達樂 (DG) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and 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. In addition to historical information, this conference call contains forward-looking information such as information regarding the Company's expectations for its 2004 net income, its 2004 and 2005 store growth targets, distribution centers, site selection, and project completion targets.

The timing and anticipated results of operating initiatives, including the implementation of EZstore and the possible expected impact on the fourth quarter of external economic factors. 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 the forward-looking statements are reasonable, however, any of these 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 differ 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 quarterly report on Form 10-Q and in their third quarter earnings press release issued today, all of which can be accessed from the Investing Section of the Company's Web site at www.dollargeneral.com.

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.

Beginning today's meeting is Dr. David Tehle, Executive Vice President and Chief Financial Officer. Sir, you may begin.

Thank you. I'm not a doctor, though, but good morning, everybody.

With me this morning are David Perdue, our Chairman and Chief Executive Officer, 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 and our plans for next year.

This morning we reported that net income for the third quarter of 2004 was $71.1 million or 22 cents per share, versus last year's net income of $77.9 million, or 23 cents per share. You should note that earnings last year were favorably impacted by a $7.8 million pretax non-recurring inventory adjustment that primarily represented a change in the Company's estimated provision for inventory shrinkage.

Sales during the third quarter of '04 increased 11.5% to 1.88 billion, versus 1.69 billion in the prior year. The sales increase was driven by a 16.2% increase in sales of highly consumables.

Our seasonal category increased 9%. Basic clothing increased 1.5%, and home products actually decreased 2.1%. We believe overall this shift is not a change in our merchandising model, it is simply a reflection of reduced discretionary spending of our consumer.

Total same store sales increased 3.4%. This comp increase was generally higher than others in our sector.

Our gross profit rate during the quarter was 29.5%, versus 30.7% in the prior year. That's a decrease of about 119 basis points. About half of the total decrease resulted from the change in sales mix during the quarter and higher transportation fuel costs.

In the current-year quarter, highly consumables, which have a lower than average gross margin rate, represented 66.6% of sales, compared to only 63.9% of sales in the third quarter of '03. Most of the remainder of the year-over-year gross margin decrease resulted from the $7.8 million non-recurring adjustment in the prior year that I discussed a few minutes earlier.

SG&A expenses in the third quarter of '04 were 440 million, versus 385.6 million in '03, an increase of 14%. As a percentage of sales, SG&A increased 54 basis points over the prior year to 23.4% versus 22.9%.

The increase in SG&A as a percent of sales was due principally to several factors: Increased occupancy cost, primarily rent and utilities; fees associated with increased customer usage of debit cards; increased costs of counting physical inventories in our stores; $4.5 million of additional sales and use tax accruals for certain jurisdictions; $3.1 million relating to the lease expiration and subsequent purchase of the Company plane; approximately $2.1 million of disaster losses, resulting primarily from hurricane damage; and increased professional fees associated with the Company's 2004 store work flow project, or EZstore as we call it.

Our operating profit margin rate for the quarter was 6.1% in the current year, compared to 7.8% last year.

Net interest expense was 6.4 million in the current-year quarter, versus 8 million in the third quarter of 2003. The reduction in interest expense in the current year was primarily due to interest capitalized and distribution center construction projects during the quarter.

The Company's effective tax rate was 33.9% in the quarter, versus 36.9% last year. Approximately 111 basis points of the tax rate decrease in the quarter is the result of the reinstatement of certain federal targeted jobs tax credits retroactive to December 31, 2003.

An additional 173 basis point decline in the tax rate resulted primarily from income tax accrual adjustments pertaining to fiscal 2003.

On a year-to-date basis, net income increased 6.1% to 210.3 million or 63 cents per share in the current year, as compared to net income in the prior year of 198.2 million or 59 cents per share.

Year-to-date sales in '04 were 5.46 billion, versus 4.91 billion in the prior year. That's an increase of 11.4%.

Same store sales increased by 3.2%. The year-to-date gross profit rate was 29.3% in '04, versus 29.4% in '03.

SG&A expenses were 1.27 billion in the current year-to-date period, versus 1.11 billion in the prior year, an increase of 14.6%. As a percentage of sales, SG&A increased 64 basis points to 23.2% in '04 from 22.5% in '03. Explanations for the year-to-date increases are essentially the same as the explanations for the third quarter.

Our operating profit margin rate was 6.2% for the year-to-date period, versus 6.9% last year. Net interest expense in the current year was 16.8 million after capitalizing 2.5 million primarily on DC construction, versus 25.3 million of interest expense last year.

The remaining decrease in interest resulted from lower deferred debt cost amortization in the prior year repurchase of outstanding notes related to the Company's South Boston distribution center.

The Company's 2004 year-to-date effective tax rate was 34.2%, as compared with 36.2% in 2003. In addition to the items that I discussed earlier, please remember we recorded a $6.2 million favorable tax adjustment in the second quarter of this year relating to tax accrual changes that we discussed on the last conference call.

During the quarter, the Company opened 215 Dollar General Stores, and four Dollar General Markets, and closed 41 stores. Year-to-date through the end of the third quarter, we had opened 633 Dollar General Stores, and six Dollar General Markets and closed 82 stores, 14 of which were the result of damage from an unusually difficult hurricane season this year.

As of the end of the quarter, we had a total of 7,257 stores, including eight Dollar General Markets. Year-to-date, we have spent $209.5 million on capital expenditures.

Our total inventory balance was 1.56 billion at October 29, an increase of approximately 13.5%, as compared against the same time last year with core items representing the major portion of the increase. Our rolling four quarter inventory turn was 3.9 times, versus 3.8 times a year ago.

Total balance sheet debt at October 29 was 335.9 million, versus 282 million at the end of the last fiscal year on January 30, 2004, and 285.7 million at the end of last year's third quarter.

Year-to-date shrink has decreased to 3.11%, down from the second quarter year-to-date rate of 3.18%. This 3.11% is essentially flat with last year's level of 3.10%.

Let me remind you, as we mentioned last quarter, although the Company performs physical inventory in all of our stores annually, the same stores are not necessarily counted in the same reporting period as they were the previous year. Therefore, the comparability of this year's shrink percentage versus last year's percentage could be impacted since many different stores may be in each sample.

As we approach year-end, the comparability of the results will improve. Year-to-date, shrink results at the stores have improved when compared to those same stores from last year.

During the quarter, we also repurchased 1.48 million shares of our common stock, substantially completing our existing 12 million share repurchase authorization. The board, at its meeting yesterday, approved the repurchase of an additional 10 million shares. This new authorization expires November 30, 2005.

I'd like to now turn the call over to David Perdue.

Good morning, everyone, and thank you, David.

First let me say that I'm personally not satisfied with our sales performance or our financial results for the quarter. I am pleased, however, with our same store sales performance in the quarter relative to our competitors, and especially considering the impact of the current economic environment on our core low-income consumer.

We believe high gasoline prices as well as high unemployment and heating fuel costs impacted our customers throughout the quarter. As David enumerated, we also had several unusual one-time expense items in the quarter.

I continue to be pleased with the progress we have made on executing our initiatives this year. Let me give you a brief update.

We said we would add coolers to 80% of our stores by the end of the year. At the end of the quarter, we had coolers installed in 6,525 stores, already exceeding our annual goal.

We added coolers to another 200 stores in the month of November. That brings us to over 90% of the chain for the year.

We said we would install equipment to accept EBT and would move as quickly as possible to get USDA approval to accept EBT in our stores. The equipment is installed in every store with 5,300 of these stores accepting EBT at the end of the quarter, and over 5,500 accepting EBT today. We're also using that equipment to accept debit cards and Discover in all of our stores.

We said we would open 675 traditional Dollar General Stores this year. Through the end of November, we have opened 703 traditional stores exceeding our target, and we expect to have opened 710 stores by the end of the year.

We continue to be very encouraged by the results of our Dollar General Market stores. We now have 10 market stores in operation and we expect to open five more DG Markets by the end of the year. We have signed leases for an additional eight markets, which we expect to open in early 2005.

We said we would improve our store operations. Our internal EZstore team, along with outside consultants, completed the development stage of the project four months ago, and we are moving forward with our EZstore initiatives.

As we've said, this project examined every aspect of operating our stores, including material handling, labor, and staffing, and basic operations.

Starting in the Southwest, we now have the major components of EZstore operational in 323 stores. We expect to complete this rollout by the end of 2006.

We said we would complete the implementation of automatic replenishment this year. As you know, we completed the implementation by the end of our first quarter, allowing us to improve our store in-stock levels of core merchandise. We have made store in-stocks a high priority this year.

We said we would continue to focus on shrink, and we have. Shrink at the store level continues to show improvement over last year.

We said we would improve the presentation of branded basic apparel in our stores. Early this year, we increased our selection of branded merchandise in the sock and underwear categories, adding additional SKUs of Hanes, Fruit of the Loom, and Jersee brands.

We had fixtures and signage to call out these brands. So far, this branding strategy seems to be working for us. While overall apparel sells have not been strong this year, sales of these items have been extremely good.

We also hired a general merchandise manager for apparel and home who is working diligently to improve these areas going forward.

Construction of our new distribution center in South Carolina is on schedule and is expected to open in mid to late 2005. We completed the upgrade of our South Boston distribution center on schedule, and the Ardmore distribution center expansion is also on schedule and expected to be complete in February of next year.

We said we would improve our hiring and training practices. We've done that, and we believe the continued decrease in store manager and district manager turnover rates reflect these efforts.

We've been very successful in our efforts to promote operations management from within the Company. This year we have 124 new district managers with nearly half of those being internal promotions.

Hopefully, you can appreciate my enthusiasm with these accomplishments despite the current economic environment.

Now, looking forward to the fourth quarter. We are better prepared for the holiday season than we were last year. Our in-stock levels of core merchandise are much better than last year and I think we have done a good job of flowing seasonal merchandise to the stores earlier than we did a year ago.

For the month of November, same store sales increased 3.4%.

Currently, we expect net income for the year to be between 341 million and 350 million, which puts us at the low end of our original earnings guidance for the year. But remember, there are still 24 shopping days until Christmas with the last two weeks typically being the highest volume weeks of the year.

Given the external environment, sales are very difficult to predict at this time.

The retail environment remains difficult and our core customers continue to be under a lot of financial pressure. We expect most of the external factors that affected us in the third quarter to linger into the fourth quarter.

Although we have seen a slight drop in the last three weeks, gas prices remain high, 31% above last year's level, and nearly 40% above two years ago. This not only affects our customers, but also our suppliers and our internal distribution costs as well.

Heating oil prices are higher now as well. November heating oil prices were 44% higher than last November, and 57% higher than two years ago.

Unemployment in the low-income segment also remains high. October was down a little from the month before but is still over 8% for workers with less than a high school education, many of whom are our customers.

We cannot control these external factors, so we remain focused on our core strategy of serving the underserved customer and executing every day.

We told you in our last call that we would give you some insight into 2005 today. We are still in the process of completing our 2005 operating plan, but would like to share a few major initiatives with you today.

Our plan is to open 700 Dollar General Stores and at least 30 Dollar General Markets in 2005. We currently expect to close 60 to 80 stores, but will continue our normal practice of reviewing potential closings.

To support store growth, we expect to have selected a site and begun work on an additional distribution center by the end of fiscal 2005, which we plan to open sometime in 2006.

Of course, our primary store initiatives center around the rollout of EZstore, which we expect to have completely rolled out by the end of 2006. We believe that successful implementation of this initiative is critical to achieving sector and industry-leading operating performance in our stores.

Our goal is to be the shopping destination of choice for our customers, and the employer choice for our employees. We think EZstore can help us get there. We will of course give you more details on 2005 at year-end.

Now we'd be happy to take your questions.

Thank you. If you would like to ask a question, please press the star key followed by the one key on your touch-tone phone. Again, star one if you would like to ask a question. Our first question comes from Daniel Berry, Merrill Lynch.

Good morning. Could you give a little more clarity into your fourth quarter forecast? You've come in a little short in previous quarters and you're now forecasting a very strong gain in the fourth quarter. Is there something that you see now in the fourth quarter that's going to benefit the fourth quarter that you didn't see in your original guidance at the beginning of the year? And then a follow-up would be, can you give us any kind of guidance on roughly how much the fourth quarter improvement will be in gross in SG&A?

Thank you, Daniel, this is David. We really can't comment on the last part of that and, no, we really don't see anything different in fourth quarter than we had when we laid the year out originally. Obviously, the economic environment still is difficult but we have a lot of initiatives that are gaining momentum right now and we expect their impact in Q4.

But, again, given that the environment is probably been a little worse than you thought and the earnings a little, probably sort of the low end of your expectations, is there anything that's offsetting that, are your initiatives coming in better than you thought?

Well, I think year-to-date, some of these initiatives are ahead of our earlier schedule, Dan, to be honest. On the other hand, I think some of the economic environment impacts have been greater than we saw maybe a year ago, although we were one of the early ones to call them out as we gave our guidance for the year. So on balance, we're still cautiously optimistic about fourth quarter, although as you know, we won't know until we get in the next couple of weeks.

We've updated our guidance this year to be in the lower end of our original guidance, and I think that reflects to some degree what you're talking about right now in terms of fourth quarter performance.

Great. Thanks.

Thanks, Danny.

Thank you. Our next question comes from Dan, is it Wewer.

Wewer.

Thank you, from CIBC World Markets.

I just want to dive into the shrink issue just a bit further. I understand that when you are inventorying the same store this year compared to last year, the shrink results are improving. But I was under the impression that you did not cycle inventories during the fourth quarter. Therefore, we would be comparable by the end of the 3Q on the year-to-date shrink figures and yet it sounds like that's not the case.

Dan, this is Perdue again. We do have some inventories in January schedule, we do have a moratorium as we go into Christmas, but we have some inventory schedule in January, as a matter of fact.

What you're seeing right now is there's still a discrepancy to the total year, or a shortfall, I should say, with regard to the actual, we do the inventory and then we rationalize those inventories and so forth, and so there is a lag there between the reported number and the actual inventories that have been taken. So we're right in that period of time right now. We will sync up by the end of the year, but we're not totally synced as we speak today.

It sounds like you have a reasonable number of stores with low shrink rates that you haven't yet taken cycle inventories, and when those are completed, then we could see the shrink accrual decline.

Well, it's not so much, Dan, and this is very technical. It's not so much that we have future stores with lower than currently reported numbers, although that could have an impact, it's really their relative difference to last year. And what we're seeing in the stores that we've looked at and we know what those inventories are at the store level on an apples-to-apples basis, what I can tell you is that we are pleased when we do it on that basis. Of course, when we report, we're reporting the actual inventories that have been consolidated at that point.

And, you know, with this, you know, favorable earnings outlook here for the fourth quarter, are we expecting the shrink accrual, is that one of the reasons why the fourth quarter earnings remain?

I really, you know, past what I've said, Dan, I really can't look, give you any forward-looking guidance on that. I will say, again, that when I look at what has been inventoried today, we are very pleased with the changes in shrink at the store level.

Okay. And just one real quick question. Different topic, on the Market Stores. Do you have any estimate on the number of existing DG stores that could be suitable for a market conversion?

That's a great question, Dan, I wish I had the answer for you. We have done a lot of work on that in certain areas, and next year, as we've just laid out, we plan to open 30 Dollar General Markets. I would say that, you know, order of magnitude, more than half of those could be conversions, if you will, from an existing traditional store location.

So an 8,000 square-foot store or a 10,000 square-foot store could work as a market?

No. What we would do is we would either enlarge that store or relocate that store, and that's predominantly what happens.

We do have, however, some 10,000-foot stores that we are in the process of converting to a type of presentation similar to a DG Market, but we don't have the full offering of products, so I wouldn't classify them in this category, but clearly we plan to take advantage of some potential conversion opportunities as we open more Dollar General Markets.

Great. Thank you and good luck.

Thanks, Dan.

Thank you. Our next question comes from Meredith Adler, Lehman Brothers.

Yeah. Hi, guys.

Good morning, Meredith.

My first question is that several people have asked you why you're looking for the fourth quarter to be so strong but you never guided quarters, so I'm just wondering how the results we saw in this quarter compared to your own internal expectations for the third quarter? I know you never gave guidance, but just, we saw it as a miss, but maybe it wasn't as much of a miss the way you had looked at how the quarter's played out.

Well, Meredith, this is Perdue. That's a great call-out. I can't really comment on the quarterly expectations that we have. Let me just suffice it to say that, you know, as we change our guidance for the year to the lower end of our range, that reflects our outlook knowing what we know today, and comparing that to what we plan for the year, that is reflected in that guidance change.

Okay. Another question I have for you is, just maybe you could talk as you started talking about the Dollar General Market, could you talk a little bit more about what you're seeing especially in terms of the return on invested capital, whether you've played around with the cost to build those stores? I think coolers are a big piece of that cost and maybe just discuss, you know, how you're feeling about it at this point in time?

Thank you, Meredith. That's a very good question. We, as you know, when we open these, we only opened two last year primarily because of that issue. The capital, and we called that out last fall in our analyst meeting here, that the capital required to open a Dollar General Market last year was considerably higher than a comparable number would be for a comparable number of traditional stores. That has changed this year.

We have made dramatic improvements in negotiating reductions in cost, we've reconfigured some of the things that we're doing in the store, and yet the results are actually better in these stores we've opened this year in relation to that capital cost. So the relationship between capital requirement going in and early operating results is much better this year.

We're getting leverage to some degree compared to our traditional stores, although it's very early, and we're still not satisfied that we've hit steady state on the opening cost of these stores, it's much different today than it was a year ago and I project it'll be, it could be a little different a year from now, as we open these 30 new stores next year.

And any thoughts about how you distribute to those stores?

Well, we still have a third-party direct distributor servicing some of our consumable items, some of our produce items, and some of our cooler items. Remember that 85% of the food SKUs in a Dollar General Market are the same SKUs in our traditional stores, so primarily we've added cooler items and fresh produce.

Having said that, the other distribution efforts for the Dollar General Markets come out of our distribution centers, and we have some procedures relating to the Dollar General Market that vary from our traditional stores. I'd rather not get into details of that, but suffice it to say that we're getting some productivity improvements by the way we're doing that.

Okay. I just have one more question. If we, you did put some cautious comments in when you gave the lowered your guidance you said, well, it could be even worse. What specifically would you worry about? Absolute levels of sales or markdowns or mix?

Well, I think right now what's happening is our consumers spending on discretionary items, Meredith, if you look at third quarter particularly, has declined. We haven't changed our mix and our model very much at all this year, and yet you can see that our consumable number has grown dramatically differently than our discretionary, more discretionary items. So that concerns us right now. I think that's the one variable that I'm most concerned about going in the fourth quarter.

The markdown picture, our inventory right now is fairly balanced. Our growth in inventory is focused mainly on core items, and I'm very pleased with that. To some degree, that's a derivative of our auto replenishment effectiveness this year compared to last year. And I think, you know, when you look at our turn number, our inventory balance right now is okay.

Now, having said that, we plan to take a good hard look at inventories next year. We are looking at EZstore and one of the things that we hope to do in an adjunct, as an adjunct to that will be to look at our inventory levels and so forth, but I'm fairly pleased with how we're positioned going in the fourth quarter from the inventory standpoint.

Great. Thank you very much.

Thanks, Meredith.

Thank you. Our next question comes from Mark Miller, William Blair.

Hi, good morning.

Hi, Mark.

Hi. You've had an adverse mix shift through most of this year and I understand it was a little bit more acute in the third quarter, but the Company's had good success offsetting a lot of that through higher markup, and I guess I'm curious to know, has something changed in that respect? I mean, you were able to drive down your costs across all the product categories, so has a lot of that low-hanging fruit been already picked, or do you expect to be able to resume that going forward?

That's a good catch, Mark. You know, in Q2 someone asked the question about that very point, that, you know, the mix was moving more toward the consumable area which in history had had lower margins and yet the margin was hanging in there. I think in this quarter we just probably had a little more of a severe shortfall on some of these discretionary items in some of the higher margin categories.

Our basic model is still the same, though. Our planograms this year haven't changed from our original planogram change for the year, and this continues to be something we look at as we add coolers and so forth we have worked hard in the other areas of our business to make sure that that balance is found.

Now, there are going to be temporary displacements quarter-to-quarter as that mix changes, obviously, but over the long-term, we're satisfied that we can continue to focus on that. Now, I think that as you add the cooler items, obviously it puts more pressure on that. But we're working hard to compensate for that.

Then with the rollout of EZstore, what have you learned so far in the implementation, what's gone better, what's been more challenging? And then the cost to implement that, how much of that is start-up versus recurring and when do you think you get to breakeven as you put that in the store?

I, Mark, I'm going to be a little vague on answering that because a lot of that is forward-looking. I can answer, we've been very pleased with the receptiveness of our store personnel. They have had to go through a good bit of change in how they handle merchandise. We've gone through our distribution centers and they have handled this very well in Ardmore, which is the distribution center that has been converted out in the Southwest.

I think the thing that is a little concerting to me that we're working on is the nature of inventory in the stores. It's not as consistent as I would want it to be from what is displayed in the store and what's in the back room.

As you might imagine, in this process change that we are undertaking, we're changing the way we are flowing material to the stores. That means that there's a transition from the old system to the new system and the store is going to have inventory in the store that came in under the old system and inventory in the store that came in in the new system, and that transition we've had to pay some attention to. After we get through that in the stores that have completed that, we're extremely happy with what we're finding.

In terms of the expenses, I would say the outside consulting expenses are a one one-time issue. There will be some capital expense over the next two years and we'll lay some of that out for you as we close the year and give guidance for next year.

But the return on this investment is extremely good. I can't quantify that for you, but obviously we would not have made this kind of commitment without it.

Let me just say this. As we looked at our business, we saw that store operations was one area where we could differentiate and we've invested there this year.

Our SG&A has grown accordingly, frankly. We took more inventories this year, we invested in consulting, but we plan to leverage SG&A going forward and part of that is getting more productivity from these stores.

That's helpful, David. One last question, then. As you're looking at that inventory, you know, last year in the fourth quarter in advance of the EZstore project, you had some higher promotional markdowns to try to clean up the back rooms, and understanding the comparison, be helpful to know what type of magnitude that was on last year's results. But then also as you're looking at the inventory in '05, you alluded to earlier, I mean when do you want to address some of these issues in terms of what you see in the back rooms versus what's on the floor? Thanks.

Thanks, Mark. Well, relative to our history, you know, our back room, while they're messy, if you've been in any of our back rooms you know that they're not large and we have a lot of inventory in these stores right now because auto replenishment has pushed a lot of inventory automatically out of our distribution centers into the stores, so you're looking at a period of time when inventory at the store level has actually increased. We think that will level off over the next six months to a year.

With regard to markdown and the implication there and I don't see any irrational change, let me say, from what we've done in the past. I mean, obviously we get in into January and we see opportunities, we'll clean up a few things that need to be cleaned up.

As you know, we are moving in a transition manner to cleaning up more of this seasonal merchandise as we go. Now, we come out of a pack and hold strategy, you move into this cleanup strategy, it takes a while and there are transitions in place. We are working hard right now on creative ways to get there quicker. Let me just say that.

This is certainly something we're committed to, it is something that is going to be in our future, and the transition will be a couple years, frankly, as we manage our way through that. But I don't see anything out of the ordinary coming at us from that standpoint.

And last year's promotional markdowns?

In relation to what we expect this year?

Yes.

I really can't comment on what we're going to do in fourth quarter other than what I just said, Mark, I'm sorry.

Okay. Thank you. Our next question comes from Sherri Eberts, J.P. Morgan.

Good morning, everybody. You mentioned that the EBT is now being accepted in over 5,000 stores and I was just wondering any other color you could provide in terms of what the response has been, what the sales boost has been, just any color that you can provide on those stores?

Well, I would say at this point the impact on our results is not material. I would say that it's so early that many of our customers aren't even aware that we have it yet. And we know that the ultimate potential is much larger than what we're realizing today.

We have just opened many of these stores, as you know it's been an exponential curve over the last nine months. We are pleased with the emotionalism in our stores that this is something that our customers need. Our employees are happy that we have it, our customers are commenting on it, those that know we have it.

We have signage in our stores but as you know, the frequency of visit here is relatively low compared to other models. In some respect, that's a good thing. Here's one where it may not be good and so we are talking about ways that we can communicate this so that we can climb the hill a little bit faster.

But I would say right now the early indications are very positive from our customers and our employees in the stores about this service, as well as Discover. We've been very pleased with the response to having Discover in the stores and we think that both of those are going to be positive impacts for us going forward.

Okay. And then another question, just on the COO position, I was wondering if you could give us an update on filling that role?

Yes. You know, Larch is a friend of mine, we were sorry to see him go, he made a career decision and he's gone. We're moving forward. We will have a search outstanding. We will have internal candidates as well as external candidates and I will keep you guys apprised of that as we go through the first few months of next year, but we are moving on that as we speak.

Okay. And then the last question just on the SG&A. I think it was very well controlled in the quarter, especially given the number of one-time items that you had in there, and you mentioned that you planned to leverage it going forward. But I didn't know if you could give us any more sense of timing on that in terms of when the consulting fees roll off or when you would expect to see some leverage?

We have spent the majority of our planned spending on outside consulting as it relates to EZstore. That's a safe thing to say.

I would offer this, that I'm personally not satisfied, I appreciate your comment on the SG&A, but I can offer to you that I'm not that satisfied with our SG&A leverage in the quarter. Even with the one-off investments that we had in the quarter we know that with productivity in the stores, our revenue line can move and that will absorb that on a rate basis.

On a real dollar basis, we will probably not spend as much on inventories going forward. This was a year that we wanted to test and make sure that what we were doing in the stores was okay. We are satisfied with that now.

Our consulting expense, as I said the majority of it is past us. We have Cap Ex coming in front of us a little bit with regard to EZstore and we'll talk about that more as we lay next year out. But all in all, yes, the SG&A is a line that as we grow our revenue we can get leverage.

Let me just give you a highlight that I'm pleased with. We are leveraging our labor today, this year. And I can't embellish on that, but I can tell you that at the store level and corporately, we are leveraging salary expense and peripherals today.

Great. Thank you. Good luck for the holiday.

Thanks, Sherri.

Thank you. Our next question comes from Patrick McKeever, SunTrust Robinson.

Okay. Thank you. David, another couple things that you talked about last year at your analyst meeting were increasing the number of closeout buys that you make and building a dedicated closeout team, and also increasing the number of direct imports that you do. I was just wondering if you might talk about those two items and how they've panned out throughout the year, the plans to build up in those areas and if that had any material effect on your margins in the quarter and what the outlook might be for the fourth quarter where those things might be a little more important?

That's a great call-out, Patrick. This is David Perdue.

What I'm pleased with and what I'm not pleased. Let me give you the one I'm not pleased with first. While we have dedicated a team to our off-price purchase or what we call opportunistic purchases, I'm not pleased with the impact on that on the business yet. It's still early but my expectations candidly were higher and they did not impact us very dramatically in the third quarter as we go forward. I expect that to have a [inaudible] if you will to some of the consumable growth that we expect in the mix.

With regard to our sourcing, I am very pleased with what's going on in that area. We have opened our office, as you know, in the early part of '04 in Hong Kong. We have changed to some degree how we're purchasing over there, we're getting a little bit better pricing, and we were able to ameliorate the potential price increases that were coming over there because we were there personally, we were dealing with people face to face. So that has helped us a little bit this year, although, the percentage of our product that is being sourced has not yet grown that dramatically.

As you might imagine, it takes, there's a lead time that's associated with that. So the first thing we had to have in Hong Kong was operational effectiveness. We have that now. We have some great people there, young people leading that, they're excited and energetic. Our vendors are responding positively. What we have not done yet is grown that very dramatically. And we expect that to, we, I frankly expect to see some of that over the next year or two.

And then just a quick second question. You've given out the average ticket with cooler items at a store that has a refrigerator. Can you update that?

Yeah, David, do we have that actual?

Yeah.

It's about --

The average ticket per cooler sales $13.62.

Okay. Let me qualify that just a bit. That 13.62 is on transactions that have a cooler item.

Right.

It may not be the average for the entire store over a period of, you know, period of time.

And how does that compare to earlier in the year, last year?

It's up a little bit but not materially. As I said, I think the EBT numbers will impact that going forward, but it's so early yet that we don't see much change in that yet.

Okay. Thanks a lot.

Thanks.

Thank you. Our next question comes from Christine Augustine, Bear Stearns.

Thank you. Can you tell us what tax rate we should use for 4Q? Can you tell us what the best selling cooler items are? And, is there an update on the Cap Ex spend? I believe it was going to be around 300 million, so I'm just wondering if you'll come in a little bit short of that given where you are year-to-date? Thank you.

Thanks, Christine. I can comment year-to-date on Cap Ex and you can probably extrapolate on that that we will probably, you know, year-to-date we are a little bit under our Cap Ex plan.

With regard to the cooler items, you know, milk obviously continues to be a big hit but also some of our cooler sandwich items, sandwich meats and so forth are doing very well.

With regard to the tax in Q4, I don't think we can offer that, given that it's forward-looking. I apologize, Christine.

Well, let me just ask it another way, then. Given the retroactive effect in the third quarter, the catchup, I guess, will it, I mean is it safe to say it'll be kind of comparable, then, to the year-ago or --

Yeah, let me jump in here for a second, it's David Tehle. In our last release we mentioned that the tax rate was 37.3% for the remainder of the year without that 50 basis point change in the job tax credit, and I think if you put those numbers together you could get an approximate tax rate.

Okay. That's helpful. Thanks very much. And then just my final question. It looks like the EBT rollout is actually a little bit faster than we thought it would be, so do you think you'll be kind of aligned by the end of this year, or maybe by sometime in the first quarter, meaning, you know, the same percentage of stores will have EBT technology or the approval that will have the coolers?

Oh, I see what you're saying, yes.

Yeah.

There are a few cooler stores that are not EBT approved to date, that's true. And the answer is yes, that we expect very shortly to have those approved and operating on EBT, absolutely.

Thank you very much.

Thank you, Christine.

Thank you. Our next question comes from Ed Roesch from Banc of America.

Yes, it's Ed Roesch. Hi.

Good morning, Ed.

Good morning. Could we get a preview of what might be on tap for '05 just in terms of the opportunities that you still see in the business?

Yeah. I'd be happy to, Ed. I wish we had a couple hours and maybe over the next couple months we can do this more directly.

We are in the process right now of finishing our operating plan for '05. I will tell you that the initiatives, the major initiatives that we started this year and some last year, some of those will be ongoing. Let me give you a few.

Obviously, EZstore, I won't belabor that, we've talked enough about that. But I think that when you look at our large store, another call-out is that I'm not happy with is our large-store initiative that we laid in last year. We have tested in the large, or changing the mix in a couple of our large stores and, you know, the results are a little bit mixed on that and we have not rolled that out to the rest of our large stores. So that remains a growing initiative for us and, growing in importance and I see that being, we'll work hard on that in '05.

The other thing I think is inventories will become more of an issue in '05 as well as we finish '04. As I've said, I think our inventories are fairly balanced, but I'm still not happy with our planning system, how we do that overall, our forecasting can be better, and so we're going to look at that and work hard in those areas. I'm not sure that we will invest in '05 in system development and so forth, but there are things that we can do in planning and inventory control that we will raise as a priority.

Past that, this turnover rate in our stores continues to be something that we focus on along with shrink. I have not backed off any at all on my shrink expectations of the business, I still think that we should get in the area of 2.5% as a Company in terms of reported shrink.

Now, you understand how accruals are reversed and all of the complicated calculations that go into that number, but what I've seen so far from our operation group tells me that we are headed in the right direction. A good many of our stores are already there, and by that I mean a very large number of our stores are already there.

Shrink and turnover is a problem in fewer and fewer stores. We have fewer stores this year with shrink over 5% than we had last year. And that's always a good indication.

Our turnover rate is also coming down and what's happening is, we are seeing some effectiveness being derived out of the training now for the first time. In other words, the store managers coming into a store, having been trained, are now performing at the level that we would have expected compared to those store operators that were running stores two years ago or a year ago that had not been trained. So those are some of the highline initiatives and thoughts in our minds as we are putting together our plans for '05.

Appreciate that. And one follow-up, I'm not sure if you can help us or not. But in case the conversion of the standard source at DG Markets becomes more significant down the road, can you help us with what that does to the top line when you make that conversion?

Yeah. That's a great question. I can only tell you that obviously you have a closing, you know, you have an existing traditional store that is at some level and that goes away. The Dollar General Market comes in and so you net out that closing revenue, or closed revenue, obviously, so you lose that off the top line.

But let me just say this. Most of the stores, the DG Market that we have up-to-date, I think all but one or two, have been relocations of an existing store, and so we know what those numbers look like and we're very pleased with what we're seeing.

To help you model that, I'd have to give you what the DG Markets are doing, you know, in revenue per store and there's still noise around that. I don't want to mislead you. So I think what we'll do is look at fourth quarter again.

I was hoping to look at several months next year while we have six, eight, ten of these operating for a while, before we go public with maybe what they're doing per store. All right. Thank you. Thanks, Ed.

Thank you. Our next question comes from Michael Baker, Deutsche Banc.

Hi, thanks. Just a real quick question. Can you discuss throughout November the pace of business? In other words, did you see the big drop-off later in the month that Wal-Mart saw and I think your month cut-off right at I think the end of Black Friday?

Yes, it did. Michael, yes, I'll comment on that. This is Perdue.

Friday was a miserable day for us but, you know, our business, and frankly we did see a drop-off in the fourth week. But I will comment that we have seen that for the last four to six months, honestly, Michael, and it's a reflection of what I've been talking about since December last year, and that is, our core low-end consumer's under stress right now and all our numbers in this sector reflect that. That's not new news to anyone. But what is manifested is this fourth-week phenomenon so far this year.

I will say that having said that, the Friday sales, while disappointing to us, we don't look for, Friday's not the biggest day of the year necessarily for us like it is some other retailers. We don't promote, we have everyday low pricing and our model is a little bit, it's able to weather downturns a little bit better than some other models. On the other hand, in really boom times we don't necessarily, we are not necessarily afforded all the benefit of a great upside either.

So having said that, that gives us some comfort as we look at the holiday season in terms of, you know, the guidance that we're giving and so forth. But in November, no question, we were hit very much like Wal-Mart was in the last few days of the month.

And so when you're referring to that typical drop-off over the last few months that's due to the payroll cycles?

Yeah, it is. Payroll, the government cycles, et cetera, et cetera.

Okay. Thank you.

Thanks, Michael.

Thank you. Our next question is from Michael Exstein, Credit Suisse First Boston.

Hi, good morning, everyone. Good morning. Just very quickly. When you listed off the things that impacted SG&A, was that in magnitude, order of magnitude, number one. And, number two, can you give us some detail, exactly, what the fuel issue, how significant that was as you included that in, on those breakouts? Thanks.

Thanks, Michael. On the second part of that, the gas price, obviously, hit our transportation costs. I can't quantify that for you, but this is the second or third quarter that we've called that out as being an item that is of concern.

We're managing it, obviously, we look at our network miles, we look at how we load trailers, we look at our utilization rates and so forth. So our transportation group is working diligently to offset that but there's just no way necessarily to get utilization high enough to offset a 30 to 40% increase in fuel.

With regards to the first question, could you elaborate just a little bit more on that so I'm clear?

When you listed the things that impacted SG&A in the quarter.

Right.

Were those and order of magnitude?

Oh, no, no, no. Okay.

I'm sorry, I didn't understand that.

They were not necessarily in order of magnitude.

They're all significant items.

Okay. Thanks.

Thank you, Mike.

Our next question comes from Wayne Hood, Prudential Financial.

Yeah, David. I just had a couple or three areas. Just coming back to this mix issue we're all kind of hammering away here at. The guidance you had given for the full year would imply some improvement in the mix in the fourth quarter relative to that third quarter trend and I'm just wondering, I think we all are, what do you expect, like over the next 30 to 60 days, to change in trend, the low end still does is doing [quarterly]. It seems like they're still going to buy the consumable side of it. And do you think you're relevant to that group during Christmas as a gift-giving kind of, you know, destination point. So I'm just curious, what are you, what causes you to believe you're going to see a shift in trend relative to what's gone on?

I'm not sure our guidance implies a shift in trend, Wayne. This is David, good morning. It's a great question and one that's certainly appropriate.

I think what we are seeing is that I think we are relevant in the holiday season. We see our seasonal business, our holiday business, and even our apparel business has always been strong as we go in the holiday season. So that I don't think is going to change. It's a relative difference between those categories and some of the consumable items.

What we saw last year, as a matter of fact, you know, actually went the other way for a little while and that is that maybe they delayed consumable items to fund a seasonal item. So I don't know how to predict that, I'm just saying that, you know, the lowering of the, or tightening of the reins to the lower half of our original guidance, I think reflects the concern that we have over the environment.

David, the second question I had relates to the EZstore initiative and flowing goods specifically, because it looks like the store still struggled, you know, when they're transitioning in and out of seasonal, it looks like they're still struggling with those trailers being there, hitting those delivery windows, and making sure they've got the rate right payroll. So if you could talk a little bit how, to me anyway, how that EZstore eliminates that issue and, you know, how do you plan to replenish? Is it going to be more during the day, at night, and how that impacts payroll hours as it relates to EZstore versus the rest of the chain?

Yeah, that's a great call-out. Anybody that's doing the volume we do per store and the tonnage we do per store has a problem when you transition into a seasonal year. We've called that out before and that's happened.

What we did last year for the first time is we float it, we scheduled it, and tried to smooth that out. This year we'll do the same thing.

The big thing that EZstore will do is it changes the material handling process and reduces the labor required to unload a trailer. I won't go into any more detail than that. It also reduces potentially for some stores the time of day in which that trailer is unloaded.

So without going into further detail, EZstore will materially impact the seasonal transition. There's no, I mean it already is. But it will have even more as we roll it out to the rest of the chain.

Why not give more detail, David, I mean if it's something you feel comfortable with?

I feel very comfortable with it Wayne, but it's a competitive issue right now and I'm just not ready to go public with everything that we're doing.

And then my next question I guess relates to margin over time. Is the model changing such that the margin will continue to decline given all the things that you've got going on, but the inventory levels will come down so the return on invested capital remain high, but we can expect to see continued pressure on operating margins due to the things that have been talked about today?

Yeah, I think most of that's fair, Wayne. I think in developing a model what we're looking at is we've told everyone what we're doing on EBT and cooler items, and we know the margins on those relative to the rest of the business.

What we haven't disclosed is what we're doing in the other parts of the business to try to offset that going forward. There are obviously, there will be bits and starts quarter-to-quarter as we go forward in that, I think you see a little of that in Q3, frankly.

Having said that, we are going to work hard on our inventories going forward, our turns. I'm not unhappy with our turn performance so far this year given we haven't made a big effort toward our planning season, our planning system and our forecasting effort.

But clearly you called out the two things that are top of mind as we go over the next two years really is, you know, to fight the pressures on margin, which is a very obvious. And then the second is, we have not called out in the past an interest really in trying to be more buttoned up on our inventory control, but I'm now calling that out as we go forward as in '05 area of concern.

All right. Thank you, David.

Thanks, Wayne.

Operator, we'll take one more question and then that will end the call.

Okay. Just a moment. Our next question, last question comes from David Cumberland, Robert Baird.

Hi, good morning.

Good morning, David.

On the 2004 net income guidance, does that include the favorable adjustment of 7.4 million in Q2? There may be some confusion on what your guidance means for Q4 because our estimates and the First Call estimates exclude that adjustment.

Thank you, David, this is Perdue. Our guidance all along has been excluding restatement-related items. It's been GAAP to GAAP, last year to this year. So when we had 10% to 14% was our original guidance and now we're using dollars in here to help try to alleviate that confusion but it's GAAP to GAAP.

Right. But I'm referring to in this Q2 the 7.4 million favorable adjustment was mostly related to the tax rate and wondering if, you know, your full-year '04 guidance includes that adjustment?

Yes, it does. It's GAAP earnings. If it wasn't, we would have had to have put a table in there reconciling the number as a non-GAAP measure. So it's a GAAP measure to a GAAP measure.

Great. And then maybe I missed this in the release, but I think in past releases you'd given an ROIC number, do you have that?

I don't think we, we don't have that this quarter, we'll have one at the end of the year, David. I apologize.

Okay. Great. Thank you.

Thank you very much. Good morning.

Thank you, everybody.

That concludes today's presentation.