Earnings Call Transcript - TSCO Q3 2022

Operator, Operator

Good morning, ladies and gentlemen, and welcome to Tractor Supply Company's Conference Call to discuss Third Quarter 2022 results. Please be advised that reproduction of this call in whole or in part is not permitted without written authorization of Tractor Supply Company. And as a reminder, this call is being recorded. I would now like to introduce your host for today's call, Mrs. Mary Winn Pilkington, Senior Vice President of Investor and Public Relations for Tractor Supply Company. Mary Winn Pilkington, please go ahead.

Mary Winn Pilkington, Senior Vice President of Investor and Public Relations

Thank you, operator. Good morning, everyone. Thanks for taking the time to join us today, and I hope everyone is doing well. On the call today are Hal Lawton, our CEO; Kurt Barton, our CFO. After our prepared remarks, we'll open up the call 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 the 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 get back in the queue. It's now my pleasure to turn the call over to Hal.

Hal Lawton, CEO

Thank you, Mary Winn, and thank you to everyone for joining us this morning. On behalf of Tractor Supply, I'd like to extend our deepest sympathies and support to our communities and team members impacted by Hurricane Ian. Our store teams, our distribution centers, and the store support center have done a tremendous job supporting our customers and communities during this tragic time. The team's dedication at times like this helps make us the dependable supplier our customers can count on. I'm thrilled to report that just over a week ago on October 12, we closed on the transaction to acquire Orscheln Farm and Home. We welcome the Orscheln team to Tractor Supply. We're very pleased with the 81 high-quality locations that will be converted to Tractor Supply over the next 15 months. While agreeing to the remedy with the FTC took longer than we anticipated, the outcome is in line with our expectations. We are committed to providing customers in the Midwest region with an expanded product assortment, a meaningful loyalty offering, and an enhanced digital shopping experience and so much more that Tractor Supply is able to offer. Two and a half years have passed since COVID emerged in the United States. With this quarter's results, we have now posted 10 consecutive quarters of exceptional sales growth. From my perspective, the highlight of this impressive track record continues to be the consistency of our results and the broad-based strength of our performance. Our 3-year comp sales stack in the third quarter was approximately 46% in line with the second quarter. And including new stores, our overall revenue growth on a 3-year basis has increased by 65%. Our addressable market continues to benefit from numerous secular trends that we believe are structurally sound. Additionally, by all measures, we are gaining substantial share in our market. We've had tens of millions of new customers shop us over the past 3 years. We've retained the majority of these customers, and a substantial portion have become active members of our Neighbor's Club program. I commend the team for stepping up to every challenge that has come at us over this time period. They've done a tremendous job maintaining their focus on the factors that we can control and all the while expanding our competitive moat through the advancement of our Life Out Here strategy. We continue to operate in an ever-changing and challenging macro environment, which could convey a new recession, but from our view, real economic growth in the near to medium term will remain flattish and tepid. On the positive side, a great sign is that we're seeing moderation in supply chain bottlenecks. However, inflation remains persistent and elevated, and we anticipate this to continue well into 2023 with some moderation in the back half of 2023. At the same time, the labor market continues to remain very constrained, and we expect that this will remain the case for the foreseeable future, particularly on the front line. As we move into next year, the labor market will be a key determiner of our country's ability to return our economy to sustainable conditions. Turning to our third quarter performance. The Tractor Supply team delivered another quarter of record results, with net sales of 8.4% growth. Comparable store sales increased by 5.7%, and diluted earnings per share were $2.10. Our business continues to be incredibly resilient, and the quarter unfolded much like we anticipated. Now let's go through some of the highlights for the quarter. Our comparable store sales growth was driven by strong ticket growth of 7%, partially offset by a transaction count decline of 1.3%. As we shared entering the quarter, we anticipated that the drought would take some of the upside potential off our sales performance, and that was exactly how the quarter played out. By our estimation, less favorable weather negatively impacted our comp sales by about 150 basis points. As the drought and the heat conditions abated, we exited the quarter with strong momentum. All months of the quarter comped positively. August comp sales were stronger than July, and September was the strongest month of the quarter, and we had flat comp transactions in the month of September. E-commerce achieved sales growth in the high single digits, and we continue to build out our ONETractor capabilities. During the quarter, we added app features such as My Pet and upgraded our in-store mode. We also rolled out inventory quantity visibility at the store level across all our digital properties. For the sixth consecutive quarter, we continued to see our consumable, usable, and edible products outperform our overall comp sales results. This is the third consecutive quarter for C.U.E. to run at about 3x the rate of our overall comp sales performance. This strong performance was driven by dry dog food and feed for poultry, equine, and wild birds. C.U.E. continues to be one of our structural advantages. These products represent the strength of our core business and what drives trips and footsteps into our stores. Our outperformance in year-round categories offset the declines in our late spring-summer seasonal product and big ticket categories. We continue to gain share across all our categories, both in-store and online. Our Neighbor's Club membership this quarter exceeded 27 million members, representing nearly 75% of our sales for the quarter. Neighbor's Club continued to successfully help migrate customers up in their spending with us. During the quarter, we reached an all-time high in high-value customers. In August, we rebranded Petsense to Petsense by Tractor Supply. In August, we also rolled out the Neighbor's Club program to Petsense by Tractor Supply stores. This expansion will deepen relationships with our existing customers and help attract new pet customers to both banners. While it's early, we are very pleased with our customers' response to these initiatives, with our Neighbor's Club membership already representing over 35% of sales at Petsense. For the third consecutive quarter, our overall customer satisfaction scores hit a new all-time high as we continue to invest in our team to provide best-in-class customer service. We ended the quarter with our inventory in great shape. As we said many times, if anything, we'd like to have more inventory, and we're now working hard to grow inventory in targeted categories to improve our in-stock position and serve as that dependable supplier for our customers. We continue to stay true to our EDLP roots, and our promotional activity in the third quarter was below the prior year's third quarter. We've made significant progress in our Life Out Here strategy. We now have over 500 stores that are in our Project Fusion layout, and our Garden Center transformation is now active in over 260 locations. We continue to be pleased with the strategic benefits and financial returns of these store-level investments. Given our performance through the third quarter, our acquisition of Orscheln Farm and Home, and our outlook for the fourth quarter, we are raising our sales and earnings guidance for 2022. Kurt will share more details on our improved outlook later in the call. Stepping back, Tractor Supply is a unique, highly differentiated retailer. Our resilient, need-based business model has a proven history of growing through varied economic conditions. Our customers and team members are dedicated to the Out Here lifestyle, and they prioritize it as their authentic lifestyle. Our customers over-index as homeowners, landowners, pet owners, and animal owners. We believe that the structural macro trends that have been benefiting us are long-term and sustainable. As the market leader, we have substantial advantages and continue to gain share. The investment in our Life Out Here strategy is reaching critical mass and furthering our competitive advantage. Simply said, Tractor Supply has never been stronger. And with that, I'll now turn the call over to Kurt.

Kurt Barton, CFO

Thank you, Hal, and hello to everyone on the call. Our business continues to be incredibly resilient. This is a business that was built for all economic environments with stability in both revenue and earnings over multiple decades. Comparable store sales have been remarkably consistent across all three quarters year-to-date. All regions of the country once again delivered positive sales comps. The geographic diversification of our store base worked to our advantage this quarter. The South Atlantic and Mid-Atlantic were our best-performing regions. As expected, we did experience softer performance in select regions of the country impacted by the severe heat and drought, particularly in the Far West and Texahoma regions, which, while positive, lagged the chain average. For background, July was the second hottest in 30-plus years, and during August, about 40% of the U.S. was under extreme drought conditions. As Hal shared, we believe that the less-than-ideal weather weighed on our transactions and our big ticket sales. Much like the second quarter, retail price inflation contributed about 12 points to our comparable store sales as the team continues to navigate the ongoing cost pressures across the supply chain. The comparable average ticket growth of 7% benefited from inflation, partially offset by declines in big ticket sales and average units per transaction. Big ticket sales performance, while positive on a 2-year stack, was impacted by the severe drought and cycling two hurricanes in the prior year. We saw the largest impact in categories such as generators, zero turns, and trailers. Moving on to gross margin. For the third quarter, our gross margin declined by 32 basis points to 35.6% of sales. Our price management actions and our other margin-driving initiatives were able to offset the pressures from cost inflation and higher transportation costs. With the continued robust growth in our C.U.E. categories, we saw pressure on our gross margin as C.U.E. runs below chain average on gross margin rate. In regard to inflation, while moderating, we continue to see increasing costs in the commodity inputs in our product categories, as well as underlying variables like higher labor wages and transportation costs impacting both us and our vendor partners. We have remained agile and nimble in managing all the complexity of today's environment, effectively managing cost increases at the SKU level through our price management actions and other margin-driving initiatives. The team has also been working to capture efficiencies in the supply chain to reduce miles, continuing to limit promotions, and leaning into the more efficient value provided through Neighbor's Club. SG&A expenses, including depreciation and amortization, increased 9% from the prior year's third quarter. As a percentage of net sales, SG&A expenses increased 16 basis points year-over-year to 26.3%. This increase was in line with our expectations, primarily attributable to our strategic growth initiatives, including depreciation and amortization, hourly wage and benefit investments in both our stores and our distribution centers. These items were partially offset by a moderation of COVID-19 response costs, more normalized incentive compensation, and leverage in our occupancy and other costs from the increase in comparable store sales. Diluted EPS was $2.10, an increase of 7.7% from the third quarter of last year. Our balance sheet remains incredibly strong. At the end of the quarter, merchandise inventories were $2.7 billion, representing a 19.2% increase year-over-year in average inventory per store. The increase reflects growth to support the robust sales trends along with the impact of inflation. Looking at our inventory growth on a 3-year stack, it represents a 30% increase in average inventory per store compared to Q3 2019, meaningfully below our sales increase over the same period. There continue to be select product categories where we are still pursuing inventory, especially in C.U.E. Stepping back, we believe our inventory position is in good shape. Our strong balance sheet and the consistency of our free cash flow continue to be a position of strength for Tractor Supply, allowing us to invest in the business for growth and return cash to shareholders. To further our financial flexibility, we just entered into a new 5-year credit agreement on September 30 that increases our senior credit facility from $700 million to $1.2 billion. We also added two new banks to our banking group, including a minority-owned bank. Moving now to our updated guidance for fiscal 2022. Our updated guidance reflects the strong results for the first three quarters of the year and the positive momentum we see in our business continuing into the fourth quarter. In addition, we are incorporating the impact of our recent acquisition of Orscheln Farm and Home. We are forecasting fiscal 2022 net sales of $14.06 billion to $14.12 billion, including about $75 million in sales from Orscheln. This is the first time in the history of our company that annual sales are forecast to be above $14 billion. Comparable store sales growth is anticipated to be in the range of 5.4% to 5.8%. For the year, we now forecast an operating margin of 10.1% to 10.5% in line with our prior guidance, but with modest pressure from the acquisition as the sales and earnings benefit from Orscheln Farm and Home are offset by incremental transaction expenses and early integration costs. We anticipate the impact of Orscheln to be relatively neutral to operating income, while we expect a modestly negative impact on net income due to the interest expense associated with funding the acquisition. Diluted EPS is now forecast in a range of $9.55 to $9.63. This compares to our previous earnings range of $9.48 to $9.60 per diluted share. We entered October with momentum. With this updated guidance, we are forecasting comparable store sales growth for the fourth quarter of 5% to 7%. We now expect to open approximately 60 to 70 new Tractor Supply stores, which is modestly below our outlook as we entered the year. We continue to be on track for 10 Petsense store openings in 2022. Given the conditions of the real estate and construction industries, the cadence of store openings for Tractor Supply has shifted a number of the openings into the fourth quarter. I give the cross-functional teams a lot of credit for completing over 250 projects this year as they lay the foundation for 2023 and beyond. Our new store pipeline continues to be solid, and we expect to improve the cadence of openings in 2023 with more balance throughout the year. We remain committed to returning cash to shareholders through the combination of growing dividends and share repurchases. For 2022, we remain on track for anticipated share repurchases in a range of $750 million to $800 million. As is customary, we will provide our full guidance for 2023 at our fourth quarter earnings call. We are early in our planning cycle for next year. I thought it'd be helpful to set the stage and share some preliminary insights and color into our thought process, given that there are a few moving parts between 2022 and 2023. Our business model has stood the test of time and has proven to be resilient. We have significant confidence with 2023 on the horizon. We are well-positioned for any consumer and economic environment. Further, we have consistent structural trends that will continue to benefit us. We continue to invest in our Life Out Here value strategy to capture this growth. Now the discrete items that impact our earnings in 2023 are the lapping of the 53rd week benefit this year, and the accretion from the Orscheln acquisition. As I've shared previously, we forecast that the 53rd week will add approximately 1.5% growth in net sales and about $0.15 to the EPS this year. As you saw our press release earlier this month, we expect the Orscheln acquisition to be accretive to diluted earnings per share by at least $0.10. When adjusting for the 2022 benefit from the 53rd week and the accretion from the Orscheln acquisition, we plan for 2023's performance to be consistent with our long-term EPS guidance of 8% to 11%, with our bias at this point in planning towards the midpoint of our range. Despite what might play out with the economy, this needs-based demand-driven characteristics of our product offering support our ability to deliver on our long-term outlook. We are making great progress towards our long-term financial goals, and we look forward to sharing with you our 2023 plans in more detail at our fourth quarter earnings call in January. Now to wrap up, we are continuing to separate Tractor Supply from the competition. In prior cycles, we have made investments that strengthened the company. We believe the current environment is an opportunity for us to lean into our strengths and further expand our lead for years to come.

Hal Lawton, CEO

Thanks, Kurt. Tractor Supply is a business with momentum. As our customers prepare for cooler temperatures and the calendar shift to the fall and winter season, our stores are ready for the change. From key categories like heating and insulated apparel, our merchants have brought newness with compelling value. In our C.U.E. categories, we have the right selection and are in stock as we continue to support our customers' lifestyles. This year, we expanded our Halloween and Harvest Decor program with a great lineup to capitalize on our customers' love of decorating their homes with seasonal indoor and outdoor decor. With more than 260 Garden Centers, we're showcasing the fall harvest season with everything from pumpkins to mums and will be ready for the transition to the Christmas holiday season with an expanded offering of outdoor decorations. Despite the economic outlook, we are optimistic about holiday-related sales. From the calendar perspective, it's a good setup with 30 days this year between Thanksgiving and Christmas, with Christmas falling on a Sunday. We have a strong day after Thanksgiving game plan and compelling offers planned throughout the season. Given the increasing financial constraints facing American consumers, we're excited in the coming weeks to introduce the Tractor Supply Visa Credit Card. This new co-brand credit card will help our consumers earn more on their everyday purchases, both in-store and anywhere Visa is accepted. With the Tractor Supply Visa Card, customers receive access to all the perks from the private label TSC personal credit card that they have, such as 5% rewards on Tractor Supply purchases or special financing on purchases of $199 and up, but they also will receive 3% in rewards on gas station, grocery, and vet purchases and 1% in rewards on all other purchases. All consumer card members with Tractor Supply receive Neighbor's Club Preferred Plus benefits. This is exciting progress on our journey to driving sales, building loyalty, and adding more value to our Neighbor's Club membership and reducing tender expense through our credit offerings. 2022 is shaping up to be another great year for Tractor Supply. With one quarter to go, we are on track to achieve several monumental milestones in the growth of our company, including annual revenues in excess of $14 billion, a store base of over 2,100 Tractor Supply locations, and a highly engaged workforce of more than 50,000 team members. That said, we are not resting on our laurels. We have robust plans in place for 2023 to continue our life out here strategic journey. As we enter the new year, the transformation of our business has significant momentum. Investments such as Neighbor's Club, our FAST program, and our mobile app are at scale on providing dividends. Our store investments are reaching scale, and we have compelling new growth vectors such as the integration of Orscheln and many other opportunities on the list. With a healthy total addressable market of $180 billion, Tractor Supply is well-positioned to continue to gain market share while fulfilling our purpose as a company. As we enter one of the busiest periods in retail, my thanks and sincere appreciation go out to each of our 50,000-plus Tractor Supply team members for their dedication to our mission and values. And with that, operator, we would now like to open the line for questions.

Operator, Operator

Our first question comes from Elizabeth Suzuki with Bank of America, Merrill Lynch.

Elizabeth Suzuki, Analyst

So you mentioned that you would have liked to have had more inventory. Do you think that you left any sales on the table as a result of being out of stock?

Hal Lawton, CEO

Liz, thanks for joining the call. I think we're doing an excellent job navigating inventory and managing it. We don't feel like we're leaving any sales on the table because of it. But I think we are, at times, incurring some higher costs to run the inventory through our supply chain than we might otherwise. Also, just on the labor side, having to work the back room a little more frequently than normal. The team has done an excellent job on it. But if you look at kind of weeks of supply and kind of pallet low quantities, we would be looking to continue to add inventory in our core C.U.E. businesses. As we talked about, this is the third consecutive quarter where our C.U.E. business has performed at 3x the chain average, dry dog food running well above 20% comps, and other feed categories running very strong as well. It's just all about keeping up with the customer and then building our supply chain for the future to ensure that we can continue to move these billions of pounds of food and feed that we do every year and maintain it as low cost as possible. We're very excited about our Navarre, Ohio, D.C. opening up early next year, as that will give us a little more streamlined supply chain and capacity to continue to serve our customers in Life Out Here.

Operator, Operator

Our next question comes from the line of Peter Benedict with Baird.

Peter Benedict, Analyst

I appreciate the insights you shared regarding next year. Hal, it's clear how robust your business is amidst various macroeconomic uncertainties, which you mentioned earlier. How do you view the company's ability to stay aligned with its earnings expectations if we encounter a tougher economic landscape than expected? What are the key strategies, and how do you plan to manage the business in such an environment? That's my question.

Hal Lawton, CEO

Yes. Thanks for joining the call today. Good to talk with you. We feel very confident in our ability to deliver in 2023 and continue to deliver on our long-term targets. If you look at the consistency of our business this year with a 5.1, 5.5, 5.7 comp, a strong outlook for Q4, very consistent in an economy this year that you would argue really is stagflation kind of flattish, real growth, high single-digit inflation. As we look towards next year, our expectation will be much of the same. Our business will continue to be very resilient and stable. The other thing I would add is, as we talked about in our prepared remarks, many of our investments are just now starting to reach significant scale, and we expect that they will pay substantive dividends next year. We're now at over 500 stores in our Fusion layout, seeing very strong results there. Many of those will be comping for the first time next year. The same thing on Garden Centers, 260 – many of those came online just at the beginning of this year. We expect, just like we saw in the first year class, they will have a new store maturity curve-like sales growth. We feel like the economy is stable. Our outlook on the economy is not much different than what it is right now. We expect our business to continue to be very resilient and allow us to deliver our long-term targets. Our Life Out Here strategic initiatives are really reaching scale now, and the benefits that we've talked about are starting to really add up across our store base.

Operator, Operator

Our next question comes from the line of Scott Mushkin with R5 Capital.

Scott Mushkin, Analyst

I wanted to ask about your continued expansion of your total addressable market. I've noticed many vet clinics in your stores and was curious if this is a significant initiative. Have I overlooked it? When do you expect it to contribute as we move forward?

Hal Lawton, CEO

Yes. Scott, it's good to talk to you today, and thanks for joining the call. The vet clinics are a core part of our fusion menu. As we go in to execute a Fusion store, we look at the existing mobile clinic activity. If it warrants – given the frequency of business and the customer count, if it warrants a stand-alone vet clinic, we are putting those in. They have been very successful and are just another value-added feature to support our pet business. As we talked about, we are gaining substantial share in pet. For the last handful of quarters, we've run 10 to 15 points above the market growth rate in pet. Even as you're hearing others talk about the pet business starting to moderate, we aren't seeing that at all in our business, and it's because we're gaining substantial share. That share gain starts with the core basics of great customer service, being in stock, the right price, strong private label brands, but then it's certainly augmented with our other offerings, whether it's pet wash, whether it's the vet clinics, and our Rx solutions, which are available online. The pet business is a strong source of growth for us, and we expect it will continue to be as we go forward.

Operator, Operator

Our next question comes from the line of Steven Forbes with Guggenheim Partners.

Steven Forbes, Analyst

I wanted to focus on member trends. So Hal, curious if you can discuss any incremental learnings around retention or repeat behavior, specifically as it pertains to the 2020 member cohort as they approach their second anniversary. And then maybe just quickly comment on whether you view the 2021 or 2022 cohorts any differently?

Hal Lawton, CEO

Yes. Thanks for the call and the question. We continue to be very pleased with our Neighbor's Club program. More broadly, our customer relationship management that we've had over the last 3 years, the Neighbor's Club rollout that we did nearly 2 years ago has exceeded our expectations. We've had tens of millions of new customers shoppers over the last 3 years, and the majority of those customers continue to shop at Tractor Supply. A majority of those that have continued to shop at Tractor Supply have also joined our Neighbor's Club program and have been a big driver of our membership growth. As we mentioned in our prepared remarks, we had the highest level of high-value customers this quarter that we've ever had. A lot of those are new customers that have grown with us over the last 2 and 3 years. As we gain new customers in '21 and '22, they are following that continued kind of above-historical average performance, both in their average purchase sizes in a year, their frequency of purchase with us, and also the expanding number of categories that they're shopping with us. This has been a big area of success for us, and it's really what's been able to create that foundation for us to have held the 65% growth in sales we've had over the last 3 years. We firmly believe that the secular trends that have benefited us are structurally sound, and that the share gains we've made are structurally sound. A lot of it has to do with our very sophisticated CRM capabilities that are far and away best-in-class overall in retail and certainly in our market.

Operator, Operator

Our next question comes from the line of Chris Horvers with JP Morgan Chase.

Chris Horvers, Analyst

So can you talk a little bit more about the shape of the quarter? With September 7 comp, and as we look forward, should the inflation lift moderate along the lines of the comparisons, but then traffic turn slightly positive? Or does the persistence of wage inflation lead to acceleration in the inflation stacks over the next 3 or 4 quarters as you can see it today?

Hal Lawton, CEO

Yes, good morning, Chris. We noted that September was our best month of the quarter, outperforming the overall average and maintaining flat comparable transactions. This momentum has carried into the fourth quarter, which has started with cooler weather. This has positively impacted our heating sales, insulated outerwear sales, and heating fuel sales. Key categories for us this quarter include propane and wood pellets. Given the high energy costs, the current cooler weather, consumer concerns about inflation, and the potential impact of European energy prices in the U.S., we are very optimistic about these categories for the fourth quarter. We also feel positive about the flat comparable transactions in September continuing into the fourth quarter. Reflecting on the first nine months of the year, we saw several months with flat or positive comparable transactions, with exceptions primarily due to last year's stimulus in March and April, drought and heat issues, or the delayed spring in the first half of the year. Looking at January and February and how we exited Q3, we are confident these trends will carry into Q4. Regarding inflation, we expect some moderation in the latter half of next year. However, based on our two-year comparisons, we anticipate inflation to remain high through at least the first half of next year, which aligns with the broader U.S. economic outlook. We feel optimistic about our comparable transactions as we enter the fourth quarter and the momentum we've built.

Operator, Operator

Our next question comes from the line of Scot Ciccarelli with Truist.

Scot Ciccarelli, Analyst

So Hal, previously, I think you touched a little bit on this earlier, maybe on Peter's question. Historically, you guys provided some expectations regarding the impact of your fusion remodels and side lot transformations. Now, with some significant experience under your belt, I was hoping you could potentially update us on any other stats that you're kind of seeing out of these initiatives? Maybe any other important learnings that you've been able to conclude.

Hal Lawton, CEO

Scott, and thanks for joining the call, and thanks for the question. We continue to be very pleased with our store remodel program. On the sales side, they continue to perform at the level of results that we articulated at the beginning of this year. For a combo store that has both Fusion and side lot inclusive of a garden center, they're performing with high single-digit lifts year-over-year, kind of pre, post, net of control. When you look at a store where we've only done Fusion, they're performing in that mid-single-digit lift. It hasn't been the case in retail for decades. When you first start a store remodel program, because you're handholding it, you'll get a nice lift, but those lifts often start to diminish and moderate a bit as you start to scale. That has not been the case with us. We're now at 500 Fusion stores and over 260 garden centers. We continue to see that same type of lift even as we reach scale, real tribute to our team on execution, operations, and ensuring that we've got the right programs as we roll those out. Other learnings? Our customers take note of these remodels. We're seeing on our customer satisfaction surveys that we're seeing overall increases after the remodel. We're observing kind of questions like the condition of the store and appearance of the store; many of our customers qualitatively ask if we've updated the store, and they notice it. The same thing is evident on the garden centers. We're seeing many new customers shop our business once we roll out a garden center, with much higher female penetration and much higher millennial penetration. This has become a driver of footsteps into our store, and we are starting the next version of C.U.E. category in our business and that being live goods. The key learning has been on cost. We continue to challenge ourselves on our rollout timing and costs. We continue to reduce the length of time required to roll one of these out that minimizes disruption and cannibalization. We are also continuing to bring down the cost through optimization of our fixtures, construction plans, and particularly on the garden center designs. If anything, we feel like the performance is better than it was nine months ago; kind of equivalent, if not better, sales lift and customer reaction. We continue to find ways to bring costs down on the program. We are very pleased with the remodels and excited to continue to roll it out to the next set of stores next year and continue to bring it to our whole store base.

Operator, Operator

Our next question is from Simeon Gutman with Morgan Stanley.

Simeon Gutman, Analyst

I wanted to ask about strategic growth initiatives with regards to either CapEx and SG&A as it flows through the P&L. Can you give us a sense, is the business at the top of a spending cycle now with a lot of the changes that have brought in over the last few years? Or do investments in SG&A step up, moderate, or decelerate from here?

Kurt Barton, CFO

Simeon, this is Kurt. Good morning to you and everybody on the call. In regards to our investment cycle, 2022 and 2023 has really been viewed as, to your point, a peak in that investment cycle. We will be opening up Navarre, Ohio, as Hal mentioned earlier. We will be building the Maumelle, Arkansas distribution center in 2023, and we'll continue our path on this cadence for the existing store remodels under the Fusion program. 2023 is really a bit of that peak, but it has been planned that way with the growth and depreciation that we've seen this year, roughly mid- to high 20%. We expect to see in 2023 about a similar year-over-year growth rate moderating net growth rate over time. Our SG&A has great visibility to it. We feel confident to the point that Hal mentioned on cost. The pressures from the investments, we also see the offsets to that in SG&A, leveraging on these comp sales. I'm thrilled about the maturity and development of the culture and the organization's view on profit improvement. We've got a lot of great things in the works right now, not only on the supply chain side on how we can continue to leverage investments to drive improvements in gross margin, but what we can do through procurement and how this organization is focused on driving efficiencies and productivities in the stores and in our distribution centers. To wrap that up, yes, there continues to be pressure from investments in the business, very much as we expected. However, we've got also in the trend rate of expectations of the offsets to it, which is how we see SG&A generally playing flattish as a percentage of sales going forward.

Operator, Operator

Our next question comes from the line of Oliver Wintermantel with Evercore ISI.

Oliver Wintermantel, Analyst

I had a question regarding trade down if you've seen any of that within categories and if you expect promotions to step up in the fourth quarter?

Seth Estep, EVP and Chief Merchandising Officer

Hey, Oliver. This is Seth. Thanks for joining the call. When we look at trends in the category today, we're not seeing any meaningful trade down at this time. In fact, if you look at our portfolio strategy, we've got a very balanced portfolio across kind of opening price points all the way up to our premium segments within our category strategies. We continue to see strength across all three categories. One of the encouraging things is the growth of our store-owned exclusive brands. We are really seeing our customer base engage with our exclusive brands. Our exclusive brand penetration in Q3 was up 130 basis points over the prior year as they're really navigating to our premium, value-oriented segments or exclusive brands and really driving loyalty. This is something you'll see us continue to lean in on for the balance of this year. More importantly, as we look into 2023, we will continue to drive loyalty with our portfolio strategy and drive innovation across all three product tiers while leaning into exclusive brands. On promotional cadence and activity, you’ll see us very similar to last year. We have over 27 million members in our Neighbor's Club today. We're really leaning into that capability. We're really hitting our stride, diving into that dataset and being very smart with our promotional activity, while also making sure that we're pulsing the market relative to Black Friday and some of the other events with just some great offers that we partner with some of our key suppliers on. You'll see some messaging there as well, but our promotional activity should be consistent with what you've seen recently over the last couple of years, as we've focused on our EDLP approach and making sure we're gaining market share in our essential businesses.

Operator, Operator

Our next question comes from the line of Kate McShane with Goldman Sachs.

Kate McShane, Analyst

Just now that the transaction is closed, I wondered if you could talk any more about Orscheln and how you plan to integrate that and what you see in terms of the future for those 81 stores you are now taking on?

Hal Lawton, CEO

Kate, good morning. Thanks for joining the call. Thanks for your question on Orscheln. To start out, just reiterating my prepared remarks that we're thrilled to have Orscheln join Tractor Supply. While the transaction took longer than we anticipated, the outcome was very much in line with our original expectations on the remedy that would be necessary. We are already well underway to welcoming them into the company and starting to map out our plans for converting those stores to the Tractor Supply brand. We will be executing the Fusion and Garden Center remodel programs in those stores. There'll be a little extra involved with them in terms of new signage for our nameplates and some updates on fixtures and painting of the walls and such like that. Our plan is to have all that accomplished by the end of next year. At the same time, we're excited to learn from Orscheln on several categories where they play differently than we do in terms of distortions. We think there's a lot of opportunity for us to take some of our best practices to them, driving dollars per square foot up closer to where we are, as they are at about 50% of where we are in dollars per square foot. Because they are at a lesser dollar per square foot, the op margin percent on a per store basis is lower as well. So we're optimistic that we can raise that over time. There'll be some sales synergies over time, there will be some op margin synergies over time. Additionally, we will be bringing our brand awareness to that business, with well over 80% unaided and aided together and things like our Neighbor's Club program and our digital capabilities. We are really excited to have them join us. It gives us a great additional footprint in the Midwest. We are excited about transitioning those stores to the Tractor Supply brand and then bringing the whole of Tractor Supply to those stores and most importantly, to our customers in that area of the country.

Operator, Operator

Our next question comes from the line of Chuck Grom with Gordon Haskett Research Advisors.

Chuck Grom, Analyst

Most of my questions have been asked, but I was curious about supply chain, how you talked about some relief on that front. I'm curious about the lag, and how long we should anticipate it to start seeing some freight relief ocean container costs start to show up in the P&L?

Kurt Barton, CFO

Chuck, this is Kurt. On transportation costs, as Hal indicated, we are seeing both domestic and to an extent imports of those costs beginning to moderate as the demand on the overall supply is starting to ease. We are taking advantage of that. To your question about the timing of it, two factors: one, it's got to work its way through the pipeline. We could start to see the cost in early to mid-2023, reflecting newer improved transportation costs. That’s from the selling through of the cost of goods that have the peak cost in them today. We work off of and advantage off of longer-term contracts. What the team is doing and has been doing is as the demand on supply in the transportation eases, our negotiations on those costs. As we begin to see overall contract prices come down, those will start to work through the pipeline. In transportation, in the long term, 2023 and beyond, we see this as one of the areas of efficiency and one of the areas that helps us as part of our algorithm for gross margin expansion over time as we come off some of these peak transportation costs. But do see about a 6- to 9-month process not only to get inventory through the supply chain but to be working off of new and lower contracted costs.

Operator, Operator

Our next question comes from the line of Michael Lasser with UBS.

Atul Maheswari, Analyst

This is Atul Maheswari for Michael Lasser. I have a follow-up question for you on inflation. You mentioned that inflation is likely to moderate in the back half of next year. But what are the chances that there could be deflation, especially given there are signs that some costs are coming in? If there is deflation, how would you expect your P&L to react to such a backdrop? Because back in 2016 and '17, there were a few quarters of sluggish comp, then because of some deflation. But how is the business today that will help you navigate the statutory backlog better than what you back at?

Hal Lawton, CEO

Yes, thanks for the question. We don't foresee a scenario of deflation in any near-term time horizon, '23 or '24. If you look at where our retailers are now and just flow those through into the first half of the year, we're going to be at mid- to high single-digit inflation. We fully expect that this will moderate into the back half, both as we start to navigate reducing COGS increases but also, hopefully, as the economy, PPI, CPI, and other inflationary indexes start to moderate. However, I don't foresee a scenario of deflation in the near future or any time horizon in the next few years. What I would say on some of those commodity-based products, we're well past just kind of core supply-demand out there, and the market is moving like they had four, five, or six years ago in a normal environment. We're now in a market where they’ve got higher input costs, whether it’s fertilizer, etc., that has not come down. Even if it comes down, it's only coming down in a moderate way. They've got higher labor costs, 10, 15, 20 points above a couple of years ago, and there are significant capacity constraints. If you look at pet food, there are significant capacity constraints in the pet food market right now. This will limit costs and any cost decreases that emerge. It’s just the dynamics of how the supply-demand is shaping up right now. Then when you factor in non-U.S. markets and all the risk there, whether it’s down in South America or certainly in Eastern Europe with Ukraine and Russia and the difficulties in the war there, I just don't foresee a market at all where commodities are moderating enough to drive substantive deflation in our business. That's just not something I see coming.

Operator, Operator

Our final question will come from Brian Nagel with Oppenheimer.

Brian Nagel, Analyst

The question I have is about Tractor Supply's strong performance, which is impressive despite some macroeconomic challenges. Looking ahead to 2023, if macro conditions were to deteriorate and affect Tractor's trends, what options do you have to adjust your business, whether through cost management or merchandising strategies?

Hal Lawton, CEO

Yes, Brian, thank you for your question and for your comments about our quarter. We are very optimistic about the third quarter and the year 2023. As I mentioned earlier regarding revenue, many of our initiatives are starting to reach a significant scale. We currently have 500 Fusion stores and 260 Garden Centers, and we are experiencing strong growth from these. As we approach the new year, we expect these elements to continue driving our business and, if the economy weakens, to help address any challenges that arise. I also expect that our main competitors will face greater financial challenges if the economy continues to decline, which will create more opportunities for us to gain market share. We are upbeat about our prospects in 2023 for gaining share and growing while staying aligned with our long-term goals. On the cost front, while many factors have affected our costs, we have performed well over the last two years, and our team has effectively managed our operating margins. However, we have encountered inefficiencies in our cost structure over the past couple of years, including increased container and freight costs and the need to set up temporary distribution centers. We expect that as we enter 2023, our business will be more streamlined from the supply chain perspective than it has been in three years. We are optimistic about our cost management and feel confident about transitioning into 2023 with momentum as we head into the fourth quarter.

Operator, Operator

Thank you for your questions. This concludes our Q&A session for today's call. I will now pass back to Mary Winn Pilkington for closing remarks. Thank you.

Mary Winn Pilkington, Senior Vice President of Investor and Public Relations

Thank you, Flora, and thank you for everybody for joining our call. Marianne and I will be around today if you have any remaining questions, please feel free to reach out. The team looks forward to speaking to you at Q4 in January. So thank you for your interest in Tractor Supply.

Operator, Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect your lines.