達樂 (DG) 2005 Q2 法說會逐字稿

This is the Dollar General Corporation second quarter 2005 earnings conference call on Thursday, August 25th, 2005, at 9:00 a.m. central time.

Good morning, ladies and gentlemen, and thank you for participating in today's conference call.

This call is being recorded by Conference America and CCBN.

Federal law dictates that no other individual or entity may be allowed to record or rebroadcast the 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 request that you listen to the following statement regarding forward-looking and nonGAAP 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 third and fourth quarter same store sales, anticipated third and fourth quarter and annual earnings per share, the expected annual effective tax rate, 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 these assumptions could be inaccurate and therefore actual results may differ materially from those projected 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 28th, 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 the 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, and the public disclosures or documents filed with the SEC.

In addition, the Company may refer to certain nonGAAP financial measures including net income and EPS, each excluding certain income tax related adjustments.

The Company may also refer to return on invested capital, ROIC, which may be considered a nonGAAP financial measure, as well as ROIC and return on assets, each computed using net income excluding a restatement related penalty.

Reconciliations of these nonGAAP measures, the most comparable GAAP measures along with the management's reasons for referring to these nonGAAP measures are included in their press release issued today, which can be located on the Company's website at www.DollarGeneral.com, by clicking on the Home Page spotlight item.

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'm going to review our second quarter financial results, update you on current operating initiatives, and outline our guidance for the remainder of the year.

David Perdue will then give his insights into the current state of business, as well as thoughts for the long-term.

This morning reported net income for the quarter of 75.6 million or $0.23 per share for the second quarter ended July 29th, '05.

That's compared to net income of 71.3 million or $0.22 per share in the second quarter last year.

If you will remember, however, the second quarter of '04 included some favorable adjustments to income tax reserves and related interest accounts, that resulted from the completion of some tax audits.

Excluding the impact of these adjustments second quarter '04 net income would have been 63.9 million or $0.19 per share.

So excluding these adjustments, this year's net income increased 18%, and earnings per share increased 21% over last year.

Sales for the second quarter of '05 were 2.07 billion versus 1.84 billion in the prior year.

That's an increase of 12.5%.

By category, sales of highly consumables were up 16%, Seasonal sales were up 9%, Basic clothing was up 7%, and Home Products were up 3%.

As was the case last quarter our largest sales increases were in the highly consumable categories, but we did show some improvement in other categories relative to the first quarter.

Same-store sales in the quarter increased by 3.9%.

Overall, we are pleased with our total and same-store sales increases for the quarter.

Particularly as we consider the impact of high gas prices and other economic pressures on our core customer.

The gross profit rate to sales of 28.6% for the quarter was down from last year's second quarter gross profit rate of 29.2%.

The decrease in the gross profit rate is primarily a factor of sales mix, which was skewed more toward highly consumables than in the prior year.

Conversely, the mix of sales of higher margin items in our basic clothing, home products and seasonal categories was lower than last year putting pressure on the gross margin.

As you would expect, our gross margin was also negatively impacted by higher transportation costs than in the prior year, primarily due to fuel expenses.

In addition, the gross profit rate reflects higher markdowns in this year's second quarter versus last year, as we focus our first store inventory reduction initiatives.

We've made good progress with inventory.

At the end of the quarter, total merchandise inventories were up only about 6% over the prior year.

This equates to a decrease of about 3% on a per-store basis.

Finally, as we noted last quarter and 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 negatively impact our gross margin.

For the quarter the impact of this change amounted to about 17 basis points or $3.4 million.

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

We still believe this to be the case, and I'll talk more about that in our guidance.

In the second quarter, we were able to leverage our SG&A expenses.

Reporting SG&A of 470.5 million or 22.8% of sales, versus 428.9 million or 23.4% of sales in the prior year.

This improvement reflects a decrease in store labor costs as a percent of sales, resulting from cost containment efforts including the Company's EZstore project, which has been fully implemented in 2,625 stores as of the end of the quarter.

In addition, the costs of counting physical inventories in the quarter were down from last year, due to taking fewer inventories in the quarter, and a lower average cost per store.

Third, our health benefits expenses were down, resulting from a decrease in the time lag used for estimating incurred but not recorded claims, or IBNR as we call it.

This change was based on a recommendation by our actuaries as a result of their review.

These benefits to SG&A were partially offset by an increase in rent expense associated with the Company's leased store locations.

We expect this trend in rent expense to continue for the remainder of the year.

The increase in interest expense for the quarter from 5.4 million in '04 to 7.3 million in '05 is primarily due to last year's adjustment to the interest-related piece of the reduction in income tax liability.

The Company's effective tax rate for the quarter was 34.8% compared to 31.5% in last year's second quarter.

As I discussed earlier, there were some favorable adjustments to income taxes in last year's second quarter.

The current quarter rate is lower than our previous estimate for the year, which was 36.9%, and our expected ongoing rate of 36.1%.

This is due to the impact of some state investment tax credits associated with the construction of our new DC in Indiana, and the impact of an internal corporate restructuring.

For the 26-week year-to-date period, net income was 140.5 million in fiscal '05 or $0.43 per diluted share compared to 139.2 million or $0.42 per diluted share in the comparable prior year period.

Excluding the effect of the income tax related adjustments I described earlier, net income for the prior year 26-week period would have been 131.7 million or $0.39 per diluted share.

Year-to-date net sales increased 12.8% including a same-store sales increase of 4.4%.

As a percentage of sales gross margin for the year-to-date period was 28.6% in '05, compared to 29.3% in '04.

The decrease in gross margin is primarily attributable to a decrease as a percentage of sales of higher margin categories, and a 17 basis point or $6.7 million unfavorable impact, resulting from the expansion of departments used in the gross profit calculation that we had discussed earlier.

We also had increased transportation costs, primarily resulting from higher fuel costs.

Our year-to-date reported shrink rate calculated at retail was 3.12% compared to 3.18% last year.

So far this year, shrink on a like-store basis continues to be lower than last year.

As we noted last quarter most of our high shrink stores are counted early in the year, so the year-to-date results may not be indicative of the results for the year.

SG&A expenses for the year-to-date period decreased as a percentage of sales to 22.9% in '05 from 23.1% in '04, primarily resulting from decreased store labor expenses and lower health expenses that I discussed when we talked about the quarter.

We also had a reduction in external consulting fees, related to the EZstore project, and our initial efforts related to Sarbanes-Oxley compliance.

These benefits were largely offset by increased rental expense as a percent of sales.

Our total merchandise inventory balance at July 29th '05 was 1.46 billion.

That's up about 6% over last year's second quarter level, and down about 3% on a per-store basis.

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're satisfied with the progress we've made so far this fiscal year.

Cash and capital expenditures through the second quarter of '05 were 139.6 million, primarily relating to the opening of 438 new stores including $15 general markets as well as the rollout of EZstore, and the completion of our South Carolina DC in June.

We are on-track to meet our target of opening 730 new stores this year.

We continue to be pleased with the initial results of EZstore, and we continue to expect to have EZstore in about half of our stores by year end.

About 3700 stores should be on EZstore as we go into the busy holiday season.

Year-to-date, we have repurchased approximately 8.4 million shares of our common stock at a total cost of $172.8 million.

So at the end of the quarter, we had about a million shares remaining under the current authorization that expires in November of '05.

Now I want to share our outlook for the rest of the year, but before I get started, I want to clarify that we believe the current circumstances warrant more guidance than we customarily give.

We are not setting a precedent here, so you should not expect this level of detail every quarter in the future.

I'll start out by saying, like everybody else in our sector, we're concerned about the impact of high gasoline and fuel prices on our customers' spending, and on our operating expenses.

We also, believe, however, that we have taken some steps from a merchandising perspective, as well as cost control initiatives such as EZstore, that help mitigate some of the impact.

For August, our same store sales are currently estimated to be in the range of 0.5% to 1%.

We're disappointed in this expected result.

We believe that consumer discretionary spending has been greatly impacted in August, due to the combination of high gasoline prices, and aggressive Back-to-School marketing and discounted pricing by our competitors.

We're hopeful and optimistic that sales will rebound somewhat in the remainder of the quarter and the year.

Same store sales are currently estimated to be in the range of 1 to 3% for the third quarter, and the range of 2 to 4% for the fourth quarter.

Based on these sales assumptions, we expect earnings for the third quarter ending October 29th '05 to be between $0.19 and $0.21 per share, and that's including an estimated negative impact of $0.02 to $0.03 per share resulting from the expansion of the number of departments used in our valuation of inventories.

Note that the impact of the expansion of the number of departments in this calculation is significantly higher in the third quarter than we've seen year-to-date.

This is because the third quarter is most affected by the timing of high margin receipts in preparation for the holidays, versus the timing of sales of this merchandise closer to the holidays in the fourth quarter.

Additionally transportation costs are expected to negatively impact earnings as the Company has its heaviest shipments in preparation for the holiday season.

We currently expect earnings per share for the fourth quarter which includes one more week than the fourth quarter of '04 to be in the range of $0.53 to $0.55.

Included in this estimate is a favorable impact of approximately $0.03 to $0.04 per share, resulting from the expansion of departments used in our inventory calculations, so we finally see this turning positive in the fourth quarter.

Consequently, for the 53-week year ending February 3rd 2006, the Company expects to report earnings per share of $1.15 to $1.19.

With that I'll turn it over to David Perdue for his comments.

Thank you, David and good morning, everyone.

I'll start by saying that I'm very pleased with the results of our second quarter.

Revenues were up 12.8%.

Same-store sales were up 3.9% for the quarter and 4.4% year-to-date.

Some of the best results in discount retailing right now.

When you exclude the income tax related adjustment last year as David mentioned, earning per share was up 21% for the quarter.

Inventories on a per-store basis were down 3% from last year, but as David said, we continue to work feverishly on this issue.

As a result, cash flow from operating activities increased from 55 million to 199 million year-to-date.

So far this year, we've opened 438 new stores, ahead of last year's pace.

In the quarter we opened our eighth distribution center on-time and on-budget.

In addition, we've repurchased 8.4 million shares of our common stock so far this year.

I'm also pleased that we were able to achieve good expense leverage in the quarter and year-to-date.

We have worked very hard on this.

As you know, we have made significant investments in our infrastructure and those investments are beginning to pay off.

EZstore has dramatically changed the way we operate our stores, and we expect to continue to see improvements as we roll out EZstore and fine-tune our processes.

Again, I'm delighted in our results in light of the current difficult economic environment, and I am extremely proud of how our team performed during Q2 to achieve these results.

Of course, in this environment, we all recognize that we have challenges ahead for the remainder of the year.

August comp results are coming in low and we believe that is, to a degree, a result of other retailers aggressive Back-to-School promotional activity.

In addition, we expect our core customers' discretionary spending to continue to be pressured by high gasoline prices and unemployment.

Consumer debt continues to rise and as interest rates rise, this may become an even greater burden.

All of these factors put pressure on our sales and our sales mix.

In the face of these challenges, we remain focused on meeting our customers' needs and expectations.

We've added coolers that allow us to sell perishable food items and to accept EBT.

As we've always done, we continue to make merchandising changes that we expect to positively impact our overall results.

We're not assuming that gas prices will drop or even level off any time soon.

Instead, we are looking for ways to give our customers some attractive discretionary choices within her limited budget.

We've implemented some positive Plan-o-gram changes for the fall and the organization has mobilized for a strong holiday rollout.

Our merchandising team has enhanced our efforts in Pet supplies, hardware, and Home Decor, and we believe our new picture frame and candle offerings should also benefit us in the holiday season.

We believe that we're in a strong position as we can be, to face the back half of the year.

Now I want to talk about our future for just a minute.

We recently completed our annual review of our long-term strategic plan with our Board of Directors.

That strategic plan recognizes the opportunity we have for significant growth.

We're already seizing that opportunity through our investments in EZstore, Project Gold standard, the Dollar General market concept, and our distribution network just to mention a few.

By the way, I'm delighted with the progress we made in our store execution within EZstore.

We remain confident in our small box model.

While we are still studying the DG market model, I fully expect the market store to play a significant role in our future growth, and sometime in 2006 we should be in a position to begin implementing our zone pricing strategy.

In evaluating the additional potential of Dollar General, I look at the recent explosive growth of value discounters in Europe.

MBI estimates that European discounters generated about 133 billion in revenue in 2004, versus about 40 billion in the same sector in the U.S.

Some analysts estimate that value discounters in Europe take in as much as 33% of grocery dollars.

That number is just 2% approximately in the U.S.

The two Aldi companies, Aldi North and Aldi South, together generate more revenues than all of the U.S. small box value discounters combined.

Dollar General is the biggest American based company ranked among the world's largest small box discounters, coming in at #7 globally.

According to AC Nielson, the highest density of value discounters in the U.S. is in the East, South-Central U.S. reaching the same level of density in the rest of the country would require the addition of some 22,000 more stores according to Nielson.

We believe the European experience sheds some light on the opportunity for the sector in the U.S.

Because of that, we are committed to investing for long-term growth.

We also believe we have a significant opportunity to increase our share, from both our core low income consumer, as well as the faster growing segment of our customer base.

Those households that make over $70,000 annually.

We believe high gas prices are driving these higher income customers to seek out value.

We continue to invest in our people, with stronger hiring and training practices as the roles of our store managers and district managers become more important than ever.

Communications with the field have improved considerably over the past year, and our financial reporting at the store level has improved dramatically.

And we're adding more accountability as a result.

Year-to-date, 96 district manager positions have been filled. 65% of these were internal promotions.

We think this is a sign that we are retaining more of our high potential performers, and we're making a strong commitment to careers here at Dollar General.

We're also investing in our corporate organizations.

Last week we announced the appointment of Challis Lowe, as our EVP of Human Resources.

Challis comes to Dollar General from Ryder systems, and brings to our team extensive leadership experience in developing and retaining employees.

In addition, Rod West will be joining our supply chain team as the Vice President of Process Improvement.

A former senior manager at Kirk Salmon Associates, Rod comes to us with a broad perspective on the retail industry, and logistics in specific terms.

Also Monique Long will be joining Dollar General as Vice President of Global Sourcing, and will be located in Hong Kong.

She will help us further develop and implement our foreign sourcing strategy.

In conclusion, we're excited about the progress we have made year-to-date, and the direction in which we're headed.

We are committed to long-term sales growth through increased store productivity and geographic expansion, as well as gross margin expansion and expense leverage.

Our strategic plan is working, and we continue to work hard to compete more effectively even in this difficult economic environment.

We believe our model is more relevant than ever, and we have tremendous opportunities ahead.

With that, operator, we'll take a few questions this morning.

Thank you very much, everyone.

Thank you. [OPERATOR INSTRUCTIONS] The first question comes from Deborah Weinswig with Citigroup.

Thank you very much and congratulations on a great quarter.

Thank you, Deborah.

In terms of -- David, I thought your comments with regard to the European landscape and the U.S. landscape were very insightful.

Do you think there's anything going forward structurally that's different between the two that wouldn't allow potentially the hard discounters, or the deep discounters to achieve the same potential level of impact in the U.S., as they have abroad?

That's a great question, Deborah.

Thank you.

I've spent a little bit of my career in Europe and it's interesting.

The cultural environment around grocery consumption in Europe is different, quite different than that of the U.S., and I think that bears some consideration in the results over there.

I also think the dominance of Wal-Mart here, and the impact it's had on the blurring of our retail channels in the U.S. is also having an impact.

Who knows?

I mean, I don't have an expert opinion on that.

I can look at the opportunity, I don't know that we'll ever have that degree of penetration in grocery, but I do know that the convenience factor in Europe in a very mature retail market, is part of what's driving that over there.

You also have some government regulations, particularly in France, that dictate this to a degree, that we don't have here in the U.S.

So we're looking at that as, there are some great performers over there that we respect and we are looking at their best practices, and trying to apply some of that same expertise here in this country to compete.

But yes, I think we've got a good runway of potential growth.

Whether it will reach that degree of penetration, Deborah, I really don't know.

Seems like there's a huge amount of opportunity.

My last question is, in terms of as we think about fourth quarter earnings, how are you guys approaching from a modelling standpoint transportation costs, and do you see any difference in terms of what we've seen in the first half of the year?

Yes.

I'll take that.

You know, the difference we see is we've done some things under our logistics area, as you may remember, we brought in a new head of logistics in January, and we've got several projects that have been worked on throughout the year, that we think will come and give us benefit in the fourth quarter.

For example, we've been looking at examining traffic lanes and shipping procedures within the distribution centers.

We've been looking at our usage of less than truckload, converting to truckload.

We've been looking at different utilization of pallets and how these might be used differently to help us.

We've looked at the economic order quantity, and made some changes there.

We also have a project called dynamic order splitting, where we look at available trailer space, and figure out what we can do to maximize that.

We've also been balancing peaks and valleys within a given week, and trying to make the work flow a little more even in all the distribution centers.

And we believe when you put all this together, we will get some benefit out of that in the fourth quarter that will help us offset some of the negatives that we will see in the transportation expense, related to gas prices, because we are not modeling gas price to get any better in the fourth quarter.

Thank you very much, and once again congratulations on a great quarter.

The next question comes from Merideth Adler with Lehman Brothers.

Hey, guys.

Hey, Merideth.

Might just start to talk about a little bit -- you briefly touched on the change in the way you're accounting for certain health care costs.

Could you go into a little bit more detail how it works and how it saves money, and then is this change going to be something we will see benefiting you for the next three quarters?

Yes, I'll take that question.

Basically our actuary took a look at how we were accruing for incurred but not reported claims that were out there.

And the feeling was, we had too large of an accrual for that.

That's something that we try to take a look at and update every year.

So really this is more of a one-time change.

And going forward, we will accrue, obviously, a different amount.

We'll look at it a little bit differently.

I will say we have, knock on wood, we have seen our health costs be a little more controlled this year, the first half of the year, particularly as we compare to what we thought they would be, so we've also seen some benefit from that, but the change in IBNR is more of a a one-time change, and it was about a $2.5 million.

Great.

And my second question is about labor expense.

I was wondering, you talk about controlling labor, and I think in the first quarter you saw labor down as a percentage of sales.

How much of that is your effort to actually just kind of flex in a not-great environment, and how much of it is because of process changes because of EZstore or anything else you've done?

Merideth.

Good morning.

This is Perdue.

Thank you.

Most of that improvement, frankly, is a result of our new scheduling practices as well as our EZstore efforts.

We've taken labor out of the stores, but we've also taken more work content out of the stores as we've taken some of the material handling requirement under sortation and unloading back to the distribution centers, and in changing the way we replenish our stores.

There is some flexing going on as it relates to sales.

We are much more nimble now to react to changes in performance at the store level, and both of these are having an impact there.

But this is not an arbitrary issue that puts us at risk in the store in terms of performance, because we actually have about the same amount of hours dedicated to customer service and things that are not related to the material handling aspects of store labor.

Okay.

Great.

And then I just have one final question.

You are anticipating that sales will be better in the fourth quarter.

And I was just wondering was there any one particular thing that made you feel a little bit better?

I think everybody thinks August has been really just unusually terrible, but you know, where does the optimism come from?

Anything in particular?

This is Tehle.

I'll comment on that, and then David can chime in.

As we look at the third quarter versus the fourth quarter, we do have some strong merchandising initiatives that we've talked about, that we think will really give us benefit in the fourth quarter.

For example, we've redone our candle line, and we've redone picture frames.

And although we've seen some help out of that, we believe that will really kick in in the fourth quarter because they make great gifts.

Additionally, the strength we've seen in Pets, we believe that will accelerate as we get in to the fourth quarter.

We're introducing gift cards as a new initiative, we've started to get those out there, and we believe that will be be a nice benefit to us particularly in January, as those cards are cashed in.

We've changed our apparel selection a little bit.

We have a more focused assortment right now.

Also on the children's side, we have Fisher Price, and that will be new for the holiday season, as well as Bobbie Brooks, in terms of our women's wear, and we have more of a national branded strategy in apparel.

We also have more of a national branded strategy in Toys, that you'll see a little bit in the fourth quarter.

So we believe we have several initiatives that will kick in and hopefully help the fourth quarter.

This is Perdue again.

I will just add a bit of flavor.

I'm obviously very disappointed with August, but I think in going back the last few years we traditionally have not performed well on a comp store basis in August, relative to the other months of the year.

Part of that is our own Back-to-School effort, but this year in particular we think that the environment is a little more difficult, and there's a little more promotional activity right now than there was in August of last year.

Going to the fourth quarter we have mobilized very similarly to the way we mobilized last year, in terms of getting help to the field to match the schedule or execute the schedule for this new merchandise.

If you remember two years ago, we had difficulty in getting that merchandise out, getting it presented properly.

Last year it was much better, and we plan to beat that execution this year, so we are well focused on the fourth quarter right now.

Great.

Well, thanks for the great efforts.

Thank you.

The next question comes from David Cumberland with Robert Baird.

Thanks, good morning.

Good morning, David.

A question for David Perdue.

What are your thoughts on advertising, both long-term and then near term?

Are you maybe planning anything in Q4 to help drive traffic in an environment that could remain difficult and very competitive?

That's a great question, David.

Can I get you on my side here?

In any event, let me answer the long-term question first.

There is no question in my mind that we need to market and pull customers in this model.

If you look at what's going on right now, we have a very fluid customer base.

Yes, we have a core customer, but the demographics of our geography are very broad and we need to speak to that.

We also have a new coming customer, and that customer is being impacted by the current economic environment in the same way that our lower core customers are being impacted, but they don't know us.

They don't know that we are not the typical dollar store, that we have national brands at everyday low prices at multiple price points, and a core of consumable products that are replenished every week.

So we need to communicate that message.

We are right now just beginning to do some of that in our Busch series NASCAR car involvement, and so forth.

We are looking at how we support our new stores, so long-term, I think it's very prudent to say that yes, as we build our P&L to afford it through gross margin improvement, cost reduction, and so forth, you will see us market a little more in the future.

In terms of fourth quarter, I'm really not prepared to say anything at this point about whether we're going to support our efforts.

Frankly, with what we did last year, I'm not sure that we need to do that kind of tactical marketing right now, but in the long-term both tactical and strategic marketing are under consideration.

Thank you.

Thanks, David.

Thank you.

Our next question comes from David Mann with Johnson Rice.

Yes, thank you.

My question is about shrink, given the reduction in inventory and the efforts you're doing on EZstore, I might have thought you'd see a little more improvement at least sequentially.

Can you talk a little bit about your progress there?

Yes.

This is Tehle.

I'll take it , and then David will have some other comments.

We do believe we're making progress there, and we mentioned as we look on a store-by-store basis we are seeing improvement.

Shrink is a little difficult at this time of the year to assess, simply because it depends upon the stores that you have taken inventories in versus last year, and we don't necessarily take the stores in the same order.

As a matter of fact, this year we purposely accelerated the inventory on the poorer performing stores to get them out of the way, and to maximize the impact of trying to turn those stores around.

So we're happy that we're running ahead of last year and again, as we get through the rest of the year, that trend may change because the stores will be taking -- probably will be a little better than what we saw at the beginning of the year.

David, the other thing and obviously we called this out a couple of years ago.

We continue to call it out.

It's a focal point for us.

We're not lessening our efforts on this thing.

One of the things that we see, we've added some SKUs in the last year, that actually have a higher shrink experience.

An example would be white men's cotton brief underwear, if you can believe that.

You know, and our efforts to become a destination in that area actually worked against us in our shrink effort.

So we're looking at where these SKUs are located in the stores, and different things to test.

We have some tests within entertainment, with music and DVDs and so forth, and obviously these are a higher shrink item.

So we're not bashful about adding SKUs that can add more excitement into our store.

Even though we know it will have some detrimental impact to our shrink effort.

But we are not out of the woods yet.

We are still working hard on it.

The initiatives we have put in place have actually been increased under Kathleen Guion's leadership in stores, and our merchants are beginning to look at the layout of the store, and the placement of these high risk SKUs as well, so stay tuned, we continue to focus on that.

And then one other question, David.

In terms of the comments you're making about Europe, you've made some comments in the past about your thoughts about consolidation in the industry.

Can you just update us on your thoughts, especially given that you know you guys are generating a lot of cash flow, and also seem to be outperforming the rest of the small box sector.

Thank you for noticing, David, one of the strategies is to separate and we're working hard to dry to do that.

Consolidation is not something you can predict.

I think that has to do with individual companies' position and individual points in time.

I still say that, you know, this industry has not had a lot of consolidation in the past.

Whether that means we'll have consolidation in the future is anybody's guess.

We're just focused on our own organic growth opportunities right now, and we have plenty to do to try to get better to compete within our own model.

But for the industry, it's an obvious -- a great question and I just don't have any direct insight into it.

I wish I did, David.

Okay.

Thank you.

Thank you.

The next question comes from Mark Miller with William Blair.

Hi, good morning.

I would add my sentiments that you guys are doing a nice job in a tough environment.

To help us better understand the ongoing SG&A growth, could you provide some color on what the benefit was from the health care accrual either to SG&A percent, or EPS in the quarter?

Yes.

It was $2.4 million.

Okay.

Great.

And then the downshift in August comps, is that predominantly on general merchandise, or are you seeing it also in food and consumables?

Good morning.

This is David Perdue.

You know, our discretionary -- items that depend on discretionary spending were greatly impacted.

You know, our apparel and our home areas as David called out earlier are disappointing.

Some of our other areas that are in our core areas, Pet, Hardware, some home categories, our early entry into candles and frames are very encouraging.

It's a mixed bag.

I would say that consumables are continuing to be strong, but remember last year in this area in Back-to-School and in holiday, to a degree, discretionary spending when you have purposeful events like Back-to-School, and maybe Christmas or holiday, you do have, in our opinion, and we can't back this up with fact, but it's an observation, that some of the consumable spending gets diverted to some discretionary purpose-directed spending.

In the months after that it comes back to a normal mix.

Having said that, our mix continues to be impacted by high gas prices, and this pressure on discretionary spending.

There's no doubt.

And we're working hard to make sure that August is not a forbearer of new trend, but there's no way to predict that at this point.

We've given our forecast as to what's included in our guidance, and as that changes obviously we will be very responsible with our information for you guys.

On the inventories it's encouraging to see that down per store.

Can you give us some color on how that would be across consumables versus general merchandise?

I think last year your consumable inventory had been up, so I guess color on where you're at for the seasonal clothing home particularly.

Yes, well, I think we believe we're in good shape, relatively good shape in most of those categories at this point.

I don't think we're going to give a whole lot more information than that in terms of breaking it out by category at this point.

I will say that, you know, we have some apparel and home inventory that we focused on in the first half of the year.

We've identified it, and we actually used some extra markdown dollars as David mentioned earlier in Q2 to get this stuff moving.

We've got a long way yet to go on inventory. 4 turns is not where I want this company to be in the long-term.

Good.

What do you expect for the promotional environment in Q4, some folks expect holidays to be similarly promotional-aggressive as we're seeing in Back-to-School.

Is that what you have built into your forecast, or are you expecting it to be a little bit more moderate than what we're seeing currently?

Thanks, Mark.

This is Perdue.

I really don't have any reason to believe that we'll see less promotional activity than we saw either last holiday season or in the current Back-to-School.

And if you look at how we performed in Q4 last year, that's no prediction of how we'll perform this year, however, it is an indication that we are doing some things that we know work, and that we're hopeful that will give a similar result that we've had the last couple of years, but I have no reason to believe that promotional activity will be any less this year than last year.

Thank you.

The next question comes from Christine Augustine with Bear Stearns.

Can you share with us what sort of goal you might have for the inventory levels per store?

Or could you at least directionally tell us do you anticipate the same trend, down 3% per store to continue through the year?

My second question is on Dollar General market.

What sort of metrics are you looking for on that test and how will you assess that and determine what type of a rollout, and timing of a rollout?

And then just finally, Could you give us Monique Wong's background, please?

On the inventory per store, I'll answer that and I'll let David answer the other two.

We do have internal goals.

We're not prepared to share that.

I will tell you and I mentioned in my comments that although we're happy with the progress we have made year-to-date, we're not happy with where we are, and we want to do better, so we would anticipate moving that number down on a per-store basis, but at this point, I don't think we're going to share any specific numbers, except that it's a priority and we continue to work hard at taking that number down.

On the DG market, we continue to roll these out.

We're very excited about what we're seeing.

What we're really playing around with, and I'll get to the metrics in a minute.

We're working on the mix.

We're trying to experiment with different adjacencies.

The warehouse racking system on the food side as you know, many of our SKUs, in fact, the majority of our food SKUs are the same SKUs as in our traditional store.

We're playing around with the cooler items, we're playing around with the fresh produce, and frankly the layouts of the store, and the locations of the stores.

We've purposely put these stores in different locations to see how they compete, whether they begin to be a destination for certain customers, and we have got great learning going right now.

We are expanding the geography right now on the 30 stores that we plan to open this year, and it's an exciting time.

We're purposely trying to make sure we get it right, and we're not overburdening the team with inordinate growth numbers until we get to where we want to be.

Now, the pressure and to be candid, the pressure is on productivity per foot.

We're excited about the numbers we're seeing there.

We haven't quantified that because it's a wide distribution, as you might imagine, at this early stage, and the second thing is on profitability.

The logic would tell you that the profitability would be less in the store because of the increased potential for grocery and food items.

And we do see some of that, but we're not willing to say yet, that that's going to be the case for this model.

We want this to have a similar contribution to our traditional network, and that's what we're working towards.

Great.

Thank you.

And just Monique Wong's background please?

I'm sorry.

Sure.

She's got a 25-year specific sourcing background in Asia, and if you can do the math, that puts her back into the 70s, when there was a lot going on in that world since then, and she'd been in the midst of that.

She's got great contacts with vendors, and other business people in that part of the world.

Most recently, she was Vice President of Sourcing at [Hager] Corporation, again located in Hong Kong, and before that she was Vice President of Sourcing for Sara Lee.

We're delighted to have her.

She is a very capable senior executive, to help us really implement what we know is a growing opportunity for us.

Sounds like somebody you may have worked with in your past.

It is.

Okay.

Great.

Thank you very much.

The next question comes from Michael Exstein with Credit Suisse First Boston

Can you talk about the internal restructuring that you had mentioned as a driver on the SG&A?

And secondly, in a recent store visit, I saw what looks like a magalog that you dropped.

Is that part of this whole initiative, in terms of advertising and getting close to your customers?

Thanks.

I'll take the first part of the question.

The restructuring I was talking about was a tax restructuring, and it's kind of a technical restructuring regarding legal entities we're doing, it isn't a restructuring in that we're taking cost out of our SG&A, it's totally related to tax.

Okay.

Thanks.

And I'm sorry I didn't understand the second part of your question.

I was at a store opening recently and there was a magalog, for lack of a better word, which is a combination sort of editorial plus coupon piece on very heavy stock, that you had dropped in that store, and I was wondering is that part of a test that you're doing in terms of advertising and promotion?

That's a great catch.

Yes, we periodically do things like that to support our new stores, and as I said in an earlier answer just a minute ago, we are looking at different ways to support our new stores.

This is one.

I frankly don't know the results of that effort yet specifically, but it's another one of those, we think, exciting ways to freshen up our approach to communicating who we are.

It's a good piece.

Heavy stock and pretty impressive across incomes.

Thank you.

Thank you.

The next question comes from John Zolidis with Buckingham Research.

Hi, thanks for taking my question.

Question on EBT.

Wondering if you could just remind us the number of stores you've got on EBT now, and if you can share with us some of the metrics you look at on how EBT is being utilized by your customer base.

Is it on plan, above plan, and where do we think we are with customer knowledge or awareness about the ability to use EBT at this point?

John, good morning.

This is Perdue.

We're virtually all of our stores have EBT except where, you know, Ohio has some restrictions, I think and then there are some stores where we have covenants in there in a strip center, but the vast majority, I think the number is well over 85% the last time I checked.

It might even be over 90% at this point.

Let me put it this way.

Virtually every store that has it from a legal point of view has it.

And we're excited about that.

The EBT, I just -- and I don't have the data to really prove this, but I just don't think that the -- and we're beginning to do some research behind that.

The awareness of EBT is growing, we think, but it's not at the level that we think it can be.

The actual sales are encouraging.

They're probably about where they thought they would be, although we didn't have an aggressive plan for them.

We knew it was going to be a big addition eventually, and we didn't put a lot of pressure on that category from our plan perspective, in order to make numbers or anything else, because we knew it would be a slow uptake, in terms of, without marketing, a slow uptake in terms of awareness.

But we're very excited about it right now.

It's impacting a lot of things in terms of ring, and we think potentially traffic as well.

All right.

Just a quick followup.

Do you think the EBT sales are incremental, or are they shifting from other forms of tender?

Thank you.

A little bit of both.

We don't disclose that, and I was just handed, John, a little more specific answer to your question.

We have -- yes, middle of August, approximately 7100 stores are approved for EBT and we're excited about that.

But I'd rather not get into the details about the other part of that question.

Okay.

Thank you.

Thanks.

Thank you.

The next question comes from Erik Mace with Credit Suisse First Boston.

Hi.

Good morning, Erik.

A followup a little bit on EBT, but more on transactions, transaction counts seem to have been moderating, could you shed a little light on where you think that number may settle out, especially as EBT starts to gain a little bit of traction and as you anniversary more the cooler rollout?

It's a great observation.

And you know, and it is a concerning number for me, but I'm not that concerned about it, because we know what we're doing to drive traffic in our stores, and to some degree, we think trips are being consolidated.

Our average ring is up moderately, and that's part of what's driving our comp sales.

But this organic growth opportunity is one that we're focused on in the stores, trying to drive, or increase our frequency, and also our ring.

We've added SKUs, we added placement of SKUs to impact our ring, and we're beginning to try to do some things in-store, to help increase this frequency.

As we go long-term, one of the purposes of a more strategic marketing effort would be to do just that.

As you might know, compared to some of our bigger box competitors who do a lot more advertising, this is an area that we really haven't been driving frequency as directly as we might possibly be able to do over time.

Okay.

Thank you.

Thank you.

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

Hi.

Good to see the EZstore contributing on the labor savings and I was wondering, could you break down how much of that potential savings you might have reallocated to better in-store service, and how much you're kind of pocketing as an outright savings?

Thanks, Ed.

I wouldn't quantify that at this point.

We only have -- we're trying to have about half our stores by the end of this year, and we're learning a lot as we put it in.

We have invested, you know, some of those savings back into stores, in terms of customer service, store appearance, et cetera, et cetera.

But I wouldn't want to quantify that.

The other thing that bears note, aside from just the quantitative measure of hours, is the enthusiasm that these stores bring to the stores.

People appreciate that we've taken into consideration that moving all this merchandise was not done in the way that it should be done, and that some of the new things of restocking, end cap maintenance.

Energy driving promotions that we are beginning to put in, the enthusiasm in the store is for those things, you can't measure that of course, but it's dramatically, in our opinion, dramatically better in the stores where we've implemented EZstore, so it's not as easy as saying well, we're booking all of the savings.

We're actually reinvesting some of them already, but I wouldn't want to quantify at this early stage.

I agree maybe they're hard to quantify, but maybe the turnover rates, and the stores on EZstore, starting to separate from the pack?

We do see some early reductions although we haven't cycled a full year, as you might appreciate.

When you talk about turnover in mid-year, it's difficult until you run a full cycle, particularly in retail as you're aware.

But we are encouraged that we do see some lower turnover numbers in our EZstores, compared to the rest of our network, and we see some other things too, with regard to other variables that are encouraging, that we're headed in the right direction.

We were focusing on damages, we were focusing on workers' compensation, as well as labor, but the big reason we do this is to try to get productivity up.

We're focused on that organic growth that has been mentioned in a couple of other questions.

We have time for one final question.

It's from Anthony [Tucumbu] with Morningstar.

Good morning.

Good morning.

I just had a followup question on DG market.

You know, even if it's just directionally, what have you seen in terms of sales per square foot and average ticket versus your regular stores and also, what have you seen in terms of the demographic profile of that customer versus the customer that is at your smaller stores?

Thanks, Anthony.

This is Perdue.

It's early, we've only got a few stores out there compared to our full network, but we see some consistent things out there.

Number one, we are pulling new customers.

We've gone in and done intercepts, we've talked to our customers, these customers that are going in, and they're telling us a couple of things.

They're telling us that this store is a more of a destination than our traditional store.

The numbers are telling us that the productivity per foot is significantly higher than our average of our network, and we're finding that the average ring is higher, and the potential frequency can be higher.

Now, it's early.

We only have a few stores up and 31 or 32 stores operating today, and it's awfully early, and there's a wide distribution around.

We have some great stores, some stores in there with great opportunities and we intentionally did that, because we wanted to test some geographies to see how these stores would stand up against different types of locations, because they respond differently than our traditional stores.

The other thing is how our labor in the stores are responding to this.

The labor in DG market stores seem to have better turnover numbers.

The enthusiasm is there, very contagious and I think people are genuinely excited about this new model.

We've got a lot of learning to go yet, on mix, and on understanding the needs of the customer in this type combination environment.

So it's a great question.

We are very excited about it.

It's giving us what we thought it would.

You'll see us continue to invest in that effort.

Okay.

Thank you.

Thank you, Anthony.

Thank you everyone.

Thank you.

You may disconnect at this time.