達樂 (DG) 2005 Q1 法說會逐字稿

This is the Dollar General Corporation first-quarter earnings conference call on Thursday, May 26, 2005 at 9 a.m.

Central Time.

Good morning, ladies and gentlemen and welcome 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 another 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 audience.

Before the presentation begins, Company has requested that you listen to the following statement regarding forward-looking information.

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: Anticipated annual and second-quarter earnings per share, the expected annual effective tax rate, growth targets, capital expenditures, 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 these assumptions could be inaccurate and therefore, actual results may differ materially from those projected and or implied by the forward-looking statements.

The factors that may result in actual results differing from such forward-looking information include but are not limited to those set forth in the Company's most recent Annual Report on Form 10-K for the year ended January 28, 2005 the most recent form 10-Q, and the earnings press release issued today, as well as 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 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 after the date of this conference call or to reflect the occurrence of unanticipated events.

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

Beginning today's call is 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 am going to take you through our first-quarter results and then David will have some comments on our operations and our plans for the rest of the year.

We reported diluted earnings per share of $0.20 for the first quarter ended April 29, 2005 flat with last year.

Net income for the quarter was $64.9 million and that compares to $67.8 million reported in the first quarter of 2004.

We are very pleased with our total and same-store sales results for the quarter.

As we had reported earlier, our sales for the first quarter of '05 were 1.98 billion versus $1.75 billion in the prior year, that's an increase of 13.2%.

Same-store sales increased by 4.9%.

The gross profit rate to sales of 28.5% for the quarter, however, was down from last year's first quarter gross profit margin of 29.3%.

The decrease in the gross margin rate is primarily a factor of sales mix, which was skewed more toward highly consumables than we anticipated.

The mix of sales of higher margin items in our basic clothing, home products and seasonal categories was lower than last year.

As we anticipated, the change in the number of merchandise departments from 10 to 23 that we are using to account for our inventories did, in fact, impact our gross margin negatively.

If you will remember, we said we thought the change would negatively affect quarters with a high mix of highly consumables and positively impact quarters with higher seasonal sales.

We still believe this to be the case.

In addition to the impact of mix on gross margin, transportation costs were up during the quarter.

We also saw some increases in markdowns and other inventory costs resulting from our work to reduce inventories in our back rooms in preparation for EZstore.

These unfavorable variances impacting the gross profit rate, were partially offset by higher average markups on beginning inventories.

Our reported shrink rate, calculated at retail, was 3.01% for the quarter down 12 basis points from last year.

On a like-store basis, operating shrink decreased 32 basis points from last year's first quarter.

We took physical inventories of many high-shrink stores in the first quarter, so this level of improvement is not likely to continue at this rate throughout the year.

SG&A expenses in the first quarter of '05 were $456.4 million or 23.1% of sales versus $397.7 million or 22.8% of sales in the prior year.

This increase is primarily attributable to higher store rent expense, increased utility costs, increased store maintenance expenses, and increased fees associated with the use of debit cards in our stores.

These increases were partially offset by a decrease in professional fees.

Consulting fees on the EZstore project are down significantly.

And as you might expect, we did not incur the level of expenses associated with Sarbanes-Oxley compliance.

We continue to show some leverage on store labor expense as we called out in the fourth quarter.

The decrease in interest expense for the quarter from 8.4 million in '04 to 6 million in '05 is primarily due to an increase in interest capitalized on distribution center construction.

The Company's effective tax rate for the quarter was relatively flat with last year's first quarter.

The rate in the recurring quarter was high are than our estimated expected annual rate of approximately 36.9%, due to an adjustment made in the quarter relating to 2004 foreign taxes.

Our total merchandise inventory balance of $1.47 billion at April 29, 2005 is an increase of about 14.8% over last year's first quarter level.

Inventory turns remain consistent with last year at about 4.

While, we still believe our inventory is too high and continue our efforts to bring inventory levels down on a per store basis, we are narrowing the gap and frankly, we are satisfied with the progress we have made so far this fiscal year.

Cash capital expenditures through the first quarter of '05 were 65.1 million, relating to the opening of 255 new stores, including seven Dollar General Markets and progress in the implementation of EZstore, as well as various distribution, transportation and systems related projects.

We repurchased approximately 1.2 million shares of our common stock at a total cost of $25.1 million during the quarter.

So, as of the end of the quarter, there are 8.3 million shares remaining under the current 10 million share authorization that expires in November 2005.

In April, the finance committee approved a 10B51 plan, which became effective last week, that will allow us to repurchase shares in periods where we may not have been able to.

Now I will turn the call over to David Perdue and he will give some more comments about our business.

Good morning, everyone.

Thank you for calling in this morning.

As David said, we had a rather mixed bag of results in the first quarter.

The sales mix was tough but we were pleased with our total sales and our same-store sales performance.

We stayed focused on our customers and on the initiatives we have underway.

Unfortunately, as we feared, the economic situation did not improve for our core customers during the quarter.

As a matter of fact, during much of the first quarter, they faced the highest gasoline and fuel costs yet.

These factors dramatically impacted their discretionary spending and we believe this was the principle factor affecting our first-quarter '05 sales mix: Where we saw disappointing sales in our higher margin categories of apparel, home and seasonal.

Again, though, we were very pleased with our highly consumable sales increase which we attribute to our sales and merchandising initiatives.

Including the addition of coolers and EBT, better store instock levels and our ongoing efforts to stock our stores with the items our customers need most.

Specifically, we were pleased with such categories as candy, pet supplies, paper products, stationary, hardware, underwear and accessories.

So you can see our growth was not just in perishables.

We continue to leverage our store labor line but at the same time, we faced some expense challenges as David mentioned.

Some of these were planned or unavoidable.

Other were within our control, however, but not well managed such as markdowns, the cost of inventory services, rent, maintenance, a portion of our transportation cost and a few others .

We know we have to get on top of these, and we will.

We told you last quarter that reducing inventories by the end of the year on a per store basis will be a major focus for us this year.

We've made progress in bringing the increase in inventories more in line with sales and we expect to show more improvement in the second half of the year.

Improving our processes and execution of the stores remains our top priority.

And we are excited about what we are seeing so far from our EZstore efforts.

Over 1200 stores served out of three distribution centers have been converted to the EZstore process.

We are convinced that our EZstore effort will enhance our ability to manage our ever increasing number of small stores.

While EZstore changes the way we replenish our stores, it also has a dramatic impact on management effectiveness at the store level.

It is still our plan to have EZstore in about half of our stores by the end of fiscal '05.

Through the end of the quarter, we had opened 255 new stores, including seven Dollar General Markets.

And we are on track to meet our target of 730 new stores for the year, including at least 30 DG Markets.

While it is still too early to definitively evaluate the market concept and there remains some noise in the data, we continue to be very optimistic about the DG Market.

At the end of the quarter we had a total of 20 Market stores open.

We are making sure we test the concept in varying demographics and competitive environments and we are learning something new from every store we open.

We believe that because of the economy and also because of some of our initiatives including DG Market, we are also attracting new customers, including some from higher income households.

Our Jonesville, South Carolina distribution center is scheduled to start shipping in a couple of weeks.

This facility, like our other DC's is state of the art.

We expect usage of the Jonesville DC to ramp up quickly.

With all shipments exiting under the EZstore process.

Earlier this month, we announced that Marion, Indiana will be the site of our ninth distribution center, which we expect to have in operation some time in 2006.

Now let me address our outlook for next quarter and for the year.

For the second quarter ending July 29, we expect earnings per share of $0.20 to $0.23.

For the year, we believe that our previous outlook of $1.15 to $1.20, per share after you eliminate the impact of expensing stock options, which we included in our earlier estimate is still achievable.

However, after considering our lower than anticipated earnings in the first quarter, as well as our continuing concern over the potential negative impact of the economy on our customers discretionary spending, we believe that these results will be more difficult to obtain.

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

And we are closely watching key economic indicators to try to determine whether things are stabilizing.

Our core customers are still faced with high unemployment rates.

The data suggests actually that these rates are higher for our customers than the population as a whole.

Gasoline, fuel cost and rising personal debt continue to be an issue for many of our customers.

Having said that, because of these initiatives and investments, as well as the strength of our model, our vision for the future of Dollar General continues to be very optimistic.

We believe we must remain focused on meeting the needs of our customers.

We must continue to compete on price and convenience.

And we must differentiate ourselves.

I firmly believe we can accomplish these things and manage the changes and challenges we face.

With that operator we'll take about 30 minutes of questions.

Thank you everyone.

[OPERATOR INSTRUCTIONS] The first question comes from Stacy Turnof with Merrill Lynch.

Good morning, everyone.

Would you be able to comment if you thought that weather had been an impact on your sales of your seasonal and your apparel?

And maybe comment on how May has been going right now?

Stacy, good morning.

Thank you.

I can't really comment on May, but let me address the weather issue in April.

We are trying to learn more about the impact of weather rigorously on our business.

Since we do have a significant portion of our business this time of year in seasonal products, both in apparel and in our seasonal categories, we do believe that weather, particularly a later that normal Spring in many parts of our market area did indeed have an impact.

I - - we can't measure it yet, but we are - - we have an outside firm that we have engaged that is helping us try to manage this proactively.

In other words, we get forecasts two weeks, four weeks out and so forth by region.

And we are trying to use that to determine what we need to do in terms of our replenishment efforts to either speed up or slow down certain categories of merchandise.

But we do think it had a significant impact in the first quarter.

And the second question I have which is a follow-up to the gross margin weakness.

You mentioned in the last quarter conference call that part of the positive impact would be the conversion of your inventory accounting system.

And I hadn't heard you talk about that.

Could you give us some color on how that is impacting your growth?

Right.

Stacy, this is David Tehle.

We changed from 10 departments to 23 departments in terms how far we calculate gross margins.

So we are slicing it a little bit thinner than we were before.

And as we stated in the fourth quarter, we believe it is not a material change when you look at a full year, because of how the mix of product comes in and out of the various quarters.

There could be some impact in quarters where we have more highly consumables as we slice those areas into a few more margins; in different price point where you get a little bit more definition between the margin.

And our belief is that we did have some impact on first quarter from that.

Should you expect to see any positive impact in the following quarter?

Well, again, we believe that as you have more seasonal sales, which we'll hit later in the year, that it does average out for the full year, so you won't have a material impact in a full twelve month time period.

Great, thank you so much.

Thanks, Stacy

Thank you.

Our next question comes from Meredith Adler with Lehman Brothers.

Hi.

Actually it's Paula Plaskin sitting in for Meredith.

I just have a question again on the gross margin with regard to the higher margin category, the seasonal, clothing, et cetera.

How is the inventory situation going forward?

Are you still at risk for further markdowns?

Well, we have a program that we talked about last year in terms of our inventory efforts this year.

On a per store basis we want to reduce our inventory.

We have our normal level of budget markdowns in place, so we don't anticipate anything out of the ordinary there.

What we do have are initiatives in place for specific selling efforts around this inventory.

And also, we planned our buying accordingly this year.

So it is not just a one-dimensional attack on this issue.

Okay.

And second question.

What would you need to see in the second quarter and going forward to give you more confidence, again, about your ability to obtain the full year guidance?

Well, I think, Paula, that is a very good question and it's one we're focused on right now, as you might imagine.

We are not sitting back and waiting for the weather to get better or for people to begin to spend discretionary dollars again.

What we are trying to do is proactively look at what is working right now and get behind those categories.

We've got a number broad categories within our mix that are doing quite well, actually surprisingly well.

And we think that we can put more fuel to the fire behind those categories.

So, I think we would have to see a couple of things.

One, I think we are very focused on our apparel at home right now.

But I am also very hopeful about our seasonal product that we know is out there and that is coming in.

Particularly as we get into the summer months.

So I think more than anything else, we're trying to address and adapt to what is being needed and desired right now and manage the back half of the year with regard to our purchasing accordingly.

Great.

Thanks very much.

Thanks, Paula

Thank you.

Our next question comes from David Cumberland with Robert Baird.

Good morning.

Can you update us on where you stand on the rollout of coolers and EBT acceptance?

How many stores for each of those?

And then has the EBT acceptance had more impact on your sales lines as that has ramped up?

Yes, David, good morning.

Thank you.

This is David Perdue.

Yes, we have about 92% of our network with coolers.

And basically, only stores that don't have coolers have some type of lease restriction or something like that that precludes us from doing that.

About 86%, was the last number I saw, that might be a little low actually, but I think about 86% of our total network today has EBT.

We are still seeing - - we still feel, David, that it is early days in both of these, EBT especially, given that we haven't really advertised that and that's a negative.

I'd like to say we have, but we from a budget standpoint, we just haven't done that.

So, we still see that people are beginning to learn about the fact we have EBT products and we have that service.

The cooler items are doing quite well, and we are very pleased with what's going on with our coolers.

And we are learning again, the merchandising challenges within those and the opportunity.

So, we are quite pleased with that effort right now and it's helping us dramatically.

My only point is our 13% growth rate is very pleasing overall.

The mix hurt us a little bit in first quarter obviously.

But I am very pleased with not only what is going on in coolers but in some of these other consumable categories as well.

Our dilemma right now is to get back on seasonal, home and apparel and get those things moving again.

Thank you.

Thanks, David

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

I'm wondering on the SG&A side, based on the fact that you did a 4.9% comp, I would have expected some leverage.

So is it - - should we think about it more 5% to 6% of where you would leverage those expenses?

And what can you do specifically with regard to rents?

I understand utilities, because of where energy costs are but what about rents?

What can you really do there to make adjustments, if anything?

Thank you, Christine.

I am in your camp.

I am going to - - basically the issue is this: We don't have to comp up much higher to leverage these expenses.

We had some expenses in the quarter that I don't - - that I am not happy with.

We spent more than we had planned on our inventories.

Now, that's good news.

That will come back us to later in the year, and we are getting - - that's part of our inventory efforts and so forth.

We're accelerating some of those this year but we could have managed that a little bit better.

I think with regard to rent, we have a number of issues going on.

One is productivity in new stores.

We have a lot of new states right now - - new stores in new states.

They are coming up very nicely.

I think that helped - - that hurt us a little bit in first quarter with regard to that line item.

We had a little higher than normal accounting charges.

None of this is basically material or we would have called it out, but it is death by 1,000 swords, if you will.

So there are a number of minor items in there.

Utilities is one we are looking at right now, as well as repairs and maintenance in our stores.

Now, we have an effort underway to clean our stores up but we also have a budget for that.

And I expect our management team to live within those budgets.

So we are - - I wouldn't say we had a stellar quarter with regard to our expense management.

I think it is as much that, Christine, frankly, as it is that we just didn't grow enough.

With 4.9 comps in this environment, I am delighted with that.

But I am not happy with it across each of the 23 categories we measure right now obviously.

I am sorry.

I am not sure I understand what you mean by the overspending on inventory.

That would be in your cost of goods, right, not in your SG&A?

No, our inventory services cost is in SG&A.

What he's referring to is the cost of taking physical inventory, and the timing of how many inventories we took and what the complexity of those inventories in the first quarter versus how they were budgeted for the full year.

Sorry, Christine, I didn't make that clear.

No, thank you for clarifying because I wasn't following.

Thanks.

My fault.

Thanks, Christine.

Thank you.

Our next question comes from John Harlow with Barrow Hanley.

Good morning.

Last year - - you usually have in your quarterly reports a computation of return of capital.

Last year you showed rent expense at $256.9 million.

This year you show for the same quarter 226.6 million.

Why the difference?

John this is David Perdue.

I will let David Tehle - - he is looking up the number right now.

We don't have to answer it right now.

You can come back offline.

Well, why don't we do that John?

Why don't we call you offline because we need two schedules in place for you.

There's an answer.

Imajo and Dave are talking about it right now.

Let us call you back at the end of the call.

Can we do that?

Absolutely

Thank you.

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

Hi, David, I was travelling around some stores and I happened on one that had some pretty interesting merchandising I hadn't seen in other locations.

It had a nice assortment of hard covered books at discounted prices some nice looking small appliances, pool assortments.

It even had some fireworks.

And I was just wondering, what is the approach right now with some of these new merchandising areas?

I haven't seen it consistently in all the stores.

Ed, I don't know which store you were in.

Some of that merchandise sounds a little alien to me.

But what we are doing is obviously we have a planagram system.

We also have an increased effort in opportunistic purchasing.

So you're going to begin to see some products in certain stores that may not be network-wide.

We are testing certain new items, particularly in partnership with some of our major vendors.

We are testing some new SKU's around.

So you may be seeing some of that.

But it sounds like the merchandise you are talking about may be the result of some of our opportunistic purchasing.

Sounds good.

And then you mentioned some noise in the numbers from the DG Market's results.

I don't know if you can elaborate on that?

Sure, I would be happy to, Ed.

What we are seeing right now is that the stores come up very nicely.

We have enough in the line right now, but they are so immature.

This is why I say noise.

One month we think we have a handle of what it takes to do a certain thing from a cost standpoint and the next month it goes up.

The following month it comes down.

We have some stores that are doing very well in some categories.

Some stores not doing quite so well.

So, we don't have that consistency right now across the network.

And what we are testing frankly, is how these stores are - - how people react to these stores in different areas.

We put them next to some of our large box competitors and then we go out in the rural areas.

So we are testing different things.

And so it is hard to generalize right now other than to say, I personally am very excited about it.

I still continue to be happy with the revenue out of it and the traffic.

And the research that we are getting back is beginning to indicate that a large number of our - - or a large percentage of our customers coming to the Dollar General Market concept are using it as a primary destination.

Now, as you know, that's not true for our normal stores.

And so we're trying to learn what that's all about and how to really take advantage of it.

But the other things - - I think - - we're working on the profitability and we are working on the mix.

And those things will continue this year as we learn how to really utilize this concept.

But I am excited about it.

We are going to stay behind it.

And we have every intention of delivering on the committed 30 stores this year.

Great.

Seems like a great consumer proposition.

I hope it will be, Ed.

Thank you.

The next question comes from Michael Baker with Deutsche Bank.

Hi, thanks, guys.

Two quick questions.

One, it looks like to get to that $1.15 or so, you do need to see some better margins later in the year.

Is that in your mind just from a combination of better expense control and this gross margin hit from the accounting coming back in your favor?

Are those what you are sort of thinking about in order to improve on the operating margin year-over-year?

And then my second question is just on pricing.

What are you seeing?

Is there any opportunity to do some zone pricing or raise prices in some areas?

Thanks.

Yes, Michael, great question.

And, yes, that's at the heart of our year actually.

When you look at the timing of margin, fourth quarter for us - - if you look back at last year, for example, obviously our margin is historically been a little stronger in the back half.

We will - - we hope we will get a little bit of this accounting voodoo, here if you will.

And the number of category changes could benefit us in the back half if the seasonal product comes in as a higher percent of the mix as it has the last few years, which we are hoping for.

I think the other thing is, we've got to manage quarter to quarter.

And we did this last year, we did it the year before, and we are on it this year: And that is managing expense control quarter to quarter, looking though at the mix of product out into third quarter and fourth quarter to accommodate and make sure that we are fully in stock behind the categories that are in demand.

And we are prioritizing it at the store level.

That's something new this year that at the store level, we have much more granularity and detail around where we drive profit at the store level.

So, the store managers are beginning to be educated about which products, which SKU's are important.

And we are driving that from the Corporate headquarters down to ensure that everybody is focused on items we are trying to drive.

So, if I can just jump in with follow-up there, so it sounds like you say some of the weakness in the margin categories is more because you seem to have the right inventory and less an economic situation?

No, I don't think so, Michael.

I wish I had the answer to that.

That is every retailer's question is; how much of it was our fault and how much of it was just in the market.

But I do think that discretionary spending continues to be under a lot of pressure.

I am always critical of our offerings and so forth to make sure that we are doing the best we can to put the product out there and it is a mixed bag.

Not all of apparel is doing poorly.

Some categories are doing very well.

Underwear, for example, and accessories are both doing quite well.

Home continues to be a problem area and then seasonal surprisingly - - I think seasonal has been impacted more than some of the other areas by a maybe little later than normal spring and other things because the SKU base looks pretty good to me.

When we look at the back half, I am excited about some of the new products I know we've purchased and that are being made as we speak and they'll be on the water soon coming to us.

So, I am optimistic that we made some significant changes in our offerings, that we haven't seen and won't see until the back half.

Let me answer the other question about pricing.

Every year, we have pressure on pricing.

We have a little bit more than normal pressure this year on price pass-throughs by some of our vendors.

It is not a crisis, it is not material at this point.

But I think it is one that we are paying a lot of attention to.

We will have that normal pressure like we have had the last couple of years.

I don't think zone pricing is going to be in the cards for this year.

We are doing everything this year to prepare for it both strategically and from a systems point of view tactically.

But I really think that is going to be an '06 issue as I have called out.

And I don't think that we can pull it forward in '05.

Great, thanks a lot.

Thank you, Michael

Thank you, our next question comes from David Mann with Johnson Rice.

Good morning.

David, can you talk a little bit about the higher IMU you saw?

That had, I guess, been a driver in recent quarters, sort of one of the first things you talked about.

Has that slowed up a little bit this quarter and what are some of the factors behind it?

This is David Tehle.

I will take that question.

You are talking about our purchase markup?

That's correct.

Yes.

We mentioned in fourth quarter, there were several factors that relate to that in terms of our merchandising area and our purchasing and a variety of things that we're doing.

And, yes, I think we continue to see those same things as we are in the first quarter too.

So I - - it is the same factors that we talked about on the last call continuing forward.

I don't think there are a lot of changes overall in that.

Yes, our issue on the gross margin wasn't on the IMU in the fourth quarter, it was clearly on mix.

And then on the shrink issue in the gross margin, is it just a function that you are getting that down through the higher shrink stores that you said?

Or is the EZstore playing some role in that rollout towards, - - that plus the clean-up of the back rooms toward taking the shrink down a little bit?

Good question, David.

I don't know how to quantify this but I will give you a subjective opinion on it.

Two years ago we put an initiative in place and really started focusing on shrink.

Part of that is we identify our worst stores.

And we really attacked those in a little different way.

One of the ways we do this is that early in the year we look at our problem stores early in the year.

So that's somewhat of what is happening in the first quarter.

So, when you see that operating shrink improvement of 32 basis points, a larger-than-normal mix of that will be some of our problem stores.

So that's either good news or bad news.

We think, though, that those stores have shown dramatic improvement.

Well, we know they have.

But there is also another - - we look at the overall mix as well.

And the overall mix of stores is improving as well.

The EZstore principal, at 1200 stores is probably not broad enough to have had a significant impact in the first quarter.

However, when you pay a lot of attention and do the things we're doing in the stores, one of the derivative benefits, we hope, will be shrink.

Because people have a little more time to focus on it, pay attention to it and they certainly know it is a priority.

So, I think it is a little early to say that EZstore has had any direct benefit.

But, you know, long-term, I am still convinced that it will have some impact on shrink.

Great, thank you.

Thank you, David

Thank you, the next question comes from Michael Exstein with CFSB.

Good morning, everyone.

Hi, Michael.

I was wondering whether you could give us a little bit more clarity on some of the issues in terms of order and magnitude of things that back up your SG&A?

Particularly things like transportation costs and utilities?

Thank you.

Yes, thanks, Michael.

Utilities, were a problem for us late last year with fuel costs and so forth.

My stress over this is that we budgeted not long ago, and yet we had a little bit of a surprise in first quarter.

Now, we've got more northern stores, and we've got stores out West that we didn't have over the last couple of years.

But this is one we are dealing with right now.

I don't have a direct answer for you other than it is weather and fuel related.

I can't quantify it for you.

I think with regard to the other issue that we are facing or working on is, maintenance in the stores.

Repairs and maintenance were one of the other callouts that we had in the quarter.

We are focused on these stores trying to clean up some of the stores.

But we have budgeted dollars to do that.

And I think that what we have is a timing issue on some of these discretionary spends in the first quarter that we know we can manage in subsequent quarters.

Under the magnitude of them, if that was your question, in the press release, clearly the rent was the largest magnitude item there.

And then by the way, the transportation actually hits our margin, not our SG&A.

Can you talk about that?

Yes.

Let me address that.

Mike, obviously we put a budget number in but as we - - for the year.

And as we saw fuel prices, particularly diesel in the first quarter were actually higher than - - they reached some of the peaks that they've had in the last 18 months.

The second thing is, we have some new outlying stores and some of these stores came on a little earlier actually.

And that might have affected the stem mile number a little bit.

But I think the biggest driver in there is really the fuel issue.

Your most comparable competitor has suggested 30 to 40 basis points.

Is that order of magnitude reasonable for you all?

I don't know.

I am not willing to say it is that much, Michael.

There are some things from an efficiency standpoint.

We are trying to become more efficient in our transportation network.

We are adding DC's.

That helps us.

And as we do that, these things we should be able to have some successes in.

But to quantify it right now, I just - - I am not qualified to do that, Michael, I am sorry.

Thank you.

Thank you.

Thank you.

Our next question comes from Bill Matthew with Addage Capital Management.

Good morning, guys.

Good morning, Bill.

Just a quick question and forgive me if you already mentioned this.

But you've talked a little bit about the impact of rent on the SG&A.

I wonder if you can drill down a little further and quantify whether that was due to surprises in renegotiations or anything of that nature?

Or whether it was just you guys had not calculated the timing of certain stores opening and therefore, hitting the P&L in the first quarter?

I am trying to understand how something that is a fairly long-cycle cost could have surprised you.

That's a great question and it should not have surprised us frankly.

There were a couple of things that I won't get into that were understandable.

Obviously we have deep dialed on this thing.

And I think that as you'll see in the future quarters we're - - this is going to be - - we are on top of the things that did surprise us.

It's not that the total rent line surprised us but some of the minor issues in there.

One of which was a simple accounting issue when we looked at the timing of when some of these new stores were coming on.

But again, that is one that we should manage and know about.

So, I think that was probably one of the bigger contributors to it frankly, Bill.

And so that cycles forward over the next three quarters as well?

Is that sort of - - you adjust the timing, if you will, for your new stores going forward?

It should come back to us a little bit, but it is still going to be an issue as we go through the year I think.

But we are managing.

I think that some of this will come back us to.

Some of it is systemic in the year.

The timing certainly will come back to us.

Okay.

Thank you.

Thanks, Bill

Thank you.

The next question comes from Jim Chartier (ph) with Buckingham Research Group.

Good morning.

I was just curious, what percentage of new stores are stand-alone buildouts versus leases and existing real estate space?

And what if any impact did that maybe have on higher rent expenses?

Thanks, Jim.

That mix does change and does have some impact on it and that bleeds up and down through the quarters.

That is one of the ones I wasn't going to get into the detail.

But since you called it out, I will respond to your question as trying to be totally transparent here.

I think - - we're - - last year, we were in the 70% range of build-to-suits.

This year we were generally wanting to be in that range.

And I think we will be but I think overall, we are higher than that in the first quarter.

The number is significantly higher than that.

And one the issues with rent in the first quarter is the direct derivative of that.

Now, that's good news frankly because we like what's happening in these stores or we wouldn't be building more and more of them.

They are a little bit more expensive as they come out of the box.

But long term, they really do - - they do perform very well.

So, I am not saying that is going to be the new policy or the new strategy for us but I do like having a healthy portion of our new store mix in these build-to-suits.

It helps us brand better.

They look better.

They are easy to maintain.

They are a little more expensive coming out of the ground as a percentage of sales.

But they catch up fairly quickly but that did impact us in Q1.

Okay.

And then I was wondering what comp assumptions are you using for second quarter and for the full year?

Jim, I - - they won't let me comment on that.

I am sorry.

I would love to, but - - let me just say.

Comp sales are very difficult as everybody - - as you can see from everyone right now.

I am happy that we are competing and that's all we try to do.

I am looking at it over the last two years and comparing how this rolling average is doing and quite - - right now quite frankly from my position, I am pleased with our performance there.

What I think we can improve on, Jim, candidly as we go through balance of the year; is comp sales and categories that have been systemically tough for us for the last three or four years, like home.

And you're - - I just - - I am calling that out now just to emphasize that we are going to be really focused on those areas that are not performing well in Q1.

Operator, this is David Tehle.

I am going to jump in and answer John's question from Barrow Hanley that he asked on ROIC.

John, are you still on?

Well, he can't respond.

Our ROIC, of course, is considered a non-GAAP measurement.

Let me say that first of all.

But difference that we had is we made a change in how we were treating CAM charges and insurance charges last year.

We had it in part of the rent expense and we pulled it out.

So that's where the difference is.

And I believe we made that change in fourth quarter of last year to ROIC because we believe that is a better representation of what ROIC should be.

So that is what the difference is if you look at April 30 last year versus this year and we - - that's the change.

Next question

The next question comes from Mark Miller with William Blair.

Hi, good morning.

I am trying to reconcile the strong improvement in the average ticket with the adverse merchandise mix in the first quarter.

And I am hoping you can comment on that.

And then as it relates to that, what are you seeing with cooler purchases?

My understanding is you were seeing a nice increase in the discretionary or general merchandise product when somebody was buying a cooler item.

Has that continued as you saw it before?

Thank you, Mark, this is Perdue.

Yes, we had the same observation, obviously.

And coolers are having an impact and it continues that we do get a positive impact when people come in for a cooler item.

Those rings are higher.

They continue to be higher.

I think with regard to the shortfall, if you will, or the less than spectacular performance in some of these other discretionary areas, I don't think that coolers had a dramatically positive impact to offset the lack of performance there.

But the cooler items themselves are becoming more consistent in terms of their performance week to week.

And the consistency is still there with regard to their impact on the ring.

Can you talk about how you are planning inventory orders for the holiday season?

How you are planning some of these discretionary categories as they have been coming in weaker than what you thought?

I think for holiday - - Mark, it's a good question.

It's one we are dealing with.

We are in here worrying about back-to-school and 4th of July promotion areas and that sort of thing.

But I think, what we are looking at now - - it is hard to generalize, so I am going to answer it this way.

We are looking at each category individually, we are looking at our inventory open to buys.

We are looking at the performance.

And we are looking at the region of the country too.

We have that visibility now.

So that we can begin to look at how we are anticipating the performance of an individual category.

So it is hard to generalize.

But we are still optimistic.

I mean, I still see that discretionary is under great pressure.

I will call out that we are getting an ever increasing number of new customers, we think.

And we just don't know how to quantify that yet.

And we know that is having a positive offset to some of these other problems.

As it relates to holiday, it is too early to really tell but we are going to be focused on each of these category items even at the SKU level to be sure that we have the things that have the most probability of giving us a good holiday effort.

Okay.

Final comment and a question within it.

You reduced the level of disclosure in this quarter related to the category trends.

And I mean, it doesn't seem like it would be for competitive reasons because you ultimately give us at the end of the quarter.

But I guess my comment is, that it makes it more difficult to understand that merchandise mix as you go through the quarter.

Would you consider providing more granularity on a monthly basis as you had before?

Thanks.

Sure, we will consider that.

Mark, it is a good question.

We talked about it even this morning.

I am sort of the one that is putting the brakes on that.

We will talk about that because you are not the first one that has asked that question.

And we do come clean at the end of the quarter with regard to sales.

They move around a little bit quarter to quarter - - or month to month rather in the mix, but I don't have any great reservation.

We will talk about it.

I think it is fine that you don't have quarterly guidance, that's great but it would help people get to the number easier.

Well, Mark, actually this year we do give quarterly guidance at least one quarter out.

Now, we don't give it each quarter for the next four quarters.

But we're trying to give a little more visibility into what we think is to be projected for the next quarter.

But we will talk about this - - the detail on the sales mix.

Great, thanks.

Thanks, Mark

Thank you.

The next question comes from John Harlow with Borrow Hanley.

I have two two-part question.

Thank you for coming back and answering the question about the rent.

You are welcome.

I think you called it CAM charges.

Can you tell me what CAM stands for?

Common area maintenance.

Okay.

Let me ask a question.

People are trying to ask the question about the rents as a percent of sales in 100 different ways.

Let me try one hypothesis, because this has been ongoing for maybe six or seven or eight quarters.

Could the rental expense be higher because the cost of building a new store et cetera is going up, construction costs et cetera?

No doubt.

No doubt.

Okay.

If you can go to a zone pricing format, wouldn't that address that?

Aren't you going into some states where - -

Yes.

- - where taxes and construction costs are higher?

Well that's it, John.

When we open up these new states, you do have some higher construction costs, higher real estate costs, some fees, state fees, et cetera, et cetera.

And zone pricing does give us - - will give us potentially, the opportunity to offset some of that .

And yes, I think that is part of what you are seeing.

As we expand the territory we have another variable coming into that line.

I hate to call it out because we should be able to manage it and the way you manage it is you put zone pricing in.

So, we are trying desperately to get that in here.

I want to make sure though, John, that we don't just knee-jerk and put a very naive zone pricing strategy in.

So, we are working on that right now.

We have one last systems thing to put in place the back half of this year.

And then '06, we fully plan to implement zone pricing.

But it's a great callout.

Can zone pricing actually applied to a specific store within the same area or state?

In other words, if the cost of construction is different and returns to - - and returns a different on assets ie. new or higher cost construction has higher rents; than the pricing for that store needs to be different than it is something you have used or had earnings from that's six years old?

Well, I agree.

I agree.

But I think if you look at best practices out there and look at how other people do it you can learn a lot.

Some people do it at the store level and give the store managers a lot of freedom to change prices to meet local competition.

I don't see us doing that.

The other - - at least initially.

And longer term, I think what you are going to see is more in a regional basis.

And the reason for that is we don't want the price of bottled water to be one thing in one store and six blocks over it be another cost, just because it is a build-to-suit store.

Right.

So, there are some of those things no matter what you do you're going to have to average across the network.

But I do think within - - it just won't be a state issue, it will be a location issue in many regards.

So we're - - that's what I am talking about right now.

Those type of questions are what we are in here working on feverishly this year.

Good.

Thanks, John.

Operator, we have time for one more question.

Thank you.

Our last question comes from Dan Kerrs (ph) with DK Equities.

Good morning, gentlemen.

Thanks for the call.

I wonder if you could give us some numbers?

You mentioned did you have some store leverage, store labor leverage at the SG&A, but I don't think I heard any quantification.

Could you give us any help on that front?

And I am sorry if I missed it.

Dan, thank you.

This is David Perdue.

I will fall on my sword on this one.

But we - - I just don't want to give the detail on that.

That is just too much detail.

And frankly we have some things going on in our labor management that I think are very competitive - - give us a competitive advantage candidly.

So this is one I want to hold on to.

I will say and we did call out last year, that we are leveraging the store labor line.

Okay.

For - - in a related sense, over the last few years and since you all have been on board and be driven this effort to expanding this store footprint and better managing of inventories and the like.

One the things that has proven elusive is SG&A leverage and you also obviously need to address shrink and better instocks.

I am just wondering at what point do you see better SG&A leverage coming?

I know you addressed part of it earlier in the call.

Or perhaps said differently, if SG&A leverage proves elusive, will this strong buildout - - maybe the assumptions on the buildout part of it need to be revisited or at least examined.

People have mentioned the higher cost to real estate and the like.

Said differently, would it be possible to look at this with less aggressive store expansion and perhaps have a better ROI as a result?

Well, yes, we could harvest the Company.

Dan, there is no question about that.

We could stop making these investments.

I can clean up this SG&A and I would look like a hero on the P&L for a short period of time.

We could slow down store growth.

We can clearly - - it is an absolute valid possibility to convert into a value stock.

Frankly, with the opportunities that we have out there, we have chosen that is not our future.

We believe that the growth opportunities are significant and they are out there.

I will call out that our SG&A is actually lower than some of our direct competitors.

But even with the SG&A you are looking at right now and you are very correct.

We have not leveraged it in the last two years.

I think when we get through some of these major investments like EZstore and so forth that we will begin to see leverage at the SG&A line.

But right now what I am trying to do is manage this margin line, manage the revenue line.

And then make sure that we are investing in absolutely the right things as they impact both our balance sheet and the SG&A line.

So I think it's premature - - it is a great question, and we are - - we have a budget in place.

We want to live to that budget obviously.

But I don't think that with the investments that we are making right now;

I want to back up from this growth strategic effort that we have put in place two years ago.

Okay.

Thanks.

Could I ask one related question as well?

In-stocks in general, I think you sort of mentioned that you couldn't pinpoint them as any reason for any kind of weakness in same-store sales growth in some of your higher margin categories, in other words, they were good.

Yes.

The instocks remained very solid, Dan.

They vary a little bit from category to category, as you might know.

But I would not pin the lack of performance on out of stocks.

Two years ago I might have done that and even last year in some categories.

But certainly this year we were in stock, the stores were replenished, they looked good for the most part.

And I don't think that was a significant contributor this year.

And you also mentioned a procurement shift more towards the Far East as you were below the average retailer on this.

Can you quantify what percent of cost of goods sealed is procured overseas at this point?

Well, we are still in the mid-teens.

We have said that before.

Whether it is 15 or 16, I won't - - I don't have that number in front of me.

But it is not over 20, for sure.

And, yes, we are trying to increase that purchasing effort in Asia.

To that end, we opened an office last year.

It became effective and it is contributing very well right now.

It is operating very efficiently and it's helped us find new product as well as getting good prices.

So, I am very pleased with that effort.

We have integrated the whole supply chain now internally.

So we are beginning to get efficiencies there.

And yes - - but that is one of our core strategies going forward is the increase, the penetration of source - - direct source product in our mix.

And finally, David, if I can ask one thing for clarification?

I must admit I could not attend your Analyst Meeting.

But perhaps others would benefit from this as well.

The new inventorying system that - - the EZstore concept and the better delineation of inventories and the better - - well, atomization is you will: Can you tell me how that could cost or push down the gross margin?

Doesn't it have to do with the shrink and accrual assumptions taken on the finer atomizations of the various items?

Let me take that question.

You've got a couple of concepts going on here.

I think the issue that we talked about earlier in the call was we went from 10 to 23 departments.

And when you slice things thin or you get a little different margin, particularly at the higher margin and the lower margin items.

So, when you have a quarter that has more lower margin items you can get an impact on the margin.

And that is just a change in the way we do our accounting.

It really doesn't have anything to do with EZstore.

Okay.

I am sorry.

I used the wrong expression.

I meant to refer to the shrink assumptions that you build in to the 23 categories.

Well, as I said, EZstore we think will have a derivative impact on it.

But right now, I don't think that the EZstore efforts had a dramatic impact on shrink.

I'm very pleased by the way with the reduction in the first quarter.

We are a long way away from where I want to be for the entire network.

And I hope that answers your question Dan.

Thank you very much.

Thank you operator.

Thank you everyone.

Thank you.

You may now disconnect.