transaction increase. Key national brands, Purina and Nutrena, as well as our private label 4health dog food, are performing well and have been additive to our business since we launched them.

Additionally, we are encouraged that consumers are beginning to purchase big-ticket items. At this time, they are particularly seeking value. And when there is a compelling value, they are purchasing product in our stores. We have seen this pattern across a number of big-ticket categories.

To be more specific, with an outdoor power equipment, we are delighted that our unit growth far exceeded the industry. We were [at] stock on riders throughout the spring selling season. We expected favorable moisture levels and an improved sales opportunity for riders at the right point -- price point and with the right features and functionality. We were able to take advantage of this through the solid assortment planning and inventory allocation.

Accordingly, we have improved gross margin in this entire category. In general, inventory management remains an area where we are excelling as inventory turns continue to improve. Our inventory levels are appropriate and they are balanced. We are confident that we will exit the summer season with limited clearance markdowns.

We have continued to reinvest marketing dollars that we previously spent on television advertising. We began this initiative in the second quarter of last year. Notably, we have increased traffic and grown the top line, despite reduced advertising spend. We are connecting with our customers in a more efficient manner, further strengthening our relationships with them, and proving that managing our business to the metric of gross margin dollars and net of advertising is productive.

We are a growth company and we are once again -- and we, once again, produced record results. We are benefiting from strategic planning and execution in all areas of the business, and we believe this momentum will continue into the second half of this year and beyond. As we continue to capitalize on opportunities, both internally and externally, we will further demonstrate that our performance is sustainable in any economic environment.

I will now turn the call over to Tony to review our financial results and discuss our outlook for the remainder of the year. And I will then return with some additional comments.

Great. Thanks, Jim, and good afternoon, everyone.

As we indicated earlier this month, our performance for the second quarter was much better than expected and marked a record second quarter. Our excellent topline and bottom-line growth was driven by strong same-store sales, high gross margin, and expense leverage.

The second-quarter results, combined with our better visibility into the second half, also enabled us to substantially increase our full-year 2010 guidance. I will provide you with more on that in a moment. But first, I will review some of the key drivers for the second quarter.

For the quarter ended June 26, 2010, net sales increased 12.6% to $1.066 billion from $946.5 million in the second quarter of 2009. Net income grew by nearly 39.7% to $76.5 million or $2.05 per diluted share. Comp store sales increased 6.1% compared to last year's decline of 2.7%. Non-comp sales were $61.6 million or 5.8% of sales.

Comp transaction count increased 6.9%, primarily due to new customers and customer shopping more frequently. An average comp ticket decreased 0.7%. We are pleased that the average ticket trend improved. reversing the trend over the past year.

Note that we benefited from better sales of big ticket items. However, excluding big-ticket sales, average ticket improved and was a slight positive comp.

As Jim mentioned, the sales strength was broad-based. This was both on a merchandise category and geographic basis. We experienced comp sales gains in all of our six major reported categories. The highest comp categories were our core consumable, usable and edible products, as well as agricultural and seasonal merchandise. Riding lawn mowers had a positive comp and we saw the largest sales increase for riders in the opening price points. This confirmed our strategic assessment that the consumer is willing to purchase big-ticket items at a value.

All of our geographic regions also had positive comp sales with the strongest region being in the Midwest and Southeast. To touch on a few states which have had macro issues, California was well above chain average while Florida performed at chain average. We also had solid performance in industrial states such as Michigan and Ohio.

Comp sales in our Del stores exceeded chain average. Del's also continues to improve gross margins at a similar rate as the chain. Del's feed unit growth and transaction growth were very strong.

While topline sales were impacted by an estimated 187 basis points of deflation, we effectively managed this impact at the gross margin level. Deflation was most evident in the livestock and bird feed, agricultural fencing, certain lawn and garden, and lubricant categories.

Turning now to gross margin which increased 174 basis points to 33.7% of sales. Direct margin was the biggest catalyst as our strategic initiatives continued to enhance our gross margin. We continued to improve our inventory purchasing and allocation, resulting in getting the right merchandise to the right stores at the right time and minimizing the markdown risk.

As we mentioned on the last call, our appropriate seasonal merchandise assortment and allocations meant that we were well-stocked for the favorable ground moisture we experienced early in the spring selling season. Given that the sales trend continued throughout the quarter and we managed markdown cadence extremely well with minimal clearance, we had a strong benefit to gross margin.

Our pricing strategies are bearing fruit while our strategic sourcing is delivering benefit. We have worked with our vendors to drive sales of key items and new merchandise programs that resulted in win-wins for both parties.

Freight expense improved over last year by approximately 9 basis points. Although fuel costs were higher than last year, consistent with our expectations, we generated freight savings because our initiatives to reduce [den] miles as well as benefit from the mix of goods.

Shrink continues to improve year-over-year as we strategically retrofit high shrink stores with electronic article surveillance and camera systems throughout the chain, along with our operational initiatives that continued to deliver results.

LIFO had a favorable impact of approximately 27 basis points on a year-over-year basis, as we continued to experience slight deflation in the categories that I had mentioned earlier.

For the quarter, SG&A, including depreciation and amortization, was 22.2% of sales which was a 41 basis point improvement over the prior year's quarter. As a result of our sales growth and continued expense management, we leveraged SG&A expenses.

Other items of note for SG&A, we leveraged occupancy for the second consecutive quarter while growing the store based by more than 8%. We are pleased with the leverage that we received as our newer stores continue to ramp sales very nicely.

Also we continue to benefit from our energy management initiatives, as well as lower energy rates. As a result, we have seen electric expense decrease even as temperatures rose during the quarter.

We remain efficient with our marketing dollars as marketing expense improved by 11 basis points. We continued to drive footsteps while maintaining our advertising spend. Although we had one additional circular compared to last year, we improved our advertising per sales ratio as a result of our strong sales performance and continued efficiencies and cost reductions.

While we leveraged store payroll, we experienced an offset from incentive compensation including store team members' sale bonuses. Incentive compensation reduced SG&A by leverage by approximately 12 basis points. Incentive compensation was approximately 1/3 higher than last year and principally accounted for the variance of SG&A growing in excess of our store growth rate.

It should be noted that we successfully completed our -- rolling out our new POS system in the early part of the quarter and completed our upgrade of our SAP, ERP system. James Callison, his technology team, and all the project team members managed the completion of these system conversions seamlessly.

The Company's tax rate was 37.3%, which is consistent with our planned full year rate of 37%. Since this is our largest earnings quarter, various book tax adjustments, such as the disqualified incentive stock options, have a very limited impact on the effective tax rate.

Turning to the balance sheet, at quarter-end, we had $181 million in cash compared to $91.8 million last year. Inventory levels per store at quarter-end increased for the first time in 2.5 years. However, the increase was less than 1% on a per store basis.

Annualized inventory turns for the quarter were 3.45 times, a 13 basis point improvement over last year's second quarter. We strategically invested inventory in two key areas. First our never out of stock program that focuses on the top 30 categories and the top 300 SKUs; and second, essential seasonal SKUs related to high moisture levels. This investment in inventory more than accounted for the year-over-year increase in per store inventory. We are very pleased with our inventory levels.

Capital expenditures for the quarter were $24 million, related principally to our new store opening program. This compares to $15 million in last year's second quarter.

We opened 19 stores versus 13 stores in the prior year's second quarter. We purchased three of our lead stores for a total of $7.2 million in the quarter. During the second quarter, purchases under our stock repurchase program were approximately 149,300 shares for $9.9 million. The impact of the repurchase program on Q2 earnings was de minimus.

Turning to our outlook for the full year. As I mentioned, we raised our previous expectations for full-year sales, net incomes earlier this month. As noted in our release, we expect net incomes to range from $4.00 to $4.10 per diluted share compared to our previous guidance of $3.48 to $3.60 per diluted share. We expect full-year sales to range between $3.04 -- $3.49 billion and $3.53 billion compared to our previous expectations of $3.44 billion and $3.5 billion.

Correspondingly, same-store sales for the year are expected to increase 2.5% to 3.5% compared to our prior expectation of an increase of 1% to 3%.

I would like to quickly discuss a few of the underlying assumptions for the remainder of the year included in our full-year guidance. While consumer sentiment was weakened in the past couple of months, our guidance anticipates our customers will continue to shop our stores and will remain value-oriented in a similar fashion as the first half of the year. Our guidance anticipates that there will not be a marked change in consumer credit availability or the unemployment rate throughout the remainder of the year.

Our Q categories will continue to be sales drivers. Additionally we expect that our new branded feed program will continue to drive momentum even after we [cycled] the launch of the program in early October 2009. Based on our CRM data trends and our seasonally adjusted projections, we believe that this program will be additive through the back half of the year and into 2011.

Although we had a modest improvement in big ticket purchases in the second quarter, we expect the consumer will remain conscious of pricing and focus on value points. However, to this point, our sales in the back half of the year have a lower mix of big ticket items.

We expect weather trends to be generally neutral, although October and December are projected to be slightly warmer than last year. November should be cooler than last year.

Q3 may appear to be a very easy comparison given the comp decrease of 5.1% in the prior year's third quarter. However, that comp resulted from strong 2008 sales of hurricane-related merchandise and the pull forward of seasonal heating products into the third quarter in 2008. We believe that 2009 sales reflect a more normalized sales base rather than weak sales on an absolute basis.

As we commented earlier, we experienced slight deflation in certain categories during the second quarter. We believe that we will have slight deflationary pressure overall in the back half of the year. We have generally experienced less inflation than originally anticipated at the beginning of the year. As such, our current guidance reflects a full year LIFO estimate of $6.6 million reduced from the $10 million in the guidance we discussed on the Q1 call.

We believe that our gross margin, transportation and logistics initiatives will continue to provide benefits, but we are conservatively projecting limited gross margin expansion of 10 to 15 basis points. We expect higher domestic and overseas freight costs and we will begin to cycle some of the benefits from our logistics initiatives last year.

I would also like to remind you that in the fourth quarter of last year, we had a LIFO credit of $1.5 million.

Although we leveraged marketing in the first half, we anticipate that we will increase our year-over-year marketing spend by approximately 10 to 15 basis points in the second half as we continue to enhance our CRM database and customer research. We have narrowed our 2010 new store projections to 70 to 75 stores, and expect capital expenditures should be $90 million to $100 million, which is consistent with our original guidance.

Our CapEx projection includes $7.2 million for leased TSC stores which we purchased during the first half of the year and an additional $9.5 million for three stores that we have a commitment to purchase under our right of first refusal. We will continue to opportunistically purchase lease stores in which we are presented with the right of first refusal and the economics are accretive to the income statement, as we believe that it is appropriate use of our capital.

To conclude, our performance for the first half of the year has been very strong. We are executing well, and this is reflected in the sales and profit growth we continue to deliver.

Now I'd like to turn the call back to Jim to discuss the key differentiators that will allow us to continue building on our momentum.

Great. Thanks, Tony. Our performance throughout the last several years is a direct reflection of plans that we put into action as well as our excellent business model. In addition, it underscores the capability of our Company to be nimble during these challenged and economic times.

With that in mind, there are a number of items that make Tractor Supply unique and I would like to discuss that in greater detail. We serve a desired -- a desirable and growing lifestyle. We have an excellent demographic that is comprised of great customers with attractive characteristics.

Our customers have small houses on large land, [low] mortgages and below average credit card balances. We believe that the resiliency has helped us during this recession. We recognized early on that consumers would adopt a much more conservative mindset and we began to make changes to our business.

To address this new needs based and value-driven norm, we began shipping our merchandise focus more than two years ago. As a result of this, we have increased categories that our consumers need to purchase more frequently, such as our [key] items.

At the same time, we have reduced our dependency on outdoor power equipment. So now, when OPE is good we respond quickly and enjoy the added sales, but we are no longer dependent on OPE to prosper in the second quarter.

Improving the business is a testament to the strength and experience-focused leadership team that we have. We have demonstrated our ability to address consumers' needs in an evolving market and to drive ongoing progress and success at Tractor Supply Company. This has led to our outstanding performance during a recession and positioned us to win in any business environment.

We also have limited and fragmented competition. The next largest farmer ranch chain has 160 stores and we are approximately six times their size.

Despite this, we still manage our business to compete at the market level. In the last few years, we have increased our capacity to price nimbly and to market locally. You have probably heard us say that you can't buy everything we carry someplace else, but you can't find someplace else that sells everything we carry.

As a result, customers view us differently. We are their destination location. And we have become increasingly relevant, particularly as we have met their needs throughout the recession and launched key national brands. We have earned our customers' trust to support the rural lifestyle with the product they need at a compelling value. We strive to exceed our customers' expectations on product quality, value and service. Achieving these objectives has led to ever-increasing customer loyalty scores -- which, in turn, maximizes the lifetime value of each customer relationship.

As we solidified our competitive position as a destination location, we also made strategic decisions to leverage this advantage. Several years ago, we began to refocus our real estate strategy to ensure that we were reducing new store costs as we continued to expand our footprint.

Without sacrificing the customer experience, we found ways to value engineer our stores and learned that we could more efficiently build out both existing and new stores. We moved from the Golden Mile to the Silver Mile. In our view, the Golden Mile is located at Main Street while the Silver Mile is just a few miles further down the road. Our customers are willing to travel a bit further because they know they can get what they need at our stores.

At the same time, this enables us to reduce costs as we continued to expand our footprint. Today we are benefiting from this real estate strategy and leveraging occupancy expense. Currently, we have 967 stores in 44 states and we are confident that we can grow to at least 1,800 domestic stores.

As our business continues to grow, we remain focused on shareholder returns. More specifically, our margin initiatives such as price optimization, strategic sourcing, prior brand development and markdown management combined with inventory management and allocation. are gaining traction. Further our efforts in these categories are driving bottom-line increases and balance sheet strength.

In turn, we are able to continue investing in the business while maintaining our share buyback program and our recently launched dividend program. Our plan's execution results demonstrate that we are a growth company. We have a long track record of growing and improving the business, and we have positioned the Company to prosper in a challenging retail environment.

At the same time, we believe we take advantage of any increase in consumer confidence. As discussed, we have a number of initiatives underway, yet are only in the early stages of benefiting from these initiatives.

I am proud of the team and what we have done, what we've achieved by executing the fundamentals of retail seamlessly, effectively and efficiently. However, we remain relentlessly dissatisfied and dedicated to continuous improvement for Tractor Supply, both in the near and the long term.

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

(Operator Instructions). [Vincent Sinisi] with BofA Merrill Lynch.

Good afternoon and thank you very much for taking my question. My question is surrounding gross margins. Just wondering if you folks could give a little bit more color in terms of the components of gross margin that you called out, both in the press release and on the call? Just to help us get a better understanding of within each one kind of how qualitatively to think of how they are contributing to the overall margin. And then, in particular, Jim or Tony, if you could, regarding price optimization, I know that you said that you are really in the earlier stages of that. Are you still at this point in only the first or second inning or so? And where do you see that going in the future? Thank you very much.

Let me try to address those and Jim can -- and Tony can also comment. Work backwards for us, let's talk about price optimization.

We are still in the very early stages. This is still a very, I am going to call it low-tech manual-type process, but we have had tremendous learnings in the last quarter and we applied those earnings as we move forward to the next, you know, weeks and months and quarters ahead.

We are right now in the process of due diligence. We will complete to diligence, evaluating price optimization systems by the end of this week, first of the next.

We plan to have something in pilot by the end of the third quarter, maybe sooner, and really start having the systemic approach to this on the early part of 2011. So still early stages, but we are finding learnings, we are finding some gross margin benefit.

The other drivers of gross margin -- really, there are two others. The seasonal gross margin management, Tom Roush and his team have done a remarkable job of really helping the Company rethink how we plan and how we go to market. The difference between where we were a few years ago and where we are today is light years of difference. And we truly plan, we monitor, we adjust and then we move forward throughout each season now with such a fluid flow that I am very proud of that group and the merchant group how well and effective they are working together.

So a lot of this comes to the upfront planning piece. We are looking to put some systemic approach to this as we move into 2011. There's some modules in SAP that we are already starting to tool with. So that could be one aspect.

The second piece is the direct-to-factory resourcing. The number one thing here is as we said earlier in the conference call, from first quarter, we are doing a lot to eliminate third-party involvement in our business. We are also increasing the level of direct import meaning us -- Tractor Supply -- pulling it direct from the factory to our supply chain to our own distribution centers.

And that will be an ongoing process. And we'll gain much more momentum as we get into third and fourth quarter and we turn the corner into 2011.

I mentioned in last, the last call that we brought on board a product development expert, who currently right now is in China and is over there helping us develop and push this model of conversion, as we will call it, much further forward.

So, to recap, you have the seasonal gross margin management piece. You've got the direct effect resourcing. And you have the price optimization. All three are starting to gain momentum.

That's very helpful. Thank you.

Brent Rystrom with Feltl.

Good afternoon, everybody. From the inventory per store perspective, can you give us maybe a feeling for how you think that might change the remainder of this year and than, potentially, next year?

As we mentioned in the -- or as Jim and Tony mentioned earlier, we made some strategic investments into this second quarter, primarily looking at what we saw as products that would accelerate in sales if the moisture levels stayed as they were. And fortunately, they did stay, the moisture levels did stay in place.

So we made some investments. The slight increase in inventory over a year ago was well offset by the conversion in sales. And what I personally see going forward is the inventory levels will stay fairly static, and somewhat flat to a year ago. We are just going to find much more efficiency and inventory that we are bringing into the system as we're pushing it through in sales.

So we are very comfortable with inventory level being fairly static, possibly some increase if we see some movement in early third quarter and maybe some big-ticket product possibly. Say heating, if heating starts to take off. We would feel that but no significant increases in inventory year over year for a while.

And if you were to characterize, I would guess that bigger increase in inventory would be in the fourth quarter then? So are we talking about going into this seasonal sales over winner?

It is all going to depend upon, honestly, how we -- what we will get as a read in the early part of third. But typically, we do build inventories going into fourth, but right now the plans are built to hold the inventory levels that we need to deliver the sales. So potentially, but I would say right now, not looking at that as an increase.

Then when I look at my model and how I build out the balance sheet and how I build cash, you just kicked way more cash off than I was expecting and particularly considering did the $7 million plus in leased store repurchases that happened during the [quar] -- a quarter?

That occurred during the quarter and as I indicated that we will also be spending another $9.7 million subsequent, that there are three stores that we are committed to purchase. That generally was outside of our CapEx forecast at the beginning of the year. However, we are still maintaining that forecast of $90 million to $100 million inclusive of those disbursements.

When you look at what you did with payables and stuff, it implies the cash billed, this is going to be huge by the end of the year.

We do anticipate the cash balance increasing.

Thanks, guys.

Jack Murphy with William Blair.

Thanks. I just -- a question on traffic and ticket. You've obviously put together several quarters here. I think you said nine quarters of the consecutive traffic increases.

From a big picture perspective, could you just talk about where you see the traffic drivers coming from here? Obviously, consumables would have been a big part of it, but as you look over the next four to six quarters.

And then on the other side of that question on ticket, you made a remark about being less dependent upon outdoor power equipment the second quarter. What is your overall strategy on large ticket and just driving the ticket from here? And where do you see some of these larger ticket categories going, over time?

Sure. On the traffic we continued to believe, witness, the fact that we are gaining share in consumable products. And when we look at our share of dog, cat and large animal feed compared to our potential, we believe that will be able to continue to drive share, gain share in those categories.

And as we've said in the past, the average food, animal feed or food customer shops us 1.5 to 2X times as frequently on an annual basis as our average customer. So we do believe that, categorically, we will continue to drive traffic that way.

Additionally, as we continue to refine our CRM program which leads us then to a much more highly refined direct marketing program, we believe that we can consent additional incremental increment of business -- or visits, rather.

On the ticket site, obviously when and if the consumer normalizes and recovers, we would certainly expect a ticket build, due to consumers buying what they have been deferring. We are not waiting for that, however.

What we are seeing within the categories and I won't go into the items, but what we have seen several items priced $400 to maybe $1,000 a little higher, that when we begin to work with our manufacturing partners, begin to plan well well ahead of peak season, begin to use some of their off cycle production capacity and allow them to have time to forward by raw materials and components, we are able to lower our cost of goods.

We could pass that cost of goods on to the consumer. And, frankly, when the value proposition is right, we have seen some pretty remarkable lifts in some big-ticket items.

Okay and just a real quick follow-up on the traffic driver. Within the consumables, are there -- do you see similar opportunities to what you have done with Purina and Nutrena and, you know, things like the 4health and is --? Are we still fairly early on in terms of merchandising innovation that could drive traffic?

Well, certainly on the dog and cat side, we believe we have a wonderful opportunity to increase the private brand offering at the premium life stage and health end of the dog and cat food spectrum. With regard to additional brand expansions, we today carry all the leading national brands of pet in our stores. However, we continue to work on some very regionally important brands and look to introduce more of those in early 2011.

Thank you very much.

John Lawrence with Morgan Keegan.

Good afternoon, guys. Greg, would you comment a little bit more on the outdoor power equipment space? And your comment about being able to hold margin in that category -- I know, historically that has been tough to do. Is that -- was that more due to the markdown strategy or the allocation process? Just some comments there, please?

I originally said back in the first quarter call that we really started with a clean sheet of paper and developed a strategy for 2010. We knew that the customer was value-conscious so we built in a layer in there across all those categories, at what I called the opening price point.

And because we were aggressive and really kind of laid the groundwork early, plus the fact that we ended the year so cleanly that -- the key in OPE is to end clean. The carryover situation always puts pressure on margins from year to year.

So going in clean, developing the plan early, working with the manufacturers to build the product to our specs, okay? What we thought our customer was going to respond to. And then coming out of this season as cleanly as we did, again I give a lot of credit to the merchant team and to the inventory management group.

They did an excellent job of running this business this year. And I will also give credit to our manufacturing community who was right there with us, step by step. As we saw business develop, we were able to go back and re-purchase and flow goods.

So it was just really kind of, you know, -- hate to say it -- hitting the restart button again on that business. And then the consumer did respond a bit more this year than they have in years past.

Thanks. And secondly, as you look at those early customers, when you brought in the premium horse feed, is -- what are you seeing with that basket now that we had six to nine months of that experience of those customers coming into the stores) Are they crossing the aisles, etc.?

This is what we do know from our CRM information is that that base of customers is growing several percentage points from where it was. So we continue to find new customers coming through, into our stores from that. And as far as overall market basket, I can't comment too specific. I will only say that that consumer typically spends more in our store from an average ticket standpoint than does any other customer.

Great. Thanks. Congratulations.

Peter Benedict with Robert W. Baird.

Couple of questions. First, I guess, Tony, the vital warnings, if you think about it, in the first half were up obviously tremendously, about 45% year over year. And I think the guidance for the back half is something more on the lines of let's say less than 15%.

Talk to us about what is driving the deceleration. I mean you talked about marketing spending up more, maybe some less freight leverage. Is it more conservative, a conservatism though? Is it a nod to the great weather that you had in the first half or is something else going on?

Clearly, our first concern is the transportation. As we circled into this year, we clearly had some tailwinds from the initiatives that we had put into place and we are going to begin to cycle those as well as we do anticipate higher freight costs. So what was a slight point of leverage in the first half, we anticipate being a slight deleverage in the second.

And additionally, we had some significant strong FICO margins in our -- what we call our direct margin line. And, as much as we expect to continue to drive some of our initiatives, we don't think it will be quite as impactful as it was in our second quarter, which is clearly our largest selling season.

So it is a combination as we move into the season and the type of products that we sell in the back And the mix of the product line, but we do from our planning and budgeting standpoint we do expect to have an increase in our direct product margins as we move through.

Additionally, the other component on the shrink line, we had some very strong performance and we don't necessarily expect that to continue at the same rate. Although, we have had some tremendous performance over the last year. So it's several couple of items, several items as well as being somewhat conservative in our guidance in the back half.

That's helpful. Just to clarify so that the FICO margins in the back half clearly expected to be up. Do you think you can pick them up in the third quarter, though? Because that is when I guess you have the tough comparison.

Yes. We look at both third and fourth quarter of having a somewhat similar increase in the margin mix. And again, the only caution really is to look at the LIFO credit that we had in Q4.

Okay. Thanks. And then, Jim, I mean in the past you spoke into a 7.5% long-term operating margin goal for the business. We're making some serious headway towards that.

Has the recent experience and the year-to-date caused you to maybe change to longer-term where you think you can take the business in terms of margin?

A good question. My confidence in our achieving the 7.5% EBITDA is obviously much firmer. And I still reserve the right to reset that number higher as we approach the 7.5. So I am not there yet.

That's well earned confidence though. Good job.

Another question, the weather wasn't very good in the first half as you guys mentioned. Can you remind us, how does the business respond to extreme heat? And I know we have seen a lot of that recently, what tends to happen when you guys get these real hot spells?

If it is extended, and it gets into drought-like conditions, we have a shift in the business. Some things stop selling, some things begin to sell. We respond to that generally quickly.

What we're seeing right now is an impact on traffic. Where markets have three or four days of record-breaking heat, our customers have a tendency to not get out and about as much, as you can imagine. I guess we all do. But at this point in time, we are not seeing anything that is sustained to the point of impacting our business tipping us into a drought-like environment.

Perfect. One more and I'll let someone else have a shot here. The SG&A leveraged about 30 basis points on a 6% comp in the second quarter, it's about 5 basis points per point. Is that the type of ratio we should be thinking about going forward? Or should it be a little better than that?

Clearly, yes. As their relationship to the comp sales increased, we -- I tried to give you some direction relative to the SG&A, really with the incentive compensation being a key component, and really increasing the SG&A well above our store growth increases.

So if I were to give you guidance, I would prefer to do it more on that SG&A increase side and say we are really looking at trying to maintain that number around the store growth number. And then, obviously, the comp sales will drive whatever percentage increase above that.

All right, great. Thanks a lot.

Peter Keith with JMP Securities.

Thanks for taking the question and congratulations on a nice quarter. You had mentioned earlier in the script that you -- when you revise your guidance you have better visibility into the second half. I was wondering if you could just provide some commentary on what has changed within your guidance from several months ago?

Clearly, it is really more of a timeline as far -- as obviously getting closer to the back half, we have more visibility. Substantially, our view of the back half is not significantly different than where we were at the beginning of the year. We are clearly much more confident in that position as we worked through the first half of the year and understood the consumer and his behaviors. And we feel more confident that he will continue to behave similarly to what we saw in the first half. And I believe that is really the driver behind having more visibility in the back half.

That's helpful. Thank you. And then, just a follow-up from a comment you made a question or two ago on the product margin opportunity in Q3, Q4. It sounds like you said that the mix and maybe markdown opportunities are somewhat different and may limit the gross margin upside. Could you just provide a little more color about what those limits might be?

Let me speak to that just for a moment, if I could. There is a change in mix third, fourth quarter versus first to second. Again, my comment about how you exit the season, how you enter the next season is what is critical.

We are feeling very confident right now that as we moved out of the second quarter into the third, we transitioned fairly clean. That would give us a little bit of confidence that margins should probably hold through the third quarter.

But the fourth quarter is always the most difficult to forecast because there's a lot of weather involvement in our fourth-quarter business. Would it be against the insulated outer wear or the heating businesses?

So I think I would temper my comment to say that as we go into third, we are feeling very good about holding margin. But into the fourth quarter, it still remains to be seen.

Thank you very much and good luck with this coming quarter.

David Magee with SunTrust Robinson Humphrey.

Good afternoon and good quarter. On the pet food side, given the share gain there that you have seen, I'm curious who you think you are getting the share from. And are you seeing any type of competitor response at this point? In that area.

I think, number one, from a share gain standpoint, probably from the smaller independents, I wouldn't say that grocery stores would be out of the realm as well. I would also tell you that I think we are becoming known and we are on the radar screen now as to a place that carries those products.

So it is becoming -- as we continue to have this traffic to our stores, more of our customers are realizing that Tractor Supply has a meaningful pet assortment. So we are gaining customers through a number of ways. I don't think there's -- I could comment to any particular category of retailer that I think we are generally stealing it from.

I mean, some of the big-box guys that still have some assortment, they play more in the opening price. We played more in the moderate to upper price point. So there is a lot of mixed scenarios here.

But I think generally, you know we have done a better job merchandising and marketing that business and probably just business that's been owed to us for some time we are now starting to see.

Thank you. Also and, obviously, this performance we are seeing is pretty broad-based in nature and certainly not a weather quarter. But just for argument's sake, is there a way to guesstimate the contribution, that weather and the new branch that you added last fall would have been to the traffic member?

I would say that it is very difficult to disassociate the two. Clearly, as we alluded to in our comments, as we came into the season it was a matter of execution against our visibility on a high moisture level. So as much as we could make a guesstimate, I think it would be unfair to try to differentiate between the weather impact and the success that we had in planning our inventories and allocating them.

Thank you. And just lastly on the apparel site, any commentary that you wish to give as far as how you are --? What you are seeing there and how happy you are with that part of the business?

Yes, very pleased with our performance in the first half of this year. We made a buyer change and that was a significant upgrade for us from a standpoint this individual really understands our customer. Put the right assortments into our stores. Our sellthroughs have been above our expectations. We have had solid margins through the season and we are looking forward to a very strong third and fourth quarter because I believe we are positioned correctly.

And again I will give some credit back to our allocation and inventory management group. We just managed through the business so far better this spring than we did last spring and we took advantage of the opportunity that was there.

Great. Thank you.

Matthew Nemer with Wells Fargo Securities.

Good afternoon, everyone. My first question is on the OP category. Just wondering if, Greg or Jim, you can give us a sense for sort of how much of the season is left in front of us? What your inventory positions looks like right now in that category? And what should we be looking for in terms of the wind down this year? What does it look like? When will you be out of stock on certain items or maybe only down to one item, one item on hand per SKU?

We're probably about 70% through the writer business right now. We are really delighted with where we are on the inventory side, both by model and by region. Actually we managed that down to the store level as we began to compress the breadth of the assortment as we go through seasons which we have already done that in the vast majority of our stores.

So we are looking, frankly, for a very good, very clean exit. And we see that business so far in Q3 continuing to perform at a very nice comp.

How do you -- just to follow up -- how do you think the margin rates, the end of season margin rates in that business compare year over year? Could we be looking at potentially much higher margins this year in the wind-down just given the inventory situation and the less competitive environment out there?

Well, I don't know if it's any less competitive than it has ever been, but I will tell you that our management of the business as we exit this season, we will definitely have a nice margin improvement over a year ago and that will again feed as we go back into the season for next year.

You know, when you are selling fresh product and we are selling fresh product right now due to the season, that is full margin product. So that is really the key to it.

Great. And then, my second question is on SG&A. Not to take anything away from a great quarter and a great performance overall, but I was surprised there wasn't a little bit more leverage and clearly sounds like a significant portion of that is in incentive compensation.

Is it also fair to assume that you may have accelerated some investments in future growth initiatives? Is there anything that you decided to invest in kind of halfway through the quarter as you saw the quarter come in much better than expected in terms of future growth that we should be thinking about?

As much as I would like to say that that was the case, it wasn't. It really is a matter of a lot of the incentive compensation does drive some of that as well. But it is the most impactful number as far as sort of out of the ordinary, because it was such a successful quarter.

In this case, why we are having sort of a year-over-year difference, is that clearly we are winning on the sales and margin line. And the stores are benefiting and having a significant impact on sort of their sales compensation piece as well as their profit piece. And that is a clear differentiator from last year. So a lot of success to the stores and they are benefiting on the incentive comp line.

And just remind me, that is a quarterly accrual based on a quarterly bonus target for each store that gets set at the beginning of each quarter? Or sort of remind us what drives that?

The sales plan out at the store is paid every month and then, at the manager level, they have a profit target that's based on their budget. It is accrued each month as well and paid at subsequent year-end. So there is a full accrual for both sales and profit each month for the stores.

Great. Great quarter. Great performance. Thanks.

Robert Higginbotham with Goldman Sachs.

Good evening. A couple of long-term oriented questions. The first one is on store growth and capital location.

You just finished putting up a record first-half. You, as someone alluded to, are generating quite a bit of cash. You mentioned a lot of the reasons that you're really shielded from some economic uncertainties out there.

So what is it that you would really need to see to get the confidence to either return to double-digit store growth or become more aggressive on your buyback program?

As far as cash generation, clearly, we feel very confident and we understand that currently the model, it will -- it's targeted to throw off a lot of cash.

First, we will continue to review our dividend policy and distribution. As we move forward into the next couple of years, we do have some significant investment there that we are going to be making in our distribution and logistics area. In particular, we will be bringing on a -- one of our largest, I guess the largest facility late next year and that we estimate to be approximately $45 million of CapEx.

As well as, we are going to go through a retrofit and put in conveyor in our existing facilities which we, again, anticipate would be somewhere in the $25 million to $30 million area. So currently, we feel very comfortable where we are at. We will continue to make investments in the share repurchase and use that as sort of the third trigger.

As we mentioned on a phone call, as well, we are looking at certain real estate that we currently (technical difficulties). Hello? Are you still there?

I'm still here, but I don't know if you could hear that but it sounded like some kind of science-fiction movie for a second. I didn't quite catch the last of that.

Yes. So we have that as a lever. Additionally, we are looking at certain leased stores that we have where we have right of first refusal. So we anticipate acquiring a few additional sites as we move through the year.

So we believe that this is where our focus is currently. Obviously, as the business improves we will include revisiting our store growth plans. Because obviously we believe that that is really the best investment, is in our stores.

Would that new facility that you mentioned perhaps give you the reach to be aggressive towards the West Coast?

Currently we anticipate that this facility would be more in the mid-South. It would give us the opportunity to serve the stores in the mid-South and South Atlantic and would free up our facility in [Hagerstown] to be able to serve the Northeast better.

Got it. And then the last question is really kind of a forward-looking question in the sense of where you see further opportunities for improving your business? And, clearly, you are doing well on things like price optimization and by installing some enhanced, sophisticated systems. You can do more there.

As you kind of look beyond the things that you are currently doing, are there any areas where you kind of feel that you are deficient or just that you can improve your efficiencies?

We talked about, at some length about the four drivers of gross margin. We are probably in the second or third, I guess, those initiatives.

We also believe that we have significant opportunity to continue to refine our assortments on a regional basis. We also have the opportunity to gain further efficiency and effectiveness with our marketing program -- programs that would be both the outbound direct mail, as well as what we could begin to do eventually with e-mail and on our website.

We also continue to learn and refine our print distribution costs and returns. So margin would be one, marketing is the next. Regionalization on the merchandise side, and we also have several new merchandise categories, items we're testing. Greg, anything else from your perspective?

The other thing will be the intensification of our private brands. We have got a fairly good start, but there is enormous potential for us. One of the reasons we brought on the product development person was we saw that opportunity and we are taking advantage of it.

And then, we mentioned earlier about the distribution network, but the installation of the warehouse management systems is a tremendous efficiency tool for us. We will have that up in one of our large DCs this fall and as we roll that through to the remaining DCs over the next year to say 14 months, that's another area of not only flowthrough improvement, but efficiency in general, in labor and processing of merchandise. So there's -- we have a myriad of things that are going on. All good.

Chris Horvers with JPMorgan.

Thanks and good evening. On the traffic and the ticket side, you talked about traffic X the bigger ticket items being actually up. So if you could help us thinking about ticket in the back half of this year. Does the fact that mowers, it's your peak ticket quarter here, in the second quarter, does the fact -- and they did well. Does the fact that they moderate out of the mix, is that a positive or a negative for the ticket growth in the back half of this year?

We were talking about ticket sequentially, obviously, as we go into Q3 and Q4 ticket always declines. We think about comp on a -- on a comp basis quarter over quarter, the driver would have very little impact. The key would be -- the key driver would be heating, of the hard goods in heeding. And we frankly anticipate some pick up on a year-over-year basis there.

And the other possible driver of tickets would be in Q4, if the consumer responds more favorably than last year to big-ticket tool and big-ticket gift.

The key takeaway, though, is to -- we wanted to make sure that people didn't walk away from Q2 thinking oh, big-ticket came back, therefore average ticket increased.

So we had two headwinds. Really big ticket had been a headwind as well as the ticket itself. And as we moved through the quarter, we saw -- exclusive of big-ticket, the average ticket did well on its own. So that was really an exciting spot for us throughout the quarter.

So then as we think about the back half of this year, do you think that -- would you expect the ticket to revert to more of a drag or do you think you could actually turn it positive?

We think that both (inaudible) and that we can maintain the ticket and without a significant influence from the ticket. But again, both work together. But if the shopping patterns continue from Q2 into the back half of the year, we believe that we can maintain somewhat of a flat type of average ticket.

Okay. I see what you're saying. And then just going back to the commentary on the heat. And just overall, we know that April was a pretty fantastic month for the seasonal business and for the consumer.

So did your business weaken as you reached towards the end of the quarter? And is the heat such that you are just seeing some softness and that is weather-related, but you have to look at your business over -- like you do on a six-month basis?

We liked April. We liked June. We liked May less was our cycle through the quarter.

And -- go ahead.

When it comes to the quarter, April clearly is break of spring and a strong April is much more meaningful than a strong May.

Generally, if we have that strong of an April and you look at the year-over-year comparisons, we anticipated that May would be a little bit softer. And that came to fruition. But, as we moved into June, June was very firm and steady course as well. So we feel really good about the trends that we saw throughout the quarter.

When you -- did June basically approach the quarterly comp? The 6 that you put up?

June was less than the overall comp in the quarter.

Okay. And then, finally, as -- one final question here. So as you think about the deflation, just numerically, is that less than 100 basic points in 2Q and that is how you are thinking about the balance of the year?

Well, Q2 was 187 basis points. We anticipate -- and again when we talk deflation in a futuristic way, we are really looking at the current prices and comparing it to last year's prices. That moderates significantly. That could be different. But currently we anticipate that it's somewhere between 50 basis points and 75 basis points.

Okay. Thank you very much.

Stephen Chick with FBR.

Thanks. And good quarter. Just really to clarify and follow up on some of the sales commentary, Tony. Moreso, I think I appreciate the granularity in the inter-quarter trend. That is helpful.

As we head into the third quarter here, and you gave some color on your guidance, I guess versus the compare of a year ago and the hurricane activity, July -- I think of a year ago -- started off pretty soft. So I am trying to connect the dots on -- you mentioned some, I think hot days and that kind of maybe affected traffic.

Are you seeing at the start of this quarter here, now, are you seeing the same type of traffic trends as where you -- where the second quarter, I guess, ended? Can you speak to that?

Yes, generally, we see very similar traffic patterns relative to June as we move into July. When it comes to the weather factors, weather impacts Q3 probably less than any other quarter. Because it is generally consistent, it is generally warm and the thing that tends to be an aberration will be the hurricane activity, which is obviously difficult to predict.

And generally we do not include -- we do not anticipate any activity in our numbers.

So I guess the -- but if you're seeing kind of maybe June or the current trend similar to the June at the end of the quarter, is the -- the compare, I think, is currently a little easier, is it? So is that what you are kind of talking about which are like -- if we look at a stacked trend, for instance, is it just -- you know because, obviously, your guidance is pretty conservative for topline for the second half.

And I appreciate that because you guys tend to be, you know, seem to be conservative and you know that's probably a pretty good stance. But have you seen -- I guess, have you seen a little bit of a slowdown is my question.

Yes. I think the point that I was trying to drive home was that generally you would look at the negative 5.1. You would look at a two-year comparison and you would say, boy, they must be owed around at least a five or six comp.

What we are saying is that 2009 was probably much more normalized number and that we would expect a comp somewhere in the range that obviously that we gave for the full year guidance.

Okay. That's helpful. Thank you.

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

Thank you, Operator. I have been the Director of Supply now for 10 terrific years. There were times we've had really remarkable growth and improvement throughout the business, but frankly things have never been better at Tractor Supply than they are today. We have several initiatives lined that will drive productivity, efficiency, gross margin, and comp store sales.

We are very enthusiastic about the remainder of the year. Our new stores are working just terrific and they were confident that we have the right people processing strategy to continue building on this momentum throughout the year and on into the future. So I thank you for joining our call and for your continued support and look forward to speaking to you soon.

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