達樂 (DG) 2003 Q3 法說會逐字稿

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

This call is being recorded by Conference America 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.

Before the presentation begins, the company has requested that you listen to the following statement regarding forward-looking information and non-GAAP disclosures.

In addition to historical information, the company's comments during this conference call will contain forward-looking information, such as statements regarding growth targets, key initiatives, and the anticipated results of those initiatives, and fourth-quarter 2003 gross margin rate expectations.

Believe, anticipate, project, plan, expect, estimate, objectives, forecasts, goals, intend, or likely result, or will continue, and similar expressions generally identify forward-looking statements.

The company believes the assumptions underlying the forward-looking statements are reasonable.

However any those assumptions could be inaccurate; and therefore actual results may differ materially from those projected in or implied by the forward-looking statements.

The factors that may result in actual results differing from such forward-looking information include but are not limited to those set forth in the company's most recent annual report on Form 10-K and in their third-quarter earnings press release issued today.

The company cautions you not to place undue reliance on these forward-looking statements, which speak only as of today's date.

Except as required by law, the company disclaims any obligation to publicly 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.

You are advised, however, to consult any further disclosures the company may make on related subjects in its public disclosures or documents filed with the SEC.

The company will be referring to certain financial information not derived in accordance with Generally Accepted Accounting Principles or GAAP, such as net income, diluted earnings per share, selling, general and administrative expenses, operating profit margin, return on assets, and return on invested capital, excluding restatement-related items.

The company includes these non-GAAP financial measures in order to indicate more clearly for investors the company's comparative year-to-year operating results.

The compensation committee of the company's Board of Directors may use portions of this information for compensation purposes to ensure that employees are not inappropriately penalized or rewarded as a result of unusual items affecting the company's financial statement.

Management may also use this information to better understand the company's underlying operating results.

In addition, return on invested capital discussed in this call may be considered a non-GAAP financial manager.

Management believes that return on invested capital provides investors with additional useful information in evaluating the efficiency of the company's capital deployed in its operations.

None of this information should be considered a substitute for any measures derived in accordance with GAAP.

The company has included its calculations of return on invested capital and reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in the schedules accompanying their third-quarter earnings press release, filed today, which can be accessed at www.DollarGeneral.com by clicking on the homepage highlight items.

Beginning today's meeting is Mr. Jim Hagan, Executive Vice President and Chief Financial Officer.

Sir, you may begin.

Good morning, everyone.

With me this morning are David Perdue, our Chief Executive Officer;

Lawrence Jackson, our President and COO; and Emma Jo Kauffman, our Senior Director of Investor Relations.

I'm going to take you through our third-quarter results, and then David will have some comments on our operations.

This morning we reported that net income for the third quarter of 2003 was 77.9 million or 23 cents per share, as compared against net income in the prior year of 68.6 million or 20 cents per share, an increase of 13.6 present.

The 2002 results include approximately 24.3 million in restatement-related items, primarily insurance proceeds, that actually served to increase our reported results.

Excluding restatement=related items from last year's results, net income and earnings per share would have been 53.2 million and 16 cents per share.

So excluding restatement-related items from both years, our net income increased in the third quarter by 46.3 percent, from 53.2 million last year to 77.9 million this year.

Sales during the third quarter of 2003 were 1.69 billion, versus 1.50 billion in the prior year, an increase of 12.5 percent.

Same-store sales increased by 3.8 percent.

The gross profit rate during the quarter was 30.67 percent, versus 28.62 percent in the prior year, an increase of 205 basis points.

The increase in the gross margin rate in the current year quarter is a result of a number of factors, including a higher markup on our total inventory balance; a reduction in the rate to sales of distribution and transportation expenses; a lower shrink provision, strong sales of high-margin seasonal items; and a 7.8 million non-recurring inventory adjustment.

The non-recurring inventory adjustment basically represents a reduction in the estimated cost value of our shrink; and let me explain why that is the case.

Our item level perpetual inventory data, which we began utilizing for financial reporting purposes in the current quarter, indicates that our shrink is a little more skewed to items with higher markups, and therefore lower costs, than what our estimates had suggested.

More specifically, though the total retail value of our estimated shrink remains the same, it appears that we have more shrink in our clothing departments and less shrink in our consumable departments.

That means that we are losing a little less merchandise at cost than previously thought.

As I think most of you know, it is the cost value, not the retail value, of inventory shrinkage that impacts the income statement.

SG&A expenses in the third quarter of 2003 were 385.6 million or 22.88 percent of sales, versus 335.2 million or 22.38 percent of sales in the prior year, an increase of 15 percent.

The 50 basis point increase in the SG&A expense as a percent of sales is due principally to increases in workers compensation, in-store training cost, and an increase in our accrual for potential 2003 bonus payments.

Our operating profit margin rate was 7.79 percent in the current year, as compared with 7.91 percent last year.

If you exclude restatement-related items from last year's calculations, last year's operating profit margin rate was 6.29 percent.

Net interest expense was 8 million in the current year quarter, versus 11.5 million in the third quarter of 2002.

The reduction in interest expense in the current year was due to lower average debt outstanding, as compared with the same time last year.

The company's effective tax rate was 36.9 percent this year, versus 35.9 percent last year.

The 36.9 percent represents an increase from what we recorded in our first two quarters; and that can be attributed to an increase in certain state income tax liabilities.

Last year the company's effective tax rate was favorably impacted by adjustments to prior estimates, resulting from the filing of the company's '98 through 2001 tax returns.

On a year-to-date basis, net income during the current year was 198.2 million or 59 cents per share, as compared against net income in the prior year of 156.9 million or 47 cents per share, an increase of 26.3 percent.

The 2002 results include 24.1 million in net restatement-related items, consisting of 29.7 million in insurance proceeds, partially offset by 5.6 million in net restatement-related expenses.

Excluding restatement-related items from 2002, net income and earnings per share would have been 141.6 million and 42 cents per share.

In 2003, we have incurred approximately 370,000 in restatement-related expenses.

So on an apples-to-apples basis, net income increased in 2003 by 40.1 percent, from 141.6 million in 2002 to 198.4 million in 2003.

Year-to-date sales in 2003 were 4.91 billion, versus 4.34 billion in the prior year, an increase of 13 percent.

Same-store sales increased by 4.3 percent.

The year-to-date gross profit rate in 2003 was 29.39 percent, versus 27.56 percent in the prior year, an increase of 183 basis points.

The increase in the gross margin rate was due to a number of factors, including a higher markup percentage on the company's inventory purchases in all four of our major categories, as compared with that experienced during the comparable period in the prior year; a reduction in our shrinkage provision, calculated at retail dollars, from 3.57 percent in the prior year to 3.10 percent in the current year; a reduction in the rate to sales of distribution and transportation expenses; a reduction in damaged product markdowns; and the relatively strong increase in sales in higher-margin seasonal items experienced in the current year.

Before we leave the topic of gross margin, I would like to point out that in our fourth quarter we anticipate a challenging gross margin rate comparison versus last year's performance.

SG&A expenses were 1.11 billion in the current year, versus 946.1 million in the prior year, an increase of 16.8 percent.

Excluding restatement-related expenses from both years, SG&A expenses were 1.11 billion or 22.53 percent of sales in the current year, versus 940.7 million or 21.67 percent of sales in the prior year, an increase of 17.5 percent.

The 86 basis point increase in SG&A expense as a percentage of sales, excluding restatement-related expenses, is due to a number of factors, including increased store labor and workers compensation cost, increases in various store occupancy costs, and an increase in our accrual for potential 2003 bonus payments.

Our profit margin rate was 6.85%, versus 6.44% last year.

Excluding restatement-related items from both years, the operating profit margin rate was 6.86% this year versus 5.89% last year.

Net interest expense in the current year was 25.3 million, versus 33.3 million last year.

The reduction in interest was due principally to lower average outstanding borrowings compared against the same time last year.

The company's 2003 year-to-date effective tax rate was 36.2 percent, as compared with 36.3 percent in 2002.

The company opened 201 stores and closed 27 stores during the quarter.

As of October 31, the company had opened 601 stores and closed 61 stores; and our store count was 6,653.

Cash capital expenditures during the quarter were 31 million, and on a year-to-date basis cash capital expenditures were 96.9 million.

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

You may know that the end of our third quarter is pretty close to the low point out our annual cash cycle, due to our holiday inventory build.

Nevertheless, the company's cash flow before financing activities, which represents net cash provided by operating activities less cash used in investing activities, was a source of cash of 24.6 million; and that includes the 49.6 million debt reduction payment made earlier this year, related to one of our distribution centers.

Our rolling twelve-month inventory turn was 3.9 times at October 31, 2003, versus 3.7 times a year ago.

Our total inventory balance stood at 1.37 billion at October 31, an increase of approximately 9.9 percent as compared against the same time last year.

Our total balance sheet debt was 285.7 million at October 31, 2003, versus 346.5 million at the end of last fiscal year on January 31, 2003, and 518.3 million at the end of last year's third quarter on November 1, 2002.

Our rolling twelve-month return on invested capital was 13.8 percent this year, versus 12.6 percent last year.

Excluding restatement-related items from both years, ROIC was 13.9 percent this year, versus 12.4 percent last year.

Our rolling twelve-month return on assets was 12.7 percent this year, versus 10.3 percent last year.

Excluding restatement-related items from both years, ROA was 12.8 percent this year, versus 10 percent last year.

Please refer to our press release for a GAAP reconciliation of ROIC and ROA.

I will not turn the call over to David for some operational comments.

Thanks, Jim.

Good morning, everyone.

We are delighted with our third-quarter and year-to-date financial results.

Year-to-date through the third quarter, our sales have increased 13 percent.

Year-to-date, in a very difficult environment, our same-store sales have increased 4.3 percent over a strong last year.

Our year-to-date operating margin, including restatement-related items, has improved by nearly 100 basis points from 5.9 percent to 6.9 percent; it improved by 150 points for the third quarter to 7.8 percent.

Our net income and earnings per share have grown 40 percent, when you exclude last year's income from restatement-related items.

As of the end of November, we had opened 667 new Dollar General stores, including two Dollar General Market stores, exceeding our 2003 annual goal of opening 650 new stores.

Over the past 12 months, we have reduced outstanding long-term borrowings by 45 percent, from 518.3 million a year ago to 285.7 million at the end of the quarter; and more importantly, we have reduced our net debt, our debt less cash, by 69 percent from 481.2 million to 147.2 million.

Our return on invested capital, as Jim just noted, excluding net restatement-related income in 2002, improved by 150 basis points to 13.9 percent.

We believe ROIC is an extremely important measure of our financial performance, and we will plan to focus on this measure even more as we go forward.

This is a pretty impressive list of accomplishments, but we recognize we still have a lot of work to do.

We are really just getting started.

I'm pleased to have a strong senior management team in place as well.

Lawrence Jackson has been on board as President and COO for a couple of months now; and Kathleen Guion has been with us as EVP of Store Operations for just a mere week.

Lawrence and Kathleen are already making a big impact on our stores.

They're focused on serving the stores and are committed to promoting a culture in the organization centered on our stores.

Also I'm very pleased to have Stonie O'Briant back in the role of leading our merchandising efforts, and to have Tom Hartshorn focused on our new stores and new business opportunities.

As a group, we have set our priorities for next year and hope to have a significant impact on sales and operations.

I would like to share some of these priorities with you.

First, we intend to significantly improve our in-stock levels at our stores.

While it is difficult to quantify, we know we have a huge opportunity to do better in this area.

We see completing the rollout of our auto-replenishment program to all stores as a major step in accomplishing better in-stocks.

We currently have auto-replenishment in over 2,200 stores, and expect to add another 300 before the end of this year.

We intend to complete the rollout to the rest of the chain in 2004.

While we are still in the early rollout phase, the results for the third quarter indicate that auto-replenishment should provide us with a nice lift in sales next year.

For the third quarter, for example sales, in our auto-replenishment stores were 80 basis points higher than our non-auto-replenishment stores.

In addition, we plan to hold the store managers and field management more accountable for their own in-stock levels.

Second, we will focus a lot of attention on our store operations.

You have heard us talk a lot about that in the last few months.

Again, Lawrence and Kathleen are committed to this, as we all are.

We're making some changes in our divisional management structure, and have added a new division to allow more focus on our Texas stores and on the new areas in the Southwest.

We are also developing better tools for the regional and area managers, so they can oversee the operations of their stores more effectively.

We believe we have added some structure and made some progress over the past two years with our Seven Habits (ph) program.

We are not where we would like to be as far as having clean and well-stocked stores throughout our chain.

Most of our stores look great and provide good shopping and working environment.

But this is not the case across the entire chain.

Soon we will begin a major undertaking at the stores that will impact all of these store initiatives.

We are currently negotiating the terms of an agreement with an outside consulting firm to conduct a store operations and merchandise flow project.

Next year, one of our biggest initiatives that we will have as a company will be to invest in our store operations with this major work flow initiative.

We will also focus on managing our business to control expenses at the store level, including programs to better manage workers compensation and salary administration, (technical difficulty) better store manager and area manager communication.

Third, our third major initiative is to improve the productivity of our large stores.

Our merchandise mix is geared for a store that is approximately 6,800 square feet currently.

However we have many stores that are larger than 6,800 square feet, and approximately 1,000 stores that are larger than this 8,000 square foot measure.

As a group these stores underperform on a per-foot basis.

We now have a team of people working on expanding the selection of items in categories we carry in these doors.

We believe we can significantly improve per-square-foot productivity.

Next, we are very concerned about management turnover in our stores.

For many of our stores this isn't an issue; but for the rest there is a tremendous opportunity for improvement.

So far, our greatest success in controlling turnover seems to be due to the emphasis we have placed on our new store manager training.

Turnover of managers who have gone through this training in our training centers is about 27 percent on annualized basis, or about half the rate of the company as a whole.

Though we're still very much committed to these training centers, Lawrence and Kathleen have already implemented new ideas to further address turnover, like sales incentives.

They are both intent on providing rewarding career opportunities for the men and women in our stores.

We expect that our store ops project will help enhance the working environment at our store, so that we can be a more attractive and rewarding place to work going forward.

We believe the training centers have also had a positive impact on shrink, our next major initiative.

We have put several new controls in place over the past year and a half; and although we are not where we would like to be, we continue to believe that we will eventually reach the goal of 2.5 percent or better.

Over the past few months, we have focused field operations and store support functions on the 250 stores with the worst shrink problems.

As a group, these stores averaged shrink of 10.5 percent prior to our initiative.

We changed some people, focused on the stores, and then took a physical inventory to establish a baseline.

In our most recent sampling of inventories of about 150 of these 250 stores, we believe we have reduced this shrink by more than half.

Though the overall rate is still unacceptable and there is a lot of work to be done, we believe we're beginning to move the dial.

Next, we have decided to roll out our cooler program companywide as quickly as possible.

We have been testing and rolling this program out over the past two years, increasing the number of stores since this time last year from about 1,300 stores to 2,342 stores.

The coolers give us a higher ring through the register and a big opportunity to drive customer traffic and improve overall store sales.

We should have coolers in about 2,500 stores by the end of this year; and I'm hopeful that we can complete the rollout in 2004.

Next, Stonie and the merchants have several significant merchandising initiatives planned for next year.

For one, we see a compelling opportunity for more opportunistic purchasing, and we plan to expand our treasure hunt merchandise.

Our customer research indicates that in addition to the value found in our core merchandise mix, the excitement or anticipation of finding interesting and unusual items at a tremendous bargain is an important component of our customers' shopping trip.

This merchandise typically yields higher margin as well.

We plan to assign dedicated merchandising resources as well as a separate open to buy budget to support this program.

We also plan to move forward with our segmentation strategy, with an increasing focus primarily on Hispanic and African-American stores; and we have a plan next year to add some fixtures and realign some fixtures to allow us to present our merchandise, apparel as well as other categories, more effectively.

Finally, we will expand our use of international sourcing as an opportunity to increase profitability and offer more affordable prices.

Next is our supply chain.

I truly believe, as I have said to you before, we have one of the best-run distribution centers in retailing, and it is supported by a very strong IT function as well.

The DCs are well thought out and are run very efficiently.

We have state-of-the-art technology and keep current on changes in the industry.

To support our current and future store growth, we have announced several new supply chain initiatives.

I will not go into all of these details, but basically we're adding a third shift to several of our DCs.

We plan to convert Ardmore in South Boston to dual sortation in 2004 and Indianola in 2005, increasing capacity in these particular DCs by 60 to 75 percent; and to begin construction in 2004 on a new distribution center in the southeast, to open sometime in 2005.

We will also continue our search for the next DC, planned to open sometime in 2006.

We are very excited about our nights (ph) initiative.

Now that we have all of our systems in place, we will develop a data warehouse.

This is an essential ingredient in tying all of the data we collect together and making it more useful for planning and decision-making.

The data warehouse will enable the collection of all company data in one location, and will support extensive analysis of our business.

The main intent of this warehouse is to support marketing and data analysis, and it will be used initially for merchandising support.

But it will be structured so that expense, market basket, or any relevant data can be added in the future.

As I said we are really excited about the opportunities we will have with easy access to all this information.

Of course we have other projects on the horizon, but these are the ones we will really focus on next year, that I believe will make the greatest impact on our business.

In addition to these major initiatives, as you have already heard, we will continue testing debit, credit, and EBT cards.

We completed the system capabilities for this in May of this year, and are now accepting debit cards in over 500 stores, and credit and EBT in most of these.

We plan to open 675 new conventional Dollar General stores next year, and will increase our focus on new store productivity.

We plan to open 20 more Dollar General Markets next year, and continue the testing of this important concept as a possible growth opportunity.

I know this sounds like a lot for one year, but we already begun to concentrate on these initiatives, and I'm very confident in the leadership team here at Dollar General.

We have spent significant time together setting these primaries and are really looking forward to see the benefits from these initiatives.

Our business strategy is not complicated.

It is commodity based, highly consumable basics, supplemented with treasure hunt items priced at everyday low prices.

Our stores are convenient and easy to shop, catering to an underserved customer base.

We remain committed to this, and believe it to be a great niche in retailing today.

Finally I want to express again our commitment to the key financial metrics that we have discussed with you before.

These are earnings per share growth, total sales growth, operating margins, return on invested capital, free cash flow, and asset productivity.

We have a strong balance sheet, strong cash flow from operations, and I believe good opportunities to improve our overall performance as we focus on these metrics going forward.

Thank you.

That is all I have for now.

I will turn it back over to Jim for questions.

I think we are ready, operator, to open it up.

(OPERATOR INSTRUCTIONS) Daniel Barry, Merrill Lynch.

You didn't say much about the sales for November that are out today.

Down 1.7; it seems a little light relative to the recent trend.

Can you comment on that?

They are; but as we came out, I think a month ago, we had revised our estimate.

We had seen a lot of noise in the system.

Dan, relative to what the other retailers are doing right now, what we see going on in the marketplace, we are not that displeased with it for the month of November.

If you look at last year, we were exactly flat;

I think it was 0.5 percent comp last year.

So there are two ways to look at it.

We would have hoped to have been up more than that, but I think relative to (technical difficulty) the marketplace, it is about where we deserve to be right now.

We are still not too excited about 1.7 percent; but relative to the other retailers in the market, it is not that bad.

You talked about having a higher markup in most of your product categories.

Are you comfortable that you're maintaining your competitive price advantage with your nearby competitors?

That is a very good question.

We continue to look at that.

We retained a group, as we mentioned in the recent analyst conference just recently; and we continue to look at that.

Yes.

We think that right now, this margin impact this year is really not coming from price increases.

So the price competitiveness has not really been impacted by this margin this year, in our opinion.

Okay, thanks, David.

Mark Miller with William Blair.

Terrific results.

I was hoping you could talk a little bit more about the outlook for the fourth quarter, with gross margin, that being a challenging comparison that you highlighted.

But does that mean that you think it is likely you'll see a decline in gross margin year on year?

I know there is a lot of factors, positive and negative; but was that your intention to signify more than a 50 percent chance that it would be down?

Thank you.

No, I think that my using the words challenging was, quite candidly, to avoid any sort of specific comment.

I think that if you were to go back and look at comments we made in our last conference call, about certain aspects of gross margin being challenging in the fourth quarter, I think those general themes would still be the same today.

I think even more specifically, in each of these first three quarters we have had a very nice improvement year-over-year in gross margin rate.

I guess if there is one thing we did not want people to do, was we did not want people to assume that we could repeat that performance in the fourth quarter.

As a follow-on, can you talk about the initial markup across categories?

I know you had said last quarter you were up more than 100 in each and every category; and total IMU was up 200 basis points on the purchases.

Can give us an update on where you stand on that?

Yes, in the third quarter the gap between this year and last year, in other words the increase in the purchase markup, is nowhere near as significant as it was in the first two quarters.

There was a modest improvement in the purchase markup in the third quarter.

And in the fourth quarter we have talked about the seasonality of this year being maybe a little bit different from last year.

In the fourth order in particular the purchase markup is going to be a very challenging comparison versus last year.

Your distribution and transportation has been (technical difficulty).

Given all of the things that you talked about, the initiatives with the third shift and the dual sortation, what type of change would you look for in distribution and transportation expenses, say, over the next year or so?

Thank you very much.

Obviously we are making some of those changes.

We don't anticipate any major changes in that.

One of the things we're really trying to do is look at that whole area as a percentage of sales, obviously.

And we think that by doing this we are leveraging our overhead quite a bit in that area.

So while we are not projecting any improvement, I don't see any dramatic increase in that cost as a rate to sales.

Thank you.

Dan Wewer with CIBC.

David, during the last couple of month we have seen a deceleration in the sales growth among all of the value retailers.

And at the same time, other retail sectors are showing accelerating same-store sales growth, that are taking advantage of the improving economic conditions.

I know that you have got a lot of experience both on the supply side and on the retail side of the industry.

I was curious as to how you would reconcile the divergence in the sales trends from your sector with others?

That is a very good question.

I'm not sure I have the answer for it.

We might have to find a few economists to help us with this one, but I will give you my opinion.

I think our model, as I have said before, is a very conservative model, in that we provide products people need on a routine basis every month, every week, basically.

I see what is going on this fall, particularly it started in August, when you saw a pretty strong back to school retail environment; particularly in apparel retailers.

Department stores seemed to have a pretty good month.

Some of our competitors who have a little more heavily weighted apparel mix; and certainly people like Gap who had good comparisons to last year showed very strong August and September.

Then came October.

So what I'm seeing right, Dan, is a lot of noise in the marketplace.

I think we all see that.

And the relative decline this year is similar to the relative decline last year.

If you look at our last year's numbers on a month to month basis, you will see very similar patterns that we're seeing this year, albeit at a little bit reduced level.

And that is true across all of the value sector, with Wal-Mart being an exception.

I think the difference in Wal-Mart right now is, frankly, their assortment mix is quite a bit different than ours, and more extensive, obviously.

We are not at all looking at this current trend as a bellwether.

But it does concern us.

And I think quite candidly, we are focused on it.

We think that some of the falloff, year-to-date anyway, in our comp sales, frankly, has to do with some of our own internal issues.

Our in-stock levels; our store operations and so forth.

We see opportunities in those areas that are independent to this macroeconomic topic that you relate to.

We think that, to summarize, I guess the answer, Dan, is that we think our model is well suited to handle good economic times as well as bad economic times.

If you go back and look at a '97, '99 period, this company seemed to do very well in much better economic environment.

So we are poised for it.

We are working hard to make sure we don't get whipsawed by any surprises.

But your observation is very correct.

Also I've got a real quick question for Jim.

You had noted that the shrink rate in apparel was higher than expected and lower in your consumables, which is not what I would have suspected given the size of your apparel.

It would make it difficult to just walk out with in the stores.

I was curious as to how you're reconciling this new development or this new understanding about your shrink?

I don't think we were particularly surprised to see that the consumables portion of the business, specifically the food side, was as low as it turned out to be.

That would be consistent with some of my experience in prior lives.

And from the clothing standpoint, do you have any feel for that, David?

Yes, I think the two observations -- and we were not grossly surprised by the adjustment.

I think the two things were HBA was higher, and apparel was a little bit higher; but understand that we think that a significant percentage of our strength is internal, and therefore it is not shoplifting or anything else.

I think that might answer that question.

Great, good luck.

Meredith Adler, Lehman Brothers.

Jim, I was wondering if you could talk to us a little bit more about that $7.8 million correction.

Is it fair to think about it as covering all three quarters of the year?

So some of it would be considered one-time for this quarter, but some of it belongs in the quarter?

Am I not thinking about that right?

First of all, I would not call it a correction.

I would call it an adjustment of an estimate.

Because at the end of the day, what it represented was it represented a change in our estimated shrink accrual or provision.

Because of the nature of that, the fact that we were adjusting the estimated shrink, it is very difficult to try and point what periods of time that the $7.8 million would specifically relate to.

From a GAAP standpoint, given the fact that it is an adjustment to an estimate, it all relates to this quarter. (technical difficulty)

I guess maybe the best way I could tell you this is that as we look at the run rate of the company going forward, we do not see this change as a reason for us to change what estimates were going forward for any one particular quarter.

We have run some simulations and any go-forward adjustment from this new shrink information would really not be material in any one given quarter.

(technical difficulty) into the future.

I guess I'm just trying to figure out whether I should be seeing this as the right earnings for the quarter.

I will tell you this way.

Again, from a GAAP standpoint you certainly should.

I will tell you that as we sit around and assess ourselves, we do not include this $7.8 million as being pretax income that we should consider something that we produced.

Okay, that is helpful.

Another question is, I think, maybe more for David, about strong seasonal sales.

Some of your competitors who reported sales today said that seasonal in fact were quite weak.

I don't know whether November was weaker; although reading your press release it didn't sound like seasonal was particular (technical difficulty) you.

I am just wondering if there's anything in particular that would explain why you're doing well, if you are.

First of all, we were doing well in our seasonal product in September, October.

I think November we are seeing the same thing that some of our competitors are seeing in seasonal.

November was a weak month in terms of seasonal.

I think it contributed, frankly, to our less than expected or less than desired comp sales in the month.

I would love to tell you we're doing better than everybody else in November, but I just don't think we were.

I think in September, October we probably had an uptick there because of the mix and because of the timing.

Remember, last year we had delivery problems and so forth.

But I don't think in November we have a solution to the mystery of the seasonal product, Meredith.

When you talk about seasonal, you are including apparel in that?

No, not really.

I have one final question for you; something that you and I, David, have talked about a little bit.

You say your pricing is not going up.

The question is whether your pricing is going down and ought to be going down; because certainly there are other discount retailers who are very aggressively investing any cost-savings from procurement or any other area in their prices.

We have talked about some of the limitations you may have with your fixed pricing system.

Can you talk a little bit about that?

And how will treasure hunt be placed?

Is it something that is more likely to be variable?

You have hit on a very important topic for this model.

I think, Meredith, as you know, we've talked about this before, we really try hard to balance two issues.

Here.

It is our earnings, obviously, our operating margin; and our market basket competitiveness.

So we continually look, obviously, at both.

We expose the earnings to you guys every quarter.

But also this market basket we're looking at every quarter as well.

When we look at year-to-date, as I said before, we have not increase enough prices to have a material impact on our competitiveness.

It does not show that way.

It is really a mix issue and a timing issue relative to last year.

To the bigger issue, should we be passing more of this increased margin on this year?

We are sourcing more product this year.

There are some very solid reasons long-term for why that margin is up this year.

I think as we improve our SG&A as a rate, as we improve some of our operating measures, we very definitely have that as an option to pass on and become even more -- continue to be aggressive on the pricing standpoint.

Obviously there are only two points of the retail pyramid we compete on, frankly; and it is price and convenience.

So we work very hard at both of those.

We are not resting on our laurels in terms of our price competitiveness, as you know.

And we do continually look at what we might do from a price point standpoint going forward.

Not this variable cost issue is one we continue to look at, particularly as look at urban markets and so forth.

But we have not made any conclusions on that at this point.

And the treasure hunt merchandise would be more likely to be variable priced?

When you say variable price, it is probably not going to be variable price from store to store.

But it will have its own unique price point.

It will still be consistent with our rational, even-numbered price point levels.

But it won't be variable from store to store.

Thank you very much.

Kelly Chase with Thomas Weisel Partners.

My question is going back to the Novembers sales.

And really actually trying to understand, given what you saw here in November, and it sounds like somewhat mediocre trend, what gives you confidence, given for your December guidance that you have provided us, 2 to 4 percent growth?

Given that your year-ago comparisons get (technical difficulty) as we go into December; and that would assume a reversal in the two-year comp trend that has been negative over the last five months.

Let me start.

And one thing I would point out is that our fiscal month concludes on a Friday.

And one thing that is different between this year's comparison and last year's comparison is that some of the government transfer payments, which are very important to us, were not in folks' hands this year on Friday.

The first of the month fell this year on Monday this week.

Last year the first would have fallen over the weekend; and therefore last year there were some government transfer payments in people's hands on Friday during the November fiscal month.

So in looking at that, we knew we had a favorable calendar comparison at least in this first week of the month.

That was one aspect.

I will turn it over to David if he has got some other comments.

I think the issue that we are looking at (technical difficulty) there are a couple.

One is in our seasonal area; two is not price promotion, but we have some ideas going forward in this period that are unique.

I think that when we look at our store operations and look at the trend over the last half a year, we are seeing some benefit of the attention we are paying in some of lower-performing stores.

So there are a myriad of contributors to get us to that forward-looking estimate.

Can you talk at all about, then, how the weeks panned out in November?

Did it start off weak and it is recovering?

And that is why you guys feel confident in a higher comp number going forward?

It is hard to look at that and say that, because of the timing day to day of when the government checks come out and so forth, as Jim was just relating.

But we don't really discuss weekly numbers.

But I will say this, that there is no trend in there, up or down, that would give you either discomfort or comfort in relating to December.

Just to piggyback on Meredith's question, just to understand the issue with respect to the shrink.

We should not be looking at that going forward as any sort of benefit that there might be in the fourth quarter, or anything that might make that gross margin comparison challenging.

Any backing into it, it helps you guys by about 50 basis (technical difficulty) quarter.

No material future impact.

Not one that, if I were sitting down estimating quarters, I would make any adjustment for.

On shrink, I don't think we've gotten an update on exactly what your shrink rate is right now.

I think you gave an update in the first quarter.

But any way we can get an understanding of where that is sitting right now?

I think we just provided that on the call, if you give me a second here.

Year-to-date, 3.1 percent.

Great, thank you.

Michael Baker with Deutsche Bank.

Given a lot of information on what we are expecting in the fourth quarter and then into next year, I'm just wondering if we can quantify that at all?

I guess specifically on the fourth quarter, you do have a guidance of EPS for the year up 15 to 20 percent.

Should we assume that that still stands?

Or with the overage today, do we expect that number might go up?

Similarly into 2004, I am wondering if you could discuss some of the cost of some of the consultants you are bringing in, et cetera; and then how this might impact your ability to grow earnings next year above your sales growth.

Maybe I will take a crack at the 2003 part and turn it over to David for 2004.

Other than the comment, gross margin, about the fourth quarter, I don't think we have any comment today about any further guidance on the fourth quarter.

What you should take away from that is more a company philosophy.

And what that represents is the fact that I know, even though it frustrates, we don't give quarterly (technical difficulty).

And if we were to provide additional guidance today on an annual basis, in effect we would be providing quarterly guidance. 2004, David?

Yes, I think the consulting project will be immaterial in terms of our ability to leverage the sales.

Do plan to leverage our sales growth next year, as we did this year.

We are in that mode right now where we are growing very rapidly.

But we also have opportunities and initiatives out there, as we discussed, that will help us leverage the earnings off that revenue growth.

So is there a long-term growth forecast or anything along those lines to look ahead to?

For next year?

Not one we are prepared to share just yet with you folks.

We do come out with that.

We talk about that when we come out next quarter.

When we do the annual review.

Thanks.

David Cumberland, Robert W. Baird.

One of your merchandising initiatives is to increase opportunistic buys.

Could you comment on availability of closeouts that you are finding as you ramp up your efforts there?

It is interesting, David.

When you look at the global supply chain for all products, it is an over (technical difficulty) marketplace.

Which means that a lot of factories out there are running below their breakeven capacity.

What they are doing is they are filling in that gap and selling things off at reduced prices.

Obviously, it is the old marginal income analysis routine.

We know a lot of products being sold out there.

We see some of it going to our competitors.

We are very closely with our vendors.

We have not been a very good source or outlet for them in the past, because of timing and so forth.

We are changing that right now.

But I have no concerns about the availability of product.

That is (technical difficulty)

On merchandising, if you could update us on your stores with coolers?

Including perhaps stores that have had coolers the longest?

Yes, I think Jim can give you that.

I will speak generally to it.

We know that the ring rate goes up from somewhere in an 8.50 range to the 13, 13.5 range in general.

We are also seeing that the majority of that differences is in non-cooler items.

In fact, there's only like 2 dollars and change of that difference is (technical difficulty) sale.

When we first started looking at this, we were worried about the margin impact and so forth.

We have been through that.

You can see what is going on with margin and so forth.

So as it blends into our overall strategy, it has been very accretive at this point.

We are excited about that going forward.

Our challenge is to begin to segment even the cooler strategy by type of store, whether it be (technical difficulty) store, small store, and so forth.

And then how we merchandise it to really hit the demographic segmentation that we are working on as well.

One follow-up on that.

On the stores that have had coolers the longest, are you seeing a greater penetration of transactions with a cooler item?

No, it is hard to say at this point.

The coolers have been out there a relatively short period of time.

There is a wide range of results.

I don't think we can say that at this point, David, to be responsible.

Thank you.

Michael Exstein with CSFB.

It is actually Christine Vang (ph) in for Michael Exstein.

We just had a quick question, going back to your comments on the fourth-quarter gross margins. (technical difficulty) if you were seeing any changes in the mix that was concerning you, versus last year, that might be reflected in the comments that you are having -- that it might be challenging in the fourth quarter?

Give me a second here.

I wouldn't say any sort of dramatic shift.

That would not be at the top of the list.

Okay, thank you.

John Harloe with Barrow, Hanley.

The way you all presented the data this time has got me a little bit confused.

I'm going to try to follow up on a question that was asked earlier.

It seems to me on this inventory adjustment that you really should take out the 7.8 million in this quarter, and that will make it simple.

And divide it by three and say each quarter ought to get that accrued across it, in order to see what the true margin trend is.

I realize you didn't add any value to get there; but you did earn the money.

We are just talking about accounting, aren't we?

I think I tried to say before that I think we look at this quarter, in measuring ourselves, without the $7.8 million.

I understand that, but if I'm looking at what is your trend in terms of your margin progress, I would take the 7.8 million out of this quarter.

Because there is a catch-up factor involved over the prior two quarters.

That's right.

It is further than that.

We agree with your statement.

It is further than the first two quarters of the year?

I know it is frustrating; but the nature of the adjustment is that it is shrink.

And it is basically truing up for the first time based upon using item level information in our system.

I think that is wonderful, and it is not frustrating if I know how to --

But the point is we can't reliably, in a manner that we would give to you folks for you folks to rely on, tell you precisely how to plot it out from a run rate standpoint.

Well, is the true-up portion of it a year-to-date measure?

Or does it go further back in time than just year to date?

It is likely that it goes back beyond farther than that.

Okay.

Tell me then, in the past you have given us what your shrink numbers have been by quarter.

The question would be, and I am not trying to get you precisely correct, but generally in the (technical difficulty).

I am in centerfield and there is something to the left and something to the right.

But what would -- if I could restate the shrinkage number by quarter, for this adjustment, so we had it all trued up, what would the trend look like?

Can't do that for you.

That is what I tried to say before.

How do you know if you're making progress on it or not?

I mean, you talk about 200 stores or whatever and that is a great example.

But it is the total that matters to shareholders.

Let me try and explain what I started to say before.

And that is that we quote the shrink number to you folks as a retail percentage in retail dollars.

Okay?

That has not changed.

The retail segment of our shrink has not changed; and you can continue to look at that versus prior periods, and you have got an apples-to-apples comparison.

What has changed has been the cost component of shrink.

So when I read out --

Good point.

I grasp your point.

What I read out during my transcript, the various shrink numbers this year, last year, they are being computed on an apples-to-apples basis.

Excellent.

Now, would you do me a favor and read what the shrink numbers are by quarter for this year and last?

I know you have given it in the past.

I just don't have it in front of me.

If you don't mind, can you follow up with Emma Jo Kauffman after the call, our IR person?

We will get that for you, John.

Thank you very much.

Patrick McKeever with SunTrust Robinson.

Sort of a follow-up on some of the cooler questioning from earlier.

That is, David, is what you are saying on the coolers, -- are you saying that they are accretive to operating profit?

Or they have been thus far?

And that is better than you may have expected originally?

I think on balance, in conjunction, it is hard to carve them out.

We do this; but what is important is the total merchandising effort in the stores that go along with the cooler program.

In other words, we have over 6,000 stores across a broad landscape, and 4,000 SKUs in the stores; so we are changing SKUs every quarter, in and out.

And along with that we have overlaid the cooler program.

So there are quite a few variables moving around in here.

We look at it overall, that the stores are moving in the right direction in terms of their operating margin and so forth.

We are not where we want to be.

I have said that before.

But this is not going to hold us back in terms of getting to where we want to be from an operating profit standpoint.

But if you isolate the stores that have coolers and compare them to those that do not, is it safe to say that the ones with coolers are, generally speaking, performing better than the ones without?

Yes, I think is safe.

Yes, I'm sorry.

I misunderstood the question, Patrick.

Yes, that is definitely a safe thing to say.

From both a sales standpoint and an operating profits standpoint?

Yes.

On the distribution and transportation efficiencies that you have seen, I know you're not giving too much away as far as forward guidance is concerned.

But could you at least tell us where the majority of those efficiencies are?

Is it in reduction of stem miles, or is it something else?

I think it is really outbound transportation is the biggest contributor, Patrick.

Outbound transportation from the DCs?

You have got that and the throughput efficiencies inside the DCs.

So those two components are the biggest contributors right now.

Excellent.

Thank you very much.

Mark Mandel with Blaylock and Partners.

In the past, merchandise resets and store resets have been very disruptive to the operation of the stores.

What assurances can you give us that as a result of the study about to be conducted by the consultants you have hired that we won't see any additional disruptions, as we go forward?

That is a very good question.

Let me clarify my earlier comment.

While we do anticipate some fixture modifications in the stores, but very minor.

We (technical difficulty) done that this year.

We have reset some stores and so forth.

But that is not really what will be involved in the consulting project.

The consulting project will be focused on two things, the work content in the stores and the workflow of material to the stores.

That's -- simply put it has strong boundaries on it, very concise objectives.

We know that material handling of our products to the stores can be improved dramatically, and that is where we are going to focus.

Thanks a lot and happy holidays.

Tom Hayes (ph) with (technical difficulty) Management.

Did you give an inventory turns number?

I guess a rolling twelve-month?

Yes, we did.

It was, give me a second here, 3.9 times this year versus 3.7 last year.

Okay.

Is that affected at all by the items you talked about previously, or not?

Mathematically it would be impacted by that $7.8 million adjustment.

Okay.

Thank you.

There are no further questions at this time.

Thank you, everyone.

We will look forward to talking to you next quarter and have a happy holiday.

Thank you.

Ladies and gentlemen, thank you for participating in today's teleconference.

You may all disconnect at this time.