達樂 (DG) 2002 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen.

Thank you for participating in today's conference call with Dollar General Corporation.

We would like to inform you that this call is being recorded by Worldcom Conferencing and CCBN.

Federal law dictates that no other individual or entity will be allowed to record or rebroadcast this session without permission from the company.

After a prepared statement by the company, we will open the conference call for questions from the audience.

Beginning today's meeting is Mr. Don Schaffer, the acting CEO, President and COO of Dollar General Corporation, sir, you may begin when ready.

Thank you and good afternoon.

Appreciate you spending some time with us this afternoon.

Welcome to our third quarter conference call.

With me today are Jim Hagan our Chief Financial Officer and Emma Jo Kauffman Director Investor Relations.

Jim will begin the call today with a review of the third quarter earnings and I'll update you on the operating issues then as the operator indicated we'll open the session up for questions.

Good afternoon, everyone.

In addition to historical information, our comments during this conference call will contain forward-looking information such as statements regarding growth targets, key initiatives, trends and annual earnings guidance.

The words, believe, anticipate, project, plan, expect, estimate, objective, forecast, goal, intend, will likely result or will continue and similar expressions generally identify forward-looking statements.

The company believes the assumptions underlying these forward-looking statements are reasonable, however, any of the assumptions could be inaccurate and therefore actual results may differ materially from those projected in, or implied by, the forward-looking statements.

A number of factors may result in actual results differing from such forward-looking statements include but not limited to those set forth in our most recent annual report on form 10-K and in the press release issued today.

You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today's date and by their nature reflect only our good faith estimate of future results.

The company disclaims any obligation to public update or revise any forward-looking statements to reflect events or circumstances occurring after the date of this conference call or to reflect the occurrence of unanticipated events.

Now on to the numbers.

Net income for the third quarter of 2002 was $68.6m or 20 cents per share as compare against net income in the prior year of $46.7 million or 14 cents per share an increase of 46.7 percent.

The 2002 results include approximately $24.2m in restatement related items that actually served to increase our reported results.

The $24.2m consists of $25.2m in insurance proceeds related to the settlement of our shareholder derivative litigation offset by approximately $800,000 in net restatement related expenses and a $200,000 dollar accrual for an expected settlement of a shareholder class action opt out claim.

The 2001 results include $9.3m in restatement related expenses.

Excluding restatement related items from both years, net income and earnings per share would have been $53.2m and 16 cents per share in the current year versus $52.5m and 16 cents per share in the prior year, an increase of 1.3 percent.

Sales during the third quarter of 2002 were 1.50b versus $1.31b in the prior year, an increase of 14.4 percent.

Same store sales increased by 5.2 percent.

The gross profit rate during the quarter was 28.62 percent versus 29.12 percent in the prior year a reduction of 50 basis points.

The reduction in the gross margin rate in the current year is primarily the result of a higher inventory shrink provision and to a lesser extent inventory purchases.

The lower markup on inventory purchases is due primarily to lower than planned receipts of high markup of seasonal items during the current year quarter and to a high volume of purchases in lower mark up highly consumable category.

We attribute some of the shortfall in seasonal receipts to the effects of the west coast dock workers Lockout.We expect to recoup some of the shortfall of third quarter seasonal receipts during the fourth quarter.

The late arrival of the seasonal product may have had a nominal impact on the sale of seasonal items in the quarter just concluded, but is not expected to have a material effect on the company's ongoing sales performance.

One other relatively minor but nevertheless noteworthy item regarding our third quarter gross profit is that during the quarter, we evaluated the adequacy of the remaining balance of the markdown recorded in the fourth quarter of 2000 to assist with the disposition of certain excess inventory.

Based on this evaluation, we recorded an additional markdown in the current year period to assist with the disposition of the remaining excess inventory.

The additional markdown had the impact of reducing inventory at cost, and increasing cost of goods sold by approximately $2.2m dollars.

SG&A expenses in the third quarter of 2002 were $335.2m or 22.38 percent of sales versus $295.1m or 22.54 percent of sales in the prior year, an increase of 13.6 percent.

Excluding restatement related expenses, 2002 SG&A expense would have been $334.4m or 22.33 percent of sales and 2001 expenses would have been $285.8m or 21.83 percent of sales, an increase of 17 percent.

The 50 basis points increase in the SG&A expense as a percent of sales excluding restatement related expenses is due principally to percentage increases in store labor, workers compensation and health care costs that were in excess of the percentage increase in sales.

Interest expense was $11.5m in the third quarter of both 2002 and 2001.

The company's effective tax rate was 35.9 percent this year versus 37.3 percent last year.

The reduction in the effective tax rate in the current year is partially a result of certain tax planning strategies implemented in the fourth quarter of the prior year which reduced the company's annualized effective tax rate to 36.7 percent.

The company's effective tax rate was further reduced to 35.9 percent by favorable adjustments to prior estimates resulting from the recent filing of the companies 1998 through 2001 tax returns.

On a year-to-date basis net income during the current year was $156.9m or 47 cents per share as compared against net income in the prior year of $110.1m or 33 cents per share, an increase of 42.5 percent.

The 2002 results include $24.1m in net restatement related items consisting of $29.7m in insurance proceeds relating to the settlement of the shareholder derivative and class action litigation, offset by a $0.2m expected settlement of a shareholder class action opt out claim and $5.4m in net restatement related expenses.

The 2001 results included $18.3m of restatement related expenses.

Excluding restatement related items for both years, net income and earnings per share would have been $141.6m and 42 cents per share in the current year versus $121.5m or 36 cents per share in the prior year, an increase of 16.5 percent.

Year-to-date sales in 2002 were $4.34b versus $3.74b in the prior year, an increase of 16.2 percent.

Same store sales increased by 7.2 percent.

The year-to-date gross profit rate in 2002 was 27.56 percent versus 27.67 percent in the prior year.

We are disappointed with the 27.56 percent gross profit rate, and it represents a shortfall versus our internal financial plan.

The primary reason for the disappointing gross profit rate is our inventory shrinkage results.

We've recorded a 3.57 percent inventory shrinkage provision on a year to date basis in 2002 which represents an increase of 63 basis points over last year's shrink of 2.94 percent.

We believe that over time we should be able to drive the shrink number down to the low to mid 2 percent range.

Don will talk about our specific shrink reduction efforts during his presentation.

SG&A expenses were $946.1m in the current year, versus $823.2m in the prior year, an increase of 14.9 percent.

Excluding restatement related expenses from both years, SG&A expenses were $940.7m or 21.67 percent of sales in the current year versus $804.9m or 21.54 percent of sales in the prior year, a an increase of 16.9 percent.

The increase in SG&A expense as a percentage of sales excluding restatement related expenses in the current year period is due primarily to percentage increases in store labor and workers compensation costs that were in excess of the percentage increase in sales.

Interest expense in the current year was $33.3m versus $35m last year.

The reduction in interest expense was due prince appeal to lower [libor] rates and lower average outstanding borrowings compared against the same time last year.

For the reasons I noted earlier, the company's 2002 year-to-date effective tax rate of 36.3 percent is down from the 36.7 percent effective rate that we recorded in our first two quarters and compares against the rate of 37.3 percent in the prior year.

Based on our current information, we anticipate that the effective tax rate on fourth quarter pretax income will revert back to approximately 36.7 percent.

The company opened 203 stores and closed 18 stores during the quarter.

On a year-to-date basis the company has opened 575 stores and closed 39 stores.

Our store count at the end of the quarter was 6,074 stores.

Cash capital expenditures during the quarter were $34.3m and on a year-to-date basis cash capital expenditures were $104.7m.

You may recall that the company's capital plan for the current year is $150m.

On a liquidity front,we are very pleased with our cash blow performance for the first three quarters of this fiscal year.

The company's cash flows before financing activities and just to be clear, that represents net cash provided by operating activities, less cash used in investing activities were a source of cash of $23.7m in the current year as compared with a use of cash of $58.2 m in the prior year and that's an $81.9m dollar positive swing.

Most of that positive swing is due to improved inventory management.

Our rolling 12 month inventory turn was 3.4 times at November 1, 2002, versus 3.1 times a year ago.

Our total inventory balance stood at $1.25b at November 1, 2002 which was essentially unchanged from the inventory level at the end of the third quarter last year even though we are operating 591 more stores.

Our total balance sheet debt was $518.3m at November 1, 2002, $735.1m at the end of last fiscal year on February 1, 2002 and $738.3m at the end of last year's third quarter on November 2, 2001.

I'd like to conclude with some comments on earnings guidance and the status of our SEC investigation.

As most you probably know, our guidance for the current year was for revenues to increase by 14 to 16 percent and net income excluding restatement related items to increase by 13 to 15 percent.

Though our third quarter results were somewhat disappointing, we are still hopeful that we can achieve the low end of our net income guidance for the year.

I will caution you that we will need a strong profit performance in the month of December to meet the annual guidance.

Given the uncertain relate environment, that strong performance is not assured.

With respect to the SEC investigation, the SEC has been taking testimony and has continued to gather information during the last few months.

The company continues to cooperate fully with the investigation and we still can't predict when the investigation might conclude or what the outcome might be.

I'll now turn the call over to Don for the operational review.

Thanks, Jim.

As a past conference call I will comment briefly on the status of our key initiatives for 2002.

As a refresher, these key initiatives are first, establish and introduce standardized work processes to improve the execution of basic retail tasks.

Second, complete the rollout of our professional inventories.

Third, develop and execute an effective disposition program for our age apparel inventory.

Fourth, is implementing [inaudible] the merchandise planning system, improve upon the merchandising planning and inventory management process.

Finally, I'll given you additional information regarding shrink reduction initiatives [inaudible] the third quarter of the year and our quarter program.

As discussed previously we have shifted our focus from earlier investments in distribution and information systems to existing stores with the intent of improving both store standards and the execution of merchandising initiatives at store level.

First half of this year, operations organizations spent a great deal of time and effort defining the work, developing efficient methods to accomplish the work and incorporating these methods into work processes with the overriding principle of simplicity for ease of execution.

I think you'll remember the seven key areas we defined were ordering, receiving, stocking, presentation, selling, support and staffing.

By standardizing these seven issues we believe we will be better able to measure results and produce increased sales, improve inventory turn, reduce shrinkage and ultimately, provide a better shopping experience for our customer.

To date, we have completed the implementation phase in all of the habits except for staffing, which is about 75 percent implemented.

While the implementation phase is basically completed, the effective execution of these work processes is a continuing project.

We have made significant progress in our ordering, selling and support phases where we rate ourselves as executing at as high as 80 percent efficiency.

In our stock and receiving areas our execution is somewhat less, we do not anticipate any significant change here until we complete the holiday selling season.

As I mentioned in our last conference call we do not want to force changes that will reduce focus on our customers during this critical selling period.

Turning to our second initiative, I'm pleased to announce in September, we completed the taking of professional inventories in all of our stores.

As you will remember, we completed 500 stores last year and plan to complete the remaining stores in 2002.

We now have inventory visibility to the SKU level by store.

We anticipate this initiative will improve our in stock position, increase sales, lower inventory there by increasing turn, and allow proper allocation of inventory based on individual store ownership.

Our third initiative was to reduce excess inventories through our now mark down program.

Last year we identified $116m in excess and aged inventory in our stores.

Our objective is to sell through this inventory by the end of fiscal 2002.

Our budget provides mark downs for SKU specific items [inaudible] and of course, clothing.

Overall company sales and inventory projections for this merchandise have been running close to plan.

However, as Jim mentioned early yes, we have increased our markdowns slightly to address the small amount of product requiring additional markdown activity.

We'll review this detail on a weekly basis.

We have approximately $20m in this product at fiscal year end.

Moving to our fourth initiative, we are continuing to improve our inventory management by implementing and leveraging our Arthur merchandise system.

The system is fully loadedwith current data in September and we are current use the Arthur product planning program to develop our 2003 merchandise plans.

This system allows planning to the class level and once these are completed we will then use the product plans to create channel plans which are merchandise plans specific to stores with demographic or geographic similarities.

Some of the benefits of the [inaudible] merchandise system include permitting merchandise planning to the class level rather than the department level, it enables timely reaction to sales trends and improves merchandise allocations based on the individual store's needs and criteria.

Follow up on Jim's comments regarding inventory shrink.

We are certainly not pleased with our performance this year, but I believe we have good understanding of what has occurred.

We have taken steps to control and reduce shrink in the future.

Our perpetual inventory taking discussed earlier use an outside service we believe has given us an extremely accurate picture of our shrink numbers.

Intuitively, I believe the higher shrink this year reflects to some extent a one time increase as the result of taking inventory at all stores at the UPC level for the first time in our 63 year history.

However, as you know, inventory results result looking through a rear view mirror because we're looking at a trading 12 months performance not future performance.

The completion of our inventories in September, there is little opportunity for our numbers to change positively or negatively in the last quarter of the year.

To date our company has not been able to identify shrink except at the company level, however with the completion of our perpetual inventory process we now expect to be in a position to analyze shrink by merchandise category, class or even down to SKU, this will provide us with important information we can use in store layout and the placement of high loss products.

What I want to share with you now are the initiatives we have put in place this year that we believe will have a positive impact on shrink performance for 2003.

First, we have performed and asset protection department staffed by 25 employees located geographically at our highest shrink areas of the country.

To assist this group we have installed an [exception reporting] software package that [inaudible] [unusual activities] at store level.

This program was installed in July, we are pleased with the information provided to date.

In addition to these initiatives we are in the process of installing closed circuit television cameras in our highest shrink stores and are adding security alarms to the stores that experienced high shrinks or burglaries.

By year end, will have over 350 stores with cameras, over1800 with security alarms.

We also implemented a shrink tip hot line to provide employees a highly confidential method to report inappropriate activities.

Finally, we have established a work committee led by our internal audit organization to identify potential shrink problems earlier in the year for immediate action.

We certainly recognize this as a major issue and feel we're taking the steps to positively impact inventory losses in future years.

Turning to new store openings, our plan for 2002 called for the addition of 600 stores this year.

As Jim mentioned earlier, we've mentioned 575 stores as of November 2.

As of last Friday, November 23, we opened our 620th and last store for 2002.

While we are currently working on both our strategy plan and 2003 financial plan, we have made a decision regarding new store openings for next year.

We plan to open 650 new stores in our existing 27 state operation.

Issues being addressed strategy planning process include identifying new states for future growth which will also drive decisions for distribution center locations.

We've also introduced a new store layout this year that creates additional shelf space to present more products or reducing floor space to allocate to aisles by having longer runs of shelving.

The layout is a front to back format similar to what you might find in a drug store industry.

It is different from our conventional left to right layout, it has shorter runs of shelving and more aisles.

We are currently viewing the results of 578 stores with this configuration.

We'll decide the number to be converted annually as we complete our planning process.

We are also testing auto replacement in 182 stores in Oklahoma and Tennessee, and based on the test results we will determine the number of stores to be add to this program for 2003 and beyond.

Assuming these programs go forward, they both will be multiyear projects.

There are a number of other initiatives under way or under consideration.

I wanted to highlight just a few to provide you some significant opportunities-- we feel provide significant opportunities for 2003 and beyond.

Finally we discussed our [cooler] program on our previous conference calls, and I want to give you an update on this project.

Again for competitive reasons I'm not going to provide specific [transaction values] or break down tranactions by product.

I can say we currently have in excess of 1300 stores on this program.

We currently have this program in operation in Louisiana, Tennessee, Kentucky, Texas, Georgia and most recently in West Virginia.

We continue to be pleased with the success of this program and can tell you the value of transactions [involving the cooler] product are well above those [non-cooler] transactions.

I can also say that current information shows that 40 percent of the increase in transaction value is coming from non-cooler product that certainly helps offset the lower margin cooler product.

In closing, I believe we are taking the steps necessary to improve future performance.

However, there's certainly considerable uncertainty in our country today.

Potential for a war with Iraq, the possibly of future terrorist attacks, general slowdown in the U.S. economy and the shortened holiday selling season certainly weigh heavily on consumer spending.

Having said that, I believe Dollar General is well positioned with stores, inventory and staffing to take care of our customers during this critical selling season.

Our customers still have daily needs and holiday wants.

That we are well prepared to satisfy regardless of external circumstances.

Now if there are any questions, we would be happy to answer them for you.

Operator?

Thank you, sir.

If you would like to ask a question at this time, press star one on your touch tone telephone key pad.

If you are using speaker phone equipment, please pick up your hand set before pressing star one to ask your question.

Stand by please while the questions register.

Once again that, is star one, if you would like to ask a question, star two if you would like to cancel your question.

One moment while the questions register.

Our first question comes from David Cumberland, from Robert Baird.

Thank you, good afternoon.

Jim, on the SG&A expense, was that above your plan and if so, which if any of the components you mentioned were above your plan?

Well, you know we gave out some comment there on shrink and the fact that we were disappointed by that.

I don't think we want to get into specific comments about how we came in versus plan on line items.

I will reiterate again that labor is running as a rate to sales, store level labor, pretty significantly higher than last year and it makes it difficult for to us achieve leverage on our expense line against the sales results.

Can you comment more broadly about whether SG&A as a whole outperformed that plan?

Well, let me say this.

I think that what we identified, especially on a year-to-date basis is that we're disappointed with the gross margin rate performance.

And I think that we even in the past had conditioned people for the fact that we were going to make an investment in store level labor this year.

So I guess I am comfortable saying that we're not terribly disappointed with the SG&A expense results overall at this point.

But we are a little bit pointed with the gross margin rate performance year-to-date.

Thanks.

One other question.

You provided a comment on guidance for full year earnings growth.

Can you comment on your current outlook for full year sales growth?

Well, I think what we're saying is that the guidance we gave at the beginning of the year which was 14 to 16 percent total revenue and 5 to 7 percent same store, we are no reason at this point to adjust that.

Great.

Thank you.

Thank you, sir, our next question is from Michael Baker with Deutsche Banc.

Hi.

Thanks.

In terms of the store level initiatives, how much of that now is behind you and I guess what can we expect in 2003?

Will there be an opportunity to leverage expense next year or are you still going to be making some more investments in your operations?

I think that's a little bit early to answer that because we haven't totally finished our planning process yet.

Certainly have made some major investments as Jim indicated earlier.

This year, we told you we're going to spend some money on the store labor.

I think [inaudible] talked about that in March at the analysts meeting.

So we have made that investment.

While the rollout has been completed, there's still some implementation issues that I talked about earlier.

So I think I'll be in a better position tend of the year when we have the 2003 plan in place to give you more concrete information than I can give you today.

Okay.

That's fair enough.

And then quickly, just you told us how many stores you're planning on opening next year, can we assume there will be a similar number of store closures you've had in the past in the 50 or so range?

I think at this point, we're going through our planning process and I think it's actually a little bit too early to say that.

I think that we're going to do an assessment of the entire store population and while we don't anticipate any massive store closing program, it's really too early to identify a number or even a range of number on closures.

We're just not there yet.

Okay.

I guess we'll have to stay tune for that one.

And let's see.

One more else compare to comment on while we have everyone on the line here on the sales trends, month to date, in terms of your zero to three percent comp plan?

I don't think that because we're close to the end of the month that we want to make any comments about that.

You know, this month is quite an unusual month in that Thanksgiving is last week it doesn't fall this week, so I think it's difficult to give any guidance right now until we get through the weekend and we'll report our numbers next Thursday.

Right.

Just looking for an early preview for everyone.

Thanks a lot, have a great Thanksgiving.

You do the same.

Bye-bye.

Thank you.

Our next question is from Meredith Adler from LehmanBrothers.

Oh, hi.

It's Karen Short from Lehman Brothers, I work for Meredith Adler.

Can you just talk about shrink a little bit more and a tell us if have you taken into account all different types of shrink, cash register, back end.

Can you maybe provide a little more detail on that?

I can talk a little bit about it, we think that were we look at the shrink numbers and we commented earlier, this is the first year we've taken a UPC inventory.

So we think we've gotten a very accurate count using a third party.

Not that we haven't in the past.

We think that there is a major issue with thefts within the store were you're looking at 3.6 round numbers that Jim talked about earlier.

We know that there's theft issue there is, both internal and external.

While it's fairly difficult to truly determine which is which, some of the information the asset protection people have been able to determine is that we definitely have our fair share of internal shrink.

but you can't break it down right now between the two?

I don't think you can ever actually break it down.

How much would you maybe relate to the economy versus just what would be part of, you know, an ongoing normal economy?

I couldn't answer that for you.

I think that, I think we've seen in my career, we've seen when the economy gets tough that there are certain issues there relative to inventory shrink and [naudible], but I wouldn't be able to just pin that down for you unfortunately.

Okay.

Thank you.

Sure.

Thank you.

Once again, if you would like to ask a question press star one on your touch tone telephone key pad.

If you are using speaker phone equipment, please pick up the hand set before pressing star one to ask your question.

Our next question is from Deborah wineZWEIG with Salomon Smith Barney.

As far as consumerables, it looked like it hit 64 percent of sales this quarter.

Realizing that [seasonal is weak] where do you expect that to shake out over the next couple of quarters and into 2003?

I think that basically what we've seen of late, there's been a slight growth in the consume end of our business, certainly would anticipate that we continue to grow that, I don't think that, Jim is looking for numbers to see if we can give an exact number but I think we have had continued growth there as we've certainly been [inaudible] about ourselves in consumable basics.

I wouldn't anticipate you're going to see a lot of change in that.

We bought down on some of our apparel [inaudible] our inventory is back in line has been part of that $116 m number.

So going into 2003 second half of the year we'll be able to purchase new products in the apparel area but you're not going so to see a lot of change in the mix over the next couple of quarters.

I apologize.

My name is Mark Sullivan, I work with Deborah Weinswig.

You didn't sound like Deborah.

Hey, Mark, this is Jim.

Just one point which may be stating the obvious.

But in the fourth quarter because of the amount of seasonal business we do, the highly consumable as a percent of the overall total sales during that quarter, it’s going to come down.

Last year it ran 52.3 percent during the quarter of total sales.

And I think you can expect to see an increase this year in the percent to sales [of] high consumables is in the fourth quarter.

I don't know exactly what that will be, but if you went back and trended the incremental increase in the first three quarters I suspect it won't be terribly different.

Thank you.

One last question I have regarding shrink also.

How much of it, if any, do you think relates to the implementation of coolers and perishables within the store?

I think very little, if any at all.

Thank you.

That's not something that we typically would associate with high shrink areas, I don't think.

Thank you.

Thank you.

Our next question is from John Rouleau with Wachovia.

Hi, gentlemen.

You had alluded earlier in the call to you know increasing the labor expenses and that was planned all year long.

We had heard recently that store level -- store managers and a assistant managers their annual comp was taken up pretty significantly in order to kind of get them more or less in line and attract a higher quality manager.

Was that done quite recently?

And maybe you can comment in terms of the type of manager that you're now able to attract with that new higher comp?

We did take their compensations up.

There was some offsetting for some of the incentives that--aren't as lucrative as they were in the past, but gave them a higher weekly or monthly salary.

Really did that to be more competitive in the areas where we have our stores after some price – after some shopping comparisons on salaries.

I think it's a little bit early, because it's only been done in the last few months to really determine if that gives us a lower turnover, a higher quality individual.

I think intuitively in talking to divisional and regional manager, they at least have the feeling that's going to be the case, but I think we need a couple of quarters to really feel comfortable with that.

We should get a better quality person with lower turnovers is what we should ultimately see come out of this.

but the majority of that was taken in the third quarter, so we've still got some time before we start to anniversary those higher expenses at the manager and assistant manager level.

No, I don’t think so.

I think [inaudible] was taken earlier.

We've been on a program with this over the last, probably, couple of quarters.

Don, you were talking about the excess inventory, the slightly higher markdowns you took in the quarter.

I missed something, you mentioned $20m dollars of that inventory may remain at year end.

Is that like a calendar year end, because I know the goal was to be rid of that merchandise by fiscal year end, can you just clarify what you said there?

John, I think we're going to have some of it left at fiscal year end, however, it will be at a price markdown that really -- we don't feel necessitates marking it down any further.

So we think we can sell it through into the first part of 2003.

We'll sell a lot, hopefully sell more it late this year, but the weather will really drive a lot that, because most of what we have now is more of the fall than winter product.

Okay.

And actually up until just the last couple of weeks because I think everybody has been saying it's been too warm.

Obviously we've seen a jump in the fall and winter product.

But we could see some of that still on the balance sheet early part of next year?

Small amount possible.

Then last question, Jim, I mean you noted that the SEC is ongoing in the investigations here and they're interviewing and taking some information and that seems to be a little bit of a change from where you were at quarter or two ago where the activity was relatively quiet.

I'm not asking to you comment in detail, but has that investigation picked up a little bit from where it was maybe a quarter or two ago in terms of the activity that you're seeing?

I think tend of the second quarter, we had said that the investigation was active.

Okay.

I believe that that was maybe the first call where we had made the change to it was active.

Okay.

And all I can say right now is it continues to be active.

Right.

So we went to non-active in the first quarter to active in the second quarter and a continuation of that in the third quarter?

Right.

Thank you.

Thank you.

Our next question is from David Mann with Johnson & Rice.

Yes, Good afternoon.

Not to belabor the shrink, but in terms of some of the initiatives you've put in place, have you been able to take any sort of sample or test in any group of stores to see if that -- if you're making any progress there?

We have.

We took some tests in late September and early October in some of our more, our highest shrink stores and we saw a, I'd say a good improvement.

Not what we would like to see, but definitely a trend into the proper direction.

As I said earlier, the problem were you put these programs in place is that you're kind of looking 12 months back when you take a physical inventory.

And we didn't have all of them in place earlier in the year, but we did see an improvement, we intend to take more of those tests in January to make sure that the things we're doing are having a positive impact on the shrink.

in terms of how you're going to accrue for shrink next year, if I remember correctly, you take a three year average is that correct?

No, at this point we're taking basically a one year average.

Okay.

Jim, also in terms of your distribution leverage, I know you've commented in the first couple of quarters about some success there.

Not something you mentioned thus far in the call.

Can you just elborate a little bit in terms of where you are in distribution level?

On a year to date basis we continue to show nice leverage against last year's distribution transportation expenses.

We did not have leverage in the quarter just concluded, I guess last year's expenses.

Distribution transportation.

And any reason why that doesn't happen in this quarter?

We have some additional expense bringing goods out of Asia.

There was a point even before the dock workers’ strike, there was a point where shipping capacity was constrained, we had to pay some excess dollars to buy capacity and to get product into the facility, so I think that was part of the impact in the third quarter.

If that hadn't happened, would you have expected to have about the 65 basis points that you had year-to-date for the second quarter?

Give us just a second to look at that.

No.

It would not have been -- it would not have been that dramatic.

And how much benefit do you expect to recoup in the fourth quarter in terms of seasonal IMU?

Well, I can tell you that in terms of inventory that we were scheduled to receive in the third quarter that we didn't receive until the fourth quarter, it was about $50m dollars, about a $50m dollar shortfall because of the dock workers’ strike.

Probably would have been here in October, we received it in November [the fact that] it's being distributed to stores as we speak.

So about a $50m dollar swing between the third quarter and the fourth quarter because of delay of products in the west coast.

I'm not sure I can you a number about what that would mean to IMU.

What percentage of your receipts would that $50m have been of your total seasonal receipts?

Let me look here for just a second.

I've only got the month of October here, but -- but just the seasonal receipts in round numbers, maybe about 30 percent of one month's seasonal receipts for the month of October.

Okay.

Thank you.

Thank you.

Our next question is from Jennifer Hansen with U.S.

Bank Corp.

Hello, this is Todd Craig for Jennifer.

Two questions.

One, can you tell us what same store sales levels you need to get leverage in both the fourth quarter and next year?

Hello?

I think that -- with respect to next year, I think it's too early to say.

As Don mentioned we're going through our planning process right now.

In particular we haven't honed in yet on what store operating expenses are going to be and what labor at the store level is going to be and that could be a real big variable in terms of next year's leverage break even.

How about the fourth quarter?

Well, I think for the fourth quarter, I'm reluctant to give any sort of specific guidance on it, but I'll tell you that obviously during the fourth quarter because of --just because of the overall increase in volume, that our comp store sales break even should be less than what you would see in the first three quarters.

Okay.

Follow up question.

Have you looked or can you give us any sense of what the impact was back in '96 when had one fewer week between Thanksgiving and Christmas, you know, given that, you know, close to 60 or 80 percent of your sales are right around that Christmas week?

Have you gone back and looked to see you know how it impacted sales back then?

And I guess --.

We have.

And what I can tell you is that I guess the obvious is that November runs very light and December runs very strong.

Now, prior history is no indicator of what's going to happen this year, but we did have a good revenue performance in the month of December in 1996, which is the last time that this did occur.

Under different circumstances than back [there then].

Okay.

Thank you.

Thank you.

Our next question comes from Jack Bellows (ph.) with Midwood Research.

Hello.

Just to follow up on that last question about sales, you had an 8.9 percent comp store sales gain in December which I know was influenced by a change in the fiscal year, but does that large increase in any way change your outlook for December this year?

I'm not sure I understand your question.

Well, in other words, you're up against 2.8 percent comp in November of last year, in December of this year you're up against 8.9 increase part of which I think occurred because of fiscal year differences with December last year.

So I'm wondering if going up against 8.9 even though you have the shift in Thanksgiving, how does that balance out in terms of what you expect for sales gain for the month of December this year?

I don't actually -- I don't know how to answer your question.

I'm not sure.

I mean we look at the sales plan for this year, all we can do is look at the days in December, when they fall and do our best estimate of what we thought that month would be, but I can't -- I'm not sure how I can answer it.

There's a whole Myriad of differences this year in the fact that Christmas comes later, it should be compress into a shorter period of time.

We're up against the 8.9 from last year.

So I'm not sure I can answer your question.

Okay.

Because you've had additional labor in the stores, has that improved your in stock position?

Do you have an idea of what it is this year compared to last year?

A couple of things I think have improved -- to answer your question, yes, our in stock position has improved.

Part of that we think is a direct result of the ordering process we put in place where we now have three people going through the ordering process as opposed to one person in the past.

We have, we feel good in stocks in our distribution centers.

They've been running very high this year.

So we do feel we've got a better in stock position in the store and part of that is definitely derived by the fact that we've had additional labor there.

Can you quantify what the in stock position is this year versus last year?

I wouldn't do that, Jack, I'm sorry.

Well, can you quantify differential like 97 percent in stock this year and 95 last year, just a differential?

What I can say to you is it's running higher this year than it did in a comparable period last year.

I don't have the specific numbers in front of me.

One last thing.

In terms of the increase in the manager and assistant manager compensation, I wasn't clear, did that start in the second quarter of 2002?

When did that start?

We started looking at that at the start of 2002.

I believe if my memory serves me properly, we didn't implement it until the start of the second quarter and into the third quarter of 2002.

So it was implemented in both the second quarter and the third quarter?

That's correct.

Is there a change in the bonus amount that a manager can get?

As I mentioned earlier, there is a change in that.

And the bonus amount as well?

I mean [inaudible] just salary.

There was a change in the overall bonus structure for the store managers.

In terms of how their bonus is calculated.

Pretty dramatic change.

In terms of how it's calculated?

Is it calculated as a depending on meeting sales goals or profit goals for the store?

That's correct, it is.

So how is that different than the way it used to be?

There are a number of variables being calculated into it this year.

And the number of variables I believe are more in the [weighting] is a little bit different on the variables.

[Weighting] toward which part?

I mean getting better sales gains or controlling your expenses better or being [a stock] or how is it weighted?

Off the top of my head, I can't tell you.

Okay.

Thank you.

Thank you.

Our next question comes from Asma Usmani with Edward Jones.

Thank you very much.

Just to follow up, you mentioned the improvement in the quality of-- the manager and assistant manager, are you also, is the store the numbers on the store floor actually also increased in addition to the quality?

As I said earlier, we feel we will bet a better quality individual with what we've done from: a store standpoint, I would say to you there are a number of stores where you've increased the staffing.

There are stores where we recognize the fact that we had excessive amounts of staffing.

So we've had both additions of staff and reductions of staff depending upon how the store was running today.

Just generally, in general, would you say it's –[net, net] --typically have the same number of associates this year that you've had last year?

Or is it just more emphasis on the quality of the associates

Well, we certainly always try and emphasize quality of individual.

I'm not sure I can give you an answer as to whether we have more or less because we've had additions where stores might have been running light in terms of staffing, [as I’ve said] we've had situations where is we've reduced the staffing because in our our analysis the store is actually running a higher number than they needed to support the sales volume in that particular store.

You also indicated that now three people are involved in store ordering.

In the past, it was just one.

The three people, is it three people that come in that's a separate responsibility or is it basically the responsibility that's still taken on by the store manager and the assistant manager and the [inaudible] associates?

That's correct.

Your latter description of it you have the manager who used to order the entire store.

Because of the quantity of the product the quality might not have been as good from a timing standpoint, their ability to get it all done.

Now we have the store divided into three sections.

The store manager orders a piece of it.

The associate orders a piece and the third person orders a piece of that.

When was that implemented?

Probably late last fall it was rolled out.

I would say the implementation phase probably the first part of 2002.

Started rolling out in late October of last year as I remember.

Then you indicated about the change in the matrix for the compensation of associates.

Has there been any change, I know you've not detailed the exact changes, but has there been any changes in management in terms of compensation?

The compensation [computation]?

When you say management, give me --.

I'm talking about headquarters management?

Has there been any changes since the restatements on how your incentive compensation is computed today versus two years ago?

I think from a -- as best I know from a salary and bonus standpoint, I wasn't here two years ago, so I can't tell you how it was before, but I'm not aware of any major changes there.

No major changes, okay.

You indicated about 180 stores today have the automatic replenishment.

Have you given any indication of when you expect to get that rolled out to all stores?

Well, we need to make sure we're having success with 180 and we certainly would, this would be a multiyear project, I've seen a lot of companies where trying to roll out an [auto] replacement to all stores [will kinda] bring to you your knees and we won't do that, so that would be a program we would build into our planning process and roll out over a number of years.

Any indication of how many -- are you looking to roll out to a number of-how many stores are you looking to roll out next year in 2003.

Not until we finish the planning process.

When do you expect that to be finished, the planning process?

Let me go back on one thing.

We talked about relatives of compensation, I guess you were talking about executives?

Correct.

What you should really do is go back and read the proxy on compensation, there's a stock option plan change in there, I couldn't fully describe it to you.

If you go back and read that, that will tell you the change there.

Thank you.

Thank you.

So you mentioned about the testing of the 180 stores when will that be completed?

They're been rolled out now.

So we'll be looking at it as we complete our planning process, we'll make a determination of what we do going forward.

An indication of when you expect the plan purchase to be completed?

Well, it has to be completed before we start 2003, so I would assume -- not assume, we'll be doing it over the neck month or so.

Finally, can you just give us some color on what you're seeing in the competitive environments?

As relates to?

To in terms of pricing in the marketplace you're operating in terms of just a kind of an overall feel from your peers?

Well, we do competitive shops on a regular basis.

We haven't truly to this point seen any major changes, we certainly try to be competitive in markets we compete in.

I think the question will obviously be not so much for us, but for some of the department store people who whether the Christmas season takes hold will or not and who takes the first markdown but that doesn't impact us because we, again, don't play in that particular environment.

Okay.

Thank you so much.

Thank you.

We can take one more question, operator.

Sir, that actually was our last question.

Okay.

Great.

Thank you very much.

Appreciate it.

Hope all of you have a very nice Thanksgiving.

Look forward talking to you later.

Thank you for participating in today's teleconference call.

You may now disconnect.