達樂 (DG) 2004 Q4 法說會逐字稿

Good morning, ladies and gentlemen.

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

The call is being recorded by Conference America and CCBN.

Federal law dictates no other individual or entity may 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 the conference call will contain forward-looking information, such as statements regarding the Company's 2005 financial outlook, including, without limitation, annual and first quarter earnings per share, growth targets, capital expenditures, and key plans and operating initiatives.

The words believe, anticipate, project, plan, schedule, 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 the assumptions could be inaccurate, and therefore, actual results may differ materially from those projected in or implied by the forward-looking statements.

The factors may vary -- 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, earnings press release issued today, and factors discussed in today's call.

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

Except as many as -- except as may be required by law, the Company disclaims any obligation to publicly update or revise any forward-looking statements to reflect events or circumstances occurring during 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 disclosure 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 2003 fourth quarter and annual net income, diluted earnings per share, operating profit margin, return on assets, and return on invested capital, each of which excludes the restatement related penalty.

The Company believes that this information is useful to investors as it indicates more clearly the Company's comparative year-to-year operating results.

Management may also use the 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 measure.

Management believes that return on invested capital provides investors with additional useful information for 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 fourth quarter earnings press release issued today, which can be accessed at www.dollargeneral.com by clicking on the home page spotlight item.

Beginning today's meeting with Mr. David Tehle, Executive Vice President and Chief Financial Officer.

Sir, you may begin.

Thank you, operator.

And good morning, everyone.

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 fourth quarter and fiscal 2004 results and then David will have some comments on our operations and plans for next year.

Net income for the fourth quarter of 2004 was $133.9 million or $0.41 per share, compared to net income in the prior year of $102.3 million or $0.30 per share.

The '03 results include a $10 million proposed settlement with the SEC, which we have discussed previously.

Excluding this $10 million from last year, net income for the quarter increased by 19 percent from the prior year and earnings per share increased by 24 percent.

Sales during the fourth quarter of '04 were 2.2 billion versus 1.97 billion in the prior year, that's an increase of 11.7 percent.

Same-store sales increased by 3 percent.

The gross profit rate during the quarter was 30.0 percent versus 29.3 percent in the prior year, an increase of 71 basis points.

The increase in the gross margin rate is the result of the following -- First, our purchase mark-up was higher in the fourth quarter this year as compared to the fourth quarter last year.

Secondly, we took fewer promotional markdowns in this year's fourth quarter to clear out Christmas merchandise.

As you might expect, higher fuel costs negatively impacted gross margin in the quarter.

Our shrink rate calculated at retail was basically flat year-over-year, although at the operating level, we showed improvement.

SG&A expenses in the fourth quarter of '04 were 439.6 million or 20 percent of sales versus 392.2 million or 19.9 percent of sales in the prior year an increase of 12.1 percent.

On the positive side, we had leverage on store labor expenses, which partially offset increased rental expense, debit card fees, and higher -- higher worker's comp and other insurance costs in the quarter.

You might note we have broken out interest income and interest expense this quarter.

Total interest expense was $7.2 million in the fourth quarter of '04 versus 8.2 million in '03.

The Company's effective tax rate in the quarter was 37.7 percent this year versus 39.1 percent last year.

Last year's rate, of course, was impacted by the $10 million proposed non-deductible settlement with the SEC.

For the full fiscal year 2004, net income increased 15 percent to $344.2 million, and earnings per share increased 17 percent to $1.04 per share, over net income in the prior year of 300.5 million or $0.89 per share.

Excluding the $10 million from last year, net income increased 11 percent and earnings per share increased 13 percent.

Sales in 2004 were 7.66 billion versus 6.87 billion in the prior year, an increase of 11.5 percent.

Same-store sales increased by 3.2 percent.

Sales in our 4 major categories increased in '04 as follows-- Highly consumables plus 14.7 percent; seasonal, plus 9.3 percent; basic clothing, plus 6.8 percent; and home products, plus 2.2 percent.

The gross profit rate in '04 was 29.5 percent versus 29.4 percent in '03.

Gross margin pressures from the higher mix of highly consumables and higher fuel costs were more than offset by our ability to improve purchase mark-ups in the year.

SG&A expenses were 1.71 billion or 22.3 percent of sales in the current year versus 1.5 billion or 21.8 percent of sales in the prior year, an increase of 14 percent.

The increase in SG&A expense, as a percentage of sales in '04 was due to a number of factors, most of which we discussed earlier in the year.

These include store occupancy costs, including rent and utilities, debit card fees, professional fees related to the EZstore project, as well as the Sarbanes-Oxley compliance, and the cost of taking physical inventories.

Interest expense for the current year was 28.8 million versus 35.6 million last year.

The reduction in interest expense was due principally to the capitalization of interest on construction during the year and reduction of debt cost amortization related to our revolving credit facility.

The Company's 2004 effective tax rate was 35.6 percent versus 37.3 percent in 2003.

Remember, the 2003 rate was impacted by the non-deductible SEC penalty.

The 2004 rate is lower than our expected ongoing tax rate of approximately 36.8 percent, primarily due to some state tax reserve adjustments made mostly in the second quarter of the year.

Our total inventory balance of 1.38 billion at January 28, 2005 is an increase of 19 percent over last year's level.

Inventory turns remain consistent with last year at about 4.

Most of the increase in our inventories resulted from Company initiatives during the year, with the largest portion of the increase resulting from our focus on improving in-stock levels of core merchandise at all the stores.

New initiatives, including the the expansion of the perishable program, the addition of certain core apparel items, magazines, and Hispanic food items also contributed to the inventory increase.

In addition, the Company received more seasonal merchandise for spring 2005 before the end of fiscal 2004 due to an early Easter this year.

We are not satisfied with the increase in our inventories, and in 2005, we plan to focus on lowering our per store inventory levels.

Cash capital expenditures in 2004 were 282.1 million compared to 139.2 million in 2003.

During the year, the Company opened 722 new stores including 13 DG Markets.

The Company also added additional apparel fixtures to most stores and installed refrigerated coolers to an additional 3,670 existing stores.

In addition, we completed most of the construction of our new distribution center in Jonesville, South Carolina, expected to open in June.

We expanded our South Boston, Virginia distribution center and substantially completed the expansion of our Ardmore, Oklahoma DC.

In 2004 we repurchased approximately 11 million shares of our common stock, at a total cost of $209.3 million.

Of the total repurchases in the year, 10.5 million shares were under our earlier 12 million share authorization and the remaining half million shares were purchased under the new 10 million share authorization that expires in November 2005.

Just briefly, I would like to comment on the impact of the lease accounting change we recently announced.

As most of you know, in February, the Chief Accountant of the SEC issued a clarification of accounting for various lease-related matters.

After reviewing our accounting, we made a couple of changes regarding the lives over which we amortized leaseholder improvements, and we added the period of time it takes to set up a store before opening to our calculation of straight-line rent, even though typically we do not actually pay rent in that period.

We completed our review, and because the cumulative pretax adjustment of approximately $36 million would have been material had we recorded it all in 2004, we restated our financial statements for 2000 to 2003.

The impact of the change was not material to any single year restated and was particularly insignificant in 2003 and 2004.

As we said in our earlier press release, we do not expect that our new accounting practices on these matters will greatly impact our future operating results.

Now I would like to turn the call over to David.

Good morning, everyone.

Thank you for your continued interest in Dollar General.

We take your interest in our Company very seriously.

When we began this year, I mentioned to you that the 2004 fiscal year would be an investment year, with the Company making sizable investments in certain areas of the business.

In addition, we called out the risk associated with our plan for 2004, arising from the deteriorating economic situation of our core consumers.

We did make those investments in our business in 2004, and our customers indeed were impacted by high unemployment and rising gasoline and heating oil prices.

Unemployment among workers without a high school diploma rose to the 8 percent to 9 percent range and stayed there for most of the year.

Also, gas prices increased to levels 73 percent higher than just 2 years earlier.

This economic environment affected all retail in general and the discount sector in particular.

Given this challenge, I am delighted with our 2004 results.

We adapted to the changing environment, overcame internal organizational adversity caused by the departures of our COO and Chief Financial Officer, and delivered against our objectives for the year.

The results speak for themselves.

Total net sales grew 11.5 percent to almost 7.7 billion, while same-store sales increased 3.2 percent.

This same-store sales increase, while disappointing to us internally, was higher than our closest competitors.

EPS was $1.04, as David has said.

This is within our original and updated guidance and 13 percent higher than 2003, excluding the restatement-related penalty.

Our return on invested capital was 13.6 percent for the year.

At the beginning of the year we told you we would open 695 new stores in 2004, a new record for Dollar General.

We actually opened 722 new stores, including 3 new states.

Net selling square footage actually grew by 10 percent in total.

At year end, we operated 7,320 stores in 30 states, including 15 Dollar General Market stores.

We told you that by the end of 2004 we would have coolers in 80 percent of our stores.

By the end of 2004, 6,846 stores or 94 percent of all stores had coolers.

In addition, over 6,300 stores were certified and accepted and started accepting food stamps or EBT.

We told you we would implement auto replenishment in all stores by the end of 2004.

We completed this during our first quarter of 2004, 9 months early.

We told you we wanted to increase our in-stock levels.

Our in-stock levels are now in the mid-90 percent range, even though we have tightened up our definition of in-stock.

This level is significantly higher than it was just a year ago.

We told you we would invest in our store operations.

We hired McKenzie & Company, completed the design project, and actually implemented EZstore in 350 stores by year end with encouraging results.

We told you we would increase our distribution capacity.

We completed the expansion of the South Boston, Virginia distribution center and substantially completed the expansion of our Ardmore, Oklahoma distribution center, converting both of these to dual sortation.

We're also ahead of schedule on our 8th distribution center in Jonesville, South Carolina which is due to start shipping later this summer.

In total, we increased our distribution capacity this year by 15 percent.

We reduced shrink on an operating basis this year.

We expect this reported shrink -- we expect the reported shrink on our financial statements to begin to reflect this improvement in 2005.

We committed to increase our store manager training.

At year end, 60 percent of our store managers had attended intensive training program at one of our 35 training centers.

Store manager turnover was reduced from a high of 56 percent in mid-2003 to 48 percent for fiscal 2004.

In 2004, we accelerated our efforts to identify internal talent and to promote from within.

In the year, 52 percent of our 200 new district manager placements were internal promotions.

We executed our Board-approved stock repurchase plan, as David has mentioned.

We repurchased 11 million shares during the year for about $209 million.

This was in addition to paying $52.7 million in dividends to our shareholders.

These are but a few of our results for the year, but I think they speak to the effectiveness of our team's efforts.

When I first arrived here almost 2 years ago, we identified 3 strategic areas of the Company of which we would focus in the first few years of my tenure.

First, we focused on our organization in all levels.

We brought new players in from outside and promoted and reassigned internal executives.

We have integrated our supply chain and combined new-store development with store operations.

We have a new Chief Financial Officer, as you know, and with the loss last year of our Chief Operating Officer, we now have a search underway to fill that position.

I continue to personally focus on this area of organizational development every day.

Second, we determined to focus and invest in our store operations.

We have done this with the most visible initiative being the EZstore project.

Many of our initiatives in 2004 were directed at improving how we operate our stores.

Lastly, we identified opportunities in our merchandising area that we have addressed and will continue to address as we go forward.

As we move into 2005, we will continue to focus on our stores.

We plan to invest approximately $100 million in our EZstore project and related efforts over the next 2 years.

This continues to be a major investment for us, and I am very pleased with the results to date.

With EZstore now in over 550 stores as we speak this morning, we are beginning to realize many of the benefits we set out to achieve.

There are many facets of EZstore, it covers our hiring and training practices, labor scheduling, product presentation, and store paperwork, but the most impactful benefit is the reduction of excess product handling.

With EZstore, we can stock our merchandise on the shelves much faster with less effort, resulting in much more satisfied customers and employees.

As David mentioned earlier, we are focused on our inventory levels.

I am somewhat comforted by the fact that a large part of this inventory is in our core product and a result of our efforts to improve in-stock levels.

In 2005, we plan to fine tune some of our replenishment assumptions.

We are also addressing our distribution center inventory levels that support this in-stock position.

Again, the bulk of the inventory increase is in core merchandise, items that we ship to our stores every week, so this is a matter of optimizing our store and distribution center inventory levels for the most part.

We will continue to execute our strategies for selling through seasonal and other non-core merchandise, and we plan an aggressive effort in 2005 to lower our per-store inventory levels.

As you can see by simply looking at a map of the United States, we have significant opportunities for store growth.

In 2005, we plan to open approximately 730 new stores, including at least 30 Dollar General Markets.

In 2004, we opened stores in New Mexico, Arizona, and Wisconsin for the first time.

We will continue moving westward in 2005.

To date, we are very encouraged by our customers' responses to our 15 existing Dollar General Market stores.

Our larger format store with an expanded food area.

And we are looking forward to the expected opening of at least 30 Markets in 2005.

We will begin testing the Market concept in new geographic areas as well in 2005.

As I mentioned earlier, we expect to open our 8th distribution center in 2005 near Jonesville, South Carolina.

Our first to open ready to begin shipping to EZstores.

We are planning to open a 9th distribution center in 2006, and are currently evaluating possible sites.

On the human relations front, we will continue to emphasize the importance of hiring the right person for the job, and that means hiring people who believe in our culture of serving others.

We are instilling in our employees a heightened sense of accountability for themselves, their employees and the Company's profitability.

Now let me address our outlook for 2005.

We expect diluted earnings per share of between $1.14 and $1.19 for fiscal 2005.

Including a charge of approximately $0.01 per share in the second half of the year relating to the expensing of stock options.

First quarter ending April 29, 2005 we expect EPS of $0.21 to $0.22.

As you know, we use the retail method of accounting, starting in 2005, to reflect the changing nature of our business.

We have expanded the number of merchandised departments used in our margin calculation.

We have previously communicated our intentions to do this and believe that the additional granularity provides more meaningful information.

I mention this because while this change is not expected to significantly impact our gross margin calculation for the year, it is expected to negatively impact quarters with higher percentages of highly consumable sales.

That is the earlier part of the year, and conversely is expected to positively impact potentially the fourth quarter which generally has higher seasonal merchandise sales.

Another important byproduct of this new system is that it will allow us to generate more meaningful store-level margins, which should help us manage the business better.

We expect to spend approximately $350 million on capital expenses in -- expenditures in 2005 with the primary reason for the increase over last year being the rollout of EZstore.

This outlook for 2005 is consistent with our internal plan, but as I did last year, I would like to add a cautionary note.

I continue to be concerned about the impact the current economic pressures are having on our customers.

Our core customers are still faced with high unemployment rates.

Gasoline and fuel costs continue to be an issue for our customers and a significant cost item for the Company.

We are also managing quite a bit of change in our stores and distribution centers with the implementation of EZstore.

Although I am confident with our direction and progress, change also brings risks.

We believe that our operating initiatives will have positive near-term and long-term benefits, but they have the potential to also disrupt in the near term.

In summary, having said that, our vision for the future of Dollar General has not changed.

We want to become one of the leading providers of highly consumable basic products for underserved customers, regardless of geography for demography.

Even though Dollar General is the oldest and largest player in the Dollar channel, we are still growing very rapidly.

As we grow, we will remain focused on meeting the needs of our customers, and we will continue to compete on price and convenience, our points of differentiation.

We will continue to provide our customers unique assortments of products at low prices through our growing network of conveniently located small stores.

We have a great team and a competitive business model, and I am excited about the opportunities ahead.

With that, operator, I think we have time for Q&A.

So we will take questions now.

Thank you.

Thank you. (Operator Instructions).

The first question comes from Ralph Jean with Wachovia.

Great.

Thank you.

I have 3 quick questions.

First, the higher gross margin in Q4.

You mentioned that, given that you had the increase in highly consumables, you had higher IMUs.

Was that due to better buying, more imports or both, or were there any one-time adjustments in the quarter?

I will answer that question.

I think there were probably 4 key factors that impacted the fourth quarter.

First of all, we achieved some margin expansion on our imported products and our import programs through our Hong Kong office.

We gained some margin contribution through initiatives of opportunistic purchasing that David has been -- been talking about over the past 2 years.

We also renegotiated some costing with several key vendors.

And then on a very selective basis, we did have some price increases.

So it was a variety of things.

Okay.

Great, thank you.

Next question is, what is your same-store sales leverage threshold for fixed expenses, and for every 1 percent you exceed that, how many basis points could that add to operating margin?

Ralph, this is David Perdue.

I wish I could answer that question for you.

Let me tell you why that is difficult to answer.

First of all, we have so many initiatives going on in the Company that are changing the balance of our SG&A expenses, obviously.

We are definitely working hard on our margin issues and so forth.

So if everything was static, you could run that calculation.

We have projections inhouse -- I am not ready to talk about that publicly, of course, based on the improvements we are talking about on both profitability and revenue.

So it is a very difficult question.

I think certainly, when you look at our efforts over the next year or 2, you will see that we are beginning to leverage certain levels of our expenses, even though comp sales are relatively low from a historical basis.

For example, in 2004, we continued to leverage our administrative expenses, even though comp sales were in the 3 percent range, and we, for the first time in several years, leveraged our store labor as well.

So, we call that out at the end of third quarter, and frankly, we are one of the few people doing that at this low level of comp sales growth.

Okay.

Just lastly, you gave guidance of 350 million for CapEx.

You want to get your inventories back in line by year end.

So it looks like either you are going to have to increase the amount of debt outstanding or possibly you won't realize the full share repurchase amount this year.

Well, I am not -- I am not sure that -- obviously our internal plans don't back up that conclusion, and we've got full confidence that we are going to be able to fulfill the share repurchase authorization that our Board has given us.

So you -- you would be willing to take on debt to do that if necessary?

Well, I am not saying that we will, I am just saying we don't think we will have to do that.

Okay, thank you very much.

Thank you.

Thanks, Ralph.

Thank you.

The next question comes from Dan Wewer with CIBC World Markets.

Hey, David, when I was talking to some of the store managers in the Dallas/Ft.

Worth area, they were telling me that they took about 15 to 20 hours of payroll each week after they plugged in EZstore, and I was curious if that seems to be accurate.

And if we are at the point now where the sourcing supported out of Ardmore, Oklahoma DC are seeing higher levels or profitability or reduced levels of payroll and it's offsetting the cost of EZstore rollout.

Dan, thank you very much.

There is a lot about EZstore that we can't talk about publicly, but we have got about 550 stores I think we said just now up and running on it.

We do take hours out.

It is different on a per-store basis.

There are a lot of things involved in this, not just the material handling changes that cause that.

We have a new scheduling system.

We have new requirements in the store.

And the primary thing that we are trying to do is have our people scheduled for when the trading activity is occurring in the store, as opposed to when the material handling needs are in the store.

And so those same people that are telling you we are taking those hours out the store are also probably telling you that the labor on truck day is quite different.

And it does vary by store, the stores that we have opened in Oklahoma, we are getting different results, but we have encouraging results from both tranches of stores, both in Texas and Oklahoma.

As you know, we chose that division out there to start this and in many areas that division is one of our most problematic divisions.

So we are testing EZstore and launching EZstore in some of the most difficult and competitive areas we have in the Company.

Right now we are very excited about the impact it's having in the store on turnover, on productivity, and all the things that we were hoping for, and certainly it is having an impact on our cost structure.

Their managers -- your managers are telling me they are seeing less damaged goods as well because the I guess the rolled painter [ph] helps protect the products better.

Dan, there are 3 areas.

I am just going -- these are big areas.

We will talk about more as we go forward.

I can't quantify on this, but obviously the cost of running the store is one.

But we really wanted to reallocate some of that labor.

Certainly there are going to be some higher reductions, but some of that labor is going to be reallocated to helping customers and making sure the store is maintained, et cetera.

The second area is lower damages.

And third, frankly, we were -- we want the place to be safer, frankly.

We had workers compensation that we felt was out of control, and we wanted to react to that.

And so this is going to impact those 3 primary areas, not to mention we hope it will increase sales productivity as well.

One quick question on -- on shrink.

Could you tell us how much of an improvement you made on shrink -- I guess you call it on a operating basis, not a financial measure.

And then what type of operating reduction will you need in '05 to allow you to reduce the amount that is run through the P&L.

Yes, Dan.

Thank you.

I'm going to give you a little detail on this.

It is awfully difficult to compare '04 and '03 because there was a change in '03 as we called out at that time in terms of our measurement of this, but I can tell you on an operating level, we saw about an 18-basis point improvement at operating shrink.

Now that's before all the release of accruals and so forth from an accounting point of view.

If you look at the details of our financials, you'll see that the publicly reported shrink is about flat, but that's because of the vagaries or the accrual reversal in both years.

And so as we go into 2005, my comment was intended to say, okay, now for the first time, if it is operational it should flow through to the reported number.

Okay, great, good luck.

Thanks, Dan

The next question comes from Gary Balter with UBS.

Thank you.

First of all, congratulations, David, on great performance in a challenging environment.

Thank you, Gary.

It was a tough year as everybody knows.

A couple questions.

One is, I missed part of the call so you may have said this, did you give comp guidance for 2005?

I see the earnings guidance.

No, we didn't Gary.

Do you want to do it now?

No, we have a policy internally.

We really don't do that.

We used to do it, as you well know, but we don't do it.

Okay.

How do we measure the impact to gas, you mentioned that's one of the risks.

Is there a way internally that you're able to -- that you could correlate it so gas goes up another dime and it has a 0.5 impact.

Is there anything like that that could help guide.

I have seen analyst -- there are some reports out there that have attempted to do that.

Internally, there are so many moving parts in here.

If you try to do a regression analysis to compare gasoline to same-store sales, as an example, there are so many other variables in here that cause noise in that.

The things that I have seen, really are not believable.

I can't tell you accurately the connection.

I can tell you subjectively what we began to see last year, and that is toward the end of the pay period, comp-store sales on a daily basis really deteriorated significantly and I think you have heard some of our competitors comment on that this year.

Yes.

And frankly, I think that is a direct correlation of our consumers doing without because of having spent more money on transportation.

And then -- I have an accounting question that -- just to clarify something.

When -- because of the retail method, when you are purchasing and you have higher mark-ups, does that actually help the gross margin in the quarter it is purchased?

It can -- I will answer that question.

Okay.

It goes into the specific department of that item and depending upon whether it comes in at a higher margin than the average for that department, it can help it.

Generally in our seasonal merchandise, if we purchase items, for example, at Christmastime where we have a higher margin than what's in there, we do get help from that and we see that sometimes in the fourth quarter in particular.

Did that help this quarter?

The key items in this quarter really were the 4 that I mentioned, the expansion in the imported products, the opportunistic purchasing, the costing -- renegotiated costing with some key suppliers and then some sporadic price increases.

When inventory get back in line next year, we will not see the offset.

We will not see a reversal in the way of that.

Or we shouldn't be looking for that.

No.

Good luck and I hope gas prices come down.

Absolutely.

Thank you.

Thank you.

Next question comes from Daniel Berry from Merrill Lynch.

Good morning.

My congratulations also.

Thanks, Dan.

I appreciate you giving guidance, it is always very helpful and I know you don't give specific guidance on gross and SG&A.

But for purposes of modeling, can you give us a little help with guidance and direction on gross in SG&A.

Specifically, you've indicated gross might be better in the fourth quarter rather than the first 3 quarters.

Are you implying gross might be flat or down in the first 3 quarters?

And on the SG&A, you were up all 4 quarters last year, particularly stronger in the first 3, would be some easing in your SG&A this year?

Let me try to address 2 separate issues.

First of all, I can't give any more granularity around first quarter than the EPS guidance we just gave.

I think having said that, the SG&A, Dan -- and these are great questions.

And we are trying to become more transparent to help within the -- the constrain of the competitive environment, but with regard to SG&A, what we saw last year and called out early in the year.

The heavy part of our investing.

This is inventories and consulting fees and things like that, were really front-end loaded and a lot of those costs are not going to be repeated in 2005, and we said that during the year in 2004.

So from that standpoint, we think we get a little relief from that.

Now there are other areas, depreciation and so forth from some of these increased CapEx investments that might negatively impact it, but I am not happy currently with our current level of SG&A.

I think there are opportunities as we grow.

Certainly, in store labor, we saw this year that we began to leverage that a little bit as we did in admin salaries, but there's still some things -- our benefit costs continue to increase.

Our worker's comp is still at a high level, although it did level off this year a little bit.

And, as we go into 2005, we continue to work on those parts of the SG&A.

So I hope that gives you some flavor, anyway, even though I can't quantify it, Dan.

Sounds like what you need is lower gas prices.

Thanks.

Even though I can't prove it, I know there is a extremely high correlation between gas prices and -- inverse relationship between gas prices and comp-store sales.

Thanks.

Thanks, Dan

The next question comes from Patrick McKeever with SunTrust Robinson Humphrey.

Thank you.

Just wondering if you might give us a little bit more color about EBT now that you have it in over 80 percent of your stores.

Anything at all there would be help helpful in terms of whether -- what kind of a lift you see to sales at the store or how it affects the margins for the store.

Really any broad comments will be helpful.

Thanks.

Thanks, Patrick.

Yes, the only comments I can give you today are really broad.

As you know, we have them in a lot of stores across our networks.

And the results are very different by store.

It is a wide range of results so far.

We are getting a lift.

I don't want to quantify it yet because there is still a lot of noise in what we are getting.

I still think it is very early in our tenure with regard to food stamps.

A lot of our customers are long-standing customers and they haven't been used to seeing us provide that capability to our customers.

So it is a little slow on the uptake, frankly.

We have signage at the store level.

Our store managers are beginning to proactively mention this to our customers.

But I think it is really early.

I think thing is, certainly it's growing quarter-to-quarter, we have seen that, but I don't think we have anywhere near reached the impact that it is going to have.

I think as we go through the year and we get some of the noise out of the results, we will be able to talk a little bit more precisely about that historically.

Okay.

Then just a second question.

Maybe asking the prior gross margin question a little bit differently.

When we look at the things that drove gross margin higher in the fourth quarter, can you give us a sense of what might be sustainable and what might not be sustainable going forward here?

Well, I really hope that -- we created an opportunistic purchasing department last year and it began to have some impact in Q4.

We hope that that is sustainable.

Our sourcing office, which we opened in the early part of last year, the latter part of the following, certainly was around the year-end, had impact in the back half, and we did realize benefit from that.

I hope -- I know that is sustainable, and we hope to actually enlarge that capability.

We are -- the other issues with regard to the timing of inventory, that's always going to be an up-and-down issue depending on the needs of our merchandising group and the full of merchandise.

There are pressures in 2005 on gross margin.

I mean, as the coolers grow in terms of their throughput and the EBT side of this on perishables and consumables, that continues to be a negative pressure.

But I will remind everyone, we are fighting that battle like we have for the last 10 years.

Over the last 10 years, this idea of rising consumables as a percentage in the mix has been a theme, and yet through the years, the Company has managed to offset the negative impact on margin by doing other things.

So we continue to do that, and I still see potential to do that.

We haven't mapped out the other areas of opportunity.

Thanks, David.

Thanks, Patrick.

Thank you.

The next question comes from Wayne Hood with Prudential Financial.

Yes, David.

Actually 3 questions.

I was wondering what impact is the EZstore process having on your DC processes and configurations or how you think about distribution and flow of goods.

Good morning, Wayne.

Thank you, it is a good question.

We are trying to revolutionize how we look at distribution, and I have -- we have consolidated our supply chain for just that reason.

We have combined planning, distribution, transportation, and sourcing into a supply chain.

We hired a new Senior Vice President that I've known for quite a while to run that, and we are trying to look at distribution, not in the silo mentality that maybe we used to, but more in a holistic -- from a holistic perspective, and that is, we feel like we run 7,300 mini warehouses, if you will, because most of our inventory is actually in the stores, believe it or not.

So we have to look at the whole cycle, all the way through to our customers' pantry, if you will, or their closet as part of our distribution network.

Having said that, EZstore is changing the way that we are delivering that merchandise.

Number 1, in the distribution center, we have a different way of loading the trailers.

Before we would load it totally randomly based on what cart came off the conveyor, and if you have been to one of our distribution centers you've probably seen that occur.

Now we are sorting at the distribution center.

We are doing some other things there that used to have to be done in the stores.

So we have moved some labor from stores back into the distribution center, and yet what we are finding is that the amount of labor incrementally we thought we would have to spend at the distribution center is significantly less because we can get efficiencies there that we could never get in the stores.

So I'm delighted with that.

Our distribution centers have done a fantastic job.

We've got 1 fully converted, another one is well underway and this new distribution center coming out of the ground in June will come out be 100 percent EZstore capable.

So we are delighted with the impact it's having, not only on our stores but at our distribution centers as well.

David, my 2 final questions relate to inventory.

One is your accounts payable to inventory dropped to about 29.5 percent from 33 percent, is the lowest level since '01.

I was wondering why that decline occurred and why it was so low?

And if you can comment on where you think your inventory per store would be by the end of '05.

That's it for me.

Thank you.

The first question is accounts payable?

Yes, accounts payable to inventory.

I think a lot of that has to do with -- we had more import items come in and some more DSW items, and there are just different -- different terms -- terms on how we pay those and I think we got a little bit of a change in how that is portrayed because of the types of items we are purchasing.

So we should think of that going back to 33 percent in '05 or even a higher number in the future?

Well, I think that is more guidance than we are prepared to give.

Wayne, let me answer the second part of the question on the inventory.

I am not prepared to quantify it today, but what we are really doing is looking at the causative factors of this inventory change.

First of all, some of this inventory increased for the right reason.

We are better in-stock and so forth.

We are looking at our distribution centers to say do we really need that level safety stock now that we are that level of in-stocks in the store.

So we are moving on that basis.

Secondly, we are trying to clean up the back rooms candidly.

We have an initiative underway.

We have got markdown money earmarked for that.

And so we want to as part of EZstores we roll through the network, we are going to look at store-by-store opportunities to improve the efficiency of that inventory.

I want turns to increase.

Now I can't quantify what it will be in '05, Wayne, but I really don't see any reason why we can't move this into the 5 range and north with our current systems.

Now there are some things we can do down the road to actually do more than that, but I really know that we can do more than 4 turns a year.

For example, our soft side of the business, the home and apparel turned very slowly.

And we know that that is a part of our business that we can improve, both profitability and productivity, but also the inventory turns.

So I can't quantify it, but it will -- we are -- we are calling it out now -- we call it out at the end of the third quarter as a 2005 initiative.

Is there an average that we can think of that EZstore took -- the amount of inventories you have taken out the back rooms in the stores you have converted to EZstore?

There is an average, Wayne, but the distribution ran is so broad because we had some stores with very little inventory and we had some stores that were just covered up with inventory.

It really varies by region too and also by a suburban store versus a rural store and so forth.

I think it will be misleading to give you that number today.

I think what we can do as we start looking at it through the year and we get more stores on it and it's more representative.

We can start talking about EZstore -- some things about EZstore, for example, productivity and inventory levels and things like that compared to the network.

Today, having 550 stores and only been on there a short time, I think it would be irresponsible to really kind of quote those numbers.

I will be prepared to do that as we go forward in the year.

Thank you, David.

Thanks, Wayne

Thank you.

The next question comes from Ed Roesch with Banc of America Securities.

Hi, good morning.

Hi.

Good morning, Ed.

Given your cautious commentary about the environment, David, is it fair to say you are not building in much acceleration at all on consumer spending at the low end in '05?

Ed, that is a fair question.

I look at -- our assumption for growth are based on the following things, number 1, obviously we have opportunities from the real estate perspective to put out new stores.

Secondly, we have such a low share of wallet that we believe that within even the constraints of the economic environment out there, that we in meeting the needs of our customers, if we do that right, we can increase our share of their wallet.

And so that gives me confidence that even with the environment that we can grow fairly aggressively.

And if you look at the EPS growth and so forth that we are talking about over the next year, that assumes significant revenue growth, just as we did in -- in '04 in a very difficult economic environment.

So while I am caution -- I am cautioning everyone about the environment, because I don't see the environment changing readily, although if you look at the last 5 or 6 months, the unemployment number has abated just a bit, just a bit, but gasoline prices on the other hand are bubbling around again.

So I continue to be concerned as I did -- as I was a year ago when I looked forward into this year.

I am not an economist.

I read all the same economists that guys read and it is anybody's guess.

But do I know that the global economic pressures of consumption are dramatic.

So with -- with the needs of South Asia, with regard to fuel and concrete and steel and things like that, I am just nervous that we are not going to see any great abatement in those pressures this year.

Great.

And so, I think the key is you are not expecting '05 to be terribly better than '04 So you are looking at the comps --

Well, I won't comment on '05, Ed.

I think, what I will say to it, what I think I said in my remarks was that, I am disappointed with 3.2 percent.

Having said that, I like the fact that it's -- I won't call it "best in class."

But it's certainly better than a lot of our close competitors in an extremely difficult year.

Sure.

I would be disappointed going forward with that number.

I mean long term, we know that to really take advantage of our opportunities, those comp sales have to be significantly higher.

Right, but your plan does not bake in a big acceleration.

It's more -- because you have seen 5 percent recently so.

Yes, I really can't -- I can't give you any more guidance on that unfortunately.

Okay.

Thanks.

Thanks, Ed.

And then one other question.

What are the drivers of lower per-store labor usage at this point?

Are you talking about the -- the labor cost.

The leverage of labor cost?

Well, it's 2 things primarily.

One is, we change some of the methodology -- even before EZstore, we changed some of the work requirements that we had in the store in terms of pricing product at the store level and in some of the things that we were doing with the product at the stores.

That's one.

Number 2, is we put a -- we are putting a scheduling -- a very rigorous scheduling system in place, and it is not a new IT system.

It's -- we have the same tools we have always had, but under Kathleen Guion's leadership, we are putting very tight controls on the allocation of labor and we are trying to match that labor up, like I said, to win consumers who are in the store shopping and not to win the material handling needs that are in the store.

When do you that, all of a sudden you run into -- you find that you can reduce the labor hours and yet give the store manager and people more hours to actually facilitate customers.

So I think that's the driver.

The biggest driver to date.

Because the EZstore has only impacted some 500 stores today.

Congratulations on a good year and good luck.

Thank you very much, Ed.

The next question comes from Michael Baker with Deutsche Bank.

Thanks.

Good quarter.

I will try to be quick.

Two quick questions on the -- on the imports and the opportunistic purchases.

What is that as a percent of sales and where can they go roughly?

What we have said in the past that sourcing, external or International sourcing is about 15 percent.

Direct International sourcing is about 15 percent.

It is a little higher than that because we buy through U.S. brand other products that are, indeed, source.

But our direct imports is about 15 percent.

I don't know, you have seen some of our competitors' numbers as high as in the 40s.

We haven't really quoted anywhere what we think that potential in our shop can be, but we continue to look at this category management opportunity within our merchandising group, and we continue to evolve the product mix.

I think the answer to the sourcing question depends as much on what we do with our product mix as it does with our sourcing capability.

But I definitely think it will increase.

Opportunistic purchasing is going to increase.

I mean it's -- even though it increased last year, practically doubled last year, it is still a very, very small percentage of our business -- it is not a material issue yet.

We are calling it out because it is encouraging and did have in one quarter, it did have an impact, but over full year it is still very, very small.

Great.

And also I guess related to the gross margins.

You just mentioned that you have markdown money earmarked for '05.

So is that, I would imagine, going to be a gross margin pressure?

Is that more impact the first quarter?

Or how does that play out by the quarters?

Well I think -- we always had -- over the last few years we have markdown money budgeted to help clean up our seasonal purchases and our seasonal efforts.

Very candidly, we are trying to get better at that honestly.

We have done that for the last couple of years.

We are not as good in that area as we want to be, but we -- we put this money in there, and it is not -- not anything new.

We've been doing -- we did it in '04, we did it in '03 and so forth, so there is nothing new there.

So it's no greater in '05 than it has been.

It's more, but on a rate basis, I wouldn't think it is -- it is not unusual.

Okay.

On a timing basis through the year, I would answer the question this way, Michael.

I think what we are trying to do is use it when the need occurs.

In other words, not hold it all to one time of the year or the other, and really what we are ultimately going to try to do is to do what a lot of other people do and that is to get clean in season.

We have got a ways to go, but, yes, it will have some pressure on margins and so forth, but I wouldn't say anything more or less than what we have had the last few years.

Okay.

Then if I could just try to put it all together, it sounds like there are a number of factors on both gross margin and SG&A going both ways.

Would it be correct to say that your guidance at the low end is probably a little bit of operating margin decline, at the high end a little bit higher, at the midpoint about a flat operating margin, is that sort of close?

Michael, I really can't respond.

I think we have to kind of stand with the EPS guidance.

I think the one thing I will conquer with you on is that our -- there are a lot of moving parts both ways.

Okay.

Thanks.

Good enough.

Appreciate it.

Thanks, Michael

Thank you.

The next question comes from Christine Augustine with Bear Stearns.

Hi, thank you.

I have 2 questions.

The first is on Dollar General Market.

I am wondering if you could share with us what has surprised you the most about the customer response to that new format?

And then secondly, home products has been an area that has been a lagger, and are there any plans to focus more on that in '05?

Thank you.

Christine, thank you very much. 2 very appropriate questions.

I will respond to the DG Market first.

I am -- I continue to be excited about the results, Christine, and my personal greatest surprise is the fact that our market research is telling us that a high percentage of our customers both are new and that are using the Dollar General Market as a primary destination.

As you may know in our traditional stores, we generally are a fill-in.

We never call ourselves a destination retailer because the research doesn't support it.

The DG Market, and this is early in the first year, but we are beginning to see evidence that many consumers are seeing us as a primary destination, meaning that we are the reason they left home or stopped by from the office or whatever.

With regard to -- I am sorry, what was the second part of the question, Christine?

The home product.

The home product, yes, I am sorry.

I am very frustrated with our -- the effectiveness of that in that area.

I think for several years that area, as you know from -- from public numbers has comped down.

We know we've got a need in our customer base for that product.

And I think you will see in spring a new offering that is fairly exciting, and I am hopeful that we will have good results from it.

We have got certain initiatives in place right now to bring more attention to that, and to make it more appropriate for the customers, because somehow we're not meeting the needs of the customers or those numbers would be better, simply put.

So we are going to get better in that area.

I am not going to walk away from that area because I think our customers need it.

It gives us an opportunity to be more than just a single-serve product retailer.

And I think that's one of the areas where our -- our shoppers really find some treasure hunt items from time to time.

So it is an interesting part of our business.

It ties into the consumable side very directly, and it, along with apparel, are 2 of our higher margin areas that we simply have to get healthy again.

So we're going to pay particular attention to that in '05 as we go forward.

Thank you very much.

Thanks, Christine

Thank you.

The next question comes from David Tarantino with Robert W. Baird.

Good morning and congratulations on a good quarter and year.

First question is related to coolers.

How would you characterize the impact of the cooler program in stores that have moved into their second and third year with the cooler?

Well, the -- the increased ring that we called out over the last year or so continues to prove itself out, and has remained consistent.

Growth in those older stores that had coolers is encouraging, and we think greater than -- than the norm for the network.

I think the other thing, too, is that what we are trying to do with the coolers is tie that into the impulse needs that -- that customers have and we -- we have done a little bit better job with that, but not -- we haven't reached the full potential.

And then the next is, just a full assortment of what is needed in the cooler.

We put in some single-serve coolers that some of our brands, soft drink brands and so forth have put in, and those have been very encouraging.

We are looking at that with regard to other single-serve opportunities in regard to our other coolers.

We are also looking at size of store and number of doors in those stores.

I mean we've got most of the configurations we have are 5 doors as you probably know.

Some stores, that may not be enough.

Some stores, the sales are very encouraging and we may have to, over time, actually increase that penetration.

Great, thanks.

That's helpful.

Second question on opportunistic purchases, how did sales for those type of items do in the fourth quarter, and how did that compare to your expectations heading into the quarter?

I think overall, as David said, it had an impact on margin in the fourth quarter -- and actually sell-through as well in fourth quarter.

It was a mixed bag.

There was some product that did extremely well and blew through and other product that we kind of sat on.

But that is the nature of that business.

We have great people doing that right now, and we are able to respond to the phone calls from our vendors when they come in, and that's different from a year ago when we just weren't one of the top people that they would call when they had a need.

Now we are not going to run head-long into that area.

We are not going to ourselves into just a closeout house, but I do think the treasure hunt dimension of our mix can be enhanced and we want to add more fun to -- to our shoppers lifes when they get to the store.

So we are trying to clean some stores up.

We are trying to add some of these fun products in there, if you will, and then we knew we had to get the basics rights of getting in-stock and cleaning some stores up and widening a few aisles, and so forth.

And our customers kept telling us that the coolers were something that they wanted and needed, so we really rushed out and did that in '04.

And, quite frankly, took on a lot of risk in that implementation and we have been very quiet about how successful that has been just because it had no great disruption last year.

So I am delighted with it so far.

Great, thank you very much.

Thanks, David.

I think -- operator, we have time for 1 more question

Okay.

The final question comes from Michael Exstein with Credit Suisse First Boston.

Thanks very much.

Actually, 2 very quick ones.

Can you give us an idea of just how much pressure the fuel cost increase had on your gross margin in the quarter?

And number 2, can you just sort of talk about the shrink accrual going forward, how that will match what we'll see in terms of reported shrink.

Thank you very much.

Thank you, Michael.

The shrink issue is -- obviously, we have got internal targets.

And I have said publicly that we want -- I am not going to be satisfied until we see ourselves down to the 2.5 percent range on a reported basis.

That includes all the variables including the accrual reversals.

As we go into this year, we do have some minor improvement that we want to achieve.

I would not get too excited about it, because it is so -- it is such a laborious effort.

Now we have a lot of stores already at the 2.5 percent range, but we have a significant amount of stores at the bottom that are not under control yet and continue to give us problems.

However, those bottom few hundred stores, their shrink is about half of what it was last year, so that's an encouraging sign for us, and it may not be the same few hundred stores that we had last year that we started talking about this.

So we see pockets of -- of dramatic improvement, but, again, one of the vagaries of operating a 7,000 rooftop retail chain is that you're generally going to have a couple hundred stores on any issue that are your headaches from productivity, employee turnover or shrink.

So we're very definitely working on that.

And the first part of the question?

The fuel.

The fuel pressure on -- primarily, Michael, it hit us on our transportation costs.

I think our transportation costs rose all year.

And we don't -- we don't really see that abating.

I don't know if it will increase again in '05 the way it did in '04.

We just haven't baked any dramatic improvement in it, I think is the best way I can answer the question.

That's primary the biggest impact to hit us.

Now, going into '05, there is another potential area that fuel could begin to have on us, we are beginning to see some inflationary pressures from some vendors in terms of passing through price increases.

So we continue to work with them and work with packaging and all the things that we can do to manage that -- that issue.

So it -- the fuel price has hit us 3 ways. 1, it hits our transportation costs. 2, it hits our cost of goods.

And 3 is, it hits the demand of our customers' ability to shop our stores.

So I hope that answers both questions, Michael.

Just real quick, can you kind of quantify what the fuel did in terms of transportation costs, was it up 20, or 30, or 40 basis points in the quarter?

I am not prepared to answer that today.

I might -- I might do that in a future quarter, but I am not prepared to answer it today, Michael.

Thank you.

Thank you very much.

Thank you, everyone.

Thank you.

You may now disconnect at this time.