Tractor Supply Company

Good morning ladies and gentlemen and welcome to Tractor Supply Company's conference call to discuss second quarter 2023 results. At this time all participants are in a listen only mode. Later we will conduct a question and answer session and instructions will follow at that time. We ask that all participants limit themselves to one question and return to the queue for additional questions. Please be advised that reproduction of this call in whole are in part is not permitted without written authorization of Tractor Supply Company. And as a result, reminder, this call is being recorded. I would now like to introduce your host for today's call, Mrs. Mary Wynn Pilkington, Senior Vice President of Investor and Public Relations for Tractor Supply Company. Mary Wynn, please go ahead.

Thank you, Megan. Good morning, everyone. Thanks for taking the time to join us today. On the call for our prepared remarks are Hal Lawton, our CEO, Kurt Barton, our CFO, and John Ortis, EVP and Chief Stores Officer. Seth Estep, our EVP and Chief Merchandising Officer, will join us for the Q&A session. Please note that we have made a supplemental slide presentation available on our website to accompany today's earnings release. Now let me reference the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. This call may contain certain forward-looking statements that are subject to significant 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, and can give no assurance that such expectations or any of its forward-looking statements will prove to be correct, and actual results may differ materially from expectations. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included at the end of the press release issued today and in the company's filings with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed, Investors should not assume that statements will remain operative at a later time. Tractor Supply undertakes no obligation to update any information discussed in this call. Given the number of people who want to participate, we respectfully ask that you limit yourself to one question. If you have additional questions, please feel free to get back in the queue. I appreciate your cooperation on this. We will be available after the call for follow-up. Now it is my pleasure to turn the call over to Hal.

Thank you, MaryWen. Good morning, everyone, and thank you for joining us. I'd like to begin by thanking the 52,000 Tractor Supply team members for their commitment to each other and our customers, and for their dedication to serving life out here. Our team is executing at a high level and did a nice job nimbly adjusting in the second quarter. We're operating in a tougher environment than we expected at the beginning of the quarter, and certainly tougher than what we forecasted as we entered the year. Consumer spending continues to shift in favor of services. Shoppers that are tired of inflation are being judicious on their baskets. Consumers continue to pull back on discretionary purchases. And additionally, our business was further impacted by the abnormal seasonal trends, particularly in the month of June. Despite this environment, we still expect 2023 to be a pretty solid year. Our customer is healthy. And we're gaining share, outgrowing our market by 2x. And we are significantly outpacing total U.S. retail sales growth. We anticipate that we will have positive sales comps and positive comp transactions for the year, albeit in the low single digits range. And importantly, net sales and earnings will grow strong mid-single digits on top of the 53rd week last year. We have a long track record of growth and high expectations of performance. We view our underperformance to these expectations as specific to the current environment. The team is dialed in and understands the challenges. For the remainder of the call today, I'll speak to a few highlights of the second quarter and then share an update on our Life Out Here strategy. John Ortis will then provide greater insights on our real estate strategy and our plans to accelerate our store growth. And then Kurt will follow John and share further details on the second quarter and our four-year outlook. So let's dig in. All right, turning to the second quarter. We grew net sales by 7.2%, with comparable store sales up 2.5%. And diluted EPS was $3.83, an increase of nearly 9%. Our comparable store sales growth was driven by transaction growth of 1.8%, and ticket growth of 0.6%. We expected and were pleased to see comp transactions turn back positive, and this trend has continued into Q3. We began the quarter with mid single-digit comp sales growth in both April and May. As we moved through the month of June, we experienced a noticeable slowdown in our seasonal categories, with the period coming in modestly positive. In my 25 years in retail, June was one of the most topsy-turvy months that I've seen. Smoke, drought, storms, heat. It had a little bit of it all. As mentioned, our customer base is healthy. Our active customer counts are stable and growing. Importantly, our new customer trends have leveled out after a period of laughing tremendous growth in 2020 and 2021. Our customer satisfaction scores continue to break records and improve year over year. And customer demographic trends continue to trend younger and more female than pre-pandemic. Our Neighbors Club reached a record 31 million members in the quarter, an increase of 5 million members in the last year. We're seeing continued favorable trends from our loyalty members. Retention rates remain at all-time highs. Neighbors Club members continue comping at a faster rate than our overall performance. And our high-value members reached a record count in the quarter. A few key trends that we're seeing our customers as follows. One, customers are increasing in their usage of credit. Two, shoppers continue to seek out value, particularly in our lower income customers. And three, customers are buying a little more often, but a little less per trip. Now shifting from our customer to our categories. Our year-round categories were up mid-single digits, indicative of our ongoing market share gains and our demand-driven needs-based business model. Our consumable, usable, and edible categories continue to deliver strong, stable performance and drive trips to tractor supply. In this quarter, Q categories had growth in the low double digits. In companion animal, we are gaining substantial share throughout the category. Again, this quarter, we had sequential increases in the number of customers shopping us for this category each week. In livestock, our spring chick days event was one of the largest ever for us, with the poultry category up strong double digits. We believe we're on track to exceed last year's record of 11 million birds sold. Not only are we seeing growth from existing customers, we are also experiencing robust growth in new customers to the category, and this is driving both trips and tickets. Our seasonal categories were flat and below expectations. The miss was primarily in June, when As mentioned previously, there were a number of choppy environmental conditions across our markets that resulted in the consumer not being as engaged in the categories we expected. This softer seasonal performance in June had a material impact on our second quarter performance and was the main driver of our miss versus our expectations. Our big ticket sales were down in the high single digits and in line with our expectations. And in fact, our performance in the quarter was a sequential improvement from the first quarter. The most significant pressure in the quarter was in zero turns, generators, and recreational vehicles. On the real estate front, we opened 17 new tractor supply stores and three pet cents by tractor supply stores in the quarter. For the second consecutive quarter, we've seen the cadence of our new store openings return to a more normalized rate. Our pet sense by tractor supply business is performing well, and comps in the quarter were greater than overall tractor supply. And the integration of Orchland is right on track. To date, we've fully transitioned and re-grand opened 15 locations. We remain very pleased with the customer's response as we convert to the tractor supply brand. Although the operating environment may be different than we anticipated as we enter the year, I'm incredibly proud of how the team has come together to navigate the various circumstances and control what we can control. Now, transitioning to an update on our Life Out Here strategy. We remain very confident in our long-term growth outlook. We participate in a large, fragmented, attractive market. We continue to benefit from numerous structural tailwinds, including rural revitalization, homesteading, self-reliance, and pet ownership. We have numerous substantive competitive advantages and are investing to expand them through our Life Out Here strategy. Since we first embarked on our strategy in the fall of 2020, the team has made remarkable progress on the transformation of tractor supply. As a reminder, the five pillars of our strategy include deliver legendary customer experiences, advance our one tractor capabilities, operate the tractor way, go the country mile for our team, and generate healthy shareholder returns. And the key initiatives that support this strategy include our Project Fusion store remodels, our garden center transformation, our neighbors club loyalty program, and the expansion of our omnichannel capabilities. Our Project Fusion store layout is now in over 700 stores, representing greater than 30% of our store base. This program is enhancing our space productivity with improved layout, signage, skew expansions, and improved adjacencies. And for remodels, it also offers an improved customer shopping experience that is much more contemporary. Complementing Project Fusion is the side lot transformation, which is leveraging and expanding our existing outdoor side lot retail space to drive greater productivity and convenience with the addition of a garden center, and a drive-through pickup lane to support our omni-channel technology investments. With more than 400 garden centers today, we've significantly expanded our assortment of lawn and garden products that are relevant to our customers' lifestyle. Importantly, these two projects are delivering on our return expectations. They're providing material sales lift. We're seeing improvement in customer satisfaction. and we're seeing higher levels of new customer acquisition in these remodeled stores. Also, our execution on the remodels continues to improve as we're in year three now of the effort, and we're reducing project costs and also continuing to shorten construction times. We relaunched our Neighbors Club program to a points-based structure in April of 2021, and the timing was very fortuitous. as it allowed us to lock in the millions of new customers that found us through the pandemic. In total, since the relaunch, our membership has increased by 12 million members, a 60% increase. Additionally, the design of the program has facilitated upward spend migration and driven strong retention rates. Lastly, the program provides invaluable insights into our customer behavior and allows us to personalize our offerings tailored to their needs. Look for us to evolve the structure again sometime in the next 12 to 18 months to further enhance value for our members. Underpinning our strategy are substantial investments in our distribution network to support the significant sales increase and store growth. Today, our network is achieving record service levels and the strongest productivity we've experienced in the last five years. Our new state-of-the-art distribution center in Navarro, Ohio, and our increased count of mixing centers, now up to 15, and the implementation of engineered labor standards are all contributing to this performance. Today, I'm excited to share with you a new strategic focus area that we've been working on for a little over a year, the transformation of our real estate model, enabled by a number of new capabilities that is designed to deliver material benefit to both revenue growth and operating margin rate and reinforce our long-term guidance. First, we're raising our new store growth target. We now believe there's a 3,000 store opportunity domestically for tractor supply. This is supported by our total addressable market of more than $180 billion, our robust growth, and our ongoing market share gains. Our new target represents an increase of 200 stores. And we believe we continue to have significant runway for growth with high-return new stores. Second, we're implementing new capabilities to enable owned development of new store builds. This capability is expected to generate significant construction cost savings and allowing for lower rents in these applicable stores once we sell them post-construction. Third, we're also announcing plans to periodically execute sale leaseback transactions of our existing ownership of 117 stores. And we're going to have a step up in our ongoing build of stores back to 90 stores per year starting in 2025. Today's real estate announcement extends our runway for growth and reinforces our long-term financial model. It's a compelling addition to our life out here strategy that will further solidify our growth for many years to come. And with that, I'll turn it over to John, who can share some more color on our real estate strategy.

Thank you, Hal. It's an exciting time for the store operations and real estate team as we embark on new ways to capture growth and market share while also driving efficiencies in our real estate processes. Over the last year, we've installed new leadership and talent in our real estate team. This has allowed us to reevaluate where we are in the natural progression of our store growth plans and our ability to leverage our real estate capital structure. This new approach will allow us to realize cost savings and be more nimble with our store portfolio. Our strong outlook for new store growth is direct correlation of the millions of new customers we have acquired and our overall sales performance over the last several years. This provides us with nearly a decade of new store growth in the United States. We believe these are low risk, high return, organic growth opportunities, We anticipate accelerating our new store growth from approximately 70 stores this year to 80 in 2024 and 90 new stores in 2025 and beyond. Opening highly productive new stores is a core strength and competency of Tractor Supply. We continue strong new store productivity metrics with performance outpace in our historical investment thesis, and our stores are profitable in year one. As part of our growth plan, let's start with new stores. We have developed a new sales forecasting model to determine new stores' mature sales and pro forma results to develop our total market store growth opportunity of 3,000 stores. This was the first update to our modeling process in four years. We have infused the process with a machine learning model and insights from our 31 million neighbors club members. This gives us tremendous confidence to raise our outlook by 200 stores for a total of 3,000 tractor supply stores in the U.S. To capture this growth, the real estate team is ramping up our pipeline to allow us to accelerate our store openings to 90 new stores by 2025. We are on track to open approximately 70 new stores this year, with a step up to 80 new stores in 2024. We have a robust pipeline of new stores in our sites over the next 24 months. In fact, our pipeline is at the best level of development since prior to the pandemic. The team is also building new capabilities to optimize our real estate portfolio. we will start own development of stores this year through a fixed fee developer model and over time anticipate self-development of new stores. This year, we anticipate 20 to 30 of our new stores will be in our own development pipeline for 2024 new store openings, many of which will begin development in this year. A benefit of these new programs is our ability to have more control and visibility in the development process. The great news is that we estimate these capabilities will result in a 10 to 20% estimated rent reduction as compared to a developer model build. This rent reduction helps us continue to improve our new store returns. Part of the investment in creation of this development model requires more upfront cash. It is exciting that we are able to fund this through the sale leaseback of 10 to 15 stores this year out of the 117 stores that we own. Going forward, we plan to use the sale leaseback program on both existing owned stores as well as new store openings. This program will help fund our planned owned store development It will also capture value in currently owned stores. With nearly 2,200 stores, we are also strategically investing in and optimizing our existing store portfolio as part of the lease renewal cycle. All stores will go through an in-depth review to ensure we have the right real estate strategy in place. We will then take action to ensure that all stores have the right location, size, facility, rent structure, and format. These factors are critical to the success of our team and stores to deliver legendary customer service. With that, let me now pass it over to Kurt for our financial review.

Thanks, John, and good morning to everyone on the call. Turning to our second quarter results. While our sales trends were below our expectations, I commend the team and how they have remained nimble and steadfast in our commitment to be the dependable supplier for life out here. In many ways, our second quarter top line results were very consistent with our results in the first quarter, with strong Q growth, slattish seasonal performance, and a decline in big ticket sales. Our comparable store sales growth was the strongest in the Far West, South Atlantic, and Texas, Oklahoma. The strength of these regions was offset by pressure in the Northeast and Midwest regions where seasonal trends added incremental pressure on consumer demand. Comp sales in the quarter benefited by about five percentage points from retail price inflation. Most of this inflation reflects retail price increases that were put in place in the second half of 2022 that we have not lapped as of yet. Much like the first quarter, the benefit of price inflation to our average ticket growth was offset by the impact of three factors. First, the average ticket was impacted by the softness in big ticket and declines in seasonal categories, which run at a higher average ticket. Second, we also experienced softer sales in discretionary and impulse add-on items. Third, on a positive note, we also saw our customers shopping us more frequently with a slight reduction in the number of items per basket. Overall, our customers are buying more units or pounds from us in total. Moving down our income statement, our gross profit increased 9.3% to $1.51 billion. Gross margin increased 69 basis points to 36.2% from 35.5% in the prior year's second quarter. Gross margin was a highlight for the quarter as we continued to maintain strong product margin from our ongoing execution of an everyday low price strategy. The gross margin rate increase was primarily attributable to lower transportation costs driven by improvements in the global supply chain and efficiencies from our new distribution center in Navarre, Ohio. Product makes pressure gross margin given the strength in Q. This was somewhat offset by the margin improvement from lower big ticket sales which carry a lower gross margin rate. As a percent of net sales, selling general and administrative expenses, including depreciation and amortization, increased 77 basis points to 22.8 percent. The increase in SG&A as a percentage of net sales was primarily attributable to our planned growth investments, which included higher depreciation and amortization and the onboarding of our new DC. Additionally, higher medical claims also contributed to the increase in SG&A. The growth in medical claims is due to new benefit offerings that had stronger engagement rates than we anticipated, as well as higher program costs overall. We have made some adjustments to the program and will continue to do so. We don't anticipate this to be a headwind in 2024. Approximately 80% of our SG&A growth year over year represents investments for growth such as new stores, the impact of Orson Farm and Home, the new DC, and the depreciation from our capital investments for items such as project fusion remodels and garden center transformations. The core SG&A costs leveraged well, even in a low comp sales environment. Overall, the team had strong execution and scaled our core cost to our sales performance. For the quarter, operating profit margin was 13.4%, an eight basis points decline from the prior year. Consistent with our guidance from the year, Orsland stores had a modest drag on operating income, principally due to factors unique to the transition. In Q2, we attribute approximately 10 basis points of operating margin decline to activities relating to Orsland. Turning now to our balance sheet, merchandise inventories were $2.7 billion at the end of the second quarter, representing a decrease of 1.7% in average inventory per store. We are pleased with the quality of our inventory as we enter the second half of the year. During the second quarter, we strategically issued $750 million in long-term debt, which brings our weighted average fixed rate to 3.4%. With strong annualized cash flows, we continue to maintain a healthy balance sheet with a leverage ratio of around two times. At Tractor Supply, we are committed to building on our track record of long-term value creation for our shareholders. Our real estate portfolio management is another way that we can continue to facilitate strong returns. Let me shift now to share a few financial highlights as a result of the evolution of our real estate strategy. The sale leaseback of 10 to 15-owned stores is anticipated to close during the second half of the year, resulting in a net after-tax benefit of about $0.20 per share. We are under contract on 10 stores and expect to close on those stores in the third quarter. The expected net gain reflects a selective reinvestment of a small portion of the benefit from the sale back into our store infrastructure this year. For modeling purposes, the net gains will be recorded in operating income as an offset to SG&A. Given the migration to our new real estate development strategy, we anticipate that we have about a decade of runway from the sale of existing company-owned stores ahead of us. This increases cash flow over the coming years and is a great way for us to leverage the strength of our balance sheet. the more efficient owned development program is expected to drive lower new store rent. As the program ramps, these savings are anticipated to more than offset the incremental rent expense from the sale-leaseback of existing stores. In 2025 and beyond, the acceleration of our new store growth to about 90 stores annually should help us capture market share and bolster the high end of our long-term guidance ranges. We continue to have very robust new store economics, providing us the confidence to make this shift. Now, let me turn to our updated fiscal 2023 financial outlook. At the halfway point of the year, we are now forecasting low single digit comp sales and mid to high single digit earnings growth. We continue to believe this will be a year of solid performance for us as we continue to gain market share and advance our strategic initiatives. We are carefully watching many leading macroeconomic indicators, consumer behavior, and retail trends, as well as our own insights to assess the health of the consumer. While our customers remain healthy, we are more cautious about their discretionary spending in the second half of the year. At the same time, we are moderating our expectations for the performance of our seasonal categories based on our trends in the first half of the year that have been choppy and below our expectations. We believe it is prudent to recalibrate our expectations for both the discretionary and seasonal categories based on our year-to-day trends. For the year, we now anticipate net sales in the range of $14.8 to $14.9 billion, comp store sales growth of 1.3 to 2.5% growth. Our operating margin rate is expected to be in the range of 10.2 to 10.3% with net income of $1.12 to $1.15 billion. Diluted EPS is forecast to be $10.20 to $10.40. This includes a net after-tax benefit of about 20 cents per share for the sale-leaseback. We anticipate about 15 cents will be recognized in Q3 and 5 cents in Q4. In the light of the updates to our real estate strategy, anticipated capital expenditures for the year are now forecasted to be in the range of $800 to $850 million compared to our prior range of $700 to $775 million. This increase reflects the move to owned development for select new store growth that will be funded through the sale of existing stores. It is important to note that the proceeds from the sale of our owned stores are expected to offset the incremental capital outlay under the development program. the combined transactions are expected to be relatively neutral to our cash position. As to the calendarization between the third and fourth quarters, we continue to believe that comp sales will be stronger in the third quarter than the fourth quarter. Both quarters are modeled to achieve comp sales growth. Please keep in mind that we are lapping a monumental winter storm in the fourth quarter of 2022 that we estimate contributed 200 basis points to comp sales in the quarter. As for retail price increases, our plans continue to reflect a moderation from the impact of inflation. At the same time, we would anticipate a pickup in our comp transaction growth as we experience this quarter. Our guidance reflects ongoing gross margin expansion in the second half of the year. We anticipate continued benefit from transportation and the new distribution center, along with some pressure from unfavorable product mix. For the third quarter, our SG&A performance, exclusive of the sale leaseback, is anticipated to be in line with the second quarter. In the fourth quarter, however, we expect a modesty leverage, given the compares from the prior year. For modeling purposes, the Orsland stores will go into our comp calculation in 2024, based on when the store is converted to our point-of-sale system. We will share more details when we provide our 2024 outlook. Looking ahead, we will remain agile and play offense. We will leverage our core competencies that have served us well, all while strengthening our capabilities and investing in our life out here growth strategy. For tractor supply, we expect to end the year in a strong position for the future. Now, I'll turn the call over to Hal to wrap us up. Thanks, Kirk.

Stepping back, Tractor Supply has achieved remarkable growth over the past few years, and the team has done an excellent job scaling our processes, capabilities, and organization to manage this growth. Key operational areas like inventory and payroll grew materially but at a lesser rate than sales and were always in control. Key philosophies like EDLP were re-embraced, and our marketing media mix shifted fully away from print to digital. And the combination of these two enabled our promotional activity to achieve all-time lows, and we remain there. In addition to these efforts, we launched our Life Out Here strategy to continue the ongoing transformation of our business. This strategy helped lock in new customers, substantiate our market share gains, and is a platform for our future growth. The timing could not have been better. At the halfway mark of 2023, it is shaping up to be a solid year for tractor supply on top of three extraordinary years. Our market is stable and our customers remain healthy. The team is effectively controlling what we control. As we celebrate our 85th anniversary, tractor supply remains a unique, highly differentiated retailer. Our needs-based business model has a track record of growing through various economic conditions. As a company, we have a proven ability to manage through dynamic environments, whether that is a macroeconomic or seasonal weather trends. Our customers and team members are passionate about the out-here lifestyle, and they prioritize it. Our customers over-index as homeowners, landowners, pet owners, and animal owners. As the market leader, we have substantial advantages that are getting stronger every day. Additionally, investment in our life out-here strategy has critical mass. The natural evolution of our real estate strategy is furthering our competitive advantages. We see meaningful growth potential in our markets. I remain extremely confident that we have a tremendous runway growth ahead of us. And with the right team and the right strategy, we're continuing to build a strong foundation for the future. With that, let's open up the call for questions.

Thank you. 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're using a speakerphone, please remember to pick up your handset before asking your question. Our first question will come from a line of Karen Short with credit tweets. Your line is now open.

Hi, thanks very much for taking my question. I'm going to just kind of roll two into one, if that's okay. So the first question and tied into the second was that I think you always had the assumption that your kind of comp would be 1% to 2% above GDP, and that relationship doesn't seem to be holding right now. So I just want to talk about that. And then excluding the benefit of the sale leaseback, you had also kind of indicated 23 would be the peak investment period for you. And then we should start to see operating margin expansion in 2024. Is this still your thinking? And I guess I'm again, excluding the so leaseback development and then benefit. Thanks very much.

Hey Karen, good morning and thanks for joining the call. On your first part of the question, A bit to my comments earlier, we see this period of time as a bit of an aberration versus our kind of ongoing growth algorithm. As you see in GDP and you see where PCE is going and then you see the shift from goods to services right now, services historically have been 68%, 69% of spend. Goods kind of 31, 32. As you know, goods kind of shifted up to say 35, 36% during the pandemic. We're kind of halfway back on that march back to 31%. So that, as we said in our prepared remarks, is a bit of a headwind in our business, but certainly expect that we've got maybe halfway to go on that, and then it would level back out in its normal equilibrium and would expect that our growth algorithm would return to that 1% or 2% above GDP growth in the guidance we've given historically. Again, we just view this period of time as a bit of an aberration from that long-term algorithm, just given the macro dynamics And then the second thing is no change to the guidance, so to speak, that we've given on the out year. Certainly expect 2023 to still be our peak investment year. As you mentioned, the sale leaseback is really just a 20 cents plus or minus that'll be in every single one of our years going forward as an adder to our EPS. But expect that we'll be at our peak investment period this year. And that will start to moderate down next year with an opportunity for margin expansion accordingly. Great. Thanks very much. Thanks, Karen.

Thank you, Karen. Our next question comes from the line of Scott Ciccarelli with Truist. Your line is now open.

Good morning, guys. Scott Ciccarelli. So I have a question on the real estate changes as well. I mean, it makes sense that you guys can improve your cost structure as you take ownership of the build. But if you would expect your stores to remain productive over a long stretch of time, isn't the better model to actually own the stores outright rather than lease in the first place? How obviously you have some history with that at one of your prior shops. Or does this real estate shift suggest that we may see changes to the existing footprint, whether it's changing locations, you know, kind of relocation type scenario or different sizes, et cetera. Thanks.

Hey, Scott. This is Kurt. Good morning. And, you know, the real estate model, as you think about the opportunity that we have to drive a strong performance of new stores that we've seen since there's a structural shift in the tailwinds into the rural economy, into our markets, the new stores are performing well. As John mentioned, we built a real estate team that is ready to begin to ramp back up to a 90-ish new store. The sale-leaseback of existing stores fits right in with that. We're an asset-light model. Do not believe owning stores fits, which is why we have over 95% of our stores under a lease. And over time, 30-plus years, we've accumulated not strategically a number of owned stores. There's a bit of pent-up value in these stores, and it's a great time right now to use those stores to fuel and be able to keep a cash-neutral value to execute on a strategy that allows us to even further drive new stores, bring efficiency in the new store model. So I look at those, we look at those very much tied in between as a great way to fund a model that drives greater long runway, greater TSR in the overall long-term algorithm. And I really keep both of those very much tied together as part of a key part of our operations.

I'll take the rest offline. Thanks, guys.

Thank you, Scott. Our next question comes from the line of Michael Lasser with UBS. Your line is open.

Good morning. Thanks a lot for taking my question. So you did a 2.5 comp in the second quarter with 500 basis points of like-for-like price inflation. You probably got some demand that was shifted out of 1Q into 2Q, and you're guidance implies you're going to do call it a one to two comp for the back half of the year, even as you lap some of the big price increases from last year. So can you give us a sense for what is an accelerate or improve in a business to offset the mitigating contribution from inflation? And have you already started to see that quarter to date?

Thank you. Hey, Michael, and good morning. A couple things. First off, I wouldn't – I don't think it's a fair comment to say we had sales from Q1 shift into Q2. I just think given the weather and the seasonality that we had this year, we don't have any data or insights or customer purchase data that would suggest that there was any pull or kind of deferral into Q2 or weather-related kind of shifting into Q2. So I'd say that's not something that we have to offset as you think about from a sequential perspective. The second thing I'd say is we have seen comp transactions sequentially improve throughout the quarter and continuing into Q3 and expect that that will be the case throughout the year. And on AUR, as we've talked about all along, we expect that that will moderate through the year. Big ticket lessens as a percent as we get through the year. So that provides a bit of a kind of mixed benefit. And then lastly, on the UPT, we do think we're at close to the bottom of units per transaction. If you go back and look over the last 15 years at our units per transaction trends, we reached an all-time high during the pandemic. As people were stocking up and consolidating their trips, we're now much closer to where we were during the 2008 Great Recession and kind of reached that bottom. And so we expect that will be a lesser headwind as we move forward. So when you put those things all together, that ends up with the guidance that we shared. And, you know, I think we try to be as conservative as possible on the low end and realistic as possible on the high end.

Thank you.

Thank you, Michael. Our next question comes from the line of Chuck Grom with Gordon Haskett Research Advisors. Your line is now open.

Thanks. Good morning. You know, Hal, there's some concern out there that as households continue to revert back to pre-COVID behaviors, that some of the gains that tractors enjoyed over the past three years when sales per store has moved from, you know, call $4 million to $6 million will be given back. I'm curious how you'd address this concern, and can you highlight the key drivers that a tractor can control in the back half and into 24?

Yeah, hey, Chuck, and good morning, and thanks for joining the call. As I think we all know on this call, this has been a question for 18, 24 months. And, you know, what I'd say is we continue to see a very healthy customer base. Our active customers were at all-time highs this quarter. We saw positive comp transactions in the quarter. And if you look at the categories that are driving the footsteps and driving our customers, it's things like pet, animal, and those are based on counts of population out there in each of those categories. And then the last thing I'd point out is our share gain. At least half of the volume that we've grown over the last handful of years has been share-related. And so if I point to share, active customers, comp transactions, pet, animal, and look at those things, it's just a very different business than many of the other companies that kind of had a pandemic benefit and reverted, whether it was technology-related companies that had a user base that shifted online and then pivoted back, or maybe something that's home-related, electronics-related. You know, we're just a very different business and don't see any elements of reversion in our customer base or business.

Thank you.

Thank you, Chuck. Our next question comes from the line of Daniel Embro with Stevens. Your line is now open.

Good morning, everybody. Thanks for your questions. I wanted to follow up on who that new customer is. How is the retention trending? I think you mentioned they're younger, so I'm curious, is there a difference in spending power between this most recent vintage of new customers and the historical ones? And are we seeing any change in the Neighbors Club adoption? I would think the push towards value makes the loyalty program more valuable. Can you provide any commentary or quantification around how that's trending differently?

Yeah, hey, Daniel, and good morning. To start out by first saying we're very pleased with the trends we're seeing in new customers. We had record high new customers in 2020 and 2021. As we've talked about on past calls, and I mentioned in prepared remarks, the Neighbors Club program being relaunched in April of 21 was incredibly well-timed as it allowed us to lock those new customers in We've grown, I think it's 15 million members over the last three years in our Neighbors Club program. And we've had increased retention rates of our Neighbors Club program each of the last few years too. So we've locked those cohorts in. They're growing with us and they're remaining active. Certainly as we got into 2022 and things balanced some, we saw our new customer counts on a year over basis trend down. That is now leveled out. and we feel really good about our new customer trends as we move forward. And sequentially, you know, that should be helpful as we look at year-over-year improvements. On the Neighbors Club program, continue to be very pleased with the 31, 32 million members of Neighbors Club that we have. Our top tier has grown, and we've reached a record number of customers in our top tier. Retention rates remain at all-time highs and continue to improve, and our Neighbors Club members continue to out-comp our overall base. And again, that's on 75% of our sales. So as I've said several times, our customer base is very healthy. Record active customers, positive comp transactions, solid trends in new customers, and feel really good as we're heading into the third quarter on our active customer base and our strength of our customer.

Thank you. Thank you, Daniel. Our next question goes to the line of Seth Sigmund with Barclays. Your line is now open.

Hey, good morning, everyone. So my question is around the second half guidance, the implied margins. It does seem like you're baking in potentially more margin improvement in the second half of the year versus the first half of the year, despite potentially lower comps. And I know some of that now is the sale-leaseback, but I guess two questions. One, can you just remind us and maybe help bridge some of the drivers for the second half margin expansion? And then second, how do you think about potentially reinvesting more of that margin improvement given the sales performance that you're seeing? Thank you.

Hey, Seth, this is Kurt. I'll take the first part of that question, and I'll let Seth answer the second part in regards to the reinvestment of any margin. The performance on an operating margin standpoint for the second half on a gross margin standpoint, will be very similar to second quarter. We continue to see, and as we signaled and guided at the beginning of the year, we have strong performance from everyday low pricing. We expect to continue to see transportation being the biggest benefit and fueling of the gross margin expansion. As a reminder, over the two years where transportation costs were pressured, we absorbed most of that, and this is anticipating somewhat transitory, we're getting the return on that in 2023. On an SG&A standpoint, that's really the big difference in, say, the second half, as you're observing. We expect Q3, on an SG&A standpoint, excluding the sale-leaseback benefit, to perform very similar to Q2 in that 70, 80 basis points deleverage, principally from the investments in the business. But Q4 really has the best compares. And so in line with what we expect to go into here, when you look back at the fourth quarter of last year, where while we had robust sales, we had increased costs in repairs from the storm. We had Orslan acquisition transition. We had higher incentive compensation. We are lapping that, and we expect in the fourth quarter, excluding the benefit from any sale leaseback, to really still only have a modest level of SG&AD leverage, principally on the comparison. So if you hold the gross margin, you get better performance on SG&A. It's really about how well we're managing the spend. And I also can't ignore that the team has done an excellent job scaling the cost, leveraging investments we made. We are seeing significant efficiencies, even SG&A, on the distribution and supply chain side of the business, driving lower costs and some efficiencies beyond our expectations. With that, Seth, maybe you can address the second part of that question.

Yeah, thanks, Kurt. Yeah, in relation to should we reinvest and how we think about that, first I would just say EDLP remains our true north, and that strategy is continues to pay off for us if you look at the success we're having with our Q-related activity, our transactions, and our continued record kind of customer accounts that are coming to Tractor Supply. And our plan is to continue to maintain that EDLP focus and not to revert from that. We will reinvest if we decide we need to, but we do not foresee a need for any meaningful type of reinvestment. And lastly, I would just kind of say is that our inventory position continues to be very strong and very favorable. And as we look ahead to the back half, instead of kind of a reinvestment of margin, we've put ourselves in a position to really partner with our key suppliers to go out there, get special buys, go after key values, and make sure we have meaningful values for our customers to drive the full basket. So I'm very pleased. I think we have an incredible team. We've got a great reset activity coming forward that we can manage the top line or we can drive the top line, drive market share, while at the same time really be able to manage the margin structure as well. Okay.

Thank you, guys.

Thank you, Seth. Our next question comes from the line of Peter Benedict with Baird. Your line is now open.

Hey, good morning, guys. So I wanted to maybe, Al, speak a little bit more about the historical context here. I mean, you started to mention some things in answering Mike Lasser's question, but obviously we're coming off of an unusual period with COVID. You're starting to see this normalization occur. The behavior of your consumer is changing. Maybe just talk a little bit more about what that means to the credit, the basket trends, And then what we think that kind of is indicating here over the next kind of six to 12 months. I know you're assuming this will continue in the back half of this year, but how are you just thinking about it longer term? Thank you.

Yeah. Hey, Peter, and good morning. If you look back over 30 years of this company's comp growth, it's been almost equally split 50-50 between average ticket and comp transactions. And if you look really at our body of work over the last three and a half years during the pandemic, there's definitely been periods of time of inflation, periods of time of UPT increases, but if you look at it collectively, it's about 50-50 comp transactions and average ticket. That's just the formula that has really just kind of always been there in our historical numbers. And our expectation is that as we navigate the current economy that we're operating in and consumer behavior is that we will migrate back to that historical blend as we kind of exit this year and move into next year. And there's going to be some ins and outs, as we said, in the second half of this year where we expect UPT, the headwind there, to kind of level out as we get towards the end of the years. And we expect AUR to kind of come down. Those will work a little bit together. Big ticket becomes a lesser portion of sales. And so we get that mixed benefit there. And that all works out to an okay average ticket. We're seeing comp transactions increase. That kind of balances a little bit right now and ends up delivering on the kind of implied guidance that we have for the second half of the year. And You know, on the comp transactions, as I said, we had all-time record active customers this quarter. Our active customer base grew this past quarter. They're shopping us more frequently. We're seeing them do a little bit of deconsolidation of their trips, as Kurt mentioned, but we're also gaining significant share in footsteps. And in categories like pet food, where we continue to take substantial share, we're really viewed as kind of a value play, almost a warehouse-like model. I mean, our average pet food bag size is 35 pounds, you know, and that's very different than, say, pet specialty and others, and if you look at a price per pound basis, I mean, we can be as good as 20, 25, 30 percent, you know, advantage on a price per pound basis, and so we're just, you know, that naturally drives footsteps in our store, so the mix will evolve a little bit throughout the balance of this year, but we've certainly thought it all through, and expect that over time it'll revert back to its historical performance of kind of a 50-50 blend.

Megan, we'll go to the next caller, please.

Absolutely. Thank you, Peter. Our next question will come from the line of Peter Heath with Piper Sandler. Your line is now open.

Hi, everyone. I hope everyone's having a good morning. I wanted to just follow up on the new real estate strategy, and just putting it in the context of your long-term algorithm, is it meaningful enough that perhaps some of those targets on an annualized basis could be adjusted? I guess I'm looking specifically at the sales growth target of 6% to 7%, and then the EPS growth target of 8% to 11%. Hey, Peter, this is Kurt.

The new real estate model, one of the many things that we're excited about is not only does it give us the long runway, but to your point, you move from 70 to 90 stores a year. It's driving incremental sales. Those new stores have the expected to have the consistent tailwind into the comps. We believe this new real estate strategy not only gives us a longer runway, but really strengthens the long-term algorithm, gives us more confidence in that, and bolsters the higher end of that. Mid-year through the year, we typically don't and aren't adjusting our long-term guidance. We certainly will factor all of that in along with the outlook for 2024 as we report in our Q4 earnings, typically refreshing any adjustments to our long-term targets at this point. But we're excited about what it does for the long-term algorithm and the overall total shareholder return.

Okay, thank you. Good luck in the back half.

Thank you, Peter. Our next question will come from the line of Brian Nagel with Oppenheimer. Your line is now open.

Good morning. Thanks for taking my question. So the question I have, maybe just dig a little bit deeper into the commentary around the trends in seasonal sales. What I would ask there is, you know, you talked a lot about the weakness here. It follows similarly what we saw in Q1. But any geographic differences that you noticed? And then as we move down to Q3, and we recognize, you know, you have trim guidance of the year, but did you see any type of rebound in seasonal sales as maybe some of these weather, some of them, not all, some of these weather events have started to abate?

Yeah, hey, Brian, and good morning. As I mentioned in my prepared remarks, the seasonal business was kind of on expectations in the month of April and May. We talked about that in our earnings calls for Q1, giving kind of a quarter-to-date perspective on that, and also just our commentary through the quarter publicly. And then June, as I mentioned, we saw significant underperformance in our seasonal business, and that was really the bulk of our myth for the entire quarter was our seasonal business in the month of June. As I mentioned, it was a topsy-turvy quarter, particularly in the month of June, with all the various environmental conditions that were out there. But to your point, we did see bright spots at moments in time throughout the quarter, as well as at certain parts of the geography. As an example, the kind of 10 days leading up to Memorial Day, were very good from a seasonal perspective and a total business perspective as the sun was kind of out almost across the entirety of the country. And we had a really good 10-day run there. Historically, you see something like that for at least a few weeks of the spring. We just only had that kind of short period. But if you look in the southeast, in the South Atlantic, as Kurt called out, we had a excellent performance there from time to time in both Texahoma and the far west. When we had good seasonal performance, we had strong, I mean, we had good weather, we had seasonal performance there. And then as Kurt called out, some of our underperforming regions around the Midwest and the Northeast, I mean, the Midwest went straight from winter to drought. And in the month of June, it rained 21 days in the Northeast. And so those were Those were large contributors to the underperformance in the month of June. So anyway, that's just a little bit of more depth and commentary there, Brian.

Great. I appreciate it. Thanks.

Thank you, Brian. Our next question will come from the line of Zach Fatum with Wells Fargo. Your line is now open.

Hey, good morning. Hal, you had hinted at another iteration of the Neighbors Club program at some point in 2024. So first of all, can you talk about the list, the comp list you saw the last time you updated the program? And is there any info you can share on the types of changes that are on the table that you think could make the program better?

Hey, Zach, and good morning and very perceptive. First off, I'd say on the comp list, it's hard to calculate that, both given the magnitude of the comps that we had in that period, but what I would say is we can absolutely look at the 15 million Neighbors Club members that we've added over the last few years and when they started to shop with us and how we locked them in using the Neighbors Club program. I've spoken to that many times, but We feel great about the cohorts from that first revision of our Neighbors Club program. As we look ahead, we've been getting a lot of feedback from our customers, and we can make it even better in the next version. Doing some things to uniquely call out certain characteristics of customers. If they're, say, a horse owner or, say, a military veteran, what can we do to better tailor that when they self-identify? There's also some things we can do on our rewards and maybe bite-sizing the rewards up and giving some $5 rewards instead of always $10 rewards. We're also looking at a way to add, say, a fourth, perhaps even a fifth tier. As we mentioned, we've got our largest number of highest value customers ever. How do we actually take it up another tier and even give further rewards for those that are in that tier? So looking at a lot of ways that, again, it's You know, that program locks our customers in. It encourages spin. It encourages migration. It really encourages purchasing on big ticket and then redemption on the Q businesses. We're just looking for ways to reinforce that more and also make it more personable for our customers. And the team's hard at work on it, and we have more detail on it. We look forward to sharing it.

Got it.

Appreciate the time.

Megan, we'll take one more question as we're at the top of the hour. Take one more.

Absolutely. Our final question will go to the line of Steven Zaccone with Citigroup. Your line is now open.

Great. Good morning. Thank you very much for squeezing me in. So I wanted to just go back to the sales guidance change just to better understand how much of the change in sales guidance is really due to seasonal missing expectations versus the discretionary being a bit weaker. You know, in one sense, the first half was really choppy with weather throughout the year, as you discussed. So that would be helpful. And then when you think about getting back to mid-single-digit, which is the original guidance, what's the biggest kind of drivers to get you back to that trend in the business? Thank you.

Hey, Steven. This is Kurt. Appreciate the question. As we talked about when Brian asked the question on Q2, I'll go back to the fact that a bit of Q2's performance, you have to acknowledge that as we saw some differentiation between some of the geographies, that indicates weather was a contributor. But even in some of the strong geographies and across all that, we saw a pullback on some of the discretionary. We're going into the second half acknowledging that it's a different seasonal trend period of time, particularly in the Q4. We plan for base weather. We do not plan for more favorable weather. And at this point, on the seasonal categories, unless we look at it as base and unless there's a strong demand for our product because of a shift in weather seasonal, the consumer on some of the discretionary items is a little bit more prudent on that today. And then also we acknowledge, as I mentioned, some of the impulse and discretionary categories. So we anticipate that the consumer behavior is in line with the first half of the year. We're taking a reasonable prudent approach there. And then we're also factoring in the strong winter storm that we had in the fourth quarter that we're lapping up against. But underpinning all of that, is a strength in our year-round core business running in the mid-single digits. Comp transactions still performing strong at this point, and we've got a really good, healthy customer. Hal mentioned some of the shifts that we've seen. UPT coming off some of its highs. As you revert back to the mid-single digits, it's really a matter of UPT and the consumer coming off of the... the cycle as we've seen the last couple quarters and really having more strength in the size of their basket and the demand for the discretionary. And we could be a couple quarters away from that and we factor that into our guidance. Our guidance is reasonable. We're not factoring in a favorable shift in the consumer or a strong shift in favorable weather. It's taken all those factors that we've seen year to date as well as some of the headwinds in the second half.

Okay, I appreciate that detail. Thanks, Kurt.

Thank you, Stephen. That will conclude our question and answer session. So, at this time, I will pass the conference back over to Mary Winn for closing remarks.

Thank you, Megan. This will conclude our call. I am available for any questions or follow-ups, so please feel free to reach out. And we look forward to speaking to you at our Q3 earnings call in October. So thank you.

That concludes today's conference call. Thank you for your participation. I hope you have a wonderful day.