Tractor Supply Company

Good morning, ladies and gentlemen, and welcome to Tractor Supply Company's conference call to discuss fourth quarter and fiscal year 2022 results. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. We ask that all participants limit themselves to one question and return to the queue for additional questions. Please be advised that reproduction of this call in whole or in part is not permitted without written authorization of Tractor Supply Company. And as a reminder, this call is being recorded. The host for today's call is Mrs. Mary Wynn Pilkington, Senior Vice President of Investor and Public Relations for Tractor Supply Company. Now, first up is a year-end video.

Thank you. Thank you.

Mary Wynn, I will now pass the call back to you.

Thank you, Operator. Good morning, everyone, and thanks for joining us. I hope you enjoyed watching the video of Tractor Supplies Year in Review. On the call today are Hal Lawton, our CEO, and Kurt Barton, our CFO. After our prepared remarks, we'll 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 available a supplemental slide presentation 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 risk and uncertainty, 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 silence with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed, Investors should not assume that statements will remain operative at a later time. Tractor Supply undertakes no obligation to update any information discussed in this call. Given the number of people who want to participate, we respectfully ask that you limit yourself to one question. If you have additional questions, please feel free to get back in the queue. I appreciate your cooperation. We will be available after the call for follow-up. Thank you for your time and attention this morning. Now it's my pleasure to turn the call over to Hal.

Thanks, Mary Wynn, and good morning, everyone, and thank you for joining our call this morning. I think the opening video was a great recap of the highlights of a record year for Tractor Supply. Your end is when we reflect on our accomplishments, and I'm pleased to share the results from the team in 2022. We had sales growth of 11.6% and diluted earnings per share growth of almost 13%, and this is on top of a record performance in 2021. We had solid market share gains across all our product categories, and these gains continue to contribute materially to our sales growth. At Tractor Supply, it all starts with the team. And my sincere thanks and appreciation goes out to the more than 50,000 team members of Tractor Supply who work diligently every day to live our mission and values. Regardless of the operating challenges throughout the year, and really over the last three years since we entered the pandemic, The team has delivered impressive results while also making significant progress on our life out here strategy. I commend and thank the team for stepping up to every challenge that has come at us over this time period. Our team plus our business model are the reasons why we have a record of consistent and stable growth across all economic environments. With this year's results, we've now posted three consecutive years of exceptional sales growth. The highlight of this phenomenal track record continues to be the consistency of our results and the broad-based strength of our performance. Including new stores in the 53rd week, our revenue on a three-year basis has increased about 70%, with a three-year comp stack of 46.5%. Over the same period of time, we've invested nearly $1.7 billion in our stores, distribution centers, technology, and other strategic initiatives as part of our life out here strategy. We also have significantly improved our operating capabilities, including relaunching our neighbors club program, creating our field activity support team, expanding our mobile footprint, and delivering on the increased volume of our consumable, usable, and edible products. We've remained focused on introducing new capabilities, improving the shopping journey, and ensuring we have scalable platforms. all with the underlying goal to be the dependable supplier that our customers count on. As a company, we hit several significant billion-dollar milestones in 2022. We grew our sales to a record $14.2 billion, increased net income to over a billion dollars, achieved $1 billion in private label credit card sales, and returned more than $1 billion in capital to shareholders for the second consecutive year. This culminated with diluted earnings per share of $9.71. Now turning to our fourth quarter and fiscal 2022 performance, our business continues to be incredibly resilient and the quarter unfolded much like we anticipated, albeit comp sales performance was stronger than forecast as the late December winter storm provided a comp sales lift of approximately two percentage points. Excluding the impact of the winter storm, Importantly, our underlying results were in line with the high end of our expectations for the quarter. Now let's go through some of the highlights for the quarter and the fiscal year. For the fourth quarter, our comparable store sales growth was 8.6%, and it was driven by strong ticket growth of 6.3% and transaction count increase of plus 2.3%. And importantly, even without the winter storm benefit, our comp transactions would have been positive for the quarter. All months of the quarter, comps positive. October and December were our strongest comp sales months. Both two- and three-year comp stacks were relatively consistent across the quarter. On e-commerce, it achieved mid-single-digit positive sales growth, and we continued to build on our one-tractor capabilities. As of year end, The Tractor Supply app has had over 4.4 million downloads since it was launched mid-2020. For the seventh consecutive quarter, we continue to see our consumable, usable, and edible products outperform our overall comp sales results. And this is the fourth consecutive quarter for Q to run at about three times the rate of overall comp sales growth. This strong performance was driven by dry dog food, as well as fee for poultry, equine, and wild birds. As we've talked about many times, Q is one of our structural advantages, and the products represent the strength of our core business, and they're what drive trips to our stores. Our outperformance in year-round categories offset the declines in big-ticket categories, and we continue to gain share across our categories, both online and in-store. Shifting down to neighbor's clubs, Our Neighbors Club membership exceeded 28 million members and represented nearly 75% of our sales for the year. Neighbors Club is successfully helping us migrate customers to a higher threshold of spending with us. During the quarter, we reached a new record in the number of high value customers. Overall, our best customers are shopping with us more frequently and spending more money per transaction. On PetSense, The rebranding of PetSense to PetSense by Tractor Supply, along with our expansion of our Neighbors Club program to PetSense by Tractor Supply, is really resonating with our customers. This expansion is allowing us to deepen relationships with existing customers in our enterprise and help attract new pet customers to both brands. Our customers' response to these initiatives is very encouraging, with Neighbors Club membership already representing nearly 50% of sales at PetSense. During the quarter, we launched Tractor Supply Visa Credit Card. This new co-brand credit card allows our customers to earn more on their everyday purchases, both in-store and anywhere Visa is accepted. This marks exciting progress on our journey to drive sales, build loyalty, and reduce tender expense through our credit offerings. And as I mentioned earlier, this past year, we crossed over a billion dollars in private label credit card sales. For the fourth consecutive quarter, Our overall customer satisfaction score hit a new all-time high as we continue to invest in our team to provide best-in-class customer service. Our team continued to make advancements in our supply chain through the expansion of our mixing centers to a total now of 15, as well as the grand opening of our ninth distribution center just last week. During the quarter, we also broke ground on our 10th distribution center in Maumelle, Arkansas, to support for the higher volumes of our existing stores that continue to build out of our new stores, as well as the acquisition of Orchland. Our supply chain continues to be a competitive advantage for us. In 2022, we moved more than 8 billion pounds of consumable, usable, and edible product through our supply chain, as we are the world's largest seller of bag feed and food for livestock and companion animals. Our scale and reach provide us with a cost to serve that is lower than our competition. We continue to advance on our commitment to be stewards of life out here. We're making progress on our absolute carbon reduction goals to further reduce emissions from our operations by 20% by 2025 and by 50% by 2030 from our 2020 baseline. We are committed to achieving net zero emissions across all operations by 2040. Additionally, in 2022 of April, we announced an ambitious three-year water conservation goal to conserve 25 million gallons of water by 2025. These commitments to the climate and society reinforce our vision that a healthy environment, properly managed resources, and vibrant communities are key to secure and prosperous future for life out here. As a result, our efforts to enhance our sustainable business practices have been recognized by various third parties. We now have nearly 30% of our store base that are in our project fusion layout, and our garden center build-out is now active in over 300 locations. With nearly 1,800 team members, our field activity support team has made powerful contributions to our in-stock performance and execution of our sales driving initiatives. We continue to be pleased with the strategic benefits and financial returns of these store-level investments. This was the year that we made significant progress on our life out here strategy. And building on our performance for 2022, our outlook for 2023 is right in line with our long-term guidance. And Kurt will share more details on our outlook, as well as more details on our performance in 2022 in just a moment. Now shifting a bit to 2023. As we plan for the year, we anticipate continuing to operate in an ever-challenging and changing macro environment. Our operating assumption is that the economy in the near to medium term will remain resilient with flat to modestly positive real growth. Wages are increasing, and consumers continue to tap pent-up savings to support spending. We expect consumers will continue to be judicious in their spend but resilient while prioritizing needs over discretionary. We believe inflation has peaked but will remain sticky as we move through the year. It is our view that an orderly loosening of the labor market will be a key determiner of the country's ability to return our economy to sustainable conditions in the second half and 2024. The effects of secondary markets on our consumer spending in areas such as housing, agriculture, and oil markets are expected to be collectively neutral and individually modest. Whatever economic environment plays out this year, or any year for that matter, we're confident that our business will remain resilient and build on our strong track record of consistent and stable growth across all economic environments. Tractor Supply is a unique, highly differentiated retailer. We are the leader in a large fragmented market. We're a needs-based business that is tailored to the out here lifestyle. Our customers have a passion for the out here lifestyle and over index as homeowners, landowners pet owners and animal owners we live our mission and values and our culture defines our relationship with our customers we're celebrating our 85th anniversary this year as we begin the year we take great pride in our past and are equally excited about our future and with that i'll turn the call over to kurt thank you hal and hello to everyone on the call let me build on how sentiment for 2022

As we started out the year, we anticipated that our business would continue to exhibit consistent performance, as we have a proven business model that has stood the test of time. The team delivered against our goals and exceeded our expectations. The impact of the 53rd week on our performance is detailed in our press release. To recap, the 53rd week added about $225 million to our net sales in the fourth quarter, representing 6.8 points of our net sales growth. On a full year basis, it represented 1.8 points of the 11.6% growth year over year. Diluted EPS benefited by 16 cents for the quarter and the year. For the fourth quarter, all regions of the country once again delivered positive sales comp. All months were comp positive. As for the cadence of the quarter, Our comp store sales were performing at the high end of our outlook as we moved into mid-December. Then as winter storm Elliott moved across the country, our sales accelerated, given the storm's impact on our customers' needs for heat, insulated outerwear, livestock feed and forage, and some load up of other Q products. As house share, we estimate the storm provided about two percentage point benefit to our comp sales. much like any emergency response events such as hurricanes the profitability of these sales from winter storm events of this magnitude is lower due to the mix of products and higher incremental operating costs our commitment to being the dependable supplier for life out here was exhibited during this historic form storm looking back When excluding the December winter storm, comparable store sales have been remarkably consistent across all four quarters of the year. Similar to trends through the year, retail price inflation contributed about 11 points to our comparable store sales in Q4 as the team continues to navigate the ongoing cost pressures across the supply chain. The comparable average ticket growth of 6.3% benefited from inflation. partially offset by a shift in sales mix to needs-based consumables versus the larger ticket items. Demand for Q categories was nearly three times the chain average, while big ticket sales performance was down mid-single digits. We did see strong performance in winter needs-based items such as heaters, snow throwers, and log splitters. The performance in these big ticket categories somewhat offset the declines we saw in more discretionary categories like utility and recreational vehicles and trailers. Moving on to gross margin. For the fourth quarter, our gross margin improved by 28 basis points to an even 34% of sales. Our price management actions and other margin-driving initiatives were able to offset the pressures from year-over-year product cost inflation, higher transportation costs, and product mix due to the strength of Q categories. During the quarter, we experienced a significant moderation in the rate of price increases from our vendors, but by no means are we seeing deflation. Our promotional activity was in line with the prior year, and we're seeing moderation in transportation costs that we expect to flow through in 2023. Of note, it's our belief that transportation costs most likely peaked in the fourth quarter. As a percent of net sales, SG&A expenses, including depreciation and amortization, increased 14 basis points year-over-year to 25.1%. As we indicated in Q3, this increase was primarily attributable to three factors. One, the impact of transaction expenses and early integration costs associated with our acquisition of Orchard and Farm and Home. Two, our strategic growth initiatives, including depreciation and amortization, And three, our investments in team member compensation and benefits. These items were partially offset by a reduction in COVID-19 response costs and leverage in occupancy and other costs from the increase in comparable store sales. Diluted EPS was $2.43, an increase of 25.9% from the fourth quarter of last year. Our balance sheet remains incredibly strong. At the end of the quarter, merchandise inventories were $2.7 billion, representing an 18% increase year-over-year in average inventory per store. Overall, we continue to believe that our inventory position is in good shape. Today, we believe we are better positioned to drive sustainable long-term growth than we were before the pandemic. Our structural tailwinds, such as rural revitalization, homesteading, self-reliance, and pet ownership continue to benefit us. Our life out here strategic investments have made us stronger. Adjusting for the impact of the 53rd week, our outlook for 2023 is right in line with our long-term targets as we continue to see the power of compounding from our compelling top-line growth, operating margin outlook, and consistent capital return to shareholders through the dividends and share repurchases. For fiscal 2023, we are forecasting net sales of $15 to $15.3 billion, including at least $300 billion in sales from Orsland. Our outlook marks another milestone in our performance as annual sales are forecasted to be above $15 billion. Comparable store sales growth is anticipated to be in the range of 3.5 to 5.5%. We expect gross margin expansion of about 20 to 40 basis points from supply chain benefits and a moderation in both product cost increases and the mixed impact of Q. We anticipate SG&A will deleverage modestly due to a few factors. Depreciation amortization is anticipated to increase by 17 to 20% relating to our strategic growth initiatives. Also, we opened our ninth distribution center just this month. As a reminder, the operating costs for the new DC are reflected in SG&A while the supply chain benefits are reflected in gross margin. We expect the incremental cost to pressure SG&A by approximately 15 to 20 basis points. The benefit in gross margin will not completely offset this pressure since it takes time for the new facility to fully ramp to maturity and realize the supply chain benefits. And lastly, the integration of Orson Farm and Home is expected to impact SG&A by approximately five basis points. These factors are partially offset by the normalization incentive compensation and leverage in occupancy and other operating costs from the increase in comparable store sales. And for the year, we forecast an operating margin of 10.1 to 10.3%. We are forecasting interest expense of approximately $55 million as we have increased borrowings to fund our capital allocation. We plan to maintain a healthy leverage ratio of two times or below. We expect our effective tax rate to be in the range of 22.7 to 23%. We continue to expect the Orslan acquisition to be accretive to diluted earnings per share by at least 10 cents in 2023. All in, diluted EPS is forecast in a range of $10.30 to $10.60. We continue to believe the best way to look at our business is not by the quarter, but by the halves of the year. As you model 2023, I want to point out a few things that will impact comparability. And I'd like to give a little color on the flow across quarters. From a sales perspective, we are planning for all four quarters to have comp sales performance generally within our guidance range. We anticipate retail price inflation to benefit comp sales by three to five points, with the benefit being higher in the first half than the second half as inflation pressures begin to moderate. We are planning for positive comp transactions in 2023. As to earnings, we expect our EPS growth to be fairly balanced between first half and second half. There are a couple of discrete items that will impact operating margins in certain quarters. The first quarter will likely be our toughest comparison from an operating margin rate perspective. Startup costs for the new distribution center will pressure the first quarter, while the supply chain benefits will not begin to be realized until the second quarter. Additionally, transportation costs are expected to continue to be higher year-over-year in Q1 and then begin to moderate through the remainder of the year, with the second half expected to see favorable comparisons. As a reminder, the Orsland stores will be added to the comp store calculation in October when we cycle the acquisition date. Also keep in mind the discrete items that impact our earnings comparability in 2023 are the lapping of the 53rd week benefit, partially offset by the accretion from the Orsland acquisition. And when adjusting for the 2022 benefit from the 53rd week and the 2023 accretion from the Orsland acquisition, Our outlook for 2023 is consistent with our long-term EPS guidance of 8% to 11%. Capital expenditures are forecasted to be $700 to $775 million with about 80% for growth initiatives. We expect to open approximately 70 new tractor supply stores. We continue to be on track for 10 to 15 pet cent store openings in 2023. 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 a growing dividend and share repurchases. For 2023, we anticipate share repurchases in a range of $575 to $675 million, which is estimated to have a benefit of a net reduction in weighted average shares outstanding of approximately 2%. Our business model has stood the test of time and has proven to be resilient. While we are closely monitoring consumer behavior and the impact of economic growth on consumer demand, we believe that we are well positioned for any consumer and economic environment. To wrap up, we're continuing to separate Tractor Supply from the competition. In prior cycles, we've 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. And with that, I'll turn the call back over to Hal.

Thank you, Kurt. As we celebrate our 85th anniversary this year, Tractor Supply is a business that continues to have significant opportunities for growth ahead of us. Our position in our customer spending is for stable, need-based, and demand-driven product categories. we are in defensive product categories for the lifestyle our customers live. At the same time, we are playing offense to capture organic growth opportunities. We have idiosyncratic growth drivers that are separating us from the competition. As a company, three words that really summarize Tractor Supplies' performance are one, consistent, two, reliable, and three, sustainable. And I'd like to walk through these three words and share what I see as structural tailwinds across them to support our future performance. Let's start first with consistent performance. We have a track record of delivering positive sales growth for over 30 consecutive years. 30 of the last 31 years have had positive comp sales. We've had consistent traffic growth across economic cycles. and we're planning for positive traffic growth in 2023. Our marketplace has shown consistent growth for decades and decades. Our total addressable market of $180 billion continues to benefit from numerous trends that we believe are structurally sound. Additionally, by all accounts, we are gaining substantial share in our market. For instance, our key product categories are driven by livestock feed for cattle, equine and poultry, and companion animal food, in addition to categories like heating fuel, wildlife feed, pest control, and lubricants. We're entering new product categories through our garden center transformations that open up new Q categories that provide a halo to the store as new and existing customers shop our expanded lawn and garden categories. Our stores with a fusion layout and garden center transformations are gaining more customers than the balance of the chain. And just over two years since we started our Life Out Here strategy, we have gained significant scale in our fusion remodels and the transformation of our sidewalks to garden centers. We have a substantial runway for growth ahead of us, as we still have 70% of the chain to convert to the fusion layout and the opportunity for another 1,000-plus garden center transformations. The conflict for the fusion remodels continues to run in the mid-single digits. When we execute a combination fusion remodel and a garden center transformation of our sidelines, we have accomplished in the high single digits. These projects provide us with the opportunity to continue our track record of consistent growth. The second word I would use to describe Tractor Supply is reliable. We are a needs-based, demand-driven business, and these product categories differentiate Tractor Supply from the bulk of retail. Our customers count on us for the products they need to deliver life out here. Since relaunching our Neighbors Club program in April of 2021, we have increased our high-value customers by nearly 50%. Additionally, our high-value customers are shopping us more frequently and spending more money. Our retention rate for our high-value customers is about 80%, with our retention rate for our highest-tier customers at over 95%. Our Neighbors Club program is a true competitive advantage for tractor supply. Once our customers are in the flywheel of Neighbors Club, their spending becomes much more reliable. Sustainable is the third key word to characterize our company. We've had tens of millions of new customers shop us the past three years. We have retained the majority of these customers, and a substantial portion have become active Neighbors Club members. We've added over 13 million members since 2019, with more than 5 million in 2022 alone. These strong results position us for sustainable growth ahead. Another important customer cohort that supports the sustainability of our outlook are the millennial customers, and they continue to have more significant spending with us and in the years ahead of them. This group will make up nearly a quarter of the US population by 2032, just 10 years from now. Our sales comps for millennials have outpaced non-millennials in tractor supply for five consecutive years. Millennials over index in sales per customer, units per customer, and average ticket. We view this strength with our millennial customer not as a pull forward, but rather as a catch up as this group delayed family formation and the pandemic really shifted their behaviors to be much like prior generations. This cohort of the population is showing accelerated rates of homeownership and household formation. Today, 50% of millennials own homes versus 30% just a decade ago. So while they may have started a little bit later, we see an inflection point in the pace of homeownership and household formation for millennials. We are focused on retaining these new millennial customers as our data shows that they are roughly double their spending at TSC in their second year of shopping. And if they continue shopping with us for five years, we experience a threefold increase in transactions and sales per customer within five years of their initial purchase. Rural revitalization also continues to be a strong structural benefit for us. Millennials are increasingly choosing to move out here. This is not just a phenomenon of the pandemic, but rather a decade-long trend of net migration out of urban areas that skew disproportionately among this younger generation. The rural lifestyle appeals to millennials and it offers greater affordability, safety, self-sufficiency, a slower pace, and the ability to pursue hobbies and passions. Many of the hobbies pursued by the millennials fit with our out-here lifestyle. Tractor supply enables passions and hobbies pursued by millennials. Whether it's a pursuit as simple as making memories with family and friends or caring for pets and animals, or getting outside to hunt fish, or camp, or being more self-sufficient and sustainable, Tractor Supply serves a key resource in our local communities for millennials to come to for trusted advice and expertise. Our passion for the lifestyle connects with our customers and allows us to serve them at scale. These three words, consistent, reliable, and sustainable, allow us to be an earnings growth compounder on both the top line and bottom line. As I started my remarks this morning, year end is when we reflect on our accomplishments. But more importantly, this is a key moment to look ahead and to focus on the opportunities ahead of us. With our Life Out Here strategy, we have ignited Tractor Supply's next horizon of strong and sustainable growth. 2023 is poised to be another great year for Tractor Supply. And with that, operator, we'd now like to open the line for questions.

Certainly. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. Kindly remember when you are selected to ask your question to meet the webcast on your end. Our first question comes from the line of Scott Siccarelli with Truist. Scott, your line is now open.

Hi, this is Joe Chiavello on for Scott. Great quarter, guys. I was just wondering if we could talk about the transaction growth you guys are projecting for 2023. Can you talk about how the expectations are driven by weaker comps, weather-driven, or other things like that, or potentially incremental visits driven by garden centers, fusion remodels, or the things you're implementing in the stores that's helping to drive growth? Thank you.

Yeah, hey, good morning, and thanks for your question. I appreciate you joining the call today. We're very pleased with the guidance we provided on our comp sales for 2023 to be between 3.5% and 5.5%, very much in line with our long-term guidance range as well. As Kurt said in his prepared remarks, we expect it will be a blend of positive comp transactions and tickets. We do expect inflation will be stronger in the first half but moderate in the second half. And what I'd say more broadly is our market that we participate in continues to run reasonably in line with GDP kind of flat to low single-digit growth. And we are taking significant share in the marketplace. As we've said several times over the last three years, our sales growth, half of that can be attributable to share gain. And we certainly are expecting that to continue in 2023. And the share gain is really a composition of the competitive advantages that we have, as well as the investments we're making in our life out here strategy, and the fact that we're reaching scale on a number of those now, particularly our fusion and garden centers. And they will continue to add material growth to our comps. But again, we're very positive on our outlook for 2023.

uh and uh expect the momentum that we exited 2022 to continue into the year okay thanks our next question comes from the line of karen short with credit suites karen your line is now open hi thanks for taking my question good to talk to you again um so just two questions if i could blend them in um so You know, just looking at your algorithm, obviously you're looking for sales growth just on a one-year basis to be lower than EBIT growth. And I guess I would argue that's probably – sorry, sales growth should be higher than EBIT growth. And I would look at that as a good thing because you are one of the few companies that have invested and not harvested as it relates to the pandemic. So maybe just talk about that algorithm. And then the second question I just wanted to lump in there, You know, when you look at your mix by category, obviously, I kind of look at it at about 26% is discretionary. So how do you think about that going into potentially a weaker macro?

Yeah, hey, Liz, good morning, and thanks for taking the call. Oh, I'm sorry, Karen, I wrote it right beside Karen. I apologize, Karen. Hey, Karen, how are you this morning? Hey, good morning. You all are right beside each other. Your names alphabetically on my list. My apologies. But hey, Karen, good morning, and thanks for your question and for joining the call. On the sales growth, as you said, we are in an investment cycle in our business, and the thing that we're excited about is that we're able to grow earnings, as we did last year, double digits, and we're able to grow our sales, as we did last year, double digits, even in the context of an earnings cycle. And we anticipate to continue to grow sales at a significant rate next year, as well as our earnings at a significant rate next year, even inclusive of all the capital expenditure and the kind of underlying DNA that comes along with that, as well as all the other investments we're making in the business. But we're very optimistic and confident in the outlook that we've provided. On the mixed by category, we've roughly talked about discretionary being more like 15% of our business. A big ticket is kind of in the low double digits. There's a few other categories that would be plus or minus in that discretionary area as well. And I think the way we think about that business is that some categories will have continued to be negative in their comps, but there's others when it's seasonally relevant that will be positive. And an example of that is what Kurt articulated in his prepared remarks saying that You know, our big ticket sales were kind of mid-single digit negative comps. And it was really, there was two sets of categories in there. The kind of discretionary, non-seasonal related ones were kind of negatives, double digits, but then you had ones that were seasonally relevant and there was a demand around those, say like log splitters and snow throwers that are also big ticket and could be viewed as discretionary or in our kind of math for discretionary. And those blended together to drive a negative single digit been single-digit comps. And we think it'll play out that way much of this year. As an example, as we get into the end of Q1 and early Q2, when we had the drought last year, that disproportionately affected, as we commented last year, things like riders. And we expect those to come back as the drought is abating in many areas of the country, even in spite of the consumer shifting more towards needs-based needs they spend. Anyway, thanks, Karen, for joining the call. I appreciate the question.

Thank you.

Our next question comes from the line of Liz Suzuki with Bank of America. Liz, your line is now open.

Great. Thank you. And I don't mind being confused or caring because she dresses better than I do. So I appreciate it. Thanks for your time. So the guidance you gave for 2023 in terms of the operating margin, I guess it sounds like the investments in new DCs and then store transformations and side lots are probably the factors that would keep that margin towards the lower end of the long-term guidance. But what do you view as the opportunities for operating margin to get to the top end of that guidance over time?

Hey, Liz, and good morning, and thanks for joining the call. As we've said several times, last year and this year are two biggest peaks in investments. And as we talked about in our enhanced earnings call a couple years ago, the first part of this five-year cycle that we're in for our life after year strategy would be towards more the bottom end, middle end of our range. And then as we move towards the out years, call it 24, 25, 26, we see opportunities to increment up on our op margin towards that higher end and kind of get back to a nice leverage across our P&L of, say, 5 or 10 basis points a year. And really, the biggest determinant of the 10.1 to 10.3 this year would just be the sales range. If we're up more towards the 5.5, we would expect to leverage more on some of our fixed costs and be more towards that 10.3. If we're down more towards the 3.5, we think we'll be more in that 10.1 to 10.2 range as there's a little less leverage on some of our fixed costs, and we pull some other leverage to kind of manage the business. But certainly as we look out towards the back half of this five-year investment cycle, we see opportunities for our margin rate to increment up.

Got it. And just a follow-up, you may have mentioned this, but in the outlook for 23, how many Project Fusion remodels and side lots do you have baked in?

Yeah, so the mix of our remodels in 2023 will be a little different than last year because of the Orsalan acquisition. This year, as we shared in our open remarks, it's kind of 70 to 80-ish new stores that will open this year. We'll also be integrating the 81 Orchalyn stores. Those will be kind of a, you know, basically a fusion remodel. And then we'll do around 150 more fusion remodels as well. And that's in line with what we did this year, kind of in that 2 to 250 range. It's just the fact that 80 of those will be taken up by the Orchalyn integration this year. We continue to be very excited about Fusion and very excited about our side lot.

Yeah, I'm excited to see you next week. Thanks.

Yeah, perfect. Look forward to seeing you.

Our next question comes from the line of Brian Neagle with Oppenheimer. Brian, your line is now open.

Hi, good morning. Great quarter. Congratulations. Congratulations. So I have two quick questions. I'll merge them into one. First off, with regard to the, so to say, the weather bump in sales late in Q4, should we think about that as incremental demand or is that potentially the pull forward demand that would have happened in Q1? And then the second question I have, you mentioned in your script that you're seeing, I guess, price increases moderating. So that's from your suppliers. The question I have is, so then what action, as that's occurring, what action is Tractor Supply taking? Are you maintaining your retail prices, or are you actually adjusting your retail prices to account for those now moderate and infant costs? Thanks.

Hey, Brian. I'll take the first part of it, and then Kurt will take the second part. On the weather bump, we don't see that as pull forward from Q1, and we see it dominantly as just incremental in Q4. I go back to some of the comments we made saying our Q3 earnings call and our Q2 earnings call where we said, you know, our business has been very consistent in that 5% to 6% comp range all last year. And as Kurt said in his prepared remarks, and I think I did as well, we were trending towards the high end of our comp guidance for Q4 when the storm hit, and then that put us well over. You know, I'd equate it a bit to what we said. If we'd have gotten, if the drought hadn't occurred, we think we would have been over our guidance. If we'd have had a better spring season, we think we would have been over our guidance for those quarters. You know, and to just get back to the point, our business is very consistent, very stable, very reliable right now in that kind of mid-single digits. And then if we get some good weather on top of that that benefits us, you know, we get that benefit. And that's what we saw in Q4 when the weather is bad. We're there for our customers and it drives some sales. But otherwise, you know, we continue to run very reliably and consistently in that mid-single-digit comp.

Yeah. Brian, good morning. And I'll just add to that. On that winter storm, we view it. very much like a discrete event like the hurricane events have been. You heard my commentary on there. The exciting thing, though, is with those types of events consistent with this storm is it introduces tractor supply as a needs-based business to other new customers. And that's what we do is we capitalize on that. We see it as part of our opportunity in 2023 as new footsteps into the business. So a great opportunity from that one event as we continue to serve our markets in a significant widespread winter storm such as that. In regards to your question about prices evading and how we manage that, one is we will, those prices will take time to work through the system. So we do very well at managing whether that be the product cost or the transportation. to be able to manage as those flow through and balance between the competitive retail price that we have, gaining market share, and how much we actually take to the bottom line. Specifically, the biggest item in the gross margin benefit in 2023 is the easing of the transportation cost. And as you look back even over the last two years on our gross margin, we've been very specific as we've been able to find offsets or pass through some of those. The transportation cost has been the primary one where we've absorbed some of that. And so we will, as those prices abate and ease through, it's a key contributor how we expect to see gross margin expansion throughout 2023. Thanks, guys.

Very helpful. Appreciate it.

Our next question comes from the line of Simeon Gutman with Morgan Stanley. Simeon, your line is now open.

Good morning, everyone. Nice results. My question, it's a couple parts, but it's one topic. It's how Q is comping three times the company average. If you could speak to, if you can, maybe the price benefit there or what's happening with the basket. And the market share seems to be staggering because I don't think some of the items in that category are growing that fast. And then I'll flip it and say, then why are you not converting or is it converting to the rest of the store? Are you seeing that conversion? Because it seems like it's a pretty good halo to have on one side of the business.

Yeah, hey, Simeon, and thanks for joining the call. It's good to speak with you this morning. On the queue, I would say our AUR is in line with the rest of the market. So kind of high single digits, generally speaking, across food and feed. But our market share is on a dollar basis, we're running 2x the market. And on a pound basis, we're running 3x the market in growth. And so it's the majority of our growth there, well over half. is transactions-based, units-based, and share gain. Dog dry food is the numbers I was just mentioning right there. Those are specific to dog dry food, but we're seeing similar type of numbers in poultry feed, in equine feed, in livestock, etc. And I would say it is pulling through to the rest of our business, you know, in terms of driving positive footsteps and transactions into our store. And then also, you know, our average ticket continues to remain very solid with very modest reduction in our UPT. In fact, this was the lowest year-over-year in our UPT decline in 2022. And when you look at the underlying customer cohorts, in our Neighbors Club program, what you're seeing, and as was mentioned in the prepared remarks, is that the millennials have moved out to kind of rural America and kind of that Sunbelt migration. They start in poultry and pet food with us and then very quickly are migrating into four to five other categories in terms of us being their destination. And so I'd say we're seeing strong growth. It's market share gains in Q that we're taking. We're confident we will be able to continue to take those gains. We're the lowest cost to serve in the market, the fastest supply chain, the lowest prices, the best customer service. And when they get in there, they shop the whole lifestyle, and we're seeing that in our average ticket and also in our underlying customer data.

Thank you.

Our next question comes from the line of Zach Fadum with Wells Fargo. Zach, your line is now open.

Hey, thanks. Good morning. A couple questions on the outlook. First of all, could you walk us through the quarterly comp impact from the calendar shift, and if there's anything we need to keep in mind on a flow-through or margin basis for those sales? And then second, on your gross margin outlook, To what extent are you incorporating reinvestment to drive traffic growth versus flowing those lower freight and input costs to the bottom line?

Zach Hayes, this is Curt. The first question in regards to cadence throughout the quarter. As I mentioned in my prepared remarks, all four quarters really would expect to be in line with our overall guidance. We don't expect significance. variation between the quarters. I would encourage you as you reflect back on last year as we talked about some of the headwinds we saw in the middle parts of the year with the late start to the spring, the drought that impacted Q2 and Q3. We talked about how in those quarters there were some headwinds that took some of the top side off of the comps in those quarters. So we see good opportunity to be able to capitalize comping up against those quarters. We obviously had a really strong Q4. We talked about the winter storm. So those are all things that factor into our model as we plan the comps. And on the gross margin question, maybe remind me again your question on the gross margin. yeah are you incorporating any reinvestment to drive traffic growth versus just flowing the lower freight to the bottom line gotcha yep um well of course we always prioritize market share gains competitive in pricing uh we are the lowest cost to serve we've invested in our supply chain and distribution to be able to capitalize on this shift in the environment where um transportations are coming down so We'll be able to take advantage of our own efficiencies that we can control as there's opportunities as prices decline. We will take some opportunity modest as we see it in our plan opportunity to invest in the gross margin. And all of that is considered in our expectation that we could see gross margin growing 20 to 40 basis points in 2023.

And, Kurt, just to clarify, the calendar shift won't be as pronounced as 2016 is what it sounds like.

Oh, exactly. Yeah, thank you. There is not a, you know, a pronouncement, anything of material. And I just point back to how consistent each of the quarters were in 2023. So there's really no meaningful shift in there.

Got it. Thanks for the time.

Our next question comes from the line of Chris Horvath with JP Morgan. Chris, your line is now open.

Thanks. Good morning, everybody. So I wanted to follow up on the sort of discretionary question that was posed earlier by Karen. As you think about, you know, what you saw in the fourth quarter, you're hearing a lot of retailers talk about a very late Christmas season. And I recognize it's a small portion of your mix, but In some of those seasonal categories, that's like fashion apparel and footwear and toys, did you see any sort of deterioration? And then similarly, if you look at the data around pet inflation, that's been very strong, but it does seem like there's some unit degradation and some sort of sacrificing treats and the accessory business. So can you talk about those two buckets in terms of how that behavior has changed, I guess, in the back half of the year in the fourth quarter?

Yeah, hey, Chris, and good morning. Thanks for your question and for joining the call. First, we were very pleased with our Q4 business in general. As I said, and Kurt, absent the storm, we were still at the high end of our comp expectations, and we would have still had positive comp transactions for the quarter regardless of the storm. And we were also very pleased with our seasonal businesses. They performed in line with our expectations. And then in the last week of right before Christmas, you know, for us, when we have a winter storm like that, it drives more footsteps into our stores and they end up, you know, shopping the entire lifestyle when they're in there. So we saw excellent performance that week and in holiday related items you know whether it's an apparel whether it was in decor candy toys tools it was a solid very solid close to the year for us on both as i said not only just on demand driven storm related items and then on pet we are seeing unit growth and double digit comps across all categories in pet whether it's dog whether it's cat whether it's hard goods, whether it's consumables, whether it's food, whether it's sundries or accessories. Certainly the food is outpacing the other categories, but all categories in our pet business are seeing very strong growth.

Very impressive. Thanks very much.

We've hit the top of the hour, but we'll let the call go just a few minutes longer because our prepared remarks were longer.

Certainly. Our next question comes from the line of Stephen Forbes with Guggenheim Partners. Stephen, your line is now open.

Good morning, Hal Kirk, Mary Wynn. I wanted to focus on member cohort trends. So, Hal, you mentioned, I think, during the prepared remarks, retention rates right among the high-value customers. I was curious if you could expand on retention repeat behavior sort of in aggregate across the member cohorts as a whole. and whether you're seeing a difference in behaviors, right, between those members acquired over the past three years, you know, versus those members acquired 2019 or earlier.

Yeah, hey, Steven, and good morning. This is a great news story for Tractor Supply. You know, what I've seen historically in my career in retail is it takes time when you have a new customer for them to ramp up through your high-spending cohorts until they become kind of a mature customer. What we've seen is the customers, as you mentioned, I said in my prepared remarks, that we've had tens of millions of new customers shop us in the last three years. The majority of those have continued to be active shoppers with us, and a huge portion have become neighbors club members. That cohort is basically shopping us, and we're seeing purchase frequency, average ticket, number of categories shopped. total spend in a year very much in line with our kind of long-time core customers. So they've ramped up very fast. And that's why when we say things like our neighbor's club is outperforming our overall comp, our total company comp, even at 75% penetration. And even with the growth we've had, that's why I think it's so exceptional because historically, in my past, as you see your membership program become such a large portion of your sales, it is a tendency to revert to the mean, right, revert to your overall comp. And I think the data set you can see, both that we're providing and also in our underlying data, just shows you how fast those customers have ramped up and become core customers for us. And, you know, it's what gives us confidence as we head into 2023. Thank you. Best of luck.

Our next question comes from the line of Peter Peace with Piper Thaler.

Peter, your line is open.

Hi, thanks. Good morning, everyone. One thing that we're hearing in the channel right now, and it's kind of a funny dynamic for Farm and Ranch, but that the chicken category is on fire. And certainly there's been some well-publicized discussion of price increases with eggs and So I guess I'm wondering, is that kind of an emerging trend that chickens have perhaps reaccelerated for you? And is that a category that actually could be big enough to move the needle as we look to 2023?

Hey, Peter, this is Seth. Hey, thanks for the question. Yeah, when we look ahead to this next year, we are incredibly excited about our poultry business. And just to go back to some of Hal's comments earlier, I would just say even in Q4 for us, poultry was a primary driver. We have Unlike some maybe commentary you've heard elsewhere, we have not seen the entire year over the course of the last three years any slowdown in our poultry business. And when we look ahead to this year, we think it could be another record year for us. Our stores are setting chick days here over the coming months. When we look out to our center court activity, we look at poultry being a predominant driver for us. And when you couple those things with our pet business, you couple those with our live goods business, All the sustainability things that customers are looking for right now, they're looking to find value, to grow those things on their own. We're looking at poultry to be just absolutely another banner year, and our team is incredibly excited for that. So we definitely agree with the commentary you're hearing out there, and we think we're in a position to communicate market share in this category.

All right, thanks, and congrats on the continued success. Thank you.

Our final question comes from the line of Peter Benedict with Farid. Peter, your line is now open.

Hey, guys. Thanks for sneaking me in. I just wanted to ask a question around CapEx. Came in above the forecast this past year. Curious if that's just projects costing more, or did you get through more of the projects than you thought? And then as you step back, CapEx is running around 5% of sales. the last couple of years. I think your outlook for 23 would suggest a similar ratio.

How do we think about the path of CapEx beyond 23? Historically, you guys used to run around 3% of sales. You've been investing aggressively for good reason.

But just curious how you would have us think about maybe the CapEx path as we move beyond 23. Thank you. Hey, Peter. This is Kurt. In regards to CapEx and your two questions, the growth in capex in 2022 at the high end of our expectations reflected a couple things certainly there's inflation in the cost of building a distribution center the new stores etc that was a piece of it but also in this environment the team's done an excellent job of ramping up and ensuring that all of the pieces that go into these fusion remodels that we've got the the fixtures and all of the equipment ready to go so the pipeline is in good shape for what we plan to use to grow into the 200 to 250 remodeled stores next year and there's some timing of that capital that impacted 2022. And then certainly for 2023, we expect consistent numbers. We've got a construction of a complete new distribution center in Maumelle, Arkansas. So for both years, they absorbed the $150 million-ish cost of some of our largest distribution centers in those years. And that leads to the second question that you had. Going forward, we really believe that, as we said, these would be the two peak years. that the biggest investment over the other years is really on the supply chain side. And it's reverting back more to that over the next few years, 600, 650 million in capital going forward. And it's a very planned, purposeful five-year growth to convert the supply chain and the stores you know, into the new life out here strategy look and shopping experience for our customers. So I would expect to see that number come down a bit after 2023. That's great.

Very helpful. Thank you.

Sure thing. And for that, we'll wrap up our call. Thanks, everyone, for joining us. And we'll look forward to speaking to you on our first quarter earnings call in April. I'm around. If anybody wants to reach out, please let me know, and we'll get you on the calendar. Thank you all. Have a great day.

This concludes today's TSEO fourth quarter 2022 earnings call. Thank you for your presentation. You may now disconnect your lines.