Tractor Supply Q3 2021 Earnings Report

Tractor Supply EPS Results

• Actual EPS: $0.39
• Consensus EPS: $0.33
• Beat/Miss: Beat by +$0.06
• One Year Ago EPS: $0.32

Tractor Supply Revenue Results

• Actual Revenue: $3.02 billion
• Expected Revenue: $2.86 billion
• Beat/Miss: Beat by +$160.29 million
• YoY Revenue Growth: +15.80%

Tractor Supply Announcement Details

• Quarter: Q3 2021
• Date: 10/20/2021
• Time: Before Market Opens
• Conference Call Date: Wednesday, October 20, 2021
• Conference Call Time: 8:00PM ET

Tractor Supply (NASDAQ:TSCO) (NASDAQ:TSCO) is a specialty retailer serving the needs of recreational farmers, ranchers, homeowners, pet owners and other customers who live a rural lifestyle. The company operates Tractor Supply stores across the United States, offering products designed for agriculture, home improvement, outdoor living and animal care.

Its merchandise includes livestock and pet supplies, agricultural and lawn-and-garden equipment, tools, hardware, fencing, workwear, footwear, outdoor power equipment, seasonal goods and home products. Tractor Supply also provides services such as pet and livestock care offerings, equipment-related services and online shopping through its digital channels.

The company traces its origins to 1938, when it began as a mail-order tractor-parts business. In addition to its namesake stores, Tractor Supply operates the Petsense retail brand, which focuses on pet products and services. Through these businesses, the company serves communities throughout the United States, with an emphasis on rural and suburban markets.

Tractor Supply Q3 2021 Earnings Call Transcript

Key Takeaways

• Positive Sentiment: Reported Q3 net sales up 15.8%, comparable store sales +13.1% and diluted EPS +20.4%.
• Positive Sentiment: Raised full-year guidance to ~$12.6 billion in net sales, ~16% comp growth, 10.2–10.3% operating margin and $8.40–$8.50 diluted EPS.
• Positive Sentiment: The e-commerce business grew over 40% year-over-year, with the mobile app surpassing 2 million downloads and now representing over 10% of online sales.
• Positive Sentiment: Supply chain resilience was achieved through dedicated container ships, pop-up DCs, mixing centers and direct-to-store shipments, leaving inventory “in good shape.”
• Negative Sentiment: Inflationary pressures contributed ~700 bps to comps, while gross margin declined ~41 bps amid higher freight, labor and import costs.

Presentation

[Mary Winn Pilkington, SVP of Investor Relations and Public Relations at Tractor Supply]

Thank you, operator. Good morning, everyone. Thanks for taking the time to join us today, and we do hope everyone is staying safe and well. On the call today are Hal Lawton, our CEO, Kurt Barton, our CFO. After our prepared remarks, we will open the call up for your questions. Seth Estep, our EVP and Chief Merchandising Officer, will join us for the question and answer session. Please note that we've made a supplemental slide presentation available on our website to accompany today's earnings release. 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 risk and uncertainty, including the future operating and financial performance of the company. In many cases, these risks and uncertainties are beyond our control.

[Mary Winn Pilkington, SVP of Investor Relations and Public Relations at Tractor Supply]

Although the company believes the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct, and actual results may differ materially from expectations. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included at the end of the press release issued today and in the company's filings with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed. Investors should not assume that statements will remain operative at a later time. Tractor Supply undertakes no obligation to update any information discussed in this call. This morning, we shortened the prepared remarks to allow more time for Q&A.

[Mary Winn Pilkington, SVP of Investor Relations and Public Relations at Tractor Supply]

Given the number of people who want to participate, we respectfully ask that you limit yourself to one question. If you have additional questions, please feel free to get back in the queue. I appreciate your cooperation on this. We will be available after the call for follow-up. Thank you for your time and attention this morning. Now it's my pleasure to turn the call over to Hal.

[Hal Lawton, President and CEO at Tractor Supply]

Thank you, Mary Winn, and thank you to everyone for joining us this morning. The Tractor Supply team delivered strong results for the third quarter, with net sales of 15.8%, comparable store sales increase of 13.1%, and diluted earnings per share of 20.4%. The team is doing an outstanding job navigating a very dynamic and challenging operating environment. We continue to benefit from many market trends that we see as very structurally sound. We have strength in our customer base. We're gaining market share across our categories. We continue to advance our Life Out Here strategy. Our business has never been stronger, and we see tremendous opportunities for growth ahead of us. As we've consistently shared with you over the last 18 months, our strong results are a testament to our 45,000+ team members, and I'd like to thank them for all their efforts in the quarter.

[Hal Lawton, President and CEO at Tractor Supply]

They kept each other safe as we went through another COVID-19 wave and navigated through broad-based supply chain disruptions and cost of goods increases and navigated and managed through a tight labor market. Through it all, they've been resilient and persevere to deliver strong customer satisfaction scores, including all-time high GURA scores. Our team members are our greatest strategic asset and a key competitive differentiator with our customers. Our loyal and highly engaged team members have helped us fare better than most as far as staffing across our stores and DCs. Back in June, we raised our minimum opening wage to $11.25 per hour. Our recent wage actions bring our average hourly wage rate at our stores to nearly $15 per hour as we exit the year, with our DC at a higher rate.

[Hal Lawton, President and CEO at Tractor Supply]

The investments we have made in store labor are being recognized by our customers by the overall customer satisfaction scores that I just mentioned. I'd also like to say thank you to our vendors and supply chain partners as we've worked together to overcome challenges in the global supply chain network. Together, we've been very focused on controlling what we can control to deliver these results. Across our network, we've been nimble and been able to navigate the unprecedented supply chain environment and macro issues, including inflationary pressures. The team has done a great job addressing issues ranging from import container shortages and port delays, driver shortages, higher freight rates, and a multitude of other supply chain constraints. To mitigate these challenges, the team has leveraged dedicated container ships, pop-up DCs, expansion of mixing centers, and direct-to-store shipments.

[Hal Lawton, President and CEO at Tractor Supply]

Despite these challenges, our inventory is in good shape, and our in-stock rates finished above last year at the end of the quarter. Our diversified vendor base, with only about 12% direct import, is a strong point of differentiation for us during these supply chain times. Given our scale and sophistication, we believe that our network is a competitive advantage to being the dependable supplier for the Out Here Lifestyle. Categories in which we participate and the Out Here Lifestyle that we serve continue to have elevated consumer spending levels well above pre-COVID levels. We fully anticipate that the environment we're in is going to continue for the foreseeable future, and consequently, we think that the sales growth that we've seen is structurally sound, given the changes in consumer behavior and the lifestyle investments that are now much more ingrained in the consumer psyche.

[Hal Lawton, President and CEO at Tractor Supply]

These structural trends that continue to work in our favor include things like rural revitalization, trip consolidation, omni-channel adoption, and a self-reliant lifestyle movement, including DIY trends and investments in hobbies like gardening, backyard poultry, and of course, pet ownership. For many workers, the return to office has been pushed out until next year, and even then, we'll very likely be in a hybrid environment at most employers. At this point, our customers will have been ingrained for over two years. As such, we anticipate that their behaviors are much more sustainable and structural. To provide some color on our results, let me share a few other highlights of the third quarter. Like the second quarter, every week had positive comps. Also like the second quarter, our growth was broad-based across regions and product categories. Our e-commerce business continues to experience strong momentum with double-digit sales increases of over 40%.

[Hal Lawton, President and CEO at Tractor Supply]

In just under a year, our mobile app already has more than 2 million downloads and now represents over 10% of our e-commerce sales. We continue to gain share across all categories. This has been a consistent trend for multiple quarters now, and this share gain has been both online and in stores. This share gain has been aided by the increase in our unaided brand awareness, which has improved by 21 percentage points since November of 2019. This improvement, combined with positive trends in our overall customer satisfaction, are significant contributor to the share gains we are experiencing. Also consistent from previous quarters, all customer segments were strong with notable strength in our core farm and ranch, which is the largest and most important of our customer base.

[Hal Lawton, President and CEO at Tractor Supply]

At the same time, our digital ad campaign to target millennials is supporting the significant growth we are seeing in this important demographic. We think the relevancy of Tractor Supply to the millennial customers has staying power given the structural changes in the market and our customer behaviors, and we're certainly seeing that consistently quarter after quarter in our data as our average age of customer trends down. For the year, more customers than ever have shopped at Tractor Supply. These customers are making more trips and are spending more money per trip, and our new customer retention remains very strong. Our Neighbor's Club loyalty program continues to exceed our expectations with year-over-year sales growth of these members north of 20%. We exited the quarter with more than 22 million Neighbor's Club members.

[Hal Lawton, President and CEO at Tractor Supply]

These members are spending more than about 3x the rate of non-members, with Neighbor's Club members now accounting for nearly 70% of our sales. This continues to be a step up from where we've been running prior to the relaunch of the program and sequential improvement over the second quarter of this year. The number of high-value customers in the program grew almost 30% for the quarter, and we continue to experience retention rate in excess of 95% for our high-value customers. These strong results demonstrate that the changes to Neighbor's Club continue to gain traction with our customers. Given our robust performance through the third quarter, along with our outlook for the fourth quarter, we are again raising our sales and earning guidance for 2021, and Kurt will share more details on our improved outlook later in the call.

[Hal Lawton, President and CEO at Tractor Supply]

Regarding our pending acquisition of Orscheln Farm and Home, we continue to work cooperatively with the FTC as it continues to review the proposed transaction. We look forward to the benefits this transaction will offer customers with improved product offering and competitive pricing. As has been the case over the last 18 months, I'm incredibly proud of the way our entire Tractor Supply team has managed to stay focused on taking care of each other and our customers. Our long-term opportunities remain very exciting. Our goal has been to emerge from the pandemic stronger. Over the course of the last one year since rolling out our Life Out Here strategy, we have gotten stronger through this pandemic, and we believe that we're going to emerge from it even stronger and better positioned as we execute our strategy. With that, I'll now turn the call over to Kurt.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Thank you, Hal, and hello to everyone on the call. Once again, our third quarter results demonstrate the strength and resilience of our business and our strategic initiatives. As Hal shared, we continue to believe the underlying health of our business is very strong. Third quarter comp store sales of 13.1%, representing a 39.9% two-year stack, were driven by a comparable average ticket increase of 9.5% and transaction count increase of 3.6%. An example of the structural advantage we have is the ongoing strength in our consumable, usable, and edible products. Our C.U.E. products represent the strength of our core business and what drives trips to the store. Once again, C.U.E. outperformed the chain average comp sales, and for the sixth consecutive quarter in a row, C.U.E. had comp sales growth at or above 15%.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Key subcategories such as poultry, livestock feed, and dry dog food were among the strongest categories, with broad-based strength. Our big-ticket categories would continue to have solid comp store sales performance in line with the chain average. Turn mowers. Inflation contributed about 700 basis points to comparable store sales. As you've heard from the retail sector and others, the cost environment remains elevated across imports, domestic freight, commodities, and labor wages. Our merchant team has been aggressively advocating for our customers where necessary with the cost pressures that we cannot offset. Our merchant and supply chain teams are currently navigating this challenging and disruptive environment extremely well. As we closely monitor our customers' purchasing behaviors, And are committed to being priced right every day. Our third quarter gross margin rate was 36%, a decrease of 41 basis points versus last year.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

For comparison, our gross margin above our Q3 2019 rate of 35%. Year-over-year, the gross margins [audio distortion]. Second, elevated freight costs and import costs, third, a more normalized product mix shift in Q. All of retail is working through the drivers of inflation and freight costs. Offset a significant portion through our price management program. Additionally, we continue in depth of promotions. A low pricing strategy and a continued strong demand for our product categories. The benefit from vendor funding for the field activity support teams for our FAST initiative, which was launched in the second half of last year, was consistent with our guidance. Our third quarter SG&A expense ratio, including depreciation and amortization, improved by 58 basis points versus last year to 26.1%.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

This improvement as a percent of net sales was primarily attributable to good leverage in occupancy and other fixed costs from the increase in our comparable store-- lower COVID-19 pandemic response costs and decreased incentive compensation. Partially offsetting this leverage were higher wage rates, incremental store labor hours to ensure we are providing great customer service, and investments in our Life Out Here strategic initiatives. Given the elevated volumes and current operating environment, we also incurred select discrete costs such as incremental team member benefits, pop-up DCs, and the timing of our annual sales meeting, which normally occurs in the first quarter. The offset to our FAST initiative benefiting gross margin was approximately 20 basis points of incremental SG&A expense for the labor cost for the team, as we are now cycling the initial investment to launch the program last year.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Much like our gross margin rate, our SG&A, Q3 2019. We've had about 70 basis points favorable expense ratio since then. Operating profit increased about 18%, with operating profit margin of nearly 10% in the quarter. Diluted EPS was $1.95, an increase of 20.4% from the third quarter of last year. Our balance sheet remains incredibly strong. At the end of the quarter, our merchandise inventories were $2.2 billion, representing an 11.7% increase year-over-year in average inventory per store. The increase principally reflects growth to support the robust sales trends along with the impact of inflation. Moving now to our updated guidance for fiscal 2021. We continue to operate in a time of heightened uncertainty regarding the pandemic. Despite this uncertainty, including product cost inflation and supply chain constraints, we are raising our full-year outlook.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Our updated guidance reflects the strong results for the first three quarters of the year and the positive and structural momentum we see in our business continuing into the fourth quarter. Against the backdrop of what we know today, we are forecasting fiscal 2021 net sales centered around $12.6 billion with comparable store sales growth of about 16%. For the year, we forecast an operating margin of 10.2%-10.3%, a step up from our prior guidance. Diluted EPS is now forecast in a range of $8.40-$8.50. This compares to our previous earnings range of $7.70-$8 per diluted share. Within this updated guidance, we are forecasting comparable store sales growth for the fourth quarter of 8%-10%. Two modeling points to keep in mind. The prospective acquisition of Orscheln Farm and Home is not included in our guidance.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

As you start to roll forward your models for 2022, please keep in mind that next year will have a 53rd week for us. This week is typically a low-volume week of sales, given that it follows the Christmas holidays. We have a unique opportunity with the positive customer trends and momentum in the business. With that, we are committed to investing in store and supply chain labor as we look to provide a legendary customer experience across all channels. The strength of our balance sheet and the consistency of our free cash flow continue to be a position of strength for Tractor Supply. We remain committed to returning cash to shareholders through the combination of a growing dividend and share repurchases. For 2021, we remain on track for anticipated share repurchases in a range of $750 million-$800 million.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

This year will mark a milestone with approximately $1 billion returned to shareholders through the combination of share repurchases and dividends. In summary, our results prove yet again Tractor Supply's unique competitive advantages. Our relentless focus on being the dependable supplier for the Life Out Here is embedded in our purpose as a company. With that, I'll turn the call back to-

[Hal Lawton, President and CEO at Tractor Supply]

I'll provide updates on our Project Fusion and Side Lot strategic initiatives, and just announced new goals that are the next step in our long-standing commitment to sustainability, stewardship, and opportunity.

[Hal Lawton, President and CEO at Tractor Supply]

By 2040, we are committing to achieve net zero carbon emissions across all our operations. As part of our social commitments, we are prioritizing and accelerating our initiatives and actions for diversity, equity, and inclusion. While we are focused on cultivating an environment of all kinds is appreciated and valued. I invite you to learn more on our dedicated ESG website. Turning next to our Life Out Here strategy. As a reminder, we've been executing against five key strategic initiatives this year as part of our overall strategy. Those initiatives are Neighbor's Club, Digital, FAST, Fusion and Side Lot. The strategy and its initiatives are designed to capitalize on the attractive opportunity that we see in our nearly $110 billion total addressable market. Our Project Fusion and Side Lot model transformations represent significant investments in our stores.

[Hal Lawton, President and CEO at Tractor Supply]

These store-level investments are designed to grow our market share and drive the productivity of both existing and new stores as part of our Life Out Here strategy. Let's start with our Project Fusion store remodel program. As a quick reminder, Project Fusion is our state-of-the-art space productivity program designed to enhance the customer experience in our mature store base and give customers that may not have shopped with us in the past more reasons to shop. We anticipate having about 15% of our total store base in the new Fusion layout by year-end. We've reduced the time to complete Fusion remodels by 50% since the beginning of the year, and in turn allowing us to minimize the disruption to the store operations and our customers' shopping experience. Our customers are taking note of the improved layout, the ease of shopping, and our new product offerings.

[Hal Lawton, President and CEO at Tractor Supply]

Specifically, in our customer intercept surveys, they call out better organization, improved merchandise selection, cleaner and brighter aisles, and easier-to-navigate layouts. Categories seeing the strongest lift in sales include areas like apparel, companion animal, and power tools. Given the size of our store base, this is a multi-year opportunity to continually refresh our store base and further drive comp sales through productivity. Another significant component of our space productivity efforts is the transformation of our Side Lot. Again, as a reminder, typically there's as much space outside of our stores in the Side Lot as we have on the inside of our store. The productivity of this space is substantially below the chain average. We're in the midst of a multi-year project to transform our Side Lot with an expanded product offering and an enhanced shopping experience.

[Hal Lawton, President and CEO at Tractor Supply]

With this investment, the Side Lot space is leveraged to offer a wider product offering in the lawn and garden categories, enter new categories with a garden center, and offer greater convenience through the expansion of our Buy Online Pickup in Store capabilities for drive-through pickup. In select locations that meet sales volume thresholds, we're also adding a feed room to help deliver the bagged feed demand. As a reminder, we're the largest seller of bagged feed in the country. We also continue to see a positive halo of product categories increase ease of shopping and new service. We need to keep our existing customers engaged, attract new customers also to the higher sales per square foot through the transformation of our Side Lot space remains a significant opportunity. We anticipate having about 150 Side Lots complete across the chain as we exit 2021.

[Hal Lawton, President and CEO at Tractor Supply]

In these early remodels, we're learning a great deal about our customers' appetite for an expanded lawn and garden assortment. We're even more excited than pilots late last year. We continue to reduce the project timeline also here by about 50% and minimizing the disruption to our customers and store teams as we implement our findings from our test-and-learn process. While still early on, we are very positive about the continued very challenging in the current macro environment. We're making progress in our ability to significantly reduce construction costs, the construction time, and the corresponding disruption at the store site. While the majority of the remodels have been completed more recently, we are very pleased with the early read on sales lifts.

[Hal Lawton, President and CEO at Tractor Supply]

Post the disruption period, we're seeing lifts of low single digits for Fusion remodels and mid-single digits for combo stores, which have both Fusion and Side Lot remodels. We expect continued improvements in these results, which is on track for the expectations we had as we began these projects. Over the course of the last year, the team has done a great job operating the business, gaining unprecedented challenges, and also executing our transformational initiatives to support our Life Out Here strategy. To wrap up, our results clearly underscore that our strategies are working, that the team is navigating the challenges effectively, and that we're emerging from the pandemic stronger than before. We're extremely optimistic about our future.

[Hal Lawton, President and CEO at Tractor Supply]

As we enter one of the busiest periods in retail, my thanks and sincere appreciation go out to each of the more than 45,000 Tractor Supply team members for their dedication and commitment to our mission and values. With that operator, we would like to open the lines for questions.

[Operator]

The first question is from the line of Oliver Wintermantel with Evercore ISI. Thank you. You may proceed.

[Oliver Wintermantel, Analyst at Evercore ISI]

Hal, you mentioned a lot about the structural changes within the business. My question is regarding gross margins. I think you said it's 100 basis points higher than before the pandemic in 2019. I was wondering if you have early indications of what you think is in gross margin structural, maybe give back when promotions come back on and maybe the comp decelerates from the very strong 40% to your comps? Thank you.

[Hal Lawton, President and CEO at Tractor Supply]

Hey, Oliver, good morning. Thanks for joining our call. Yeah, on gross margins, we're very pleased both with our short-term results, kind of this past quarter on gross margin. Also very optimistic about the long-term nature of our gross margins. On the short-term, we've had significant amount of cost coming through our business, whether that's in cost of goods as it relates to raw materials and commodity-based goods. Also vendors passing along costs related to labor and freight. We've also seen freight costs increase as well, as well as the cost related to imports. The team's done an excellent job navigating those costs, finding offsets, productivity measures, really being the advocate for the customer, to keep prices as low as possible.

[Hal Lawton, President and CEO at Tractor Supply]

That said, as Kurt mentioned, we did have inflations of 2%-7% in the quarter, which helped us offset a lot of those costs and deliver the gross margin results that we did in the quarter, which sequentially from a GAAP to last year improved from Q2. Long term, as we've talked about on several of our calls, the question's really around the promotional intensity and the clearance intensity in the business. Those two remain at the same levels as they have over the last six quarters. Very low. We remain very focused on everyday low price. We remain very focused on delivering value every single day to our customers. We see it playing out that way for the plans for significant promotional intensity in Q4. We think that we'll remain in a very supply constrained environment as we move into the first half of next year.

[Hal Lawton, President and CEO at Tractor Supply]

That too will continue to limit any sort of promotional intensity in the market. A couple of years in now with minimal promotional intensity, I think that bodes well for being able to maintain kind of a low promotional kind of structure going forward. As I said, again, we're very pleased with our short term gross margin results and also very optimistic about the structural nature of our long term gross margin.

[Oliver Wintermantel, Analyst at Evercore ISI]

Thanks very much. Good luck.

[Operator]

Thank you.

[Analyst]

Hi. Thanks very much. Based on all those comments that you just provided, Hal, the question would be on obviously the longer trending well above that, wondering if you could maybe just give a little color on how you think about long term broadly versus the prior 9.5%, because that just obviously isn't really realistic at this point.

[Hal Lawton, President and CEO at Tractor Supply]

Good morning, and thanks for joining the call. We see significant growth opportunities ahead in our business. $110 billion total addressable market. Super excited about our Life Out Here strategy and the runway ahead there. We're investing in that strategy to ensure we capture sustainable market share. To your point, acknowledge that absent the write-down on Petsense, that we did a 10.1% op profit in 2020 and our guidance for 2021 here at 10.2%-10.3%, that both of those exceed our long term targets. We certainly don't want to get ahead of ourselves here in the third quarter. What we commented on is that we're in the midst of our annual planning for 2022. At the same time, we're also just always looking at our long term targets. It's very natural for us to be reviewing that over the next few months.

[Hal Lawton, President and CEO at Tractor Supply]

When we have more news on that, we'll certainly let folks know. Again, I think we're in a period where there's a significant amount of opportunity ahead. We're very pleased with the results we put up this quarter, the outlook we have for the balance of the year, and also excited about the long term opportunity that we still see out there in our $110 billion market as we're gaining significant share in it. The team's just executing on all cylinders right now.

[Operator]

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

[Brian Nagel, Analyst at Oppenheimer]

Hi, good morning. Congrats on another great quarter. I think my question may be a bit repetitive here to the prior two. The question I have is, Hal, you mentioned structural a lot in your prepared comments. From the demand side, clearly demand at Tractor now the last several quarters has been outstanding. There's still this very odd, unique dynamic within the rural consumer environment. I guess the question I have is, what are you seeing in your business, how your consumers are performing that gives you greater confidence that there is a structural shift in demand trends that will persist once the COVID crisis is completely behind us?

[Hal Lawton, President and CEO at Tractor Supply]

Yeah. Hey, Brian. I'd point to three things in our business. First off, I'd talk about just kind of broad macro trends. Second thing I'll talk about is the consistency of our business, and the third I'll talk about is share gains. In the broad macro trends, all the trends that we saw in Q2 of last year really have all sustained themselves. I think there are certain retailers and other businesses that waned. I think that's not been the case for us, whether it's things like rural revitalization, which is a bit more of a permanent, or whether it's things like pet ownership and adoption, again, permanent in more so in nature. Whether it's homesteading, just this self-reliance mentality. We're seeing those as more permanent behaviors.

[Hal Lawton, President and CEO at Tractor Supply]

Really no matter what data set you look at, whether it's home purchases, whether it's mobility, whether it's pet ownership, any sort of qualitative data on where people are spending their money, they all reinforce the structural nature of those trends. The second thing I'd point to is the consistency, as I mentioned. Our business has been remarkably consistent month to month, week to week, by category and by region. That's been regardless of whether or not we've been in COVID surges or whether or not certain states have been more in lockdown or less in lockdown. That, I think just again, speaks to the structural orientation. Lastly, we're gaining significant share, really in almost every category in our business. We're seeing that share gain in our core customers who have long shopped us.

[Hal Lawton, President and CEO at Tractor Supply]

As they come to us now with the confidence that we're in stock with the right level of customer service and at the right price. Also new customers who are finding the lifestyle that we serve to be I'd point to those three things that give us real confidence in the structural orientation of our business. As I said, I think there's a set of COVID winners that were early on that have seen some of that wane. There's another set that are seeing it much more structural and sustained, and I'd very much put us at the top of that second camp.

[Brian Nagel, Analyst at Oppenheimer]

Yeah, that's very helpful. I appreciate it. Congrats again. Thank you.

[Operator]

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

[Peter Keith, Analyst at Piper Sandler]

Hi, thanks. Good morning. Great results, everyone. Looking forward to the next couple of months and with the winter here, looks like we're gonna be seeing kind of record energy prices, home heating. Thinking back to 10, 12 years ago, with some of the heating exposure you guys have, there sometimes can be a nice benefit for Tractor. I guess the question is, on a net basis, how do you feel about this elevated heating cost that we're gonna see this winter? Is it actually maybe elevating costs for your core consumer?

[Seth Estep, EVP and Chief Merchandising Officer at Tractor Supply]

Hey, Peter. This is Seth. Thanks for joining the call. When we look ahead over the next couple months, just a little bit more broadly, other than just outside of kind of the energy Hal just discussed, I'd love to just highlight a couple things that we look to see to drive our business over this holiday season and then to maximize and capitalize on that opportunity. When we think about that, we are really excited about how the team executed our portfolio strategy, leveraging the FAST team sets throughout the year, not just call it pre-holiday, but continuously as we go through the quarter. For holiday, specifically, we are really excited about the momentum we're seeing core customers that are coming to us for categories more broadly than maybe they have in the past, things like apparel and footwear.

[Seth Estep, EVP and Chief Merchandising Officer at Tractor Supply]

We're seeing expansions like in key brands that consumers are really resonating with. Own brand like Ridgecut, where we're expanding into the women's lineup. Weren't in the past where we can continue to drive market share in those categories. We're also seeing that with that rural revitalization, consumers coming to us for outdoor activities even here in the fall. Things like

[Seth Estep, EVP and Chief Merchandising Officer at Tractor Supply]

Even like wildlife and UTVs driving that demand. We're still seeing strength across the board there. Then we're going to continue to focus on our C.U.E. activity, where customers are coming to us for footsteps. With the record number of pet adoptions over the last few years, we continue to be extremely excited about the momentum that we have in our pet business holistically, as well as the C.U.E. business. We're going to be looking to drive that throughout the whole holiday season. I know it's a little bit broader than just the energy market question there as well, but also, where we see it as we're coming through, we're seeing activity across our consumer base be very consistent with what we've seen over the last few quarters.

[Seth Estep, EVP and Chief Merchandising Officer at Tractor Supply]

They're really resonating with the new items, the new categories as well as the new partnerships that we're continuing to establish.

[Peter Keith, Analyst at Piper Sandler]

Okay. Thank you very much, Seth.

[Operator]

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

[Kate McShane, Analyst at Goldman Sachs]

Hi, good morning. Thanks for taking our question. I just wanted to go back to inflation for one minute. I wondered if you could talk to us about how much inflation you are expecting for the fourth quarter. When it comes to the pricing actions that you took, was it across most of the store or in certain categories? When do you expect, or what has been the reaction from an elasticity standpoint?

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Kate, hey, this is Kurt. Good morning, and good morning to everybody. On the inflation side of it, as Hal mentioned, on the top side, there was 700 basis points of inflation benefit on the business. We saw at that or slightly higher cost pressures in Q3. As we look ahead to Q4, we exited Q3 and into Q4 with continued levels of inflation, moderating at the levels compared to what we saw coming out of Q2 into Q3. There continues to be some levels of inflation that's factored into our guidance. In regards to how we handle that, it really is more of a portfolio approach. We take a look at where those costs are contributing, both in transportation and product costs, and we look at our portfolio.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Seth and the merchant team manages the shopping patterns from the customers, as well as making sure that in key traffic driving areas, we've got great everyday low pricing. We leverage our pricing tools really well and make sure that from the portfolio standpoint, that we can balance from a retail side, as well as what we can do to leverage the strength of our mature supply chain to keep costs as low as possible. Again, our team has just managed through this great. Our forecast and our guidance for Q4 expects that they're able to manage that in a similar pattern.

[Kate McShane, Analyst at Goldman Sachs]

Thank you.

[Operator]

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

[Michael Lasser, Analyst at UBS]

Good morning. Thanks a lot for taking my question. Kurt, can you just clarify what you intended to say with the response to that last question in terms of the inflation contribution moderated relative to the 700 basis points, or in the inflation contribution that you're expecting in 4Q moderated relative to the 350 basis points-400 basis points? Hopefully that wasn't my question because it was just a little confusing how that was answered. My question really is, moving forward, do you still need a 3% comp or so to lever your expenses? In your prepared remarks, you noted that SG&A has levered 70 basis points relative to 2019, and given the sheer magnitude of the volume increase your stores have had, there would be some opportunity to rightsize or manage your cost structure such that you might be able to lever on a more moderate comp moving forward.

[Michael Lasser, Analyst at UBS]

Thank you.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Yeah, Michael, I'll hit the two questions. In response to clarification on Kate's question. For Q4, the inflation pressures in the business will be fairly similar to what we described and saw in Q3. Flattish to potentially slightly up, in regards to Q4. To your point, right now we're seeing really strong momentum in the business, and that does elevate our ability to leverage on the cost. We're also using that to the point that Hal made and that I made in our prepared remarks, that we definitely see this as a tremendous opportunity. We're investing from a position of strength.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Our continued outlook about managing SG&A to flattish over time will still be our outlook and the way we're managing this business. Great opportunity to just continue to gain market share and drive traffic into the stores.

[Michael Lasser, Analyst at UBS]

Thank you very much.

[Operator]

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

[Mary Winn Pilkington, SVP of Investor Relations and Public Relations at Tractor Supply]

Operator, we can just move on to the next question if Chris isn't on.

[Chris Horvers, Analyst at JPMorgan]

Hello?

[Mary Winn Pilkington, SVP of Investor Relations and Public Relations at Tractor Supply]

Hey, there you are.

[Chris Horvers, Analyst at JPMorgan]

Thank you, Mary Winn.

[Mary Winn Pilkington, SVP of Investor Relations and Public Relations at Tractor Supply]

Hey, Chris. Sure thing.

[Chris Horvers, Analyst at JPMorgan]

Seth, with your commentary around 4Q, obviously soft lines, a lot of Asian sourcing, I'm guessing the heating business and OPE. It sounds like you're feeling good from an in-stock level there. Is that accurate? How are you thinking about next spring? At this point, you're probably making orders for that. Will you be ordering up for next spring?

[Seth Estep, EVP and Chief Merchandising Officer at Tractor Supply]

Hey, Chris. Yeah. We always want more, but we're satisfied with where we are right now. As we've managed through the supply chain. As we've managed through this throughout the course of the whole year, we've looked at every piece of our process. We're giving earlier forecasts. We're working with our overseas factories to give commitments than we have historically, so that we can properly plan with them, plan through the supply chain, look for alternative ways to source product where need be to make sure that we can have product hit shelf. We'll be able to take it when we can get it even earlier than we have in the past as well, so that we can be locked and loaded and ready for the spring business.

[Seth Estep, EVP and Chief Merchandising Officer at Tractor Supply]

Really feel good about the across with our supplier base, this global supply chain challenge that's been out there.

[Chris Horvers, Analyst at JPMorgan]

Got it. Thank you.

[Seth Estep, EVP and Chief Merchandising Officer at Tractor Supply]

Yeah.

[Operator]

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

[Peter Benedict, Analyst at Baird]

Hi, guys. Thanks for taking the question. I guess back onto the expense stuff. The investments you guys are making, obviously the CapEx has been up some, and how we were thinking about that. Kurt, it would seem this year is probably up 25% year-over-year. Maybe it's $270 million of D&A. How do we think about that as you kind of pencil through 2022? How should we think about that? That's my question. Thank you.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

For this year, the depreciation growth year-over-year, throughout the quarters, mid to high 20% growth rate is very much in line with our expectations. The investments we've made this year, the incremental ones, principally with the new distribution center build. Side Lot remodel has us right where we expected to be on depreciation. For 2022, at this point with our plan, we would expect very much similar, in the low 20% growth rate, likely. That's very much what we framed out when we launched the Life Out Here strategy.

[Peter Benedict, Analyst at Baird]

Okay, got you. Thanks so much, Kurt.

[Operator]

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

[Simeon Gutman, Analyst at Morgan Stanley]

Hey, everyone. Good morning. Hal and Kurt, maybe I'll take another stab at the longer-term margin question. I think the math would suggest that your business could be running above that level. The question is, philosophically, do you let it run above that level? Hal, in that regard, are there things along the Out Here strategy that you can accelerate? Are there price investments that you would think about? Are there any other reinvestments that second or third layers of the plan where you could lean in? Curious how you think about that.

[Hal Lawton, President and CEO at Tractor Supply]

Hey, Simeon. Good to talk with you this morning and thanks for joining us. I'd say first off, we see sizable opportunity ahead in our market. For those who've followed us for a long period of time, it's a very attractive market. It's one that's very fragmented. One where we're very well sized and relationships that we have historically. We think that there's significant further opportunity as we look out to continue to grow in an outsized way and take share. We're committed to going after that share and continuing to grow. That said, would acknowledge two straight years of performance above 10% op margin. That's above our long-term guidance. As we go through our 2022 annual planning process, that'll help us really think through our long-term guidance and the relevance of that as we look forward. For right now, it is our long-term guidance.

[Hal Lawton, President and CEO at Tractor Supply]

What I would say is, as it relates to investments, we're very bullish on our investments. We're very focused on excellent capital allocation. We're seeing the results of our investments in the business. As we shared today, the Fusion stores and the Side Lot stores are performing very well. As they mature and begin to normalize, we're seeing the results right in line with what our expected business model and business plan for them were. That said, also our business continues to grow at an outsized rate, that gives us an opportunity to leverage and scale on our business in a way that we didn't fully anticipate last year at this time. I think as we see how that continues to evolve into early next year, you can expect to hear more from us on that.

[Hal Lawton, President and CEO at Tractor Supply]

Again, we remain very bullish on our opportunity, very pleased with our business. It's never been stronger. We're excited about both the short-term and long-term potential inside of it.

[Operator]

Zachary Fadem with Wells Fargo, you may proceed.

[Zachary Fadem, Analyst at Wells Fargo]

Good morning. Kurt, first of all, can you talk through the lingering impact of some of these items? As we look to 2022, you mentioned an uptick in strategic spend. Is there any detail you can provide there? Separately on the 20% D&A growth, is that with or without Orscheln?

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Yeah, Zach, this is Kurt. A number of things in there. Let me just try to package that in this. One, I'll hit the last one first. Orscheln's not considered in any of the numbers of the guidance that we've given. In regards to the depreciation, the expense structure. COVID expenses have been elevated from the level that we entered the year into, just because the pandemic with the Delta variant and others have lingered. They're at quarters last year. Having our team members. The incentive comp with the outperformance this year, while at lower levels than last year, continue to be above target. As you think about going forward, those are in future years, those are leverage points. If, like in this year, while there's incentive comp above target, the performance gives leverage above and beyond the average this year.

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Next year, those will be favorable items to compare against. The depreciation expense as I mentioned earlier, the growth rate that I quoted and referring to is very much in line with what we expected in our long range plan when we launched the Life Out Here strategy and talked about a three to five-year plan. With the elevated sales, we feel very comfortable with a 20% growth rate in depreciation because that's where those investments are at. Does not include Orscheln. Again, we're very comfortable with the management we've got and what we have visibility on our expenses for the fourth quarter and even the near term beyond that.

[Zachary Fadem, Analyst at Wells Fargo]

Got it. Thanks, Kurt. What about the strategic side?

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

The strategic initiatives that we've had, we haven't really specifically mentioned what we strategy on technology, digital continue to execute the plan. Maybe just clarify what you're referring there.

[Zachary Fadem, Analyst at Wells Fargo]

You mentioned you were going to continue 2022, so I was just curious if there was an uptick in strategic spend that we should anticipate?

[Kurt Barton, EVP, CFO, and Treasurer at Tractor Supply]

Got you, Zach. No, it's very much in line with what we said that our capital expenditures over the next few years, we anticipate those still to be in that $450-$550. Some years could be higher because of launching of distribution centers. The level of investment in the business is consistent with what we expected.

[Zachary Fadem, Analyst at Wells Fargo]

Got it. Appreciate the time today.

[Operator]

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

[Seth Basham, Analyst at Wedbush]

Thanks a lot. Good morning. My question is just a clarification in terms of comp lift following the Fusion and Side Lot rollout. I think you said you're seeing low single digits of Fusion and mid in the stores that have been completed. Your plan is for a full first year lift of mid-single digits. Is that correct?

[Hal Lawton, President and CEO at Tractor Supply]

Hey, good morning. It is accurate. The add that I'd make to that is just as is typical with a store remodel, there's a little bit of disruption. There's disruption that happens during the remodel. Particularly with the current supply chain environment, there's a little disruption that's occurring still even after the remodel as some kind of fixtures and other types of things come in sometimes a little late. Then we start to see the lift happen as customers get used to shopping the new layout and find the new categories and the new brands and the new remodel. What we're seeing is kind of what we would expect, which is kind of every week, every month that goes by post the re-grand opening of the remodel, that the performance of the store continues to improve.

[Hal Lawton, President and CEO at Tractor Supply]

That's the case with both combo stores and the Fusion remodels. The adder that I would make to that is as it relates to the Side Lot with the garden center, we have a couple of stores that went through kind of year two of spring. We saw kind of outsized gains in those, which is in line again with our expectation that we would see more of a maturity curve with the garden center than we would with the inside of the store Fusion remodel. We expect and what we're seeing in the Fusion remodel is more of an immediate impact with kind of the maturity curve being more of a three, four, five, six-month maturity curve. Whereas with the garden center, we're seeing a nice, strong, immediate impact. Then we're also seeing kind of 12, 18 months kind of continuation of that maturity curve.

[Hal Lawton, President and CEO at Tractor Supply]

Yeah, the results are very much in line, nice positive lift already, even a few months into each of the remodels. Then we see even continued lift as we complete year one of those remodels, whether it's Fusion or the combo.

[Seth Basham, Analyst at Wedbush]

That's helpful. Just a point for clarification. When do you start measuring since the disruption period ends?

[Hal Lawton, President and CEO at Tractor Supply]

We start measuring lift the day of the re-grand opening. Not to get too tactical, but there's a sign-off that the store manager and the project manager and the construction manager do on the is complete. The re-grand opening happens reasonably quickly after that, one week, two weeks kind of thing. Then we start measuring the lift from that re-grand opening.

[Seth Basham, Analyst at Wedbush]

Thank you.

[Operator]

The next question, Chuck Grom from Gordon Haskett, you may proceed.

[Chuck Grom, Analyst at Gordon Haskett]

Hey, thank you. Good morning. Great quarter. Curious what's been the biggest areas of what have you learned in the class of 2021 Side Lots that you would look to apply to future store efforts? Any sense for where you think the productivity longer term could be relative to your in-store productivity?

[Hal Lawton, President and CEO at Tractor Supply]

Hey, Chuck, thanks for joining the call today. I'll hit kind of three things on Side Lot, and then I'll just briefly touch base on Fusion productivity. Side Lot, the three things I'll talk about is the Garden Center, I'll talk about BOPIS, and then I'll talk about our feed rooms. First on the Garden Center, our customers' key data set is that the category that we least address is live goods. That's really what the Garden Center strategy is all about, is creating another C.U.E. destination category in our, but we're seeing that in our results. I'd say we're more excited now adding to our fleet to Garden Center than we were even this time last year. The behavior we're seeing our customers is exactly what you'd expect. It's a little less around beautification than store in terms of the core product.

[Hal Lawton, President and CEO at Tractor Supply]

Shrubs and trees speak to Life Out Here, whether it's the gardening you do in your backyard or whether it's the shrubs and the trees you're planting along your fence line and in your land. We have significant convenience kind of advantages for our customers from a location perspective. The Garden Centers are performing very well and we're just getting started both on the build-out of those, obviously, but also with our relationships with our live goods vendors and the assortments, tailoring it by store. The second thing is on BOPIS drive-through. We're seeing incredibly high levels of drive-through behavior from our customers. We're seeing in some of our stores that have been open for four, five, six, eight months now, we're seeing 50%, 60%, 75% of the Buy Online Pickup in Store being drive-through.

[Hal Lawton, President and CEO at Tractor Supply]

Just that extra convenience factor you're seeing with customers, that's driving repeat behavior. Really pleased with how that's evolving and the behavior we're seeing from our customers is consistent with what the feature was when we rolled it out. Lastly is the feed room. We are the largest seller of bagged feed in the country. If you think about our average store volumes and the growth we've seen in those store volumes, combined with the outsized performance in C.U.E., that's put a lot of stress on our stores as it relates to the receipt of bagged goods, getting it out onto the store, staying in stock for our customers, being able to get that onto customers' trucks and get them on their way.

[Hal Lawton, President and CEO at Tractor Supply]

The feed rooms have provided valuable capacity and also allowed us to effectively, from a cost perspective, serve that customer because we're not touching the bags two and three, four times. We're able to leverage our mixing centers in a way that they're designed now. All three of those things are really coming together. We're seeing excellent performance across all three, exactly as we designed them and built them, and we're continuing to use our test and learn to tweak it along the way. As you think about our productivity as we move forward, we're still committed to our comps kind of outpacing overall retail and outpacing the Life Out Here market that we define as that $110 billion market. You can expect continued productivity improvements on our same store sales in an outsized way as we move forward.

[Hal Lawton, President and CEO at Tractor Supply]

Even in spite of six consecutive quarters now with double-digit comps, we still have that expectation moving forward. One other thing, just while I've got the mic here, so to speak, I'd like to just step back and reference, there's a bit about kind of our long-term op margin leverage, as Kurt was talking about. What I'd say is, if you look at our long-term guidance, because there are several questions on this topic, our long-term guidance that we announced last year had 6%-7% sales growth and 8%-10% earnings per diluted share, which implies continued leverage on the business as we move forward. We admit we're not in a state of normalcy right now, obviously, with our comps being the sixth consecutive quarters of double-digit growth. What I would say, the spirit of the continued leverage you are seeing in our results.

[Hal Lawton, President and CEO at Tractor Supply]

That is the expectation we have of our business, whether we're seeing outsized costs from labor and outsized costs from freight and cost of goods, or whether that's in a more normal environment. We're holding ourselves accountable to executing in that way, regardless of the environment that we're in. Just wanted to clarify that. I think Kurt's point around 3% comp and whether that's a point of leverage is still accurate in a normal environment. We still, even in a kind of "non-normal environment," still accept that same challenge.

[Mary Winn Pilkington, SVP of Investor Relations and Public Relations at Tractor Supply]

Great. Thanks, Hal. Operator, that will conclude our call today. I really appreciate everybody's cooperation that allowed us to get through a lot more questions. Thank you all. Look forward to speaking to you in January on our fourth quarter earnings call, and Marianne and I will be around this afternoon for any questions. Thank you all for your cooperation. Have a great day.

Participants

Executives

• Hal Lawton, President and CEO
• Kurt Barton, EVP, CFO, and Treasurer
• Mary Winn Pilkington, SVP of Investor Relations and Public Relations
• Seth Estep, EVP and Chief Merchandising Officer

Analysts

• Brian Nagel, Analyst at Oppenheimer
• Chris Horvers, Analyst at JPMorgan
• Chuck Grom, Analyst at Gordon Haskett
• Kate McShane, Analyst at Goldman Sachs
• Michael Lasser, Analyst at UBS
• Oliver Wintermantel, Analyst at Evercore ISI
• Peter Benedict, Analyst at Baird
• Peter Keith, Analyst at Piper Sandler
• Seth Basham, Analyst at Wedbush
• Simeon Gutman, Analyst at Morgan Stanley
• Zachary Fadem, Analyst at Wells Fargo
• Analyst