Tractor Supply Co (TSCO) 2013 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Tractor Supply Company's conference call to discuss second 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 follow 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.

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 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 actual results to differ materially from those reflected in the forward looking statements are included in the Companies filings with the Securities and Exchange Commission.

The information contained in this call is accurate as only 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 Greg Sandfort, President & Chief Executive Officer. Greg, please go ahead.

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

We are delighted with our results and our level of execution in the second quarter. Despite a late start to spring with cooler weather early in the quarter, our team made the necessary adjustments to address those shifts while delivering improvement in sales and operating profitability. Our performance in the first half of 2013 demonstrates the continued strength and stability of our core business model.

At Tractor Supply, we continue to focus on our sales driving and margin enhancing strategic initiatives. And through our expansion of our exclusive brand offerings, better localization of our assortments and the improvements in our supply chain capabilities, we are increasing our market share and improving our profitability as a company.

Our previous call in late April, we discussed that the second quarter started with much cooler weather and, as we had anticipated, we experienced a slower sales ramp into spring. We adjusted our plans accordingly for this shift, and, although we felt we did not recapture as much of the postponed spring seasonal sales from the first quarter as we would have liked, we are pleased with our team's ability to deliver strong comparable store sales increases over a year ago.

While certain big ticket seasonal products such as riding lawn mowers did not rebound as we had hoped, we experienced strong sales trends in our CUE categories, our new live goods and garden products, poultry as a category and apparel and footwear. More importantly our teams managed our seasonal products effectively, and we finished the quarter well-positioned with current high quality inventory as we enter the back half of the year.

Now let me discuss our second-quarter results in a bit more detail. Regarding sales drivers, our CUE categories, the consumable, usable and edible part of our business remain strong. These are need based items that are driving repeat footsteps into our stores.

The repair and maintenance parts business for outdoor power equipment, a CUE category, has traded above last year's sales levels reinforcing the behavior that our customers are repairing their products to extend life versus replacing. CUE remains a foundational piece of our sales driving strategies, and we work dilligently every day to enhance and expand these products to meet the changing needs of our customers.

Another strategic area of focus for us is driving sales in our drive aisle and center court areas where we strive to maximize sales per square foot. We utilize this space to host special events and to introduce new and seasonally appropriate products. This is not only -- this not only enhances customer shopping experience and expands the overall size of the customer's market baskets. But it also signals to our merchant teams what products customers have the most interest in purchasing as we build forward assortments.

One such event was our garden event which provided our customers with a selection of new products and great everyday values on seasonal commodities such as seed, soil and fertilizers. Additionally, we hosted a poultry event during the same period labeled chick days. During this event we provided our customers with a wide array of items related to raising poultry. Both of these planned events performed well, delivering results above the prior year.

Our introduction of newness into our stores utilizing our test and learn approach continues to gain momentum. One great example is our live goods program which we began testing about three years ago. In this category we expanded our assortments of bedding plants, vegetables, seedlings, herbs and fruit bearing trees. Our customers have responded well to our offerings, and we are optimistic about the potential for further expansion of this business over time.

Our exclusive brands continued to exhibit growth during the second quarter and accounted for roughly 29% of our sales mix. Exclusive brands are an important differentiator for Tractor Supply and a key initiative in and driving increased footsteps, customer loyalty and improved profitability.

During the second quarter we continued the expansion of our 4Health exclusive brand dog food through the introduction of grain free products. Customer response has been very positive. This is an expansion of our super premium assortments which continues to be one of the fastest-growing segments in our pet food category. We also added several new products to our pet health department with similar positive responses from customers.

To summarize, I am delighted with the team's ability to manage through the numerous variables and seasonal shifts we faced during the quarter. The diligent work of our teams both at store level and at the store support center was exceptional resulting in solid comparable store sales, transaction count improvement and another quarter of double-digit growth and profitability.

I will now turn the call over to Tony to review financial results and discuss our outlook for the remainder of 2013.

Thanks, Greg, and good afternoon, everyone.

For the quarter ended June 29, 2013 on a year-over-year basis, net sales increased 12.7% to $1.46 billion, and net income grew by approximately 15.9% to $123.6 million or $1.75 per diluted share. Comp store sales increased 7.2% for the second quarter compared to last year's increase of 3.2%. As Greg discussed, although there was much later start to the spring this year, spring did finally come and correspondingly drove solid sales performance. Although we believe we did not recapture all the postponed seasonal sales from the first quarter as a result of the delayed spring, we did plan for the seasonal shift between quarters. And managed accordingly to deliver strong performance for the second quarter and the first half overall.

The animal and pet categories continue to be the main drivers of our business with strong comps that were above the chain average. Seasonal categories such as live goods, certain gardening categories, outdoor recreation and rubber foot wear all performed well above Company average for the quarter and the season.

Comp transaction count increased for the 21st consecutive quarter gaining 4.8% on top of a 2.9% increase last year. With the delayed spring and the continued strength of pet and feed products, two products that serve our customer's basic and functional needs continue to be the key driver of the transaction count increased. Average comp ticket decreased by 2.3% versus last year's 11 basis point increase. The increase was driven by inflation and mix and to a lesser extent big-ticket sales.

A few key points about the quarter. Despite the slow start to the quarter, sales were consistent with our expectations. Adjusting for the $38 million pull forward sales into the first quarter from the second quarter last year, comparable sales to this year would be very consistent for each quarter in the first half with the year-to-date comp of 4.2%.

On a regional basis our warmer regions performed the best as they were the least impacted by the delayed spring weather, and all regions generated positive comp sales. As we anticipated, April was the softest month of the quarter with May delivering the strongest comp store sales gain. All three months achieved solid positive comp sales. Big-ticket delivered a solid comp sales increase but was below the chain average. For the quarter we did have a comp sales increase in the riding lawn mower category which resulted principally from the weather related sales shift between quarters compared to last year.

For the overall season the riding lawn mower industry continues to be sluggish which was reflective of our first half performance in that category. We estimate that inflation was approximately 140 basis points and was within our projected range of 1% to 2% for the full year.

Import sales increased 25% and represented 10.8% of sales mix. Exclusive brand sales also increased by almost 25% and represented 29% of total sales.

Turning to gross margin which as a percent of sales decreased by 18 basis points to 34.8%. This was consistent with our outlook as we anticipated the gross margin would be flat to slightly down in the first half of the year. Our initial direct margin continues to improve significantly as a result of our initiatives around price optimization, mark down management and strategic sourcing. The largest factor offsetting the benefits from our margin enhancing initiatives was merchandise mix which we estimate had a negative impact of approximately 40 basis points.

This was primarily related to CUE products which continue to make up a larger percentage of our sales compared to the prior year. We continue to manage gross margin dollars per unit which again increased in our CUE categories this quarter.

Freight increased approximately 16 basis points principally as a result of the continued mix shift to freight intensive CUE products as well as costs related to increased import activity. We also opened a small percentage of new stores relative to the total store base in the first half of this year compared to last year. We estimate that this had a negative impact on gross margin in the quarter of approximately 10 basis points as new stores generally run a stronger margin.

For the quarter, SG&A including appreciation and amortization was 21.2% of sales reflecting 63 basis points of improvement from the prior year's quarter. As we have discussed in the past, although our increasing mix of CUE sales impacts gross margin rate, it also provides us with an increasing sales base that allows greater leverage of SG&A expenses. We continue to effectively manage and leverage store level operating expenses. Even in light of a very strong sales quarter, our incentive compensation program provided 13 basis points of leverage. We are pleased with our ability to leverage SG&A despite the additional costs related to our DC and data center relocations which we estimate negatively impacted EPS by approximately $0.02 for the second quarter.

Our effective income tax rate increased to 37.4% in Q2 compared to 37.2% last year. The increase was due principally to higher effective estate tax rate and reduced federal tax credits as well is a small percentage of incentive stock option disqualifications relative to a higher taxable income base.

Turning to the balance sheet at the end of Q2, we had a cash balance of $56 million compared to $179.1 million last year. During the second quarter, under our stock repurchase program, we acquired approximately 177,000 shares for $19.4 million. Our stock performed very well during the quarter which limited the purchases under our Matrix 10b-5 plan. We estimate that the share repurchase program did not have a material impact on EPS for the quarter.

Average inventory levels per store at quarter end were 4.7% higher than last year while annualized inventory turns increased by 10 basis points and 3 basis points for the quarter and year-to-date respectively. We are pleased with the productivity of our inventory during the quarter despite later inventory carry in a number of spring categories related to the later extended spring season this year. Additionally, we shifted some Q3 receipts to the end of the second quarter this year and also carried additional inventory to support the transition to our new Southeast distribution center both of which contributed to our higher inventory levels at quarter end.

Overall we do not anticipate any mark down exposure in Q3 outside of our normal clearance activity. In fact, we believe we are in better position than last year to clear our spring inventory productively given our improved inventory turns as well as improved moisture levels and fewer drought affected regions relative to last year.

Capital expenditures for the quarter were $49.3 million compared to $33.8 million last year. We opened 26 stores this quarter compared to 18 stores in the second quarter of 2012. The increase in capital spend relates to the construction of our relocated Southeast distribution center and the construction of our new store support center.

Turning our attention to the full-year outlook, as a result of our stronger than expected operating performance in the first half, we are increasing our net income expectation for the full year 2013. We now expect net income to be in the range of $309 million to $315 million or $4.36 to $4.44 per diluted share. This compares to our previous guidance of $304 million to $310 million or $4.32 to $4.40 per diluted share.

When now expect full-year sales to range between $5.1 billion and $5.17 billion compared to our previous expectation of $5.07 billion to $5.17 billion. Correspondingly, same-store sales for the year are expected to increase 4% to 5% to our prior expectation for an increase of 3% to 5%. Based on the volume of our share repurchase program year-to-date, we are also adjusting our estimate for full-year diluted shares outstanding to approximately 70.9 million.

While we do not see any changes to our estimated range for capital expenditures of $240 million to $250 million, we are trending at the lower end of the range. The new store pipeline is full, and we continue to track very well to our full-year goal of 100 to 105 new stores. Inflation has tracked as expected, and we continue to estimate it will be approximately 1% to 2% for the full year with the back half projected to be in 0.5% to 1.5% range as we begin to cycle the high corn prices from a year ago. With respect to margin for the full year we continue to expect to achieve slight gross margin rate improvement due to the execution of our key gross margin initiatives.

Also we believe we have easier comparisons to the clearance activity we experienced last year, and we will also be tracking some emergency response activity in Q4 last year related to hurricane Sandy. We expect that the mix shift to our CUE products which carry a margin rate below chain average of continue to present a headwind but should start to moderate slightly. We also expect freight cost to remain a headwind due primarily to the continued mix shift to the more freight intensive CUE products as well as increase in core container volume.

With respect to SG&A we expect to have a drag in the second half of the year of approximately $5 million to $6 million or $0.04 to $0.05 in EPS related to the relocation of our Southeast distribution center and our corporate data center which for the most part will be expensed in SG&A in Q3. We also saw an uptick in our medical and other fringe benefit expense trend line and have forecasted a larger increase in the back half of the year.

As a result of the impact of the DC and data center charges and the fringe benefit increase, we expect to have a flat to very slight SG&A leverage in the back half of the year. Based on the above discussion we anticipate that our target EBIT margin improvement will be driven more by gross margin rate improvement than by SG&A leverage in the back half of the year.

For the full year we are increasing our forecast effective tax rate to 36.7% from our previous guidance of 36.5%. The increase relates to the higher effective state tax rates and a smaller percentage of incentive stock option disqualifications relative to a higher taxable income base this year.

So to conclude, we again executed very well in the second quarter despite a slower start to the quarter than we would have liked. The core business is very strong, and we saw seasonal sales accelerate as the weather warmed producing solid financial results for the first half overall and positioning Tractor Supply for a healthy summer selling season.

So with that I would like to turn the call back over to Greg.

Thank you, Tony. Regarding the current retail environment, we have seen relatively no change from recent quarters with the behavior of our customers. They continue to purchase conservatively seeking compelling values based upon need rather than want. We continue to adapt our assortments to meet their changing needs while continually elevating our in-store experience.

Before I close, I would like to provide an update on a few of our Company's current initiatives. Our new distribution center in Macon, Georgia, which is the relocation ff our Southeastern distribution center in Brazleton, Georgia, is now complete and operational. The facility is currently receiving inventory, and we expect to begin shipping to stores from this location later in the third quarter.

Construction of our new store support center in Brentwood, Tennessee, which will enable us to consolidate our three leased store support center locations into one owned facility that will accommodate our growth for many years is on track. And the project is scheduled for completion in the back half of 2014.

The functionality enhancements to our website continue, and, while there was still much more to do, we are encouraged with our results thus far. We have completed the upgrades to our website for drop shipment of products from vendors to customers, our Franklin, DC is functioning well as our online in-house fulfillment center. And we are adding more SKUs each quarter to expand both the breadth and the depth of our product offerings.

Our annual square footage growth continues at approximately 8% as we further expand into the West. We now have a number of stores open in the West, and we see more growth for this region over time. We currently operate stores in Arizona, Colorado, New Mexico, California and soon to be operating our first stores in Wyoming and Nevada.

Looking forward to the second half of the year, I am confident about our plans and the forward momentum we have as a Company. We are executing at a high level making continued progress on our sales driving and operating margin, enhancing initiatives. And we are regularly introducing product newness into all our stores to ensure our customers stay highly engaged with the Tractor Supply brand.

In closing, I would like to thank all of our Tractor Supply team members for their ongoing hard work, passion for our customers and commitment to our Company with special recognition to all of our Oklahoma team members impacted by or helping those impacted by the recent tornadoes. Our team members are the driving force behind Tractor Supply's growth, and we all look forward to a successful second half of 2013.

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

Dan Wewer, Raymond James.

Greg, in five of the past seven quarters, the gross margin rate has been flat or slightly lower. I know that you're expecting margin to improve the second half of the year, but do you think we are possibly at the point where the future significant gains of gross margin might be unwise and perhaps it is best to start returning some of those efficiencies to customers to drive market share?

Dan, great question, let me answer it this way. The mix of our business continues to shift in a positive way to CUE which is the foot drivers of our customer base and really is kind of the basis of how we structured the Company back in '08 or '09 when we made some changes to some of the assortments. Gross margin rate on just a straight topic conversation is something that shifts between quarters based on not only mix but other factors and other variables. As Tony mentioned in his comments, our direct margin is actually increasing at a very nice rate, and that is the positive side of gross margin. We are still fighting some headwinds with freight. We are still fighting headwinds with overall mix.

We believe we will start to normalize more of that as we get into the third and fourth quarter as we cycle through. And I believe we have a better handle on what is happening as we go forward, but I would agree with you that the steep incline that we have seen maybe in the past three or four years may not be the same as we go forward. We are still are confident, though, we can still get the 20 basis points or so as we said each year. And remember our new operating margin goal is still targeted at 10.5%.

Right, and then just a follow-up question for Tony on the new store growth and square footage. It looks like square footage is up about 7.3% year-over-year. In your prepared comments you noted that it would probably wind up the year at around an 8% growth. Could you discuss why the store openings I guess are somewhat back loaded and how that might impact your expenses the second half of the year?

Sure, you are absolutely correct. The first half grew a little slower than we had originally anticipated. Some of it had has to do with the wet weather and pushing back some of the stores. Some of it has to do with obviously some lease negotiations that pushed out some of our deals. We do anticipate easily hitting our number of the 100 to 105, and they will be a little more back loaded into the October and even potentially November time frame. From an expense standpoint when it comes to the pre-opening, those costs have been relatively flat with last year so you again from a model standpoint -- you can predict those. As I noted in my comments, in the first half of the year by opening up fewer stores on a percentage basis, it has a slight impact on margin. We would expect in the back half that would help margin slightly.

Thank you.

Peter Benedict, Robert W Baird.

It is actually Justin Kleber on for Pete. First for Greg, just on the traffic number, obviously another strong number here, can you guys maybe discuss the frequency of your average shopper -- how that has evolved and changed over the past few years? Is the visitation gap between your best and maybe your average customer becoming wider, or do you think it is narrowing?

Great question, Justin, and we typically don't talk to some of those specifics. What we can tell you is the number of trips the consumer seems to be making to our store is growing. It is more consistent than it was in the past. I think it ties itself around the CUE strategy. These are consumable, usable, edible, necessary items, and as long as we can keep the customer engaged there, and I will also tell you I think it is a gain of market share across many of those categories we have become the most dependable supplier of, that is what is driving it. We've got some statistics we do track at our best customers at the very high end of the scale and what I would call probably our more moderate customer usage, and we're seeing more footsteps clearly.

That's great. Tony, some clarification on the guidance. It looks like the earnings grew about 18% in the first half of the year on a comp slightly over 4%. And your second-half guidance seems to imply a comp of at least 4%, but the earnings growth looks to be about 13% at the mid-point. Is that deceleration simply the DC and the data center cost and the healthcare issue you noted, or is there something else that we should be aware of? Because I would have thought the inflection in gross margin you were expecting would offset some of those headwinds in the second half?

You are correct. The margin does -- the gross margin does offset some of the SG&A expense, but the real pullback or headwind is the anticipated cost of transitioning to full operations on the distribution center and then the subsequent relocation of our data center. One of the big driving numbers is were going to be running duplicate rents for both of those locations until the end of the year. We will be able to cycle some of those costs as we move into next year.

So that rent -- is that included in that $0.04 to $0.05 you called out?

That is included. As well as there is temporary labor that is included, and there is obviously some handling and movement of product between the former DC, the lease location, and the new location. So those are really the largest expenses.

Okay, thanks.

John Lawrence, Stephens

Greg, would you comment just a little bit -- you mentioned recently a lot about regional assortments. Would you talk a little bit of that and the program of how much of these stores are now getting inventory regionally versus from other methods?

John, we have become a little more refined than just talking about regional. We're really talking about local -- localization is our new moniker if you want to call it that. It is because, as we move into different parts of the country, stores that are, and I'll give you an example. Stores that are in a mountainous region versus stores that are maybe in a valley. They may be in the same state, but they act very differently, the needs are very different. So, I had mentioned before that we have about 600-plus different types of assortments out there in our stores based upon their locations and their regionalization, but we've taken it a step rather and were looking at the local level. A lot more input from the management teams in the field, and we still have a lot of work to do, but we do our homework before we go into a new area of the country. And we are understanding the needs of that market much better. A lot of work there and a lot of assortment planning and planogramming work that is done well in advance of those stores' opening.

Great, thanks. And, secondly, left-hand side of the store, tools, et cetera. I know you've been doing a lot of work there the last several years. Anything to update there that is going on?

If you have been in our stores recently, you will note we are expanding what we call the hardware set, and we're revamping it. We're making some moves to shift product categories around, place some new products into that area, and we are this year we will be moving several hundred stores into that new format. We have tested it for a few years now, and we are happy with the results. You will see that left-hand side changing a bit, and that whole hard lines component. Still having seasonal toward the front and placing the hardware component in a little different setting, you may call it. And we've also done some work in the back there within the automotive and truck and tool. (multiple speakers) work.

Thanks, last question on cross [duck] on the feed, any update there in Texas?

The current test is complete. We are very happy with the results, and we are currently beginning the process of trying to locate a facility in the same region to actually start to roll this process forward.

Great, thanks and good luck.

Michael Lasser, UBS.

First on the gross margin side, I think last quarter you had 65 basis points of pressure from the mix shift in CUE. This quarter it was 40 basis points, and you had the overall gross margin degradation was about the same. Can you connect those two points? Did you see less of a benefit this quarter from some of your gross margin initiatives?

Michael, this is Tony. We saw actually about the same increase when it came to the direct margin piece, but there's obviously so many other variables as far as the way we look at margin internally. I highlighted the larger pieces, in particular, the impact we that get from the new stores and also the way we manage markdowns during a particular quarter and then some of the programs we put together with our vendors. That all comes into play and can impact a particular quarter but from a standpoint of our initiatives, they are really driving a very strong initial direct margin on the products that we are bringing in now. So we are very pleased with how that is working and truly relates negative or the degradation really is a result of the mix of the product.

The rate of improvement from -- on the direct side was similar in the second quarter to what was in the first quarter?

Correct. It's a very strong performance. As we look out, we are anticipating the headwind we do get from the CUE items should start to moderate and should decrease slightly.

Why is that?

One, as we cycle some of the higher cost from last year. And then with the anticipation that some of the pricing will come down in some of the feed categories in particular. You have the opportunity to be able to better manage the rate. In times of escalating prices, we will manage as we've talked in the past to try to get a certain dollar per bag or dollar per unit as we go through lower inflation or potentially deflation in some categories. We will still manage to that same dollar per unit, but that dollar per unit now returns you a higher margin rate. So we believe the degradation that we get from that headwind will be a little less or start to moderate in the back half.

My last question on that point, we've seen some volatility in commodity prices, grain prices, corn prices. What sort of impact is that having on your customer, and what have you assumed about that in the back half of the year?

There has been some volatility. Some of it has been more conversation than actualization. It has been a little more steady than you would suspect. As we look into the back half, like I just previously mentioned, we do expect some of the prices to be less than they were last year. Although we have yet to see that sort of precipitous decrease in any of the particular grains we deal with. And as I stated previously, we would expect that would benefit margin rate in the back half of the year.

So will it have an impact on the amount of income that your customers are going to have such that they may have less to spend in your stores?

It's a possibility but right now we don't anticipate it having a significant impact. Obviously we will have to work through that as we see the environment and the economy in the back half of the year. As we said in the past, it generally has more of a trickle down effect into the economies that we deal with in the Midwest, and it tends to be a little more isolated and generally would not have a significant impact.

Okay, thank you for all the helpful comments.

Matthew Fassler, Goldman Sachs.

One cleanup question to start with, you talked about the investment from the DC relocations, et cetera, and the expansions from the second half of the year. Did you give that number for the second quarter?

Yes, it was about a $0.02 impact on EPS.

Got it. That's helpful. And then secondly if you could comment on essentially what you saw in June. Obviously April was a challenging month given the later start to spring. We heard a lot about precipitation in certain parts of the country, what impact did that have on your business in the quarter, and how does that set you up -- how does that influence the set up for Q3?

As I said in my comments, all three months were strong comps relative to obviously the overall quarter. That is the detail that we provide for June. The other thing that I would comment on is that we believe this year there is been more moisture. We believe that also, when it comes to drought, it is much more isolated, and it is isolated more in sort of the Southwest area of the country. And last year it extended much more into the Midwest. We believe the weather conditions do provide for little more extended spring/summer selling season. We think that bodes well obviously for the June performance as well into some of the July performance. Also, as an editorial, I would say any type of spring performance does start to moderate significantly as we move into July and the August time frame. So it becomes a much lesser portion of our sales.

Thanks, Tony.

Austin Pauls, RBC Capital Markets.

I have a couple of high level questions on the topics of market share and competition. With respect to some of the bigger box national retailers that maybe don't focus solely on the farm and ranch segment that you do but do have some overlap with you in certain product categories, are there any signs of those retailers are seeing the strong sales growth you have been putting up, and have any interest in expanding their assortments in those areas? Secondly with respect to some of your smaller more regional competitors that do focus on your core rural customer, are you seeing any actions from those companies on market share, whether it is more competitive pricing or potentially even increasing their own new store growth plans?

Let me start with first -- this is Greg. Interest or signs of interest from the large box retailers that may sit around us, on occasion we will see one of these -- or several of these guys will get into some of the businesses in a small way looking at it as a potential, I believe, a potential foot driver for them. The differences we are in this business to stay, and our customers understand that about Tractor Supply. If someone else wanted to jump in and out of the business, that doesn't make you an authority. And I think over the long haul what we see is the customers continue to come back to us. We have not had anyone that we can tell from our core customer base that would be moving to a big-box or something like that to buy some of these products, because they don't really have the expertise to talk to them and to really sell them to the consumer.

The second piece about regionals. Some of the regionals when they move into their markets have a tendency to believe it is about price. Our belief is it is about a better store, a better assortment in that store and it's about a good -- a great customer experience along with a fair price. Most compete on a high low basis, we do not. We compete on an everyday price basis with some promotions. They have a tendency to try to play the price game. We will in many cases play the match game for a period of time, but in the overall scheme of things we tend to win that battle. I'll also tell you that in some instances as our growth of store base has expanded, many of what I will call the smaller independents who are specialty retailers in either feed -- maybe it's a pet operation -- maybe it's a tack operation -- maybe it is something that is just in three point equipment. We have a tendency to be the store that can draw that consumer to one location and make the purchase versus having to go to multiple locations. We somewhat I guess outman them from the standpoint of our assortment having a one-stop shop. A number of factors. We continue to run our game and play our game and we continue to improve what we do. And I think we will continue to win.

Okay. Got it. Thank, you guys.

Denise Chai, Bank of America Merrill Lynch.

Could you talk about some of your progress in newer markets like Colorado where you've been operating now for a bit over a year? Any early learnings? What do you see as some of the key differences from your core markets in terms of the customer and also the competitive environment?

This is Greg. I'll speak to that. We studied the Colorado market, and we will study any new market for a period of time before we will open our first store. What we found was that the consumer was being underserved in some aspects. There were some requirements expected of us if we were going to compete with those independents and we'll be the points of differentiation that we could exploit versus what that competitor regionally was doing. That is a little bit of a simplification of how we go about it, but we've had great success in Colorado and in a number of other states as we have expanded because of using that formula.

Okay. Great. Thank you. Going back to your 25% growth in exclusives, could you talk about what categories are driving this? I saw that you were advertising your expanded paint and tools assortment. Is this another opportunity to put more exclusives into the stores?

The exclusive brand categories are growing for several reasons. One is we are offering the customer a far better value equation for their hard earned money. Secondly there are always gaps in anyone's assortment that can't be filled by a national brand, so we are able to use our exclusive brands to fill those gaps. And I would say, third, across the store we are finding opportunities but we don't try to force those opportunities. We test them first and let our customers respond. If they give us the positive response to allow was to take it to the next category or the next extension of products, we will do that. And that's worked for us. It's been successful to this point. And that will be our plan going forward.

Great. Thank you.

Chuck Cerankosky, Northcoast Research.

As you are looking at new store openings, any change in the real estate market out there? Any sense that supply is tightening or the cost of sites is going up or things of that nature?

Chuck, Tony. We have seen that some of the rents have been increasing. Very modest, and it has not impact our ability to identify locations and/or to obtain a very -- the required return that we would expect to get out of our new stores.

Do you cover that increased rent in the pricing of that individual location, or is it sort of the overall pricing of the chain?

It is going to vary from state to state so we are going to see different prices in the various states. Generally, we are going to cover that through the increased sales level that we would anticipate getting from that particular marketplace. So, as the economy rebounds, if the rents rebound, we are generally going to be able to drive some additional sales volume that would easily cover any additional rent expenses we would have to manage.

Somebody earlier might have said this, but I want to get a clarification, did you say the new store mix in the most recent quarter skewed to a somewhat lower size?

No, I would not say that. We just opened a few less stores in the first half of the year relative to the prior year.

Got you. All right. Thank you.

Jeff Black, Avondale Partners.

Thanks, congrats. Nice quarter. Just to sharpen an earlier point, your gross margin guidance for the second half, is that premised on CUE lessening as a headwind from that 40 basis points, or is it premised on the margin initiatives you are working on kind of offsetting in total the CUE headwind? Then on the inventory, you mentioned that we had some more carryover but you think there is less margin risk to the carryover. Could you clarify what's really going on with the inventory build at least from the Q2 [sub] leftover aspect?

Jeff, I will take the inventory and let Tony talk to gross margin. At the end of the quarter, we already planned to have two facilities operating, Braselton and Macon. We had already indicated that there was going to be some carry of inventory -- basically duplication of inventory for a period of time as we ended the quarter because we still would not be fully transitioned to Macon. So that was some of the dollars. Some of the dollars were also an investment piece we made as we saw the quarter start to open up with sales. We said let's get ahead of it. Let's make sure we keep the CUE categories driving business as they were. So we made some I would call it inventory investment forward to make sure that we stayed in the stock positions we wanted.

And then the last piece was something to do with the end of the quarter, we had some early receipts of third quarter that actually came in about say a week early by the end of the quarter. That shifted in. That was probably the largest impact overall for the quarter. That is all forward inventory, it just arrived here about a week earlier than we would have liked, to be very honest. But the way we book our inventories, if it's been picked up, if it's in transit, it's going to get on the books. That was a larger portion of it, but we are in great shape for our transition out of spring and into summer and fall.

When it comes to gross margin guidance in the back half, as I noted in the comments, we think we are up against easier compares. As Greg just mentioned, we like where we are relative to our inventory position. So we believe as we go into the spring clearance mode we will be able to manage those markdowns effectively. We obviously n the back half of the year also are going up against some emergency response from Sandy. That last year carried a lower margin, so we believe that is an easier compare as well. We will be opening a lot of new stores in the back half, and that could have a slightly positive impact. Then, in addition to seeing some of the impact of lower prices in some of the grains, we would anticipate that the headwind from the rate impact on margin could moderate as well -- as well as the mix starting to moderate as well.

A lot of different factors affecting the back half. Obviously, I wanted to make it clear we really expect to have some gross margin momentum in the back half that we had not experienced in the first half. And then with that additional charge for the DC and the data center impacting SG&A, the back half just will act a little bit differently than what we saw in the first half. I just wanted to make that clear to everybody.

Okay, good luck, guys.

Thank you.

Chris Horvers, JPMorgan.

Following up on the inflation question, I still expect about 100 bps in the back half on inflation. Is that the chemicals business driving the positive move in the food category? It seems more like disinflation. And related to that can you talk about the inflation outlook in maybe the horse side versus the dog side in the food category.

We would anticipate that -- there are so many different categories. Were looking at over 340 different categories and they all react a little bit differently so it's hard to isolate. We don't have anything that we are seeing that has a significant increase to it. We are probably looking at a very modest increase across the majority of the categories. And where we see sort of that offset to bring it down from what we experienced in the first half really is more on the grain side of the business and the animal feed. So that is why we think it will be a little bit less as we look at the back half of the year.

Understood. And you would include the dog food in there as well?

No, we look at the pet food side as generally being flat in the back half of the year.

Understood. And then on the live goods, can you talk about how many stores that you had live goods in during the spring season where it compared to last year? And how do you think about the number of stores you that you can and want to get that into? And do you think eventually down the road there is a garden center perhaps on the side of the store using up some of the yard?

Chris, this is Greg. First of all we had limited stores in 2012. We were still going through some more testing. This year we had an excess of 500 stores with live product. I would tell you that we are finding that side lot if you want to call it which is now our area for storage can be productive if we can place the right products there. So I won't give you an absolute on the fact that that's where live goods may wind up and will there be a garden center there, but I will tell you that we are pleased with the results. We are still looking at how we would position the business for next year if we take it to more stores in the chain. It is a business that has to be run regionally so we have to have the availability of product and the growers there to be able to service it. But we do believe that there is future growth in that category.

Thanks very much.

David Magee, SunTrust Robinson Humphrey.

A couple of questions. Is it possible to assess what the longer-term penetration would be of the CUE category? Is that something that you think will be growing rapidly throughout next year? How do you all assess that?

David, as you know it is a number of different categories. It's not just the feed, food or whatever. There is a multiple of things that we have classified under CUE. It is really the products that we would consider would be footstep drivers and what I would consider to be the most dependable supplier of these are the items the customers can count on when they come to our store. Its overall penetration that is growing because we are gaining market share from others around us and were running a much more powerful business, a business that as well priced day in and day out. And with our new price optimization modeling, we are able to do that. I can't tell you today if there is a percentage or not, I can only tell you that we see further growth as we go forward. But we also see it more becoming on a run rate of where we have been. At this point we are happy with it because it is bringing a lot of footsteps. You saw that with over 4% increase in transaction count. The customers are continuing to come to us. Over time that gives them the opportunity to shop other places within our store, and that's where we can build more margin. It will be a balancing act as we go through the next couple of years.

Thank you, Greg Secondly, with the enhancements are making to the eCommerce site, any update with regard to your thinking on the ultimate profitability of that business and perhaps the penetration there, too?

Even some the most developed retailers out there that have websites, they are doing sub 3% and 4% of their overall business on the web. In my thought process about the web, it is first, just another vehicle for us to exchange either commerce information or just exchange commentary with the consumer. It is a way for us to understand what they are purchasing from us and why and how we can go back to them and talk to them about things they are interested in. The commerce side of this is a little longer term from the standpoint of its ramp and its run.

Because you have to have a number of things, as I said earlier in my prepared comments about having capabilities. But we do believe there will be some business for us longer-term, but I believe what it does it drives -- it probably drives more business for our stores than it will probably drive online by a great margin. So the store business -- we are a four wall retailer, and this is another way to exchange commerce, I believe, with the consumer. And we will not be probably any more than some of the best at retail today as far as the percent to overall sales.

Great. Thanks, Greg.

Adam Sindler, Deutsche Bank.

Sorry to go back to gross margins again, but just when we're talking about the back half of the year, really the comparison is not easy in the fourth quarter. It's not too much lower than what we saw in the second quarter. You were up 80 last year in the second quarter up 50. On a run rate in the second quarter this year you were probably about plus 50, plus 80 and then minus 20 or something like that, up 60. As we look to the back half of the year, is most of that improvement going to be weighted to the third quarter? And then sort of for the year, how are you looking at gross margins? Are you looking flat for the year? Are you looking slightly up? What would you say about that?

As we look at the back half, we see a lot of the opportunity in Q3, but as we move into Q4, the one thing about Q4 is that there is a lot of import activity, so we have the potential of driving some gross margin improvement there. The new stores we opened in the back half are weighted toward the fourth quarter as well. We always believe we can go through the season more effectively as far as managing markdowns. We are hopeful that it will be a little colder in December and that will provide us the ability to manage through the holiday season some of our obviously insulated and cold weather products. We definitely recognize it is a tough comparison as we move into the fourth quarter, but we believe there are some variables that we can deal to react and drive margin improvement in both the third and fourth quarter.

Okay. On the merchandise outlook, obviously live goods was very successful for you guys in the summertime this year. Any sort of new tests you are working on for the winter?

Adam, there is always new tests. I've always said there would be 40 to 50 ongoing. Yes, we will bring -- continue to bring newness to the stores and continue to have testing, but I'm really not at liberty to tell you the specifics on it. I can only tell you to visit our stores. You will find it.

All right, very good. Thank you.

Arum Rubinson, Nomura Securities.

Thanks, good evening and great results. A lot of questions have been asked so I will focus my attention on kind of CRM. I know you guys have been working hard on understanding the makeup of your customer more over time. Can you tell us a little more about what you have learned so far? Specifically I'm interested in the distribution of customer and visits and your best customers representing x percent of sales. I'm wondering if you can give any inkling there? And then I have a follow up.

Let me give you some insight, this is Greg. We are spending quite a bit of time on understanding our consumer. We have developed a five-year road map which we are now in the initial stages of starting to roll into that plan. The first thing we understood we had to do was pull all of our data together on customers, and we have it in a number of buckets in the Company. We're doing that merge right now. Once we have that information we will be able to start talking to this customer and looking and cross-referencing. As they buy one category, are they buying another category. And if they are not buying into that category, why aren't they? And so on and so forth. And we have some current learnings through some of the initial merge of some of the information. We actually used that in the middle part of this year during the July 4 period. We did change some distribution using that information, and we had very, very positive results. We know the power of it, and the matter of fact is we have to start to harness that. So that's going to take some time. We do have a very rigorous process we put into place. We are in the first stages of doing that first consolidation, and we will be able to share more with you as time develops.

If I could follow-up in the absence of kind of science on the CRM side, you got [art] which is testing and experimentation in some of those tests are working and some are not working. If we could use that as a proxy for CRM, can you tell where you see your bandwidth with customers? Are there any up obscure tests that are succeeding or obvious wins that are failing? I'm curious where you getting permission from that customer and let's say shortcomings in that regard, too?

What I can tell you is in some of our current learnings, we were spending some time about a year ago talking about the aware non-shopper. We were not sure if this was a suburban or if this was a more suburban rural type of consumer that lived around the edge. I can tell you what we found out in our current research is they are actually live much closer to the store than we thought. These are the customers that don't shop us but would have an interest to shop if they understood what was inside the box. So that is just one segment of a number of things that we have learned. How we are going to market to them will be different. How we will attract them to the store will be different than our core customers who already know us and who already spend money with us. It is exciting news and I'm very anxious to get more of this information and take this data and convert it into information we can use across the Company.

Thanks and best of luck in the back half.

Thank you.

Simeon Gutman, Credit Suisse.

Greg, on price optimization, I think in the past we have talked about four phases or four components to it, and I think promotional being the second bucket. I think if I've got it right that is where the Company is at or starting to pursue. Can you put some time frame parameters around it? And then I'm not sure if one bucket of price optimization is more opportunistic than others, but where this one stands relative to others?

Let me set you straight on this. We are in the regular price component today and continuing to learn and continuing to refine. The second bucket will be around clearance because it is the other component of our business. Since we do have some seasonal categories, we'll move to clearance next. Third and the most difficult would be promotion, because we're not a highly promotional company. And when we do run promotion whether it be something in preprint or the Internet, or with a coupon or whatever, there is a lot of variables so that is always the most difficult. We will -- we are looking forward into 2014 to start to work in the clearance bucket, and there is no exact timing yet, because there is still some system upgrades we will need to do. But it looks like we will continue to stay with Revionics and we'll be looking at that in 2014.

Okay, just a quick one for Tony. You mentioned the incentive comp program that it provided leverage. Is that because of the program design or is it because, I think in the comments, you expected sales to be a little bit stronger and maybe some of those numbers were just not hit.

It is really generally how the program is designed each year as we go into the year and put forth what we believe are fairly aggressive targets both on a sales and an operating level for our team members out in the stores. We should be able to benefit from the incentive compensation program. This year is a little unique because of the way the sales fell last year versus this year, and we had such a strong first quarter and how we level out the incentive compensation. But coming into this quarter being a fairly strong sales quarter with the shift relative to last year, we did expect the incentive compensation to increase relative to the sales level, which it did. But again with the more aggressive targets that we come in with at the beginning of the year still provide us with the opportunity to leverage that program.

And if I could just clarify, if the business does a 7% comp in the future, does the program -- is the program designed to provide leverage?

At a 7% comp year-over-year you will probably have very limited leverage from the incentive compensation. There is a combination. You have to look at both pieces. One is the store piece, and then one is the store support center. Over a course of a year at 7%, it will provide leverage because at a store support level, store support center level, the incentive compensation is capped at a particular point. So net-net overall you should get some leverage at a 7% comp. And it is designed where the shareholder will benefit from a strong selling season.

Okay. Thanks, and nice results.

Thank you.

Matt Nemer, Wells Fargo.

I just have one quick follow up. Your account payables days are starting to stretch again after a long period of some compression. Has there been a change in philosophy around AP timing, or is this more of a product mix issue, and what impact could that have on the gross margin rate going forward? Thanks.

Matt, there hasn't been a change in the philosophy. We obviously try to be as aggressive as possible when it comes to the accounts payable and the payment terms. What you see is -- included in the accounts payable is not only just merchandise payables but also expense payables. Some of what you are seeing is timing. You also see, as we sort of lap versus last year, a little bit more consistency in that build because there are more comparable periods. Last year was a difficult comparison, because we had added the extra week from the 53rd week before so they really were not apples to apples comparisons. As we go through this year, there will be some spikes as we go through and we see quicker turns on some of our CUE items, that generally will hold back the accounts payable, and we will not be able to get the leverage that we would like to get out of the accounts payable. But to the basis of your question, there has not been a significant philosophical approach or change in the way the accounts payable is managed. Okay. Thanks so much.

Eric Bosshard, Cleveland Research.

The increased or slightly increased sales guidance for the year, can you talk a little bit about what is within that if it is market or market share growth or if there is anything within specific categories that is contributing to that?

Yes, Eric, it relates to the strength of the CUE product and the performance of the CUE throughout the first half of the year. The majority of the sales driver is related to what we believe has been sales above expectations for the first half. And then to a certain extent, a little bit lesser extent, the back half relative to the trend we had seen when it comes to the performance of the base functional CUE items.

Is that the CUE category growing faster, or are you gaining incremental share, and if it is share, are there specific areas where you feel like you're making the most progress?

We're definitely -- it is a combination of increased trips from our current consumer as well as additional market share.

Thank you.

There are no other questions at this time. I would like to turn the conference back over to our speakers for any closing remarks.

Thank you, operator. As you can see, we are very passionate about our business and the opportunities that still are ahead of us. We will continue to focus on our strategies to drive sales and grow operating profits. Thank you all for your continued interest and support of Tractor Supply Company, and we all look forward to reporting third-quarter results in about 90 days.

Thank you, everyone. That does conclude today's conference. Thank you for your participation.