Tractor Supply Company (TSCO) Q3 2021 Earnings Call Transcript

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Tractor Supply Company (TSCO 1.04%)
Q3 2021 Earnings Call
Oct 21, 2021, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Mary Winn Pilkington -- Senior Vice President of Investor Relations & Public Relations

Thank you, operator, good morning everyone. Thanks for taking the time to join us today and we do hope that everyone is staying safe and well. On the call today are Hal Lawton, our CEO; Kurt Barton, our CFO. After our prepared remarks we will open the call up for your questions, Seth Estep, our EVP and Chief Merchandising Officer will join us for the question-and-answer session. Please note that we've made a supplemental slide presentation available on our website to accompany today's earnings release.

Now let me reference the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. This call may contain certain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the company. In many cases, these risks and uncertainties are beyond our control. Although the company believes the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements would prove to be correct, and actual results may differ materially from expectations. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included at the end of the press release issued today and in the company's filings with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed. Investors should not assume that statements will remain operative at a later time. Tractor Supply undertakes no obligation to update any information discussed in this call.

This morning we've shortened the prepared remarks to allow more time for Q&A. Given the number of people who want to participate, we respectfully ask that you limit yourself to one question. If you have additional questions, please feel free to get back in the queue. I appreciate your cooperation on this. We will be available after the call for follow-up. Thank you for your time and attention this morning. Now it's my pleasure to turn the call over to Hal.

Hal Lawton -- President and Chief Executive Officer

Thank you, Mary Winn, and thank you to everyone for joining us this morning. The Tractor Supply team delivered strong results for the third quarter with net sales of 15.8%, comparable store sales increase of 13.1% and diluted earnings per share of 20.4%. The team is doing an outstanding job navigating a very dynamic and challenging operating environment. We continue to benefit from many market trends that we see is very structurally sound. We have strengthened our customer base. We're gaining market share across our categories. We continue to advance our Life Out Here Strategy. Our business has never been stronger, and we see tremendous opportunities for growth ahead of us.

As we've consistently shared with you over the last 18 months, our strong results are a testament to our 45,000 plus team members and I'd like to thank them for all their efforts in the quarter. They kept each other safe as we went through another COVID-19 wave, they navigated through broad based supply chain disruptions and cost of goods increases, and navigated and managed through a tight labor market. Through it all, they've been resilient and persevered to deliver strong customer satisfaction scores including all-time high [Indecipherable] scores. Our team members are our greatest strategic asset and a key competitive differentiator with our customers. Our loyal and highly engaged team members have helped us fare better than most as far as staffing across our stores and DCs. Back in June, we raised our minimum opening wage to $11.25 per hour. Our recent wage actions bring our average hourly wage rate at our stores to nearly $15 per hour as we exit the year, with our DCs at a higher rate. The investments we have made in store labor are being recognized by our customers by the overall customer satisfaction scores that I just mentioned.

I'd also like to say thank you to our vendors and supply chain partners as we work together to overcome challenges in the global supply chain network. And together, we've been very focused on controlling what we can control to deliver these results. Across our network we've been nimble and been able to navigate the unprecedented supply chain environment and macro issues including inflationary pressures. And the team has done a great job addressing issues ranging from import container shortages and port delays, driver shortages, higher freight rates and a multitude of other supply chain constraints. To mitigate these challenges, the team has leveraged dedicated containership, top up the fees, expansion of mixing centers and direct to store shipment. Despite these challenges, our inventory's in good shape and our in-stock rates finished above last year at the end of the quarter.

Our diversified vendor base with only about 12% direct import is a strong point of differentiation for us during these supply chain times. Given our scale and sophistication, we believe that our network is a competitive advantage to being the dependable supplier for the Out Here lifestyle. Categories in which we participate and the Out Here lifestyle that we serve, continue to have elevated consumer spending levels well above pre- COVID levels. We fully anticipate this environment we're in is going to continue for the foreseeable future. And consequently, we think that the sales growth that we've seen is structurally sound, given the changes in consumer behavior and the lifestyle investments that are now much more ingrained in the consumer psyche. These structural trends that continue to work in our favor include things like rural revitalization, trip consolidation, omnichannel adoption and a self-reliant lifestyle movement, including DIY trends and investments in hobbies like gardening, backyard poultry and of course pet ownership. For many workers, the return to office has been pushed out until next year. And even then will very likely be in a hybrid environment at most employers. And at this point, our customers will have been ingrained for over two years. As such, we anticipate that their behaviors are much more sustainable and structural.

To provide some color on our results, let me share a few other highlights for the third quarter. Like the second quarter, every week had positive comps. Also like the second quarter, our growth was broad based across regions and product categories. Our e-commerce business continued to experience strong momentum with double-digit sales increases of over 40%. And in just under a year, our mobile app already has more than 2 million downloads and now represents over 10% of our e-commerce sales. We continue to gain share across all categories. This has been a consistent trend for multiple quarters now, and this share gain has been both online and in stores. The share gain has been aided by the increase in our unaided brand awareness, which has improved by 21 percentage points since November of 2019. This improvement combined with positive trend in our overall customer satisfaction, are significant contributor to the share gains we are experiencing.

Also consistent from previous quarters, all customer segments were strong with notable strength in our core Farm & Ranch, which is the largest and most important of our customer base. At the same time, our digital ad campaigns that target millennials are supporting a significant growth we are seeing in this important demographic. We think the relevancy of Tractor Supply to the millennial customers has staying power, given the structural changes in the market and our customer behaviors and we're certainly seeing that consistently quarter after quarter in our data, as our average age of customer trends down. For the year, more customers than ever have shopped at Tractor Supply. These customers are making more trips and are spending more money per trip, and our new customer retention remains very strong.

Our Neighbor's Club loyalty program continues to exceed our expectations, with year-over-year sales growth that these members north of 20%. We exited the quarter with more than 22 million Neighbor's Club members. These members are spending more than about three times the rate of non-members, with Neighbor's Club members now accounting for nearly 70% of our sales. This continues to be a step up from where we've been running prior to the relaunch of the program, and sequential improvement over the second quarter of this year. The number of high-value per customers in the program grew almost 30% for the quarter, and we continued to experience retention rate in excess of 95% for our high-value customers. These strong results demonstrate that the changes to Neighbor's Club continue to gain traction with our customers. Given our robust performance through the third quarter, along with our outlook for the fourth quarter, we are again raising our sales and earning guidance for 2021, and Kurt will share more detail on our improved outlook later in the call. Regarding our pending acquisition of Orscheln Farm and Home, we continue to work cooperatively with the FTC, as they continue to review the proposed transaction. We look forward to the benefits this transaction will offer customers with improved product offering and competitive pricing.

As has been the case over the last 18 months, I'm incredibly proud of the way our entire Tractor Supply team has managed to stay focused on taking care of each other and our customers. Our long-term opportunities remain very exciting. Our goal has been to emerge from the pandemic stronger. Over the course of the last year since rolling out our Life Out Here Strategy, we have gotten stronger through this pandemic. And we believe that we're going to emerge from it even stronger and better positioned as we execute our strategy. And with that, I'll now turn the call over to Kurt.

Kurt Barton -- Executive Vice President, Chief Financial Officer and Treasurer

Thank you, Hal, and hello to everyone on the call. Once again, our third quarter results demonstrate the strength and resilience of our business and our strategic initiatives. As Hal shared, we continue to believe the underlying health of our business is very strong. Third quarter comp store sales of 13.1% representing a 39.9% two-year stack were driven by a comparable average ticket increase of 9.5% and transaction count increase of 3.6%. An example of the structural advantage we have is the ongoing strength in our consumable, usable and edible products. Our C.U.E. products represent the strength of our core business and what drives trips to the store. Once again C.U.E. outperformed the chain average comp sales, and for the sixth consecutive quarter in a row, C.U.E. had comp sales growth at or above 15%. Key subcategories such as poultry, livestock feed and dry dog food were among the strongest categories with broad based strength. Our big ticket categories which were going against significant growth in the prior year continued to have solid comp store sales performance in line with the chain average. This was driven by strength in trailers, recreational and utility vehicles, safes and zero turn mowers.

Inflation contribute about 700 basis points to comparable store sales. As you've heard from the retail sector and others, the cost environment remains elevated across imports, domestic freight commodities and labor wages. Our merchant team has been aggressively advocating for our customers. Where necessary, we are taking price increases to pass through some of the cost pressures that we cannot offset. Our merchant and supply chain teams are currently navigating this challenging and disruptive environment extremely well. As we closely monitor our customers' purchasing behaviors, we are focused on product unit trend and are committed to being priced right every day.

Our third quarter gross margin rate was 36%, a decrease of 41 basis points versus last year. For comparison, our gross margin rate this quarter was still about 100 basis points above our Q3 2019 rate of 35%. Year-over-year, the gross margin drivers were principally three items. First, higher product cost inflation; second, elevated freight costs, inclusive of domestic and import costs; and third, a more normalized product mix shift in C.U.E. All of retail is working through the drivers of inflation and freight costs. The Tractor Supply team effectively offset a significant portion through our price management program. Additionally, we continue to see favorability in the frequency and depth of promotions. This is due to our commitment to our everyday low pricing strategy and a continued strong demand for our product categories. The benefit from vendor funding for the Field Activity Support Teams for our FAST initiative, which was launched in the second half of last year was consistent with our guidance.

Our third quarter SG&A expense ratio, including depreciation and amortization, improved by 58 basis points versus last year to 26.1%. This improvement as a percent of net sales was primarily attributable to good leverage in occupancy and other fixed costs from the increase in our comparable store sales, along with lower COVID-19 pandemic response costs and decreased incentive compensation. Partially offsetting this leverage were higher wage rates, incremental store labor hours to ensure we are providing great customer service, and investments in our Life Out Here strategic initiatives. Given the elevated volumes in current operating environment, we also incurred select discreet costs such as incremental team member benefits, pop up DCs and the timing of our annual sales meeting, which normally occurs in the first quarter.

The offset to our FAST initiative benefit in gross margin was approximately 20 basis points of incremental SG&A expense for the labor cost for the team as we are now cycling the initial investment to launch the program last year. Much like our gross margin rate, our SG&A performance compares favorably to Q3 2019. We've had about 70 basis points favorable expense ratio since then. Operating profit increased about 18% with operating profit margin of nearly 10% in the quarter. Diluted EPS was $1.95, an increase of 20.4% from the third quarter of last year.

Our balance sheet remains incredibly strong. At the end of the quarter, our merchandise inventories were $2.2 billion, representing an 11.7% increase year-over-year in average inventory per store. The increase principally reflects growth to support the robust sales trends along with the impact of inflation.

Moving now to our updated guidance for fiscal 2021. We continue to operate in a time of heightened uncertainty regarding the pandemic. Despite this uncertainty, including product cost inflation and supply chain constraints, we are raising our full-year outlook. Our updated guidance reflects the strong results for the first three quarters of the year and the positive and structural momentum we see in our business continuing into the fourth quarter. Against the backdrop of what we know today, we are forecasting fiscal 2021 net sales centered around $12.6 billion, with comparable store sales growth of about 16%. For the year, we forecast an operating margin of 10.2% to 10.3%, a step up from our prior guidance. Diluted EPS is now forecast in a range of $8.40 to $8.50. This compares to our previous earnings range of $7.70 to $8 per diluted share. Within this updated guidance, we are forecasting comparable store sales growth for the fourth quarter of 8% to 10%.

Two modeling points to keep in mind. The prospective acquisition of Orscheln Farm and Home is not included in our guidance. And as you start to roll forward your models for 2022, please keep in mind that next year, we'll have a 53rd week for us. This week is typically a low volume week of sales given that it follows the Christmas holidays. We have a unique opportunity with the positive customer trends and momentum in the business. And with that we are committed to investing in store and supply chain labor as we look to provide a legendary customer experience across all channels. The strength of our balance sheet and the consistency of our free cash flow, continue to be a position of strength for Tractor Supply. We remain committed to returning cash to shareholders through the combination of a growing dividend and share repurchases. For 2021, we remain on track for anticipated share repurchases in a range of $750 million to $800 million. This year will mark a milestone with approximately $1 billion returned to shareholders through the combination of share repurchases and dividends.

In summary, our results prove yet again Tractor Supply's unique competitive advantages. Our relentless focus on being the dependable supplier for the Out Here lifestyle is embedded in our purpose as a company. With that, I'll turn the call back over to Hal.

Hal Lawton -- President and Chief Executive Officer

Thanks, Kurt. Now I'd like to share with you an update on our recent ESG announcement as well as provide updates on our Fusion and Side Lot strategic initiatives, which are key parts of our Life Out Here Strategy. At a time of urgency and action on climate change and social justice, we just announced new goals that are the next step in our long-standing commitment to sustainability, stewardship and opportunity. By 2040 we are committing to achieve net zero carbon emissions across all our operations. As part of our social commitments, we are prioritizing and accelerating our initiatives and actions for diversity, equity and inclusion. At Tractor Supply, we are focused on cultivating an environment of inclusion, where diversity of all kinds is appreciated in value. I invite you to learn more on our dedicated ESG website.

Turning next to our Life Out Here Strategy. As a reminder, we've been executing against five key strategic initiatives this year as part of our overall strategy. And those initiatives are Neighbor's Club, Digital, FAST, Fusion and Side Lot. The strategy and it's initiatives are designed to capitalize on the attractive opportunity that we see in our nearly $110 billion total addressable market. Our Project Fusion and Side Lot model transformations represent significant investments in our stores. These store-level investments are designed to grow our market share and drive the productivity of both existing and new stores as part of our Life Out Here Strategy.

So let's start with our Project Fusion store remodel program. As a quick reminder Project Fusion is our state-of-the-art space productivity program designed to enhance the customer experience in our mature store base, and give customers that may not have shop with us in the past, more reasons to shop. We anticipate having about 15% of our total store base in the new Fusion lay out by year-end. We've reduced the time to complete Fusion remodels by 50% since the beginning of the year, and in turn, allowing us to minimize the disruption to the store operations and our customers' shopping experience. Our customers are taking note of the improved layout, the ease of shopping and our new product offering. Specifically, in our customer intercepts surveys, they call out better organization, improved merchandise selection, cleaner and brighter aisles, and easier to navigate layout. Categories seeing the strongest lift in sales include areas like apparel, companion animal and power tools. Given the size of our store base, this is a multiyear opportunity to continually refresh our store base and further drive comp sales through productivity.

Another significant component of our space productivity efforts is the transformation of our Side Lot. Again as a reminder, typically there is as much space outside of our stores in the side lots as we have on the inside of our store. And the productivity of this space is substantially below the chain average. We are in the midst of a multi-year project to transform our side lot with an expanded product offering and an enhanced shopping experience. With this investment, the Side Lots space is leveraged to offer a wider product offering in the lawn and garden categories and our new categories with the garden center, and offer greater convenience through the expansion of our Buy Online Pickup in Store capabilities for drive-thru pickup. In select locations that meet sales volume thresholds, we're also adding a feed room to help deliver the bag feed demand. And as a reminder, we're the largest seller of bagged feed in the country.

We also continue to see a positive halo effect from the garden center to the existing store and vice versa. The addition of product categories, increased ease of shopping and new services, provides us even more ways to continue to keep our existing customers engaged with Tractor Supply and attract new customers also to the brand. Our ability to drive higher sales per square foot through the transformation of our Side Lot space, remains a significant opportunity. We anticipate having about 150 Side Lots complete across the chain as we exit 2021. In these early remodels we're learning a great deal about our customers' appetite for expanded lawn and garden assortment. And we're even more excited than we were when we embarked on the initial test pilots late last year. As with our Fusion remodels, we continue to reduce the project timeline also here by about 50%, and minimizing the disruption to our customers and store teams as we implement our findings from our test-and-learn process. While still early on, we are very positive about the continued refinement and learnings.

While implementing construction projects of this scope and scale has been very challenging in the current macro environment, we're making progress in our ability to significantly reduce construction costs, the construction time and the corresponding disruption at the store site. While the majority of the remodels have been completed more recently, we are very pleased with the early read on sales lift. Post the disruption period, we're seeing lift of low single digits for Fusion remodels and mid single digits for combo stores which have both Fusion and Side Lot remodels. We expect continued improvements in these results as the stores normalize, and are forecasting year one lift of mid-single digits for Fusion and high-single digits for combo stores, which is on track for the expectations we had as we began these projects. Over the course of the last year, the team has done a great job operating the business at elevated levels, navigating unprecedented challenges and also executing our transformational initiatives to support our Life Out Here Strategy.

And to wrap up, our results clearly underscore that our strategies are working, that the team is navigating the challenges effectively and that we're emerging from the pandemic stronger than before. We're extremely optimistic about our future. As we enter one of the busiest periods in retail, my thanks and sincere appreciation go out to each of the more than 45,000 Tractor Supply team members for their dedication and commitment to our mission and values. And with that operator, we would like to open the lines for questions.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] The first question is from the line of Oliver Wintermantel with Evercore ISI. Thank you. You may proceed.

Oliver Wintermantel -- Evercore ISI -- Analyst

Yeah, good morning guys, Hal, you mentioned a lot about the structural changes within the business, and my question is regarding gross margins. I think you said, it's a 100 basis points higher than before pandemic in 2019. So I was wondering if you have early indications or what do you think is in gross margin structural gains versus what you have to maybe give back when promotions come back on and maybe the comp accelerates from the very strong 40% two-year comps. Thank you.

Hal Lawton -- President and Chief Executive Officer

Hey, Oliver, and good morning, thanks for joining our call. Yeah, on gross margins, we are very pleased, both with our short-term results this past quarter on gross margin, and also very optimistic about the long-term nature of our gross margins. On the short-term, we've had significant amount of cost coming through our business, whether that's in cost of goods as it relates to raw materials and commodity based goods, also vendors passing along costs related to labor and freight. We've also seen freight cost increase as well as well as the cost related to imports. The team's done an excellent job navigating those costs, finding offsets, productivity measures, really being the advocate for the customer to keep prices as low as possible. That's it. As Kurt mentioned, we did have inflation to the tune of 7% in the quarter, which helped us offset a lot of those costs and deliver the gross margin results that we did in the quarter, which sequentially from a gap to last year improved from Q2.

Long term, as we talked about on several of our calls, the question is really around the promotional intensity and the clearance intensity -- clearance activity in the business, and those two remain at the same levels that they have over the last six quarters, very low. We remained very focused on everyday low price, we remained very focused on delivering value every single day to our customers. And we see it playing out that way for the foreseeable future. We have no plans for significant promotional intensity in Q4, and we think that we'll remain in a very supply constrained environment as we move into the first half of next year. And that too will continue to limit any sort of promotional intensity in the market. Couple of years in now with minimal promotional intensity. I think that bodes well for being able to maintain a low promotional structure going forward.

So as I said again, we're very pleased with our short-term gross margin results and also very optimistic about the structural nature of our long-term gross margin.

Oliver Wintermantel -- Evercore ISI -- Analyst

Thanks very much. Good luck.

Operator

Thank you, Mr Wintermantel. The next question is from the line of Karen Short with Barclays. You may proceed.

Karen Short -- Barclays Capital, Inc. -- Analyst

Hi. Thanks very much. So based on all those comments that you just provided, the question would be on obviously the longer-term algorithm and we haven't had an update on that for a little bit, but you're clearly trending well above that. So, wondering if you could maybe just give a little color in how you think about long-term operating margin algorithm more broadly versus the prior 9% to 9.5%. Because that just obviously isn't really realistic at this point.

Hal Lawton -- President and Chief Executive Officer

Hey, Karen, and good morning, and thanks for joining the call. We see significant growth opportunities ahead in our business. As we've talked about several times, $110 billion total addressable market, super excited about our Life Out Here Strategy and the runway ahead there, and we're investing in that strategy to ensure we capture sustainable market share. Absolute -- to your point acknowledge that absent the write-down on Petsense that we did a 10.1% op profit in 2020, and our guidance for 2021 here at 10.2% to 10.3%, that both of those exceed our long-term targets. We certainly don't want to get ahead of ourselves here in the third quarter. What we commented on is that we're in the midst of our annual planning for 2022. At the same time, we're also just always looking at our long-term targets and it's very natural for us to be reviewing that over the next few months. And so, when we have more news on that, we'll certainly let folks know. But again, I think we're in a period where there's a significant amount of opportunity ahead and we're very pleased with the results we put up this quarter, the outlook we have for the balance of the year. And also excited about the long-term opportunity that we still see out there in our $110 billion market as we're gaining significant share in it and the team is just executing on all cylinders right now.

Karen Short -- Barclays Capital, Inc. -- Analyst

Great. Thanks very much.

Operator

The next question is from the line of Brian Nagel with Oppenheimer. You may proceed.

Brian W. Nagel -- Oppenheimer & Co. Inc. -- Analyst

Hi, good morning. Congrats on another great quarter. So I think my question maybe a bit repetitive here to the prior two, but the question I have is -- Hal, you mentioned the structural a lot in you prepared comments. It was from a demand side. Clearly demand at Tractor now for the last several quarters has been outstanding. There is still this very odd unique dynamic within the overall consumer run. I guess the question I have is, what are you seeing your business? How your consumers are performing that gives you greater confidence that f there was a structural shift in demand trends that will persist once the COVID crisis is completely behind us.

Hal Lawton -- President and Chief Executive Officer

Yeah. Hey, Brian. I'd point to three things in our business. First off, I'd talk about just broad macro trends. Second thing I'll talk about is the consistency of our business, and the third, I'll talk about is share gain. In the broad macro trends, all the trends that we saw in Q2 of last year really evolved to sustain themselves. And I think there are certain retailers and other businesses that had -- that saw the benefit as it relates to COVID behavior early to mid last year, and that waned. And I think that's not been the case for us. Whether it's things like rural revitalization, which is a bit more of a permanent and in if people move and -- whether it's things like pet ownership and adoption, and again permanent in more so in nature, whether it's home setting and just the self-reliance mentality. We're seeing those as more permanent behaviors -- and really no matter what data set you look at, whether it's home purchases, whether it's mobility, whether it's pet ownership, any qualitative data on where people are spending their money, they all reinforce the structural nature of those of those trends.

The second thing I'd point to is the consistency. As I mentioned, our business has been remarkably consistent month-to-month, week-to-week, by category and by region. And that's been regardless of whether not we've been in COVID surges or whether or not certain states have been more in lockdowns or less in lockdown. And that I think just again speaks to the structural orientation.

And lastly, we're gaining significant share really in almost every category in our business. And we're seeing that share gain in our core customers who have long shopped us, and as they come to us now with the confidence that we're in stock, with the right level of customer service and at the right price. And then also, new customers who are finding the lifestyle that we serve to be what they're seeking in this time. And we're gaining share really across the board on all of our categories in that context. I'd point to those three things that give us real confidence in the structural orientation of our business. And as I said, I think it -- there is a set of COVID winners that were early on that have seen some of that wane. And then there's another set that are seeing it much more structural and sustained, and that very much put us at the top of that second camp.

Brian W. Nagel -- Oppenheimer & Co. Inc. -- Analyst

Yeah, that's very helpful. I appreciate it. Congrats again. Thank you.

Operator

The next question is from the line of Peter Keith with Piper and Sandler -- Piper Sandler & Co. You may proceed.

Peter Keith -- Piper Sandler -- Analyst

Hi, thanks, good morning. Great results, everyone. Looking forward to the next couple of months and-or the winter here, looks like we're going to be seeing record energy prices, home heating costs. And I'm just thinking back to 10-12 years ago, with some of the heating exposure you guys have, there sometimes can be a nice benefit for Tractor. So I guess the question is, on a net basis, how do you feel about this elevated heating costs that we're going to see this winter? Is it a net positive or conversely maybe elevating costs for your core consumer?

Seth Estep -- Executive Vice President, Chief Merchandising Officer

Hey, Peter, this is Seth. Thanks for joining the call. Hey, when we look ahead over the next couple of months, just a little bit more broadly, other than just outside of covering energy cost as well, we're really excited about the opportunity that lies ahead based off a lot of the macro benefit that Hal just discussed. And I'd love to just highlight a couple of things that we look to see to drive our business over this holiday season and then to maximize and capitalize on that opportunity. When we think about that and -- we are really excited about how the team and the merchandising team continues to execute on our portfolio strategy, leveraging the FAST team.

We are doing a record number of resets throughout the year, not just call it pre-holiday, but continuing that reset in the new item activity as we go through the quarter. And for holiday, specifically over the next couple of months, we're really excited about the momentum we're seeing in some of these new customer trends as well as our core customers that are coming to us for categories more broadly than maybe they have in the past, things like apparel and footwear. And we're seeing expansions like in key brands that consumers are really resonating with, with brands like Columbia, and Ariat Carhartt. Even our own brand like Ridgecut what we're expanding into the women's line up, where that shopper is now coming to us, where they weren't in the past, where we can continue to drive market share in those categories.

We're also seeing that, with that rural revitalization, consumers coming to us for outdoor activities, even here in the fall. So I think patio heaters, grills, evenly wildlife and UTVs driving that demand. We're still seeing strength across the board there. And then we're going to continue to focus on our C.U.E. activity where customers are coming to us for footsteps. So you know with the record number of pet adoptions over the last few years, we continue to be extremely excited about the momentum that we have in our pet business holistically, as well as the C.U.E. business. And we're going to be looking to drive that throughout the whole holiday season. So -- and it's a little bit broader than just the energy market question there as well, but also, where we see it as we're coming through, we're seeing activity across our consumer base be very consistent with what we've seen over the last few quarters, and they're really resonating with the new items, the new categories, as well as a new partnerships that we continue to establish.

Peter Keith -- Piper Sandler -- Analyst

Okay. Thank you very much, Seth.

Operator

The next question is from Kate McShane with Golden -- Goldman Sachs. You may proceed.

Kate McShane -- Goldman Sachs -- Analyst

Hi, good morning. Thanks for taking our question. I just wanted to go back to inflation for one minute. I wondered if you could talk to us about how much inflation you are expecting for the fourth quarter. And when it comes to the pricing actions that you took, was it across most of the store or in certain categories? And when do you expect -- or what has been the reaction from the elasticity standpoint?

Kurt Barton -- Executive Vice President, Chief Financial Officer and Treasurer

Kate, hey, this is Kurt. Good morning, and good morning to everybody. Yeah, on the inflation side of it, as Hal mentioned, on the top side, there was 700 basis points of inflation benefit on the business. We saw at that are slightly higher cost pressures in Q3. As we look ahead to Q4, we exited Q3 and into Q4 with continued levels of inflation moderating at the levels compared to like what we saw coming out of Q2 into Q3. But there continues to be some level of inflation that's factored into our guidance. In regards to how we handle that, it really is more of a portfolio approach. We take a look at where those costs are contributing, both in transportation product cost, and we look at our portfolio. Seth and the merchant team manages the shopping patterns for -- from the customers, as well as making sure that in key traffic driving areas, we've got great everyday low pricing. So we leverage our pricing tools really well and make sure that from the portfolio standpoint, that we can balance from a retail side as well as what we can do to leverage the strength of our mature supply chain to keep costs as low as possible. And again, our team has just managed through this great. And we -- our forecast and our guidance for Q4 expects that they're able to manage that in a similar pattern.

Kate McShane -- Goldman Sachs -- Analyst

Thank you.

Operator

The next question is from the line of Michael Lasser with UBS. You may proceed.

Michael Lasser -- UBS -- Analyst

Good morning, thanks a lot for taking my question. Kurt, can you just clarify what you intended to say with the response to that last question, in terms of the inflation contribution moderated relative to the 700 basis points or in the inflation contribution that you're expecting in 4Q moderated relative to the 350-400 basis points. And I -- hopefully that wasn't my -- question wasn't just a little below confusing. That was answered. My question really is, moving forward, do you still need a 3% comp or so to leverage your expenses? In your prepared remarks, you noted that SG&A has leveraged 70 basis points relative to 2019. And given the sheer magnitude, the volume increase your stores have had there would be some opportunity to right size or manage your cost structure such that you might be able to lever on a more moderate comp moving forward. Thank you.

Kurt Barton -- Executive Vice President, Chief Financial Officer and Treasurer

Yeah, Michael. I'll hit the two questions. In response to clarification on Kate's question, for Q4, the inflation pressures in the business will be fairly similar to what we described and saw Q3, flattish to potentially slightly up in regards to Q4. In regards to our leverage point, where we're at right now with the business, the elevated levels of revenue growth as well as our focus on our investments really makes the whole algorithm different than just saying, is it a 3% comp that you leverage on. And to your point, right now we're seeing really strong momentum in the business. And that does elevate our ability to leverage on the cost, but we're also using that to the point that Hal made and that I made in our prepared remarks, that we definitely see this as a tremendous opportunity. We're investing from a position of strength, so, our continued outlook about managing SG&A to flattish over time will still be our outlook in the way we're managing this business. Great opportunity, just continue to gain market share and drive traffic into the stores.

Michael Lasser -- UBS -- Analyst

Thank you very much.

Operator

The next question is from the line Chris Horvers with JPMorgan. You may proceed.

Mary Winn Pilkington -- Senior Vice President of Investor Relations & Public Relations

Operator, we can just move on to the next question if Chris isn't on.

Christopher Horvers -- JP Morgan Securities LLC -- Analyst

Hello?

Mary Winn Pilkington -- Senior Vice President of Investor Relations & Public Relations

Hey, there you are.

Christopher Horvers -- JP Morgan Securities LLC -- Analyst

Thank you, Mary Winn.

Mary Winn Pilkington -- Senior Vice President of Investor Relations & Public Relations

Hey, Chris. Sure thing.

Christopher Horvers -- JP Morgan Securities LLC -- Analyst

Seth, with your commentary around 4Q obviously soft lines a lot of Asian sourcing. I'm guessing the heating business in OPE. So it sounds like you're feeling good from an in-stock level there. Is that accurate? And then how are you thinking about next spring? At this point, you're probably making orders for that. So will you be ordering enough for next spring?

Seth Estep -- Executive Vice President, Chief Merchandising Officer

Hey, Chris. Yes. So we're -- we always say we're not -- we always want more, but we're satisfied with where we are right now, as we've managed through the supply chain with both our supplier partners and our supply chain team and merchants to get the products where we are. We feel really good where we are heading into the holiday season as products flowing in. As we've managed through this throughout the course of the whole year, you're spot on. We've looked at every piece of our process, we're giving earlier forecasts for our key supplier partners. We're working to -- with our overseas factories to give commitments in our earlier lead time than we have historically, so that we can properly plan within, plan through the supply chain, look for alternative ways to source products or any deed to make sure that we can have product hit shelves. And we're taking it -- we'll be able to take it when we can get it even earlier than we have in the past as well, so that we can be locked and loaded and ready for the spring business.

So really feel good about the planning that's going on across the team, across with our supplier base, to make sure that we can continue to navigate this supply -- global supply chain challenge that's been out there.

Christopher Horvers -- JP Morgan Securities LLC -- Analyst

Got it. Thank you.

Seth Estep -- Executive Vice President, Chief Merchandising Officer

Yeah.

Operator

The next question is from the line of Peter Benedict with Baird. Thank you. You may proceed.

Peter Benedict -- Robert W. Baird & Co. -- Analyst

Hi guys, thanks for taking the question. I guess back on to the expense stuff, the investments you guys are making, obviously the capex has been up. So I'm curious just on D&A, and how we're thinking about that, Kurt for this year, and then next year. We've seen this year is probably up 25% year-over-year, maybe it's $270 million of D&A. How do we think about that as you pencil through 2022? Should we see a similar growth rate or how should we think about that? That's my question. Thank you.

Kurt Barton -- Executive Vice President, Chief Financial Officer and Treasurer

Yeah, sure. Peter. So for this year, the depreciation growth year-over-year throughout the quarters, mid to high 20% growth rate is very much in line with our expectations. The investments we've made this year of the incremental end principally with the new distribution center build as well as the Fusion and Side Lot remodel has us right where we expected to be on depreciation. And for 2022, at this point with our plan, we would expect very much similar in the low 20% growth rate likely, and that's very much what we framed out when we launched the Life Out Here Strategy.

Peter Benedict -- Robert W. Baird & Co. -- Analyst

Okay, got you. Thanks so much, Kurt.

Operator

The next question is from the line of Simon Gutman with Morgan Stanley. You may proceed.

Simeon Gutman -- Morgan Stanley -- Analyst

Hey, everyone. Good morning. Can I, Hal and Kurt, maybe I'll take another stab at the longer term margin question. I think the math would suggest that your business could be running above that level. The question is, philosophically do you let it run above that level? And how in that regard are there things along the Out Here strategy that you can accelerate? Are there price investments that you would think about? Are there any other reinvestment that layers -- second or third layers of the plan where you could lean in and just say, hey, we don't want to run the business at a higher margin, so that we can keep building on the growth. Curious how you think about that.

Hal Lawton -- President and Chief Executive Officer

Hey, Simeon. Good to talk to you this morning, and thanks for joining us. I'd say first off, we see sizable opportunity ahead in our market. It's -- for those who followed us for a long period of time, it's a very attractive market. It's one that's very fragmented, one where we're very well positioned with our scale and size and relationships that we have, and investments we've made historically. We think that there is significant further opportunity as we look out to continue to grow in an outsized way and take share. And we're committed to going after that share, continuing to grow. As -- that said, would acknowledge two straight years of performance above 10% op margin, it's above our long-term guidance. And as we go through our 2022 annual planning process, we'll be look -- that will help us really think through our long-term guidance and the relevance of that as we look forward. But right now, it is our long-term guidance.

What I would say is, as it relates to investments, we're very bullish on our investments, we're very focused on excellent capital allocation, we're seeing the results of our investments in the business. As we shared today, the Fusion stores and the Side Lot stores are performing very well. As they mature and begin to normalize, we're seeing the results right in line with what our expected -- our business model and business plan for them where. That said, also our business is much -- continues to grow at an outsized rate, and that gives us an opportunity to leverage and scale on our business in a way that we didn't fully anticipate last year at this time. And I think as we see how that continues to evolve into early next year, you can expect to hear more from us on that. But again, we remain very bullish on our opportunity, very pleased with our business. It's never been stronger and we're excited about both the short-term and long-term potential inside of it.

Simeon Gutman -- Morgan Stanley -- Analyst

Thank you.

Operator

The next question is from Zach Fadem with Wells Fargo. You may proceed.

Zachary Fadem -- Wells Fargo Securities LLC. -- Analyst

Hey, good morning. So, Kurt another expense question. As you're lapping a year of elevated COVID costs incentive comp and strategic spend. So first of all, can you talk through the lingering impact of some of these items? And then as we look to '22, you mentioned an uptick in strategic spend. Is there any detail you can provide there? And then separately on the 20% D&A growth, is that with or without Orscheln?

Kurt Barton -- Executive Vice President, Chief Financial Officer and Treasurer

Yeah, Zack, this is Kurt. And a number of things in there. Let me just try to package that in this one. I'll hit the last one first. Orscheln's not considered in any of the numbers of the guidance that we've given. In regards to the ex -- the depreciation expense structure. So COVID expenses have been elevated from the level that we entered the year into, just because the pandemic with the Delta variant and others have lingered, they're at lower levels than we saw in comparable quarters last year. But we continue to emphasize having a safe and clean environment for our customers and our team members.

The incentive comp, with the outperformance this year, while at lower levels than last year, continue to be above target. And so, as you think about going forward, those are items for us as in future years. Those are leverage points. And if -- like in this year, while there is incentive comp above target, the performance gives leverage above and beyond the level that we're paying in incentive comp, so it's net and overall leverage this year. And next year, those will be favorable items to compare against.

The depreciation expense, as I mentioned earlier, the growth rate that we're -- that I quoted and referring to, is very much in line with what we expected in our long-range plan, when we launched the Life Out Here Strategy and talked about a 3 to 5-year plan. And so with the elevated sales, -- we feel very comfortable with a 20% growth rate in depreciation because that's where those investments are at. Does not include Orscheln, and again we're very comfortable with the management we've got and what we have visibility on our expenses for the fourth quarter and even the near term beyond that.

Zachary Fadem -- Wells Fargo Securities LLC. -- Analyst

Got it. Thanks, Kurt. What about the strategic side?

Kurt Barton -- Executive Vice President, Chief Financial Officer and Treasurer

The strategic initiatives that we've had, we haven't really specifically mentioned any increased spend on strategic initiatives outside of what we had planned in the Life Out Here strategy on technology, digital that we had this year and we'll continue to execute the plan. So, maybe just clarify what you're referring there.

Zachary Fadem -- Wells Fargo Securities LLC. -- Analyst

Well, you mentioned you were going to continue to invest in 2022. So I was just curious if there was an uptick in strategic spend that we should anticipate.

Kurt Barton -- Executive Vice President, Chief Financial Officer and Treasurer

Got you, Zach. No, it's very much in line with what we said that our capital expenditures over the next few years. We anticipate those still to be in that 450 to 550. Some years could be higher because of launching of distribution centers, but the level investment in the business is consistent with what we expected.

Zachary Fadem -- Wells Fargo Securities LLC. -- Analyst

Got it. Appreciate the time today.

Operator

The next question is from the line of Seth Basham with Wedbush. You may proceed.

Seth Basham -- Wedbush Securities, Inc. -- Analyst

Thanks a lot, and good morning. My question is just a clarification around the trends you're seeing in terms of comp lift following that Fusion and Side Lot rollout. I think you said you're seeing low single-digit for Fusion and mid single-digit per combo stores, in the stores that have been completed. But your plan is for a full first year lift of mid single-digit for Fusion and high single-digit combos. Is that correct?

Hal Lawton -- President and Chief Executive Officer

Hey, good morning. And yes, that is what we said in our prepared remarks and it is accurate. The add that I'd make to that is just as is typical with a store remodel, there's a little bit of a disruption. There is disruption that happens during the remodel. Particularly with the current supply chain environment there's a little disruption that's occurring still even after the remodel of some fixtures and other types of things come in this months a little late. That and then we start to see the lift happen as customers get used to shopping the new layout and find the new categories and the new brands and the new remodel. And so what we're seeing is what we would expect, which is, every week, every month that goes by post the regrand opening of the remodel, that the performance of the store continues to improve. And that's the case with both the combo stores and the Fusion remodel.

The adder that I would make to that is, as it relates to the Side Lot with the garden center. We have a couple of stores that are -- that went through year two of spring. We saw outsized gains in those, which is in line again with our expectation, that we would see more of a maturity curve with the garden center, than we would with the inside of the store Fusion remodel. We think that in that we expect and what we're seeing in the Fusion remodel is more of an immediate impact with the maturity curve being more of that three, four, five, six-month's maturity curve. Whereas at the garden center, we're seeing a nice strong immediate impact. But then, we're also seeing 12 to 18 months continuation of that maturity curve.

But, yeah the results are very much in line. Nice positive lifts already, even a few months into each of the remodels. And then we see even continued lift as we complete year one of those remodels, whether it's Fusion or the combo.

Seth Basham -- Wedbush Securities, Inc. -- Analyst

That's helpful. Just a point of clarification, when do you start measuring the lift post disruption? How many months after the completion does a disruption period end?

Hal Lawton -- President and Chief Executive Officer

Yeah. We start measuring lifts the day of the regrand opening. So not to get too tactical, but there is a sign off that the store manager and the project manager and the construction manager do, that -- on the day that sign off, that's when the project is complete. The regrand opening happens reasonably quickly after that one week, two weeks kind of thing. And then we start measuring the lift from that regrand opening date.

Seth Basham -- Wedbush Securities, Inc. -- Analyst

Thank you.

Operator

The next question is from the line of Chuck Grom with Gordon Haskett. You may proceed.

Chuck Grom -- Gordon Haskett Research Advisors -- Analyst

Hey, thank you. Good morning, great quarter. Hal when we look at the Side Lot initiative, I'm curious to what's been the biggest areas of upside surprise for you guys. Or said differently, what did you learn in the class of '21 Side Lot [Indecipherable] apply future store efforts? And then, any sense for where you think the productivity longer term could be relative to your in-store productivity?

Hal Lawton -- President and Chief Executive Officer

Yeah, hey, Chuck, and thanks for joining the call today. I'll hit three things on Side Lot, and then I'll just briefly touch base on Fusion productivity. On the Side Lots, the three that I will talk about is, garden center, I'll talk about BOPIS and then I'll talk about our feed rooms. So first on the garden center, our customers -- key data set is that the category that we least addressed from a destination perspective, that they most engaged in is live goods and garden. And so, that's really what the garden center strategy is all about, is creating another C.U.E. destination category in our business. And -- but we're seeing that in our results. I'd say we're more excited now about the prospects for adding to our fleet the garden center, than we were even this time last year.

And then just taxing the behavior we're seeing our customers is exactly as we expect it. So a little less around beautification, like what you might see in a more of a home improvement store in terms of the core product and much more about fruits and vegetables and shrubs and trees. All those sorts of things that really speak to Life Out Here, whether it's the gardening you do in your backyard, or whether it's the shrubs and the trees you're planting along your fence line and along -- in your land. And we have significant convenience -- advantages for our customers from a location perspective. So the garden centers are performing very well and we're just getting started, both on the build-out of those, obviously, but also with our relationships with our live good vendors and the assortment tailoring it by store.

The second thing is on BOPIS drive-thru. We are seeing incredibly high levels of drive-thru behavior from our customers. And we're seeing -- in some of our stores that have been open for four, five, six, eight months now, we're seeing 50%, 60%, 75%. The Buy Online Pickup in Store being drive-thru. And just that extra convenience factor you're seeing with customers and then that's driving repeat behavior. And so really pleased with how that's evolving, and the behavior we're seeing from our customers is consistent with what the feature was when we rolled it out.

And then lastly, is that the feed room. So, we are the largest seller of bagged feed in the country. And if you think about our average store volumes and the growth we've seen in those store volumes combined with the outsized performance in C.U.E., that's put a lot of stress on our stores as it relates to the receipt of bagged goods, getting it out under the store, staying in stock for our customers and then being able to get that on the customers trucks and out the -- toward -- get them on their way. And the feed rooms have provided valuable capacity and also allowed us to effectively from a cost perspective serve that customer because we're not touching the bags, two and three, four times. We're able to leverage our mixing centers in a way that their design now.

And so, all three of those things are really coming together, we're seeing excellent performance across all three exactly as we, as we designed and built them. And we're continuing to use our test to learn to tweak it along the way. If you think about our productivity as we move forward, we're still committed to our comps outpacing overall retail and outpacing the Life Out Here market that we defined as that $110 billion market. And so you can expect continued productivity improvements in -- on our same-store sales in an outsized way as we move forward. We even -- in spite of six consecutive quarters now of double-digit comp, we still have that expectation moving forward.

One other thing I just -- while I've got the mic here, so to speak, I'd like to just step back and reference -- there's a bit about our long-term op margin leverage as Kurt was talking about. What I'd say is, if you look at our long-term guidance, because there are several questions on this topic, we -- our long-term guidance that we announced last year had 6% to 7% sales growth and 8% to 10% earnings per diluted share. Which implies continued leverage on the business as we move forward. And we're not -- we admit, we're not in a state of normalcy right now, obviously, with our comps being the six consecutive quarters of double-digit growth. But what I would say, the spirit of the continued leverage you are seeing in our results. And that is the expectation we have of our business, whether we're seeing outsized costs for labor and outsized costs for freight and cost of goods, or whether that's in a more normal environment. And so we're holding ourselves accountable to executing in that way regardless of the environment that we're in and just wanted to clarify that. I think Curt's point around 3% comp and whether that's a point of leverage is still accurate in a normal environment but we still, even in a quote, unquote non-normal environment, still accept that same challenge.

Mary Winn Pilkington -- Senior Vice President of Investor Relations & Public Relations

All right thanks, Hal. And operator, that will conclude our call today. I really appreciate everybody's cooperation that allowed us to get through a lot more questions, so thank you all. Looking forward to speaking to you in January on our fourth quarter earnings call. And Marianne and I will be around this afternoon for any questions, so thank you all for your cooperation. Have a great day.

Operator

[Operator Closing Remarks]

Duration: 63 minutes

Call participants:

Mary Winn Pilkington -- Senior Vice President of Investor Relations & Public Relations

Hal Lawton -- President and Chief Executive Officer

Kurt Barton -- Executive Vice President, Chief Financial Officer and Treasurer

Seth Estep -- Executive Vice President, Chief Merchandising Officer

Oliver Wintermantel -- Evercore ISI -- Analyst

Karen Short -- Barclays Capital, Inc. -- Analyst

Brian W. Nagel -- Oppenheimer & Co. Inc. -- Analyst

Peter Keith -- Piper Sandler -- Analyst

Kate McShane -- Goldman Sachs -- Analyst

Michael Lasser -- UBS -- Analyst

Christopher Horvers -- JP Morgan Securities LLC -- Analyst

Peter Benedict -- Robert W. Baird & Co. -- Analyst

Simeon Gutman -- Morgan Stanley -- Analyst

Zachary Fadem -- Wells Fargo Securities LLC. -- Analyst

Seth Basham -- Wedbush Securities, Inc. -- Analyst

Chuck Grom -- Gordon Haskett Research Advisors -- Analyst

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