Tractor Supply Co (TSCO) 2015 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 2015 results.

(Operator Instructions)

Please be advised that reproduction of this call in whole or in part is not permitted without written authorization of Tractor Supply Company. And as a reminder, this call is being recorded. I would now like to introduce your host for today's call, Ms. Christine Skold of Tractor Supply Company. Christine, please go ahead.

Thank you, Operator. Good afternoon and thank you for joining us for Tractor Supply Company's quarterly earnings conference call.

Before we begin, let me reference the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. This 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 expectation 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 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 statements will remain operative at a later time. And lastly, Tractor Supply Company undertakes no obligation to update any information discussed in the call.

I'm now pleased to introduce Greg Sandfort, Tractor Supply Company's President and Chief Executive Officer. Greg, please go ahead.

Thank you, Christine. Good afternoon, everyone. Thank you for joining us. On the call with me today are Tony Crudele, our EVP, Chief Financial Officer, and Steve Barbarick, our EVP and Chief Merchandising and Marketing Officer. Lee Downing will not be joining us today. He is out attending a trade show.

We had a solid second quarter and we're pleased with the continued sales trends in our business. Our merchandise planning, inventory and store teams did an excellent job of managing both product assortments and other things to deliver both a strong sales and earnings performance for the quarter.

Comparable store sales increased 5.6%, and the increase was distributed across all of our major merchandise categories and geographic regions. We also saw growth in both traffic and ticket. Transaction counts increased 4.1% and average ticket improved 140 basis points in the quarter. And this was our 29th consecutive quarter of positive comp transaction counts. Seasonal, big ticket and C.U.E items all performed well in the quarter and benefited from merchandise resets and planogram updates.

As we have discussed many times, we are a test and learn company, and we are constantly evaluating and updating our product assortments to meet the needs of our customers. This year, we made some notable changes to several categories. In Pet food and feed, we upgraded and expanded our assortments of premium products in equine and livestock, and we added [show feeds]. In outdoor power equipment, we've revamped with new products from Cub Cadet and Bad Boy, and we introduced for the first time higher end commercial grade products in outdoor power equipment in a number of select stores. And in towing and trailer, we increased our assortment of heavy duty products and added new steel and aluminum trailers to a select number of stores. And finally, in outdoor recreation, we expanded our assortment in utility and recreational vehicles.

These changes to our assortment products demonstrate our culture of continuous improvement as part of our ongoing merch strategy. We are always testing new products and upgrading our assortments across the store to strengthen our position as the most dependable supplier of everyday basic merchandise needs for the rural lifestyle consumer.

On the gross margin side of our business, strong execution of our price and inventory management strategies contributed to a healthy increase in overall product margins. Investments in new systems, such as demand planning, inventory allocation and price optimization, are enabling us to shorten the supply chain turn around time and improve our global management of inventory.

In regards to stores, we continue to refine our payroll allocation, which we believe is allowing us to better serve our customers at peak selling periods. And while some of this resulted in higher expenses in the quarter, we remain committed to investing in the people and systems necessary to drive profitable growth over the longer term.

Now to update you on our omni channel business. Last week, we launched a new and completely redesigned website. The updated site offers many enhancements to improve our customers' browsing and shopping experience. It is a responsive design that delivers the same shopping experience across all mobile devices and has improved our overall search and check-out capabilities, as well as added more robust product descriptions, customer reviews and social media tie-ins.

In regards to our supply chain activities, construction of our new distribution center in Casa Grande, Arizona is on schedule and under budget and expected to be operational late in the fourth quarter of this year. The two mixing centers in Texas are also scheduled to open in the third quarter of this year. We opened 17 new stores in the second quarter and remain on track to open 110 to 115 new Tractor Supply stores in 2015. Our western expansion continues to be a key initiative and our stores that have opened in that area over the past few years continue to comp favorably against our chain average.

Looking ahead, we are pleased with our first half performance and we feel positive about our positioning for the back half of the year. Along with some of the assortment changes I spoke to earlier, we continue to make strategic investments in key businesses that are important and relevant to our customers. And as a result, we made the decision to take early receipt on several categories of products that we believe will benefit our late summer and early fall selling season.

Now let me close by thanking all of our dedicated team members across the country and all our store locations and our facilities that go the country mile for our customers each and every day. And for everyone else on the call today, we appreciate your time and interest in Tractor Supply. I will now turn the call over to Tony for a more detailed commentary on our second quarter financials. Tony?

Thanks, Greg, and good afternoon, everyone. For the quarter ended June 27, 2015, on a year-over-year basis, net sales increased 11.9% to $1.77 billion. Net income grew 14.9%, to $153 million, and EPS increased 17.9%, to $1.12 per diluted share. Overall, we are pleased with our sales performance and our gross margin management during our strongest selling season.

Comp store sales increased 5.6% in the second quarter, compared to an increase of 1.9% in last year's second quarter. Comp store sales were strong across all three months of the quarter, with April and May benefiting from favorable seasonable weather and easier comparisons. June also posted a solid comp, but faced a tougher comparison, given the back end weighted promotional cadence of last year's second quarter.

Sales were strong across all regions, with the strongest regions being the South Central and the West. A wet spring season in Texas area benefited comps in the South Central region. Our new stores in the Western region continued to produce above chain average comp sales, as they gain market awareness and share.

Comp transaction count increased for the 29th consecutive quarter, gaining 4.2% on top of a 2.3% increase last year. Sales growth continued to be broad based, as spring and year round categories performed well. C.U. E. items such as pet food and lubricants continued to post solid comps. Key spring seasonal categories, such as riding lawn mowers, trailers and lawn and garden, and other year round categories, such as outdoor recreation and rubber footwear, performed very well.

Average comp ticket increased by 130 basis points compared to last year's 30 basis point decrease. Big ticket was the principal driver of the average ticket increase. Comparable sale of big ticket items were well above the Company's average for the quarter, as big ticket items such as riding lawn mowers, trailers and utility vehicles all performed well. This increase was partially offset by deflation, which we estimate at 20 basis points, and was less than our expectations. The deflation was driven principally by livestock feed.

Now turning to gross margin, which increased approximately 50 basis points to 35.3% compared to flat last year. Although we had an easier comparison, our direct product margin was bolstered by strong price and markdown management which was facilitated by the strong sales throughout the quarter. Price management tools helped us optimize our retail pricing, while negotiating lower costs in some of the deflationary categories. We believe that our gross margin and system initiatives are providing our team with better tools to drive gross margin enhancement and benefited the quarter.

Freight was favorable to 20 basis points, which was a direct result of the lower diesel prices. The very favorable fuel price more than offset the stem miles increase from our western store expansion. We estimate that deflation had a slightly favorable impact on gross margin. This is much less impactful than in previous quarters, as deflation has begun to moderate.

Our gross margin improvement was even more notable, as we overcame a negative mix variance of approximately 20 basis points. Strength in big ticket items, which tend to carry below average gross margins, was the primary driver of the negative mix impact. Import purchases in the quarter increased 18.5% and represented 11.4% of the sales mix. Also, exclusive brand sales increased 9.8% compared to last year's Q2 and was approximately 30% of sales.

For the quarter, SG&A, including depreciation and amortization as a percent of sales, was essentially flat compared to the prior year's quarter. SG&A growth was impacted by several factors. Incentive compensation had a deleveraging impact of 20 basis points, as incentive compensation increased year-over-year based on the strong results of the quarter. We did allocate more payroll hours to our stores in order to capitalize on the selling season; and therefore, we did not obtain the leverage we normally would receive with such a strong comp sales increase.

We also experienced slightly higher payroll and rent deleveraging from the new stores, as they ramped to maturity. This was more notable in the Western store base, as we have opened over 50 stores in the past year and they generally open with a higher rent to sales ratio. The expansion of our Hagerstown DC in Q1 added incremental expense to SG&A, but we realized the cost benefit of lower stem miles in gross margin.

Our effective income tax rate increased 37.2% in Q2, compared to 36.7% last year, resulting from the availability of state tax incentives related to the construction of our store support center last year.

Now turning to the balance sheet, at the end of Q2 this year and last year, we had a cash balance of $56 million and no outstanding debt. During the second quarter, under our stock repurchase program we acquired approximately 876,000 shares for $76.6 million. We estimate that the share repurchase program for the quarter did not have a material impact on EPS.

Average inventory levels per store increased 4.1%, compared to a 3.4% decrease in last year's second quarter; and inventory turns were flat compared to last year. As Greg mentioned, we made some strategic investment in key categories and took early delivery on some product to better position ourselves for the late summer and early fall season. We are comfortable with our seasonal inventory as we move into the third quarter and we expect a normal seasonal markdown cadence.

Capital expenditures for the quarter were $48.2 million, compared to $40.2 million last year. We opened 17 stores and closed one Del's store in the second quarter, compared to 23 new stores opened in the second quarter of 2014. The CapEx increase relates to the construction expenditures of our Southwest distribution center, which were higher than the expenditures on our store support center which was under construction last year at this time.

Now looking ahead, as a result of our strong performance in the first half and as noted in today's press release, we have revised our financial expectations for the full year 2015. We now expect full-year sales to range from $6.25 billion to $6.33 billion. Correspondingly, comp sales are forecasted to increase between 3.5% and 4.5%. We have increased our EBIT margin target and are forecasting a 15 to 20 basis point improvement compared to 2014. We now anticipate net income to range from approximately $412 million to $422 million, or $3.00 to $3.08 per diluted share.

We have decreased our capital expenditure forecast for full-year 2015 to a range of $220 million to $230 million. Additionally, we still anticipate that the full-year tax rate will be approximately 37%. We will continue to make purchases under our share repurchase program and currently project full-year diluted shares outstanding to be approximately 137 million to 137.5 million.

With respect to sales, we had anticipated that the first half of the year would have stronger comps than the back half, as we are cycling stronger comp sales in the back half of the year. With high moisture levels and mild summer temperatures, we are optimistic that the seasonal demand pattern for the third quarter will be consistent with the past two years and we will see an extended spring and summer selling season. Despite a difficult comparison to last year, comp sales through the first three weeks of July have been positive and are in line with our expectations.

We continue to expect deflation in the back half, but it has moderated more than we originally expected. We expect it to range between 30 basis points and flat, moderating as we progress through the back half of the year. We will continue to use our price management tools to drive both sales and margins, while remaining focused on our goal of growing market share.

As we look at the back half of the year, we expect a flat to slight improvement in EBIT margin, driven by improved gross margin in both quarters. Our gross margin initiatives continue to drive improvement in merchandise margin and lower diesel prices should benefit freight transportation more than our original assumptions.

We expect SG&A will run slightly higher than our original forecast and will offset the majority of the gross margin benefit in the back half. We expect SG&A to run approximately 10% to 10.5% increase over last year's back half. The key elements driving the incremental increase in our SG&A run rate include expenditures on system enhancements, such as inventory allocation in omni channel, CRM and system security, additional store payroll hours, consistent with the allocation we saw in the first half, rent deleveraging resulting from the increased mix of new Western stores, which have a higher rent to sales ratio as they ramp to maturity, and pre opening expenses for our Southwest DC, as well as the two mixing centers we plan to open in the second half.

We're off to a strong start to the year and the team has done a great job of capitalizing on the spring season. We believe we are well positioned to continue growing the chain while delivering mid-teens EPS increases over the long term. So that concludes our prepared remarks. Operator, we will now turn the call over for questions.

(Operator instructions)

Peter Keith, Piper Jaffray.

Good evening. This is actually Jon Berg on for Peter tonight. Congrats on the nice quarter.

Thank you.

You're welcome. Just on our first question on the sustainability around the big ticket, I think you guys said comp ticket was up 1.3%, which is, I think, five consecutive quarters now of positive comp growth. So I guess under this context, does it seem that big ticket items are making a comeback, such that there might be some sustainability as we look out to 2016, even with the tougher compares?

John, this is Steve Barbarick. A couple comments on big ticket. Where we made changes -- and I think Greg noted mowers, trailers, and a couple other categories like UTVs -- we saw a nice impact in our business. Because our customers are looking for value, and when we change things, we see a pretty good return. We did have categories, however, that fall into the big ticket, I guess, area, that didn't perform quite as well. So while we saw a benefit in Q2, I would say that we're still cautiously optimistic and we're not going to declare victory at this point, but we like what we're seeing.

Okay. Great. And then as far as the impact of clearance optimization, with your gross margin up 50 basis points and I think you cited markdown management as a driver, are you beginning to see the early benefits of your clearance optimization software? And if that is the case, are there any examples you could provide on how that clearance activity was better managed in the second quarter?

Jon, great question. This is Greg. The optimization on clearance is only in a select number of departments today, so it's not across all buying divisions yet. But in some areas, particularly in seasonal and in some of the lawn and garden, the systems have helped us enormously, I would say, to look at the sales trends, act appropriately. And it is always my belief that the first markdown is always the least expensive and the customer can be brought to the side counter and make a purchase, particularly if you're seeing some slowness in a category. So I think the systems absolutely did help us this spring. But again, it's only rolled out in several divisions, we still have the rest of the Company to roll out through the year.

Thanks a lot, guys. Good luck in the second half of the year.

Thank you.

We'll go next to Peter Benedict with Robert Baird.

Hello, guys. So first question, there seems to be a lot of concern around seasonal out there in the market right now, and you guys obviously did very well in seasonal businesses, both the small ticket, lawn and garden, but also the larger ticket, OPE, and it sounds like it was pretty consistent across the months. You said June was a little softer because you'd done some promoting last year. Steve, was this just a solid seasonal quarter, and do you think you guys just were taking a lot of share, or do you think -- because there's some concern about Texas with the heavy rains, et cetera. So maybe a little more color on just the seasonal business would be great. Thank you.

Yes, Peter, this is Steve. You know, we did go in the season really prepared, and we are using inventory as a strategic lever to drive sales and take share. In terms of some of the changes we made, we worked with our vendor partners and we upgraded the specifications in a lot of the lines. And using OP as an example, with MTD, for example, we upgraded the design frames and the engines, and our customers voted for a lot of the categories where we made those changes. So we were really pleased there.

In terms of live goods, we're getting better at what we're doing today out in the marketplace and being more regionalized and localized. So I would tell you, we talk about Tractor Supply and our ability to be nimble, and I think this was a really good case study in how we're able to manage through the season.

Well, that's great. My next question would just be around the level of investment expense that you're stomaching right now on some of these systems in Q2. I think Tony called it out as one of the pressure points in SG&A. Can you give us a sense for maybe how much larger the expense hits were this quarter versus a year ago around the systems, and then just maybe map out a little bit of the payback cadence from some of the larger, more meaningful systems you've got coming, the demand planning, omni channel, I'm thinking some of the DC stuff, that's what comes to mind. Thank you.

Sure, Peter. When we look at the investment that we're making, again, we're doing our best to be methodical in how we allocate our capital. And so there was definitely a slight uptick, but overall it was really several items that impacted the expense structure in the quarter. As we mentioned, we talked a little about the payroll, the new stores coming on board. So when it comes to the pure investment piece, as we improve our systems, as we've noted in the past, we have that investment, it's somewhat in the run rate. There was a slight uptick in the quarter, but not overly significant. As we look into the back half of the year, we do have some additional investments coming forward; but again, we believe that it's something that we can absorb in the run rate as we move forward.

Okay. Fair enough. Thanks, guys.

Aram Rubinson with Wolfe Research.

Hello. This is Cody Ross on for Aram Rubinson today. How are you?

We're good.

Just a quick question regarding your supply chain. Once the West Coast DC is up and running at the end of this year, can we expect GMs to expand faster than the 20, 25 bps that you guys had forecasted out previously?

Cody, this is Greg. I would tell you that today we are seeing some deleveraging because of stem miles. As we open that facility, we will see some leverage from transportation. But you've got other expenses. Now I've got an overhead cost of a new building. So to be honest with you, the way we planned it is to be somewhat of an offset for now and then we'll learn. As time progresses, I think we can have some leverage, but it would be hard to forecast that today.

Great. I understand. And then just a quick update, can you guys update us on where you stand with your loyalty program and some of the capabilities you expect to have and hope to have down the line?

Yes, sure, Cody. This is Steve. In the back half of Q3, September, we'll be piloting our program, and I think we've mentioned it will be in three markets. What we're looking at is a program that will have both soft and hard rewards, and it will give us a chance to understand what our customers are looking at from Tractor Supply for a rewards program. So at this point, we're not really getting into a lot of the specifics. We're still working through some of the infrastructure needs that we've got. We'll be training our team members that will be in those pilot stores here shortly. And more than likely in the next call, we'll be able to give you all at least a little more insight as to how that program is working.

Okay. Great. Thank you very much, and good luck going forward.

Thank you.

Thank you.

Simeon Gutman, Morgan Stanley.

Thanks. Simeon Gutman. One follow-up on gross margin, Tony. thanks for some of the color on the buckets. Can you tell us, I guess looking back on the promotional side, you said it was an easier comparison, how much was an easier comparison cycling either promotions or items that were sold below at full margin a year ago, how much did that contribute to the 50 basis points?

Yes, Simon Gutman -- I couldn't let that one go. If you remember last year, when we talked about the second quarter, in June we had some in-store selling promotions. They were somewhat limited, and the impact on gross margin really was only a few basis points, relative to this quarter.

Okay. And then my follow-up on traffic, the 4%, which I think is among the best in our space, maybe across retail, can you tell us how that compares? Is that pretty uniform across the chain, or are you seeing a mature stores versus immature stores? And then your customer frequency, are you seeing the same customer visit you more often or what is it? Or the other side of it is, I guess, how are new customers or new customer acquisition trending?

Sure. You know, clearly as we've talked in the past, the newer stores will have a little bit higher transaction increase, but we are seeing that there is a positive transaction increase across the chain in all maturity levels of the stores. So as we move forward, we see that this is coming both from increased number of visits from our current customers, as well as new customers coming on board.

That's fair. If I could just follow up on that, though. If you think about a waterfall, immature stores should comping better. The presumption is that they should be driving better traffic. Is that the case, or are you seeing some of the mature stores drive just as good traffic as some of the immature stores?

On an overall basis, the newer stores definitely drive more transactions than the more mature stores. But we do see in different areas of the country, as well as in stores that may have been renovated or running certain tests, we'll see an uptick in comps that may be very comparable to some of the newer stores.

Okay. Thanks. Nice results.

Thank you.

Seth Sigman, Credit Suisse.

Great. Thanks. Good afternoon, guys. And nice quarter. I wanted to ask about the Purina expansion in the quarter, any early commentary there and any sense on how incremental of a customer you're getting into the store and how we should be thinking about the ramp in the second half of the year?

Seth, this is Steve Barbarick. I'd tell you that the launch of the new Purina SKUs is really -- the way I look at it and what I told my team is it's really part of our overall C.U.E. strategy. What I can tell you is the SKUs we added from Purina are C and D SKUs. We took the A and B SKUs originally when we launched in 2009. So these SKUs are having an impact in the rounding out the assortment; hence, really building some credibility with our customers. There is some incrementality to it, but it's not material to the top line.

Got it. Okay. And just more broadly, as you look at the second half comparisons, when you drill down, last year you had a great second half from a ticket perspective. You talk a little bit about big ticket and the potential for that to continue in the back half. But besides that, anything else you can point to that should help navigate the more difficult comparisons? I know in the past, you've talked a little bit about gun safes and the headwind there. Is that something that's easing? Any other drivers there? Thanks.

Yes, this is Steve again. I will say that the safe business was a headwind, a pretty significant headwind this past year. And we are starting to see that moderate a little bit. I think you heard Tony talk a little bit about deflation and that moderating versus maybe what we were up against some last year, to some extent. We are making some strategic inventory investments. And as we talked about before, we want to be a dependable supplier of basic maintenance needs. So we will be putting inventory in the key categories to drive some sales and to make sure we're not going to disappoint our customers. So there's a variety of things that we're doing. We always talk about not having a silver bullet, but a lot of BBs out there. And I will tell you, the test and learn approach that we've used, up to this point, has been working, and you'll likely see some new things in the store, if you go visit this next quarter.

Okay. Thanks for that.

Adam Sindler, Deutsche Bank.

Good afternoon. Thanks so much, guys. A couple questions, if I could. First is on the payroll hours. If you could just talk -- so this is something we really haven't seen before. But as we think about how your testing -- is this a test, is this something that we're rolling out, is this something that's one-time and then you'll start to leverage it as we go through next year? Maybe a little bit more color on what the increase in store labor was, and then how you're thinking about that going forward.

Adam, it's Greg. Here's the difference. A year ago in the second quarter, we had talked about how business had been a bit sluggish, and we were really watching costs and payroll and so on and so forth. So we really trimmed it back a bit until the sales started to come late second into third quarter.

This year was up. We saw a more normalized second quarter and we felt as if it was prudent to go ahead and leave the payroll as we had planned. And in some instances, we added some payroll to take advantage of the sales trends and the customer transactions. So that's really the basic difference. If you compare year-to-year, it's kind of an odd comparison, because the seasons were very, very different.

So as we look at the third quarter then, with the third quarter having the extended selling season last year, should we look for a little bit more normalized labor in the third and fourth quarters?

I believe so. And I think it will be very comparable to a year ago.

Okay. Great. And as we think about the third quarter, can you remind us about the cadence last year, the July, August, September, how those months comped?

Sure. This is Tony. We generally don't give specifics on the months, but I will tell you that the months were very consistent relative to the overall comp for the quarter last year.

Okay. Perfect. Thanks so much. I appreciate it.

Michael Lasser, UBS.

Good afternoon. Thank you for taking my questions. On your expectations for the back half of the year, maybe you can -- the comp here is a little confusing. You mentioned flat. Maybe you can provide a little bit more, a clearer picture of how you're thinking about the breakdown between the third and the fourth quarter, on a comp perspective?

Sure, this is Tony. As is our standard, we don't provide quarterly guidance and we provide full-year guidance. So the overall comment is that we expect that the full-year comp will be between 3.5% and 4.5%. Obviously, running at 5.5%, there is clearly a range for the back half that obviously it's up to you guys and your modeling to determine. But we feel very comfortable within that 3.5% to 4.5% range on a full-year basis.

Okay. Maybe you can just give us some of your puts and takes on what's going to push you towards the higher end of the range and what's going to push you towards the lower end of the range? Is it going to be heavily weather dependent, or is the back half a little less influenced by the weather than the first half of the year?

Well, generally, the back half is less influenced by weather than the first half of the year. I would say as we look out into the second half, that extended spring-summer, consistent with last year, will be critical to the third quarter. And as in the past, the earlier we have a nice cool, seasonal winter coming on board, that generally drives some of the heating product and some of the winter product and insulated outerwear, and that tends to be the main driver in the fourth quarter, as well.

Okay. And my last question is on the West Coast stores. We know in the past, you've mentioned that they're higher volume, but it sounds like they're also now faster growing. So is that pretty consistent, has that been pretty consistent quarter in and quarter out, or are you seeing an acceleration, at this point?

I would answer that it's been relatively consistent. What we've seen is that we will have a slightly higher sales volume, and the ramp will be generally consistent with a new store, however, we will have some acceleration because they tend to be a little bit of a higher volume store. What we've seen, and the point we were making in the comments, was that generally in modeling the West stores, we will have a higher rent to sales relationship or ratio in the first couple years of that store's growth. And then as we continue to ramp, because they are a little bit higher in sales volume, then we'll start to get the leverage that we expect out of the Western stores. So a slightly different ramp than the rest of the chain, but for the most part, consistent with our new store pro formas.

That's very helpful. Thanks again. Have a good night.

Stephen Tanal, Goldman Sachs.

Thanks a lot, guys. Good afternoon. I wanted to focus a little bit on gross margin and just understand what really contributed what. The price manager and the markdown management, can you talk a little bit about those maybe independently, maybe not, to the extent that they're related and frame them relative to the overall increase year on year?

Sure. We tend not to give too much detail relative to each factor when it comes to gross margin, because many of these factors interrelate. And so it's hard to carve out each one. We gave somewhat specifics on the fuel component, which was a major driver. So we can carve that out pretty well. And so it was around the 20 basis point mark.

Then when it comes to price management and deflation, again, that is very difficult to parse those two pieces out. Now what we did see is that as we've had some cost decreases, we have been able to manage our retail prices very effectively, and so a good portion of that increase in margin is really related to price management component. So if you wanted me to outline the two big drivers, I would say it is the fuel component and the price management piece, was the two principal drivers of the margin improvement.

Very helpful. As we're thinking about the back half and what it could look like, specifically clearance optimization is one thing I was thinking about, and you noted the big benefit it's had in seasonal and garden, and I'm wondering what other categories, or said another way, will all categories be on that program by year end? Is that the right timing for this? And maybe you could help us think about the relative impact in the quarter versus what's still to come on that initiative.

Stephen, this is Steve Barbarick. I would tell you that we're still rolling this program out and we're still going through a season right now. So a lot of the categories that we put into our clearance price optimization tool are spring-related categories. And what we saw was that the system said would we be better off taking some early marks in a number of these categories, because we think we can see some benefit on the back side. But we haven't yet got through the full season yet to see this all the way through. That's the way the tool is designed. So rather than in the past, where we were taking more global markdowns, these markdowns were taken at a site level, based on sales rate and inventory levels. So we to think that there's going to be some nice benefit. But until we get through the season, I'd be hard pressed to put too much into this. We'll be able to communicate better probably at the end of next quarter and share with you what we experienced here in spring.

Okay. Very, very helpful. Thanks, guys.

Mark Miller, William Blair.

Good afternoon and good work. One of the things that's most impressive to me about Tractor Supply is the diversification of gross margin drivers. And from semester to semester, it's shifting in obviously the price and markdown optimization here. But I was hoping you could talk a little bit about what's coming with the demand planning system, the timing of when we might begin to see those benefits kick in and how we can dimensionalize the size of that potential opportunity?

Mark, hello, it's Greg. Let me talk to this a little bit. Demand planning is a roll out over really the next year, year and a half. And its basic component is to help us look at forward demand for product, whether it be at regular price selling or at promotional price selling, and instead of us having what I would call these peaks and valleys with inventory, it is looking out, forcing us and forcing the system to say, it estimates X amount of demand coming, because it knows more. The inputs that go into this are different than the inputs that go into E3, which is somewhat of a basic, static replenishment system.

So this is much more sophisticated than anything we've had. We are learning right now. We've had several departments that have been turned on. So far, we're seeing fairly good results. We're bringing inventory levels down and we're seeing some positive comp sales in those categories over their comparison store groups. So like stores to like stores, we're seeing improvement. But it's truly a test and learn process over the next 18 months. But very encouraged with the initial reporting that's coming from it.

So where the organization could see the biggest uplift, it sounds like, through next year, but really 2017, 2018, potentially?

It's going to be a bit of a maturing process. So yes, I'd say it's a good year out before we're really going to see a lot of the benefit.

Okay. Great. And then on the exclusive products, you've had tremendous success there historically, it looks like it's plateaued recently, but some of that is because you're getting such strong sales elsewhere, I assume, in big ticket and other. But what are the top priorities for exclusive products going forward? Thanks.

Mark, this is Steve Barbarick. Exclusive brands continue to be a focus for us. Part of what you're seeing in the top line numbers is a bit of a byproduct of deflation. So we're still seeing nice growth there, but as our costs have come down in some of our key businesses, we're not getting necessarily the benefit on the top line, and therefore, the mix has changed. So I would tell you the engine is still running and what you're seeing in the margin line, some of that is a byproduct with both deflation and what we're doing as far as bringing more products into the exclusive brand family.

Okay. Great. Thank you.

Thank you.

Scot Ciccarelli, RBC Capital Markets.

Hello, guys, how are you?

Good.

Great. It seems like you guys have accelerated your reset activity over the last, certainly, several quarters and it sounds like they're generating very good results. Can you give us some additional color on the difference in sales performance between categories in general, but between categories that have been reset or remerchandised and those that may not have been touched quite as much?

Yes, Scot. This is Steve Barbarick again. What I can tell you is I've been with the Company, this is my 17th, 18th year, and we've always been a company that's focused on resetting merchandise and bringing new things into the center core of our stores. I will say that we continue to put different levels of scrutiny on the reset activity that we're doing. We use a tactics model, going back to a little bit of the data or science-driven part of our business.

Where we do resets, they vary. In some cases, we'll do resets to bring new products in or we'll try to keep our assortments fresh. Other cases, it may be to leverage cost, because we multi-source products out there. So it's really hard to say specifically when you do a reset that they all are going to give you 10% comp sales increases. But what I can say, they very dramatically and, generally speaking, we see a nice comp as a result of the activity that we do. That's why we keep doing it.

Okay. But you guys have certainly emphasized that in various categories, this is what changed, this is what we remerchandised, we got a nice lift from it. Is there any way to provide it -- and maybe there is, maybe there isn't. Maybe the results are just too varied.

Well, you have to understand, a large part of the store gets reset. And as a byproduct of that, it varies by category. So we've talked winches before. And the winch line has performed really significantly well. We've recently looked at our power tool assortment and expanded a line in DeWalt. And we think that our customers will respond favorably, and the initial read looks like they will. And I could go into the pet food line, where we expanded premium categories, such as Blue Buffalo and others.

It's really different by category, but I can tell you we're putting more scrutiny into the work that goes into the reset and making sure that we're trying to bring costs down, while bringing good quality products and value to our consumers. And they seem to be responding favorably. That's probably the best I can answer that.

That's great. Thank you very much for that. And then just a quick -- hopefully it's a quick question -- we have heard about incremental sales challenges from a lot of retailers around energy intensive markets. I don't think you guys mentioned anything on the call. And obviously, it didn't seem to impact the total top line, but I would think a bunch of your products would be susceptible to a slowdown in some of these oil and gas markets. Have you seen any of that kind of impact?

Yes, this is Steve again. What I can tell you is in those oil drilling stores specifically -- and again, you have to remember, they're just a part of a much bigger chain of stores -- in those subset of stores, there are some categories that you're seeing comp sales declines in. We've seen them in truck boxes, in fuel handling. We've got local assortments for these stores in fire retardant apparel, and those are seeing some declines.

But if you look at the total store, we're a needs-based retailer and we carry so many more products than those areas that just relate to oil, that we're seeing nice comp store sales in those stores themselves. So it's not material to the top line, at this point. You can see that in the overall company numbers.

Got you. Thank you. Very helpful.

Ben Bienvenu, Stevens Incorporated.

Yes, thanks. Good afternoon, guys. So just quickly on ticket. Obviously, big ticket sales was a key driver for the higher ticket in the quarter, but did you all -- I would be curious to know if you also saw a lift in items per transaction. And if so, what do you think is a driver for this? Is it better assortment, a healthier customer? What could be factoring into that?

Sure, Ben. This is Tony. When we look at the ticket, obviously, a substantial portion was driven by big ticket. But we also look on an items per transaction basis. We did have a very nice lift there, as well. And again, when you're dealing with some small numbers, in like 3.5 items per transaction, when you move to 3.6, that's a nice move. So it's still a very small number of items per transaction, but we did have a nice lift.

And I think, as you commented, there's just several factors that go on. A lot of what Steve has been talking about as far as our enhanced assortment, we've done a great job of making the store more shoppable, picking up new products. The operations team gets excited about having items of the month and making sure that they drive that basket. So I think it's a combination of several factors. And it is something that we continue to focus on.

Awesome. Thanks. Secondly, looking to HomeTown Pet, are there any learnings there that you've seen that could be promising in the Tractor Supply store, anything jump out at you there?

Ben, this is Greg. What I will tell you is that we have two stores up and running. We're about in our ninth month now of operation. And we are seeing a little different mix of sales in those stores versus Tractor, which means it's attracting, in our opinion, a little different customer. And there are some learnings. I'll give you one. And I won't speak to too many, but I'll give you one.

We have services in these stores that we don't have in a Tractor Supply. And what I mean by that is the grooming salon. The grooming salon has taught us a number of things. One, that if you have a great groomer, they can bring traffic to that store. And unlike other grooming salons, we allow our groomers to step outside the salon, if they find that the animal that they're grooming has a need for something, whether it be for their coat, or they've got hot spots or whatever, we allow our groomers to go out on the floor and actually suggest a sell to the consumer a product that could be a solution. So it's a little more intimate relationship in our store than you may find in other pet operations. But that's an example of something that we're seeing and we're looking and saying to ourselves, is that something that is potentially an expansion point for Tractor some day?

Great. Thanks. Best of luck.

Thank you.

Eric Bosshard, Cleveland Research Company.

Good afternoon. I'm wondering if you could provide a little bit more color, you talked about the early receipt, or strategic early receipt of some inventory, to be better prepared, it sounds like, for late summer and early fall. Can you just talk a little bit more about what you're specifically doing there, why you haven't done it in the past, is there something that enables to you do it now and what you think the payback from that can be?

Sure. Eric, this is Steve. A couple of things here. I think you and I talked a while back about the fact that as an organization, we're going to start using inventory to really help propel sales and to really make us more of a dependable supplier of basic maintenance needs. When we came out of Q2 last year, we were running a comp inventory decrease. And this year, that increase that you saw partly built back up the hole that we had put ourselves in.

But I can tell you, what we're bringing in to make sure that we make the right commitment to our customers, will be heating. We're going to be bringing that in, to make sure we're locked and loaded for the season. What we typically find is when there's a cold winter the season before, customers tend to want to get out early, because last year they got caught short and maybe weren't able to get the goods that they needed.

So no different than we did last year, but maybe at a little higher level, we're going to make sure that we're in the heating business, and that includes fuel, making sure that we've got our assortment set when it comes to apparel and everything else laid out. So we did get some early receipts in. We will be setting our stores here shortly. And when customers come in, they're going to know that we're ready for the season and we're going to be there to take care of their needs.

Great. And then secondly, and I know that you operate across a number of different categories and perhaps even industries, but inasmuch as you have a feel for market share or a feel for your customers, do you feel like your share of wallet is growing at a similar pace to the past or if there is a change taking place that you're getting better penetration with your customers, gaining market share, any sense on that?

Eric, this is Greg. Let me make a couple of statements real quick. Number one, the consumer continues to spend their hard earned dollars in the same way. They're looking for good value. Our consumers are continuing to spend on need-based products, less discretionary. I would say that with the kind of unit increases that we are experiencing in a number of categories, both in C.U.E. and in some other seasonal categories, I have to believe that there is some market share that's probably shifting to us. But there are so many -- it's very difficult, with all of those categories, to be able to pull some data. The data that we get is basically from our suppliers talking about how much of their business now is coming from Tractor Supply. So the answer there would be I believe we are getting more share and I think our share of wallet is increasing.

That's helpful. Thank you.

Matt Nemer, Wells Fargo Securities.

Good afternoon. I'm just curious if we are seeing a more sustained shift to big ticket, and you didn't say that, but if that happens, does that drive payroll hours on a more sustained basis? Is there more training and assembly and selling that takes place that would more permanently drive payroll hours?

Matt, this is Tony. Seasonally, where we would incur the most hours would be in Q2, as we have the spring season. So as we move forward, it's less of an impact, big ticket has less of an impact on our payroll allocation.

Okay. And then I guess secondly, and maybe this already came up, but did you explain the change in the CapEx guidance for the year?

No, I did not give the details. Generally, it relates to several factors across the board. We are under budget, as Greg had mentioned, on our Southwest distribution center. That is probably the largest piece of the decrease. Some of the IT initiatives are coming in on plan and under budget, as well as some initiatives we may not get to. And so as usual, at the beginning of the year we have a little bit greater appetite for some of the key projects. But the majority is as a result of being under budget on some of the key initiatives that we've executed so far this year.

Okay. Great. That's all I've got.

Thank you.

David Magee, SunTrust.

Hello, everybody. Good afternoon.

Good afternoon.

I had a question regarding some of the resets in terms of the upgrades that you're showing success with. I'm curious if you think you could have done this a few years ago, or is this a reflection of the economy or the ability to manage with the systems more effectively?

You know, I would tell you that it's probably as much to do with relentless dissatisfaction. You know, we've always done resets. We haven't really talked a whole lot about them on the call. For those of you who attend our IR conference, where we've got our sales meeting, you see a lot of the changes that take place with our vendors on the sales floor down there at the convention center. So I think that this has been an ongoing thing for Tractor Supply; and I think if you go back and you look at our traffic count, you look at our comp store sales performance, you'll see that in a lot of the numbers. We're just probably today giving more color around some of the changes we're making.

I will say, however, that when it comes to some maybe more of the commercial product, we are testing more there than we have in the past, and it seems to be resonating pretty well with our customers. The higher price points that we have out there right now and how we're selling those price points, I think are a real show of support from our customers and their trust in the Tractor Supply brand, and also their trust with the team members that we have in our stores and the relationships they've built. So I think we're taking advantage, quite frankly, of a foundation that's been built for years and we'll continue to try and test new things.

Okay. Great. Thanks, Steve, and good luck.

Thank you.

Denise Chai, Bank of America.

Great. Thank you, and I apologize for the background noise here. You talked about the comp sales between the Western stores and the chain average, is that more a function of store maturity or is it related to the competitive environment there?

Denise, it really relates more to the maturation cycle of our new stores. We believe that in several of the areas, it is very competitive out there, and that's why we're extremely pleased with the ramp of the stores out West and that accelerated comp that we're experiencing with those Western stores.

Okay. Thanks. And recently corn and soy has moved some -- moved up quite a lot. I wonder if these prices hold, when would you expect to see those come through in your inflation or deflation numbers?

We'll likely see, if these hold, and as our costs tick up, we'll see it start to moderate at the end of Q3 and into Q4. But again, we're still watching that very closely and our teams are challenged to keep costs down, so we'll see how good of negotiators they are.

Okay. Thanks. And just one more. You've talked a lot about the new commercial and professional level tools and things that you've brought into the store. Were those contributors to your strong ticket this quarter, or is it just too early to see their impact and ticket was more a function of big ticket items?

I would say that the upgrades that we made when it comes to engines that are in the same size mower, but by changing the deck style and the frame, as well as upgrading the engines, if you want to call that commercial, I guess you could. But our customers tend to like things of high quality when they can see value, and that's what we'll continue to focus on.

I'll use one other quick example. And that is, is we added a $5,999 commercial zero-turn mower into a handful of stores. And at the beginning of the season, we saw it performing really well and we expanded it out to even more stores and we were delighted with the sales. And to be able to sell a $6,000 riding motor at a Tractor Supply Company store is something that I wouldn't have felt we could have done years ago. So there is a need, and I think we're filling that need and that gap really well.

Great. Thank you very much.

Joe Feldman, Telsey Advisory Group.

Hello, guys. Thanks for taking the question. Wanted to just ask, get another update on the on-line business. And I know it's still small and emerging, but are you seeing any difference in customer or what people are purchasing or how far people are shipping from the store, or if there's a demand for pick up at store, buy on-line, pick up at store, that kind of thing?

Joe, it's Greg. We're seeing a lot of positive signs. The comp ramp there is far greater than we'll have in our four-wall stores, because it's still a very immature business. But no question, with the new website launch, the reason we did that was to give customers more options as far as the way to acquire the product. Our goal is to be 24/7 Tractor. So in order to do that, we had to do the upgrades and give ourselves the ability to have a platform that can handle that.

We are adding more and more drop-ship vendors, as we speak, daily. We are seeing very good customer response to those additions, and more of our business is coming from that element today than probably, I would say, direct fulfillment is coming greater than what we've seen in just normal replenishment from the Franklin DC, which is the replenishment point for the on-line business. So we're encouraged with that, because that's a direct connection between us through and it's a drop ship from the vendor. So lowest cost for us, a little faster delivery for them.

But in general, our conversion rates are moving upward. The amount of people that are hitting the website is increasing. We're looking at adding new extensions of products. You're going to see this thing develop over the next several years into something that I think can be much more meaningful. However, I will caution you, there are a lot of things that we sell at Tractor Supply that would be very difficult to sell online and deliver to the customer, because of their cost of transportation. So there will be a point when there's going to be some things that could be somewhat prohibitive, but all indications, all signs right now are that this thing is moving ahead well, and we are very pleased with our performance.

That's great to hear. Thanks. Just a quick follow-up on where orders are originating. Are you seeing a big increase in mobile? Obviously, you said you guys revamped some of the mobile site.

Mobile is growing very rapidly, Joe. And the consumer who is buying from us is still somewhat within a proximity of our store base. So we're not seeing someone in some distant place, in let's say, Alaska trying to buy a product on TractorSupply.com. That has not been prevalent. It's been customers that are looking at that as a convenience factor. They can buy it at 3:00 in the morning, they can buy it at 6:00 in the evening. That's what we're seeing. So it's really still somewhat based around the current consumer base, the distance of our stores, within the base of the -- that's where the base of the business is coming from.

Got it. Thanks. And if I could sneak one more quick one in. As far as new stores and real estate, the outlook, are you finding any differences in procuring new sites or the cost of rent or the new sites going up at all? Anything to note on the real estate front?

The only thing we have noticed, and we mentioned it in the write-ups, Tony commented to it, it's a little more expensive to do business in the West. No question that occupancy costs are higher. But our retails are different out there and the volume of those stores will be considerably different. So we're finding plenty of sites. There doesn't seem to be any concern for finding quality sites.

And one thing I should mention is when we open stores, we don't look at it as just opening the all A locations. We will open stores across a spectrum of small, medium and large in volume and in size, so that we can continue to see productive store opening improvements over the next decade or so of store growth. So we're not looking at just A stores. We're looking at A, Bs and Cs. We're looking at different markets, some larger, some smaller. The mix of stores is just as important as finding the location of that store.

That's helpful. Thanks. And good luck with this quarter.

Thank you.

Jessica Mace, Nomura Securities.

Hello. Good afternoon, and thanks for taking the question. My question was on new customer acquisition. You mentioned some of the learnings from the HomeTown Pet format. And I was wondering about the process of applying those learnings to the Tractor Supply format, as well as any other opportunities you see for increasing business with new customers?

Jessica, let me just comment on HTP and I'll let Steve take it from the other side. In HTP, we can attribute generally all of our customers that are coming through from a purchasing standpoint, because it's a different format. It's very intimate and they're willing to give us their information, so on and so forth. Little different in Tractor, however.

Jessica, what I would tell you is that the acquisition of new customers is critically important. We talk a lot about the aware non-shopper and we talk a lot about how difficult sometimes it is to get people in our stores that just look at the name Tractor Supply. We've done a lot with our assortments over time. We've done some different things with our marketing and how we target different areas. So I would tell you that we're making good strides. I would tell you by the comp transaction growth, we're continuing to see that in our numbers. And so while there is more work to be done here, I'm pretty pleased with the degree of support that we're getting from our marketing team in bringing new folks in.

Great. Thank you. And then just a quick follow-up on the performance of the exclusive brands. You mentioned deflation as one of the dynamics that is causing some of the difference in the performance of the exclusive brands versus the remainder of the offering. Is there anything else to think about or maybe expectations for the back half?

I would tell you deflation has had the biggest impact. So whether it be in our brands like Royal Wing in bird seed or some of what you're seeing on the livestock feed side of our business, we're selling some good units. We continue to think that we're gaining share. Units are a focus for us. But it is difficult when you're pedaling uphill here, because of deflation on the top line. So it's still a focus for us as an organization, and that's what I can tell you at this point.

Great. Thanks again.

That concludes our question-and-answer session for today. At this time, I would like to turn the conference over to Mr. Greg Sandfort for any additional or closing remarks.

Okay. Thank you for your interest, everyone, and your support of Tractor Supply. We look forward to speaking to you again in October regarding our third quarter performance.

This does conclude the conference. We thank you for your participation.