Tractor Supply Co /De/ Q3 FY2021 Earnings Call

Thank you, Operator. Good morning, everyone. Thanks for taking the time to join us today and we do hope everyone is staying safe and well. On the call today are Hal Lawton, our CEO, and Kurt Barton, our CFO. After our prepared remarks, we will open the call up for your questions. Seth Estep, our EVP and Chief Merchandising Officer will join us for the question and answer session. Please note that we've made a supplemental slide presentation available on our website to accompany today's earnings release. Now let me reference the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. This call may contain certain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the Company. In many cases, these risks and uncertainties are beyond our control. 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 and actual results may differ materially from expectations. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included at the end of the press release issued today and in the Company's filings with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed. Investors should not assume that statements will remain operative at a later time. Tractor Supply undertakes no obligation to update any information discussed in this call. This morning, we shortened the prepared remarks to allow more time for Q&A. Given the number of people who want to participate, we respectfully ask that you limit yourself to one question. If you have additional questions, please feel free to get back in the queue. I appreciate your cooperation on this. We will be available after the call for follow-up. Thank you for your time and attention this morning. Now it's my pleasure to turn the call over to Hal.

Thank you, Mary Winn. And thank you to everyone for joining us this morning. The Tractor Supply Team delivered strong results for the third quarter with net sales of 15.8%. Comparable store sales increased by 13.1% and diluted earnings per share of 20.4%. The team is doing an outstanding job navigating a very dynamic and challenging operating environment. We continue to benefit from many market trends that we see as very structurally sound. We have strengthened our customer base. We're gaining market share across our categories. We continue to advance our Life Out Here Strategy. Our business has never been stronger. And we see tremendous opportunities for growth ahead of us. As we've consistently shared with you over the last 18 months, our strong results are a testament to our 45,000+ team members and I'd like to thank them for all their efforts in the quarter. They kept each other safe as we went through another COVID-19 wave and navigated through broad-based supply chain disruptions, cost of goods increases, and managed through a tight labor market. Through it all, they've been resilient and persevered to deliver strong customer satisfaction scores, including all-time high satisfaction scores. Our team members are our greatest strategic asset and a key competitive differentiator with our customers. Our loyal and highly engaged team members have helped us fare better than most in staffing across our stores and distribution centers. Back in June, we raised our minimum wage to $11.25 per hour. Our recent wage actions bring our average hourly wage rate at our stores to nearly $15 per hour as we exit the year, with our distribution center at a higher rate. The investments we have made in store labor are being recognized by our customers, as evidenced by the overall customer satisfaction scores that I just mentioned. I'd also like to thank our vendors and supply chain partners, as we've worked together to overcome challenges in the global supply chain network. Together, we've been very focused on controlling what we can control to deliver these results. Across our network, we've been nimble and able to navigate the unprecedented supply chain environment and macro issues, including inflationary pressures. The team has done a great job addressing issues ranging from import container shortages to port delays, driver shortages, higher freight rates, and a multitude of other supply chain constraints. To mitigate these challenges, the team has leveraged dedicated container ships, pop-up distribution centers, expansion of mixing centers, and direct-to-store shipments. Despite these challenges, our inventory is in good shape and our in-stock rates finished above last year at the end of the quarter. Our diversified vendor base with only about 12% direct import is a strong point of differentiation for us during these supply chain times. Given our scale and sophistication, we believe that our network is a competitive advantage in being the dependable supplier for the Out Here Lifestyle. Categories in which we participate that serve the Out Here Lifestyle continue to have elevated consumer spending levels well above pre-COVID levels. We fully anticipate that this environment will continue for the foreseeable future. Consequently, we think that the sales growth that we've seen is structurally sound, given the changes in consumer behavior and the lifestyle investments that are now much more ingrained in the consumer psyche. Key structural trends that continue to work in our favor include rural revitalization, trip consolidation, omni-channel adoption, and a self-reliant lifestyle movement, including DIY trends and investments in hobbies like gardening, backyard poultry, and, of course, pet ownership. For many workers, the return to office has been pushed out until next year. Even then, we'll likely be in a hybrid environment at most employers. At this point, our customers will have been adapting for over two years as we anticipate that their behaviors are now much more sustainable and structural. Let me share a few highlights of the third quarter. Like the second quarter, every week had positive comps. Also, like the second quarter, our growth was broad-based across regions and product categories. Our e-commerce business continues to experience strong momentum with double-digit sales increases of over 40%, and in just under a year, our mobile app already has more than 2 million downloads and now represents over 10% of our e-commerce sales. We continue to gain share across all categories, a consistent trend for multiple quarters now. The share gain has been both online and in stores, aided by the increase in our unaided brand awareness, which has improved by 21 percentage points since November of 2019. This improvement, combined with positive trends in our overall customer satisfaction, are significant contributors to the share gains we're experiencing. Also consistent from previous quarters, all customer segments were strong, with notable strength in our Core Farm and Ranch, the largest and most important part of our customer base. Our digital advertising campaign targeting millennials is supporting significant growth we're seeing in this important demographic. We believe the relevance of Tractor Supply to millennial customers has staying power given the structural changes in the market and customer behaviors, which we've consistently seen in our data as our average customer age trends down. More customers than ever have shopped at Tractor Supply this year. These customers are making more trips and are spending more money per trip, and our new customer retention remains very strong. Our Neighbors Club loyalty program continues to exceed our expectations with year-over-year sales growth of these members exceeding 20%. We exited the quarter with more than 22 million Neighbors Club members. These members are spending about three times the rate of non-members, with Neighbors Club members now accounting for nearly 70% of our sales. This continues to be a step-up from where we've been running prior to the re-launch of the program and shows sequential improvement over the second quarter of this year. The number of high-value customers in the program grew almost 30% for the quarter, and we continue to experience retention rates in excess of 95% for our high-value customers. These strong results demonstrate that the changes to Neighbors Club continue to gain traction with our customers. Given our robust performance through the third quarter, along with our outlook for the fourth quarter, we are raising our sales and earnings guidance for 2021. Kurt will share more details on our improved outlook later in the call. Regarding our pending acquisition of Orscheln Farm and Home, we continue to work cooperatively with the FTC as it reviews the proposed transaction. We look forward to the benefits this transaction will offer customers, including improved product offerings and competitive pricing. As has been the case over the last 18 months, I am incredibly proud of how our entire Tractor Supply team has managed to stay focused on taking care of each other and our customers. Our long-term opportunities remain very exciting. Our goal has been to emerge from the pandemic stronger. We have emerged from it even stronger and are better positioned as we execute our strategy. And with that, I'll now turn the call over to Kurt.

Thank you, Hal. And hello to everyone on the call. Once again, our third-quarter results demonstrate the strength and resilience of our business and our strategic initiatives. As Hal shared, we believe the underlying health of our business is very strong. Third-quarter comp store sales of 13.1%, representing a 39.9% two-year stack, were driven by a comparable average ticket increase of 9.5% and transaction count increase of 3.6%. An example of the structural advantage we have is the ongoing strength in our consumable, usable, and edible products. Our C.U.E. products represent the strength of our core business and drive trips to the store. Once again, C.U.E. outperformed the chain average comp sales, and for the fifth consecutive quarter in a row, C.U.E. had comp sales growth at or above 15%. Key subcategories such as poultry, livestock feed, and dry dog food were among the strongest categories, with broad-based strength. Our big-ticket categories, which we are up against significant growth in the prior year, continue to have solid comp store sales performance in line with the chain average. This was driven by strength in trailers, recreational and utility vehicles, safes, and zero-turn mowers. Inflation contributed about 700 basis points to comparable store sales. As you've heard from the retail sector and others, the cost environment remains elevated across imports, domestic freight, commodities, and labor wages. Our merchant team has been aggressively advocating for our customers. Where necessary, we are taking price increases to pass through some of the cost pressures we cannot offset. Our merchant and supply chain teams are currently navigating this challenging and disruptive environment extremely well. As we monitor our customers' purchasing behaviors, we're focusing on product unit trends and are committed to being priced right every day. Our third-quarter gross margin rate was 36%, a decrease of 41 basis points versus last year. For comparison, our gross margin rate this quarter was still about 100 basis points above our Q3 2019 rate of 35%. Year-over-year, the gross margin drivers were principally three items: first, higher product cost inflation; second, elevated freight costs, inclusive of domestic and import costs; and third, a more normalized product mix shift in C.U.E. All of retail is working through the drivers of inflation and freight costs. The Tractor Supply team effectively offset a significant portion through our price management program. Additionally, we continue to see favorability in the frequency and depth of promotions. This is due to our commitment to our everyday low pricing strategy and a continued strong demand for our product categories. The benefit from vendor funding for the field activity support teams for our FAST initiative, which was launched in the second half of last year, was consistent with our guidance. Our third-quarter SG&A expense ratio, including depreciation and amortization, improved by 58 basis points versus last year to 26.1%. This improvement as a percentage of net sales was primarily attributable to good leverage and occupancy and other fixed costs from the increase in our comparable store sales, along with lower COVID-19 pandemic response costs and decreased incentive compensation. Partially offsetting this leverage were higher wage rates, incremental store labor hours to ensure we are providing great customer service, and investments in our Life Out Here Strategy initiative. Given the elevated volumes and current operating environment, we also incurred select discrete costs such as incremental team member benefits, pop-up DCs, and the timing of our annual sales meeting, which normally occurs in the first quarter. The offset to our FAST initiative benefit in gross margin was approximately 20 basis points of incremental SG&A expense for the labor costs for the team as we are now cycling the initial investment for launching the program last year. Much like our gross margin rate, our SG&A performance compares favorably to Q3 2019, with about 70 basis points favorable expense ratio since then. Operating profit increased about 18%, with an operating profit margin of nearly 10% in the quarter. Diluted EPS was $1.95, an increase of 20.4% from the third quarter of last year. Our balance sheet remains incredibly strong. At the end of the quarter, our merchandise inventories were $2.2 billion, representing an 11.7% increase year-over-year in average inventory per store. The increase principally reflects growth to support the robust sales trends along with the impact of inflation. Moving now to our updated guidance for Fiscal 2021. We continue to operate in a time of heightened uncertainty regarding the pandemic. Despite this uncertainty, including product cost inflation and supply chain constraints, we are raising our full-year outlook. Our updated guidance reflects the strong results for the first three quarters of the year and the positive and structural momentum we see in our business continuing into the fourth quarter. Against the backdrop of what we know today, we're forecasting Fiscal 2021 net sales centered around $12.6 billion with comparable store sales growth of about 16%. For the year, we forecast an operating margin of 10.2% to 10.3%, a step-up from our prior guidance. Diluted EPS is now forecast in a range of $8.40 to $8.50, compared to our previous earnings range of $7.70 to $8 per diluted share. Within this updated guidance, we are forecasting comparable store sales growth for the fourth quarter of 8% to 10%. A couple of modeling points to keep in mind: the prospective acquisition of Orscheln Farm and Home is not included in our guidance, and as you start to roll forward your models for 2022, please keep in mind that next year we'll have a 53rd week, which is typically a low-volume sales week since it follows the Christmas holidays. We have a unique opportunity with the positive customer trends and momentum in the business. We're committed to investing in store and supply chain labor as we look to provide a legendary customer experience across all channels. The strength of our balance sheet and the consistency of our free cash flow continue to be a position of strength for Tractor Supply. We remain committed to returning cash to shareholders through the combination of a growing dividend and share repurchases. For 2021, we remain on track for anticipated share repurchases in a range of $750 to $800 million. This year will mark a milestone with approximately $1 billion returned to shareholders through the combination of share repurchases and dividends. In summary, our results once again prove Tractor Supply's unique competitive advantages. Our relentless focus on being the dependable supplier for the Out Here lifestyle is embedded in our purpose as a Company.

Thanks, Kurt. Now, I'd like to share with you an update on our recent ESG announcement, as well as provide updates on our Fusion and Side Lot strategic initiatives which are key parts of our Life Out Here Strategy. At a time of urgency and action on climate change and social justice, we just announced new goals that are the next step in our long-standing commitment to sustainability, stewardship, and opportunity. By 2040, we're committing to achieve net zero carbon emissions across all our operations. As part of our social commitments, we are prioritizing and accelerating our initiatives and actions for diversity, equity, and inclusion. At Tractor Supply, we are focused on cultivating an environment of inclusion where diversity of all kinds is appreciated and valued. I invite you to learn more on our dedicated ESG website. Turning next to our Life Out Here Strategy. As a reminder, we've been executing against five key strategic initiatives this year as part of our overall strategy. Those initiatives are Neighbors Club, Digital, FAST, Fusion, and Side Lot. The strategy and its initiatives are designed to capitalize on the attractive opportunities we see in our nearly $110 billion total addressable market. Our Project Fusion and Side Lot model transformations represent significant investments in our stores. These store-level investments are designed to grow our market share and drive the productivity of both existing and new stores as part of our Life Out Here Strategy. Let's start with our Project Fusion store remodel program. As a quick reminder, Project Fusion is a state-of-the-art space productivity program designed to enhance the customer experience in our mature store base and provide reasons for customers who may not have shopped with us in the past to visit us. We anticipate having about 15% of our total store base in the new Fusion layout by year-end. We've reduced the time to complete Fusion remodels by 50% since the beginning of the year, which minimizes the disruption to store operations and our customers' shopping experience. Customers are taking note of the improved layout, ease of shopping, and our new product offerings. Specifically in our customer intercept survey, they highlight better organization, improved merchandise selection, cleaner and brighter aisles, and an easier-to-navigate layout. Categories seeing the strongest lift in sales include areas like apparel, camping, animal care, and power tools. Given the size of our store base, this is a multi-year opportunity to continually refresh our store base and further drive comparable sales through productivity. Another significant component of our space productivity efforts is the transformation of our side lots. Typically, there's as much space outside our stores in the side lot as we have inside the store, and the productivity of this space is substantially below the chain average. We're in the midst of a multi-year project to transform our side lot, expanding the product offering and enhancing the shopping experience. With this investment, side lot space can offer a wider product selection in the lawn and garden categories. We are also entering new categories with a garden center and offering greater convenience through the expansion of our buy-online-pick-up-in-store capabilities for drive-through pickup. In select locations that meet sales volume thresholds, we're also adding feed rooms to help meet the demand for bag feed. We are the largest seller of bag feed in the country. We are also seeing a positive halo effect from the garden center to the existing store and vice versa. The addition of product categories, increased ease of shopping, and new services provides us with more ways to keep our existing customers engaged with Tractor Supply and attract new customers to the brand. Our ability to drive higher sales per square foot through the transformation of our side lot space remains a significant opportunity. We anticipate having about 150 side lots complete across the chain as we exit 2021. In these early remodels, we're learning a great deal about our customers' appetite for an expanded lawn and garden assortment, and we're even more excited than we were when we embarked on the initial test pilots late last year. Although implementing construction projects of this scope and scale has been challenging in the current macro environment, we're making progress in our ability to significantly reduce construction costs, construction time, and the corresponding disruption at store sites. While most remodels have been completed recently, we are pleased with early indications of sales lifts. After the disruption period, we're seeing lifts of low single-digits for Fusion remodels and mid-single-digits for combo stores, which had both Fusion and Side Lot remodels. We expect continued improvements in these results as the stores normalize and are forecasting year-one lift as mid-single-digits for Fusion and high-single-digits for combo stores; this is on track with our expectations when commencing these projects. Over the last year, the team has done a fantastic job operating the business at elevated levels while navigating unprecedented challenges and executing our transformational initiatives to support our Life Out Here Strategy. Our results underscore that our strategies are working, the team is navigating the challenges effectively, and we are emerging from the pandemic stronger than before. We're extremely optimistic about our future as we enter one of the busiest periods in retail. My sincere appreciation goes out to each of the more than 45,000 Tractor Supply Team members for their dedication and commitment to our mission and values. And with that, operator, we would like to open the lines for questions.

We will now begin the question-and-answer session. The first question is from Oliver Wintermantel with Evercore ISI. Thank you. You may proceed.

Good morning, guys. Hal, you mentioned a lot about the structural changes within the business. My question is regarding gross margins. I think you said it's 100 basis points higher than before the pandemic in 2019. I was wondering if you have early indications of what you think is in gross margin structural gains versus what you may have to give back when promotions come back on and maybe the COO decelerates from the very strong growth to your COO. Thank you.

Hey Oliver, good morning. Thanks for joining our call. On gross margins, we're very pleased with both our short-term results this past quarter and also very optimistic about the long-term nature of our gross margins. In the short term, we've had a significant amount of cost coming through our business, whether that's in the cost of goods related to raw materials and commodity-based goods, as well as vendors passing along costs related to labor and freight. We've also seen freight costs increase, along with costs related to imports. The team has done an excellent job navigating those costs, finding offsets, and productivity measures to keep prices as low as possible for customers. As Kurt mentioned, we did have inflation of 2% to 7% in the quarter, which helped us offset a lot of those costs and delivered the gross margin results that we did in the quarter, which sequentially improved from Q2. Long term, as we've talked about on several of our calls, the question really is around promotional intensity and clearance intensity in the business. Those two have remained at low levels over the last six quarters. We remain focused on everyday low pricing, delivering value every single day to our customers, and we see that continuing in the foreseeable future. We have no plans for significant promotional intensity in Q4, and we think this will remain in a very supply constrained environment as we move into the first half of next year. With multiple years now of minimal promotional intensity, I think that bodes well for maintaining a low promotional structure going forward. Again, we're very pleased with our short-term gross margin results and also very optimistic about the structural nature of our long-term gross margin.

Thanks very much. Good luck.

Thank you, Mr. Wintermantel. The next question is from the line of Karen Short with Barclays. You may proceed.

Hi. Thanks very much. So based on all of those comments that you just provided, Hal, my question would be on the obviously the longer-term algorithm and we haven't had an update on that for a little bit. Clearly, we're trending well above that. So I was wondering if you could maybe just give a little color on how you think about the long-term operating margin algorithm more broadly versus the prior 9 to 9.5%, because that just obviously isn't really realistic at this time.

Hey Karen, good morning and thanks for joining the call. We see significant growth opportunities ahead in our business, which we have talked about several times: a $110 billion total addressable market. We're excited about our Life Out Here Strategy and the runway ahead. We’re investing in that strategy to ensure we capture sustainable market share. To your point, we acknowledge that absent the write-down on Petsense, our 2020 operating profit margin of 10.1% and our guidance for 2021 of 10.2 to 10.3% exceed our long-term targets. We certainly don’t want to get ahead of ourselves here in the third quarter. As we mentioned, we're in the midst of our annual planning for 2022, at the same time we’re always reviewing our long-term targets. When we have more news on that, we'll let folks know. For now, we see a significant amount of opportunity ahead, and we are very pleased with the results we put up this quarter, the outlook we have for the balance of the year, and we're excited about the long-term opportunity we still see in our market as we're gaining significant share and executing on all cylinders.

Great. Thank you very much.

The next question is from the line of Brian Nagel with Oppenheimer. You may proceed.

Good morning. Congrats on another great quarter. I think my question may be a bit repetitive here, but what I want to know is what you are seeing in the business that gives you greater confidence that there was a structural shift in demand trends that will persist once the COVID crisis is completely behind us?

Hey, Brian. I'd point to three things in our business. First, I'll talk about broad macro trends; second, I'll talk about the consistency of our business; and third, I'll talk about share gains. In the broad macro trends, all the trends we saw in Q2 of last year have sustained themselves. Certain retailers and other businesses saw early benefits from COVID behavior last year that waned, but that hasn't been the case for us. Rural revitalization is more permanent, with people relocating. Pet ownership and adoption is again, more permanent. Self-reliance mentality we’re seeing is also more sustainable. Regardless of the data set you look at, including home purchases, mobility, and pet ownership, they all reinforce the structural nature of those trends. The second point is consistency. Our business has been remarkably consistent, month-to-month, week-to-week, by category, and by region. This consistency persists regardless of whether we've been in COVID surges or different states are more or less on lockdown. Lastly, we're gaining significant share across almost every category. We're observing this share gain in our core customers who have long shopped with us, as they return with increased confidence in our stock levels and the right level of customer service at the right price. Also, new customers are finding our lifestyle appealing. Given all these reasons, we should feel confident in the structural nature of our business.

That's very helpful. I appreciate it. Congrats again.

The next question is from the line of Peter Keith with Piper Sandler. You may proceed.

Hi. Thanks. Good morning. Great results everyone. Looking forward to the next couple of months with winter, where we will see record energy prices and home heating costs. I remember that during the previous heating exposure you guys had, there sometimes can be a nice benefit for Tractor. So I guess the question is, do you view elevated heating costs this winter as a net positive or conversely, as elevating costs for your core consumer?

Hey Peter, this is Seth. Thanks for joining. Looking ahead over the next couple of months, just a bit broader, other than just energy costs, we're really excited about the opportunities driven by macro benefits that Hal just discussed. When thinking about this, we’re enthusiastic about how our team, along with our merchandising team continues to execute on our product portfolio strategy, leveraging our Fast team. We're conducting record numbers of resets throughout the year, not just before the holiday, but continuing resets and new product activity throughout the quarter. Specifically for the holidays, we're excited about the momentum we see with new customer trends as well as our core customers coming to us for categories more broadly than they have before. Items like apparel and footwear are seeing an uptick, with expanded key brands that consumers resonate with such as Columbia, Carhartt, and even our own brand Ridgecut. We’re also welcoming a new shopper demographic to Tractor Supply, with growth opportunities that we see around rural revitalization. Customers are still coming to us for outdoor activities as we approach fall, with demand in categories such as patio heaters and grills. We're also witnessing strong performance with our C.U.E. business, as there have been record rates of pet adoptions over the past few years, so we continue to drive momentum in our pet business. We feel confident that our consistent customer activity will resonate through the holiday season.

Thank you very much, Seth.

The next question is from Kate McShane with Goldman Sachs. You may proceed.

Hi. Good morning. Thanks for taking our question. I just wanted to go back to inflation for one minute. How much inflation are you expecting for the fourth quarter? And regarding pricing actions, were they across most of the store or in certain categories? When do you expect or what has been the reaction from an elasticity standpoint?

Good morning, Kate. As Hal mentioned, we saw 700 basis points of inflation benefiting the business. We saw that or slightly higher cost pressures in Q3, and looking ahead to Q4, we exited Q3 and into Q4 with continued levels of inflation that are moderating compared to what we saw moving from Q2 into Q3. However, there continues to be some inflation factored into our guidance. In our approach, it’s really more of a portfolio perspective. We assess where those costs are contributing across transportation and product costs, and our team manages customer shopping patterns while ensuring we maintain competitive everyday low pricing. We effectively leverage our pricing tools to ensure the portfolio balance on the retail side while managing through our mature supply chain to keep costs low. Our team has managed through these challenges spectacularly well, and we're forecasting our guidance for Q4, expecting them to manage that in a similar manner.

Thank you.

The next question is from the line of Michael Lasser with UBS. You may proceed.

Good morning, thanks all for taking my question. Kurt, could you clarify your response to the last question regarding inflation contributions? When you said inflation contributions moderated relative to the 700 basis points, did you mean for Q4 relative to the 350 to 400 basis points or just to clarify that? My actual question, however, is, do you still view a 3% comp or so as necessary to leverage your expenses? You noted that SG&A has leveraged 70 basis points since 2019. Given the sheer magnitude of the volume increase your stores have experienced, is there a chance to right-size or manage your cost structure, so you might leverage on a more moderate comp in the foreseeable future?

Michael, I’ll address your two questions. Regarding clarification on Kate's question, for Q4, inflation pressures on the business will be fairly similar to what we described for Q3: flattish to potentially slightly up in regards to Q4. Now, regarding our leverage point, our current elevated revenue growth, along with a focus on our investments, makes the whole algorithm different from just saying is it a 3% comp that you leverage upon. To your point, we see strong momentum in the business, which elevates our ability to leverage costs. We’re also investing from a position of strength, so our continued outlook to manage SG&A to flattish over time remains our outlook in how we manage this business. This presents a great opportunity to continue gaining market share and drive traffic into the stores.

Thank you very much.

The next question is from the line of Chris Horvers with JP Morgan. You may proceed.

Seth, with your commentary around Q4, I think you're feeling good from an in-stock level. Is that accurate? How are you thinking about next spring, as you’re probably placing orders for that now? Will you be ordering enough for the upcoming spring season?

Hey, Chris. Yes, we always want more, but we are satisfied with where we are right now. As we manage through the supply chain with our supplier partners and supply chain team to secure the products we require, we feel good heading into the holiday season. We have managed this throughout the year. You are correct; we are providing earlier forecasts to our key supplier partners, ensuring commitments from our overseas factories and providing them with earlier lead times to enable proper planning. We’re also looking for alternative sourcing options as necessary to ensure we can have product available on the shelf. We're continuously refining our planning processes and collaborating with our supplier base to ensure readiness for the spring business.

Got it. Thank you.

The next question is from the line of Peter Benedict with Baird. Thank you, you may proceed.

Hi guys, thanks for taking the question. On the expense side, your Capex has been up, and I’m curious about how we think of D&A for this year. I believe it's running up 25% year-over-year, so how should we think about that as we pencil through 2022? Should we see a similar growth rate, or how should we model that moving forward?

Sure, Peter. This year, the depreciation growth year-over-year has been around mid-to-high 20% growth rate, very much in line with our expectations. The investments we've made this year, particularly with the new distribution center build, along with the Fusion and Side Lot remodels, puts us right at where we expected to be. For 2022, we expect to see very much similar growth rates in the low 20% range. We are very much in line with the plans we discussed when we launched the Life Out Here Strategy.

The next question is from the line of Simon Gutman with Morgan Stanley. You may proceed.

Hey everyone. Good morning. I would like to take another stab at the longer-term margin question. The math would suggest that your business could run above that level. The question is, philosophically, do you let it run above that level? Hal, are there things within the Out Here Strategy that you can accelerate? Are there price investments that you would consider? Any re-investments in layers of the plan that you could explore?

Hey, Simon. Good to talk to you, and thanks for joining this morning. First off, we see sizable opportunities ahead in our market. For those who have followed us for a long time, it’s very attractive. It's fragmented, and we are well-positioned with our scale, size, and historical investments. We believe there is significant opportunity to continue growing in our market. We’re committed to taking market share while acknowledging two consecutive years of performance above the 10% operating margin. It is above our long-term guidance. As we go through our annual planning process for 2022, it allows us to thoughtfully think about our long-term guidance and its relevance as we move forward. For right now, this remains our long-term guidance. Our long-term investments are focused on capital allocation. We're pleased with the investment returns we're seeing in the business. As Kurt mentioned, our Fusion and Side Lot stores are performing well, and as they mature, we are seeing the results align with our expectations for the business model and plan. Our business is positioned to continue growing at an outsized rate, which gives us an opportunity to leverage and scale in ways we didn’t fully anticipate a year ago. There will be more to communicate as this evolves into early next year. Again, we remain bullish on our opportunities and are very pleased with our business, which has never been stronger, while being excited about both the short-term and long-term potential.

Thank you.

The next question is from Zach Fadem with Wells Fargo. You may proceed.

Good morning. Kurt, could you touch on the lingering impact of elevated COVID costs, incentive compensation, and strategic spending? Additionally, looking to 2022, you mentioned an uptick in strategic spend. Any detail you could provide there? Also, regarding that 20% D&A growth, is that with or without Orscheln?

Zach, I’ll address those. First, Orscheln is not considered in any of the guidance provided around depreciation. For COVID expenses, while they've been elevated due to the pandemic, we're currently at a lower level than comparable quarters from last year, but we continue to emphasize a safe and clean environment for our customers and team members. As for the incentive compensation, this year we’ve paid above target due to performance levels being above historical averages. Thus, these expenses should be viewed as leveraging points moving ahead. The depreciation expense growth rate I referenced earlier is consistent with our long-range plan when we launched the Life Out Here Strategy. Our elevated sales justify that growth rate and does not include Orscheln; we're comfortable with how we manage our expenses for the remainder of Q4 and the near-term future.

Got it. Appreciate the time today.

The next question is from the line of Seth Basham with Wedbush. You may proceed.

Thanks a lot, and good morning. My question is clarification around the trends you're seeing in terms of comp lift following the Fusion and Side Lot rollout. I think you said you're seeing low single-digit for Fusion and mid-single-digit for combo stores with the remodels. To clarify, is that your plan for the first year lift in mid-single-digits for Fusion and high single-digits for combos? Is that correct?

Good morning, and yes, that is accurate. As is typical with store remodels, we do experience some disruption, which can persist even after completion due to any delayed fixtures coming in. We're seeing what we would expect, where performance improves over time as customers get used to the new layout and product offerings. We expect continued improvement in these results. Similarly, with Garden Center remodels, it’s a bit more immediate in terms of performance. However, we notice a continued lift over 12 to 18 months, which aligns with our expectations. Our overall results are very positive, and we anticipate even further improvements as we complete the year.

That's helpful. Just a point for clarification. When do you start measuring lift post-disruption? How many months after the remodel is the disruption period considered over?

We start measuring lift from the day of the re-grand opening. There's a sign-off from the store manager, project manager, and construction manager that indicates completion, and re-grand openings typically happen within a week or two after that. That's when we start measuring the lift.

Thank you.

The next question is from the line of Chuck Grom with Gordon Haskett. You may proceed.

Thank you. Great quarter from you all. I'd like to ask about the Side Lot initiative. What have been the most significant areas of upside surprise that you’ve learned in the current class of 2021? Conversely, what insights will you apply to future store efforts? Also, how do you think productivity will compare in the long term relative to your in-store productivity?

Hey Chuck, thanks for joining. Regarding Side Lot, I’ll mention three aspects: the Garden Center, BOPIS, and feed rooms. Starting with the Garden Center, our customers highlight categories where we have less emphasis and where we’ve seen significant engagement, particularly in fruits and vegetables. This reinforces our strategy and we expect added demand in these areas. The second is BOPIS drive-through: we’re seeing up to 75% of our bio line pick-up in-store being drive-through. This convenience is fostering loyalty. Lastly, we see the feed room as a critical addition, allowing us to streamline our operations and serve customers while maintaining cost efficiency. All three elements are performing well and we’re eager to build on these. Our productivity goals for the future depend on our commitment to maintaining higher same-store sales than overall retail. Additionally, our long-term operating margin guidance has projected growth of 6% to 7% sales and 8% to 10% earnings per share, which implies accumulated leveraging as we move forward. We hold our strategies to remain effective for cost management and focus on driving performance regardless of the environment.

Thank you, Hal. Operator, that will conclude our call today. I appreciate everybody's cooperation that allowed us to get through many questions today, so thank you all. We look forward to speaking to you in January for our fourth-quarter earnings call. Maryanne and I will be available this afternoon for any questions, so thank you all for your cooperation. Have a great day.

That concludes today's conference call. Thank you for your participation and enjoy the rest of your day.