Tractor Supply Company (TSCO) Q2 2016 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen and welcome to Tractor Supply Company’s Conference Call to discuss Second Quarter 2016 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 the host for today’s call, Ms. Christine Skold of Tractor Supply Company. Christine, please go ahead.

Thanks, Tom. 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 expectations or any of its forward-looking statements will prove to be correct. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in the company 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. Lastly, Tractor Supply Company undertakes no obligation to update any information discussed in this call. I am now pleased to introduce Greg Sandfort, Tractor Supply Company’s Chief Executive Officer. Greg, please go ahead.

Good afternoon, everyone and thank you for joining us today. On the call with me today are Tony Crudele, our EVP and Chief Financial Officer and Steve Barbarick, our President and Chief Merchandising Officer. As you are all aware from our pre-release on June 29, we had a challenging second quarter, not the typical Tractor Supply performance. And clearly, the weather was not favorable. The bottom line is our business was heavily influenced by weather in Q2. We have worked very hard to be the most dependable supplier of products to the rural lifestyle customer. And the fact remains that some of those products, being seasonal in nature, can be impacted by weather. Weather has always been a factor in our business and we know it’s our job to manage around those external factors. However, we generally have not experienced the extreme conditions in variability in the weather from region to region like we saw in this second quarter. Hot and dry in the West, cold and wet in the East and Midwest and severe flooding and damage in the South Central. Just about every region experienced some form of weather variance and the conditions were very different from region to region. When the weather began to normalize in June, so did our business, but the turn was not enough to offset the weakness in April and May and not enough for us to anticipate that a significant shift in seasonal sales will occur coming into the third quarter. As a result, we have become a bit more cautious in our outlook for the remainder of the year, although last year’s sales comparisons are more favorable in the second half. During the quarter, very strong demand for our core animal and pet offerings continued and we believe we are gaining share in these areas. We also saw continued momentum with events that directly support the sustainable lifestyle. Chick Days and our garden event both experienced strong year-over-year growth. We saw healthy demand for outdoor furniture, pest and rodent control products, barbecue grills, but unfavorable weather and a difficult year-over-year sales comparison challenged our ability to drive sales providing lawnmowers, lawn and garden products and utility vehicles. We did see increased demand in departments where we continued to innovate and introduce newness such as truck lighting and accessories, trailers and outdoor water recreation. Our inventory and planning teams did an excellent job reacting to the softer sales trends in the quarter and through a balanced approach managed the sales margin and inventory investment in relationship to customer demand. Tractor Supply will continue to invest in our business to drive sales, shorten our supply chain timeline and increase our overall productivity and profitability as a company. In addition to implementing an improved allocation system, we are continuing our test and learn process on the merchandise side, expanding our new customer loyalty program pilot, growing our store mobile point-of-sale test and conducting a comprehensive DC network analysis. And we are pleased with the progress we are making on all of these initiatives. Just this month, we expanded the test of our Neighbors Club customer loyalty program to the California market and now have over 190 stores participating. While still early in the process, the initial enrollment rates continue to be ahead of our expectations. We are finding that our Neighbors Club members are highly engaged to a tractor and we are experiencing higher open and click-through rates on our targeted e-mails and communications to them. We have now completed the implementation of our new allocation system. The new system is designed to improve the efficiency and accuracy of our allocation process and is scalable to support our long-term store growth targets. We continue to expand the test of mobile POS devices into our stores. And as the functionality has improved, the adaptation from our team members and customers have also increased. This capability will enable us and our team members to sell and assist customers with products from any point in or outside our stores. And lastly, we are continuing the analysis of our DC network and systems, which we believe will be critical in supporting our growth to 2,500 stores and evolving our supply chain strategy and capability for the longer term. Overall, we believe these and other investments have made our business more nimble and less susceptible to external factors. But recent results remind us that extreme weather conditions from region to region can impact our business in the short-term and this is not likely to change. We continue to manage the business with the future in mind and believe continuous improvement in our product and service offerings in addition to improving systems and efficiencies will keep Tractor Supply well positioned for growth. Looking forward into the second half of the year, we are a bit more cautious. Despite the more normalized trends in June, we do not believe that we will see much of an extended spring selling season to recoup the sales loss in the second quarter. We revised our full year guidance in our June 29 business update press release and are reiterating that guidance today. Tony will take you through this in greater detail in a moment. From a product and inventory perspective, we believe we are in a solid position to meet the needs of our customers as we transition the business from summer to fall. And before I wrap up, I want to thank the nearly 23,000 members of the Tractor Supply team for their continued hard work and dedication to our customers and our overall business. I also want to congratulate Tony on his planned retirement and Kurt Barton on his planned promotion to CFO. As we announced in today’s earnings press release, Tony has notified the company that he plans to retire during the first quarter of fiscal 2017. Kurt Barton, the company’s Senior Vice President and Corporate Controller, will succeed Tony as Senior Vice President, Chief Financial Officer and Treasurer. Kurt has been with Tractor Supply for 17 years and is a talented financial leader with a proven track record of creating value. We all have the utmost confidence in his ability to continue leading the financial team forward. To ensure a smooth transition of duties, Kurt and Tony will work together over the next 7 months, with Kurt increasing his interface with the investment community through investor meetings and calls in the back half of the year. I will now turn the call over to Tony for a more detailed commentary on our second quarter results and outlook for the remainder of 2016.

Thanks, Greg and good afternoon everyone. For the quarter ended June 25, 2016, on a year-over-year basis, net sales increased 4.5% to $1.85 billion, net income grew 2% to $156.4 million and EPS increased 3.6% to $1.16 per diluted share. Comp store sales decreased 0.5% in the second quarter compared to a very strong increase of 5.6% in last year’s second quarter. Comp store sales were challenged throughout the quarter, with April and May impacted primarily from unfavorable weather patterns and tough comparisons from prior year. Beginning with Memorial Day weekend and warmer weather, seasonal sales trends normalized and comp store sales were in line with our expectations in the month of June. Sales were the weakest in the Northern regions of the country, where unseasonably cool temperatures reduced demand for many spring items. The Southern regions, which were less impacted by the cooler weather, performed more consistently with our expectations and had positive comps except for the Texas region. In addition to the impact of the oil patch economy, certain areas of Texas were negatively impacted by heavy rains and flooding, which limited some of the spring season activities. Comp transaction count increased for the 33rd consecutive quarter, gaining 1.5% on top of a 4.2% increase last year as C.U.E. items such as pet and animal food continued to post high single-digit comps. Average comp ticket decreased by 190 basis points compared to last year’s 130 basis point increase. Big ticket drove last year’s increase and was the principal driver of this year’s average ticket decrease. Comparable sales of big ticket items declined approximately 8.5% as big ticket items such as riding lawn mowers and utility vehicles were challenged due to strong comparisons to last year and this year’s unfavorable selling conditions. Deflation also had a slight impact on average ticket and contributed approximately 25 basis points to the decrease. Now turning to gross margin, which decreased 23 basis points to 35% compared to a 50 basis point improvement in last year’s second quarter. Product mix had a negative impact on margin. Although margin benefited from soft sales of some of the key big ticket items such as riding lawn mowers, this benefit was more than offset by the soft sales in other high margin departments and the strong sales of lower margin C.U.E. items. With respect to margin rate, while promotion cadence was relatively consistent with last year with the exception of a friends and neighbors event, we were slightly sharper on price to drive sales. Freight was unfavorable as an increase in inbound transportation costs more than offset the benefits from lower diesel prices and a reduction in the outbound stem miles. We estimate deflation had a slight favorable impact on gross margin. For the quarter, SG&A, including depreciation and amortization as a percentage of sales de-levered by 15 basis points to 21.6% of sales compared to 21.4% of sales in the prior year’s quarter. SG&A growth was impacted by several factors. The deleverage was primarily due to the lower comparable sales results as SG&A expense grew only 5.2% from the prior year. Excluding incentive compensation expense, SG&A expense increased 6.7%, which is below the SG&A growth rate over the past several quarters. We experienced strong cost control in personnel, including store level, distribution center and store support payroll as well as medical expense. Occupancy expense was well managed as we began to benefit from our LED lighting retrofit. The strong expense management was achieved against the headwind from our Arizona distribution center that was not open at this time last year. We estimate the deleverage from this center’s operation to be approximately 15 basis points. Our effective income tax rate decreased to 36.8% in Q2 compared to 37.2% last year due to additional federal and the state tax credits. Turning to the balance sheet, at the end of Q2 this year we had cash balance of $151.1 million and $196.2 million in outstanding debt, principally comprised of the term loan compared to a cash balance of $56 million and no outstanding debt last year. During the second quarter, we had limited purchases under our stock repurchase program. Average inventory levels per store decreased 1.2% compared to 4.1% increase in last year’s second quarter and inventory turns decreased compared to last year. We had strong inventory management in the quarter considering the soft sales environment. The transition between second and third quarters generally does not have significant markdown exposure. We are comfortable with our seasonal inventory as we move into the third quarter and we expect a normal markdown cadence exiting the season. Capital expenditures for the quarter were $64.3 million compared to $48.2 million last year. We opened 22 stores and closed 1 Del’s store in the second quarter compared to 17 new stores and one closed store in the second quarter of 2015. The CapEx increase relates to our new store expansion, which includes an emphasis on retrofit locations that generally require renovation capital and our LED lighting retrofit project. Now looking ahead, based on the trends and results for the first half of the year, we revised our outlook for the full year fiscal 2016 in our June 29 business update. We are reiterating that outlook today. We expect full year sales to range from $6.8 billion to $6.9 billion, comparable store sales to increase between 2.5% and 3.5% and net income to range from $451 million to $456 million with earnings per diluted share to be $3.35 to $3.40. Assumed in this guidance is an EBIT margin improvement of about 10 basis points to 15 basis points, a tax rate of 36.8% and capital expenditures of $230 million to $250 million. We will continue to make purchases under our share repurchase program and currently project full year diluted shares outstanding to be approximately $134.5 million to $134.8 million. In our June 29 business update, we stated that although June sales were more normalized, we did not expect a shift of spring sales into the third quarter. While it is still early in the third quarter, the trends through the first few weeks of July would appear to support this expectation. From a comparison standpoint in the third quarter, we face our toughest year-over-year comparison in July and our easiest comparison is in September. As a reminder, we had a record mild winter last year and therefore, we believe that any upside in our forecast will be in the fourth quarter. We also have our 53rd week and an additional comp sales day in the fourth quarter. The additional sales week will provide incremental expense leverage in the fourth quarter and we estimate that the additional week will provide $0.03 to $0.04 increase to EPS, which is contained in our guidance. In our original full year guidance, we have forecasted $0.01 negative EPS impact from the closing of several Del’s stores in the fourth quarter as part of our transition to Tractor Supply stores in Washington State. We have now made the decision to close those stores closer to their lease expiration, with most of them expiring in 2017. We are pleased with the performance to-date of the Tractor Supply stores that we have opened in the former Del’s markets. We continue to expect limited deflation in the back half of the year in the 15 basis point to 20 basis point range. As we look at the back half of the year, we expect improvement of EBIT margin driven principally by improved gross margin in both the third and fourth quarters and expense leverage from the 53rd week. While transportation expenses will continue to be a headwind as we cycle the decline in diesel prices, we expect our gross margin initiatives to continue to drive improvement. With respect to SG&A, we were very pleased with our expense management in Q2. We will continue to drive cost saving programs in the back half and we will react accordingly to sales trends, but we would expect year-over-year increase in SG&A to track closer to the overall growth in sales. We expect to maintain the appropriate payroll allocation to drive sales in the back half and incur a more normalized incentive compensation expense. We will continue to have the headwind of the Arizona distribution center until we cycle its opening in late December. That concludes our prepared remarks. Operator, we will now turn the call over for questions.

Thank you, Sir. [Operator Instructions] And we will take our first question from Steven Forbes with Guggenheim Securities.

Hey guys.

Hello Steven.

As it relates to the top line performance over the past few quarters across the different regions and you briefly touched on it, but is there anything you are learning from the region with the loyalty card – with the loyalty program as it relates to weather and just general consumer behaviors during these unique weather events, what I am trying to get at, is there any – is there less variability right in the region where you have those – where you have the loyalty program in consumer trends and behavior because your ability to communicate with the consumer – or is the region – is it really not that different?

Steven this is Greg. It’s really early for us to say that we have seen anything significant because of it, but what I can tell you is that the reason we took – the program expanded to California is it – we really liked what we are seeing in Michigan with the engagement and how the customers are responding to it very openly. So, we want to move it to California to take it another step. And I think 6 months from now we will probably have a better idea to give you some ideas of how it is impacting. We don’t have enough data yet to say that we can use that to really reach back to customers and either poll them for information about how they are feeling or what they are buying or not buying. So, it’s now just gathering the data and getting them into the database, to be honest.

And then as a follow-up, maybe as it relates to the merchandising since we are really 2 days away, I believe from the next open buying day. Can you just briefly talk about what departments in your mind right as of today represent the greatest revenue margin opportunity, especially from a productivity standpoint in the box? I mean, I know from our pricing in our reports and from our own visits, paddles seems to stick out just given the space allocation. But heading into an event like the open buying day on Friday and so forth, is there – are there anything that you guys can talk about that you are looking forward to or you see a lot of opportunity from a merchandising side?

Yes, Steve. This is Steve again. Hey, what I would tell you is that it’s kind of two-pronged here. The advantage of the open buying day is this. We are going to get an opportunity to see 300, 400 folks come through and talk to our teams, all of which are doing business with Tractor Supply today and really getting a better understanding of what’s going on in the marketplace, because most of these folks, either seller or competitors or they are somewhere else out there that we can get a better read on what’s happening in the marketplace. Everyone who signs up, we will give some time, too. And so we don’t really narrow it down into any one given category. In terms of what we are looking at in the box itself to move our business forward, we have talked a lot about the C.U.E. business. And you will see a number of resets that are going to take place in the back half of this year that will support that, whether it would be what we are doing in feed with the launch of our Do More equine program or what we are going to see in terms of Blue Seal, which will expand out to another couple of hundred stores in the Northeast and down the corridor. So, there is a lot of things that are happening within the box right now, not just in terms of resets, but also events such as Deer Feeding that we have got out there right now that’s doing particularly well or the Stock Your Shop tool event. And in that then itself, we are going to have about 60% new products that we didn’t have a year ago to really give our customers a treasure hunt experience. So, I could go on and on about all the things that we are working on, but I would say across the board, we have got a lot of things cooking.

Thank you.

And we will take our next question from Alan Rifkin with BTIG.

Thank you very much. And Tony, best of luck in your retirement. Certainly, you made it abundantly clear the impact of weather on the business, particularly in that first two periods of the quarter. I guess, can you maybe shed a little bit more color then why, if you feel so strongly it is weather-related, you are incrementally more cautious for the second half? And then I do have a follow-up.

Alan, this is Greg. Couple of things to note. The second quarter was difficult and there was just incredibly, let’s say, challenging weather in some of the regions of the country, where we have typically been able to weather those storms in the past, but I will give you an example in Texas, very, very difficult, massive flooding, lot of destruction. That will take time for that market to come back. It’s not – it doesn’t snapback tomorrow. So, our feeling was, let’s be a little more conservative as we go in the second half. We know it’s going to take some time for a large market like that where we have 170 plus stores to recover. And we – and as we talked amongst ourselves, our feeling was we are always kind of a conservative group here. We would rather be more conservative and give ourselves an opportunity to exceed that than to say, well, we think – we can’t forecast the future. We could only kind of deal with the past and try to look at that and understand what could be in front of us. So, that’s really – we are just – we are being a little more conservative given the fact that we had such a difficult second quarter with the weather variations.

Okay. And as a follow-up, so if we were to dissect your business in another way, namely, classes of stores added in more recent years, let’s call it, 2013, ‘14, ‘15, are the stores that were added in those classes possibly more susceptible to the weather than prior classes?

Well, Alan, this is Tony. We generally – other than in sort of ‘14 and ‘15, where we were trying to build our base out in the Southwest to create the volume for our Arizona distribution center, we generally are very geographically dispersed. So, I don’t think there was a particular emphasis. And in this case, the Southwest has performed very well for us and so there is less of a concern. Obviously, if you ran into a significant drought situation in a particular area of the country, that may have an impact, but generally because of the geographic disbursement of the stores, we tend to be somewhat insulated from one – some particular area of the country having some weather event.

Okay, thank you very much. I appreciate it.

We will take our next question from Peter Benedict with Robert W. Baird.

Hey, guys. Thanks and congrats Tony. Best of luck. First question, just to clarify, on the Del closings, I think you have 13 of those stores left. Are you going to – are you closing any of the balance of the year or are they all going to be in ‘17? Just can you help us with that?

Sure. Right now, it looks like there is a few that are scheduled for the back half, so it’s more like just two or three. And that will leave about, I want to say 10 to 12 for next year and they will be spread throughout the year and a lot of them again in the back half. But when we looked at it and we saw that some of the stores actually are performing well, we haven’t had a match necessarily of a Tractor Supply store coming into that marketplace, we just felt it would be more prudent to leave them opened until they come closer to their lease termination date.

Okay. You had mentioned that there was a $0.01 hit to earnings that was embedded in your guidance, I think you said at the beginning of the year, but that’s not in there now. Is it – did I hear you correctly?

Correct. And so that would be the one area where we had $0.01 pickup in the back half of the year relative to our original forecast and that’s probably part of the conservativism in the back half that we did not pick up that $0.01 in our forecast.

Right, got it. Understood. And then the next question is just around the DC analysis, Greg that you are talking about. When can we expect kind of more color on maybe some developments that would come from that? I am also thinking about an update around the mixing centers, what your plans are from that perspective?

Okay, Peter. First of all, we have been in this process of analysis working with Avista for 6 months, I think, Steve?

Yes.

Close to that. And we now have their results and their suggestions and we are now going through that saying, okay, what looks plausible and what would the timing really be and how do we move forward? If you remember correctly, we did a similar project about 6 years ago. And that helped us understand the next wave of growth for the company and we got a little ahead of the curve on building buildings and systems, infrastructure and so on. This is the next step again to take us forward. So, you will know more about this. We will speak more to this on the next call, because we just got the results and we are still digesting it.

Okay, great. Thanks, Greg.

We will take our next question from Seth Sigman with Credit Suisse.

Thanks. Good afternoon, guys. And Tony, congrats. Twofold questions here. First, just on the sales, so it sounds like the conservative view is somewhat based on what you have seen early in the third quarter. The weather did improve a bit in June and then into July. So, I am just wondering, is there something else happening here where maybe there is some timing dynamic where consumers just end up delaying certain big ticket purchases that they may have missed out on earlier in the season? Is that part of what’s happening here early in the third quarter?

Yes, Seth. This is Tony. Based on our prepared remarks, the message that we are trying to send is that as we move through the quarter, we are hopeful that with sort of the softness in April and May that we would see a little bit stronger bounce back in June. We did not see that. So, as part of our update on – in our June 29 business update, we had anticipated that we would not see significant spring sales falling in the July time period. So – and the last three weeks has verified that expectation. So, we expect it will be limited as we move through the rest of the quarter. And obviously, our easiest compare is in the September timeframe and a lot of that can be driven by cooler weather as people start to ramp up for the winter season. And right now, we expect that it will be cooler in September than last year, but still will be warmer than normal. So obviously, it’s just too early to have an indication as to the third quarter.

Okay, got it. And then I just want to follow-up on Peter’s question about the network analysis that you are doing, is there a scenario here where you need to significantly increase your spending or do you feel like the earnings growth algorithm that you have laid out previously should account for any potential investments that you need to make?

Seth, this is Greg. That analysis – that’s the part of the analysis we are working through right now as far as what looks plausible. When you – anytime you do all these analyses, they do every – it’s ran on a model of the perfect scenario, correct. Nothing is a perfect scenario. And we have some buildings in places that honestly, if we want to look – went back 10 years ago, we may not have put them in this city, maybe we put it in a city 200 miles to the East, North or the West. So that’s what we are sorting through right now. We do believe that the cost of this as we go forward will be part of our capital plan that we have had and we continue to invest through in this – the next leg of the growth. So yes, we believe it will be part of that plan. And again, we will share more of this with you. And when we get to the third quarter call, we will have all this sorted through at that time.

Okay, prefect. Best of luck in the back half.

Thank you.

We will take our next question from Michael Lasser with UBS.

Good evening. Thanks a lot for taking my question and congrats Tony.

Thank you.

Greg, there have been points in the past where Tractor Supply has been burdened by the weather, but it was able to power through it either because store base is maturing and driving growth or because it still had a plethora of merchandising activities and new products introduced, is there a case where maybe just given the company’s size or stage of development, it’s harder now to overcome external factors like the weather?

No, Michael. I would tell you that we have looked at this and looked at this and no that it would not be the case. There is plenty of newness, plenty of things that we are bringing to the customer. But we have all looked back and did some studying of the last several years of weather trends and things. And it’s just become a little bit more I will call it, unpredictable, meaning that it’s moving the sales around a little bit more than we thought. And so we are reacting to that fairly well, keeping our inventories in control and moving our assortments to the product categories of the customers willing to buy and want to buy. But no I don’t think the size has anything really to do with it. We are still as nimble as we were. We saw plenty of newness. So I think this is us learning something new about how we need to react as these – I think what we are going to see is more and more of this type of weather patterning and it’s a new learning to be very honest.

Maybe that being said, is there anything you could have done differently to help drive a better comp during the quarter?

I don’t think so, because when you look at the weather patterns in the parts of the country that it affected and how it affected them, we managed the inventories extremely well by region. So I think we did that part extremely well. And to say that there was other opportunities that we may have missed on boy, we looked at it very thoroughly, Steve and the team spent hours and we took advantage of every opportunity that was there. The customer demand just didn’t develop in second quarter. That’s the answer.

And then on the new store productivity, which also has been trending a bit below average, was that metric impacted by the weather or is that still a lingering effect of some of the lack of brand awareness on the West Coast?

Michael, this is Tony. We actually are pleased with where we are with the new store productivity. It plateaued pretty much over the last three quarters and the stores out West are performing better. I think that as we cycle through, you will see that the newer stores that we have opened this year are again exceeding pro forma. And we should be able to maintain that new store productivity if not increase it.

Got it. Thanks again.

And we will go next to Christopher Horvers with JPMorgan.

Thanks. Good evening. You mentioned that you were a bit more sharper on price in adding friends and neighbor event, was that mainly in response to the spring seasonal business and as you have transitioned away from that time of year for that business, are you back to a comparable I guess promotional and pricing posture on a year-over-year basis?

Yes. Chris, so this is Steve Barbarick. And one of the things that we have talked a lot about, Tractor Supply being a fairly nimble company and we are able to react pretty quickly to the needs of our consumer. And what we saw in the Q2 in the softness in a lot of the seasonal businesses, we felt like we needed to react with something. So we did put a promotional piece out there as Tony referred to. As we look forward, we are going to continue to use all the arrows in our quiver to best support the business. And whether that be using inventory to help move our business forward, it could be looking at additional promotional pieces and it could be a variety of things. Maybe it’s getting more targeted around some of the C.U.E. businesses. Another thing that we are doing is local presentation. So right now, where it’s hot and dry out West, we have got our store teams out there, putting together water movement and fans and things that we are doing down in Texas. So we are constantly moving the business around based on the needs of the consumer. I am not suggesting that we are going to steer one way any – too far any one way because we use a balanced approach and we have got plenty of initiatives that move us forward. But I also don’t want to rule anything out either.

Okay, understood. Well, I guess to clarify that I mean that response is going to make people think that you are being – continue to be more promotional and it’s a reaction to current demand trends, so is that the message that we are expected to understand?

Yes. I wouldn’t suggest that whatsoever. I mean we have run our business the same way we have since I have been here and that’s been for the last 18 years. And I wouldn’t want anybody to think that we are going to steer one way any too far, one way left or one way right. We try to present value to our customers day-in, day-out. And that’s what they come in for. So again, I wouldn’t read anything into that.

Understood. And then as you think about the oil patch and the performance of the stores, you had baked in lapping that, I think it fell off – those stores really fell off at the end of the third quarter, as you looked over the first half of this year, how was your outlook for those – the performance of those stores as we start to lap the fall-off later, has anything changed and are we expecting them to return to positive?

Sure, Chris. This is Tony. When we look at the last three quarters, their performance relative to the control group has been relatively consistent. So the impact on the comps has been again, relatively consistent for the last three quarters. As we move forward, we will start cycling in. And I agree with what you said that we really started to see sort of that fall-off in the third and fourth quarters. So as much as we do anticipate that it will moderate, we do believe that it will still be a drag in the back half of the year, but not to the extent that it has been in the first half.

Understood. Thanks very much.

We will take our next question from Simeon Gutman with Morgan Stanley.

Thanks and congratulations Tony. Were there any undertones that discretionary spending is slowing or the weather just make it very difficult to judge that?

Simeon, let me take that one. I would tell you that what we saw in the second quarter, we could directly tie that back to the weather and how it slowed the development of some of the businesses. We had a very favorable end of March. And it seems like since we got – and we had that early Easter shift. And it looks like we had a bit of a reversal in trends, all of a sudden, April and May versus where we were at the end of March. And we started seeing some pullback a little bit on big ticket because we had seen a good pull forward at the end of first quarter. So we thought well, that’s just going to be a trade-off between a couple of months. But as we said in the 29th update, we really haven’t seen anything significant with the customers’ use of credit or shift to spending and so on and so forth at this point. It’s fundamentally they are still buying the things they need, they are still shopping for us, our traffic counts are up. So, it was a bit of a tough pill to swallow when we saw the business just not develop and then, again, little warmness in June and we saw a nice push again in the business. So, it’s just very unusual, but no, I can’t say that we have anything that would give us any indication that there is some current trend with the consumer, because we would have seen some of the signals and we haven’t seen it. Our core business couldn’t be stronger.

Okay. And then my follow-up on inventory’s gross margin, Tony, made a comment regarding the third quarter that there is not a big transitional quarter, a big markdown quarter. I guess you are not getting the pickup in seasonal July. One, is there some carryover risk from those items? And then if we do see some – when we talk in the third quarter, if we do hear that there was some markdown, what would explain that? Our markdown during the quarter, what would have explained that or is that just likely out of the question?

Simeon, Steve Barbarick here. I thought the team did a really nice job managing to the demands of the business. And we saw that early and we are able to pullback in a lot of the ordering. And our seasonal inventories are in a great position right now for spring. So, I have very little concern about markdown or clearance going into the third quarter or fourth quarter for spring product.

Okay, thanks.

And we will take our next question from Ben Bienvenu with Stephens Incorporated.

Yes, thanks. Good afternoon and congratulations, Tony.

Great, thank you.

So, just following on that question as it relates to inventory and some of the variability that we have seen around weather. Has there been any deviation or evolution in the number of resets that you anticipate to do for the fall selling period or do you anticipate sticking with that traditional reset cadence?

We went back and we looked at what we are doing in the back half of this year and looked at the categories that maybe most impacted that we think that our customers still have a lot of demand for. And we have modified our approach slightly, but it’s really around some key areas. And I feel really good about the reset work that we are going to be doing. So, it is around a lot of the C.U.E. merchandise. But in addition to that, we went back, we have reset our stores for footwear and leather and in rubber. We have got heating resets that are going to be taking place and assortment adjustments there as well. So generally, when you look across the four walls, I feel very confident that the work the team is doing is going to be in line with what we are seeing our customer demand for.

Okay, great. And then you touched in the past on some ammo tests in a handful of stores. I would be curious to hear how that’s progressing? And then any change in thought process either around extending the number of stores that offer that SKU set and/or potentially adding firearms of some kind to your assortment?

Yes. I would tell you, at this point, it’s still early in the test. It’s in 25 stores and we are getting some results now. We still need to dissect it and determine whether or not it meets our threshold for being a successful test, so that it would roll forward in more stores. In terms of firearms, it’s way too early in the game to even talk about that. So, I would leave that for future date.

Fair enough. Thanks and best of luck.

Thank you.

We will take our next question from Peter Keith with Piper Jaffray.

Hey, thanks. Good afternoon and my congratulations as well to Tony and to Kurt also. I want to just look at the mix dynamic in Q2. Far back as I can remember when you have had these late springs or colder springs, you usually have had this mix benefit because of the lower OPE sales. It seemed like there was a bit of a change here in Q2 and you identified there was some higher margin items. Could you just maybe provide some more specifics there and anything that’s kind of surprised you on the weakness?

Sure. When it comes to the bigger ticket, we definitely had a benefit, in particular, when it came to the riding mower category. So, the softer sales in that category did help margin, because it is well below chain average. When we look at some of the other key departments, obviously, the first thing that comes to mind is the strength of the C.U.E. items, in particular, the animal feed and pet food, which have just a slightly below chain average margin. But that strength obviously de-levers on margin. So, that had a negative impact. And then when you look at some of the other spring items that are higher margin, that were soft as well and even some of the other hard line items, the softness in those sales, we didn’t obviously pickup the margin there as well. So, those two factors offset the benefit that we get on the larger ticket hard line category.

And anything there, in that last comment, Tony, that was different from previous cold springs?

Generally, we would have some key categories of spring that would sell well. In this case, some of those categories, we didn’t get that lift. So, we would generally get some offset. And so it just – we just didn’t have the same lift that we would get from the other higher key categories. I know Steve has some comments that he would like to make.

Yes. A year ago, when we were sitting here talking about the strength of the business, a lot of it was driven by seasonal and a lot of it was driven – we had a new OPE lineup. We saw demand across the board in trailers and a lot of other categories. And we were comping that this year, in all fairness. And to your stack, I think you would feel really good about, but unfortunately, we are comping ourselves and we – that’s what we need to be doing and we didn’t do it like we should have this quarter. But if you looked at the totality of the business, it’s still strong, there are some very strong fundamentals in the business, but we are lapping what was a very robust Q2 last year in the seasonal category.

Okay, that’s helpful. Steve, while I have you, too, so you have mentioned you have rolled out the new and improved inventory allocation system, do you have any early wins or insights you could share and how might that benefit the back half of the year?

Yes. It’s rolled out now to the entire team. And I would tell you I really do think it’s going to have a positive impact on the business. It’s really going to help us mainly with things like end caps, event merchandise, a lot of the seasonal builds, both initial and end of season. And those are the ones that are going to get the greatest benefits. And talking with the team, we believe we will see a lot of those benefits in Q4 because the work we are doing right now is going to have that impact.

Okay, thanks a lot guys. Good luck in the back half.

Thank you.

We will take our next question from Stephen Tanal with Goldman Sachs.

Hey, good afternoon guys and congrats Tony. Good luck. So, the one thing I was trying to sort of understand on the weather, if we think about that $25 million pull forward into 1Q and sort of normalize for that, it’s about 140 bps, I think to 2Q and you kind of add it in, pull it out of 1Q and it does actually look like the underlying rate slowed. Is that a fair way to think about it or do you think that doesn’t really capture the entire seasonal effect? And if you could maybe just give us a number, an all-in number on the weather impact for 2Q. If you guys have something in your head, that would be pretty helpful, too?

Stephen, I think what you are referring to is if you try to normalize, looking at the pull forward and you push that through and kind of work the numbers that I think what you are saying is did we see a bit of a slowdown in second quarter just in general from what we saw in first quarter in sales if we did that.

Yes, X the weather, like the core kind of trend rate here.

Well, with the slowdown that we did see was, again, in the big ticket categories. No question that was part of it, but we believe that, that was due to the fact that the weather just was not complementary for selling those kinds of products. Our customers, as you know buy very much to need. And so when we looked at that and we did some normalization of our own with the numbers. Those big ticket categories are riding lawnmowers, as Steve mentioned and a few other categories, UTVs now which were very robust a year ago at this time, did not anniversary themselves.

Understood. But just to be clear, is the big ticket impact part of that $25 million or not?

Some, but not...

It definitely is.

Yes, yes.

We got off to a very strong rider season in March and so we clearly had anticipated that rolling through into Q2.

But it didn’t roll through.

But it didn’t. And as we stated in the prepared remarks, big ticket was down 8% and in particular, after being very strong in the March timeframe. So, you can adjust the month, but still, the trend was very consistent to the overall trends, where April and May were softer than June.

Okay, got it. And just lastly, as we think about kind of the weather, obviously, a big topic of everything that’s happening, it’s been hot, which I think is generally good, but it’s also been dry. And I think in June, we typically like wetter weather. And to be honest, I am not sure what we root for in July. Does the dryness hurt you? Do you want it to be wetter in general or how should we think about weather just high level?

Well, for the most part, we do prefer wet because things will continue to grow and it’s a continuation of spring. But when you look at the moisture generally throughout the springtime, we have good moisture throughout. So as we move into the summer, it shouldn’t be a significant impact. Obviously, when you look at the drought map, tends to be a little bit in sort of the Southwest and the California area. But because there is too much rain in say the Texas area, the heat is good because it helps dries out a little bit sooner. But generally, we look for moisture. It will be a positive thing as we move through the year.

Great. And just last one for me, if there is any update you could share on that – I am sorry the inbound freight issues with the Casa Grande, have you made some headway with the vendors or have you switched up vendors, how is that going?

This is Steve. This is going to be an ongoing challenge for our merchant team and our sourcing team, to continue to bring new folks on. We have made some headway in that, but when you are talking about as many product categories as we carry and 70-plus percent of those go through our network. This is not a one and done kind of scenario. So we are making headway. We have got about another 20 or 30 vendors that we are looking at right now in terms to trying either resource or find secondary vendors out West to be able to reduce those stem miles.

Got it. Thank you very much guys.

Thank you.

We will take our next question from Scott Mushkin with Wolfe Research.

This is Chris Bottiglieri on for Scott Mushkin. Our first question was, taking a step back, you guys have – obviously, it’s a very strong track record, but it seems more recently, the annual comp algorithm has kind of slowed a bit. So one, kind of like putting weather aside in the last couple of quarters, but in the last couple of years, like why do you think this is happening. And then as a follow-up, like do you think that your current growth initiatives can lead to reaccelerated comp algorithm looking forward or are you kind of comfortable in this range?

Chris, let me start with that. Tony will probably jump in. I have been with the company now – I will be 9 years in November. And I would say that the last 4 years had been the most interesting from a standpoint of the mix of our products, when things were selling, when things peaked, introductions of newness and so on. But I can’t underestimate and we used to – I think things that we could control more things around some of the weather patterning across the country, but as we have gotten now into 49 states and that store dispersion is a good thing generally. I would tell you that it makes it more challenging for us to understand sometimes how these ebb and flows will affect the overall business on an annual basis. We typically can work our way through some of these slight, if you call it, troubled spots where we have, I will say, less than ideal weather and less than ideal conditions for selling certain products. But we are in a new learning curve here I believe, as we look at some of these things moving forward. And the team has done some great work as we forecast forward through the second half and into next year. And I am convinced that we can kind of push this thing back on this growth trajectory that is kind of expected from Tractor. I mean we are a test and learn company. We learn all the time. There is no lack of newness, as Steve mentioned earlier. We continue to introduce new products and those are things that really drive all the footsteps. And then we are getting far better at this localization component. And that’s going to be a key as we go forward because that helps us defend ourselves when conditions are less than ideal for selling some products. I can’t reiterate enough, our customers buy to demand or to need. They don’t buy early, they haven’t been for a long time.

And I will just add that over my 11 years here, we don’t necessarily see what the next silver bullet is going to be, but being the test and learn, we are constantly coming up with really good ideas and products. And we let our customer dictate what the next best item is going to be. But when it comes to the model itself, generally our forecasting is always in the 3% to 5% range. We don’t need to reach the high single-digit comps anymore to have a really successful year. And so as we look out, we think that the model will work just terrifically at the 3% to 5% comp level.

Okay, great. You guys absolutely had strong track record didn’t mean to take anything away from there. Just one brief follow-up about the C.U.E. strategy, how much do you think is left in that, like what inning do you think we are in, if you benchmark yourself to the industry, like talking to your suppliers, are you taking share there, like do you think your customers have adopted the premium brand in the space like kind of what’s left there you think in the C.U.E. like the next, call it 3 years to 5 years?

Yes. This is Steve. We still see more opportunity here and we have seen continued growth over the last several years. And it’s really driving footsteps into our stores. Our focus is really around being priced right. It’s about having the right inventories. And it’s about expanding our assortments. And we have continued to do that very well. I still think that there is upside and a lot of momentum here that we still have. Depending upon the category you look at, I will use – if you benchmark maybe our overall pet business versus industry, I think if you looked at that, you would probably say we are outstripping and indexing higher than industry and therefore you would have to make the assumption that you are taking share. If you look at our feed business, I would tell you, based on what we hear from our suppliers, there is a good likelihood that we are taking market share there as well. And you could go across the four walls, whether it would be in lubricants, whether it would be in lawn and garden or other categories such as betting. And I think we continue to do a nice job, offering a great assortment that has the right in-stock at great value prices for our customers every day. So I still think that there is a more upside here.

Okay, great. Thank you for your time. I appreciate it.

We will take our next question from Chuck Cerankosky with Northcoast Research.

Good afternoon everybody. Best wishes to you Tony. Just a real quick question on the big ticket items in this most recent quarter, are there attached products that went missing because somebody wasn’t buying an ATV say, a trailer or hitches, things like that, that took away from the total sales beyond just the big ticket merchandise?

Yes. This is Steve. And that’s a great question because when you talk seasonal, there is a lot of attachments that come with OPE. There is a lot of replacement parts and whatnot. And we saw a relative softness across many of those compared to a year prior’s strong comp store sales there. So many of those attachments and accessories do carry a little higher margin that was a question asked earlier and we did see those sales be soft over the course of the second quarter.

Alright. Thank you.

We will take our next question from Dan Wewer with Raymond James.

Greg, the way that these three measures new store productivity began to weaken a bit about a year ago I know that from your perspective, it really hasn’t had much change, but based on the publicly available information, that’s how the number shake out. And then a few quarters after that, we saw the weakness, the negative comps in the fourth quarter last year and now another negative quarter, if you have any concern from your part that perhaps some of the weaker new store openings could be a leading indicator of, call it, saturation and that could be contributing to this current sales trend?

Dan, what I can tell you is the facts. No question, when we first opened the new Western markets, we saw some weakness there in a few markets and that drag for about 1 year and 18 months was there. But the process we use in finding and aligning new stores and how we plan for cannibalization in this, we are seeing a more normalization again. We are seeing stores performing back to that level. And on a year-over-year basis, the run rates are very similar. So we did have a little period of time there when it was, gee, what happened and we looked at it and it was really very concentrated in really the Utah market. So no, we are not seeing new store productivity sliding. As a matter of fact, it’s as good today as it was a few years back. But we did have a little blip in there and I think we got to – we worked our way through that.

The second question I have revolves around Revionics and your pricing optimization, you have been very bullish about the benefit to gross margin rate, in light of the recent sales trends, have you taken a fresh look at elasticity of demand and perhaps come to the conclusion perhaps we squeeze about as much out of pricing as we can and in fact, maybe there is the case that we make for becoming more promotional, which sounds like you did during the quarter?

Yes, Dan, this is Steve. I mean, the pricing tools that we use in regular price are ongoing, and they give us recommendations based on demand by area of the country. So we are constantly looking and fine-tuning that, challenging it ourselves. And where we have upside, we take it up. And where we think we need to be more aggressive, we will move those prices down. So from that perspective, I think that there is still more we can get out of the tools. As a matter of fact, we just recently extended our contract with Revionics because we continue to see value there. In addition to that, the clearance module that we use has still been very effective for us and helping us work our way through a lot of that product while it’s still in home before it gets moved and try to move it through while we’re still in season. Our units in terms of SKU products, we’re still seeing strong comp store units movement, and we really track units as much as we do sales in many cases. Now you’ve heard the last couple of years, we have seen some deflation there, so we have got some headwinds to overcome. But generally speaking, I still think that there is some more opportunity for us in using that tool.

Okay. And just real quickly on the comments about July, we have known that the year-over-year comparison would be difficult for 12 months. In fact, as I recall, July of 2014 was a very strong month for Tractor Supply as well. So based on your comments about the first 2 weeks of July of 2016, are you saying they are weak, but that’s exactly the way it was budgeted or is the company communicating – we knew it was going to be a tough comparison. Could you even take that input now, we are running below where we thought we would be?

Dan, this is Tony. Let me answer that one. What we are saying is that we did not see a shift of sales, spring sales from Q2 into Q3. And so we are not making a statement one way or the other relative to the performance to our expectations or comparison to comps of last year. I will say – and I would say I am in agreement with you. We have had three very strong Julys in a row. And obviously, when we look out and we forecast, we would forecast July not to be the strongest of the three months in the quarter.

So your cautiousness, this reflects the fact that you are not recovering the sales lost in April and May, but you are not necessarily saying that the current run-rate is below plan, it’s just that you are not making up for the ground that was lost?

That’s correct.

Okay, thank you.

[Operator Instructions] We will go next to Scot Ciccarelli with RBC Capital Markets.

Yes, I will keep this one short given the timeframe here. Tony, you referenced earlier and you have said this in the past, what spring should be good for at 3Q trends since it does extend the growing season. Are you expecting any benefit from that – this, call it, third quarter or is something different this year?

No. As we stated, we had anticipated that with the moisture and with the slow start to the spring that it would be a delayed spring and would continue into Q3. But since we did not experience that bounce back in June, we were very cautious and did not anticipate extending out. So yes, it is a little bit different than what we’ve seen in the past. But we did not expect any additional spring sales in the July, August timeframe.

But haven’t you discussed in the past that more moisture in the ground actually helps you kind of throughout the balance of 3Q or am I misunderstanding that?

No, I think that’s correct. And again, as we saw throughout the quarter, with the softness in sales as well as the big ticket being soft as well as having the last sort of 3 years of strong Q3, in particular, strong July, August, it’s just is a more difficult comparison.

Okay, I will follow-up later. Thank you.

We will take our next question from Adam Sindler with Deutsche Bank.

Yes, good morning. I am sorry, good afternoon everyone. Just to focus on margins for a couple of minutes here. As we look to the second half of the year, what are the major puts and takes in the gross margin line in the third and fourth quarters? Is it more the impact of inbound freights on C.U.E. on the West Coast, D.C., is it mix? Just as we think about how the weather plays out, what are the different things we should try and think about?

As we move into the back half of the year, they tend to be – the margins as well as most of the P&L tends to be a little bit more predictable. Now obviously, as we work our way through the quarter and sales and how we react to sales and continue to drive sales, obviously, we can have an impact. But really, as we look year-over-year, there is not any significant aberrations from last year that we are going to be comping. So I would say generally, relatively consistent. We look to see that in both quarters, we anticipate improving our gross margin, which will help us drive the EBIT margin improvement for the overall company and in the back half of the year.

So slightly higher gross margins both in the third and fourth quarters?

Correct.

Okay. And then on the expense line, I mean, so that is one thing that really sort of has changed quite a bit over the last 3 years, not only has sales, but a little bit as you pulled back your square footage and as you’ve lost the very significant benefit of inflation that you had several years ago. But your SG&A is now running up closer to 10% a year versus maybe 6%, 7%, 8%, 9% a year, and then that’s converged with sales. So obviously, there’s a need to continue to invest in the business. But at the same time, sort of what is the thought process around what can be done perhaps to try and get a little bit of a greater spread between sales, dollar growth and SG&A dollar growth?

True. We continuously look at cost savings initiatives. And in actuality, we feel that we have been very successful. One, in managing headcount both at the store support center and in the stores and you can see that in Q2 in particular as we really managed the payroll expense and the variability relative to the softer sales. And we have some key initiatives looking at all levels of expense structure. So when you look at the increase, we believe that it really is very focused on growth areas and areas that we need to make investment in. And as I alluded to in our prepared remarks, as much as we only ran about a 6% increase year-over-year, net of the incentive compensation, we do expect as we continue to move forward to be in – somewhere in the 9% to 10% range, consistent with our growth in sales, in particular because some of the investments that we made last year that we are cycling in particular, the Arizona distribution center and the mixing center.

Alright. I guess longer-term though, they are never – at least as you stand right now, it’s sort of just perpetuity investment mode, is that the way to think about it?

Yes. I wouldn’t necessarily say perpetuity, but as we continue to grow the chain at obviously a fairly significant clip of 110 to 120 stores, we are going to continue to invest in the infrastructure and that’s where the majority of the dollars are going.

Okay, alright. Thank you very much.

We will take our next question from Eric Bosshard with Cleveland Research.

Hi. Two things, first of all from a competitive standpoint, Greg I think you have mentioned localization and the opportunities there, I am just curious from a competitive standpoint, if you are seeing anything different, if you are seeing challenges or opportunities in that regard that you sort of look forward to pursuing?

Eric, are you talking about – let me say competitive, you mean other farm store competitors in particular?

You could say farm store or broaden it and say basically, where else your customers may acquire the product they get at your store?

Yes. I would say to you that from a competitive standpoint, I think the overall farm community or farm business is probably fairly healthy from a retail standpoint. And we are opening stores in markets where the competition is at. Vice versa, they are opening a few in our markets. And we have plans and I will call it tactics to challenge that and offset that. So we are not seeing any real competitive intrusion to any great degree, anything different than we have seen in the past. One of the things we don’t and will not do is go and try to buy sales for the short-term. Steve mentioned earlier that we are going to look at all the ways that we can be in front of our customer with our mix and the brand itself. But the more stores that we put out there in the landscape, the more often and more chances we have to win customers over. So I think our plans as we go forward are solid. I think our store expansion strategy is solid. And there is not a competitive intrusion that’s causing any issues for us at this point.

And then secondly, just to understand, from a big ticket standpoint obviously, dilutive to the second quarter comp, do you expect big ticket to run below the average comp in the third quarter as well?

That’s obviously pretty difficult for us to project. Being the optimistic retailers, we want to take each one of our categories and drive a comp increase in each one of those categories. As we look at the back half, it tends to be less sensitive to big ticket. However, as we saw last December there, we do have some big ticket items. Our focus is going to be to continue to drive value. And as Greg has indicated, our core business has been very strong. So we are going to continue to emphasize in those key categories that will drive footsteps. And hopefully, as we get those customers into the store, we will be able to get them to create a bigger basket and drive the comp sales in the back half of the year.

Great. And then just one last point, in terms of core categories being strong, which is great to hear, anything within the core categories that have slowed a little bit relative to where they were previously or is that sort of other than big ticket, everything else is running basically where it’s been?

Yes. Eric, this is Steve. I would tell you that the business continues to be pretty strong in a lot of those basic core businesses. I mean Tony I believe talked about it in his prepared remarks that we continue to see good growth in the animal side of our business across all species. And so I don’t see a slowdown there whatsoever. I think we continue to invest in those businesses and our assortments, our prices and our in-stock and we are seeing the traction and the benefit of those investments.

Okay. Thank you.

And we do have a final question for Seth Basham with Wedbush Securities.

Thanks a lot and good evening.

Good evening.

With the business not bouncing back as much as it historically has in June and July with the high moisture levels and the late spring, is that bounce more limited in big ticket or in the core consumables part of the business?

It clearly was not in the big ticket categories. And one of the things you need to understand about our business is that there is a cycle and timing to this. And when you get past a certain point – we know our customer and they will say to us, it’s too late in the season now to buy that x product. I will wait now until next year. And we have heard that in a number of instances as we have been out in the stores ourselves, so that really is the culprit right there.

Got it. And as you assess the move into selling more kayaks and more UTVs based on what you experienced this season, is it something that you continue to expect to repeat next year or if you change the merchandising plan around those types of outdoor rec categories?

Yes. This is Steve. Well, we had a challenging overall top line. I would tell you that there were a lot of gems in the quarter. We talked about a lot of what we did with gardening, in organics, sustainability. We saw a lot of growth there. We saw a lot of growth in our Chick Days event and a lot of what we are doing there as well. When it comes to what we are doing with our outdoor rec, we saw nice growth. Our kayak business really drove a lot of incremental units and top line sales there. So there is a lot of things in the box that are working incredibly well and I know that gets overshadowed by the overall top line sales for the quarter. But I would be remiss if I didn’t say a lot of that as well as our core business being strong and the foot traffic coming in for those categories. So again overall, when you look at the quarter, it was a miss. And I think we are all disappointed by that, but at the same time we can build on those things that really worked this year for next year. And those categories that suffered this year a little bit, we will have a plan to reconcile.

Thanks a lot and good luck.

Thank you.

And Mr. Sandfort there are no further questions, I will turn the call back to you for any closing remarks.

Okay. Well, thank you, all for your continued support and your interest in Tractor Supply. And we look forward to speaking to you again in October regarding our third quarter performance.

Ladies and gentlemen, this does conclude today’s conference. We appreciate your participation.