Oct 21, 2009
Executives
Erica Pettit - Financial Dynamics James F. Wright - Chairman of the Board & Chief Executive Officer Anthony F.
Crudele - Chief Financial Officer Gregory A. Sandfort - President, Chief Merchandising Officer Stanley L.
Ruta - Chief Operating Officer
Analysts
Jack Murphy – William Blair & Company Dan Wewer - Raymond James Robert Higgenbotham – Goldman Sachs Vincent [Senisey] - Bank of America Matt Nemer - Wells Fargo Securities Mitch Kaiser – Piper Jaffray Kristin [Applegee] - Sun Trust Robinson Jay McCanless – FTN Equity David Strasser - Janney Montgomery Scott Christian Buss - Thomas Weisel Partners Christopher Horvers - J.P. Morgan
Operator
Good afternoon, ladies and gentlemen, and welcome to Tractor Supply Company's conference call to discuss third quarter 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. (Operator Instructions) Please be advised that reproduction of this call in whole or in part is not permitted without prior written authorization by Tractor Supply Company.
And as a reminder, ladies and gentlemen, this conference is being recorded. I would now like to introduce your host for today's conference, Ms.
Erica Pettit of FD. Please go ahead, Erica.
Erica Pettit
Thank you. Good afternoon, everyone, and thank you for joining us.
Before we begin, let me take a moment to reference the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. This conference call may contain forward-looking statements that are subject to significant risks and uncertainties including the future operating and financial performance of the company.
Although the company believes that 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. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included 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 the statements will remain operative at a later time.
Lastly, Tractor Supply Company undertakes no obligation to update any information discussed in this call. Now I am pleased to introduce Jim Wright, Chairman and Chief Executive Officer.
Jim, please go ahead.
James F. Wright
Thank you, Erica. Good afternoon, everyone.
I'm here today with Tony Crudele, our Chief Financial Officer, Greg Sandfort, our President and Chief Merchandising Officer, Stan Ruta, our Chief Operating Officer. Our team did an outstanding job as we, again, delivered higher-than-expected net income driven by significant improvement in gross margin and modest top line growth.
As you recall we are cycling against a number of factors that benefited our performance from last year including landfall hurricanes in both Louisiana and Texas which created high demand for emergency preparation and response items, volatile fuel prices that created early sell through of heating products and high inflation levels which provided tail winds for our sales. We recognize that this will be a challenging quarter and I'm even more pleased with our achievements in light of the headwinds that we faced.
We took a proactive approach towards planning and we executed our strategies very well. Let me go into more detail about the strategies that allowed us to win in the third quarter and are continuing to position us for success for the remainder of this year and beyond.
First, our merchandise assortment supports our customers' everyday lifestyle needs. We have a thorough understanding of what is relevant to our customers, our core consumable, usable or edible or [Q] categories are very attractive to consumers looking for a one-stop destination for products that fit their rural lifestyle at a compelling value.
These items, including animal and pet related products, repair and maintenance parts for machinery and lubricants are continuing to drive footsteps into our stores. We are pleased that we delivered positive comp transaction growth for the sixth consecutive quarter.
We continue to explore opportunities to build upon the strength of our [Q] categories. In the last few weeks we've introduced a select equine and livestock feeds from Purina and Nutrena to our stores nationwide.
Early response to these prominent brands has been positive. We believe that adding nationally recognized best selling feed brands for the first time will drive category expansion and attract the new customers.
Secondly, we intensified our focus on managing gross margin net of advertising, one of the key metrics that we are using to both plan and to gauge our team's performance. In doing so we planned our inventories and manage markdowns carefully to ensure that inventory was fresh and selling at optimal price points.
For the eighth consecutive quarter we reduced total per-store inventory levels at a year-over-year basis. Concurrently we improved our in stock position on key items, our strategy to focus on the top 20 merchandise categories and the top 250 SKUs continues to service well by ensuring that the products our customers need the most are in stock and in quantity.
The benefit of eliminating television advertising in favor or direct marketing was not as substantial as it was in Q2 since we've not historically used television during the third quarter. Third, we are maintaining disciplined expense control.
We successfully kept our cost down and improved the shopping experience for our customers. We continue to emphasize and invest in the train of our team to ensure that a store execution is a leading competitive advantage for us.
We are proud that we continue to improve upon our customer loyalty stores. Our customers are recognizing that we have had the products they need and our giving our stores high marks for organization and friendly, knowledgeable service.
Overall we're pleased with the performance in the third quarter and the first nine months of 2009. Throughout the year we maintained our focus on continuing to differentiate our stores and executing our retail strategy.
Our ability to perform well consistently is a testament to our working as one cohesive and cross functional team. We are using the breadth and depth of information across the organization as well as individual and collective expertise to work towards the best outcomes for our customers, our business and our shareholders.
Now I'd like to turn the call over to Tony to review our financial performance and to discuss the outlook for the year.
Anthony F. Crudele
Thanks, Jim. And good afternoon, everyone.
As Jim noted, we are very pleased with our results for the quarter as we continue to proactively navigate through a number of headwinds. On a year-over-year basis we grew sales and EPS, effectively managed our margins, generated an increase in customer traffic and reduced our per-store inventory levels for the eighth consecutive quarter.
For the third quarter ended September 26, 2009 net sales grew by 1.9% to $747.7 million. And net income grew by 38.5% to $22.0 million or $0.60 per diluted share.
Total comp store sales in the period decreased 5.1% compared to last year's 6.2% increase and non-comp sales were $51 million or 6.8% of sales. We estimated that comp sales were negatively impacted by approximately 110 basis points as a result of cycling last year's emergency preparation and response sales related to the two gulf hurricanes.
We estimated inflation was approximately flat and had no significant impact on comp on a year-over-year basis in Q3. While we have seen some deflationary pressure in certain categories such as livestock, feed and fencing, there has also been some retail price increases in areas such as pet food and finished steel products.
We continue to gain customers and our customers are continuing to shop more frequently primarily for essentials that support their rural lifestyle. The comp transaction count increased 5.9% and we are very pleased that we continue to drive footsteps into the store.
This is even more favorable when considering the traffic generated last year from the hurricane activity and pre-selling of heating fuel. The average comp ticket decreased 10.4% resulting principally from softness in the sale of big-ticket items such as stoves and furnaces.
Our core consumable, usable and edible categories including animal and pet related products, continue to be the key merchandise drivers of our sales. Additionally, all repair and replacement part categories continue to perform well as the consumers are extending the life of their assets in a last effort to postpone big-ticket purchases.
Seasonal items such as heating and hurricane-related emergency preparation and response merchandise face a difficult year-over-year comparisons and comped below chain average. Weather, with the exception of no hurricane activity, was neutral year-over-year.
Sales were the strongest in the mid south, southeast as we cycled against drought conditions in the prior year. Sales were the weakest in the southwest as areas of Texas had an expansive drought compared to much more favorable conditions in the year before.
Comp sales in our Del stores were better than chain average. Feed and hay make up a significant portion of Del’s product mix.
And while we are pleased with Del’s transaction count increase in these categories, these gains were partially offset by deflation in these categories. Overall, we are pleased with Del's gross margin improvement and their ability to exceed plan.
Turning now to gross margin, compared to the prior year quarter we increased gross margin by 317 basis points to 32.9% of sales. The favorable LIFO provision relative to last year's abnormally large provision accounted for 119 basis points of the improvement.
The LIFO provision was approximately $0.03 per share in the third quarter of '09 compared to $0.17 in the third quarter of 2008. Three other components contribute to growth margin improvement.
The first, lower freight expense compared to the prior year, with a strong drive of this improvement resulting from fuel price decreases relative to last year and benefit from our transportation cost-saving initiatives. Reduction in freight expense was 73 basis points of the gross margin improvement.
Second, lower markdown impact, as we have kept inventory fresh and achieved a good markdown cadence, we’ve minimized exposure to market erosion from the markdown. And third, continued vendor support from our merchandise initiative and promotions.
For the quarter, SG&A, including depreciation and amortization was 28.1% of sales; which was 194 basis points increase over the prior year quarter. Although we did not leverage SG&A expense, due to the decline in comp sales, we are still pleased with the SG&A expense control.
In addition to the leveraging impact from the comp sales decrease, the following attributed to the deleveraging. The incentive plan accrual was higher than percent of sales compared to last year’s quarter.
We increased our sales tax reserve, as several states have initiated or have notified us of their intent to conduct sales audits. And lastly, we experienced the expected deleveraging from new store growth relative to the mature store base.
With respect to marketing, our expense was flat as a percent of sales compared to Q3 last year. As we noted in our last conference call, we generally do not spend TV dollars in Q3 and therefore did not benefit as significantly as we did in Q2.
Importantly, we continue to drive comp transaction increase, without increasing our advertising spend, thus effectively managing gross margin dollars net of advertising expense. Pre-opening expenses for the new stores were $1.9 million, compared to $2.1 million in the prior year quarter.
In the third quarter, we opened 17 stores, compared to 20 stores opening last year. Pre-opening expenses per store was consistent on a year-over-year basis.
Turning to the balance sheets, we are pleased with the inventory productivity. At quarter end, inventory levels per store were down approximately 4.8% on top of an 8.5% decrease at the end of Q3 last year.
Our calculation is based on average cost of inventory and excludes in-transit and inventory held in unopened stores. It’s important to note that we achieved the decrease in per-store inventory while simultaneously increasing our in-stock percentage.
Annualized inventory turns for the quarter were 2.7 times, a 4 basis points decrease over last year’s third quarter. We are pleased with our inventory productivity, given the comp store sales decrease while also improving our in-stock position on our key 20 to 50 SKUS and improving receipt flow for winter purchases.
On a year-to-date basis, inventories turns have improved 7 basis points. We did have a decrease in inventory financing from 44.9%, down 350 basis points, as we have been more aggressive in working with our vendors to insure we capture discounts.
Capital expenses for the quarter were at $15.3 million, related principally to our new store openings program. This compares to $15.4 million in last year’s third quarter.
During the third quarter, we made limited purchases under our stock repurchase program. We purchased approximately 19,400 shares for $915,000, for a cumulative total of $214.7 million since the inception of the program of February of 2007.
The share repurchase program did not have a significant impact on EPS for the quarter or year-to date. We are extremely confident in our cash flow and liquidity position.
We had no revolver debt as we moved into what has generally been one of our peak borrowing periods, as we’ve built inventory for the winter holiday season. We had $95 million in cash, compared to a net borrowed position $6.8 million last year at quarter end.
We have demonstrated an ongoing commitment to carry higher cash and more liquidity, to ensure we are managing our balance sheets prudently in the current environment. Turning to our outlook for the full year.
In our business update release earlier this month, we raise our previously financial expectations for full-year net income to a range of $2.88 to $2.98 per diluted share compared to our previous guidance of $2.78 to $2.92 per diluted share. We have narrowed our full year sales range to between $3.17 billion and $3.2 billion, compared to our previous guidance of $3.15 billion to $3.25 billion.
Correspondingly, we have narrowed our guidance for same-store sales for the year to range between a decline of 1% to 2% compared to our previous expectation of flat to a decrease of 2%. Let me discuss a few of the underlying assumptions for the remainder of the year, included in our full year guidance.
With respect to sales, we have balanced our full-year guidance to reflect a combination of current economic trends and our performance for the year-to-date period. As we look ahead to the fall, winter, and holiday season, we have taken a cautious perspective that we believe is appropriate.
Our approach considers the following factors. Customer spending has remained generally in line with our expectations in the first nine months of the year.
Our customers have continued to shop our stores for functional, non-discretionary items that support their lifestyle, while maintaining their focus on compelling values. We have not altered our view on the consumer’s hesitancy to make big-ticket, discretionary purchases, as we head into the fall, winter, and holiday seasons.
Although our performance is least dependent on big-ticket items in the fourth quarter, we have a variety of big-ticket items throughout all seasons. Unemployment is still at a very high level and economic forecasters are projecting that unemployment will increase as we move into the fourth quarter.
While our customers appear to have some resiliency to this, we are not immune to the negative impact that unemployment has on consumer spending. We will be cycling a 1.3% comparable sales increase in Q4 last year.
Initially, this may not appear to be a tough comparison, however, this was a strong performance given the economic turmoil last year and the benefits we received from high inflation levels. As we expected, the inflationary pressures subsided in the second half of 2009 and we now estimate that the deflation could provide a headwind of approximately 2.0% in the fourth quarter.
From a weather perspective, as most of you are aware, harsh, cold winters generally will have a positive impact on sales when our insulated work wear, heating products, snow-removal, and emergency response equipment are essential for our customers. In the fourth quarter, our weather analytics provider forecasts that weather will be only slightly colder in October and slightly warmer in November and December.
We did have some storm activity at the end of last year’s quarter. We believe that the weather impact will be neutral to slightly negative.
Overall, we anticipate that we will continue to benefit from safe freight savings and reduced LIFO compared to the prior year. However, we expect gross margins exclusive of the year-over-year favorable LIFO comparison to be flat to slightly down compared to the prior year.
More specifically, with respect to gross margin, we expect some margin pressure as we move into Q4, although we will be cycling against a very heavy inflationary period last year, we believe that the most significant cost-reductions that we have negotiated have cycled through our moving average costing. While we expect deflation in the 2.0% range in the quarter and we have proven that we can maintain retail prices and manage gross margins effectively in the current environment.
We believe that this will limit our ability to obtain the margin expansion exclusive of the LIFO impact that we experienced during the first three quarters of 2009. We believe that the pressure on the margin will be partially offset by a favorable mix, as big-ticket sales will continue to be soft and generally big-ticket items have a lower than chain average margin.
We anticipate freight will continue to have a favorable impact on margins, but less than we experienced in Q3. Fuel prices remain well below last year’s prices, and although fuel prices began to decline in the latter part of 2008, the P&L benefit was delayed as freight costs are capitalized into inventory.
Additionally, we believe that our initiative to increase the efficiency of transportation and freight will continue to gain traction. We are cycling our fourth quarter of strong shrink performance and we do not anticipate a benefit in Q4, as we had very strong results last year.
With respect to LIFO, based on our expectations for year-end inventory levels in mix, we are currently estimating a full year LIFO provision of $11.6 million, a reduction compared to our full-year estimate of $13.1 million at the end of Q2. As you’ll recall, the LIFO provision is dependent upon the combination of year-end inventory levels and mix of product, as well as the inflation rate for various product categories.
As inflation has subsided, we have continued to reduce our LIFO estimate throughout the year. To date we have been pleased with our SG&A expense management, but given our comp sales forecast, we expect that SG&A will delever in the fourth quarter.
Consistent with our approach in the second quarter, we will benefit in Q4 from negligible [telegent] costs and continued efficiency in our advertising spend. However, we do not expect our benefit to be near the same extent as in Q2, because our fourth quarter spend historically has been significantly less than Q2.
We have begun our rollout of POS system and have installed approximately 150 stores. We will continue to incur additional payroll through early November to support this implementation.
Additionally, at the earnings level implied in our guidance, we will continue to have incentive compensation above prior year's expense consistent with the year-to-date trend. We expect to open 76 new stores in 2009 and we have opened 58 stores year-to-date.
Additionally we have targeted 70 to 80 stores for 2010 as we continue to believe that expanding the chain at 8% to 9% is appropriate in this environment. As you all know, earlier this year we increased our long-term store count to 1,800.
We have been able to increase the ultimate potential store count, due to our research based on our knowledge of cannibalization trends, drive-time distances and further research about the Tractor Supply Company household. While new store sales levels have been impacted by the economic downturn similar to the comp stores, our new stores in aggregate continue to meet our pro forma and internal rate of return hurdle.
We expect that capital expenditures will approximate 70 million to 75 million. In closing, we remain very pleased with our performance in a very difficult retail environment.
We are confident that our ability to execute our retail strategy and serve the functional needs of the out-here customer will be the key differentiators as we manage through the fourth quarter and head into 2010. Now I'd like to turn the call back to Jim.
James F. Wright
Thanks, Tony. As we enter the final quarter of 2009, I'd like to review the tremendous strides we’ve made throughout this recessionary period to both grow and to improve our business.
Now, we recognized the downturn very early in the cycle and adjusted to the near-term realities of our business without losing sight of our long-term outlook for Tractor Supply Company. Now more than ever, this environment has accentuated the value of our relationships with our customers, the significance of swift execution, and the critical role of our team members.
Early in 2008 we developed a plan to proactively address a challenging macro environment and we then enlisted and aligned our team around that plan. We refined our merchandising strategy as we observed our customers' changing spending behaviors.
With a more conservative mindset, consumers have dedicated their spend to nondiscretionary and to essential merchandise, deferred items that did not fit that criteria, and reduced their credit card purchases. We saw a shift away from big ticket items while sales of basics continued on their growth trajectory.
We believe our emphasis on [Q] items and the compelling value proposition has helped to offset this pressure. At the same time we've controlled and reduced expenses across the organization.
We recognized it would be important to find ways to cut costs as far away from the consumer as possible. In many cases we've discovered we can do more with less.
We optimized our marketing program to ensure that we were driving profitable traffic and sales with every event, and frankly, every cut in every event. In doing so we eliminated TV costs in favor of more efficient and productive direct marketing.
We're able to track the success of this effort and ensure that it's producing the way we planned by measuring our gross margin left in that of advertising. As I mentioned earlier, we reduced our year-end inventory for eight consecutive quarters while improving our in-stock level.
We recognize that one key component of our retail engine is our people. We did not implement a hiring freeze but instead implemented a frost to ensure that we could continue to add talent and critical roles and replace key positions.
Our team members worked hard and generated, and we granted raises and paid bonuses commensurate with their performance. We also improved our health care program while holding costs to our team members.
We maintained our 401K match. Through our store opening program, we created 1,600 jobs since the beginning of 2008.
We managed our balance sheet very prudently to ensure that our capital structure was solid. We reduced our long-term debt to zero and increased cash flow from operations to fund working capital needs as we approach the peak borrowing season.
Additionally, we expanded our credit facility. At the same time we returned approximately $65 million to our shareholders since the beginning of 2008 through our share repurchase program.
Although we've slowed store expansion, we remain a growth company, and I'm delighted that we've opened more than 140 stores since the beginning of 2008. Overall, we believe that our business has improved through this recession.
We are pleased with our earnings growth at this time. In sum, our combination of great people and prices along with unique merchandising mix has served us well.
We continue to manage our business effectively for both near and long-term. We, through very deliberate actions and diligent planning, have achieved a great deal during this recession.
The most critically, we've made the investments to ensure success when the economy normalizes. As we approach the holiday season, we are confident that we have the right plan in place.
We believe a conservative but nimble posture is appropriate given the level of uncertainty with consumer spending. As such, our gift assortment for this season will again be focused on key basics and compelling values.
This includes offering a range of gift items at mid and lower price points. This approach was well received this year and we also believe will continue to produce sales while allowing us to limit markdown or carry-over risks as we move forward.
Looking beyond 2009, we'll continue to leverage the merchandise and operational strategies that have served us well during the recession. While we anticipate that pressure on big ticket will persist, we believe that the repair cycle will gradually swing to replacement as eventually the economics of replacement versus continued repair will shift.
The real customer will continue to be needs based and value driven for some time to come. Nonetheless, as the authority on the rural lifestyle, we are confident that our consumers will continue to rely on Tractor Supply Company.
Operator, with that, we conclude our prepared remarks, and we'd like to open the call for questions.
Operator
(Operator Instructions) Our first question comes from the line of Jack Murphy – William Blair.
Jack Murphy – William Blair & Company
Good afternoon. Just a couple of questions.
Jim, wonder if you could give us a little insight into how you view the sustainability of the traffic trends that you've seen so far. You’ve obviously done a nice job through the downturn, but what initiatives you have in place for the fourth quarter and beyond that could give us a sense of the sustainability of those traffic gains.
James F. Wright
Sure, Jack, a couple things, probably a couple key factors. One, as we look at the knowledge that we continue to gain and refine on customer segmentation, the number of households that we attribute customer name and address to and our increasing ability to refine our direct response marketing efforts, we believe that we'll be able to drive increased frequency of visits with existing customers as well as begin to use that media to prospect for new customers.
So I feel very good about the advertising reach. Also, as we've reported several times, our pet food, which is a high frequency business, and our large animal feed have grown now for several years at a rate exceeding that of the overall chain, yet when we look at our relative market share, it's lower.
We’re pleased with our growth. Our market share is frankly rather de minimus compared with our opportunity and we are confident that we can continue to grow those businesses.
And now that we have added the two most significant major brands of large animal feed we're very confident that we can grow that also recognizing that those customers are amongst our most valuable.
Jack Murphy – William Blair & Company
Great. Just one last question - I wonder if you could just update us on your thinking in terms of the timing or potential timing of acceleration and square footage growth, how you're seeing the retail real estate market out there right now and how that might factor into your square footage plans as you look a few quarters out here?
James F. Wright
Yes, you bet. Again, we've not yet seen a significant change in the space availability or pricing, somewhat on the pricing side, not significant, not a lot of change on the price of construction, however.
So the overall availability of retail sites in rural America has not changed significantly. Obviously we are committed at this time for 2010 and our number will be in the 75 to 80 stores for next year.
We have a little bit of time before we have to begin filling the pipeline for 2011 and at this point, I would suggest we're probably going to be at 9% growth again but reserve the right to accelerate that if we see a turn in consumer behavior and consumer confidence in the next, let's say, five to six months.
Operator
Your next question comes from the line of Dan Wewer - Raymond James.
Dan Wewer - Raymond James
Tony, a few years ago you guys were talking a lot about the silver mile strategy in an approach to reduce your occupancy cost. In your prepared comments you did note that your new store volumes are running in line with your plan.
But could you remind us how your budgeting first year sales with the silver mile strategy compared to the gold mile strategy? And then also in terms of are we seeing the benefits in reducing occupancy expenses that you were anticipating?
Anthony F. Crudele
Yes, a couple points on that, Dan, and then I can turn it over to Stan for any other additional comments. But generally when it comes to sales the differential between the golden mile and the silver mile is not significant.
So we did not anticipate either a decline or an increase in the sales level for store. The sales level for store generally is driven by the location of the stores.
And in some areas of the country they're going to be a little bit lower sales volumes, other areas there'll be higher sales volumes. So that really is more the driver than the silver and the golden mile.
Relative to the silver and golden mile, the silver mile we would expect to have lower costs and we have seen that as we've had a shift to the silver mile from, I believe we were up to about 60% or lower, I guess, when it came to the silver mile and shifting to the silver miles. We have seen an expense reduction.
Stan, if you wanted to add any points to that.
Stanley L. Ruta
I think you covered very well, Tony. We did quite a bit of analysis before we really started focusing on the silver mile and at that time, Dan, really didn't see any significant difference in store volumes in the markets we served.
Of course, usually the smaller markets, the distance between the golden mile and the silver mile is just across town or down the road. So it continues to be a good strategy for us.
It's helping us maintain good store growth at a reduced cost.
Dan Wewer - Raymond James
Can I just have a follow-up question, if I could? I think that you noted that suddenly the pet food prices were actually increasing year-over-year.
Was that at the wholesale level to you or Tractor being able to push through the price increases on pet food?
Gregory A. Sandfort
This is Greg. Dan, it is a combination of really the prices holding in some cases or slightly becoming elevated and us literally as we've always done kind of move with the market as the cost would increase.
We're not seeing a real deflation yet in pet food. And that's something that we're watching closely.
But there have been some slight increases. We've taken advantage of those and moved with the market.
And we also, with you, anticipate the first half of the year possible some prices coming down. But we really just don't know at this point.
Operator
Your next question comes from the line of Robert Higgenbotham - Goldman Sachs.
Robert Higgenbotham - Goldman Sachs
I wanted to dig into gross margin a little bit. And Tony touched on much of this.
But I’m hoping for some incremental color. When you talked to the third quarter performance, you broke out the 70 bips of impact from freight, certainly a big number.
The overall FIFO margin was up nearly 200 basis points. I'm wondering if you can help us quantify or at least sort of bucket those other two factors between better markdown performance and vendor support.
James F. Wright
Yes, Robert. Basically what we've seen is - and from our internal reporting we break these out and why I try not to get too granular when it comes to the specific break outs is because a lot of times you allocate either vendor support or promotions or discounts as part of the direct margin.
And so I try not to get too granular as far as how we break that out. Generally the initial margin, purchase price margin was probably about 20 basis points less.
And we saw generally in those categories of volume support or rebate again improvements in sort of the 10 to 20 basis point range. And then as far as we can best quantify markdown management, there is probably somewhere between the 70 to 80-basis point improvement there.
So hopefully that gives you some sense of the magnitude of the various categories that we're talking about. But, again, between freight and the management markdowns how you allocate that to your direct margin can be a little bit subjective.
But for the most part, those are your three key components.
Robert Higgenbotham - Goldman Sachs
Understood. That is actually very helpful.
And on mix shift was there no positive mix impact? I kind of would have thought that to the extent that you had lower sales of your alternative heating products, which I imagine would have lower margins, that you would have seen some positive impact there.
Is that not correct?
James F. Wright
Yes. Interesting, as far as mix goes we actually had a negative impact.
And a lot of that is a result of the shift to some of our consumables in the feed line that have just a slightly lower-than-chain-average margin. But we were doing some significantly higher volumes.
So in this case we had a negative impact when it came to mix, which I would agree with you is a little counterintuitive to the impact that normally the slowness in the large-ticket items would prevail.
Robert Higgenbotham - Goldman Sachs
And lastly, on your comments around 4Q margins, did I understand you correctly to say that you're expecting a net decline in FIFO gross margins in the fourth quarter?
James F. Wright
I said - yes, I said flat to slightly negative.
Robert Higgenbotham - Goldman Sachs
And - I'm sorry. I may have interrupted.
James F. Wright
No, I was just saying on an ex LIFO basis or a FIFO basis we are looking to flat or slightly down.
Robert Higgenbotham - Goldman Sachs
Right. And I guess I understand that you may have cycled through your average cost of inventory from your biggest price negotiations.
It still seems like year-over-year though that you would see some further benefit from that. I might be missing something.
James F. Wright
Again, a lot of it has to do with the mix and looking at the mix and the way it's been trending as well as the management of those price decreases that we've attained and how much we've passed on to the customer, etc cetera. So but based on our forecasting we're looking at a FIFO basis of flat to slightly down.
Operator
Your next question comes from the line of Vincent [Senisey] - Bank of America.
Vincent [Senisey] - Bank of America
Yes, first question, regarding your outlook for 4Q deflation you said potentially you think there could be 2% worth of deflationary headwinds in the quarter. Just wondering if you can give, Tony, a breakdown there by category, if that is strictly taking into account the livestock feed and the fencing you had mentioned or if there is anything else in there.
James F. Wright
The categories I mentioned initially that were deflationary were two of the larger categories that would drive this inflation for the most part. Other than that, we don’t provide too much guidance and some of it is speculative as to directionally where it could be headed.
We basically will take a look at what our current pricing is and try to extrapolate that as to where we see the pricing going at year end. But we believe that overall given what prices were last year, looking at it on a year over year basis that we would expect to have some deflationary pressure.
Vincent [Senisey] - Bank of America
Okay, then just one quick follow-up, if I may, your CapEx came down minimally only about $5 million. Is that just strictly timing, or is there anything else in there?
James F. Wright
A combination of timing and obviously a good portion relates to our store expansion program and those expenses came in a bit less than we anticipated as well. But the majority relate to the timing of some projects that are getting pushed into 2010.
Operator
Your next question comes from Matt Nemer - Wells Fargo Securities.
Matt Nemer - Wells Fargo Securities
My first question is around the branded feed product introduction, when did that actually find its way into stores and is that increase margin per bag or is it designed to drive new customers? What is the thinking behind that?
James F. Wright
Sure. Well, Greg why don’t you take that.
Gregory A. Sandfort
Matt, it went in around the early part of October, officially around the 10th would be the date and to be honest with you, as we went in with the pricing structure against this, it was very similar to what you would find at local markets so there really wasn’t any margin gain out of this. It was pretty much typical to what you would find in our relative margins across other feed, so no great margin gain here.
This was a strategy to go acquire new customers.
Matt Nemer - Wells Fargo Securities
All right. Maybe then you can just give us a quick update on additional product launches or merchandising initiatives we should look for towards the end of this year or early next year.
Gregory A. Sandfort
First of all, the wraparound of branded feed as it goes into the first part of next year is going to be a big plus. And secondly, I would say the fourth quarter from a merchandise execution strategy on gifting and on the positioning of product throughout the store targeted toward a usable gift is… We have taken a much stronger stance on this than we did last year as I mentioned earlier, it worked well for us.
This year, we believe it will work even better. I would tell you that we have also repositioned the location in the store where this product is going to be found.
It is now down the center court where a year ago it was up in the left hand corner in what we call the seasonal area. This year, that positioning is for all heating and for what we call warm wear products.
So we are feeling very good about how the fourth quarter should translate to sale on seasonal products.
Matt Nemer - Wells Fargo Securities
In turning to the balance sheet, quickly, your cash balance, I think is at or close to a record high. You didn’t draw down on your revolver which would be sort of typical for this time of year.
What do you expect in terms of cash build and your philosophy into deploying that back into shared purchase?
James F. Wright
Currently, we look at the shared purchase program and again, each quarter we will look at our matrix and will fine tune the matrix relative to some internal calculations that we do around the share pricing. As you may sense, the stock price had a nice movement throughout the quarter and therefore, moved away from the matrix which we had established so that the purchases were minimal.
We will continue to look at how to deploy the cash. We have set targets internally as far as what we would like to maintain as our cash balances.
We are slowly approaching those targets and as we move into 2010, we will continue to look at alternatives as far as returning cash either to our shareholders or deploying it in what we believe are the most efficient growth potentials. We will be able to provide more clarity as we move into 2010 and give guidance on the 2010 forecast P&L and balance sheet.
Matt Nemer - Wells Fargo Securities
Okay, if I could just sneak one more quick one in, can you just give us an update on the point of sale system and all that?
James F. Wright
Yes, Matt. Point of sale is, as Tony mentioned earlier, right now, we have got it at about 174 stores.
We are going to stop at 174 for this year. We are going to focus on fourth quarter business and right after the first of the year, we are going to start rolling the POS out to the rest of the company.
The feedback from our stores has been extremely favorable on the system in the 174 stores that we have rolled it out to in all phases. It’s initial feedback is a big win for the stores and for our customers and we plan on having a full roll out completed by the end of queue one of 2010.
Operator
Your next question comes from Peter Keith – Piper Jaffray.
Analyst for Mitch Kaiser – Piper Jaffray
I’m calling in for Mitch. I wanted to follow up a little bit on Robert’s gross margin question.
I apologize if it is repetitive, but just to make sure I fully understand. On the financial margins, you do expect some small benefit from freight and mix, but then is it the impact from the average inventory costing will more than offset that so that you think it will be flat and slightly down?
James F. Wright
Yes, that is one of the drivers and I also mentioned that we do not anticipate having the same performance in shrink as we had on a year over year basis last year. So that will be a tough comparison for us and again, as we move in… and some of the promotional… we are a little uncertain as to the promotional environment.
So we will look at that as far as the fourth quarter. But we feel that on the direct margin, again, you have to look at the year over year comparison and look at some of the categories in the mix.
But potentially, that would be one of the drivers as far as pulling down the margin relative to the two anticipated drivers as far as improvement in the margin which is freight. Obviously, being the lead candidate there.
Analyst for Mitch Kaiser – Piper Jaffray
Okay. And is that, does that dynamic now starting in Q4, is that something that we might continue to expect in some of the quarters in early 2010?
James F. Wright
Well, we feel very confident that we can continue to manage in a low inflationary or low deflationary environment. Again, it is a matter of how those costs cycle though.
When we get to cost savings in a deflationary period, and how we can manage our pricing. Clearly, if the retail price is maintained, and have a certain stickiness to it, it gives us an opportunity for those costs to move through our costing and therefore, we have a better matching of the costs and the retail price to maintain the margin.
So, again, several variables, but we believe that as we have shown in the first three quarters that we can mange through a low inflationary and to a certain extent, a deflationary period as well.
Analyst for Mitch Kaiser – Piper Jaffray
All right, okay. That helps.
Then, one unrelated question, but we haven’t heard much about it apparel. I know you’re moving into apparel heavy Q4 with some of the outerwear.
Would you update us with any trends that you are seeing there at this point?
James F. Wright
Yeah. Peter, I failed to mention in some of the fourth quarter initiatives, the rollout that we started in third quarter of CE Schmidt For Her which has been very, very positive.
We also are seeing some early solid indications that the cold weather products insulated and the boots and such cold weather gear is going to perform well. We have our inventories in great shape.
They are fresh inventories, no carry-over from a year ago. So we are very bullish on that and I think that we really structured in apparel, more of a price point program for this fall and that is also benefitting us.
The consumer really relates to, I hate to say this, but item price. We are very much a key item [inaudible] START FILE 6 sat on the floor right now and it is working very well for us.
Operator
Your next question comes from the line of Kristin [Applegee] - Sun Trust Robinson.
Kristin [Applegee] - Sun Trust Robinson
You said earlier that you expect the big-ticket items to remain under pressure. And I was wondering if you expect the recovery there, the shift from repair back to replace to basically be in line with whatever happens in the macro economy.
James F. Wright
Well, I think we have to recognize that there is - that consumer behavior and the declared end of the recession are likely to be decoupled. Consumers continue to deleverage their balance sheets.
They continue to be credit adverse. They continue to save.
And as we know, every dollar that goes into debt reduction or savings is a dollar that does not go into retail. So I think we are going to have to wait and see but I do think that the discretionary spender, big-ticket spender probably lag the official end of the recession.
Eventually it'll come back. Eventually the consumers repair capital goods cannot be repaired forever.
At some point that one actually becomes more economical to replace over term.
Operator
Your next question comes from the line of Jay McCanless - FTN Equity.
Jay McCanless - FTN Equity
Two questions - first one, on the 5.9% transaction increase year-over-year, could you all talk about how much of that is actually boots coming into the store versus people ordering online? Just wanted to see if you're actually pulling people in or they're taking advantage of all the internet promotions and email promotions I've seen.
James F. Wright
Yes, that's all store traffic. That's the same-store foot traffic, actually, same-store transactions, not traffic, transactions.
Jay McCanless - FTN Equity
And then my other question on - with the increases we've seen since the beginning of the quarter in oil prices and some of the other commodities am I reading it correctly with the way you're capitalizing those input costs now that we won't see any affect in Q4 if oil prices and grain prices sort of keep going up but we might see some pressure in fiscal '10? Is that the right way to think about it?
James F. Wright
Generally since our turns are close to three it could take four months on average for the cost to cycle through, the inventory costing, so the freight cost matching up with the turns. Now obviously the turns are different for various categories, so some of it may be accelerated through.
So some of it could impact a little bit earlier. But generally, on average, you're looking at sort of a three to four-month lag when it comes to the oil prices impacting freight and subsequently the P&L through the inventory capitalization.
Jay McCanless - FTN Equity
Have you all seen anything? I know you talked a little bit about deflation.
I'm guessing that's lagging from earlier this year. But have you all seen any other or new recent price increases from any of your vendors or anything you didn't expect in the way of coming price increases?
James F. Wright
No, we have not, to be honest with you. We continue to challenge the vendor community to bring prices back down.
And we've been for the most part successful in that. It's been - they've been receptive.
Operator
Your next question comes from the line of David Strasser - Janney Montgomery.
David Strasser - Janney Montgomery Scott
I was kind of a little bit looking at sort of the mix of sales as it relates debit versus credit. Are you seeing any incremental, I guess, refusals at the register?
Is that having an impact on the bigger ticket? And how are you thinking about that going forward?
James F. Wright
Yes, generally what we're seeing is that the applications themselves have declined and that is because the consumer just isn't looking to make that big-ticket purchase. The declines that we're actually getting from the credit company generally is just slightly less but it's not something that is overly significant.
So what we're seeing is that people just generally are not applying for the credit.
David Strasser - Janney Montgomery Scott
I mean, so when they're - because people who are applying - but inside the store, I guess, as it relates to the credit cards, you're not seeing anything incremental or mixed towards cash. It's more just people not buying the stuff or applying as opposed to a mix towards cash away from credit.
James F. Wright
Yes, when we look at sort of the cash/debit mix we see that cash/debit/check has increased year-to-date about 130 basis points.
David Strasser - Janney Montgomery Scott
How significant a number is that? Like, do you think of that, is that something that you step back and say, wow, or is that something that's more just maybe just kind of not a big deal to you?
James F. Wright
It's not overly dramatic especially in light of the trend that debit had prior to the economic situation. So we saw significant movement towards debit and that continued.
However, the movement to cash and check has increased and that had gone in the other direction prior to. So we definitely see the consumer being more conservative and only spending what he has in his pocket.
David Strasser - Janney Montgomery Scott
One other clarification, I'm sorry, but when you were talking about some new grounds on the pet side having Purina.
James F. Wright
Purina and Nutrena, they're both within the livestock side.
Operator
Your next question comes from the line of Christian Buss - Thomas Weisel Partners.
Christian Buss - Thomas Weisel Partners
You'd mentioned the deleverage impact from newer stores on the SG&A. Could you help us quantify what that was?
James F. Wright
I could probably help you quantify it but we generally don’t give that type of directional information. As in the past few years, we know that the real estate and to a certain extent some of the payroll new stores, until those stores reach maturity those stores will have a deleveraging impact.
We felt that through - as we moved into 2010 that that would become a much - that difference would moderate and probably be in the 20 to 25-basis point range and that we could eventually overcome that with our other SG&A management. With a negative comp sales, that obviously becomes more exaggerated.
So in a range you're probably looking somewhere between sort of the 15 to 40 basis point range at any given time depending on the comp sales volume.
Christian Buss - Thomas Weisel Partners
And maybe a follow-up there, is there any way you can help us gauge the hurdle for new stores as a percent of revenue at that 9% store growth rate that you guys have slowed to, sort of what the hurdle is there to hit the inner targets?
James F. Wright
I'm having a hard time translating the question. When we look at a particular store, it doesn't necessarily matter what the sales level is.
It's obviously the whole economics of the box itself. So we'll be looking at it over a 10-year period and we'll do a discounted cash flow for that 10-year period.
So a store, depending on its cost structure, could be very successful at $2.2 million or very successful at $4.4 million.
Operator
(Operator Instructions) Your next question comes from the line of Chris Horvers - J.P. Morgan.
Christopher Horvers - J.P. Morgan
Tony, can you talk about how the markdown management benefit trended over the past four quarters? You had mentioned it was roughly 70, 80 basis points this quarter.
I'm curious if 4Q is just a tough compare in spite of it sounding like being stronger on seasonal is more a comparison issue versus the execution.
Anthony F. Crudele
Well, it's probably a little of both. It has built throughout the course of the year.
Some of it - again, I think we need to go back to some o the history but Greg joined us near the end of 2007, so his first year coming through in 2008, we started to experience the improved inventory management and obviously cycling through some of our older goods and moving those out. So the freshness of the inventory really had a significant impact and as we continue to cycle that is really when we started to show the benefit, so obviously the cycle year-over-year 2009 compared to his first quarter 2008 had less of an impact and as we continue to show that improvement throughout his tenure, we continue to be able to improve that markdown management focus.
So, there has been a slight improvement from a sustainability standpoint. I believe that we can continue, but not necessarily at the pace that we saw in the third quarter, but we believe that there will be some benefit as we move into Q4.
Christopher Horvers - J.P. Morgan
So, that 70 or 80 basis points sticks, it’s just that some of the cycling shrink of a year ago and some of the vendor allowance dollars; that’s the tough compare, not necessarily the mark down management. Is that fair?
Anthony F. Crudele
I think as we move into Q4, that’s a fair statement. The benefit on the mark down management may not be to the extent that it was in Q3, but we do believe that we will be able to have enhanced performance on a year-over-year basis.
Christopher Horvers - J.P. Morgan
And then on the freight side, you turn inventories three times per year, so for freight to have 70 basis point improvement in the quarter being the biggest of the year, that is a little counterintuitive, so perhaps [inaudible] the driver there and is it some of the supply chain effort coming thorough in driving that and why is that not sustainable in the 4Q?
Anthony F. Crudele
Clearly we will have a benefit in Q4. We just don’t think it will be to the extent of the 73 basis points, but we do believe that it will be substantial.
As we cycle through and compare to last year, we did have very high costs in the summertime months and the majority of that did cycle through in the fourth quarter, so we believe that we will have some significant benefit there. But, as gas prices have increased, obviously, throughout this year we may not have the benefit that we had in Q3.
But, you are correct, on a year-over-year basis, freight expense was very high last year coming into the fourth quarter. So, we will have some substantial benefits, we just believe it will be slightly less than the 73 basis points we experienced in Q3.
Christopher Horvers - J.P. Morgan
Then, all told, ex LIFO, you are thinking that the direct margins are going to be down 60 to 70 basis points and freight comes in plus 50, ballpark, directionally.
Anthony F. Crudele
I don’t believe the initials will be down as significantly as that. I think it will be less than that as far as initial margins.
Again, it’s a matter of how you allocate the promotional dollars, as well. But net net, the big eternal will be the shrink.
And we believe that, obviously, the markdown managements will be a positive contributor. But, when it comes to the initial margin, net of the discounts, we are probably looking at more the 20 or 30 basis point level.
Christopher Horvers - J.P. Morgan
Down?
Anthony F. Crudele
Down, correct.
Christopher Horvers - J.P. Morgan
And then finally, if I could just sneak one in, you hear a lot of, like, the apparel retailers; even some home furnishings guys, seeing some renewed, maybe pent-up demand on big ticket. Just curious, if as the quarter progressed or even into October, if you saw any signs of life on the big ticket side of the mix.
James F. Wright
I think we have to temper what we are hearing from certain retail sectors against how far they fell last year. So, they are seeing improvement on a year-over-year basis, but their rate of decline, I guess, in Q3, certainly Q4, last year was much more severe than ours was.
So, I guess the answer is no, we are not anticipating any significant improvement on trend for ourselves.
Christopher Horvers - J.P. Morgan
Thank you very much.
James F. Wright
You’re welcome. We have time for one more call.
Operator
There are no further questions. Please continue with any closing comments.
James F. Wright
Great! Well, thank you all very much, delighted with our results, glad that you are with us on our growth journey and look forward to talking to you with final year results.
Thank you.
Operator
Ladies and gentlemen, this does conclude our conference call for today. You may all disconnect and thank you for participating.