Tractor Supply Co (TSCO) 2013 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Tractor Supply Company's conference call to discuss first-quarter 2013 results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time.

(Operator Instructions)

Please be advised that reproduction of this call, in whole or in 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. Jennifer Milan of FTI Consulting. Please go ahead, Jen.

Thank you, Operator. 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 Greg Sandfort, President and Chief Executive Officer. Greg, please go ahead.

Thank you, Jen, and good afternoon, everyone. Thank you for joining us on today's call. With me today is Tony Crudele, our Chief Financial Officer.

We are pleased with our first-quarter performance, given the variables we faced during the quarter. Our Q1 performance demonstrates the continued underlying strength of our core business and our ability to adapt to challenging weather conditions. As we have said in the past, it is important to assess our performance by the halves and not by the quarters; and while we now expect a slower ramp into spring, we believe we are well-positioned to take full advantage of the selling season ahead. Tractor Supply remains committed to our strategic initiatives and we are making positive strides in the areas of new exclusive brand offerings, expansion of our regional assortments, and further supply chain capability, all of which are contributing to our capture of market share, sales growth, and longer term profitability.

On our last call, we discussed that the first quarter of 2012 benefited greatly from the early spring weather, and as we had anticipated, the weather was not as favorable in the first quarter of 2013. We planned conservatively for the first quarter, and we were delighted with the team's ability to deliver positive comparable store sales, despite the extended winter selling season. While specific big-ticket products within our seasonal categories, such as riding lawn mowers, were negatively impact by the colder weather, we experienced very strong sell-through of winter product and winter-related Q items. Most importantly, we ended the first quarter well-positioned, with current, high-quality forward inventory to support our spring business.

Now let me discuss in more detail some particulars regarding our first-quarter results. In terms of specific sales drivers, CUE categories, the consumable, usable and edible part of our business, remained very strong. Pet food and animal feed experienced unit sales growth versus a year ago, and more importantly, drove increased foot traffic to our stores. Another area of focus is our drive on merchandising, which has proven to increase the basket size and enhance the treasure hunt experience for our customers. One such example is our Dollar Day event, which provides provide great values on everyday commodities; and another, is our poultry event, labeled Chick Days, that drive sales of live birds and the necessary items you would need to raise poultry. Both events performed above last year results, and these type of in-store events provide Tractor Supply with a great opportunity to grow sales in our center court space, while enhancing our relevance in the eyes of our customers.

Our focus on providing newness with product innovation across the store has kept our assortments fresh and our customers highly engaged with our brand. In this regard, we continue to see growth within our exclusive brands, through brand extensions and new product introductions. During the first quarter, exclusive brands accounted for roughly 30% of our mix of sales. Exclusive brands enable TSC to differentiate our products from that of our competition, in both the off-line and online channels and remains another important area for improving our profitability and customer loyalty. During the quarter, we expanded our 4Health exclusive dog food brand by adding new SKUs in grain-free formulas, and were are very pleased with the initial reception by our customers' purchase of the product. CUE remains a solid foundational piece of our key sales driving strategies, and we are pleased that we are experiencing market share growth here. Through our growth in sales, it is clear that our customers choose Tractor Supply as their most dependable supplier of these need-based products.

Another great example of our commitment to providing product newness is our Live Goods category, which we started testing about three years ago in select stores. Our spring Live Goods program is now in approximately 500 stores and we are very optimistic about the sales potential for the Company. Already in our southern regions, we've experienced solid sell-through on many of the early receipts of vegetables, herbs and fruit-bearing trees.

I am delighted with our team's ability to manage through a wide array of variables. The diligent work of our teams to adjust merchandise offerings and flow of inventory to meet customer demand in Q1 was exceptional. And this resulted in comparable store sales growth against very difficult comparisons from the prior year.

I'll now turn the call over to Tony to review our financial results and discuss our outlook for the remainder of 2013. Then I'll return, following his remarks, to share my closing comments.

Thanks, Greg, and good afternoon, everyone. For the quarter ended March 30, 2013, on a year-over-year basis, net sales increased 6.4%, to $1.09 billion, and net income grew by approximately 9%, to $44 million, or $0.62 per diluted share. As Greg discussed, we prepared for weather that would be not be as favorable as we experienced in the first quarter of last year, where we benefited meaningfully from early spring weather in March. As a reminder, we had estimated that approximately $38 million in sales, which translates to approximately $0.10 impact on EPS, was pulled forward into Q1 from Q2 last year, as a result of the early spring. We planned for this shift accordingly and managed through, to deliver another solid performance in the first quarter.

We tracked well to our internal plan, although it was really a tale of two seasons. The winter season was very strong in the first quarter and exceeded our expectations, as the cold weather drove solid sales performance and clearance of winter product. This resulted in a solid mid-single digit comp gain through February. As we headed into March, the colder than average temperatures resulted in softer sales than anticipated. Temperatures in our markets were 13 degrees colder than last year, on average, and almost 4 degrees colder than historical averages. Some days were actually colder by as much as 50 degrees compared to last year's warm spring weather. This dampened sales of big ticket riding lawn mowers, as well is higher margin spring seasonal categories, and resulted in very difficult comparisons to last year. Although the second quarter has gotten off to a colder than expected start, we have seen that our consumer responds as the weather's warmed to more typical spring conditions, and we are hopeful that this will result in a strong spring selling season. Also, as we head into May, we begin to see softer sales comparisons to last year.

As Greg stated earlier, we believe it is more appropriate to look at our performance by the halves rather than the quarters, and we believe that this year's spring variation relative to last year will be reallocated between the first two quarters. Comp store sales increased 0.5% for the first quarter, compared to last year's very strong increase of 11.5%. Comp transaction count increased for the 20th consecutive quarter, gaining 2.2% on top of a 4% increase last year. We remain very pleased with our core business, as CUE products continue to serve our customers basic and functional needs and drive transaction count increases.

Specifically, pet food and animal feed were particularly strong and delivered comp increases in dollars and units across the chain, driven in part by the extended winter season. Average comp ticket decreased by 1.7% versus last year's strong 7.1% increase. We estimate that the softness in riding lawn mower sales had a negative 220 basis point impact on average ticket, resulting from the shift in spring weather just discussed. Average ticket was also impacted by the increasing CUE transactions, which generally carry a lower average ticket than the chain average. This was partially offset by inflation, which we estimate was approximately 140 basis points and within our projected range of 100 to 200 basis points, but significantly less than last year's 400 basis points benefit. On a regional basis, the Western regions performed the best, and comps were positive in all regions except the Midwest, where our winter seasonal goods do not offset the soft spring sales.

Turning now to gross margin, which as a percent of sales decreased by 19 basis points, to 32.4%. This was consistent with our outlook, as we anticipated that gross margin would be flat to slightly down in the first half of the year. Mix had the most significant impact on margin, which we estimate at approximately 53 basis points. This was primarily related to CUE, which as we mentioned, performed exceptionally well in the first quarter and made up a larger percentage of the first-quarter sales compared to the prior year. Q1 generally has the largest mix of CUE sales, and this was further exaggerated with the cold weather trends in the quarter. We continue to manage gross margin dollars per unit and again, we increased margin dollars per unit in key CUE categories this quarter. Strong sales of heating-related products, which carry margins below the chain average, also negatively impact gross margin in Q1. We did receive a slight benefit from the softness in riding lawn mower sales, as riders carry a lower than chain average margin; however, this was more than offset by the softness in the sales of higher, full margin spring merchandise.

Freight increased approximately 31 basis points, principally as a result of the continued mix shift to freight-intensive CUE products and costs related to increased import activity of seasonal goods, as we had a mix shift in the quarter to merchandise that is duty-intensive. Import purchases in the quarter increased 16.2% year-over-year and represented 8.6% of the total purchases. Also, exclusive brand sales increased over 20% compared to last year's Q1, and were close to 30% of sales. Although we always strive to deliver gross margin improvement, we are pleased with our ability to manage gross margin rate, in spite of the product mix and freight headwinds, while continuing to provide great values to our customers. In turn, this allows us to increase our market share, drive gross margin dollars, and deliver solid operating margin performance, and a healthy growth in earnings per share.

For the quarter, SG&A, including depreciation and amortization, was 26.1% of sales, reflecting 13 basis points of improvement from the prior year's quarter. The improvement resulted from the reduced incentive compensation relative to last year's strong first-quarter performance. This demonstrates the alignment of our incentive structure with our sales and operating performance. We are pleased with our ability to control costs, particularly as we cycled against below normal store costs in the first quarter last year, due to the mild winter, and the leverage provided by last year's strong comp sales in the quarter.

Our effective tax rate decreased to 35% in Q1 compared to 36.8% last year, which was consistent with the guidance that we provided in our fourth-quarter conference call. The decrease was principally due to the favorable impact of the reversal of certain taxes pursuant to FIN 48 and the reinstatement of the WATSI federal incentive tax credits that were approved by Congress in the early part of our first quarter and, as such, treated as a discrete item in the quarter.

Turning to the balance sheet. We have managed well against our capital allocation strategy over the past year, utilizing our dividend and share repurchase programs to move us into a borrow position at quarter end, which is one of our peak seasonal inventory periods. At the end of Q1, we had a cash balance of $57 million and borrowings of $105 million, compared to a cash balance of $126.7 million last year and no debt. During the first quarter, under our stock repurchase program, we acquired approximately 522,500 shares for $49.9 million. We estimate the share repurchase program did not have a material impact on EPS for the quarter.

Average inventory levels per store at quarter end were 2.3% higher than last year, which was in line with our expectation and is related to the spring inventory build and the impact of inflation. Excluding key spring seasonal categories, average inventory levels per store would have been down relative to last year. We exited the winter season in great shape, as the extended winter season allowed us to effectively clear through winter merchandise.

Capital expenditures for the quarter were $49.3 million, compared to $31.8 million last year. We opened 22 stores this quarter, compared to 33 stores in the first quarter of 2012. The increase in capital spend relates to the construction of our new Macon, Georgia distribution center, which is the relocation of our Braselton, Georgia facility.

Turning our attention to the full-year outlook, with respect to our financial expectations for the full year 2013, as noted in today's press release, we have confirmed our previous guidance for net sales, comp store sales and earnings per share. As a reminder, we still expect full-year sales to range from $5.07 billion to $5.17 billion. We continue to forecast comp store sales to increase between 3% and 5%. We are targeting improvement of approximately 10 to 20 basis points in EBIT margin compared to 2012. We anticipate net income to range from approximately $304 million to $310 million, or $4.32 to $4.40 per diluted share. Capital expenditures will range between $240 million and $250 million. The new store pipeline is full, and we continue to track very well to our full-year goal of 100 to 105 new stores.

We have not seen any significant change in our customers' behavior, even with concerns about the economy or the impact of the higher payroll tax on their take-home pay. Our customer continues to purchase their basic and everyday needs, spending on larger ticket items only when it is essential. Inflation has tracked as expected, and we continue to estimate that it will be approximately 1% to 2% for the full year, with our expectation that it will likely be at the middle of that range in the first half of the year, and slightly less than that in the second half of the year.

As we stated in the fourth quarter press release, we expect a drag of approximately $6.5 million to $8 million, or $0.06 to $0.07 in EPS, related to the relocation of our Southeast distribution center and our corporate data center. These costs include duplicate occupancy expense and temporary labor during the transition, freight movement costs between facilities and equipment depreciation. These costs will be principally reflected in SG&A, with the majority occurring in Q2 and Q3.

With respect to margin, gross margin. The full year, we expect to achieve a slight gross margin rate improvement through the execution of our key gross margin initiatives. We expect this will not be realized until the back half of the year. We will continue to have a headwind from the mix shift to CUE products, which carry a margin below the chain average. We also expect freight costs to remain a headwind, due primarily to continued merchandise mix shift to more freight-intensive CUE product and increased import container volume. We estimate that the impact of the mix shift and the transportation expenses discussed will prevent us from realizing gross margin rate improvement in the first half of the year. We will continue to focus on driving market share and growing gross margin dollars.

With respect to inventory, we may experience slightly higher levels at the end of Q2, as we transition to the Southeast distribution center. With respect to SG&A, excluding DC and data center charges, as I discussed previously, we continue to target SG&A growth to leverage at a 3% comp. Store support and store payroll is expected to leverage slightly, as we drill our comp sales base and cycle a more normalized level of incentive compensation, which should offset wage and health care increases. Based on the above, we anticipate that our EBIT margin target improvement will be weighted more towards SG&A leverage than gross margin rate improvement. For the full year, we continue to forecast our effective tax rate will be approximately 36.5%.

To conclude, weather trends in the first quarter were essentially the opposite of last year, and therefore not as favorable to our business in the first quarter of this year. However, we again executed very well, successfully managing through the things that we were able to control in our business, to produce solid financial results for the first quarter and position ourselves for a healthy spring selling season overall.

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

Thank you, Tony. Now regarding the current retail environment, our customers' shopping patterns have remained consistent with recent quarters. They seek compelling values and they purchase based upon need. At the same time, we are nimble and capable to react quickly to the trends that are developing in our business, which has enabled us to capture market share.

Before I close, I'd like to provide a brief update on some of our current Company initiatives. We are pleased to report that we remain on schedule with the construction of our new distribution center in Macon, Georgia, which is the relocation of our southeastern distribution center in Braselton. In April, we completed the necessary upgrades to our website which will provide us with the infrastructure to accommodate drop ship, and we now have fulfillment capabilities from our own distribution center in Franklin, Kentucky. While very early, we are executing well and very pleased with our results thus far. The new store support center is well underway and construction is on schedule for completion in mid- to late 2014. This will enable the Company to operate together again in one complex and will further our culture of mission and values.

Lastly, in the area of strategic sourcing, we recently hosted a vendor conference in Shanghai, China. We do this about every two years. We reiterated our commitment to the factory base there and their need to be in compliance with all US laws, FCPA in particular. The attendance was very strong and through this event, we were able to strengthen not only our factory relationships, which we believe will advance our sourcing capabilities over time.

Looking ahead to spring, I am excited about our plans and the people and the process we have in place to drive our results. Our balance sheet remains very strong, allowing us to invest in capital initiatives to ensure our growth for the longer term. We continue to implement newness throughout the store, which will enable us to grow our sales. We continue to expand our footprint in key growth regions, and remain very committed to our annual square footage growth rate of approximately 8%. In closing, I'd like to thank every Tractor Supply team member for their ongoing hard work, passion for our customers, and commitment to our Company. Because of their efforts, TSC is well-positioned today for growth, and we all look forward to a successful 2013.

Operator, I would now like to open the call for questions.

(Operator Instructions)

David Magee, SunTrust Robinson Humphrey.

Can you tell us how the Business seems to be trending in the parts of the country that have resumed more normal temperatures seasonally?

What I can share with you is what Tony had mentioned in his script, where we've had a typical spring season, or at least the warming trends of a spring season, very pleased with how the Business is responding. That's across the categories of live products, our outdoor power equipment and other categories that we typically see movement in once there's weather.

And is there a danger that in other parts of the country that have not experienced a spring yet that we get too deep and people will just defer and not buy the seasonal products?

You know, I've been with the Company now six years, and I have yet to see that really happen. What typically you will find is, even though the season is pushed back a bit, this is actually more of a typical spring season. Now, we haven't seen this in five or six years. But typically, spring comes about this time, if you go back and you look at, probably, historical data. So, no, I believe, and I think we believe as a Company, that as the warming trends occur -- and they will come in the North and in the upper Midwest -- our Business should return to normal there, and we have every expectation that we'll have a strong finish to the spring season.

David, this is Tony. I think really the best way to look at it is to look at last year as being the aberration in the season, which actually generated such an early season that it was a little bit slower as the season went through. That's why, as I commented earlier, we'll start to go up against much easier compares as we enter into May and even slightly into June.

Great. Thanks, Tony.

Michael Lasser, UBS.

You did a good job last year of sizing the amount of sales that you thought were pulled forward due to the weather. Do you have some estimate of what you think the weather impacted your first quarter, all in, this year?

Well, Michael, this is Tony again. We really like to cycle back and say that last year had the impact. As we looked at this current year, the winter trend was favorable, but again, relatively consistent to what we would think a normal winter condition would be. So, really, the difficulty is in the comparison to last year, when it comes to March and the springtime. So, really, the best way to look at it is not so much what the impact was with weather this year, but it was more of what the impact was last year. And that's the easiest way to quantify it, and that's why we feel very comfortable with the $38 million estimate.

Okay. And traffic remained very strong in the first quarter this year. Do have a sense, is that coming from greater frequency of existing customers, or are you starting to attract new customers, as they gain awareness of the different product offerings?

It's absolutely a combination of both. We continue to grow our store base. As our newer stores continue to mature, we continue to drive comps and get new traffic and new customers. So, it's definitely a combination of both, because when we look at each of the age of the stores, we see improved comp sales in all of the ages of the stores. So, we're really pleased with attracting then new customers and then continuing to have additional shopping transactions or shopping visits from our current customers.

Okay. That's very helpful. Thank you very much.

Brad Thomas, KeyBanc Capital Markets.

Thanks. Just another follow-up on the weather impact here. Will we see any additional markdown pressure, because of the later spring that we're seeing this year versus last year? Or is that something you don't need to do, it's just a matter of waiting for people to come in the doors and buy this product.

Brad, this is Greg. We are very cognizant of our flow of product and the demand that sits in front of us. We do a lot of estimating and forecasting of production. So, we feel very comfortable, right now, that our inventories are well-positioned, both South as we move all the way to North, and we are not concerned with any -- I'll call it outsized lumps of product or anything, at this point. We are in great shape. As those customers start to come through as the weather warms, we think we'll convert that into sales. And if we see anything that's changing, because we are nimble and we have the capabilities, we'll make the adjustments. But so far, no need to adjust.

Great. And as a quick housekeeping item, can you just remind us, were all of your stores closed on Easter Day this year? And would that have been a drag in the first quarter that provides a little bit of a benefit then in the second quarter?

We were closed on Easter. Easter fell in our same quarter, so there was no impact there. There was a slight shift, obviously, the earlier Easter, generally, the better. That was somewhat negated by the cold weather. But when we look at it, we don't see it being a significant impact one way or the other.

Great. Thanks.

Peter Benedict, Robert W. Baird.

Tony, so the second quarter, sounds like gross margin expected to be down again. Should we think, in terms of magnitude, that down more than the first quarter, or kind of a similar rate? And then related to that, as you look to the back half of the year, your view for improved gross margins. Is that going to be driven, in your view, by less of a mix headwind, less of a freight headwind? Or how do you expect to achieve that?

Sure. When it comes to Q2, as we do a build and take a look at Q2 from a detailed level, we still expect to have that mix headwind. However, we do expect that to moderate some, because in Q1, the CUE items had a significant increase in the percent of total business. So, as we move into Q2 with the Spring business, we expect that to be a smaller percentage. But, at the same time, we still expect to have that as a headwind. So, with that moderating somewhat, but with the addition of what we would anticipate, additional riding lawn mower sales, which again have a lower than chain average margin, there's going to be an offset.

So we are looking, generally, in the same range. But, what we do anticipate, or are hopeful of, as we continue to drive sales in Q2, that we will be able to offset any gross margin rate reduction with SG&A leverage. And that's again, what we are trying to communicate is that we believe that we'll be able to drive more of an SG&A leverage than improvement in gross margin in Q2 and be able to wind up, overall, with an EBIT margin somewhere flat to slightly down.

Okay. That's helpful. And then as you think to the second half and getting the gross margin up year-over-year, the components driving that, is it just less of a mix headwind or less freight?

Yes, when we look at it, because there is less imports, and that obviously -- the buildup this time in Q1 and the release of the freight, there was an impact when it came to transportation. So, that's a little bit less of a headwind. We think that the CUE mix will be a little less of a headwind, as well, as we move into the back half. Then we do get some margin lift as we get into some of our giftables, as we get back into Q2. So, that's what gives us the optimism that the gross margin rate will have more of an improvement in the back half of the year than in the first half of the year.

Okay. Thanks. And then, maybe for Greg. Could you just talk a little bit about the ground moisture levels you see across the chain right now, how they compare to where you've been in the past? And then related to that, I recognize you guys haven't seen this in a bit, but at what point do delayed seasonal sales become lost sales? At what point would that occur? Thank you.

Okay. Let's take the first question, the ground moisture. By now, Peter, as you well know, we've had a lot of moisture in the North, the Northeast, the Midwest and the accumulation of snow. And when snow melt happens, that puts more ground moisture in. So, versus a year ago, much more moisture right now. We are seeing a little bit of drought in the West Texas region. That hasn't changed much in the last several years. But if you look at the drought monitor across the country, there's a lot more green then there is brown. So, we are in better shape today than we were a year ago, and we believe with the snow melt that the Northeast and the upper Midwest is going to be more moisture there for a longer period of time in the spring.

When you talk about lost sales, it really isn't so much lost as, I believe, it will be more delayed. I actually had a conversation this morning with one of our large outdoor power equipment vendors, and we were talking about, is this a more normalized spring or is this another aberration. And his comment was, he's been doing this for 30 years, and he said we've finally have gotten back what I believe is more of a normalized spring period.

And he said, the longer the season extends, the higher propensity we'll have of selling more units, because these units have to go a little longer into the season and so on. And he says, we're hoping for a turnaround here, and being able to sell new units and replacement units versus repair and extending.

In my opinion, it is too early to say that there's been any real missed sales. I believe these sales have shifted. I think we'll capture much of this as we get into late April, May. And it is our hope that the season will extend in and through possibly June, which is more typical. Now we haven't seen that in many years, but this could be a more typical year.

All right. Terrific. That makes sense. Thanks very much.

Helen Pan, Barclays.

Just a couple of quick questions. There was a step up in your buyback activity for the quarter. Is this a level that we can expect going forward from you?

Hello, Helen. This is Tony. We have it targeted as we begin the year. And again, I'd like to refer you back to our analyst day presentation that's still available out on the web, where we talked about what our goals are over the next five years. Each quarter, we will set a matrix under a 10B5, and it will be based on our internal calculation of what we believe the intrinsic value of the stock is over the next couple of years, and we will set our buying targets based on that. Depending on how the stock moves within that quarter will dictate how much we buy.

We were somewhat fortunate this quarter that in the early part of the quarter, the matrix was buying at a relatively large clip, principally prior to our fourth quarter announcement, where we announced earnings. As the stock rose, it again went outside of our matrix. We can't adjust it during our quiet periods, and so there was a lot less buying in the second part of the first quarter.

So as much as we sit out there with a target generally somewhere between $100 million to $200 million, it's very dependent on how the stock price moves within a particular quarter. As we move forward, $50 million in a quarter, generally, would be at the high end of our target for a particular quarter.

Okay. That makes sense. Then a question on your marketing. Can you just update us on your initiatives to continue to drive traffic, especially with new customers and increasing awareness of people who might not be as aware of the Tractor Supply brand.

Helen, hello, this is Greg. In the first quarter of the year, there really wasn't much of a change from what we did in last year. We continued with our circular program, we continued with some CRM products and direct mail. And what we're finding is we're getting more and more efficiency as we gain more information on these customers. We're starting now to use the web quite a bit more to talk to these specific customers about things that they're interested in and the information that we've now gathered on them.

So if you're referring in specific to the aware non-shopper comment that we made, and we've talked about a few times, that customer base continues to be more difficult to target, although we know that we're gaining some new customers on a day-to-day basis, as we hear the commentary from our stores talking about customers making the first trip into Tractor Supply and saying, wow, I didn't realize you had all these things to sell. But we continue to work that side of the business, as well. But in the first quarter, there's probably less of that than you will see as we move forward into second quarter, because the apex of our business starts to move here towards second quarter, and we'll ramp up some of those activities as this quarter develops.

Great. Thank you.

Vincent Sinisi, Bank of America.

We appreciate all the color around the gross margin headwinds. I also, though, just wanted to ask, you did mention within your gross margin commentary that exclusives were around 30% of sales, clearly a nice step up. If you guys could just give us some further input, in terms of where you potentially see that going throughout this year, in terms of product expansions. It was pretty evident at your Investor Day that that is certainly a focus.

Vince, this is Greg. No question what we saw in the first quarter in exclusive brands, particularly in the CUE categories, we saw a large acceleration. And as you know, some of those CUE products, whether it's our private brand or our exclusive brand feeds and pet foods and things don't carry the same margin as some other products maybe on the left-hand side of the store that are more hard lines driven and such. So we are thrilled with the market share growth that we saw. It did put a little pressure on margin.

Now as we move forward through the balance of the year, Steve and the team have put together some really, I think, some terrific programs that are continuing to build out categories or line extensions within existing categories in exclusive brands. Whether if you look at our spring assortments, whether it's long-handled tools in the garden area, or heating in the fall, or clothing and apparel and footwear. We just had some new products that are now coming through the pipeline there. But I'm comfortable that we're going to see continued movement and growth.

But again, I must caution everybody. This is really driven by how the consumer responds. And as the consumer gives us the green light to move ahead and take categories further, we move those categories forward. There will be a point in time where in a certain category, we'll say, we're already penetrated X percentage and it's enough, and we still need to have a balance of brands that are recognized on a national level and so on. But by no means are we well-developed here, and we're excited about what we're seeing. We haven't had any real setbacks yet. So we're pleased with the progress we've made.

Thank you, Greg. That's helpful. And then just a follow-up question, if I may. Regarding the replacement cycle, I believe you said you haven't really seen a true tick up from that pent-up demand. Just wondering, and maybe using markets that have seen more spring weather to date, at least, have you seen any signs that are making more or less positive that we could potentially see an uptick in that replacement cycle?

Vince, that's a great question. It's very early in the season. And I think anyone who's selling outdoor product would give you the same answer. It's very early. What I can tell you is that our replacement parts, maintenance businesses, are still running very strong, which leads me to believe that consumers are still looking to extend the life on the current product. As I said earlier, and talking with some of the experts in the outdoor product equipment category, if we have an extended spring and it goes in and carries through June into July, some of these units that have an extended life, let's call it that, are probably going to start having failure.

And that could be a sign that we could start seeing some movement. But we just haven't seen it yet. We just really haven't. It's still a replacement cycle, and it's out of need when they need to. The days five, six, seven years ago when we were seeing new units being sold, preferably, versus repairing and maintenancing the one that they had, I just don't see it yet.

Okay. Good to know. Best of luck in the second quarter.

Thank you.

Scott Ciccarelli, RBC Capital Markets.

You guys talked about being able to leverage SG&A at a 3% comp, and did a little bit better than that this quarter. I guess the question is, if we stay in the low single-digit kind of comp rate here, does that change the complexion of SG&A going forward, just given the commentary you made on incentive comp?

I think as you move forward and we cycle up against last year, our incentive compensation program is designed to continuously raise the bar each year. So, if we were riding it down in a lower single-digit, and I'm talking more of the 1% to 3% range, I think that you would be able to see us manage through and lever SG&A.

However, as we move into the spring season and our discussions about the sales shift between quarters, we believe that we have a significant opportunity to leverage SG&A, as we potentially drive sales at a little bit higher clip than that 3% comp. So, that's what gives us the optimism. Again, as we cycle some of the incentive comp from last year, as well of some of the enhancement that we've made in our cost structure, we believe that we can drive SG&A efficiency in Q2.

All right. That's helpful, Tony. And then a follow-up would be, it's been a while since you guys dipped into your revolver. I guess what I'm wondering is, is that any kind of change on the capital structure you've talked about in the past? Or is it just the combination sales were little bit slower, slightly higher inventory levels and that's what you need for the balance sheet to reconcile? Thanks.

As we entered the year, we did anticipate that we would be in a borrowing position at the end of the first quarter. And again, our other heavy inventory period would be at the end of the third quarter. So, as we looked at this year, I would expect to be in a borrowing position throughout the year. And I do anticipate having a cash balance in our targeted range of $100 million to $150 million at the end of the year.

So, I would say, I would cast it as being pretty much where we had planned, and that the ongoing share repurchase program and dividend program that we've had in place for the last couple of years, we've been able to allocate that out to our shareholders and return value in that capacity.

Got it. Thanks, guys.

Arum Rubinson, Nomura Securities.

Couple of things, just housekeeping. Can you give us a sense of the gross margin benefit that private label gave you? And also, order of magnitude of CUE, how much that increases in the mix? Just curious, the order of magnitude, because it sounds bigger than normal.

Generally, we would not disclose the gross margin benefit of the private label and/or the CUE I would tell you that the impact relative on the quarter was close to mid-single digits, as far as the mix of the CUE and the increase in CUE relative to the sales in Q1. So that was a significant movement of those CUE categories, and obviously, what put pressure on the gross margin rate. Now again, as we emphasized earlier, as much as there was pressure on gross margin rate, we were still making the same gross margin dollars per unit or gross margin per bag that was sold. And that's really what drove the results and continued to drive EBIT performance and EPS improvement over last year.

And then on the private label side, you had, I think it was a 50-some odd basis point hit from mix, and then there was a hit from freight, but you only ended up down 20. Is it possible that private label would have helped you by 30, 40?

I would say, it would not be that large of a number. Because again, a lot of our private label brands are used as sort of entry price-point. So they're not going to carry as significant of a mix. And when we look at the CUE and some of the drivers within CUE, as much as private label was up, the CUE mix really was what was driving the margin rate down. So there was a slight offset. It was positive. But it was not overly significant.

Would you guys also mind updating us on the cross job function? I wasn't sure if Greg hit on this a little bit at the end of his prepared remarks, but just in terms of kind of the flowing goods differently throughout the supply chain? Can you update us where you are, and when and where you'd like to be with that? Thanks.

Arum, I can tell you. We have completed our test of the mixing center out of the back of one of our distribution centers, and it has given us confidence that this model can work. We are now planning and looking forward and saying, okay, how do we make this work within the mix of the supply chain that we have? How do we take this high velocity, low value, and really fast term product and move it into this sector?

And we haven't got all the plans f finalized. We just got the results, honestly, and have dug through them. But it looks like it could be an option for us. We'll speak more to that, probably, as we do get to the next call or two. But there are plans to move forward in some shape or form with looking for sites and trying to put this into play over time.

All right. We'll wait for that. But thanks again and good luck in the quarter.

Matthew Fassler, Goldman Sachs.

I have two questions that relate to gross margin. First, you alluded to some higher margin spring product that didn't sell through particularly well, I guess because of the weather. Can you just refresh our memory and what product you were speaking to?

Matt, this is Greg. The products we'll talk about would be things like long-handled tools, seed packets, mulches, products like three-point equipment that would be used for tillage. Things that work across that when you have -- when the snow's gone and the ground thaws, people start to use. Those types of things, to be honest with you, we delivered in the latter part of the first quarter, anticipating we may see a little movement. We did not see much movement in those categories. Subsequent to that, though, the weather is starting to change now, and now we're start to see movement in those categories. So it really is a delayed effect, is what we're seeing here, particularly in the Midwest and the North.

Got it. And then my second question related to gross margin. So the 31 basis point impact that you saw from freight, substantially higher than you saw a year ago. Diesel, which I know this typically tracks to some degree, didn't do very much over the course of the quarter, based on our measurements. I know that you alluded to the mix shift to CUE as a driver of freight. So now that the CUE mix shift won't be quite as pronounced over the remainder of the year, but it looks to be persistent, what structural freight impact do you expect us to see in a level fuel price environment?

Matt, this is Tony. When we look out, we believe that the transportation impact should moderate. You're correct, when we look at diesel, less of an impact. We have increased some of the stem miles, in which we have to deliver to our stores, especially as we open out our West -- a lot of the stores out West. And I think you will see some expansion, significant expansion, as we move into Colorado and Arizona. So, there is some additional expense relative to that. But when we isolate the transportation piece, we break it out for the conference calls, but obviously, there's a component that is part of our import initiative and that creates a positive effect net between the two.

So as much as we do focus on the transportation and that being a headwind overall, the major driver in that headwind is CUE product being much more freight intensive. And then, as we continue to allocate and match our freight expense, as we bring down the cost of goods sold and expense it, we will continue to match that up. And that tends to moderate, as well, as we get through the season and begin to sell the more margin fruitful product of spring. So again, as we look forward, we expect it to moderate but, we still expect it to be a significant headwind throughout the year.

Understood. Thank you so much.

Peter Keith, Piper Jaffray.

Just a couple puts and takes on the gross margin line for you, Tony. So previously with the full-year guidance, you thought that you'd get EBIT expansion of 10 to 20 basis points, largely form gross margin. Did that dynamic change? Should I hear you correct, it's more SG&A? And if so, when did that gross margin outlook change?

That's correct. As we looked at the year in the first conference call, our view is to increase EBIT margin 20 basis points. We said that we anticipated that 10 to 15 would come from gross margin rate improvement, and that 5 to 10 could possibly come from SG&A. As we went through this quarter, we see the increase in the CUE items and we look at the mix. We anticipate that that would actually level off and that it would be more of a 50-50 mix, and potentially SG&A on a full-year basis actually could contribute more.

Because the key to the operations, as we look at it, is as the CUE items become a larger percentage of the mix, we're going to have an impact on rate. Gross margin rate. However, that should continue to drive market share, continue to drive sales expansion. And as we drive that sales expansion, that's where we believe that we will get the SG&A leverage. So absolutely, the outlook has changed, when it comes to the relationship and the impact of gross margin rate and SG&A leverage. But we think that, as we demonstrated in the past, our model will work, as we continue to drive customer loyalty and market share.

Okay. That's helpful. So I guess, it sounds like it's mostly the dynamic around CUE Now, the drivers with CUE, or I guess the performance there, that's been strong for a couple of years. But it really seems to have accelerated here in the last few quarters, where now it's become a more meaningful gross margin headwind. What's been causing that, that acceleration within the mix?

Dave, this is Greg. I can tell you that it's market share. We are very conscious of gaining market share in categories that are meaningful to us as a Company and to our customers. There's been some adjustments down, Peter, there's been some adjustments down with the amount of independent feed stores, that steps dropped off, we picked up share there. We believe in the pet food categories, as we've enhanced our assortment and the buying teams have bought, really, a lot of newness into those categories, we're seeing acceleration there. And we believe that, again, that is market share gain. So, it really is coming back, it's market share. That's we believe and what we see in our numbers.

And Peter, when it comes to the first quarter, the weather had a significant impact on the CUE items. Because just for example, when it's cold -- and as long as it was cold this winter, you'd have to think that you don't have the animals out grazing. They are in and they're buying feed. So that was, I don't want to say an aberration, but that was a strong driver of transactions in the quarter. Additionally, for another example, would be when it comes to heating. In the winter, people that have wood-burning stoves are going to be buying a lot of wood pellets. So, another CUE type of transaction that's a consumable that will drive footsteps.

So we had a very, very heavy base this first quarter. And again, obviously had an impact on the gross margin rate. But to get through this first quarter and have a transaction increase of 2.2%, that was huge. And that's why, when we look back on the quarter, we think it was a very, very successful quarter and are very optimistic as we roll into Q2.

Okay. That's helpful, guys. I just want to sneak in one more clarifying question around the margin dynamics. It sounds like Q2 operating margin would be flattish, but myself and others would expect a meaningful comp acceleration in Q1. So, you're talking about EBIT margin expansion performance similar with Q1 on a better comp. Is that simply due to some of the extra SG&A around the DC and the support center? Or is there something else we're missing?

You know, there's definitely an impact. When we look at -- we talk about the $0.06 to $0.07, the majority will come in Q2 and Q3. So you'll see an impact in Q2. So that is a part of it. And a lot of it will have to do, as we work through the quarter and continue to manage the SG&A, it's currently our model. It might be a little bit more conservative, relative to entering the quarter, when it comes to the expense structure. But again, we're very optimistic when it comes to the SG&A leverage as we move into the quarter.

Okay. Thanks for all that detail, and good luck this coming quarter.

Thank you.

Brian Nagel, Oppenheimer.

My first question, I just wanted to follow-up on the answer to the question before me. But as you look at the strength in sales in this CUE category and the percent market share gains you are getting from that, is that increased wallet share with your existing customers? Or are you bringing -- is there potentially a new customer coming to your store for some of these products?

Brian, this is Greg. I would tell you, again, I think it's a combination of both. We look across our sales and we say, you know, if we've got a consumer that's buying feed and they have horses, let's say, and we say, they are not buying in our category of dog food or whatever, we start to talk to them. We start to get them to buy in the dog food category. That's a new customer now that we've acquired for that category of business. We do a lot of that.

At the same time, I think we have a very compelling offer in our store. Our balance of offer, good, better, best in these categories, is as good as anything that's out there, and our values on a day-to-day basis are better than most. We're not a high-low retailer. We price right every day, with some promotion. And I think I would say that's part of the secret sauce, and the word is out, and I believe customers are starting to recognize that. So it's a combination of both.

Got it. Second question I had, most was of the focus in the Q&A here on the shift in sales Q1 to Q2, with the weather and such. But Greg, you made a comment in your prepared remarks about your consumer holding up well, despite such things as higher taxes. Maybe just expand a little further. Given the results, it looks like indeed your consumer is holding up well. As you look at the data, is there anything to suggest maybe the consumer is even getting better from here? So many of us are focused right now with the improving housing environment and what impact that's having on spending. Do you guys see any evidence in your sales trends and how this is starting to have a positive impact with your Business?

I would say that there is nothing from a direct correlation that we've seen, yet; however, we know that when housing starts are robust, it seems to flow over and people seem to buy outdoor power equipment, the new lawn mower for the new house, and so on and so forth. I don't think it's robust enough yet for us to make a call.

I will tell you, though, that from what we can see in our mix of spend from our consumer, it's very similar to what we've seen from past quarters. I would say that because they're conservative in the way that they have smaller mortgages and the fact that they don't have large amounts of debt, they pay with a lot of cash, they are holding up well. Our traffic is, like Tony said, it's up 2.2%. So what else can you ask for? That's a good sign, a good health in the business.

Well, thank you.

Chris Horvers, JPMorgan.

A couple random follow-ups. So the CUE categories, can you share with us what the units and dollars were up? I think last year it was low double digits in the first quarter and high single, mid-to high singles for the balance of the year. Can you share what that category did in the first quarter?

It was really the strength. And I can tell you that it was significant and a major driver of the transactions and the volume in the first quarter. But we don't provide specific guidance as far as the CUE categories and how they performed.

Okay. Maybe it came out in the Q&A or commentary in previous. So--

We're pretty tight-lipped about -- (multiple speakers)

All right. Well. Fair enough. Then can you share with us, also, I don't know, did you share with us how much the incentive comp actually helped SG&A rate in the second quarter on a basis point level?

Again, we haven't given the specifics. I will tell you that it exceeded the amount of improvement, so it was clearly the main driver. Obviously, there were obvious other pluses and minuses, but the incentive comp was greater than the total improvement in the SG&A. But again, I would stress to you that the incentive compensation, which primarily consists of the annual bonus compensation, it's structured around a sales performance targets for the stores and operating performance target for the stores, as well as, obviously, a corporate or store support center bonus structure.

And so it's tied to how we drive the business, and that we believe that will provide leverage in times in which there might be some softness in sales, as well as we believe that it really returns well to the shareholders, as sales increase significantly in a particular quarter throughout the year. So, I think that's a key component in how we can manage the Business and drive the operating model.

Thanks very much.

You're welcome.

Adam Sindler, Deutsche Bank.

I wanted to turn back to gross margins for a second here. When you look at your CUE products, would you say that the combination of the merchandise margin including -- and then freight, so the all-in gross margin, is that still better than outdoor power equipment?

It all depends what category. But generally, it is better than the outdoor power equipment.

Okay. And then, secondly, on the CUE, it seems like just with the amount of turn in this business, not too dissimilar from what goes on in the auto parts space. Have you guys ever looked at a hub and spoke model, so that you didn't have to distribute from your distribution centers all the time? Especially things like Texas and the Northeast, where stores are clustered are a lot closer together, or even in some of your emerging markets?

Adam, this is Greg. The answer to that question is what we're doing with these mixing centers. That gives us the ability to be close to the manufacturer, as well as closer to the stores, to keep this type of product primarily out of the large DCs, which are used more for individual pick, and so on and so forth. And if it's palletized product, the key there is to move it with the least amount of touches to the store. So, that's really our solution longer term.

Okay. All right. And then just lastly, on outdoor power equipment. At what point in the season, just on that product specifically, would you start to mark down? And then, is it anything that's -- how significant is the markdown? I know it's a low margin item to begin with.

Well, the first thing is, before you take the markdown, you want to control what's coming through the pipeline. And as I said earlier, we have a very rigorous production planning process that we work with our LPE vendors on. For example, we already know that because of the drought situation in the west part of Texas, we're already starting to trim delivers to that part of our store chain, because the demand's just not going to be there. But in other parts of the chain, where we see demand is in front of us, we'll continue to flow product.

So when you talk about markdowns, OPE is a category that you try to avoid the markdown if you can, because what you want to try to do is sell it at either the regular price or some type of maybe gift-with-purchase scenario, so that you don't have to go through the markdown process. But we have very little markdown, honestly, in our OP equipment from year to year. We manage that business very effectively, and a lot of that is the partnership between us and our manufacturers.

Okay. Great. I appreciate it. Thank you.

Joe Feldman, Telsey Advisory Group.

Nice job in the quarter. Most of my questions were answered. I just wanted to go back to more of a bigger picture topic, though, that we talked about at the analyst day, which was on regionalization. And you guys touched on it, I think, in the prepared remarks. But just wanted to get the latest update on where things stand, as far as regionalizing the assortments and more store clustering. And I remember the example you've given us before about, even in your home market, where you could four or five different types of assortments within a 30-, 40-mile radius of the home office. I just wanted an update on that. Thanks.

Well, Joe, it's an ever -- improving all the time in the process. It's ever-changing. One of the things we are learning as we move stores further west is these assortments have to be different. We may have elevation of store. I'll give you an example in New Mexico. Higher elevation, lower elevation, valley touch stores. Very different mixes. And in some cases, we can model sister store off of that. In some cases, we have to do a little bit of trial and error.

But regionalization is ongoing. And we work at it every day. We are looking at our demand forecasting opportunities as we go forward. We take a lot of input from the field. So, I would tell you that we are still in the early stages. We're fairly good, but we're not great at this, just yet. So, there is more to do.

Got it. Thanks very much, guys. Good luck with this second quarter.

Thank you.

Simeon Gutman, Credit Suisse.

Quick question on CUE We know the impact from a freight perspective. What about on a store labor model? Does it change, or can you just reallocate? I don't know if it takes more time to get this merchandise onto shelves, et cetera.

It really has little impact. The stores are structured with their labor model to handle this type of product. And particularly at the velocity that we're selling some of those product, at full pallet-type sell-off, it actually can make it a little easier sometimes for the stores as they roll it out to the floor. It's almost like just-in-time inventory. As we're selling down the last four or five bags, they bring out another pallet, drop it down, and convert and go. So, really no impact.

Okay. And then on Live Goods, I think we discussed at the Investor Day, a lot of that is on recourse, if I'm not mistaken. To the extent there is shrink or spoilage if the season takes later to happen, is there -- most of it is recourse, but is there still some impact that the Company bears, whether it is some transportation piece of it or some other piece that's in the numbers, at least now or going forward?

No, not for this year. Our structure is set up so that it's scan-based. And we were more cautious than maybe some others, as far as how we would flow that product. I was actually traveling stores in the Florida region several weeks ago, and we were fully set there. And then I traveled some stores in the upper Midwest, and we had yet to set, because there was still the threat of frost and so on.

So for us, it's a new business. It's a business we're being cautious about and trying to do it the right way, and we're listening very closely to our partners out there. Because the people that grow the product and that have worked with larger based retailers on the product will tell you that being early is probably not good. Being at the right timing is what you need on the product. So, really no issues. We are very happy with the sell through and very pleased with the partnerships we have with our growers right now.

Okay. And last, competition in OPE category, are you seeing anything different from a pricing perspective from either big-box or from independents?

Again, it's early in the season. I would tell you, I haven't seen anything that's worrisome at this point. But we kind of run our own program. Our units are a bit unique. The features and benefits and what we build and what we need for our consumers who have more land and don't need a small deck, small type of riding lawn mower, they need something that's more durable, that's more industrial in strength. So, it really gives us the point of differentiation, and there's not a lot of crossover between our assortments and the others that are out there that we would compete with.

All right. Thanks. I appreciate it.

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

Thank you, Operator, and thank you all for being on the call today. As we've said, we're very pleased with the recent performance, given the weather impacts and such from a year ago. And we are a company that operates with a sense of relentless dissatisfaction. We are always looking to improve, and we are a continuous improvement organization. Remember, we are a growth Company and committed to 8% square footage growth, and we are still looking at a domestic store target of 2,100.

We have and will continue to have a pipeline of sales drivers for the Company. Our store team members are doing a fantastic job serving our customers, and that reflects in our improvement in our customer loyalty scores, which we track weekly, monthly and quarterly. We plan to continue returning value to our shareholders through earnings growth, as well as our dividend and share repurchase programs. Needless to say, we are and continue to be excited about our Business and about the opportunities that lie in front of us. Thank you today for your continued interest and support of Tractor Supply, and we all look forward to speaking with you again on our next earnings call in about 90 days.

Ladies and gentlemen, that does conclude our conference call for today. You may now all disconnect. Thank you for your participation.