達樂 (DG) 2005 Q4 法說會逐字稿

This is the Dollar General Corporation fourth-quarter and fiscal year 2005 earnings conference call on Tuesday, March 21, 2006, at 9 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 shareholder.com.

Federal law dictates that no other individual or entity may be allowed to record or rebroadcast this session without permission from the Company.

After a prepared statement by the Company, we will open the conference call for questions from the audience.

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

In addition to historical information, the Company's comments during this conference call will contain forward-looking information such as statements regarding the Company's first-quarter and fiscal 2006 financial outlook and the Company's fiscal 2006 operating initiatives.

This forward-looking information includes but is not limited to anticipated first-quarter and annual earnings per share; expectations regarding a pending hurricane-related insurance claim; the expected annual effective tax rate; the expected impact from merchandising and promotional activity; expected performance of the leadership team; capital expenditures; infrastructure improvements; and key plans, operating initiatives and 2006 growth targets.

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 on Form 10-K 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 date of the conference call or to reflect the occurrence of unanticipated events.

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

Beginning today's call is Mr. David Perdue, Chairman and Chief Executive Officer.

Sir, you may begin.

Thank you, operator.

Good morning, everyone, and thank you for calling in this morning.

With me this morning are David Tehle, our Chief Financial Officer, and Emma Jo Kauffman, our Senior Director of Investor Relations.

Before I turn it over to David for his financial remarks, permit me a few general remarks as we get started.

While 2005, an investment year for Dollar General, was a very difficult year, we believe we are still on target with regard to our strategic plan and the initiatives included therein.

As you know, our fiscal 2005 year included a 53rd week, and my comments are based on a 53-week 2005 versus a 52-week 2004.

For the year, we reported net sales of $8.58 billion, which represents growth of $921 million or 12% over our 2004 net sales, and net income of $350 million in 2005 was 4.1% of net sales.

David Tehle will get into the financial details of gross margin and expenses in a few minutes.

Let me just say up front that we're not satisfied with our operating margin rate of 6.6 for the year, and we're working feverishly to improve that.

And you will hear more about that later today.

We reported earnings per share of $0.46 for the fourth quarter, compared to $0.41 last year, and $1.08 for the year, compared to $1.04 in fiscal 2004 per share.

Also in 2005, we were not able to reach a settlement with our insurance carrier with regard to our claim for losses from Hurricane Katrina.

This claim to date is about $23 million, in addition to our $2 million deductible.

Of course, most of that loss occurred in 2005.

But of that $25 million in loss, we've only received $8 million in insurance proceeds in 2005, leaving more than $15 million outstanding today.

I believe that our poor performance in the fourth quarter of 2005 was a short-term misstep resulting from a number of factors rather than a sign of long-term weakness in our basic operating model.

The fourth quarter was difficult for all retailers serving the lower-income customer.

Frankly, the highly promotional activity seemed to me an attempt by other retailers to combat what was indeed an overall weakness in the sector.

We know that the external economic environment was difficult for our consumers, causing them to consolidate buying trips and defer discretionary spending.

However, we fully recognize that our competitors may have been similarly affected by these issues.

With that in mind, and after much analysis, we have identified several internal issues that we believe negatively impacted our own result in the fourth quarter.

First, our EDLP model, with its lack of promotional flexibility, has generally not performed well during highly promotional periods like the recent holiday season.

That, along with the fact that in retrospect, our merchandising planogram changes for 2005 did not have the same energy that we had achieved in 2003 and 2004, contributing to our poor comp sales performance in the quarter.

Also, fourth quarter was the first quarter in which we anniversaried the substantial completion of our [EZstore] effort.

Second, our home, apparel and seasonal product offerings did not perform to expectation during the quarter, which in addition to hurting our sales was also a significant drag on our gross margin.

Third, our inventory initiative, while increasing our inventory turns from 4.0 to 4.2 and significantly reducing our older inventory, as we intended, did have a negative impact on our comp store sales.

It also had a negative impact on our gross margin due to increased markdowns in the fourth quarter and the year.

Fourth, our total sales weeks were negatively impacted by a delay in some of our new store openings, partly caused by Hurricane Katrina, mostly in the back half of the year.

And fifth, increased transportation fuel costs, as we called out before, significantly affected our gross margin during the quarter.

In summary, we're not hiding behind the external environment for our poor performance in the fourth quarter, and we have identified the primary internal causes.

The good news is that we are tackling those causes and we believe we have the people and plans in place to address them and be equally successful, even in highly promotional times.

If you will remember, shortly after I came to Dollar General in 2003, we identified three major strategic initiatives that we needed to accomplish before we could confidently move forward in achieving the long-term goals of the Company.

First, we had to address our organization and strengthen the leadership team.

Second, we had to review store operations and begin to clean up our older stores and modify how we run our stores.

And third, we had to challenge our merchandising and marketing practices.

We began our work in store operations in 2004, when we started the implementation of EZstore to address the operational challenges in our stores.

We ended fiscal 2005 with 3825 stores on EZstore and have a plan in place to complete that rollout this year.

EZstore redefines the workflow in our stores, and we're pleased so far with the result.

Over the past couple of years, and particularly in 2005, we have made significant progress in strengthening our organization, our first strategic initiative.

Earlier this past year, we added or replaced senior leadership in merchandising, store operations, real estate, supply chain, human resources and the Dollar General Market.

Specifically, to mention a few, we hired Beryl Buley, Executive Vice President and Division President of Merchandising, Marketing and Supply Chain.

We brought in Challis Lowe as Executive Vice President of Human Resources.

We hired Gayle Aertker, Senior Vice President of Real Estate.

And we brought Wayne Gibson in to become Senior Vice President of Dollar General Markets.

There are others, but those signified the significant senior leadership changes that we made in the year.

Also, Kathleen Guion, whom many of you have met, was promoted in 2005 to Executive Vice President and Division President of Store Operations and Real Estate.

Yes, we have been busy in this organization area, but we believe these changes will make us more competitive going forward.

Even though our financial results were not what we had planned, we made significant progress on many fronts in 2005.

We opened 734 new stores, including 29 Dollar General Markets.

At year end, we operated 7929 stores.

A month later, on March 3, we celebrated the opening of our 8000th store in Mission, Texas.

We opened our eighth distribution center in Jonesville, South Carolina, this past summer, on time and on budget.

Inventories on a per store basis are down from last year, with inventory turns at 4.2 times compared to 4.0 times in 2004.

Inventory on a per store basis is down 1% and the aging of the inventory is significantly improved.

We significantly increased our cash from operating activities and used free cash flow to purchase approximately 15 million shares of our common stock for $297.6 million.

With that, I will turn the call over to David Tehle to discuss the financial results for the quarter, and then we will discuss the outlook and some key initiatives for next year.

Thank you, David.

Good morning, everybody.

Just to reiterate what David said, except for the same-store sales numbers, the increases or decreases from the prior year in all items expressed as a percentage of sales discussed in this call are based on our 53-week year and 14-week fourth quarter in '05 versus a 52-week year and 13-week quarter in fiscal '04.

This morning, we reported net income of $145.3 million for the 14-week fourth quarter ended February 3, '06.

That is an increase of 8.5% over net income of $133.9 million in the 13-week fourth quarter last year.

Because of the effect of our share repurchase program that David mentioned, we were able to increase earnings per share in the fourth quarter by 12.2% to $0.46, compared to last year's earnings per share of $0.41.

As David said, we are not happy with the results of the quarter, which fell short of our expectation.

In discussing the quarter, obviously you have to start with sales, which is the biggest factor in our shortfall.

Sales for the fourth quarter of '05 were 2.48 billion versus 2.20 billion in the prior year.

That is an increase of 12.9%.

By category, sales of highly consumables were up 18%, seasonal was up 7%, home products were up 6% and basic clothing was down 1%.

Same-store sales in the quarter computed on a comparable 13-week basis decreased 1.6%, a very disappointing sales result.

As you know, when we first shared our expectations for the fourth quarter, we were expecting comps of 1 to 3%.

Sales in the quarter continued to be affected by the impact of high gas prices, heating fuel and other economic pressures on our core customer.

But we believe our sales were also significantly affected by other retailers' aggressive promotional activities during the holiday season, as well as some of our own inventory reduction initiatives.

Our gross profit rate to sales of 29.5% for the quarter was down 56 basis points from last year's fourth-quarter gross profit rate.

The gross profit rate for the quarter was affected by several factors.

First, we incurred higher markdowns for a couple of reasons -- one, as we saw weakness in our sales early in the holiday season, we decided to use some markdowns to generate activity in our stores.

And two, we've had an ongoing focus on reduction of older inventory in our stores throughout the whole year.

In addition to pressure from markdowns, gross margin was affected by lower markups on receipts in the quarter; higher transportation expenses, again primarily attributable to increased fuel costs; and an increase in inventory shrink.

These negative gross margin factors were partially offset by a $12.3 million favorable impact from the increase in the number of departments we use in our retail inventory method of accounting, or RIM, which we have been discussing throughout the year.

Higher average markups on beginning inventory in the 2005 period as compared to '04 also contributed to gross margin.

That favorable RIM impact that I mentioned in the quarter was about $3 million less than we anticipated.

And this was due to the sales mix being skewed more heavily toward consumables.

SG&A expenses were essentially flat, up 9 basis points in the fourth quarter.

We are reporting SG&A of $498.7 million or 20.1% of sales, versus 439.6 million or 20.0% of sales in the prior year.

We incurred significantly higher utilities expense in the quarter.

And unfortunately, the lower-than-anticipated sales performance in the quarter did not permit us to leverage store labor expense for the quarter, as we had done earlier in the year.

Just to remind you, we did leverage labor on the year as a whole.

These factors were substantially offset by a reduction in administrative bonus expense and lower insurance benefit.

Because the Company did not meet its internal earnings targets, no incentive-based bonuses were earned by the Company's executives or corporate employees.

For the 53-week fiscal year, net income was $350.2 million or $1.08 per share, as David said.

That compares to 344.2 million or $1.04 from the 52-week prior year.

Sales for the year were 8.6 billion, a 12% increase over the prior year, including a same-store sale increase of 2.0%.

The Company incurred significant losses caused by Hurricane Katrina, which occurred in late August of 2005.

This included damaged inventory, damaged store fixtures, damaged leasehold improvements, as well as substantial business interruption resulting from store closings.

Our current claim for losses, as David mentioned, from the hurricane is approximately $23 million net of the $2 million deductible, of which we have collected and recorded $8 million.

Until very recently, we anticipated we would be able to record substantial additional insurance proceeds to offset our losses in 2005.

Unfortunately, we were unable to reach a final settlement with the insurance carrier, and therefore we did not recover the additional proceeds that we had anticipated in 2005.

The Company does anticipate settling the claim and recording additional proceeds in the first half of 2006.

Gross profit for fiscal 2005 was 2.46 billion or 28.7% of net sales, compared with 2.26 billion or 29.5% of net sales in 2004.

The decrease in our mix of seasonal home products and basic clothing categories, which carry higher gross margins, was the most significant reason for the declining gross margin.

Increase markdowns, which I discussed earlier; higher transportation expenses, primarily from higher fuel costs; an increase in the Company's shrink rate; and a net $5.2 million unfavorable impact resulting from the change in the number of departments used in our retail inventory accounting were also important factors.

We had anticipated the impact of this RIM change to be immaterial for the year, but as it turned out, the impact of the RIM change was also negatively affected by the sales mix.

Our year-to-date reported shrink rate calculated at retail was 3.22% compared to 3.05% last year.

We are disappointed in this result, and while shrink was likely affected by the economic environment, we also believe that some of the changes in our merchandise mix, like CDs and DVDs, may have contributed to higher shrink.

Shrink control remains a top priority in 2006.

SG&A expenses for the year decreased as a percentage of sales to 22.2% in '05 from 22.3% in '04.

The most significant item of note was the nonpayment of incentive compensation for executives and corporate employees resulting from the failure of the Company to meet its 2005 financial targets.

Additionally, the Company's health benefit costs were down year over year, partially due to a change in claim lag assumptions and decreases in claims costs as a percentage of sales.

We also incurred lower consulting fees than in '04, when we were developing the EZstore project and addressing the initial Sarbanes-Oxley implementation.

These decreases in SG&A were partially offset by higher rent and utility as a percentage to sales.

The Company leveraged labor for the year in spite of the difficult sales environment.

Interest income for the year increased by $2.4 million to 9.0 million and interest expense decreased by 2.6 million for the year.

Interest income increased as a result of higher interest rates on short-term investments.

Interest expense decreased due to a $1.4 million reversal of income tax-related interest and a reduction in our average outstanding borrowings.

The effective tax rate for the year was 35.7% in '05, and that compares to 35.6% in '04.

Turning to the balance sheet, we ended the year with total inventory at 1.47 billion, up 7%, mainly due to our increased store count.

On a per store basis, inventories were actually down 1% from last year end, and inventory greater than a year old was down substantially more than that.

We made tremendous progress on selling off that inventory in 2005 and will continue these efforts in 2006.

We are very pleased with the cash flow generated by the Company during the year.

Cash from operating activities was $555.5 million, up from 391.5 million in 2004, primarily as a result of the lower increase in inventories.

CapEx for the year was 303 million, and 297.6 million of cash was used during the year to repurchase approximately 15 million shares of the Company's common stock, in accordance with Board authorizations.

Currently, approximately 4.5 million shares remain authorized for repurchase under a 10 million share authorization that will expire September 30, 2006.

A couple of comments on guidance for 2006.

For 2006, we expect earnings per share to be in the range of $1.14 to $1.21.

That includes a charge of approximately $0.01 per share related to the expensing of stock options as required by SFAS number 123R, share-based payments.

The Company expects an effective income tax rate for the year of about 37%.

The first half of fiscal 2006 is expected to be more difficult than the second half of '06 due to the time needed for our new merchandising initiatives to have an impact, and also, we have a much more difficult comp comparison to 2005 in the earlier months.

Just to remind you, first quarter of 2005 had a comp of 4.9%.

For the first quarter of 2006, the Company expects earnings per share to be between $0.15 and $0.18, excluding the potential effect of proceeds from the hurricane-related insurance claim.

The Company expects to incur significant expenses in the quarter related to advertising and planogram changes, and these planogram changes will particularly be in housewares, pet supplies, domestics, hardware, automotive and paper products.

Markdowns are also expected to be high in the quarter, due to the Company's promotional efforts and the continued reduction of older seasonal and apparel inventory.

And finally, we plan to spend approximately $375 million on capital expenditures in fiscal 2006.

With that, I will turn it back to David for some final comments on the business.

Thank you, David.

David mentioned our guidance for the year and for first quarter.

That first-quarter guidance reflects some investments we are making now to address some of those internal issues identified earlier.

We expect those investments to pay off this year, but much of that payoff will likely come after the first quarter.

Let me talk a little bit about our plans for the year.

First and foremost in 2006, we will focus on improvement in sales performance in every area of the Company.

Specifically, we plan to strengthen our EDLP strategy in 2006 and to add more promotional energy in the way of special purchases.

The EDLP strategy unaided by promotional energy is much more vulnerable in a highly promotional environment.

In addition to building more energy into our planogram for 2006, we recognize the need to be more flexible in making planogram changes throughout the year as we experience success or failure in specific departments or SKUs.

We are optimistic about our new spring planogram, which includes as many as twice the number of new SKUs in some areas versus last year, particularly in the paper and cleaning areas.

We are also adding more dominant brands in our packaged foods and condiments.

We plan to strengthen our treasure hunt offering and execute a variety of new marketing, promotional and advertising strategies.

We plan to focus more energy around holiday events, when traffic is traditionally heavier.

As an example, we plan to execute a circular around the Easter sales window this year.

We have yet to correct our poor sales in home and apparel.

But with Beryl's background, I believe that we will begin to achieve the kind of results in these areas that we want.

We are also going to implement a new store prototype for our traditional stores, emphasizing improved merchandising adjacencies, operational efficiencies and improved customer service.

And we will continue to develop the Dollar General Market concept.

While zone pricing continues to be important to us, we want to improve some of our basics first before ramping this up.

Also, we will continue to work on our segmentation plans within the context of Beryl's merchandising and category management initiatives.

In store operations, we will continue to invest in EZstore, with the goal of completing the rollout by the end of 2006.

We will continue our Project Gold Standard program begun in 2005 to improve the shopability and financial performance of existing stores.

And we will further increase our efforts to control inventory shrink in our stores.

Efforts include plans to continue to improve hiring practices, employee retention and increased accountability among the Company's employees.

I spoke earlier of adding new leadership in the real estate area.

In 2006, we plan to open approximately 800 new traditional Dollar General stores, continuing to pursue further geographical expansion.

Lowering rent as a percent of sales is a key focus going forward this year.

We expect Gayle and her team to place an increased emphasis on the quality of our site selections, and we have already made changes to our site approval process internally.

In addition, we have significant number of leases up for renewal this year, giving us an opportunity to begin to address rent on our existing stores, as well as on new stores.

We will continue to invest in the Company's infrastructure.

We expect to open our ninth DC in the fall of this year.

We will continue to increase our Asian and global sourcing, centered in Hong Kong.

And we will further develop our information technology capabilities.

In conclusion, we are disappointed with our fourth quarter's financial performance.

But we learned from it and are making significant changes to be more aggressive and competitive.

We remain committed to the precepts of our strategic priorities, which we have been discussing with you for the last couple of years, and believe we are on track.

We are pleased with the direction in which we are headed, and we are committed to long-term sales growth through increased store productivity and geographic expansion while working to make our financial model more productive.

We believe our model works, but we have tremendous opportunities to add energy in our merchandising and promotional efforts.

And we plan to address that aggressively this year.

We have strengthened the leadership in the organization and expect these new players to contribute in their respective areas of responsibility, as well as to the overall effectiveness of the group in 2006.

In short, we plan to be more aggressive in defending our space this year.

We have made great progress and plan to be more competitive going forward.

With that, operator, we will take a few questions as time permits.

Thank you.

(OPERATOR INSTRUCTIONS).

Charmaine Tang, Citigroup.

I was hoping you could provide some more details just on the advertising plans.

Obviously, this is a change in your strategy, and maybe you could give us some more color in terms of the number of circulars, the media, the formats, just for 2006, please.

Thank you, Charmaine.

I'd be glad to.

This is Perdue.

It is a departure from recent years, but it is consistent with the strategy that the Company took some years ago.

And frankly, what we plan to do is in addition to talking to our consumers a little differently in 2006, we plan to have a base of new energy about which to talk to them.

We will have a circular during the Easter drive period.

We will do it in many different ways.

We also plan to consolidate some of our new store opening communications this year -- instead of maybe having individual notices for each individual store, we may pool those in general areas.

When we opened our 8000th store, we had dramatic impact across some 22 stores in that general area.

So we are learning how to use the minimal dollars that we have been spending in the past.

Going forward, in 2006, I'm not prepared right now to discuss the schedule of events that we have planned for the year because of competitive reasons, but just take it from me right now that we are going to be much more aggressive in this area in 2006, both in terms of product energy and in terms of our communication with our consumers.

And just one other follow-up -- is there anything you can give us just in terms of comp guidance or cadence of comps, particularly as you think about your advertising?

I wish I could, Charmaine, but we really don't do that.

We just don't have a history of doing that.

The one thing I think we can say, and we had this in the press release that I had mentioned in my comments, that we do anticipate the first half of '06 to be more difficult than the second half of '06.

David Cumberland, Robert Baird.

First, some questions on the new store floor plan.

How extensive are the changes?

What is the timing of the rollout of these changes?

And is a portion of the CapEx plan for '06 including these resets?

Thank you, David.

This is Perdue again.

This new prototype initially will be for new stores only -- in other words, new stores we build and start this year.

And we expect to start implementing that around mid-year, sometime in the second quarter -- late second quarter.

We are also testing this in terms of retrofitting it across a few existing stores.

But we at this point don't have any significant plans to roll that at this time.

And we'll have more to say on that after we get the first few prototypes up and going when the new stores open.

Let me say this -- yes, we will spend a significant amount of our CapEx this year on new store openings.

We are going to open some 800 stores.

There is not an incremental increase in terms of the prototype.

There might be some new fixtures, some new types of fixtures and that sort of thing.

But in general, it's the same mode -- active -- same issue that we've had before in terms of new stores openings, so we don't anticipate any significant increment to our CapEx requirements because of this prototype.

The prototype is intended to do a couple of things.

One, it organizes the store by department in a more disciplined manner to facilitate the use of adjacencies by product.

It also drives traffic in our stores a little bit differently.

And the third big advantage is it really begins to give us the opportunity to call out our significant national brands.

We have great brands in our stores, but we don't generally get credit for it when we talk to our customers in market research.

So we have a significant increase in the number of end caps and so forth.

There will be -- the merchandising changes that we're talking about will impact all stores and not just new stores.

But this new prototype and the new adjacencies, we are going to see that facilitated in the new stores.

And we are very excited about that, and we have been working with some of our major vendors over the last two years specifically to see how we could get productivity in individual departments up.

And this is a derivative of all that work over the last couple of years, much of it with our vendor partners.

Thanks, and one other quick question.

On the insurance claim proceeds, I understood that those are not included in the Q1 guidance.

But are they included in the '06 guidance?

No, they're not.

Our feeling was although we wanted to get credit for it in '05, because it's part of what happened to us in '05, clearly as we enter '06 it's going to be an item relating to the prior year, so we didn't put in our guidance.

Wayne Hood, Prudential.

Mark Miller, William Blair & Co.

Is my line open?

Yes, I couldn't hear the operator.

We can hear you.

Can you discuss what you have learned on the EZstore implementation and how you're seeing the cost savings now versus your expectations?

Then, if you can provide more color on the various elements in the distribution center, transportation and then the in-store experience?

Yes, Mark, this is Perdue, I'd be happy to.

Thank you.

First of all, we did EZstore for a number of reasons.

One, the workload in these stores, as you have heard us talk about before, was very substantial.

We were moving in excess of 10 tons in many of our stores per week and it was being handled by the store personnel, the unloading and the stocking and so forth.

What we have moved to do is change the workflow such that some of that labor is moved back into the distribution centers.

We consolidate that, aggregate it, send it out in these aggregated -- what we call rolltainers.

And we significantly reduce the amount of unload labor required in a store.

That has been achieved.

And we're seeing that across all the stores that we've implemented.

The second thing is, we implemented a work scheduling plan that was significantly different than what we had before.

It allowed us to schedule our labor around the drive times when we had the most traffic.

The last thing is it allowed us to facilitate more energy around the merchandising at the store level.

The second big benefit, besides labor -- and we are getting the benefits from the labor side as we open or convert more stores -- the second big benefits is in damages.

And on a relative basis, we see improvement in that area.

The third big area is in workers' compensation, and while it will take awhile for us to get that benefit, or realize that benefit, the early indications are that the severity and the number of incidences are both declining.

And so it will take time for that insurance piece to come back to us.

But we are very optimistic about that.

So I would say overall, we are very pleased with the results.

Now, anytime you have a transition that is this significant, Mark, you're going to [have up] people.

Let me give you a couple.

One is, I think it contributed to turnover this year, candidly.

I think that whenever you do this much change across 8000 stores, you're going to get some personnel in stores that were hired under a different way of doing business and therefore can't adapt to the new way of doing business.

So both voluntary and involuntary turnover can be an issue.

Secondly, I think we are getting a sense of excitement in the stores around productivity.

We are beginning to see some indications that we're getting productivity lift, although it's very early to document that.

Suffice it to saying that we are encouraged at the store level by what we are seeing.

In the distribution center, we have issue there with regard to the transition.

We changed the methodology of loading the trailers.

We are not deadloading trailers anymore.

We are loading rolltainers.

We work with our transportation group.

We have challenges on the utilization of trailers and so forth.

We've got plans in on all the ones that have been converted.

And there are three or four distribution centers now that have been converted.

I'm very pleased with the progress there.

And then the last thing on inventory, I think there's really -- every indication is that our efforts last year on dealing with our inventory level is going to benefit us in many ways as we go forward -- in labor, in shrink, employee turnover, in all of these subjective areas because of the amount of excess inventory that we have been carrying in these stores.

We are continuing to be dedicated to that, Mark, and you will see us talk more about the inventory effort this year.

So that was not a one-year effort, and we will continue to push on that front this year.

But bottom line is we are pleased with the progress we are making in EZstore at this point.

I appreciate that.

And then in the earnings guidance, you were discussing comp store sales, but could you give us I guess some sense, are you looking for basically the current trends to continue in the first quarter?

And then I assume some acceleration built into the back half.

And then also, I'm curious about the mix.

Based on the information you gave, it looks like consumables comping up around 4, and the rest of the business comping down more in the range of high single digit.

Is that the rough range?

And then are you looking for that to change quickly, or are you expecting that's going to continue in the first part of the year?

Thanks.

Mark, I don't think we're able to give a whole lot more guidance on sales.

Again, what we put in our press release and my prepared comments are really what we're prepared to say at this point.

Again, I'd come back to the statement we made earlier that we do anticipate the first half of fiscal 2006 to be more difficult than the later half.

And we listed a couple of reasons, one being having time for these new merchandising initiatives to have an impact.

And then we did secondly say that we do have -- we're up against higher comp store comparisons for the first half of the year than we are the second half of the year.

So I think that's really the extent of clarifying the guidance that we're prepared to give at this point.

Wayne Hood, Prudential.

I had three questions.

One, I guess, starting at the management level -- you've still got three DMM positions that are open and one Senior Vice President of Apparel and Home and Seasonal.

So I'm wondering to what extent or how fast you can fill those positions, and filling those positions, what it means for the strategy that you've outlined and in the future.

I mean, it seems like you've got a lot going on and you're throwing a lot at the stores with a lot of things going on.

I just wonder -- I can appreciate you wanting to do a lot, but are you stretching this organization here in the short term?

Maybe you do five things rather than 10 with those holes, and what is going on?

That is a great comment, Wayne, and you bet you we are stretching.

This Company is not accustomed to having a 2.6 negative month in December, although many Decembers over the last 10 years we just didn't perform well.

And we have got to become more competitive in those drive periods.

With regard to merchandising, we announced organization changes some few days ago, I guess.

And Beryl is in the middle of that right now.

Challis Lowe, our new EVP of HR, is on staff now and making great headway in terms of helping us fill these spots.

But we've got candidates who we are interviewing real-time and so forth.

The second thing I will comment on is that I don't think these changes will have any impact on the lack of people being in those positions as we sit here today -- will have any impact on our strategy in terms of homes seasonal apparel.

Beryl just got back from Asia.

I am going in a few weeks.

We've got people over there paying attention to what we're doing in detail that we just haven't had before in terms of what we're trying to do.

So I'm very optimistic about those changes.

With regard to the total number of things that we are attempting, many of these are carryforwards from initiatives that we started over the last year or two.

So bottom line, Wayne -- I know you've got a couple other questions, so I will be brief -- yes, we have a lot going on.

We are taking risks.

I just think we have to become more aggressive to be more competitive in this comp sale environment.

And the two final questions, the costs for these initiatives in the first quarter -- can you put some numbers around that so we can think about it?

We really -- we're not -- again, I sound like a broken record.

We're really not prepared -- I will give you a little more flavor around the costs, but not numbers.

In terms of the circular program that we're going to be doing in the first quarter, in addition to the actual ad expense, there will be some incremental distribution costs.

There will be some incremental transportation costs and additional store labor in terms of executing this program, as well as some markdowns related to that as a piece of this circular will be promotional.

So we will definitely have some costs related to that.

Additionally, as I mentioned, we have accelerated some of the planogram changes into the first quarter.

And there is some additional labor associated with those planogram changes.

Michael Baker, Deutsche Bank.

So my question is on the CapEx.

It looks like a pretty big increase.

First of all, does that 375 include capital leases?

And then it's a much bigger increase than I think the number of stores you're doing, so are there systems investments in there?

Or what is the big increase?

Right.

The biggest increase is for the stores -- the new stores that we're going to be opening.

We do also have some remodels and relocations located in there within the store piece of it.

We do have some distribution center expenses as we continue to finish out our Marion, Indiana DC and then plan ahead for potential future DCs.

We do have some IT support in there -- mainly IT supporting the stores, although there are a few other initiatives we have going on in IT in the year, again, to try to provide better planning and analysis for the Company overall.

Then we have the final EZstore capital hitting.

And that's a little bit higher than it was last year as we finish out the rest of the chain.

But I would say predominantly we are investing in our stores.

That is the key theme to the capital this year.

We want to make our stores better.

And obviously, we are opening a lot of stores in fiscal '06.

And just for bookkeeping purposes, does that 375 include or exclude the capital leases?

It would include.

One more question on the balance sheet.

Is the inventory, the aged inventory -- so, can you just give us some color as to how far you are through that initiative to clear the old -- the aged inventory?

Are you 50% of the way through, 75% of the way through, etc.?

You know, I think we made great progress in -- and I want to stress, I would not call it aged inventory.

When we talk about inventory, anything that is not current season we work on very hard to get rid of.

So we have made great progress on it in '05.

We are going to continue working on it in '06.

I don't think I have a specific number that I can give you on what percentage of the way we are through moving the inventory.

And again, part of this will depend also on our merchandising strategy as we move forward and as Beryl has a chance to look at merchandising and some of the activities that he will want to do in the stores.

That may determine how quickly we move the existing inventory.

Michael, this is Perdue.

Let me add a little flavor to that.

We are also in a transition with Beryl's addition and some of our merchandising initiatives that we are just now kicking off over the next year or two.

The way we handle seasonal purchases and seasonal sales in season will change such that we want to become more contemporary in the way that we move this merchandise at full cost and then at the end of the season at reduced cost to get rid of it in season.

This has not been our practice over the last years, as you might know.

And so the old pack-away strategy is one that we're trying to get out of.

And so it is a transition.

We are not going to do it cold turkey;

I think that put the Company at too much risk.

We did move aggressively last year and sold off a significant amount of non-2005 inventory.

I feel very good about that.

The aging of our inventory got much younger.

And we're very pleased with that.

However, we do know that we've got potential to continue to improve that as we go forward.

But I think it will be something you'll hear us talk about in our merchandising efforts as we lay out plans for how we are going to dispense of in-season merchandise at the end of the season.

David Mann, Johnson Rice.

First of all, David Perdue, can you talk about why you believe that the current environment is temporary, given where energy prices are and the fact that it looks like your competition is still being fairly promotional out there?

That is a great question, David.

We were one of the first ones to start talking about the environment over two years ago with regard to unemployment, rising debt, increasing fuel costs and so forth.

We do not see this as a temporary situation.

As a matter of fact, the evidence is just the opposite.

When you look at the moves that other retailers are making, you hear people talking about doubling the number of circulars this year.

In fact, I said this week in a meeting that I see '06 actually being more promotional than 2005 was.

And we know 2005 had more promotional energy than 2004.

So in no way do I think this is temporary.

I paid more for gas last night than I have in the last six months, personally.

So I don't think that this is a temporary situation.

The other thing is that the rising debt that I've started talking about over the last year hasn't really been -- it hasn't hit the front page of the press yet because the interest rates haven't kicked up behind it.

As you see some of these adjustable mortgages and so forth start to kick in this year, I believe, you'll see a lot more rhetoric around that, and it's already impacting our low-income consumer.

These are long-term trends.

One of the reasons why we're changing our merchandising strategy is -- yes, it's part of our long-term strategy we laid out a few years ago, but it's also contemporary with the current pressures our customers are facing right now.

We are moving internally to adapt to that.

And frankly, I think with our history of 65-plus years of dealing with low income consumers through various cycles in the economy, we've got a great deal of legacy learning there that we can bring to bear in this period.

We did not perform well in Q4 due to some internal things, but not because we didn't understand the macro or the microeconomics that our consumers are dealing with.

David, given that the environment is perhaps -- there's some structural things going on and also that you're, using your words, throwing a lot at the stores this year, why would you continue or why do you see the need to continue to grow at the kind of pace that you are growing at in '06, rather than take a little bit of a breather to ensure that your current base of stores were operating better?

Well, you know, I firmly believe that when you are operating 8000 stores, if you waited until every single store was where you wanted it, you would stop adding new stores entirely.

And I think people from the restaurant industry and coffee industry and all that might say similar things.

We debated this over the last couple of years with regard to taking a year or two off in terms of adding new stores, to go back and clean up stores.

We are doing both.

We have initiatives to go back and we will close more stores than we have in the past.

We will renovate and relocate more stores.

We have a significant number of leases that are coming due over the next 18 months that gives us an opportunity to evaluate in a different way the true performance of that individual store.

In the past, if it was cash-flowing and making minimal profit, we would keep the store and keep it open.

Now we have an opportunity to go back and really evaluate that store with regard to how it is returning capital against our cost of capital and so forth.

So we believe we can do both.

I think 800, if you go back a few years, is actually a smaller percentage than what it was maybe four or five years ago.

So we think we've got that under control, particularly with the reorganization that we are underway in in our real estate group.

It's a challenge, no doubt.

But I think it's the right thing to do for the Company.

The other is in trying to grow earnings per share, we firmly believe there are opportunities out there in the marketplace that customers are not getting their needs met.

And we believe we need to be there.

That's one reason why we opened up the geography from the 24 core states that we had a few years ago to now trying to move judiciously into these outlying states that are contiguous with our core states.

And then one last question on the planograms that you're doing -- can you just talk about what percentage of either the mix or square footage of the store that you plan on affecting and what level of disruption we should look at, or if some of that has already been done?

It is underway now.

And I think that is one reason why first quarter is problematic.

We are trying to do a lot of that in first quarter, the benefit of which will not hit us until -- some of it until second quarter.

It will be a little bit more than the normal year, but not a lot.

I mean, we always go through these planogram changes.

The big difference this year is that we've reached out and brought in some key brands that fill holes that we didn't have -- for example, Heinz ketchup, French's mustard, Jiff peanut butter, just to mention a few.

We've also gone to some areas -- incontinence for example, had an end cap.

We've now given it a significant place on the wall.

We have engineered our paper allocation on the wall.

If you go back to the cleaning wall, where we have a dominant market share in this sector, we've changed out a significant -- actually, almost double the number of changes that we made last year, more in line to where we've been doing over the last prior years before last year.

We've aligned the labor in the stores.

We've worked with our store operations group with regard to these planogram changes.

These are not major resets.

Let me just say that.

This is basically SKU effort.

We're not trying to relocate shelves and so forth in the store in a big way.

So I'm not too concerned about that.

I am concerned about the marketing effort at the store level with regard to these new SKUs.

And we are going to try to communicate externally about it, and then internally we're going to try to execute so that we engineer these end caps and make sure this product is very visible.

[Chris Blackman], Imperial Capital.

A couple of quick questions.

You mentioned the inventory levels were down about 1% per store in '05.

What would you expect those levels to be as we exit '06?

Well, let me address the first part and I'll turn it over to David for forward-looking -- he will keep me out of trouble on that one.

But looking back, though, I'm not too happy with the 1% reduction.

If you look at the turns, up at 4.2, I'm relatively pleased with that.

But through three quarters, we were up over -- I mean, we were down over 6% in our inventories.

So the sales miss in the fourth quarter, the early receipts of some spring goods combined to get us at year end to be in a total inventory position that is not quite as attractive as I wanted it to be.

Going forward, as I have said before, we're going to continue to focus on, at the store level, the balance of the inventory and the relative combination of non-season -- non-current-season inventory that is active in the present season, with the new product that's coming in there.

Looking forward, I don't think we can give you any guidance on that except to say that we're going to focus -- we're not going to reduce the level of focus that we have had on it this past year.

I would agree with what David has said.

I think those qualitative comments are the extent of what we can comment on because we don't give specific guidance on inventory levels as we move forward.

Would you discuss a little bit more the zone pricing rollout?

It kind of sounded like in your commentary that maybe there's a little bit of a delay there or it's not progressing as quickly as we had anticipated.

Can you just --

Thank you, Chris.

Yes, let me clarify that.

The progress on the preparation for it is moving along very nicely.

I want us to get back to basics in some key areas, though.

And we are going to our real estate people and telling them to limit the push into some areas where we had to have zone pricing to get in there.

And we are refocusing on getting our comp sales back, getting this traffic stabilized and so forth.

So I feel real good about that.

In the meantime, we are continuing to develop the internal strategies about how we will use zone pricing, where we will use it and so forth.

Frankly, I don't think that's going to be an '06 issue.

As I said last year, we had hoped to have that implemented in certain areas of the country in '06.

Given where we were in fourth quarter, I am now saying that I would not be upset to see that move -- zone pricing, anyway, move as an issue into an '07 issue if we can attempt -- if we can achieve what we want this year in terms of traffic and comp sales.

Maybe as a follow-up on that, geographically, are you moving into some new geographic markets?

Any new markets that you all have mentioned?

Not really.

I mean, we are in Colorado, New Mexico, Arizona, Nebraska and so forth.

Wisconsin.

We are filling in around where we've been.

Now, we may be in a corner of a state like Montana or South Dakota, someplace like that.

But nothing really in a major way.

We consistently move out contiguously.

And we're limited in some respect by the location of our distribution centers and the attempt to keep stem miles under control.

So we're not running amok out there.

We don't have anybody in Oregon looking for store locations yet.

And we are doing our homework about California and other places, for that matter.

But right now, from Arizona, Colorado, we may actually cross into the Nevada border this year.

But I would not call that out as a major change from what we've done these past two years.

This will be our final question.

Meredith Adler, Lehman Brothers.

I wish you could talk a little bit more about the addition of more advertising, more promotion, flyers -- is there a risk here that you deviate from the efficiency of everyday low price?

Well, of course.

I think, Meredith -- thank you, good morning.

I think this is certainly something we did not take lightly.

We've been talking publicly about advertising as a long-term strategy.

We are choosing in '06 that we will begin to do that.

It is consistent with the three-pronged strategy we laid out back in '03 of organization, stores and merchandising.

Now we are moving into merchandising.

We've gone in and worked on that organization.

We have brought Beryl in and we're doing the things to get back to basics in that area that I think are important.

Along with that is this continued investigation and now active work in this whole communication piece.

Yes, it's an issue, but we are not going to walk away from our EDLP strategy.

We are committed to that.

And we think it's a pretext of our successful model.

Now, having said that, there is nothing wrong with the treasure hunt dimension.

Frankly, as I have said publicly over the last year, I feel like we have lost some of our treasure hunt dimension.

We're going to get back to that.

We have dedicated resources to it.

We have people in various parts of the world working feverishly on that right now.

And I believe that's where we'll see a lot of the synergy come from.

We are not necessarily going to take our everyday products and bounce their pricing around in a high/low manner.

And in that regard, I have no concern that we will maintain the efficacy of the EDLP model.

I just think it's time that we make this model competitive a full 12 months of the year, and not just 10 months of the year.

Back to school and holiday have always been very difficult for this model.

People come off of us as consumable, everyday low price.

They go out and get the flyers and they go use their discretionary spending in other places.

Then the next month, they typically come back to us.

This year, the promotional environment was so intense that that return hasn't been as rapid as we would have liked.

And so we think it's time and we think it's totally prudent to start moving in this direction.

We are not going to move in this direction, Meredith, without measuring everything that we do.

So we're not throwing caution to the wind and knee-jerking here in reaction to our fourth quarter.

What we're really doing is implementing our long-term plan to get more intimate with our consumers.

And by the way, that includes -- we already spend a good bit of money every year advertising the opening of our new stores.

We think we can do a better job of that and impact not only that store, but the entire community in which that store resides.

So it is a multi-faceted approach.

We feel good about our pricing right now.

We have new pricing benchmarking capability we haven't had before.

That is profound and it's giving us tremendous information about where we are competitive and where we aren't.

And I'm quite happy with our price-competitiveness right now.

So we are going to continue to use that as our constraint -- our master constraint.

And within that, we're going to move out and try to compete more aggressively.

And a couple more questions.

There have been people expressing concerns about EZstore.

But one of the things that I don't think you've discussed at all is whether there is a tradeoff between improving labor efficiency because of EZstore, but increasing your fuel costs because the trucks just can't get as much stuff on them using the rolltainers.

Well, actually, the latter part of that premise is not true.

If you look at the practices that we had before in terms of having full loads to stores and not breaking those loads, we actually see potential to actually increase utilization.

And so the last premise, the tradeoff, should not be there in our environment.

The second thing is, is that when you look at the biggest -- when we talk to our store managers, particularly exit interviews and that sort of thing of people leaving, the biggest concern about EZstore is the reduction in hours.

And we've taken hours out relative to the work that has been reduced.

We want these people to have more time to focus on the merchandising of the stores and so forth.

And recognize when you have change of this magnitude, you're going to get mixed signals from throughout the organization.

I'm telling you, from my seat, that the results are very encouraging right now.

In the stores that are using it the way it should be used, the results are very encouraging.

And the people see the benefits at the store level.

The tradeoff -- Meredith, let me say one more thing -- there is a tradeoff in labor.

And we've said this before.

One thing that is true is that when you take the labor out of the store, the sortation of the goods that we used to do in the stores, in the back room and in the aisles of the store, by the way, on truck day and the day after truck day, are now -- that sortation is now being done in the distribution center.

And so there's an incremental increase that we have absorbed in the distribution centers there.

And I'm very happy with the way the DCs have absorbed that.

So there is a tradeoff there.

It's not like we don't have to sort the goods.

We do.

But we are now doing it in the DC where I can do it much more efficiently than we could ever do at the store level.

And then you haven't commented really much about the DG Market and whether you're happy with the stores you opened this year and the ones that were opened last year.

Are you getting the results you're looking for?

Yes, thank you for that call-out.

We mentioned it in the rhetoric, or in the script, but we haven't had an opportunity to embellish that.

I am very pleased with what we're doing.

Wayne Gibson is a fireball.

And he is very smart.

He's got a background -- he's very entrepreneurial.

And we're getting into this in a detail that we have not been able to before.

We have a distribution.

The number of stores that we have operating now, we have a couple of stores that have been out there long enough to be a comp store, [prizefighter] comp store.

We also have some new stores.

We tested different types of locations and we now have a learning about which locations really work very well and which locations don't.

We have also tested size a little bit, although I still want to test some other size variations that will give us a look at maybe a little bit different size.

But overall, the allocation of the merchandise, the layout of the stores, the cleanliness of the stores, the labor efficiency in the stores and the financial productivity I am generally pleased with.

I'm not ready to tell you that we're going to stop opening traditional stores and open DG Markets, because we just got some learnings that we still need to accomplish.

But I'm very pleased with it.

We are going to commit another 30 stores this year that we've said publicly to open.

And I think that's a strong indication that we are continuing to push that as a long-term strategy.

I just have one more question for David Tehle.

The guidance that you had given us for '05 -- did that include the insurance proceeds that are being delayed?

Yes.

Okay.

Have you quantified what that is as an earnings per share number?

Well, you know, I have to be careful because we are still negotiating with the insurance company.

Our claim net, what's left in our claim -- we tried to spell this out -- is $15 million.

And that is what we're working on to get from the insurance company right now.

But that was what was in your guidance for last year?

Correct.

Thank you, everyone.

Thank you, everyone, for joining today's conference call.

Please disconnect your line.