Tractor Supply Company (TSCO) Earnings Call Transcript & Summary

Well, guys, thanks for joining us at the top of the hour. We'll get started. I think I know most -- everyone here, but Daniel Imbro, I'm the hardlines and automotive analyst at Stephens. Thanks for joining us for the Tractor Supply presentation. This is going to be a fireside. So pretty open Q&A. I'll kick it off, but I want group interaction, please ask your questions. From the company, really pleased to be joined by the CFO, obviously, Kurt Barton. Everyone should know Seth Estep, Chief Merchandising Officer, Mary Winn and Marianne from the Investor Relations. I should start with the congratulations. I think best CFO, CEO, IR and God knows every other award on IR recently. So congrats to you guys. But yes, thank you all for joining us.

Yes. Thank you, Daniel.

I'll start high level Kurt, for those that might be newer to the story. I don't think you need an introduction. But can you maybe spend a couple of minutes, a brief overview of the business, who your customer is? What really differentiates you from your main competitors in your market, and we'll go from there.

Yes, I'd be glad to. First, let me say good afternoon, and pleasure to just spend time talking about Tractor Supply Company. I'll hit 2 things. One, give a brief history and overview of Tractor Supply for those that don't know the complete story. And then I'll share a little bit on one of the best topics is what's been going on in the last 2.5 years and the trends in the business. And so -- for those that may not know, Tractor Supply has got 85 years of history. We'll be celebrating this year our 85th anniversary. But most of our growth has really been in the last 20 years. And Tractor Supply is a lifestyle retailer. We're a retailer that serves that what we call Out Here lifestyle. Those that live life on the land, with animals, pets, in rural ex-urban communities. Number of stores. We've got 2,100 Tractor Supply stores in 49 states. We have almost 200 of our pet specialty, Petsense by Tractor Supply brand as well. We serve the customer, like I said, it's that lifestyle customer. That could be someone that lives on 5, 10 or a few hundred acres. Many of the core customer have -- were raised, lived their life on the land, and there's -- it's a passion to them. And for Tractor Supply, our concept is have great customer service, have team members in our store that are experienced in our lifestyle and can solve the problems that our customers come in. So it's very relational, not transactional in regards to what we bring and offer. Our size of our stores are moderate in size. It's about 15,500 square foot selling box. It's an easy in and easy out. We move a lot of consumables, feed, food, other product in and out of that box, and it makes it a very convenient trip for our customers that are shopping Tractor Supply. Key merchandise categories. We're a livestock animal feed and containment. We are the #1 retailer supplier for livestock animal in the U.S. We've sold over 5 billion pounds in feed last year, bag feed last year. Second, pet. We have a strong pet presence, food, supplies. We're a top 5 pet retailer in the United States. All the agricultural type side of the business, the 3-point equipment and fencing, we sell that. Truck and tool and hardware, we offer a deep assortment of that. And then lawn and garden, that could be riding lawn mowers, push mowers, live goods and plants. Seth and I'll talk about our Garden Center concepts as well. And then lastly, but certainly not the least, we also have apparel. And our apparel is very focused on outdoors and the tradesmen and work related. And we're a key provider and seller of Carhartt, as an example. So that's generally who Tractor Supply is. And then second, I'll just say the trends of the business have been strong. As many of you may know, we were an essential business in COVID, and there's been a number of tailwinds that we've been a benefactor of, and we've seen that over the last 2.5 years. Sales have grown 65% since 2019. Comp store sales of over 40% since 2019 in that period of time. It's principally driven from 4 key tailwinds. There is a -- certainly a rural migration, a movement out of urban or suburban into ex-urban and the rural where our stores are at. And so the population and individuals that are moving out into these markets want to live life out here. They have the ability because of mobility and where they can work from home, and we're a benefactor of that. Pet ownership would be a second tailwind. Pets grown in the last few years significantly. Our customer has a high percentage of them owning pets and, in many cases, a high -- more than one pet. And then homesteading and self-reliance will the last other tailwinds, just being able to live life at home and have home be that place. And so in the last 2, 2.5 years, we've had consistent growth of both a mix of traffic and ticket that have driven the significant growth in Tractor Supply. And I think, Daniel, with that, there's a lot we can get into. So I'll turn it back over to you.

Yes, I think we hit a lot of those things I wanted to stay on that demand topic. Those 3 tailwinds, rural migration, work from home, all these things. What specific categories have you seen really surprised you? I guess, even sitting here 12 months ago, I think none of us thought you would be as strong as you were this year. What has been that next leg of outperformance? Because it feels like rural migration has happened, this year that's continued. There hasn't been that next leg. So what's really been that next leg higher this year that's driven that growth?

Yes. I'll take that in 2 things. One, I'd say, consumables. We -- in our business, we look at our -- what we call our queue, our consumable, usable, edible type product. These are things that move fast. They are the traffic drivers. Think about it in a Tractor Supply store where they're coming in for needs for their land and their animals. This is like the milk, the bread and the butter, the traffic drivers. And in that particular area, it's been the #1 sign. It's the #1 indicator of new customer growth and sustained customer growth because you've got x number of animals, and they're going to need a certain amount of feed, food and supplies and all that. And the growth has just been now for the third year since the beginning of the pandemic, has continued to grow, comping over the previous years. As we mentioned in our Q3 call, as we had in the other 2 quarters this year, dry dog food, as an example, has grown over 20% comps in there. So we continue to see growth in our consumables. That certainly is an indicator of market share gain, and that's been a really good benefit. More than we expected to see when we entered the pandemic. And then the other areas of the business has really just been some of the new categories that we've been in that I'm sure Seth can talk about, whether it'd be live goods or even grilling and categories like that.

Yes. That'd be great. I was going to ask you the TAM expansion you all talked about, I think it was like a 60% or so, a very large TAM expansion in the last few years and how much of that is stuff your merchandising team has done to bring in new categories versus that core growth?

Yes, when you look at the TAM, I mean, obviously the TAM went from around $110 billion to $180 billion. And with that, we attributed about $30 billion of that to just the market growth of the rural revitalization. The balance of that is more on the categories in which we serve. Whether that'd be, when you think about lawn and garden, as Kurt was mentioning here, is we're investing in garden centers. The lawn and garden categories, for example, are close to like a $20 billion TAM. So for every share point we can gain, you've got a couple of hundred million dollars that we can go after. And when we are going after these type of things, when we talk to our customers, I mean, -- we have an incredible resource in our Neighbor's Club database, and we have the ability to pulse our shoppers to see, hey, what do they look to us for, what are they shopping us for? What are they not shopping us for relative to lifestyle they serve? And what we found was core lawn and garden, specifically the Garden segment was the #1 hobby in which they -- that they live, that they did not look to Tractor Supply as their primary destination. And so with that, obviously, it's just opened up an incredible opportunity for us to leverage our side lots, our store base, to go after Garden. And we've seen just fantastic growth in that. When you think about homesteading, we talk a lot about backyard poultry, which has been fantastic. But also the Garden segment as well, not just a typical lawn and garden relative to like what we call color, flower, things of that nature, but we're really focused in on true gardening, right? Things that people can plant raised garden beds, et cetera, in order to support that lifestyle. So homesteading categories, the pet categories, the lawn and garden categories as well as categories such as like grilling, where people are just using their homes that for -- to create experiences, and we can be that destination for them.

And that leads into remodels. Obviously, they've been very topical and a big sales are for you guys. When I look at side lot infusion, how -- I wouldn't say how pleased are you with them? I am sure they're doing great. It sounds like we're getting into year 2 of those, like what are you learning in the vintage as we get into year 2? Are there still further increases? Are you finding better optimization or better localization opportunities? I think Seth, when you mentioned like Fusion 3.0, and it feels like you're making small evolutions. But what does that look like as these keep maturing?

Yes. So if you go back, just right before the start of the pandemic, we had store #1 in Rome, Georgia, as we were looking at a remodel program and really going after our Garden Center concept. And we right away liked the performance of what we were seeing. We were taking mature stores that could be 10, 12, 15 years old, and in that time frame, a lot of the categories that Kurt talked about earlier, we've grown significantly over the course of the last decade. We've invested heavily in pet. We've invested heavily in our feed. We invested heavily in other areas of the business. And those older -- the older floor plans, if you want to take it, didn't necessarily reflect our current merchandising strategies and our future merchandising strategies. So we were able to go back and basically remodel mature part of our fleet, put our current concepts in there, put a better brand and shopping experience in there and really it was all about driving space productivity and enhancing that shopping experience. Learned a lot. We built scale quickly even in the heart of the pandemic. At the end of this year, we will have roughly 30% of our store base already in our Fusion format. With remodels as well as new stores we're north of 500 stores. Today, we sit in about 260 Garden Centers. We will be north of 300 going into spring next year. And the team and the merchant team -- give them a tremendous amount of credit. We are constantly looking at what's working, what's maybe not living up to a little bit of expectations, how do we reallocate footprint and space. And to Mary Winn's point, we're basically like 3.0 at this phase where we can make sure that we're maximizing that footprint. And we continue to see the returns based on the business cases that we set out. Our Fusion only, with our pre-post lift, we're looking at around mid-single digits. Our combos, our Garden Center plus Fusion are high single digits. So continue to iterate on that and excited about what's ahead.

That's helpful. Maybe taking a step back, some of the consumer broadly -- been a lot of cross currents, headlines, everything else around what's happening with the consumer. I mean your core customer, can you talk about demographics, whether it's income, I think it is still at a higher level. And what are you seeing from that suburban rural customer despite all the background noise?

Yes. First, I'd just say, in general, we are seeing in our stores, our consumer is healthy. And I'll give you some of the points to consider about that consumer right now being healthy. We have seen consistency in transaction and traffic flow. Throughout the quarters, week by week, the biggest indicator is consistency in the business. Secondly, I'd say is that the ex-urban rural consumer from a position of employment, where their income is coming from is solid. There's -- our consumer either a tradesman, there is a plant production worker. There is a high demand for the work in the rural marketplaces. And so our consumer feels confident. They tell us in our surveys. They feel confident in their employment. Certainly, they're cost-conscious, right now with inflation. But for the most part, they indicate strength and healthiness. We've seen consistency in the performance. And then the last thing I'd say is in regards to our core customer. Our core customer, that individual that lives on 5-plus acres, they're passionate about their lifestyle. And so to them, what they've shown, we saw this. Seth and I saw this in '08, '09, we saw it in other periods of time where we've had softness. They're very committed to their lifestyle, and they continue to show us that their land, their animals are a high priority. So we're seeing across income scales, whether that's high or low income, we aren't really at this point, seeing a difference in spend patterns. There's not any strong indication of a step down. But what we do see is a consistency to a needs-based business and a lifestyle. And so we feel good about where our customer is at. Always recognizing they're cost conscious. And for us, we -- as we've talked a lot about, we are committed to an everyday low pricing with value through Neighbor's Club, and we believe that's really resonating. They recognize Tractor Supply being the lowest cost to serve, is giving them the price that is best in the marketplace with the value with Neighbor's Club, and that's really our approach to going after that customer. At this point it's playing out well.

That's helpful. Maybe things aren't slowing yet. But I guess 2 questions. One, are you seeing any change in whether it's credit card usage, financing, right? So any leading indicator of someone trying to find them more affordable, but maybe loyalty with Neighbor's Club. And then, Seth, as you think about categories in the box, what would you be looking at as leading indicators of slowing, whether it's, maybe slowdown in center store, kind of what are the leading indicators you would look, as you were talking, maybe things are changing, that's right?

Well, I'll take the credit card one. Seth, you can address that. The -- as we look at the business, the only shift we see today, Daniel, on credit card is that coming off of 2020 and 2021, where we saw increase in cash or debit, mainly because the stimulus dollars were in their accounts. We're seeing a reverting back more to a pre-pandemic level of credit card sales. So we've seen that shift back. And in that particular case, the consumer is working through any of the excess savings or cash that they have, they're now leveraging and utilizing credit more consistent with pre-pandemic. So we're very in tune to that. Two things that we're doing in relation to that. One is our credit card offering. As we announced, we had -- we just launched our first co-branded Visa credit card for our customer. And with that comes the same value points as our private label credit card, our Neighbor's Club Points. So we're adding that value to our customer, keeping Tractor Supply in their wallet, right? First card to pull out. And then the second thing is with our private label credit card, we can leverage the scale of that program. And we have great offerings, whether that's 12, 18 or even 36-month on some of the big tickets. So we will help our customer get the value they're looking for. And in some customers, that is an ability now to pay over a payment term. And they can do that in the no interest or same as cash type programs. So those are the things we're doing in this environment because there is more of that shift back to the credit.

Yes. And some of the category trends. Obviously, we definitely acknowledge the inflationary environment we're in today, in the economic climate that we are in as well. But when we look at our Neighbor's Club data so far, we're not seeing any meaningful trade down in spend at all. And it's been very, very resilient. And if you think about the model that we serve and the customer that we serve, we are very much a needs-based business and a demand-driven business. So our core shopper is coming to us again for queue for pet food, for all those type items. And our store teams have been phenomenal. They get them in the box. They have the ability to sell them, cross-sell up, so, et cetera. We obviously have watched some of the major kind of discretionary, there was some inflation like we mentioned on a call or 2 ago, things like wild bird seed, right? Queue item that's very discretionary, those type of things, that you can watch and see consumers kind of pull back there from time to time. But other than that, I mean, it's kind of one of those things, we're obviously continuing to monitor it and have the nimbleness to be able to respond accordingly.

So another big tailwind has been the rural migration. And -- but now we're seeing, clearly, a lot less just movement in general, people who did this and homestead and stuff [indiscernible] stay a little more. So I'm just wondering like the non- categories, are there any categories that you guys see that might be correlating on a live basis or people acquire a property and things that they do, like improve the property or whatever, so we might see, or should be prepared for housing related kind of...

The new customers that we've seen come into the market, new homeowners may buy riding lawn mowers, other big-ticket items, trailers, et cetera. And we saw a bit of a peak in there in 2020 and 2021. We planned for this year in our expectations, not only in sales, but also in the merchandise inventory that we bought that we'd be back to more normalized numbers of volumes of some of those big-ticket items. And it's played out very much as we expected. And in some cases, with higher inflation, there's a bit more pressure. But in our business, we're not necessarily as much about the product that the customer needs because of a new home purchase as much as the everyday needs that they have for their activities, other things outside of it. So there's not a particular category of our business that is a onetime initial launch into the new home ownership or anything like that. It's really been examples of millennials that outsized any other demographic, coming into our marketplace and being introduced to Tractor Supply, who are focused on sustainable living or focused on pets, poultry, et cetera, and then getting into that lifestyle. So like poultry launches with a chicken coop and some chicks. But then the life cycle of the owner of poultry then goes into all the feed, the food, the supplies, the treats, et cetera, that actually is equal or grows from that point. And it's same thing with some of the lawn and garden that is every year. So at this point, we see consistent benefit and trends on those new customers. We see the highest level of retention rate on new customers. So not only we, like, for instance, grew 5 million new Neighbor's Club in the last 12 months, but it's the highest-level retention rate of those new customers. And then -- last thing I'd say on the move. The one thing that we focus on is this continued migration, and we may have seen migration in 2020 and 2021. An interesting data point on an article just in the last week or so from the Wall Street Journal, when they report the 12-month rolling average ending June of 2022, and they looked at the moves by homeowners from their existing or the previous home to their new home, it well outpaced, the average move was 50 miles, when a typical average has been 15 miles and the highest percent of that went into rural markets. And it just continues to show the tailwind that we're talking about. And a lot of our expectation, a lot of our future targets are not necessarily based on that trend continuing to accelerate, but necessarily that those customers stay in our markets and they shop Tractor Supply and we retain them as customers.

It's helpful. Another tailwind we've talked a lot about in the last couple of years has been inflation. And Seth, you mentioned it so have the leeway to bring it up now -- no. You guys have been benefiting, I think, this year on the top line, especially in queue and some of those categories. I mean, next year, if commodity inflation becomes disinflation or just flat lines, I mean, how do you guys feel about your pricing, you're going to be EDLP, but you're also the lowest cost to serve. So what does that mean for average retail ticket into next year as you assess that?

Yes. On inflation, we definitely have been transparent, talked about the level of inflation. First, I'll give a little bit of backdrop on the -- where we've seen the inflation; second, our view, our opinion on how structural the inflation is and then how that might play out in future years. But in the last 1.5 years, the core significant piece of the inflation roughly about 1/3 of our inflation that we've seen has come from commodity based, grains, oil, steel, et cetera. Another 1/3 through supply chain, transportation, ocean freight, all of that. And it's really transpired in kind of in the order, I'm walking it through. And then thirdly, broad-based inflation in our -- the overall business model of our vendors, et cetera, principally wage based. If you think about those 3 drivers of it, our position is most of this inflation is structural. Wages are structural. There continues to be a strong labor market. And so we believe that the wage pressures are permanent parts of the cost structure. Secondly, on supply chain, while there's some easing of ocean freight on the spot, ocean freight costs, our expectation, while moderating will be above pre-pandemic levels and certainly the domestic transportation costs just from this -- the industry itself and the pressures on the supply there be above pre-pandemic levels. So there might be some moderation there. And then commodities, while some could moderate and we've seen that. If you think about just even the area of oil, petroleum or grains, there's a number of global impacts that would -- that are more supportive of that from the supply standpoint, whether that's the war in Ukraine or other aspects, oil and grains likely, while some moderation not likely to see deflation there. So all of that, our belief is that we're in a point of whether it's stagflation or disinflation, is a scenario for 2023, but not necessarily deflation. If you were to play that out -- and we made this statement on the call, if you were to take a look at the inflation rates we quoted, if you took the current retail prices, next year, as we cycle that, those retail prices just lapping the 2022 numbers, still puts some level of inflation in the ticket in there. And so we expect this to be on a top line, a bit of a tailwind on comps in 2023. And then how do we manage that? While we manage some of the easing of pressure on supply chain, the easing of pressure on commodity, Tractor Supply is the #1 in farm and ranch, a price leader, a price setter. We will continue to use that position along with all of the aspects of what we offer in, in-stock inventory and great customer service, we'll manage both retail prices for gross margin rate, but also use the lever of competitive market share. So we're -- Seth and team will manage retail pricing to be very competitive, gain market share, but also an opportunity to have some easing of the pressure that we've seen in the last 12 months on the margin rate.

This is a question for Seth. With inflation, customers are increasingly focusing on value, do you see any categories where you see potential to grow further, either private label penetration or outsourcing opportunities to get better, a new price?

Yes, we are very focused on exclusive brands, they are -- or what we call versus our private labels. So today, we have north of 20 exclusive brands in our store, represents around 30% of our sales. And with that, I mean we are highly focused on driving that, whether that be in pet food, whether that be in apparel, with brands like our Blue Mountain or Ridgecut. On the feed side, as Kurt mentioned, or even if you go over the lawn and garden side with our GroundWork line up, because the inflation that you're likely going to see like in fertilizers and things of that nature, we're really leaning into our exclusive brand portfolio this next year, and you'll continue to hear us talk through that as we want to continue to create kind of that stickiness, that loyalty offer value proposition to our shopper. And our customer, for the most part, when they look at our exclusive brands, I mean, they're not looking for, call it, a cheap private label. They're looking for value proposition to help them build their lifestyle. High-quality product that can be premium based, that lives up to the demands of their lifestyle, that they can only come to Tractor Supply for. So we are highly focused on exclusive brand penetration. You're going to hear us continue to talk about that across the 4 walls.

What's the big difference, your exclusive brands versus private label?

It varies by category, but just like most private labels, which you would see, obviously, you'll get a value proposition to the customer, but you'll get a margin benefit in that category for the most part.

And have exclusive brands been equally as inflationary on top line? Obviously, there's still a value, but are they also inflationary and feel good about keeping that kind of price you're taking?

Yes. I mean absolutely. I mean I would say basically no product has been immune from inflation over the course of the last couple of years. But obviously, we've got some fantastic supplier partners that we've been able to work with. And with that, I mean, we feel really good about the ability to manage that.

Got it. I want to touch on the supply chain. And obviously, we're starting to see some alleviation. We'll talk about freight and fare in a little bit. But how are inventory levels, but almost more importantly, how are your competitors? I feel like that was one reason you guys gained a lot of share in the last 24 months because you had product, others didn't. As others get product back, how do you retain that share, it has become more competitive marketplace? How do you see that playing out?

I feel really good about our inventory levels. So we're in a fantastic inventory position today. Obviously the course of the pandemic as you mentioned, we heavily relied on our supply chain to be in stock and put us in a great competitive position. But our inventory levels in total are extremely healthy. I mean a lot of the headlines that you see out there right now are people. We're really looking at that last cell that they kind of missed and then they doubled down and loaded up on inventory that's now driving a lot of clearance. We've been very cautious at that. I mean, again, being needs-based, demand-driven, really going and modeling what we thought the impact was for stimulus, et cetera. What we thought maybe those risks were and how can we shift and drive those other cells from kind of bottom up. So today, for example, over the course -- or in the last quarter, for example, like our clearance position is actually less than where it was even pre-pandemic levels. So I mean, we are extremely healthy when it comes to our inventory position because again, we're very needs based. Only 10% to 12% of our inventory is direct import or cost of goods or direct import. So we get the ability to really manage and be nimble on our inventory levels, really drive it to the levels that we need. And with that, I mean obviously, just really be able to go after. I mean we've talked all along -- we're still as good as we thought we were as getting inventory. We still wanted inventory in some categories relative to queue and some of those things. And we really feel like we're in a really strong position right now as we are entering Q4 to make sure that we can capitalize on the traffic of the holidays.

I wanted to ask, you recently, Kurt, closed Orscheln. Congrats. M&A has not been as big a focus for a couple of decades, it feels like at Tractor. Why was now -- what was attractive about that? Is that going to become more of the growth arsenal, the tool in your toolbox as you think about deploying capital here on the M&A side?

Yes. Orscheln is a -- has always been a really good competitor, a Midwest-based farm and ranch retailer that out of all the competitors is most like Tractor Supply, and they're a great competitor. They're in -- they were in markets where most of the stores were in markets that we were not in, ones that, if you were to evaluate, do you put a second farm and ranch store in that town. And when we look at our other locations, it would be better to just go to a different market in that place. So they've got -- they had a number of stores that are in markets that would be great for Tractor Supply to be in. And we run the numbers, the demographics of those and we understand the value of those markets. So for the most part, a company that has a mission and value like us with a great set of team members, where we knew if there was going to be a time for an exit strategy versus a generational transfer that it will be a great fit for Tractor Supply. We were able to retain roughly half of those stores and all 81 of those stores are in, as you can naturally assume with the process that we went through that they're in stores where there's no Tractor Supply or a Tractor Supply near. And we see a great opportunity to grow those stores with the merchandise assortment, the service and all the scale that Tractor Supply has to grow those into size of Tractor Supply revenue. And at, eventually at margin rates consistent with Tractor Supply. So it's really about market -- the real estate market that we wanted to be able to get a footprint in. And we're excited to be able to get that over the finish line.

A couple maybe on the digital or omnichannel strategies, starting on maybe the loyalty program. I kind of lump it in with that. We're on a couple of refreshes here. I think now you're on a tiered program. What -- where does that outperform your expectations? And then maybe where are some areas you still see opportunities to better leverage that, whether it's data or whether it's actually just monetization of that program?

Yes, certainly. So on our Neighbor's Club program, it's just been phenomenal growth. We basically doubled the number of members since 2019, now at nearly 28 million members. What's been really exciting. First, we got a lot of questions about whether or not -- could you ever see yourself at 20 million members, right? So we flew past that number. The 20 -- the now almost 28 million members represent about 75% of our sales. And that's the other number that's pretty impressive is that we've got a core customer that we can speak with. We've got their data, and they share with us, and we can meet their needs and make sure that it's driving merchandising decisions. We've got more visibility to what their patterns are. It impacts the -- what we know about the demographic of a customer and even insight on other markets what the value of a market that we're not in. We've got -- we've had some of the highest retention rates in Neighbor's Club. Our biggest growth area over the last year since we introduced that tier program has been in movement up into the highest-level tier. So while Neighbor's Club members have outpaced in comp, the non-Neighbor's Club members, the highest level of performance is the number of members now in the highest tier. And we have 95% retention rate at that level. And so these are the best customers, the ones that we will speak to and really build that relationship. Last thing I'd say about one of your question, is about how are you leveraging it. There's a number of ways that we'll leverage. Just give you 2 examples of ways we can leverage it. On pet, an example. Now we've got more visibility whether the consumer is disclosing, which they have a lot of opportunity in our app to disclose their pets, but we have the visibility to their shopping patterns, more confidence in the data. So we know if they're consistent with their patterns, if they're buying across all of their pet categories with us, and we can speak to one of our best customers in regards to shopping with us for food if there was a gap, supplies, other things that we can add to it, services like vet, Rx, pet wash. So we are leveraging Neighbor's Club to just grow pet. And then the second thing I would say is, one it gives us an ability on the digital side, on social media or other aspects further look like. We now know with this new cohort of higher percentage of millennials, we now know more about them. And so we are targeting not only them, but those that look just like them. And that gives us -- and our social media team and our marketing more information to be able to rifle into and focus on those customers to bring them into the Tractor Supply box.

Yes. The other one I wanted to ask about, Hal's background, had a little more experience, I think than a lot at Tractor. In hindsight, it's been a couple of years -- when we look back, like what are some of the shifts that Hal really was instrumental in leading some of the changes, nothing revolutionary but evolutionary, kind of making small changes. What were some of those that he's really been pioneering within the company?

Yes, I'll take it. So it's pretty amazing. So I've been at Tractor almost 17 years and now multiple CEOs. And I'd just say, it's pretty remarkable to see that each of the CEOs that we've had at Tractor Supply, it's the right person at the right time. And under Hal's leadership over the course of the last few years, his background in omnichannel has been very strong and it really at the essence of omnichannel retail. When you look at his background, people look eBay, they look at leading the e-commerce initiative at Depot. But it's not just e-commerce. It's about having a seamless shopping experience with the customer at the center across all your touch points and all your channels. And we went from really focusing on what was our ONETractor strategy, which was really building the foundation for e-commerce and omnichannel for how he is able to come in introduce the Life Out Here strategy. And it's really about all those touch points. And under his leadership, how fast and quickly we've been able to leverage that scale to be very transformational, starting with our front-line workforce. Then go into our store base and our remodel program; third, then obviously continuing to enhance our digital capabilities, accelerating our app. We have now over 1.5 million app downloads after that launch. And then now obviously, moving to supply chain to make sure that we can continue to meet the demands of the top line growth that we have. So to me, it's not just about the e-commerce piece, but to your point, in a really true omnichannel and how he's brought his leadership, his experience to really be able to accelerate that and accelerate quickly so that it can be incredibly sticky from a shopper perspective. And that's what the essence where we are. And if you think about who Tractor Supply is at our heart of our mission and values, it's about serving a lifestyle. It's about serving a customer. It's about driving convenience. It's about driving that loyalty. And so from an omnichannel perspective, it's one of those things that we are a retailer, I think that at the heart of who we are, it's just incredible to see those things kind of take root and our customers are really gravitating towards it.

Kurt, maybe a couple on margins. Can't let you get out of here too easily. Yes. I think my freight team would actually -- not let me come home, if I didn't ask about it. So we've seen truckload pricing coming down. A lot of those companies are up here talking about if pricing is down mid- to high singles next year, I mean, how does that flow through the model? How sensitive is that gross margin line? It's been up high singles for a couple of years now. It's been a big headwind. So kind of what does that year-over-year look like as you look to '23?

Yes. Great question. I'll hit 2 things. Our thoughts on the transportation industry, the timing of when that flows through. And then how we would really -- how we manage that. And so first, on the transportation side of the business, for Tractor Supply, we've got a mature, robust supply and transportation department between our distribution centers, our networks with our vendors. And the fact that we manage while we contract with carriers, both domestic import, we manage our transportation costs through contracts. And even in the peak of some of these import costs, a vast majority of our ocean freight, a vast majority of our domestic was all under contract. And it really helps us in all the different variables of being the lowest cost provider for farm and ranch because we have good consistent growth that allows us to have contracts. And we did not see necessarily some of the immense peaks in it. That said, the industry right now is going through levels of moderation of those costs. And so like we did in previous times, we are now negotiating and getting new contracts, some of which have already been retained. And these are either 1-year, 2-year contracts that allows us to reduce our transportation costs. And the biggest benefit is more on the importer ocean freight. Seth said, we're about, 12% of our business is direct import. So it's a smaller part, but we are definitely seeing some moderation in that -- that will take some time to flow through. So for instance, product that's being sold in Q4, Q1. Those costs have the existing prices. You start to see beyond Q1 of next year, any reduction in cost you start to see that flow through and maybe principally mid and late next year on it. We will manage like we did when prices went up. We will first make sure that we maintain competitive pricing for our customers. We have a sophisticated web scraping and other retail competitive tools and entire team -- so we'll make sure that we have the most competitive price. It still allows us because we have the best supply chain in farm and ranch to be the lowest cost provider. So that allows us to do a number of things, and we'll manage the levers from giving us -- being able to recoup some of what we absorbed in gross margin from transportation pressures in the last 2 years. It allows us to be more competitive in pricing. And we're going to manage the balance between those. Gross profit dollar is a key factor, but for us, timing could be mid next year. And we will balance between the ability to have the sharpest best prices for market share and being able to maintain or even grow our gross margin rates.

Good work on the SG&A side, you guys were proactive, investing in team members kind of leading -- not leading the charge, but very much investing in from a labor standpoint. How do you feel about those wages today? Is there going to be a continued inflation, I won't say pressure next year, but a continued cost inflation that you have to navigate through next year as well on the labor side?

Yes. I'll -- 2 points. On the labor market first. It was highly competitive and significant growth rates in the last couple of years. Tractor Supply got ahead of that early on in 2020 and launched a hiring effort to grow alongside the growth of our business and increase our wage rates. And we've had 2 years of high single-digit to double-digit wage rate growth in the cost structure. We are positioned well right now from a competitive standpoint in our stores and distribution centers, because of the investments that we've made, because of our culture that we will hire and retain our team members. And because we hire our customers, our turnover rate, by the way, is low as it was pre-pandemic. We have great retention. And because of our investments, our employee engagement scores are all-time high. I believe that is highly correlated to the fact that our customer satisfaction scores measured by third parties that measure other retailers is at an all-time high. So I really like where we're at. We took some of those COVID benefits of the growth and invested in our team members, and I think it's paying dividends in that aspect now. Looking ahead, likely to see continued competition for labor. Wages may outpace historical norms, but likely lower than the high single digit and any double-digit numbers. I think they're moderating back down, whether that's mid-single digit or high low single digit type numbers in the next year or two. But in our current state, in retail and in distribution, frontline team members in competitive wages, I think, are necessary and it's a high priority for us. But again, I think we -- the key investments are behind us in our structural cost structure today.

Got it. And then maybe last one on the financials. If we think about the long-term targets you gave about a year ago, all the different margin inputs you guys were assuming, I think it was 10.1% to 10.6%, somewhere in the range. COVID costs have come down since then, wages are maybe a little bit worse than we thought. Freight is coming down. Just given 12 more months under our belt, how do we feel about those long-term targets and how you guys are executing against towards getting longer term within that kind of mid-10% EBIT margin range?

Yes. And I think to your point, as we mentioned on the Q3 call, as we see the consistency and the strength in the trends of our business, the visibility we have on cost gave us the confidence to even give an indicator of -- 2023, in our view, should be in line with our long-term algorithm. And to that point, how that looks in 2023 and even future years, I'll hit SG&A first because you hit a number of those points. Wage rates, maybe growth year-over-year, may be not too far off sales growth levels. Depreciation, because of our investment in supply chain and our investment in our Fusion remodels will outpace and will be a bit of a headwind on the SG&A. But between leverage on our comps, between coming off of some of the costs like COVID. And when you just think about supply chain, while we've not opened a distribution center since 2019, when we were an $8 billion revenue company, and we'll open one in the first quarter of next year as a $14 billion revenue company. We have managed through with pop-up DCs, third-party logistics, et cetera. So from a distribution standpoint, while we're adding a distribution center, we are driving some efficiency next year. So we believe there's some puts and takes that continues to give us the confidence that SG&A will be flattish as a percentage of sales. Gross margin for some of the things we talked about, we've managed inflation very well and the rate has been only modestly down mainly due to mix. And next year, we believe between retail pricing, the efficiencies in our supply chain that we can see flat or even growth in gross margin next year. So it really -- those are the things that fit our algorithm, that's really the crux of our algorithm over the next few years. So opportunity to maintain SG&A while we're investing, opportunity to leverage this and flex the high scale of our supply chain and our merchandising group to be able to see some modest growth in gross margin. Those are our -- that's the formula for our long-term algorithm that we will work towards each for the next few years.

Well, we are up on time, but congrats on the results so far against it, and best of luck.

Thank you.

Thanks, Daniel.