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Edited Transcript of TSCO earnings conference call or presentation 25-Jul-19 2:00pm GMT

Q2 2019 Tractor Supply Co Earnings Call

Brentwood Aug 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Tractor Supply Co earnings conference call or presentation Thursday, July 25, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gregory A. Sandfort

Tractor Supply Company - CEO & Director

* Kurt D. Barton

Tractor Supply Company - Executive VP, CFO & Treasurer

* Mary Winn Pilkington

Tractor Supply Company - VP of IR & Public Relations

* Steve K. Barbarick

Tractor Supply Company - President & COO

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Conference Call Participants

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* Brandon Fletcher

Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst

* Charles P. Grom

Gordon Haskett Research Advisors - MD & Senior Analyst of Retail

* Christopher Michael Horvers

JP Morgan Chase & Co, Research Division - Senior Analyst

* Daniel Robert Imbro

Stephens Inc., Research Division - Research Analyst

* Katharine Amanda McShane

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Oliver Wintermantel

Evercore ISI Institutional Equities, Research Division - MD & Fundamental Research Analyst

* Peter Jacob Keith

Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst

* Peter Sloan Benedict

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Seth Ian Sigman

Crédit Suisse AG, Research Division - United States Hardline Retail Equity Research Analyst

* Simeon Ari Gutman

Morgan Stanley, Research Division - Executive Director

* Steven Paul Forbes

Guggenheim Securities, LLC, Research Division - Analyst

* Zachary Robert Fadem

Wells Fargo Securities, LLC, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Tractor Supply Company's Conference Call to Discuss Second Quarter 2019 results. (Operator Instructions) Please be advised that reproduction of this call in whole or in part is not permitted without written authorization of Tractor Supply Company. And as a reminder, this call is being recorded. I would now like to introduce your host for today's call, Mary Winn Pilkington, Vice President of Investor and Public Relations for Tractor Supply Company. Mary Winn, please go ahead.

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Mary Winn Pilkington, Tractor Supply Company - VP of IR & Public Relations [2]

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Thank you, Greg. Good morning, everyone. On the call today are Greg Sandfort, our CEO; Steve Barbarick, President and Chief Operating Officer; and Kurt Barton, our CFO.

Now let me reference the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. This call may contain certain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the company. In many cases, these risks and uncertainties are beyond our control. Although the company believes the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct, and actual results may differ materially from the 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 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.

After our prepared remarks, we will open the call up for your questions. (Operator Instructions) We will be available [after] the call for a follow-up after the call. Now it's my pleasure to turn the call over to Greg.

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Gregory A. Sandfort, Tractor Supply Company - CEO & Director [3]

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Thank you, Mary Winn, and good morning to everyone joining us on the call today. Overall, Tractor Supply had a very solid second quarter, which allowed for a strong first half performance for the company. Our second quarter results were driven by sales strength across all geographic regions as well as both in comparable average ticket and traffic. We saw broad-based strength across our merchandising categories with notable strength in our core year-round categories and solid sales growth in our spring and summer assortments.

Our second quarter results represent the eighth consecutive quarter of comparable store sales above 3%. And during the quarter, the Tractor Supply team was very nimble across store operations, merchandising and our supply chain, which enabled us to capitalize on the shifting consumer demand for products across the many markets that we serve. At the same time, we were in-stock for our customers with our everyday basic assortments that we know our customers rely on us to have so that they may continue to live the Out Here lifestyle.

Now that we are at the halfway mark of the year, we are updating our outlook for the full year. And as we enter the third quarter, we believe our merchandising and marketing initiatives, accompanied with our ONETractor strategy initiatives, have us well positioned to drive our business for the second half of the year.

Now let me touch on a few highlights from the second quarter as compared to the second quarter a year ago. We delivered a strong comparable store sales increase of 3.2% in the second quarter with comp average ticket increasing 2.2% and transactions growing at 1% in the quarter. This marks over a decade of annual positive traffic growth. Net sales plus 6.3% to $2.4 billion for the quarter, as we continued our strategy to open new stores in both Tractor Supply and Petsense. Diluted EPS was $1.80, an increase of 6.5%. And year-to-date, we have returned $414 million to shareholders through the combination of share repurchases and cash dividends.

During the second quarter, as a demonstration of our confidence in our business, our Board increased our dividend by 12.9%. This marks the ninth consecutive year of dividend increases. In addition, our share repurchase authorization was increased by $1.5 billion as we remain committed to maintaining a disciplined capital allocation strategy to create long-term value for our shareholders. And based upon our performance year-to-date, we are raising the low end of our full year earnings guidance by $0.05, bringing our new range to $4.65 to $4.75 per share.

Now let's review several of the operational highlights for the second quarter. We opened 15 new Tractor Supply stores and 2 Petsense locations. Our newest distribution center in Frankfort, New York received LEED Silver Certification from the U.S. Green Building Council, reinforcing our commitment to sustainable business practices. Our GURA and Hi Five programs, which were part of our unique selling process for our store teams, continue to drive sales through legendary customer service. This quarter, we continued strong double-digit sales growth in our e-commerce business and during the second quarter, we continued to experience solid growth with our Buy Online Pickup in Store programs.

Our customers appreciate the relevance of our stores in the rural community. And between the combination of our Buy Online Pickup in Store and direct delivery to stores, greater than 70% of our e-commerce orders are being fulfilled at our stores. This continues to illustrate the importance of our store assets and their key role in the fulfillment of our e-commerce business. And more importantly, this is a very cost-effective way to fulfill our customers' orders for the products that they need with greater speed and efficiency.

We believe that our capabilities of Buy Online Pickup in Store, mobile point-of-sale, Neighbor's Club and Stockyard ordering position us uniquely to serve this customer base better than anyone else in this highly fragmented market. And we see significant opportunities to broaden our customer reach and increase our market share as our store base and digital capabilities mature over time. As we've said, our ONETractor strategy remains focused on 4 objectives: driving profitable growth, building customer-centric engagement, offering the most relevant products and services and enhancing our core and foundational infrastructure capabilities.

We are building a solid momentum behind our ONETractor strategy that serves our customers anytime, anywhere and any way they choose. And I believe our ONETractor strategy positions us to meet the unique preferences that our customers have for demand-driven, immediate need products in an easy and seamless shopping experience.

We also believe that the continued convergence of our physical and digital storefronts and the updates to our in-store and online shopping experiences are not only resonating with our customers, but they are defensible. It is an exciting time for Tractor Supply, and as we grow larger, we believe, we have developed superior capabilities to better serve the Out Here lifestyle customer. Now let me turn the call over to Steve.

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Steve K. Barbarick, Tractor Supply Company - President & COO [4]

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Thanks, Greg, and good morning, everyone. I wanted to take a moment this morning to give you a brief update on product performance during the quarter, the progress we're making on building on our capabilities and a look forward to the second half of the year.

As Greg mentioned, during the quarter, we had a solid comp store sales performance, driven by both average ticket as well as continued increases in traffic. The team was nimble and well-prepared to capitalize on the spring selling season with a great lineup of merchandise in our stores as well as online.

Our strong average ticket growth of 2.2% was positively impacted by several factors, including product mix and overall retail price management. We are able to capitalize on seasonal trends during the quarter. Our updated assortment of outdoor power equipment produced positive results. Tractor Supply continues to be a shopping destination for this important category.

Turning to traffic. We benefited from consistent performance in our everyday merchandise, otherwise known as consumable, usable and edible or C.U.E. products. During the quarter, we were pleased with our sales dollars and unit growth across these consumable categories. For example, we experienced strength in product lines such as pet food and supplies, animal feed, live goods, grass seed and forage, to name a few. As a company, our mission is to be a dependable supplier of basic maintenance products, and it's these products that drive repeat traffic to our stores.

Turning to big ticket sales. We had strength in zero turn mowers, welders and 3-point equipment. Given the seasonal trends in the second quarter, especially in the Northeast and Midwest, we did experience some softness in our front-engine motors, cooling products as well as trailers. We were [lapping] significant big ticket growth in the second quarter of last year, and as a result, our big-ticket sales were down slightly.

Lastly, we were pleased that all major product categories delivered positive comp store sales in the second quarter. Our supply chain did an excellent job staying nimble and managing to the needs of the business. Our ability to capitalize in geographic weather trends is a core competency and strength of Tractor Supply.

Now let me turn to the progress we're making on building on our capabilities. Consistent with what we communicated at our May Investment Community Day, we continue to be pleased with the traction we are gaining with our key initiatives. Specific examples include capabilities such as growing our Neighbor's Club engagement, the chain-wide rollout of our Stockyard kiosk and mobile point-of-sale technology, enhancing our Tractor Supply credit card offering and investments in our supply chain.

As part of our ONETractor strategy, we are actioning the rich customer data we are receiving from our loyalty program. The data allows us to target specific customer groups based on their frequency and category-specific spendings. This personalized approach is allowing us to drive engagement and build share of wallet over time. By using our customer data to identify people who shop in specific categories, we're able to target potential new customers in social channels. We then use targeted messaging to these customers because our modeling gives us confidence that they're more likely to purchase in whatever category that we're targeting.

This year's spring marketing campaign for power equipment was a great example of how we're leveraging our data. We knew we wanted to make a bold statement about our great lineup of power equipment. Our goal was to stay top of mind with our current customers who were in the outdoor power equipment market, while also introducing the Tractor Supply brand to new look-alike customers. The team created a series of videos featuring brands such as Bad Boy, Cub Cadet and Husqvarna to ensure customers knew that we carry these brands. We then used machine learning to digitally market these videos across multiple online sites to existing customers and potential new customers that had an affinity toward the outdoor power equipment business. We geo-targeted these ads around each of our stores. These videos were viewed over 8 million times and linked to more than 300,000 store visits. These are significant and measurable results, and we are able to unlock the power of our customer data and be highly efficient with our digital marketing campaigns.

Our Neighbor's Club membership growth continues to be a transformational and growing asset to drive brand loyalty. With a 1-year retention rate at nearly 90%, our customers' feedback continues to be overwhelmingly positive. The use of Neighbor's Club data to drive sales by improving customer targeting and personalization continues to evolve based on customer insights. Using our new campaign management tool, thousands of versions of each campaign are being deployed as compared to a limited manual process in the past. As a result of more relevant messaging, our personalized campaigns are outperforming the control group.

The rollout of our Stockyard kiosks will allow us to provide even more customers with the long tail of product assortment, as we have well over 100,000 SKUs on our website. At the store level, the Stockyard kiosks are a proven tool for driving incremental sales. The rollout of these kiosks, along with the expansion of mobile point-of-sale technology, is anticipated to be completed by the end of the third quarter.

The Tractor Supply credit card offering supports our ONETractor strategy by driving sales and building loyalty. We have seen the use of our private label credit card increase across-the-board as a result of more compelling financing offers. We know that our credit card customers visit our stores more frequently and have a higher average spend. Starting in the fourth quarter of this year, cardholders will be able to earn $5 in Neighbor's Club rewards for every $100 they spend on the card, essentially, a 5% reward. This compares to $5 for every $150 under the existing program.

Over time, we anticipate that this will become a key tool in deepening our relationship with our customers, drive loyalty and increase our share of wallet.

Let me now briefly highlight a few merchandising initiatives we have for the back half of this year. To build on our portfolio of exclusive brands, next month, we'll be introducing a new Workwear line called Ridgecut. We've recognized that we have an opportunity to close the gap in our assortment in the Workwear category. The brand standards we compared Ridgecut to includes Duluth Trading, Filson and Carhartt. The Ridgecut pipeline is designed for exceptional quality and durability with a great value proposition. The product line will retail at 20% to 30% less than the national brands. We are very excited about this brand launch as we transition into the fall season.

We have 2 additional brands we will be launching in the third quarter. First up is our partnership with Miranda Lambert's MuttNation Foundation. We will offer an exclusive assortment of branded dog beds, toys and supplies. To kick off this partnership, we will be hosting a nationwide pet adoption event in our stores as a part of our month-long Out Here with Animals celebration. This event aligns perfectly with MuttNation's mission to promote and facilitate the adoption of sheltered pets.

Just in time for deer season, we'll be launching the Catchin' Deers brand of apparel. This is a fun lifestyle brand for our hunters with a sense of humor. We are the first to partner with this brand that was cofounded by Mike Fisher, a former hockey player. Our product assortment will be exclusive to Tractor Supply. We've talked a lot about the importance of retail [theater] , and during the third quarter, in addition to our month-long Out Here With Animals campaign, we will also be having our fall Chick Days event across the vast majority of the chain.

To wrap up, we believe, we are well positioned to support our customers' needs in the second half of the year with our in-store and online product offerings, complemented with our store engagement initiatives, all supported by a nimble supply chain. I will now turn the call over to Kurt.

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [5]

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Thank you, Steve, and good morning, everyone. Overall, we delivered a very balanced quarter that came in much in line with our expectations.

For the second quarter of 2019, we had solid comp store sales growth of 3.2%. April and June were the strongest months of the quarter, with moisture levels and cooler conditions impacting our performance in May and to a lesser extent, the early part of June in select markets.

Petsense stores continued to have positive comp store sales increases in line with our chain average. For the second quarter, gross profit dollars increased 6.7% to $820.7 million. Gross margin improved by 11 basis points to 34.9%. The increase resulted principally from product mix and effective price management initiatives.

Our merchandising and pricing teams did an excellent job, both planning for and reacting to the shifting time line relating to tariffs. In addition, for the first time in a few years, freight headwinds moderated and along with the favorable impact of our efficiency initiatives, freight costs were essentially neutral year-over-year.

Including depreciation and amortization, SG&A, as a percentage of net sales, increased 24 basis points to 22.7%. The increase in SG&A, as a percentage of net sales, was primarily attributable to incremental cost associated with the new distribution center in Frankfort, New York, and to a lesser extent, investment in team member wages. Partially offsetting these increases were leverage in occupancy and other costs from the increase in comparable store sales.

Specific to our Frankfort distribution center, we estimate that about 20 basis points of our SG&A increase as a percent of sales is attributable to the ramp-up of the DC in the second quarter. As the distribution center increases the number of stores it serves in the back half of the year, we anticipate the deleverage to be slightly less in the back half.

Excluding the impact of DC ramp-up, we had good underlying SG&A performance. For the quarter, our effective tax rate was 22.4%, as we received incremental, nonrecurring tax benefits from share-based compensation.

Now to our balance sheet and cash flow. We have a strong balance sheet, and we continue our track record of generating robust cash flows from operations. At quarter end, our merchandised inventories were $1.73 billion, an increase of 3.5% on a per-store basis from the 2018 second quarter. The increase is principally due to inflation, inclusive of the impact of tariffs as well as growth in fast-turning C.U.E. merchandise to support the positive trends in the business. We believe, our inventory is in great shape and we are very comfortable with its quality. As we enter the second half of the year, we are well positioned to take advantage of the change of the seasons.

We remain committed to returning cash to our shareholders through our share repurchases and dividends, while maintaining a disciplined approach to capital allocation. Through the first half of the year, we repurchased about 3.5 million shares of our common stock for $334.2 million and paid quarterly cash dividends totaling $79.7 million. Since the inception of our share repurchase program in 2007, we have repurchased approximately $2.8 billion of our common stock. With the increased share repurchase authorization from our Board in May, our remaining share repurchase authorization was approximately $1.7 billion as of the quarter end.

Let's now turn to our guidance. Given our performance year-to-date, we're updating our financial outlook for 2019. For the year, we now anticipate net sales in the range of $8.4 billion to $8.46 billion, an increase of 6% to 7% over fiscal 2018. Comparable store sales in the range of 3% to 4%, operating margin rate of 8.9% to 9%, net income in the range of $562 million to $575 million and earnings per diluted share of $4.65 to $4.75 compared to our previous guidance of $4.60 to $4.75 per diluted share.

We continue to forecast our annual effective tax rate to be in the range of 22.4% to 22.7% and our capital spending in the range of $225 million to $250 million for the year.

While the timing of our new store openings is behind our original forecast, we continue to anticipate opening about 80 new Tractor Supply stores and 10 to 15 new Petsense stores. The shift in timing of new store openings does have a modest unfavorable impact on the top line sales as well as operating profit. This has been factored into our revised guidance for the year. We have taken steps to correct the executional issues impacting this timing. We continue to believe that our real estate model is a core strength of Tractor Supply and our pipeline for new stores in 2020 is healthy.

Our profit improvement plan work streams, which are focused on driving supply chain efficiencies, store productivity and indirect procurement savings remain on track. And we are committed to ensuring our spending is directed to our highest strategic priorities, all on a sustainable basis. Our profit improvement plan is designed to help mitigate cost pressures and enhance our ability to reinvest back in the business over time.

As you model the remainder of the year, please keep in mind key factors [to the] cadence of our profitable growth. We continue to anticipate operating profit performance and earnings growth to be stronger in the second half of the year. We are forecasting that our effective tax rate will be higher in the second half of the year as we don't anticipate that the discrete tax benefit from stock-based compensation in the first half of the year will occur at the same rate. Also recall that we're [lapping] an estimated 40 basis point benefit to comp sales growth from hurricanes in both the third and fourth quarter of 2018.

To wrap up, the first half of the year was strong. The momentum in the business is solid, and we are executing robust plans to continue to build the business for the long term.

Now, I'd like to turn the call back to Greg.

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Gregory A. Sandfort, Tractor Supply Company - CEO & Director [6]

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Thank you, Kurt. And in closing, I'd like to thank the nearly 30,000 team members across our entire organization for their commitment to our mission and values and their focus on delivering a great experience every day to our Out Here lifestyle customers. Their passion for living our culture is a competitive advantage for us. And while we've had a strong first half, we know we have much work to do to finish this year. As a team, we are energized about our business and look forward to talking to you again later this year regarding our third quarter results.

And with that, Mary Winn, we'd now like to open the lines for questions.

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Mary Winn Pilkington, Tractor Supply Company - VP of IR & Public Relations [7]

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All right. Greg, we can [poll] for questions, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And first from JP Morgan, we have Chris Horvers.

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Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [2]

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So question for you. As you think about the weather in the second quarter, do you think it was a headwind in the quarter? I mean we know we had a sort of a tough compare in May, but April was easier on the spring front. So do you think it was a headwind and could you quantify that? And then as you look ahead, and just looking at the map, soil moisture levels are very high in many of your markets. You've had that sort of recent heat waves. So do you think you'll have this extended spring season that you -- like you saw a few years ago?

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Steve K. Barbarick, Tractor Supply Company - President & COO [3]

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Yes. Chris, this is Steve. And I guess I would put it this way. I mean we're always navigating between year-over-year, what's normal, what's not normal. When I look at the totality of the business, Greg mentioned that we had strength in the spring seasonal businesses that we're positive for the quarter. I believe I've mentioned it as well. What I would also say is when you look into Q3 because we're already several weeks into the Q3 for us right now, it's in line with what our expectations have been. And so the last thing I would mention is our inventory is in good position to take advantage of any extended summer selling season we might have. And while at the same time, we are well prepared to take care of customers if we have an early cold weather [business hit] us in the quarter. So that's kind of how I see it shaping up. We're a nimble company and we can react pretty quickly.

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Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [4]

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And then as a follow-up, as you think about the tariff, how have you seen pricing play out in the market? What have you done and to what extent how did that affect your guidance for the back half of the year versus your original expectation?

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Steve K. Barbarick, Tractor Supply Company - President & COO [5]

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Let me start with that, Chris. This is Steve, and maybe, Kurt, you can follow-up on that. So we're a year into it, believe it or not, to the first wave of tariffs that we originally -- that we will pass through. And for tractor, we're in a little bit of a unique position of being a needs-based company, which really serves us well at a time like this. Over the years, we've made some key investments in some pricing tools, whether they be web [screening] that then feed into our pricing tool and allows us to know what's going on out there across the wide spectrum and manage our pricing accordingly. As you're well aware, our business has held nicely over the past several quarters. And if you look at the business, I mean it's working well within the 4 [walls of the box] as well as geographically. So we feel like our customers are in a pretty healthy position right now. And then the last thing I would say is we feel we're well prepared to manage the general uncertainties of these tariffs going forward. Kurt?

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [6]

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Yes. And Chris, I'd add to that and I'd just tag on to what Steve said at the end. One of the things we factored into the back half guidance is just an overall consideration of the back half of the year. This is the time where the consumer, if you think from a macro standpoint, this is the back half where the consumer is going to have all of the impact of these first 3 layers of tariffs. And we felt it was prudent to make sure an overarching consideration was what does that do to the consumers' spend and how will they adjust to [all-in] tariffs? And I would just say from a broad overarching theme, we had that as a key consideration when we designed the guidance, the updated guidance for the year.

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Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [7]

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So does that mean that some prices are [a little less,] but some volume headwind and a little bit of gross margin tucked in there, too, headwind as well?

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [8]

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Right. We were just aware that those are all factors. Whether they all go in that same direction, but those are adjustments or variables that could happen with the back half that's got some level of uncertainty.

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Operator [9]

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And next from Evercore ISI, we have Oliver Wintermantel.

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Oliver Wintermantel, Evercore ISI Institutional Equities, Research Division - MD & Fundamental Research Analyst [10]

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My question was you mentioned the delay in the new store openings this year. Could you give us a little bit more details what was driving that?

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [11]

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Yes. Oliver, this is Kurt. We -- I'd summarize it pretty simple. We pride ourselves on consistent execution. And execution in this area includes adequately covering for the inherent risks in construction and opening of stores. This year, we didn't execute well on coverage for those inherent risks and it shifted the timing of new stores a bit. We've addressed the issue. This is specific to this year. The existing pipeline is strong and we -- as I said, we continue to expect to hit our target goal of 80 stores this year and continue to have confidence in our ability to open stores timely in 2020 with a robust pipeline of future sites in progress at this point.

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Oliver Wintermantel, Evercore ISI Institutional Equities, Research Division - MD & Fundamental Research Analyst [12]

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Got it. And then just for the back end of the year, if you look at the first half, where I see your comp ticket was certainly a lot stronger than your comp transactions, I mean both positive, which is great, but the ticket was stronger. How do you expect that playing out in the second end of the -- second half of the year? Are we -- is ticket going to grow faster than traffic or do you see that reversing?

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [13]

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First, I'd say, each quarter can be different. But in general, our assumption is that with the cost pressures, it may be very similar [and] directionally in the back half of the year as you saw in the first half.

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Operator [14]

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Next, we have Kate McShane with Goldman Sachs.

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Katharine Amanda McShane, Goldman Sachs Group Inc., Research Division - Equity Analyst [15]

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If I could just follow-up on the tariff question posed earlier. I wondered if you could talk through just in terms of how successful you were at mitigating, I guess, some of the headwinds in tariffs, especially in light with some of the products [unless 1 through 3] growing from 10% earlier this year to 25% starting in June.

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Steve K. Barbarick, Tractor Supply Company - President & COO [16]

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Sure. Kate, this is Steve. For the quarter, I believe, we showed that we were able to manage through that climate pretty well. Margin rates, as Kurt mentioned, were positive. And so the tools and technology we have today are really allowing us to use science to manage our business. And thus far, we've managed it pretty well and we feel like going into the back half, we've got a plan to mitigate whatever those tariffs may be. Understand one last thing here, and that is, is that we have built up a very large consumable side of our business over the years. And so the tariffs don't have probably as significant an impact on Tractor Supply as other retailers that are out there and that's a benefit to us as we move forward.

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Katharine Amanda McShane, Goldman Sachs Group Inc., Research Division - Equity Analyst [17]

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Okay. And if I could just follow-up on ticket. It seemed like it was a little bit lower than it's been in the last few quarters. I know you mentioned some big ticket softness in the quarter. I just wondered if you could talk to us about how you think about big ticket for the rest of the year and how it influences overall ticket at the company.

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Steve K. Barbarick, Tractor Supply Company - President & COO [18]

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Yes. This is Steve, again, Kate. What I would say is, in the quarter, we were up against some very strong big ticket sales from a year ago. And as I went down the longer list of some of the weather trends or seasonal trends that we experienced in the quarter, big ticket things like [cooling and] trailers, some front-engine [riders tillers] , they were all soft for us. And I think that had probably an overarching impact for the first half and certainly in the quarter there. As we move forward, every quarter is a little different. Weather has -- the seasonal trends have a bit of a different impact on us. So I suspect, as we get into this and we're able to use our private label credit card with the new offering, as I mentioned, the $5 for $100 spend, I think that we may see a shift backwards, and we should hopefully see some improvement on big ticket.

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Operator [19]

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And next from Piper Jaffray, we have Peter Keith.

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Peter Jacob Keith, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [20]

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Congrats on the good first half of the year. I want to dig into both the private label and the direct sourcing as a percent of sales. So those are trending down year-on-year in the second quarter. Curious if you could address that if it's more of a seasonal dynamic if you're starting to see some impact from tariffs and certainly, I don't expect [your cap down] , but maybe address if you think that direction can be reversed.

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Steve K. Barbarick, Tractor Supply Company - President & COO [21]

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Peter, I would tell you that we still have an emphasis around growing exclusive brands. But at the same time, and you may have heard me say this before, we're a branded house that offers exclusive brands as well. And the team has done a really nice job working with the folks like Carhartt, Scotts and others to build out a broader portfolio of some of those strong national brands. And we're seeing strength in those businesses. So while we've seen a slight decline in percentage of sales, that wouldn't necessarily suggest that it's a concern because we're growing the whole pie. And so the team is still focused on that. We talked about Ridgecut launching here shortly [in] some other categories. So that's not a real concern of mine. And in terms of direct sourcing, there's ebbs and flows to that some of it is receipt timing, et cetera, so that's not a concern either.

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Peter Jacob Keith, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [22]

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Okay. Maybe I guess a little bit different topic. We're hearing some rumblings about rising inflationary pressures. I think it's a little bit tariff-related, but also commodity-related. Maybe, Kurt, could you give us your update on the inflation trends looking at the back half? And then related to that, with the multiyear highs in corn prices when do you think some of that impact could start to show up in your results?

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [23]

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Yes. Peter, this is Kurt. We often in the quarters will give you some indication on commodity level inflation. And as we've been seeing in the past few quarters some modest level of commodity inflation, Q2 saw that as well. We did continue to see some level of impact. We'd estimate around 50 basis points of commodity level inflation on the cost as well as the top line average ticket. And there's a number of variables in there. And we would say based on our estimate today what we can see, we'd anticipate the back half to probably stay similar to that range of commodity level impact on the inflation factor.

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Peter Jacob Keith, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [24]

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And how about on the -- do you think corn prices will eventually sneak into those numbers as we look out to next year?

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Steve K. Barbarick, Tractor Supply Company - President & COO [25]

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Yes. This is Steve. It's very interesting. I'm not really sure. Right now, we do see an increase in grains, mainly corn. It depends on how the harvest goes. I mean if yields come out higher than what was expected, you'll see corn prices decline. And so we're keeping close tabs on that now, working with our suppliers. It's too hard to gauge. I guess we'll probably know here in a couple of months once they get into the field.

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Operator [26]

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And we have Simeon Gutman with Morgan Stanley.

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Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [27]

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My first question is on the full year margin guide, I think it's flat to up 10 bps-or-so. To get to the midpoint, I think it averages about 25 bps of positive in the second half. Does that spread evenly across Q3 and Q4?

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [28]

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I'd say the way we factor it, fourth quarter has more potential for the margin expansion than the Q3. But our guidance is that, overall, throughout the second half, that we anticipate that with some SG&A deleverage at a lesser extent and gross margins modestly improving that we've good upside throughout the back half.

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Simeon Ari Gutman, Morgan Stanley, Research Division - Executive Director [29]

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Okay. And then my follow-up I guess related -- is on freight. You mentioned it was I guess a little bit better than you expected. I think -- I don't think it was supposed to really taper until the second half. So what was causing that? Is it just spot rates, which have come in? Or is it something about your process getting better? And then does that mean it's an incremental positive [or good guide] to the back half now that it's become a positive a little sooner?

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [30]

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Sure. This is Kurt, Simeon. In regards to the performance in Q2, it's a mixture of both things that we are controlling as well as more of the macro. And on the macro standpoint, it's a bit more than just spot rates. There is an improvement overall that we see in the capacity. The average carrier rates are moderating, and we've done a great job with our initiatives of renegotiations in the process as well as controlling the use of spot rates. The things that we've done to reduce the stem miles and increase the capacity or the amount of value in the loads have also benefited. And those are some of the things that we're real proud of the transportation team to jump on and address that ahead of our schedule. And that benefited second quarter. Our anticipation though was those types of benefits would start to hit in Q3 and Q4. So no real change to our expectation of the back half of transportation.

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Operator [31]

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And next we have Daniel Imbro with Stephens.

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Daniel Robert Imbro, Stephens Inc., Research Division - Research Analyst [32]

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I had a few questions on some of your geographic exposure in different markets. I guess first kind of starting on your more ag exposed markets. Given the delay we saw on the planting season, our sense from the industry was that many of those markets could end up facing actual headwinds this year despite the spike in commodity prices. Have you seen those markets soften at all? Or what are some of your more ag-exposed markets looking like through the second quarter given the more rain?

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Gregory A. Sandfort, Tractor Supply Company - CEO & Director [33]

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Daniel, this is Greg. Let me address that one. If you've done the study of our business and the farm store business, you will know that most of these ag markets are in the upper Midwest of the country, there's some in Northern California, but primarily up in Midwest. Those areas, from a seasonal trend standpoint, had been softer due to tremendous amounts of moisture and probably, I would say a little bit more on the basis of elongated cool weather. And we anticipated that. And as the weather is now drying and as the weather is warming, we're seeing those areas of the country come back into the normal, we call it, normal performance of the business. But remember, we are not ag, directly ag related. A large production farming operations are not really who we address. We address the more, call it, casual individual who has some properties, some land and probably has a 2 or 3-acre garden. It's not [the production site] . So yes, we'll feel a little bit of that drag in those markets. But to be very honest with you, as the weather has warmed and things have improved [to mitigate] conditions of moisture, we're very pleased with what we're seeing in the business.

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Daniel Robert Imbro, Stephens Inc., Research Division - Research Analyst [34]

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Great. That's helpful. And then just on a similar related topic, [moving geographies] , I'm thinking about the energy markets, obviously, crude's been volatile year-to-date. But how consistent have those markets held up? Obviously the last cycle seems a little bit different than this one, but just, yes, I would love an update on those.

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Gregory A. Sandfort, Tractor Supply Company - CEO & Director [35]

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Well, this is Greg again. It's quite a bit different than the last cycle. But here's what I would tell you that there's been some modest level of commodity inflation, but not great. Steve mentioned about our retail price management programs, which helps us to make sure that we're pricing accordingly. We're not seeing any current waning in the oil markets, the rig counts and employment seem to be stable and oil is running around $60 a barrel, so really not a major consideration. It's more moderate today than it's ever been. I think the oil companies had a great [learning a] few years ago from what they experienced. And so geographically, it is somewhat limited now to say, I would say, the Western Texas corridor. So I think we're feeling pretty good about what we see and the performance of the business in those markets.

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Operator [36]

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And from Crédit Suisse, we have Seth Sigman.

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Seth Ian Sigman, Crédit Suisse AG, Research Division - United States Hardline Retail Equity Research Analyst [37]

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I wanted to follow up on the guidance and the implications for the second quarter. So I think you'd talked about Q1 coming in better than you expected. It sounds like Q2 is about in line. I'm just curious and maybe just to clarify, have you made any changes to your assumptions for the back half of the year? I know you made that comment about the delayed openings. I wasn't sure if that implied maybe lower growth in the back half than you were expecting previously. If you could just clarify that, that would be helpful.

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [38]

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Yes. This is Kurt. In regard -- if your question is a little bit about how do we frame up the guidance in the back half. And I'd start by saying, from an overarching view, our guidance reflects the belief in the strength of the business, not only the first half strength, but also what we expect for the back half. And I think it's demonstrated best by our updated guidance of an annual 3% to 4% comp rate for the year. But when considering the back half and the updated guidance, it reflects really 3 things: first, a solid performance in the first half, as you mentioned, with some upside results that we factored in, particularly related to Q1. The second thing is on the back half, as I mentioned, we did factor in on the impact, not only the top line, but the bottom line for the timing shift on new stores as well as the shift on the income tax rate where, as I mentioned, we believe, some of that discrete benefit shifted into the first half of the year out of the second half and drives a higher tax rate in the second half. And those 2 factors do impact our expectation on the bottom line for the back half of the year. And as I mentioned earlier, the third thing, certainly a level of consideration for the macro issue that the consumer may be facing as they adjust to an all-in tariffs.

Wrapping it all up, the back half is very much in line with our original expectation with adjustment for those 2 items that I mentioned and consistent performance evidenced with the strength of the business in the first half continuing into the second half.

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Seth Ian Sigman, Crédit Suisse AG, Research Division - United States Hardline Retail Equity Research Analyst [39]

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Okay. That's helpful. And then maybe just a follow-up here. The bridge to the second half margin improvement what you're guiding here, can you just talk about some of the areas where you are making progress in driving operating efficiencies? I think we talked a little bit about transportation already. Your first quarter and second quarter, you had really good underlying SG&A performance. Can you maybe help isolate some of the buckets where you're making progress? And also what is expected to ramp as we move through the year to deliver that better flow-through?

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [40]

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Sure. On the gross margins side, the assumptions are simply the strength of the merchandising team have been able to manage through these varying costs with improving year-over-year freight cost. As you move to the SG&A area, we anticipate, as I said earlier that the new distribution center will have a less of a deleverage impact in the back half than it did the first half. And we're also recognizing we are facing some cost compares last year that we don't believe will repeat at the same level. Lastly, the profit improvement initiatives are showing some traction. We're receiving and anticipating some benefits, particularly in areas of occupancy where some of the indirect procurement and managing the cost and things we can control are driving some benefit. And those are things that we've been putting in place and laying the foundation over the last 6 to 9 months.

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Operator [41]

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And next we have Steve Forbes with Guggenheim.

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Steven Paul Forbes, Guggenheim Securities, LLC, Research Division - Analyst [42]

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I want to start with the 2019 class of stores. I know we're early here and you mentioned the delay in openings. But the initial productivity thus far looks above trend. So maybe just comment on the outlook for this year's class as it pertains to the footprint, right, new versus existing and then sales productivity outlook relative to the average.

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [43]

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Yes. Steven, this is Kurt. I agree with you. We're very excited, proud of the new store productivity. The model continues to be a strength of our business. And the real estate team does a fantastic job of identifying sites and utilizing the greater customer data that we've got to make sure we're opening strong stores in the right locations. And we're pleased with new store productivity so far this year. And we think 2019 will be a real strong class, and it helps gives us more confidence in the strength of the pipeline as well.

In regards to the overall performance on top line, we don't anticipate from an average sales standpoint that, that really varies significantly different from the history, particularly with what I showed and walked through at the Investor Community Day. It's just a strength in the level of not only ramp-up, but the productivity of the new stores.

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Steven Paul Forbes, Guggenheim Securities, LLC, Research Division - Analyst [44]

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And then as a follow-up, right, if you think back to the Analyst Day, you specifically discussed various store productivity initiatives, right? And I think we are sort of in test phase with a lot of those back in May. So maybe update us on the anticipated timing of the rollout of these strategies, right, receiving, et cetera and what the learnings are thus far?

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [45]

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Sure. This is Kurt, again. We're right on track with our plans as we mentioned back in May. And just as a reminder, our store productivity initiative included a lot of reengineering of process, particularly back-office or inventory handling. And additionally, with some tools like mobility, scheduling tools, all of that gets packaged together and then introduced to the stores as they get trained and rolled out. And so we're right on track with our plan to methodically go through the stores throughout the back half of the year with a target goal of completing the rollout by the end of the year. What that means is it is factored into our guidance. There's not a lot of efficiency driven as -- in the back half as we're rolling this out. But it puts us in a great position to be able to capitalize that in 2020 and beyond.

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Operator [46]

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And next we have Chuck Grom with Gordon Haskett.

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Charles P. Grom, Gordon Haskett Research Advisors - MD & Senior Analyst of Retail [47]

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Can you reinforce a little more of the gross margin puts and takes in the quarter? And I guess what factors were less of a headwind -- sorry, less of a tailwind in the second quarter versus the first quarter? And then how we should be framing out the third and fourth quarter?

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [48]

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Yes. Chuck, this is Kurt. Our performance on the gross margins side was very much in line with our expectations. As we mentioned, it benefited both from product mix and price management, price management being the larger of those 2. The team did an excellent job, as we mentioned, utilizing the pricing systems to manage the rising costs. But compared to Q1, we mentioned in Q1 that we benefited from some discrete opportunities, whether it be mixed or the pricing specific to coming out of the winter selling season and did a fantastic job of capturing sales at better marks. The second quarter was really a matter of just executing to the plan and driving good pricing along with the benefit of some product mix and not having headwinds from the freight side of it. We would anticipate that those are the primary factors in the back half of the year. Freight moving from neutral to targeting to having some benefit from that and then utilizing the expertise of the merchant team and systems to drive some benefit from the pricing.

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Charles P. Grom, Gordon Haskett Research Advisors - MD & Senior Analyst of Retail [49]

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Okay. Great. And then just bigger picture on the Neighbor's Club, and I think the 12 million members you have today as you map out the various customer life cycles. I'm just curious and thinking what you're learning and what it's taught you about how to better engage with both new and existing customers?

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Steve K. Barbarick, Tractor Supply Company - President & COO [50]

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Yes. This is Steve. I would tell you that the system has really benefited us in a lot of ways. We are continuing to take the data, segment the data, we can look at the frequency now, we can look at the cross-sell, up-sell. As I mentioned earlier, when we do a campaign now, that campaign is no longer manually managed and kind of paintbrushed across [the lot] of customers. We can have thousands of different deployments of that exact campaign with different banner, ads and whatnot. As we dig deeper and deeper into the data, it's just a rich stream that's coming back out and it's becoming more actionable across the entire organization. Kurt even talked about the performance of new stores. A lot of the data now we're able to use across the organization. So whether it be tapping into a [lapsed] customer that we haven't seen in several months, whether it be communicating and engaging a customer that we just onboarded, the treasure trove of data is going to benefit us go forward.

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Operator [51]

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And next from Wells Fargo, we have Zach Fadem.

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Zachary Robert Fadem, Wells Fargo Securities, LLC, Research Division - Senior Analyst [52]

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Could we talk about the private label credit card impact in the quarter just given the financing offers? Curious how that's impacted to get your top line relative to last year? And then any color on the impact of new sign-ups in the quarter versus existing cardholders, would also be helpful.

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [53]

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Zach, yes, this is Kurt. Great question. And we're excited about what the private label credit card is doing and believe, it is a driver of the business. All metrics continue to be showing solid growth in line with our expectation of what we targeted. We saw growth in tender in both big ticket and broadly across the store. So we know it's resonating and helping us in an environment of rising cost to show value added. The level of applications and new sign-ups continue to be strong double-digit growth and helping us build the program. Our team members in the stores are embracing it. They're selling better than ever before. And we continue to work on enhanced training and systems improvement.

Last thing is to say that between those and what Steve mentioned about the new value we're driving in the back half with the 5% reward, we believe that's going to resonate in all 4 corners of the store, help drive comps and improve and be part of our whole Neighbor's Club drive loyalty with our consumers. So the lot of the data I mentioned at the May Investor Community Day is still applicable and we're moving in our progress rate towards our target of 3 to 5 years seeing this at about 10% tender mix.

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Zachary Robert Fadem, Wells Fargo Securities, LLC, Research Division - Senior Analyst [54]

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Great. And then quickly on your C.U.E. categories. Could you refresh us on the subscription efforts here? You've called it out as an opportunity in the past. I know you don't push it, but any commentary on progress and whether you still think this can be a meaningful opportunity going forward.

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Steve K. Barbarick, Tractor Supply Company - President & COO [55]

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Yes, this is Steve. You know we're a customer-oriented company and this is one of the capabilities we put out there to better understand what our customers might be interested from us. We did expand the assortment out to some more animal health products, so it's not just pet food and supplies related. There's still a lot of learning to be done. And I would say, at this point, we are going to continue to learn as we go. The goal ultimately not only to be able to serve our customer with convenience, it might be a play down the road where we're able to connect with customers that want pellet type deliveries and more business-to-business type aspects of what we might be able to use the tool for. So as we're thinking forward, the subscription of a bag of dog food or a [treat] is one thing, we're trying to think and make this more global and really tie it back to our ONETractor strategy.

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Operator [56]

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And next we have a Peter Benedict with Baird.

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Peter Sloan Benedict, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [57]

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Just a clarification. I mean, Kurt, can you talk a little bit more this new store [delouse] , I'm just still a little unclear as to what that was. Was that construction delays more broadly and just you guys weren't as on top of it as you normally are or was there an internal issue? I understand it's transitory and it doesn't sound like it's going to be an issue going forward. But I just was -- I'm still a little confused as to what drove that.

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [58]

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Yes. Peter, I appreciate the question. I'll try to help clarify on it. In the first half of the year, there were weather challenges, there are often with new stores. There are challenges just with getting through planning and regulations in the local municipalities. And we could point to all of those things and say that the weather or the regulatory items were there. But we have that and, in our view, we say we are challenged and it's our job to offset those headwinds. And we faced a lot of those headwinds. And probably more headwinds than normal. And that was part of the challenges of getting stores opened. And for us, as a team, we look at that as an executional issue and say, we can do better making sure that we can have the offsets that can help us not have shift in timing of stores when those headwinds pop up like they did.

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Peter Sloan Benedict, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [59]

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Okay. Now that's helpful. And then just lastly, just on Neighbor's Club, I know you guys are not giving the full numbers anymore on that. But as we think about it from a comp store basis, do you feel like you've kind of reached the penetration at least in the existing stores in terms of the number of members per customer -- I mean per store? And that the growth from here will just be basically new stores or you're continuing to see some growth in members per store?

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Steve K. Barbarick, Tractor Supply Company - President & COO [60]

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Yes, Peter, this is Steve. And yes, we continue to see the program grow in comp stores as well as new stores and it's still growing at a really good clip, which is exciting. And then when you add onto that what we're doing with, what Kurt talked about, the private label credit cards, I think we'll even see more engagement and more enrollments. So again, it continues to expand. The data continues to come in. We're building out our CRM team, and we're excited about what the future looks like in terms of being able to use that data [in action] .

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Mary Winn Pilkington, Tractor Supply Company - VP of IR & Public Relations [61]

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And Greg, we'll try to slip in one more question, please.

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Operator [62]

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Okay. And in that case, we'll take the final question from Brandon Fletcher with Bernstein.

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Brandon Fletcher, Sanford C. Bernstein & Co., LLC., Research Division - Senior Analyst [63]

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I don't want to simplify your very complex business and all the hard work of everybody, but if we do what we do on The Street and make this just a growth algorithm, we've got 6% of store growth, maybe 3% of sales, 3% of buybacks and dividend. You can adjust those, however, you want half a point either way, that gets you to 12% kind of the center point of your growth algo. We were so impressed with the quality of the talent that you have and those that you brought in to do some really awesome stuff in analytics and the supply chain and finance, et cetera. It sounds to me if you have all these awesome people, there must be some headwinds hiding in there that we'd love to have any color on, so we know what all these great people are fighting against. That's why the algorithm is kind of comfortable at 12% and that there isn't a reach higher beyond that.

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Kurt D. Barton, Tractor Supply Company - Executive VP, CFO & Treasurer [64]

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Yes. Sure, this is Kurt. I'll start on that. And we look at our guidance as confirming that we're doing what we'd said we'd do this year, driving a strong comp sales performance, driving great top line, operating margin expansion with the real solid EPS growth rate. And that continues into the back half of the year. And for us, we have a lot to be excited about what we are driving overall for the expectation and guidance, which is raising that a bit from original expectation. So the business is strong. There's a lot to be excited about it. I mentioned it earlier, we're going to make sure halfway through the year with the consumer that will be facing a number of changes. We're going to be realistic with what the outcome can be in this environment. But all that given Tractor Supply has got a great algorithm, as you mentioned, and great performance expected for 2019.

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Mary Winn Pilkington, Tractor Supply Company - VP of IR & Public Relations [65]

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All right. Greg, we'll wrap up our call. I want to say thank you to everyone for joining us. And [Marianne] and I are around today if you have any questions or follow-up. And we look forward to talking to you in October. Thank you.

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Operator [66]

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Ladies and gentlemen, that does conclude our conference for today. Thank you for joining us. You may now disconnect.