達樂 (DG) 2005 Q3 法說會逐字稿

Thank you for holding, everyone.

This is the Dollar General Corporation's third-quarter 2005 earnings conference call on Tuesday, November 22, 2005, at 9 AM Central.

Good morning, ladies and gentlemen, and thank you for your participation 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 requested that you listen to the following statement regarding forward-looking and non-GAAP information.

In addition to historical information, the Company's comments will contain forward-looking information such as anticipated, fourth-quarter, and November same-store sales, anticipated 2005 fourth-quarter and full-year earnings per share, expected 2005 capital expenditures, the Company's expected annual effective tax rate, key plans and operating initiatives, 2005 and 2006 store growth targets, intentions regarding fourth-quarter share repurchases, and expectations regarding future insurance proceeds relating to the recent hurricanes.

The words believe, anticipate, project, plan, schedule, expect, estimate, guidance, 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, Form 10-K, 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.

The Company disclaims any obligation to publicly update or revise any forward-looking statements to reflect events or circumstances occurring after the call or to reflect the occurrence of unanticipated events.

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

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

Reconciliations of these non-GAAP measures to the most comparable GAAP measures, along with management's reasons for referring to these non-GAAP measures, are included in the press release issued today, which may 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.

First of all, I want to thank everybody on the call for your continued interest and support of Dollar General.

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 third-quarter financial results; update you on current operating initiatives; and outline our guidance for the remainder of the year, as well as touch a little bit on guidance for next year.

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

This morning, we reported net income of $64.4 million or $0.20 per share for the third quarter ended October 28 '05.

That is compared to net income of 71.1 million or $0.22 per share in the third quarter last year.

If you remember, at the beginning of the year we increased the number of departments utilized for our retail inventory method of gross profit calculation from 10 to 23.

We call this the RIM expansion.

In the third quarter, the impact of the RIM expansion was to decrease income before income taxes by approximately $10.8 million and to decrease earnings per share by about $0.02.

Sales for the third quarter of '05 were 2.06 billion versus 1.88 billion in the prior year.

That is an increase of 9.5%.

By category, sales of highly consumables were up 12%, seasonal and home products were up 4%, and basic clothing was up 3%.

Our same-store sales in the quarter increased by 1.4%; and that was slightly below the midpoint of our sales guidance for the quarter.

Our sales in the quarter continued to be affected by the impact of high gas prices and other economic pressures on our core customer.

David Perdue will discuss some of our thoughts on sales more fully in a few minutes.

The gross profit rate to sales of 28.1% for the quarter was down from last year's third-quarter gross profit rate of 29.5%.

The gross profit rate decrease was impacted by a change in sales mix which, like earlier quarters this year, was skewed more toward highly consumables than in 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 (technical difficulty) gross profit.

The gross profit rate reflects higher markdowns in this year's third quarter versus last year, as we continue to make progress on our per-store inventory reduction initiatives and, 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.

Finally, as we have noted previously and as we anticipated, the change in the merchandise departments or the RIM expansion negatively impacted our gross margin by about 52 basis points in the quarter.

As anticipated, the third quarter has the highest unfavorable impact of the year.

As a reminder, we expect the impact of this change to be favorable in the upcoming fourth quarter.

These negative factors were partially offset by higher average markups in the 2005 period as compared to the 2004 period.

We were able to leverage our selling, general, and administrative expenses even with lower sales growth than in the second quarter.

SG&A improved to 23.2% of sales for the third quarter of fiscal '05 versus 23.4% of sales during the comparable prior-year quarter.

The decrease is attributable to lower employee incentive compensation expense, based on the Company's year-to-date 2005 financial performance; a reduction from last year in professional fees, consulting fees related to the EZstore project as well as our Sarbanes-Oxley compliance efforts.

Also, the Company continued to leverage store labor as a percentage of sales in the quarter.

These expense reductions were partially offset by increased store occupancy and utilities expenses.

In addition, during the prior-year period, the Company incurred certain expenses that did not recur in the current-year period, including increased sales and use tax accruals, and a charge related to the expiration of a lease for and the subsequent purchase of the Company's airplane.

The effective income tax rate for the third quarter of '05 was 34.2% compared to 33.9% in last year's third quarter.

The rate for the 2005 period is lower than the Company's estimated annual effective rate of approximately 36.0%, primarily due to favorable reductions in certain contingent income tax related liabilities.

The tax rate for the '04 period was favorably impacted by the October '04 retroactive reinstatement of certain federal jobs credits and a favorable adjustment to the Company's '03 income tax liability upon filing the '03 return in October of '04.

For the 39 week year-to-date period, net income was 204.9 million in fiscal '05 or $0.63 per diluted share, compared to 210.3 million or $0.63 per diluted share in the comparable period last year.

For the 39-week period, the RIM expansion resulted in a $17.5 million decrease in income before taxes or about a $0.03 per share decrease in earnings per share.

And again, that is the current year.

Year-to-date sales increased 11.7%, including a same-store sales increase of 3.4.

As a percentage of sales, gross margin for the year-to-date period was 28.4% in '05 compared to 29.3% in '04.

The decrease in gross margin is primarily attributable to the decrease in sales of higher-margin categories as a percentage of total sales, as we discussed above; increased transportation costs; and a 29-point unfavorable impact from the RIM adjustment.

These factors were partially offset by higher average markups in the 2005 period.

SG&A expenses for the year-to-date period decreased as a percentage of sales to 23.0% in '05 from 23.2% in '04.

This is primarily resulting from decreased store labor expenses, reflecting the Company's cost-containing efforts including the easy EZstore project; decreased health expenses, resulting from decreased claims and a downward revision in the claim lag assumptions based upon review and recommendation by our outside actuaries -- and, again, we did that in second quarter and discussed that last call; and a reduction in external consulting fees related to EZstore as well as Sarbanes-Oxley.

These items were partially offset by increased store occupancy and utilities costs.

The effective income tax rate for the 39-week '05 period was 35.5% compared to 34.2% in the 39-week '04 period.

The '05 rate is less than the Company's estimated annual effective tax rate of about 36.0% primarily due to the reduction in '05 of certain income tax related contingent liabilities.

The '04 rate was also impacted to a much greater extent by a reduction in contingent income tax related liabilities.

Switching to the balance sheet for a moment, we made good progress reducing inventories in the quarter, with our total inventory balance at the end of the quarter up just 1% year-over-year.

This equates to a decrease of about 6% on a per-store basis.

We have made notable progress in selling through some older inventory, as we continue to emphasize cleaning up the stores so we can operate more efficiently.

Cash capital expenditures through the third quarter of '05 were 216.8 million, primarily related to the opening of 605 new stores, including 23 Dollar General Markets, as well as the rollout of EZstore, the completion of our South Carolina DC in June, and the startup of construction on our ninth DC in Marion, Indiana.

Year-to-date, we have repurchased approximately 13 million shares of our Common Stock for $260.7 million, with approximately 6.4 million shares remaining as of October 28; and that is available under our current repurchase authorization of 10 million shares, which goes through September 30, 2006.

However, we plan to continue purchasing shares under this buyback in the fourth quarter aggressively.

During the fiscal 2005 third quarter, Hurricanes Katrina, Rita, and Wilma impacted the Company in the form of store closings prior to and during the hurricanes' landfalls, as well as after the storms, due to power outages and damages sustained.

The most significant storm-related Company losses were related to merchandise inventories, furniture, and fixtures, which were primarily offset by insurance proceeds.

The Company anticipates recording additional insurance proceeds upon receipt, including amounts to offset losses related to business interruption, although we currently cannot predict the amounts or timing of the additional proceeds or whether any proceeds will be received in the fourth quarter.

The net impact of the hurricanes was not material to the Company's financial position, liquidity, or results of operations in the quarter or year-to-date period, although we now have fewer stores operating than we would have had otherwise.

We estimate the potential lost sales in the fourth quarter related to the remaining closed stores to be about $12 million; and again that is in the fourth quarter.

Again, we had a high density of stores, including, unfortunately, our highest-volume store, in the affected area.

It is impossible to measure the impact that these stores and the fewer number of people in the affected areas will have going forward.

Now I want to talk a little bit about guidance both for the fourth quarter and then very briefly for '06.

November same-store sales continue to be impacted by a combination of higher fuel prices and aggressive advertising and marketing by the Company's competitors.

Same-store sales are currently estimated to be in the range of 1% to 3% for the fourth quarter in total.

However, November is estimated to be below this range due to a relatively difficult comparison to last year and the fact that most of the Company's holiday initiatives should have a greater impact on December sales versus November sales.

Company expects per-share earnings per share for the 14-week fourth quarter to be in the range of $0.51 to $0.54.

As previously discussed, the fourth-quarter estimate includes a favorable impact of about $0.03 resulting from the RIM expansion.

For the 53-week year ending February 3, 2006, the Company expects to report earnings per share of $1.14 to $1.17.

Capital expenditures for the year are expected to be approximately 330 million to $350 million.

In 2006, the Company currently plans to open a minimum of 800 new traditional Dollar General Stores and approximately 30 Dollar General Markets, some of which may be replacements for traditional stores.

The Company plans to issue earnings guidance for fiscal 2006 at its year-end earnings press release on March 21, 2006.

Now I'm going to turn the call over to David Perdue, and he will give you some more perspective on our business and our business model.

Thank you, David, and good morning, everyone.

Thank you for your interest in Dollar General.

As you know, we continued to face significant external economic pressures in the third quarter, exacerbated by the impact of the three hurricanes that hit areas of high store density for us, as David has mentioned.

But all things considered, I am very happy with our overall results for the third quarter in a very competitive and promotional environment.

We accomplished a 1.4% comp for the quarter on top of a 3.4% increase in the third quarter last year.

This increase reflects an increase in average ticket, partially offset by a decline in customer traffic during the quarter.

Also, our year-to-date comp increase of 3.4%, while not where I would have personally liked it, is certainly competitive given the environment.

We were able to achieve expense leverage in the quarter and year-to-date, even though we have lower comp sale increases than earlier in the year.

We also reduced our inventory by 6%, as David has said, on a per-store basis over last year.

If you remember, this was one of our key initiatives this year, and I am very happy with the progress we have made thus far.

We now have over 333,700 stores on EZstore, and the impact of EZstore on store labor continues to be very encouraging.

In addition to labor savings, we are beginning to see decreases in damaged merchandise and decreases in our workers' comp claims, both in frequency and in severity.

We have three of our DCs converted to EZstore now and three more are underway.

Through the third quarter we opened 582 traditional stores in 23 DG markets, and are on track to open a total of 730 stores this fiscal year.

We now operate a total of 40 DG Markets networkwide.

We're also now fully operational in our Jonesville DC, which currently is servicing 740 stores.

As David mentioned, construction of our ninth DC in Marion, Indiana, is underway with its opening scheduled for sometime in mid to late '06.

Having said all that, our same-store sales in November continue to be somewhat weaker than our expectation.

We take this recent softness in same-store sales seriously and are taking several steps to combat some of the effects of the current promotional and economic environment.

Of course, in this environment we all recognize that we still have many of the same challenges we faced in third quarter.

Gasoline prices soared above $3 a gallon in September, and they will continue to pressure our customer, along with heating fuel cost, as we move into the colder months of this winter.

Remember, even with recent reductions current gas prices are still significantly higher than last year.

Unemployment in the lower income sector remains high, as does consumer debt; and consumer confidence also remains low.

In the third quarter, we had hundreds of stores closed at various times before, during, and after the hurricanes; and some of these stores remain closed today.

The aftereffects of the hurricanes, although impossible to quantify, are still impacting our customers, our employees, and some of our vendors.

We have been concerned about these external economic forces all year and continue to be.

There is no doubt that discretionary spending has been impacted among our core customers and shopping trips consolidated due to these economic realities.

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

However, we remain focused on meeting our customers' needs and expectations.

We also continue to look for ways to give our customer some attractive discretionary choices within her limited budget.

Our merchandising team has enhanced our efforts in pet supplies and hardware; and we believe our toys, picture frames, and candles should benefit us in the holiday season.

While short-term performance measurements are important, we remain committed to our long-term strategy.

We manage the business to maintain a long-term balance between increasing ROIC, achieving total sales growth, and realizing long-term profitability targets.

This year, as we outlined in the beginning of the year, we have focused on the balance sheet as well as the P&L.

Our ability to reduce total inventory on a per-store basis, in an environment where sales are not what we would've liked, speaks to the impact of some of the new processes and disciplines we are using to manage the business.

We continue to stay the course on our strategic plan developed two years ago and updated each of the last two years.

In accordance with that plan, this year we have worked hard to strengthen our organization, focused on improving the working and shopping environment in our stores through EZstore.

We have started our preliminary efforts to fully integrate category management and SKU productivity along with market and product segmentation.

We continue to work feverishly to fully integrate our supply chain and institute new planning disciplines.

We have progressed in the development of our DG Market and begun implementing our initial operational changes in our real estate area.

We have continued 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.

We continue to add more accountability in the field.

Year-to-date, 134 district manager positions have been filled; 56% of these placements were internal promotions.

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

We've also invested in our corporate organization.

During the quarter, two new Senior Vice Presidents have joined our store operations team.

Penny Katsaros comes to us with a depth of retailing experience, most recently at Sears.

Tom Mitchell, comes to us from Payless ShoeSource with more than 20 years of retail experience.

At Payless, he led the operations of more than 4,500 stores.

Penny and Tom both bring extensive retail experience and a shared enthusiasm for improving store performance and store operations at Dollar General.

Also, last week, Wayne Gibson joined us as Senior Vice President of the Dollar General Markets.

Wayne has outstanding academic and professional credentials.

Wade was previously an executive with the Home Depot and Rite Aid Corporation.

He also served numerous retailers as a management consulting principal at Deloitte and Touche.

Wayne is a great addition to our leadership team and will help us raise Dollar General Market to the next level.

This placement is another indication of our commitment to the Dollar General Market and to developing its potential.

Looking ahead, as we have indicated, in 2006 we expect to complete the rollout of EZstore to the balance of our network and to continue Project Gold Standard to improve the stores that we can get to in '06.

We want to begin implementing category management; and to that end we have retained an outside consulting firm to assist us in 2006.

We are also looking at zone pricing and rolling that out in certain geographic areas in 2006.

After two years of hard work in our store operations area, we plan to now increase our rate of new store growth, as David has said, so that in 2006 we plan to open more than 800 traditional stores, more than a 10% increase.

We also plan to open another 30 DG Market stores as Wayne gets his feet on the ground and develops our long-term strategy there.

In conclusion, we remain confident in our small-box model.

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

Our strategic plan is in place; 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 believe it will bring tremendous opportunities ahead.

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

Thank you, again, everyone for your participation.

(OPERATOR INSTRUCTIONS) John Harloe with Barrow, Hanley.

Talk a little bit about the EZstore initiative, whether that is having any negative impact on sales in terms of execution.

And also talk a little bit about the possibilities of leveraging store labor expense.

And please repeat the number of stores that are on EZstore at the end of the quarter.

There are about -- I believe the number is 3,700; and obviously that changes every day.

We are delighted with how EZstore is impacting our store effort.

As we have mentioned before, the number of hours that we have reduced in the store are actually less than the number of hours that were required to handle the merchandise in the old system.

So we have actually built in additional hours for our store managers to merchandise the stores and manage their people.

The early indications are that in some geographic locations -- although it is not universal -- we are getting productivity increases.

But the primary thing that we're identifying today are reductions in our damages and reduction in the severity and the incident rate of our worker comp claims.

So at this point, being a little less than halfway through in terms of store penetration, I would say we're on track.

We're getting what we thought we would.

Frankly, I am very delighted with the progress so far.

The other thing, John, we believe that the turnover rate of the individuals in the stores will go down because we have changed the job dramatically.

It really makes the environment a lot more pleasant for them to work in.

We believe that will have long-term payback for us.

Did you give out a statistic on shrink this quarter?

Are your in-stock statistics what they should be?

We did not give out a statistic on shrink.

It will be in our 10-Q that is being filed as we speak.

Our year-to-date shrink is 3.2%; and that compares to 3.11% for the same time period last year.

So shrink has gone up a little bit in this year-to-date period.

Let me give you a little color around that.

Our watch stores, the stores that we have really been focusing on, continue to get better overall.

However, it appears that our better stores or the majority of the stores, where we haven't had the focus on, have actually slipped a little bit.

The economic conditions of higher gas prices, increasing theft, etc., we believe have had an impact on this.

We also are carrying a little bit -- a few different products such as DVDs that have a higher shrink rate.

So we again believe there are reasons for this.

However, we have taken action, as we continue the actions we have taken; but we have got some software that will help us identify where the shrink is in the stores, and which stores are potentially having more issues with shrink.

We are also looking at the closed circuit TVs that we're using, closed circuit cameras as well as burglar alarms in terms of beefing up some of the stores.

So we will continue to concentrate on what we used to think were our better stores that appear to have slipped a little bit on shrink.

Thanks a lot.

I misstated.

I'm sorry, with regard to in-stock, I think during the quarter we did have some issues in some categories that were vendor-related, particularly in the food area.

Overall, though, our in-stock percentages remain at the levels that we need them to.

There are a couple of areas in HBA, in food, as I have said, that we're working on.

But I would think that our BSR system, that is a replenishment system, and our inventory system have got us in a good position going into the holiday compared to last year.

Thank you.

Charmaine Tang with Citigroup.

I was hoping you guys could give us an update on how EBT is going.

Specifically, what are some of the key observations you have noted, particularly with regard to traffic and ring?

Lastly, on the EBT vein, just how are you growing customer awareness that it is in fact in the stores now?

Thank you.

EBT got off to a slow start, candidly.

It has accelerated.

We don't really disclose those numbers.

We haven't yet disclosed those numbers.

But the rate of growth is increasing each month, particularly in the last two months, significantly.

We have gone in the stores.

We have signage in the stores and so forth.

We have had an initiative of actually interacting with customers to make sure they're aware that we have EBT.

We're learning where it is popular and where it is not.

Frankly that is a new learning for us, given this is our really first year going through this.

We have talked about generally things that we're going to do in '06 to try to further acknowledge the fact that we have EBT to our customers, in terms of both in-store and out-of-store communications.

So it's an ongoing development for us.

I would say right now we're on track, although it got off to a slow start, primarily because we really did not go, I think, out of our way to communicate to the degree that maybe we should have.

But we're going to look at that in '06.

Great, thank you.

Meredith Adler with Lehman Brothers.

A couple of questions for you.

I have been struggling maybe to understand why we have seen this slowdown in sales.

If you look at the rollout of coolers, can you see any trends with the stores with coolers in for the longest time showing the most slowdown in sales?

Or is there really no relationship with the coolers?

Meredith, we obviously look at that among other things.

There really isn't a correlation as you suggest.

There are some geographic issues.

Texas continues to be slow region for us.

But the other thing I think that concerns me more than anything else has been -- and this is the third quarter that I have called this out, I think -- is the slowdown in our seasonal home and apparel.

To some degree I think that is a function of two things, candidly.

I think it is the impact on discretionary spending of pulling dollars out of the pockets of our core consumers.

The second thing is I think we have had a number of opportunities that we have tried that frankly have not worked in terms of product offering and so forth in our latest offerings.

These continue to be areas of focus for us.

If you look at our year-to-date performance in those divisions, though, if they had held up in any manner to last year we would have had a fantastic sales year.

So I think there are some geographic issues; there are issues around own performance candidly in our product offering; but I think the biggest thing is the general impact on discretionary spending.

Okay.

Then you mentioned something in the beginning about you were going to be taking specific steps to drive sales.

Can you comment any more?

Give us any more detail about what those steps are?

Sure, Meredith, as you are well aware, we try not to go into the high-low pricing model that seems to pervade this time of year.

But there are some things that we're doing.

Obviously, holiday is important to us, although we try to be out there for our customers every week and every weekend.

We're working on an in-store presentation of some of our seasonal holiday items, particularly toys this year.

If you go in the stores, you will see a different presentation of toys.

I won't go into a lot of detail there.

We have a little better branded position with one of our suppliers I will call out;

Mattel has done a good job this year in terms of helping us get ready for holiday.

We have also made a little higher than normal effort in terms of special buys, so we have some products in the stores that were unique purchases and offer a little bit more of a treasure hunt this year than we had last year.

Just the normal scheduling process of deliveries, of this mass of merchandise into the stores that every retailer has this time of year, but we have gotten better over the last two years in terms of trying to get that scheduled without damaging our core consumable business.

Remember, when we load our holiday merchandise in here, unlike some retailers we still have an ongoing consumable business that we have to maintain.

We also have gift cards this year, which we didn't have last year.

And along with that we have a unique promotion around the gift cards; that the $5 dollar gift card that basically the way it works is with a $40 purchase, we're going to give a free $5 gift card.

So that is partly in terms of trying to educate our consumers about the fact that we have gift cards.

Then I think we have a little bit above normal inventory this time of year.

Even though we reduced inventories by 6% on a per-store basis, we have higher inventory position this year on our typical holiday items.

So I think we're in a little better position, although we have not gone on the price promotional trail to the degree that maybe we could have.

I am confident that we have made good efforts here to combat the environment that we are in.

Thank you.

I just have one final question.

As you take labor out of the stores because of EZstore, but you are also ramping up labor at the distribution centers, does the labor in the distribution centers get expensed as you pay people's salaries?

Or does that somehow get put into the cost of the inventory?

Well, I will let David answer that; but it is up in our gross margin line.

The distribution cost is in our margin calculation.

It goes into our inventory.

Distribution transportation expenses are part of our cost of goods sold.

So it would get expensed as that inventory is sold.

So in a sense you are capitalizing the labor costs in the distribution center?

In essence.

But again the way our inventory turns, it is not in there very long.

Okay, great.

Thank you very much.

David Cumberland with Robert Baird.

On inventory, where do you stand on the cleanup process through the increased markdowns?

Looks like the green tag discounts have increased as the year has gone along.

Does that indicate that you are most of the way through this effort?

Yes, that is a good callout, David.

We have increased our markdowns through the year on some of this older inventory.

I am delighted, frankly, with the progress we have made there.

Both in -- we have different degrees of over inventory; and I am delighted with the green tag merchandise that is out there.

But also even in our '04 inventory we made dramatic reductions.

So I am very pleased with where we are there.

We will continue to look at our markdowns needs in fourth quarter as we go through our holiday season and so forth.

But with regard to this older inventory we are ahead, frankly, of where I thought we would be at this point in time.

Then on EZstore, can you comment on the approach you're taking on passing through the cost savings or reallocating those freed-up hours to other activities?

Is the approach you're taking near-term perhaps affected by the backdrop you are in?

There is no doubt about that.

It's a tough environment.

Plus we chose -- and we mentioned this before we started -- that we chose our most difficult division to begin the implementation of EZstore.

Not because we thought that we would have a bigger improvement, although that is still a hope; it was to make sure that if we could do it there, we knew we could do it throughout the network.

So that the environment is adding a complication to it.

But I think the real issue is what is going on at store level.

The store manager is no longer having to schedule people and get there and wait on a tractor and a trailer.

The tractor and trailer don't have to get there and be held up for several hours, while the staff unloads the trailer.

The driver can actually unload the trailer themselves now.

So I just think it simplifies the job of managing the store.

We know it does.

Then secondly, the hours that were reduced, we did a couple of things.

Number one, we had a couple of pay increases last year at the store level that we may not have called out particularly, to maintain our competitiveness and giving us a little better edge in terms of recruiting people at the store management position, given its importance.

The second thing is we reallocated some of that reduced time back into store hours, so that the store manager and the second keyholder could actually merchandise the end caps a little better, manage the in-stocks, maintain inventory accuracy a little better.

So far I would say the stores EZstore compared to the rest of the network are making greater gains in those areas.

That is noticeable.

So again, as I said earlier, we are certainly on target there.

I know it is new for everyone both inside and outside the Company, but we're delighted with our progress at this point.

Then a quick question for David Tehle.

What is the expected tax rate in Q4?

36.0%, and again there are always ups and downs to that number.

But that is our expected rate going forward.

Thank you.

Dan Wewer with CIBC.

Congratulations on hiring Wayne Gibson at DG Market.

I think he will be a great addition.

Curious on the next 30, I guess it is, DG Markets that you're opening in 2006.

Without giving away all your secrets, what different tests you may have run on this next group of stores compared to what you have done in the last year and a half.

Yes, thanks, Dan.

I don't know; in this environment I am not sure there is such a thing as a secret.

But I will be candid with you.

We're looking at our merchandise offering and, frankly, how we combined the merchandising effort at the store level between general merchandise and our food offerings.

We're also continuing to be very aggressive in terms of our pricing and how we compete in local markets.

We're doing a lot of consumer work.

We really want to know how consumers are reacting to this model.

Then I guess the third big area is the real estate.

We had several learnings in '05 about where they work and where they don't work.

We have many of our stores in the DG Market effort that are doing everything we want.

We have a few that were a little disappointing.

But I think that they were primarily real estate related.

So we knew we were testing some things both in merchandise and in real estate.

We had some learnings there, and I think we're going to try to step out in '06 with a little broader geographic penetration with regard to, again, testing some areas that we did not go into in '05.

I would say, right now, that Wayne is very excited about this opportunity.

He has got a great track record, and he's certainly the entrepreneurial type that we want to head this up.

We're also going to consolidate our organization in the DG Market under his authority.

We have been using people from different parts of the organization to support this effort.

It's been a great effort to crystallize, I guess, the needs of certain consumers and our ability to meet them.

I think Wayne is just really going to be the perfect guy to lead us through the next few years as we get this thing going.

Then just a separate question on the 6% reduction in inventory per store.

Is that primarily merchandise in the backroom that you have cleared?

Or was this actually on the selling floor?

And if so, does this give you the room or the space to add new items, to maybe help rejuvenate your sales growth?

It is really both, items in the backroom as well as items on the floor.

It is kind of split between the two of them.

Yes, we're always looking for new items to put on the shelves; and it does help our effort to do that.

Great, thanks and good luck.

Mark Miller with William Blair.

Can you, I guess, categorize kind of how you are progressing right now with manager turnover?

I know you have made some strides.

My perception is that it is maybe flattened out a little bit here.

Then as you have rolled in EZstore, I am curious if your -- it doesn't sound like it's necessarily had much of an impact yet on store manager turnover.

Are you surprised by that?

What is the feedback you're getting from managers?

Why would not that be helping sooner?

Because you talked about it in terms of more the long term where you think you get improvement.

This is Purdue.

Let me address two things.

A couple years ago, we called out employee turnover at the store level to be a critical issue.

I'm still calling that out as a CEO issue.

The second thing was shrink, candidly, and we have flattened out in both areas a little bit in the last few months, to be quite candid.

On the shrink side, I think we've had a couple of things.

One as David said, we have added a few SKUs this year that have had higher shrink.

DVDs, CDs, even cotton underwear if you can believe that.

But on the turnover side, the last few months it has ticked up again a little bit.

To some degree, self-imposed.

But we're moving in the right direction in terms of finding the right people, testing them, promoting them, and then supporting them and training them.

We are on the turnover issue, and inside EZstore we are seeing improvements in turnover.

We just don't quantify those publicly yet.

We probably will do that as we start going through next year and have more and more stores on it.

We're convinced that the number one issue in terms of store performance is obviously the store manager and the longevity of that manager in place.

So as I said earlier we have taken care of some pay issues last year and we continue to look at that.

We continue to work on support from the district manager and also from our HR group.

Remember this is the first year where we have really integrated our HR group from corporate into the field.

A couple years ago, the field fundamentally had no HR support, and now we are moving in that direction and that is beginning to pay dividends in the quality of people that we're hiring.

So it continues to be a major initiative for us.

You're exactly right that it has flattened out.

I am not happy about either one of those.

But we continue to focus on those from my chair.

I like the fact that that continues to be a focus.

Can you talk about IMU?

I didn't hear that called out.

What is happening with the beginning inventories, basically, on life (ph) items as you try to increase the level of direct imports?

Are you seeing cost savings; and then is that being neutralized by the sellthrough not be as strong on some of those items?

Yes, IMU is going up; and yes, we're seeing some cost savings.

I think the real issue is that it is more the mix factor than anything else, in terms of the mix of what we are selling is why we're not seeing more of that IMU falling through to the bottom line.

We believe you have to look at those two items together, in terms of the IMU, what you have in inventory and then what you actually sellthrough.

But we have made progress on IMU this year.

Mark, with regard to the second part of the question, the sourcing effort continues to improve.

We're moving in certain categories that we have not had through our direct control; we're now beginning to absorb those.

Our new officer in charge of sourcing, Monique Wong in Hong Kong, is getting her feet on the ground.

That office is really contributing, and we are increasing the number of SKUs and the quality of the merchandise, along with the pricing.

So I see marked improvements in that already.

Great.

My final question is on your comment on above-normal inventory for holiday items.

I want to make sure I understand the context.

Are you saying that it is a little bit higher than you would like, or just that you're putting more emphasis on the category here in the fourth quarter?

How much risk do you see to that level of inventory?

Thanks.

Thank you, Mark, for that call-out.

That is a good catch.

No, this is a planned increase in that inventory.

One of the ways that we felt like last year we hurt ourselves is that we were a little thin in some holiday categories, some items that were very popular and moved through.

So we picked a few items this year and got behind them.

So no; this is a planned move.

I think we're in good shape.

We know what we have got to do to get it moved.

I don't think we are taking an inordinate risk in terms of markdowns coming out of it, because I think the items that we got behind are really highly probable to move.

Great, thanks.

Stacy Turnoff, a research analyst.

That is Merrill Lynch.

I have two questions regarding your RIM expansion and the impact in gross margin.

First, is there a level of sales performance between consumables and discretionary that you need?

The second part is, now that you have gone through a couple quarters, maybe if you could give us a little bit more concrete examples of what you are learning from this conversion of the system and how we will start to see that impact in the fourth quarter.

Right.

We actually put a number out there for the fourth quarter in terms of what we think the impact will be, Stacy.

This is really a one-year issue; because next year, we will be on 23 departments, just as we are this year.

So we should not have this comparison issue.

This is because we were on 10 departments last year and 23 this year.

So really I think it's a one-year type of adjustment that you're seeing.

Again for the full year, we don't believe it is a material issue.

It is just in individual quarters some of the quarters have spiked up a little bit higher -- for example the third quarter -- such that we felt like we should call it out.

Again in a positive way, we believe the fourth quarter will spike up and offset much of what we're seeing on a year-to-date basis.

It really has to do with the mix of what is sold in individual quarters.

Obviously, as you sell -- again, the way I say it -- it is like you're slicing it a little bit thinner than you did last year with 10 departments.

With 23 departments as you get out to the ends of either the consumables or on, conversely, the higher-margin items, you can get a little bit of a different answer than you had with the 10 departments.

Again, we believe this is more representative of our business today and that is why we made the change to 23 departments.

I guess, a follow-up to that is, what kind of comfort can you give us that if in the fourth quarter we wind up seeing a lot of strength in consumables, what kind of risk do you see to the downside at the same time (ph)?

At the opposite, what type of upside do you see to that number?

Yes, well, we obviously have a detailed forecast for the fourth quarter that we have used to estimate the impact.

We have done actually a couple of forecasts looking at what ifs.

What happens if consumables are higher?

Then conversely, what happens if seasonal comes in higher?

Again, we're relatively comfortable with the number that we put out there.

But clearly, there could be some movement in that based on what we sell through.

But we put our best estimate forward.

There is some sensitivity to the number, though; it's a good point that you are raising.

That is encouraging.

My final question is on distribution.

At the distribution level, you guys have rolled out EZstore concepts at three DCs at this point, I believe.

Any statistics in terms of maybe in-stock levels or anything that you could share, to show us some of the change that has been going on there?

Yes, Stacy, we don't really quote that.

But as I said before, with the exception of our food and maybe one other area with regard to in-stocks, our in-stocks are where we need them to be both with EZstore and not.

EZstore really doesn't have any much impact on that.

So with regard to our position in the DCs, the biggest change is really the handling of the rolltainers.

I must say the three DCs that are completely converted and the three additional DCs that are underway right now, they have handled that magnificently, in my opinion.

I have a background in that area; and I must say, they have done a wonderful job of absorbing that change.

Now with regard to in-stock at the DCs, in many cases, we are actually better.

But in certain areas, particularly food as we called out, we were a little bit lower in third quarter.

Great, thank you.

Patrick McKeever with SunTrust Robinson Humphrey.

I just had a question on product costs.

Are you seeing increases in your product cost, particularly for consumer products and plastics?

If so, are you able to pass any of those cost increases along to your customers, or is it affecting your margins?

Yes, Patrick.

We are seeing for the first time some institutional increases.

For about a year, we have been having this -- actually two years, we have had this pressure from different areas.

I think it is more concerted now certainly in the CPG area as well as food, mostly in the consumables side.

For the most part, we are -- we have limited price points, Patrick, as you well know, so we are in a little bit of a competitive disadvantage in the short term.

We work with our vendors on packaging, pricing, the size of units that we have per package, etc. etc.

So some of these items, I think we may have passed along where we might have been on lower side of a price point.

But many times we're not able to in the short term.

So it is a difficult game that we are in right now.

As I would characterize it, we're sort of in the early stages of some of these moves.

So it is hard to tell where it's going to come out.

I think more than anything else it has some downward pressure on our internal margins, though, in total.

I have noticed even at the stores recently that -- and I don't know if this is -- how new this particular price point is -- but I think I may have seen recently dishwashing detergent at $1.15.

It looks like you are making some selective price increases.

I know that particular product has been -- the prices for that product have been pushed up by the consumer products companies.

But are you -- do you plan on making greater use of non-even-dollar price points?

Yes, Patrick, we have a hard time describing that strategy as well.

But yes, I think that are some manifestations around, We have done a -- we have put in an organized pricing benchmarking capability.

We used an outside firm to help us develop this, this year.

We use that to continually look at our price competitiveness.

As you might imagine, we compete on price and convenience; we better well know what our price competitive position is.

So we continue to do that.

We have broken the even-dollar -- this is years ago -- the even-dollar mentality when we went through quarters and so forth.

There may be the odd price out there at $1.15 on occasion.

But that is really the exception, and it may be more temporary than anything else.

The other thing I will say, inside Dollar General Market, when you get into food, there are also some broken price points there as well.

So we are continuing to look at our core strategy.

We still in research -- our customers still give us high marks for having limited price points, believe it or not.

But it does put us at a little bit of a disadvantage at this early stage when prices do start to bubble up.

Just one quick last one.

On the competitive front, you talked about a difficult competitive environment.

Are we talking about Wal-Mart here, or are there other competitive issues outside of Wal-Mart?

We all know that Wal-Mart has gotten out early and is being very aggressive with its holiday marketing campaign.

Are there other competitive issues out there beyond Wal-Mart?

I think what you're seeing today is a number of retailers using some high frequency, highly consumable both CPG and food-related consumable items as price leaders.

We have them out there at everyday low prices.

It's not just the large box that you mentioned, but I would say that there are pharmacy retailers that have taken a strategy with that regard.

The other thing I am relating to is really the overall price promotion that is out there this year, not only with the seasonal merchandise but with the core consumable merchandise.

In many cases, there are competitors doing that to drive comp sales; but we will see what their quarters look like from a financial standpoint.

We're concerned about comp sales but we're also concerned about a lot of other things -- profitability, consumer turnover, frequency, and ultimately ROIC.

So it is a balance that we're trying to find here, and to knee-jerk around one quarter with regard to what we might do with our overall strategy -- I am just nervous to do that, Patrick.

So I know you're not suggesting that.

But with regard to these competitive pressures, I am talking about specifically Wal-Mart but also some of the pharmacies and other dollar stores as well.

Okay, got it.

Thank you, David.

I think with that we will take one more question, operator.

Michael Exstein with Credit Suisse.

Two quick questions that I ask all the time.

Can you just sort of order of magnitude of what energy cost you, in terms of pressure on SG&A for the quarter.

Then finally, you have talked over the last couple of six to nine months about the issue of how do you get close to your customer.

I know you spun out to the NASCAR.

Some of your direct competitors have become very promotional.

How do you balance that?

Where do you think you are?

Do you think you're being impacted by what some of the competitors are doing right now?

Thank you.

Thank you, Michael.

Yes; while David looks up the gas number, I don't know that we have really quoted that number.

We have some ideas internally.

Let me address the customer issue.

The NASCAR investment this year -- and we partner with many of our vendors, and so several of our vendors -- this year has been a great success.

NASCAR does a wonderful job of integrating new vendors and new sponsors into their family.

It's been a great experience for us.

I think we have been able to communicate to our customers in a way that we have not before; so we're learning from that experience.

We're also trying to partner with our vendors to do a little more market research than maybe we have done in the past.

We are also doing some of our own proprietary work to try to understand what is going on with our consumers.

I think we are impacted, candidly, Michael, by some of the price promotion right now.

When you look at our frequency, and along with a lot of other retailers, frequency is down overall.

But the average ring per transaction is up.

The question is, are we being impacted negatively?

I think we are to some degree.

But I think, again, let's wait and see how all of the scores average out once we get this holiday season behind us, with regard to overall profitability and so forth.

Obviously, comp sales are important to us.

We continue to use that.

But I look at a rolling average of this over a couple years, certainly at least two years, to make sure that we are not overreacting to a short-term issue.

But I think the NASCAR thing is going to be one of several things that we're going to be looking at over the next few years.

We have made a recent announcement that we're going to be a NASCAR next year.

I am very excited about that.

I think we're going to be able to do some things around it that we were not able to do this year with regard to not necessarily price promotion but product promotions with the general area where these 38 races are held next year.

Michael, on your question on the fuel prices, if you look at our utilities on a year-to-date basis, we are probably up somewhere between 15% and 20% from last year on utilities.

So it has had a sizable impact on us.

But also transportation.

And transportation hits gross margin.

The impact of transportation too.

So how much do you think it may have depressed gross margin?

You know, we don't really break it out to that fine amount of detail, Michael.

So I really can't comment on that.

Okay.

Well, thank you all both.

Okay, thank you.

Thank you, everyone.

Thank you.

You may disconnect at this time.