Tractor Supply Co /De/ Q1 FY2023 Earnings Call

Good morning, ladies and gentlemen, and welcome to Tractor Supply Company's Conference Call to discuss First Quarter 2023 results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. We ask that all participants limit themselves to one question and return to the queue for additional questions. 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 our host for today’s call, Mrs. Mary Winn Pilkington, Senior Vice President of Investor and Public Relations for Tractor Supply Company. Mary Winn, please go ahead.

Thank you, operator. Good morning, everyone. Thanks for taking the time to join us today. On the call today are: Hal Lawton, our CEO; Kurt Barton, our CFO; and Seth Estep, EVP and Chief Merchandising Officer. After our prepared remarks, we’ll open the call up for your questions. Please note that we have 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. 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. We will be available after the call for follow-ups. Now, it is my pleasure to turn the call over to Hal.

Thank you, Mary Winn, and good morning, everyone, and thank you for joining us today. For today's call, I will go through some highlights of our first quarter. Seth will then share some merchandising initiatives and updates and Kurt will review the quarter and our outlook in greater detail. Before we get started, I'd like to thank the Tractor Supply team for their ongoing commitment to each other and our customers. No matter the operating environment or how the seasons of the year unfold, this is a team that is always there for our customers and our communities to be the dependable supplier for the Out Here lifestyle. For nearly 85 years, our business has proven to be resilient, stable, and very consistent, as we provide needs-based, demand-driven product categories as a lifestyle retailer. Now, let's turn to a review of the business for the first quarter of 2023. We grew net sales by nearly double digits at 9.1%, with comparable stores up 2.1% and diluted earnings per share of $1.65. We had 7 points of non-comp sales growth in the quarter. The two primary drivers were new stores and the Orscheln acquisition. We opened 17 new Tractor Supply stores and the Petsense by Tractor Supply stores in the quarter. And the Orscheln integration is running ahead of schedule. Our comp sales results were below our expectations. We attribute just over 200 basis points, the majority of our sales miss to a delayed start to the spring and to a lesser extent, a milder January. We continue to closely review customer data for trends and changes in their behavior. While select discretionary categories were below the chain average, this was offset by stronger demand in our consumable, usable, and edible products. We believe our customers remain resilient, but are being judicious with their spending as they seek us out as a destination for value and are buying closer to need. Excluding our seasonal categories, our sales were in line with our expectations, and our core business remains very strong. Our comparable store sales growth was driven by ticket growth of 2.8%, offset by a decline in transactions of 0.7%. Importantly, our comp transaction trends improved each month of the quarter and were positive in February and March, with strong performance in our year-round categories. The strength in our year-round categories was driven by CUE products, which exhibited ongoing impressive demand this quarter. These products are needs-based and demand-driven and are what drive trips and transactions to our stores. Across companion animal and livestock, we had strong performance. The strength we've experienced over the last three years in our CUE customer trends remains robust, as we continue to gain material market share. In companion animal, we continue to see substantial share gains throughout the category. And we're seeing sequential increases in the number of customers shopping us for this category each week, each month, each quarter. In livestock, our Chick Days event is shaping up to be the largest ever for us, with the poultry category up strong double digits. Not only are we seeing growth from existing customers, we're also seeing robust growth in new customers to the category, driving both trips and ticket. One exciting aspect of the new customers to the poultry category is that they're gravitating to our unique offering of premium breeds and organic feed products for their chicks. Chick Days is a great gateway for our new customers to explore Tractor Supply and use this as a resource for all things related to homesteading, beyond poultry to categories like gardening. Big ticket declines were driven by seasonal trends and, to a lesser degree, ongoing pullback in discretionary categories. The slow start to spring impacted outdoor power equipment, which weighed on our big ticket results and average ticket. The most significant pressure was in zero-turn tractors, generators, and trailers. Our customers have a long history of buying these items based on need. Current trends support that we are seeing purchasing consistently closer to the season or moment in need. Overall, our big ticket trends were very similar to what has been reported in the recent March retail sales data. Our mobile app currently represents more than 20% of our digital sales. The app is now ranked in the top 100 shopping apps on the iOS store. This is a major recognition of the progress in our ONETractor strategy to offer our customers a more seamless shopping experience. Our customer scores continue to run at all-time highs. Overall, our customer experience metrics continue to keep momentum into 2023, with strong improvements over the last quarter and year-over-year. Our store teams are doing a tremendous job servicing our customers. Our Neighbor's Club just celebrated last week a significant milestone with over 30 million members. As our points-based program enters its third year, the strength in Neighbor's Club continues to exceed our expectations. Our members are comping at a faster rate than our overall performance, and we continue to see strong growth and retention in our high-value customers. As mentioned previously, the Orscheln Farm and Home integration is going very well. I had the opportunity recently to visit one of our first store conversions to the Tractor Supply brand. There was excitement across both our team members and, importantly, our customers as they recognize that we're committed to providing the region with an elevated product assortment, a meaningful loyalty offering, and enhanced digital shopping experience and so much more that Tractor Supply is able to offer. During the quarter, we opened our ninth and largest distribution center in Navarre, Ohio. The ramp of the distribution center is right on schedule. With the opening in the new DC, the integration of 81 Orscheln stores and addition of new TSC stores, we capitalized on the opportunity to realign the store servicing areas across the DC network to balance transportation costs and DC capacity while improving service levels to our stores. It is great for our DC network to have this new capacity to better position our inventory and better service those stores and allow us to reduce our freight costs, which you'll hear more about from Kurt. At Tractor Supply, our purpose as a company is to serve Life Out Here. As we celebrate our 85th anniversary this year, we remain steadfast in our commitment to preserve and protect our way of life. Two weeks ago, we issued our fourth annual Stewardship Tear Sheet, highlighting the actions and progress that we've made on our sustainability, DE&I, and community commitments. I am proud of our progress towards our ambitious stewardship goals, but know there is more to be done as we work towards achieving our net-zero and other goals heading towards 2040. To wrap up, while our first quarter sales were below our expectations, we have a lot of the year still ahead of us. The American consumer broadly remains challenged, but we believe that our customer remains resilient. Spring continues to be cooler and wetter as we've turned into Q2. That said, we're encouraged by quarter-to-date trends, with comps mid-single digits and comp transactions positive. Based on our experience and the nature of our needs-based demand-driven business, we continue to believe that the best way to look at this business is on the half, as the timing of spring impacts the first half of the year. While we acknowledge that the softer sales in January will not be recouped, we are pleased with our lineup for spring and summer. As a company, we have numerous levers to continue to gain market share and numerous levers to effectively control expenses. We continue to see significant opportunities for growth and earnings growth as well. With the majority of the year remaining, we are reiterating our guidance for fiscal 2023. Before I turn the call over to Seth, I'd like to share some background on Seth and the merchandising team at Tractor Supply. Seth is an 18-year veteran of Tractor Supply, having held roles across marketing, finance, e-commerce, and merchandising. He has a passion for this lifestyle and has served as our Chief Merchant since 2020. Given our record sales growth over the last three years, we recently completed a realignment of our merchandising product categories and promoted two Vice Presidents to Senior Vice Presidents to better support the growing needs of our business. Seth will provide a review of our sales by category and our plans to continue to gain market share. Now, I'll turn the call over to Seth to discuss some further insights.

Thank you, Hal. I'm excited to share with you some insights into our merchandising categories and market share position. We are committed to driving sales productivity as we deepen our relationships with our customers. I'd like to start by congratulating Nicole Logan, SVP of Animal and Softline divisions; and Randall Dodds, SVP of Seasonal and Hardline divisions on the recent promotions. They each bring significant retail and industry experience that complement their tenure at Tractor Supply. These new roles each have three merchandising divisions reporting to each of them. It is exciting to have this new organizational structure to allow us to operate at greater scale, have deeper category insights and enhanced strategic partnerships. Overall, we're now organized into six merchandising divisions. So let's start with our largest division, companion animal, that represents more than 20% of our 2022 sales. This business includes both the consumables and hard lines across companion animals. Around 75% of the Tractor Supply customers have a pet, and approximately 50% have more than one pet. Also, our customers' dogs weigh on average about 20 pounds more than the US average. With the ongoing humanization of companion animals, these key structural tailwinds support our positive outlook on this category. We are a destination for pet customers, with a comprehensive and differentiated assortment at an everyday low price, and we continue to gain share. For example, our growth in pet food, treats, and litter continues to lead the market in both dollar and pound growth, gaining another 33 basis points of share in Q1. Our business model of private brands, strong national, and differentiated partners, club pack sizes, and legendary customer service sets us up to continue gaining share, perhaps even more if we see the consumer more pressured for value. Moving on to our second largest division, livestock and equine, which represents just under 20% of sales. This is a key category for farm and ranch, and we continue to consistently outperform the market. Of note, this category is almost solely the consumables portion of our lifestyle seed categories. In other words, this business does not include fencing, which, in many ways, can be considered containment for large animals. With strong exclusive brands like DuMOR and Producer's Pride, along with national brands from Purina, Cargill, Triple Crown, and more, we continue to innovate across our key categories of poultry, equine, and cattle. We are the clear leader in this space, with approximately 20% market share. Broadly, one out of every five bags of animal feed is bought at Tractor Supply, and we continue to take share, consistently outperforming the market by 5 percentage points. Next up in our category lineup at an equal weighting are our seasonal and our truck tool and hardware divisions. We are excited to get our spring seasonal business off and running. This is an area where we think we have substantial share opportunities. We are a leader in core categories like outdoor power as the destination for Zero Turn Mowers and categories like grass seed and fertilizers. Also, our live goods assortment is included in this division. As of today, we have more than 350 garden centers ready for spring, with the vast majority just entering year two of operations. Where spring weather has cooperated, we are very excited about our customers' response to the expanded product offering and layout in our Fusion and Garden Center stores. More broadly, this season, we are offering a differentiated garden assortment of live goods, including vegetables and plants, soils, mulch, and chemicals tailored to Life Out Here. We like our initial reads for seasonal products where the weather has turned and are excited for the spring season. Our fourth division is truck, tool and hardware that includes lifestyle items like trailers, power tools, welders, and truck accessories. Historically, in tools, we have serviced as a convenience play in power tools and hardware. As part of our Fusion layout, we have made significant investments in corresponding progress on elevating our power tool selection, and it has resulted in one of the highest sales lift categories in our Fusion stores. The additions of Makita, Bosch, and Dremel, coupled with being the exclusive retail destination for Porter-Cable power tools, has allowed us to have consistent share gains over the last three years. Up next is our Ag and Outdoor Recreation division, which includes categories such as fencing and sprayers as well as our outdoor sport categories. We are in the business of helping people maintain their land and contain their animals. We have the largest share in the country and have outgrown the market by mid-single digits. And for outdoor recreation, we are very excited about the growth prospects for this segment as we test an expanded assortment in several Orscheln Farm and Home stores. Our final segment ranked on sales volume is clothing and decor, which has exhibited rapid growth since the pandemic, trending well above the company average. This business includes apparel, footwear, and farmhouse decor. As one of the largest retailers of Carhartt, along with other brands like Wrangler and Columbia, our customers are finding our assortment meets their workwear needs and their lifestyle. For years, we've known there was a market opportunity in women's workwear at Tractor Supply. And the team has leaned into this category, and the shopper is responding. While still off a relatively small base, our women's apparel business grew 24% in Q1, led by growth in our exclusive brands of Blue Mountain and Ridgecut. We will continue to look for ways to grow these high-margin categories by growing both leading national and best-in-class exclusive brands. In closing, with our new alignment and additional resources, Tractor Supply is well positioned to continue to be the market leader and operate with speed, agility, and efficiency to capture growth and drive sales productivity. We are in the midst of one of the most exciting times at Tractor Supply as we are in the spring season. And I hope you get a chance to get out to our stores and see all the exciting merchandising experiences and product innovation. Now, I'll turn it over to Kurt.

Thank you, Seth, and hello to everyone on the call. I will add on to Hal's comments about the quarter and our outlook for the year. Let's start with our first quarter results. Regarding the cadence of comp sales for the quarter, we started out with a soft January. Last year's January was strong, so we expected it to start soft, but we did not anticipate that the month would be the second warmest in 30-plus years. February was more normalized and in line with our expectations, but the mild winter continued to pressure results. To put it in perspective, our heating categories were down nearly 50%, insulated outerwear was down over 30%, and emergency response categories were also down significantly. As a result, our winter seasonal products were down double digits for the quarter. Our expectation was that as we moved through the quarter, we would see a more normalized spring selling season unfold, where we saw the majority of the shortfall was really in the last three weeks of March, which were abnormally wet and much cooler than normal, as well as winter weather continued in the Midwest and Northeast. To put it in historical context, March was the coldest in four years with below-average temperatures nationally, the wettest in eight years, and the snowiest in 30 years. Correspondingly, our spring seasonal products were flat to the prior year, well below our expectations. Sales in the quarter benefited in the high single digits from retail price inflation. Most of this inflation reflects retail price changes that were put in place in the second half of 2022 that we have not lapped as of yet. The benefit of price inflation to our average ticket growth was offset by three key factors: First, the majority of the pressure on average ticket all revolved around seasonal goods. This includes the softness in big ticket, declines in seasonal, which runs at a higher average ticket and higher winter clearance. Second, faster growth in consumable transactions, in particular companion animal and poultry, which typically have a lower average ticket. And then third, to a lesser extent, a reduction in units per transaction in impulse add-on items like dog treats and candy and snacks. Moving down our income statement. Gross margin was 35.5%, an increase of 52 basis points from 34.9% last year. We were very pleased with these results. We remain committed to being the everyday low-price leader in our markets. Promotional activity was in line with last year with a modest increase in winter clearance, as we looked to exit the season clean. Moderating freight costs for import and domestic shipments provided a net gross margin benefit. Our price management initiatives and lower freight costs more than offset the impact from cost inflation and product mix from the robust growth of our CUE categories. As a percent of sales, SG& A expenses, including depreciation and amortization, increased 119 basis points to 28.1% from 26.9% a year ago. For perspective, about half of this growth was anticipated for our strategic initiatives. As a reminder, our planned investments included higher depreciation and amortization from the step-up in capital spending to support our growth agenda, and the addition of our new distribution center and the impact from the Orscheln acquisition. The remaining increase in SG&A as a percent of net sales was primarily attributable to deleverage, given the moderate comparable store sales growth. As we've mentioned, the quarter was trending in line with our expectations, leading up to the last three weeks of March, providing limited opportunities to adjust the cost structure. Specifically, we chose to continue to fully fund payroll for the last two weeks of the quarter to support the spring season, utilizing the hours to get ahead on product assembly and other sales-driving tasks. For the quarter, operating income was essentially flat with last year, with a modest decline in net income. Diluted EPS was $1.65, also flat with the prior year's first quarter. We opened 17 Tractor Supply stores and three Petsense by Tractor Supply stores in the first quarter. This represents a significant improvement in the cadence of our new store openings. Turning now to our balance sheet. Merchandise inventories were $3 billion at the end of the first quarter, representing an increase of about 12% in average inventory per store. This increase is primarily attributable to inflation, a better in-stock position from last year and the delay in the spring selling season. We are pleased with how we exited the winter season and the quality of our inventory as of the end of the first quarter. With strong annualized cash flows, we continue to maintain a healthy balance sheet, with a leverage ratio of around 2.0 times. Our guidance for 2023 is unchanged. We continue to expect full-year sales of $15 billion to $15.3 billion and project comparable store sales to increase 3.5% to 5.5%. As we manage through the first half of the year, we expect to see comp sales towards the top half of our guidance for the second quarter. We anticipate some increased pressure on discretionary categories, but are pleased with the growth in CUE products along with DIY categories like repairs and maintenance. Let me share further insights on the outlook for the remainder of the year. We anticipate Q2 and Q3 to have the strongest comp sales growth potential, while Q4 is expected to be closer to the low end of the guidance range due to the strong compares to the prior year. Operating margin performance is expected to improve as we move through the year with Q4 having the highest potential, principally from the lap of the one-time acquisition-related costs of Orscheln. As a reminder, our Novar, Ohio, distribution center is expected to begin to benefit gross margin in the second quarter with the ramp up in the second half of the year as we capture freight savings. The benefits in gross margin will be offset by approximately 15 basis points of negative drag on SG&A as the cost of the distribution center are reflected in SG&A. We have confidence in our earnings in a variety of sales scenarios. For example, at times, a cooler and wetter start to the spring can provide an extended selling season. We've seen this type of seasonal cadence before such as 2013, and we are cautiously optimistic of the upside it can bring to the third quarter. Regardless of the state of the consumer, we are confident in the resiliency of our business model and our ability to manage the business. In a scenario where we do not make up missed January sales, we see opportunities for further operating leverage. Specifically, we are seeing an easing of our supply chain capacity constraints, which should drive additional efficiencies in the second half. And we now anticipate greater accretion for Orscheln in the back half. We are raising our accretion assumption to $0.15 per share compared to our prior expectation of $0.10 per share. To sum it up, for the full year, we continue to guide toward net income of $1.13 billion to $1.17 billion, and diluted earnings per share of $10.30 to $10.60. Over my 23 years with Tractor Supply, it has been proven time after time that weather can be transitory. And the best way to look at our business is not by the quarter, but by the halves of the year. In this environment, what sets Tractor Supply apart is our ability to effectively manage the top line and bottom line while investing in our Life Out Here strategic growth drivers. And with that, I will turn the call back to Hal.

Thanks, Kurt. Tractor Supply has a proven business model that has been resilient over many business cycles. Throughout our 85-year history, we have successfully navigated all types of business environments and have emerged stronger each time. We continue to see positive migration trends to our markets. This marks the third consecutive year of positive population growth in rural America. This reflects an increased desire to seek out more space and take advantage of the affordability that country suburban, exurban, and rural markets offer with a lower cost of living and the ability to live Life Out Here. It is our view that the sense of community found in our markets, and perhaps more importantly, the ability to secure a piece of property at a reasonable price, has ensured the rural migration trend is one that's here to stay for the time being. The millennial generation has embraced Life Out Here. Our customers have been resilient thus far in the face of slower macroeconomic growth, elevated inflation, and higher interest rates, and they prioritize their lifestyle and passions. With significant growth and market share opportunities, we are excited about the balance of the year and remain confident in our business. My thanks and appreciation go out to the team for their dedication to living our mission values every day. And now, we'd like to open up the call for questions. Thank you so much.

We will now begin the question-and-answer session. Our first question comes from Steven Zaccone with Citigroup. You may proceed.

Great. Good morning, everyone. Thanks for taking my question. I wanted to start just thinking about the context of the year. So given the slightly weaker-than-expected same-store sales in the first quarter, can you just talk about the confidence to recover these spring sales over the balance of the year? It sounds like January can't be made up, but how material is that for the full year? And then just you sounded a bit more cautious on discretionary from what you've seen from your consumers. So just elaborate on how much that could be an impact to the full year. Thanks very much.

Good morning, it's Hal, and thank you for your question. We are very confident in our sales and earnings guidance for the year. As mentioned, we were below our sales comp expectations by about 200 basis points due to weather. Approximately 80% of that shortfall occurred in the spring and fall during the last three weeks of the quarter, with about 20% in January. January's impact is minimal when viewed over the entire year. As Kurt noted, we have several opportunities to recover not just our Spring sales but also potentially the winter sales as the year progresses. In previous years, including 2013, we have seen cooler spring weather push sales into the summer when lawns remain green and cultivation continues on farms, and our business has thrived during those months. For context, last summer experienced a significant drought, and comparing this year to last looks promising. Regarding consumer behavior, we have not observed any notable change from Q3 and Q4 last year to Q1 this year. The trends we discussed last year remain consistent. Discretionary spending, which accounts for 15% of our business, continues to perform below average, mirroring the pace from the previous quarters. Our units per transaction are experiencing slight pressure, with consumers being careful in their purchasing. We have highlighted this trend for the last few quarters. Overall, there’s been no significant change in consumer spending patterns. In some categories, such as poultry, we see an increase in spending, and our organic feed remains the strongest segment. Dog food sales remain robust due to an increase in new customers, but our core customer base has maintained their purchasing habits over the past years. Big ticket items continue to perform similarly, and while we experienced a measurable but minor decline in January, this was largely due to the unexpectedly cooler, wetter, and snowier weather in the last weeks of the quarter, compounded by last year’s disappointing spring.

Great. Thanks for all the detail. I’ll leave the floor.

Yes. Thanks, Steven

Thank you for your question. The next question comes from the line of Scot Ciccarelli with Truist. You may proceed.

Good morning, guys. It’s Scot Ciccarelli. And how this may be a function of my stating memory. But I don't recall you guys talking about customers buying closer to need before. So if I'm wrong about that, I apologize. But if that's the case, can you give us an idea of how much that has changed over the last, say, six months in terms of buying closer to need? And did you guys expect that behavioral shift when you provided your initial outlook?

Hey, Scott, so I'll reference that really just in the context of dominantly a big ticket and the fact that, historically, if you were to take out 2021, when you had the stimulus and you were to take out 2020 when there was a modest stimulus combined with, obviously, COVID, I think if you were to go back over like my 20-plus years history in retail and home improvement and the farm and ranch, Seth, and Kurt, I think we'd all say that like things like riding lawn mowers, bigger ticket items like that, customers typically buy them when they need. The vast majority of those categories or purchases are needs-based. And that's really what we were trying to signal is we're seeing more of that than we did kind of in 2020 and 2021, really more of a reversion to kind of historic purchasing patterns of those sorts of categories, nothing otherwise intended to be implied.

Got it. Okay. So just the normalization of what you have historically seen prior to pandemic-related changes?

Exactly, exactly. Nothing otherwise intended to be implied. And thanks for the clarification.

Got it. Thank you.

Thank you for your question. The next question comes from the line of Chris Horvers with JPMorgan. You may proceed.

Thank you and good morning. I have a follow-up question regarding the weather and trends in April. Last April was quite challenging, and spring really improved in May and June. I'm assuming those months were better for your business. How do you view the current trend compared to the tougher comparisons? Is it simply that April's cold and wet conditions mean that the mid-single-digit growth doesn't fully capture your potential despite the tough comparisons?

Hey, Chris, as we mentioned earlier, we're nearly finished with April, and we are seeing mid-single-digit comps and low positive single-digit comp transactions. Considering the cool, wet weather that has persisted into April, we are quite satisfied with that performance. Last year, June was not a strong period for spring sales, with only a few good weeks before it turned very hot. I previously noted the drought that started in the latter half of June and continued into July, which we felt impacted us for the first six to eight weeks of Q3. We are hopeful for a solid May comp following a weaker June and expect an extended selling season into July and August, especially in key states like Florida, Texas, and California. By mid-June last year, California and Texas were experiencing severe drought conditions, which lasted into September. This year, those areas have faced extreme weather, including flooding in California, which we believe will positively influence our performance as we approach summer in those regions.

Got it. And then as a follow-up on the margin line, historically, your first quarter gross margin is a decent indication of what the year looks like, but it also sounds like some things are breaking their way on the freight side and inventory is very clean. So, is there just a general bias upward over the year on the gross margin line? And could that lead to some potential operating margin upside as if sales come in line with plan?

Yes, thank you for pointing that out, Chris. As Kurt highlighted in his remarks, we have several avenues to meet our guidance this year, both in sales and earnings. Regarding earnings, we are beginning to see numerous expense reduction opportunities, particularly in our supply chain and the integration costs related to Orscheln. On the gross margin front, being a large player in our market provides benefits. When we experience even slight stabilization in pricing, we can capitalize on that to improve our gross margin rate while remaining highly competitive in pricing. Furthermore, container costs have significantly decreased, which is already affecting our results and will have an even greater impact in the second and third quarters. Domestic freight is also trending downward, and recently, a major freight company discussed being in a freight recession, which could be advantageous for us as we leverage our scale to lower freight costs, especially with our new distribution center and the 150 stores we are building along with Orscheln. We are optimistic about our gross margin rate performance and believe there is continued potential for improvement as we move through the year, which reinforces our confidence in maintaining our guidance.

Thank you. Have a great finish this spring.

Thank you for your question. The next question comes from the line of Simeon Gutman with Morgan Stanley. You may proceed.

Hey good morning everyone. A quick follow-up to the last question. Your Q1 gross margin, it looks like it's the highest ever. So, can we just talk about the conceptual drivers, not some of the seasonal movement, but why is it the best ever. And then the 200 basis points of weather, I think Hal called out in the prepared remarks. Is that a spread between certain markets? Was there anything in that regarding the judicious comment you made on the consumer, or is that pure weather?

Simeon, this is Kurt. I'll address both of those points, starting with the second. The variation between different regions and weeks confirms what Hal mentioned earlier. Regarding your question about the Midwest and Northeast Commonwealth states compared to other regions, there was a noticeable difference because those states experienced a very mild winter, which benefited them. They had more snowfall in March than in January, leading to a clear discrepancy between those low or mid-single-digit negative impacts and mid-single-digit positive changes in other areas. This gives us confidence in business trends. On the gross margin question, I'll outline the main drivers and provide a sense of what we're seeing. All these are structural improvements that we anticipated, and as Hal noted, we still see potential for gross margin growth. The most significant driver was our price management, which was somewhat offset by the mix impact from CUE. The third driver was the benefit we received from freight, which we believe continues to hold potential benefits going forward. When we talk about price management, it's important to note that it encompasses more than just adjusting the retail price. It includes retail pricing, managing everyday low pricing, promotions, and negotiating costs and concessions. Seth and the team did an outstanding job leveraging our scale and size in this environment, resulting in a strong price management direct margin that more than offsets the CUE impact. So, the benefits from retail price management and the pressure from CUE accounted for roughly half of the gain, with transportation contributing about the other half.

Thank you. Good luck.

Thank you for your question. The next question comes from the line of Seth Sigman with Barclays. You may proceed.

Good morning. Thanks for taking the question. I wanted to follow up on a couple of the last points. So I think you raised the accretion by $0.05 for Orscheln, which is obviously encouraging. You did keep the full year guidance and probably appropriate just given the Q1 challenges. But can you just help frame what some of the underlying changes may be in that guidance? Because it sounds like the message is that you should be able to recoup a lot of the sales from Q1, maybe not January, but the bulk of the rest and then gross margin seems to be tracking ahead. SG&A, while it was elevated, it does seem to be as planned and maybe just we were all mis-modeling it. So is there anything else that you could sort of point to within that?

Good morning, and thank you for the question. I want to provide an update on the Orscheln integration. The integration process is going very smoothly and is being positively received by the Orscheln team members as they transition to Tractor Supply. Customers are also responding better than I expected. The team is doing an excellent job transitioning the stores to Tractor Supply branding, with nearly 20 locations already converted in terms of point-of-sale systems. We are implementing the Fusion remodel in all of these stores and are ahead of schedule with these transitions. This success allows us to better optimize our planned expenses. Two key factors contributing to this are the integration of our IT costs, where our team is finding efficiencies that reduce expenses, and the timeline for selling the SSC and the DC. We initially expected that sale to occur at the end of the year, but now we believe we can advance this by a month or two, providing additional savings on operating costs. Overall, the Orscheln acquisition is progressing very well, and we are pleased with its current status. More generally, many companies, including ours, are refraining from changing guidance despite positive developments in gross margin rates and expenses since there is still a significant part of the year remaining.

Okay. Understood. Thanks very much.

Thank you for your question. The next question comes from the line of Brian Nagel with Oppenheimer. You may proceed.

Hi. Good morning. Thanks for taking my question. I want to clarify something regarding the weather. There was clearly a weather disruption in Q1, and it seems that in early Q2, sales have picked up significantly. However, in areas across the country that were not affected by the weather, are sales performing as you would normally expect?

Hey, Brian, this is Kurt. I'll share a few points. In regions less affected by weather, such as the South, Texas, and Far West, we observed performance that met our expectations, unlike the North and Midwest, which underperformed. Additionally, we noticed that categories within merchandising that are not influenced by weather were right on track with expectations. Analyzing specific weeks shows variations, particularly at the beginning and end of the period. Our external market data also indicates that Tractor Supply outperformed the overall market. In the farm and ranch sector, we noted negative trends, especially in highly competitive areas. Overall, in Q1, any softness was seasonal, and as we progress through this quarter, it's about when spring will begin. It’s not a matter of if but when, and regardless of the conditions, Tractor Supply has managed to adapt. This year seems to promise a favorable extended selling season.

And Brian, this is Hal. To add to that, if you look back at weeks eight, nine, and ten, we started to compare against tougher weather from last year, and late spring and early March had relatively good weather across the country, which resulted in high single-digit comparisons during those three weeks. However, in the last three weeks, we experienced negative comparisons, primarily due to the geographies that Kurt mentioned, from the State of Virginia all the way up to the Northeast and Midwest. They were comparing against difficult weather from last year, which was worse than this year. In areas like Florida and Texas, as Kurt noted, we saw strong seasonal spring performance. So we’re really focusing on those three weeks, and then as we mentioned, we've started to bounce back here in April with a mid-single-digit comparison rate.

No, that's very, very helpful. And just one quick follow-up. So again, I'm asking you necessarily to be a meteorologist, but as you look at the dynamic here, as we've had this, what seems to be a very wet late winter, early spring, going historically, has that ever not led to an extended spring or in the spring that was actually better for Tractor Supply?

We would like to accurately predict weather patterns. Typically, weather forecasts are available for one year ahead or just a few weeks out. We referenced the years 2013 and 2014 because they followed a similar pattern, which led us to review our earnings calls from those times. In those calls, we discussed how the cold and wet conditions in the first quarter could result in a longer selling season during the summer, and that is indeed what occurred in both years. This serves as a precedent for our current situation. This year, we are also coming off a significant drought from last year. Therefore, we are cautiously optimistic about the potential for a longer selling season this year, especially since our comparisons will be easier than last year's tougher environment. Yes. Thanks, Brian.

Thank you for your question. The next question comes from the line of Kate McShane with Goldman Sachs. You may proceed.

Hi. Good morning. Thanks for taking our question. We wanted to ask about market share. There seems to be a lot of commentary on this. And I wondered if you could remind us what assumption you're making for market share in your guide for this year? Was it something you saw an acceleration of in the first quarter? And with some of the changes you're highlighting with the new leadership and merchandising, in those categories, are you expecting more of a lift in market share than maybe originally planned, or is that more for 2024?

Kate, this is Kurt. To reiterate our original expectations and guidance as we entered this year, we anticipated GDP growth of 1% to 2%. Historically, Tractor Supply has experienced growth beyond that as we continue to gain market share, so we expect another 1% or 2% growth. As Seth mentioned, we're definitely gaining market share in areas like companion animals and poultry. This gain is part of our expectations moving forward. I would also highlight that while we may face challenges with consumer behavior this year, it presents a great opportunity. Just as we observed some softness in discretionary spending, we have seen a robust increase in market share. The resilience of our business is exciting; if certain categories experience softness, we still have opportunities in live goods and companion animals to gain market share. We expect to see increased market share gains compared to our standard model for this year and the next couple of years.

Hey, Kate, just to add a couple of points on that. Thanks for your question. This is Seth. Hey, in general, right now, if we look at our business and we think about where we're going to continue to grow market share, again, to Kurt's point, we are very excited to see market share gains, particularly like in our companion animal or our pet and our dog businesses as well as on the cat side. Our entire portfolio, if you call it like in pet food, is growing extremely strong. As Hal mentioned earlier, we're seeing our current customer base, our previous customer base really maintaining those categories in which they were purchasing, they're coming more often. And we're gaining a lot of new shoppers across the portfolio. And we think our merchandising strategy and our portfolio strategy, particularly in things like pet and pet food, is very much a strategic advantage for us to continue to gain market share. Newness and innovation are critical. Our merchants are continuing to drive comprehensive resets across the box and where they're planned. And if you also look at other items that are relative to lifestyle, whether that be like poultry, feed, forage, sporting goods, as we mentioned earlier, we are continuing to lead in those categories. So, for us, we are, by far, leading share in the industry and in farm and ranch, far away leading pet share gains. We don't anticipate that slowing down based on the activity that we're seeing and the customer response we're seeing in our database today.

Thank you.

Thank you for your question. The next question comes from the line of Scott Mushkin with R5 Capital. You may proceed.

Hey, guys. Thanks for taking my question. A little bit focused on the merchandising management team. You're obviously beefing it up. And so I was wondering, what drove that decision? Do you see significant opportunities to expand the total addressable market? And if yes, where do you think those opportunities are?

Hey, Scott, yes, Seth, thanks for the question. Absolutely on those questions today. For us, kind of what we said earlier, for us, as we continue to grow rapidly over the course of the last few years, we saw an opportunity to continue to double down and drive at a greater scale, our merchandising activities, really driving toward innovation, really driving towards strategic partnerships, driving into categories, driving into regionalization, localization, so that we can really maximize all the work we're doing with like our Fusion, our Garden Centers, all those type things. So if we look at our portfolio strategy, we see share opportunities across many of the areas of our addressable market. We just mentioned pet. We see that we continue to have opportunities there. We reorganized our feed and our core livestock and equine division to species, where we're really driving a category management approach. We're basically taking the way in which we've managed our pet business over the course of the last few years and applying those same category management principles on new items, shopper insights, adjusting the flow, localization, and regionalization to continue to make sure that we are offering the best-in-class shopper experience as we have new shoppers entering today. I mentioned we're going to be piloting some things like in Orscheln Farm and Home, Sporting goods did very well for us in Q1. And we're going to continue to lean in where we have our strengths. A lot of those categories today are just in our center core for six months. We think we have an opportunity to drive those businesses year-round. I can go on and on, but we think that the new structure that we're putting in place today is allowing us to have more agility, continue to move fast, operate at scale and continue to drive deeper partnerships and innovation. So very excited about this, and we're starting to really see some programs come to life under this new structure.

And do you see the data from the frequent shopper card helping you with the vendors and the relationship is getting stronger and more beneficial?

Absolutely. Utilizing our 30 million members in our database gives us a significant advantage not only in farm and ranch but also in the broader retail categories we address. We are continuing to explore these categories in depth and are actively collaborating with our vendors to identify opportunities, understand the target groups we should focus on, and enhance our regional and local strategies in our assortment planning process. Neighbor's Club is essential to all our efforts, not just from a marketing standpoint but also as a key driver in our merchandising strategy, as we aim to understand our customers' current needs and anticipate their future demands.

Thanks guys.

Thank you for your question. The next question comes from the line of Steven Forbes with Guggenheim Partners. You may proceed.

Good morning, Hal, Seth, and Kurt. I wanted to revisit the side lot plus Fusion remodels in terms of cost versus sales lift as we approach the core of the spring selling season here. So two-part question. One, can you remind us of the net cost of such projects, and whether you've been able to improve the net spend behind these projects as you scale the initiative? And then, two, how has the spring selling season, albeit early, changed your expectation, right, for the overall sales lift or the ROIC that you expect to generate behind this spend as well?

Yeah, Steven, thanks so much for the question. I'll hit three things quickly and just in the sake of time. First off, the capital spend for both the garden center projects, kind of side lot transformations and the inside-the-store Fusion transformation continues to reduce. It's a key area of focus and one of our primary metrics that we're evaluating our performance on our strategic initiatives this year. The second thing is the performance of our Fusion and Side Lot remodels are continuing to perform at the same rate as they have in the last couple of years, which we're incredibly pleased with because we're now reaching significant scale on both inside of our company. The third thing is, we are very pleased with the live goods performance. I think it's strategically going to be big for us this year. It's a low-cost way for people to beautify their yards, kind of, and there's going to be a lot of refreshing coming out of the December and November storms that happened and we are well-positioned for that. And one of the things we always talk about is you can now see live goods sales, from space in our daily and weekly sales reporting, which is exactly what the plan was at the beginning of the year now with 350 garden centers.

Operator, we have time for more questions.

Absolutely. The final question comes from the line of Peter Benedict with Baird. You may proceed.

Hello, everyone. Thank you for taking the time to join us. I have a question about inflation. Kurt, I'm interested in your thoughts on the high single-digit retail price inflation we saw in the first quarter. What do you expect for the second quarter and the latter half of the year? Is there a possibility of change? You've mentioned that some costs are decreasing, particularly supply chain costs. Are you now noticing that overall product costs are lower year-over-year in some areas? How are you approaching pricing in this context? Are there segments of the business experiencing price deflation at the retail level compared to last year, or is that not yet the case? Thank you.

Yes. Peter, I'll hit those. On the inflation, our outlook on the retail price inflation for the year hasn't changed much at all. A vast majority of retail price inflation, as I mentioned in Q1, was what was put in place in the second half of last year. And we're seeing a bit of a steady plateau. Maybe some categories like pet will continue to see some. So our expectation is high single-digit Q1 moving into the mid-single-digit Q2 to maybe slightly lower in Q3 and then getting into low single-digit Q4. And we're not seeing significant cost deflation. So at this point, there may be some deflation in certain areas of the business. But overall, there's some disinflation that we have expected in there. The great thing is, this year, we expect to see comp transactions really being a key driver to it. And that's what we're seeing right now, as Hal mentioned. And our expectation, as the year unfolds, it really is a good balance between ticket and transactions. Lastly, I'd say what is exciting, you heard this from both Hal and I is in other parts of the business, in cost, in SG&A, we are taking advantage of our ability to use the scale where there's either excess capacity or there's cost coming down. The operating expenses have efficiencies there and you heard that in some of our messaging. So hopefully, that helps answer the question, a lot of great expectation. Our ability in any sales scenario to really have increased operating margin in 2023.

No. That's helpful. Just to follow up on something you mentioned that you've brought up transactions, and it's encouraging to see them up despite the soft seasonal stuff. I know that would not have been the case several years ago with this business. I'm just curious maybe if you guys can talk a little bit about the role that Neighbor's Club might be playing in this. I mean, just how those members are shopping more frequently, if they are? How you're expanding your wallet with those members and there's a lot of marketing initiatives underway on that front. So just maybe a little bit more on the behavior of your Neighbor's Club members and how that might be something that's helping maintain the traffic during periods of seasonal weakness? Thank you.

Yes, Peter. Neighbor's Club has been crucial in driving our business and shaping customer behavior, especially regarding our consumables. An increasing number of our customers are enrolling in our private label credit card, and we announced last quarter that we achieved $1 billion in sales using that card for the first time. When customers use the credit card, they receive a 5% discount on their purchases, which encourages repeat buying, particularly in food and feed. As Seth mentioned, we have been outpacing the feed market by 5 percentage points every single quarter, maintaining a 20% market share, which is by far the largest in that category. The same applies to dog food; we lead the market significantly, regardless of the metric—whether it’s pounds, units, dollar growth, or new customer counts. Each week, our new customer counts for dog food continue to rise, which helps drive our transactions. Additionally, the business has undergone some changes over the past few years. We now have the scale in pet food to complement the scale we've always had in animal feed, which is enabling positive comparable transactions. Even in March, despite the soft weather affecting seasonal sales, we still managed to achieve positive comparable transactions.

Thank you, Peter. Operator, that will conclude our remarks today. Thank you to everyone for joining us. We look forward to speaking to you on our second-quarter call in July. I'm around all day, so please reach out if there's anything that I can do, and I look forward to speaking to you. Thank you.

That concludes today's Tractor Supply Company's conference call to discuss first quarter 2023 results. Thank you for your participation. You may now disconnect your lines.