達樂 (DG) 2006 Q3 法說會逐字稿

This is the Dollar General Corporation third-quarter 2006 conference call on Tuesday, December 12, 2006 at 9 a.m. central time. Good morning, ladies and gentlemen and thank you for participating in today's call. This call is being recorded by Conference America and Shareholder.com. Under federal law, no other recording or rebroadcast of the session is allowed without the Company's permission. After a prepared statement by the Company, we will open the call for questions from the audience.

Before the presentation begins, the Company has asked that you listen to the following statement regarding forward-looking information. In addition to historical information, the Company's comments today will contain forward-looking information. The words believe, anticipate, project, plan, schedule, expect, estimate, objective, forecast, goal, intend, will likely result or will continue and similar expressions generally identify forward-looking statements. While the Company believes the assumptions underlying these statements are reasonable, any of the assumptions could be inaccurate and therefore actual results may differ materially from the results projected or implied by the forward-looking statements.

The factors that may cause actual results to differ from the forward-looking information include but are not limited to those outlined in the Company's most recent Form 10-K and Form 10-Q, as well as factors assessed in today's call. The Company cautions you not to unduly rely on these forward-looking statements, which speak only as of today's date. Except may be required by law, the Company disclaims any obligation to publicly update or revise any forward-looking statement to reflect events or circumstances occurring after this call or to reflect the occurrence of unanticipated events. You are advised, however, to consult any further disclosures the Company may make on related subjects in its public 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 and good morning, everyone. With me this morning are David Tehle, our Chief Financial Officer and Emma Jo Kauffman, our Senior Director of Investor Relations. Because I just spoke to you two weeks ago on our strategic revitalization process, I am going to abridge my remarks this morning to allow more time for questions.

We have now completed the process of recording the financial impact of these actions on our Q3 financials. So I am going to turn the call over to David Tehle to let him share with you the financial results of our third quarter and give you a brief update on these strategic efforts. I will also be available later for questions after David completes his remarks. David?

Thank you, David and good morning, everyone. As David mentioned, on November 29, we announced major strategic changes in the way we plan to manage our merchandise and our real estate and we also announced the expected impact of these changes on our third-quarter earnings.

The Company has already taken significant steps forward on the execution of these initiatives. The first wave of the store closure process started last week and is moving forward as planned. A steering committee composed of executives has been formed and will report to David Bere, our new President and COO. The committee will meet on a regular basis to execute all necessary actions related to both store closures and the new inventory strategy.

A seasoned Vice President, Michael Buxton, will have the full-time job of coordinating every aspect of this project. Michael has over 33 years of experience in retail and has executed similar projects with another retailer. We recognize the importance of superior execution of this project and are taking numerous steps to ensure its success.

The primary purpose of our call today is to review our third-quarter financial results. As we discussed on November 29, this quarter includes pretax charges of approximately $79 million resulting from these strategic changes. Specifically, cost of goods sold include $63 million of below-cost inventory adjustments related to our decision to eliminate the use of packaway inventories in our model and $8 million of below-cost inventory adjustments related to stores we plan to close outside the ordinary course of business in fiscal 2007.

SG&A includes the remaining $8 million of the $79 million to account for asset impairments on the stores to be closed. As a reminder, these adjustments were based on management's assumptions regarding the timing and adequacy of markdowns and store closings and the final adjustment may vary materially from the amounts recorded depending on various factors, including retail market conditions, timing of the execution of the plan and the accuracy of our assumptions used in developing the estimates.

I will be speaking to GAAP numbers as we go through the financials. So please keep the effect of these charges on our P&L in mind. As you know, we have to be cautious about discussing any non-GAAP results, so I will stay away from that.

For the fiscal 2006 third quarter, we reported a net loss of $5.3 million or $0.02 per share. Net sales for fiscal 2006 third quarter were $2.21 billion. That is a 7.6% increase over net sales of $2.06 billion for the fiscal 2005 third quarter. In total, highly consumables were up 8.4%; seasonal was up 13.7%; basic clothing was down 0.3% and home products were up 0.5%. The increase in sales includes the sales of 430 net new stores and a same-store sales increase of 2.0%.

As a percentage of sales, gross profit for the fiscal 2006 third quarter was 23.8% compared to 28.1% for the fiscal 2005 third quarter. That is a decline of 436 basis points. The charges I discussed earlier account for 322 basis points.

In addition to the charges, gross profit was negatively impacted by a higher sales mix of lower margin merchandise, a decrease in purchase markups, increased promotional markdowns and, to a lesser extent, increased inventory shrink. Selling, general and administrative expenses, or SG&A, were 23.6% of sales for the third quarter of fiscal 2006 versus 23.2% of sales in fiscal 2005 for the same quarter, an increase of 43 basis points. Again, the '06 period includes $8 million of impairment charges related to the store closings that we announced.

Expenses contributing to the increase in SG&A as a percentage of sales were store labor due to additional labor associated with various store initiatives, store occupancy costs due primarily to higher store rental rates and administrative salaries resulting from additions to the Company's leadership and reorganization of the merchandising and real estate teams earlier in the year, as well as the expensing of stock options. These increases in SG&A were partially offset by $7.0 million of proceeds from the final settlement of our hurricane Katrina insurance claim recouping some of the losses from last year.

Interest expense net of interest income for the fiscal 2006 third quarter increased $6.4 million over the prior year quarter due to higher net borrowings and an increase in income tax-related interest of $3.2 million. That $3.2 million was primarily related to income tax reductions in Q3 '05 resulting from the resolution of certain income tax-related contingencies.

For the 39-week year-to-date period, net income was $87.9 million in fiscal '05 or $0.28 per diluted share compared to $204.9 million in fiscal '05 or $0.63 per diluted share. Year-to-date net sales increased 8.4%, including a same-store sales increase of 2.3%.

The Company's gross profit rate to sales was 26% in the 2006 year-to-date period compared to 28.4% in the '05 year-to-date period. In addition to the below-cost inventory adjustments recorded in '06 in the third fiscal quarter, the decrease in our gross profit rate was primarily impacted by lower markups on purchases, increased promotional markdowns mainly in the second quarter, a higher sales mix of lower margin merchandise, some increase in shrink and increases in transportation costs primarily due to higher fuel costs earlier in the year.

Year-to-date, our inventory shrink rate was 3.38% in '06 compared to 3.20% in '05. SG&A expenses for fiscal '06 year-to-date were 23.5% compared to 23.0% in '05. In addition to the $8 million of asset impairment charges described above, SG&A was impacted by increased advertising in the first two quarters, higher store occupancy costs and increased administrative salaries. These increases were offset by proceeds of $13 million related to the settlement of the hurricane-related insurance claims.

Our year-to-date effective income tax rate for fiscal '06 year-to-date was 38.6% compared to 35.5% in the 2005 year-to-date period. This increase is a result of a tax law change in the '06 period that reduced previously recorded deferred tax assets related to the Company's operations in the state of Texas, which we discussed last quarter, the nonrecurrence in the '06 period of benefits realized in the '05 period related to an internal corporate restructuring, an increase in deferred tax valuation allowance in '06 due to revised estimates regarding the Company's ability to utilize certain state income tax carryforwards and a reduction in income tax reserves in the '05 period due principally to the expiration of the statute of limitations that did not reoccur in the '06 period.

As you may have heard, Congress approved a federal jobs credit program yesterday. If the President signs this into law, we would expect to record jobs credits retroactive to the beginning of the year reducing our effective tax rate.

Switching to the balance sheet for a moment, we made good progress reducing the increased level of highly consumable inventory that we had on our balance sheet at the end of the second quarter. As expected, we were able to sell through most of this inventory in the ordinary course of business. We discussed our new plans to eliminate packaway inventories in our recent press release and conference call, so I won't spend time on that topic now.

We will be putting substantial focus and effort into this project over the next four to five quarters. We are very optimistic about the opportunities to reach out to our customers both during and after this timeframe. Internally, we are very excited about the changes we are making and the feedback from the field has been very supportive of this effort. I might point out that after the adjustments, our inventories on a per square foot basis are flat to last year, but we believe we are actually better prepared for the holidays this year.

We've flowed merchandise to the stores differently this year allowing us to manage in-stocks on seasonal merchandise better. We have a little more treasure hunt than last year in the stores and we are pleased with the sales results from our holiday circular, which ended yesterday. Of course the competitive environment is extremely tough, so we have to remain cautious.

Through the third quarter, our capital expenditures were $221 million primarily related to the opening of 408 new stores, as well as the final rollout of EZstore and the completion of our Marion, Indiana distribution center. As we said a couple of weeks ago, we expect to open a total of approximately 60 new stores for the fiscal new year. Excuse me. 600 new stores for the fiscal year.

With that, operator, we will take 30 minutes of questions.

(OPERATOR INSTRUCTIONS). Deborah Weinswig, Citigroup.

Yes. So in terms of looking towards the future, what would you say are the milestones that we should be watching to make sure that you are kind of hitting everything as planned, David?

Deborah, this is Perdue. It's a good question. We internally have our glide paths if you will. There are two things. One is the sell-off of this inventory that we have identified and the second is the closure of these stores.

In that regard, we have got certain milestones during the year that, for various reasons, we don't want to publicly discuss today, but we will be talking to you at the end of each quarter about those milestones and where we are in relation to them.

The second thing is there are various merchandise -- or the third thing rather -- various curious merchandising changes that we are putting in place to accommodate the switch from the packaway model to this clearance model. And we will be talking about those milestones with you as we go through the year.

The biggest thing for us right now is to get this thing started with a lot of enthusiasm and we have been very successful with that the first couple of weeks here. We have started the process with the first wave of our store closures. There's about 130 plus stores in that and that has been started very successfully and has been received very well in the field. So we will be talking to you every quarter this year about these milestones.

Congratulations again with the significant changes underway and best of luck.

Thanks, Deborah.

Thank you.

Mark Miller, William Blair.

I was hoping you could provide some perspective for the financial performance of those 400 closed stores. Assuming a normal distribution, I am guessing that you had some significant losses on an operating basis with those. So not counting these nonrecurring charges for inventory, could you give us some sense for what the annual earnings benefit would be by having those closed?

Yes, absolutely we get an earnings benefit out of doing that. We are not prepared to give an exact number on that. We ran various models on it. I want to stress that we looked at all our stores when we went through this process and we looked at a whole variety of factors in terms of trying to determine which stores would be candidates for closure.

We tried to look at competitive forces in the marketplace. We tried to look at the real estate factors and then certainly, as you mentioned, we had to look at the financial aspects of the stores. And clearly we do get a positive impact from the 400 stores in getting out of these stores, but again, we are not going to give a number on that.

David, I was having conversations with investors, some of whom thought this could be as much as six figure losses on these stores on average. I am following up because it would be a material number for it to be that large. That would be approaching a $0.10 benefit to EPS. Is that reasonable? Can you comment on those perceptions?

Well, again, I think I have got to go back to the answer that we gave you earlier that we are not going to quantify what the impact is going forward. Suffice it to say, it is a positive impact to the Company and that is all we are prepared to talk about there.

Okay. Can you give us an update on store manager turnover of what is the trend there and just comment on I guess what adjustments you are making to drive improvement there? Thanks.

This is Perdue. I will be glad to. Thank you for that question as well because that, in my way of thinking, is one of the big objectives that we have in this revitalization effort candidly. A couple years ago, we focused on store manager turnover. We got it down significantly down in the 40s. It has bumped up again in the low 50s and during the second and third quarter of this year, we were very concerned because on an annualized basis, it was actually increasing.

There are various reasons for that and we have attacked those and I can tell you in the last few weeks on an annualized basis, we have seen those numbers turn down significantly. We are focused on that. Challis Lowe, our senior HR person, has been chosen to head up a task force to attack this problem next year with her partners in operations and merchandising and we are seriously adapting changes right now to affect how we pay, how we hire, how we manage, how we train our store managers and that also includes our district managers, region managers as well. But just rest assured that this is one of the top areas of focus for the Company in '07.

Just one final question then that has come up. Do you expect shrink to stabilize or given that that is frequently a leading indicator for shrink, do you think we might see shrink continue to climb a bit further before you have a chance to bring that back down? Thanks very much.

That is anybody's guess and that is a forward-looking conversation. I can give you my point of view. First of all, we have a more intense effort on this right now than we have had in the last, I would say, two years and it is multi-functional. We have now not just looked at the problem stores; we are now looking at the problem SKUs. It really is a very complicated issue.

We know we have made tremendous improvement in our lower -- our worst performing stores over the last few years. As a matter of fact, back in '03 and '04 timeframe when we reduced shrink significantly, we proved that we could get the stores lower. In the last year or two, what we have done is added some SKUs into the mix that have contributed to the increase in turnover. I'm sorry -- in shrink.

We think that this thing could be stabilizing, but there is no way to really guarantee that and I think what we are focused on right now is significant decreases in that over the next year or two as part of this revitalization effort.

Thanks. Good luck.

Christine Augustine, Bear Stearns.

Now that you have completed the EZstore rollout, do you anticipate making any adjustments to the program? That is my first question. And then secondly, I would like to know if you are seeing any results yet from the various planogram changes that you executed through the second and third quarters? Thank you.

Yes, I will speak to that. One of the things that we are very excited about frankly and we haven't been able to talk a lot about this because it has just really shown up in the second half of the year. When Beryl Buley, our new head of merchandising, showed up in the first of the year, he came in after a very difficult comp sales quarter and fourth quarter of last year. We made several changes to the merchandising mix, but one of the things we did is we actually delayed the planogram schedule for the year to allow him time to have impact on what we were doing in the first half of the year.

They did that. And as these planograms have come on in the second and third quarter particularly, we are becoming more and more encouraged that the changes we made in the cleaning wall, the paper wall and HBA, particularly, are bringing great results.

Let me call out seasonal as well. Seasonal made some significant changes in the first quarter this year that we did not see until third quarter this year and we are now seeing very encouraging positive comp sales in that category. That gives us some hope that home and apparel will follow suit as we go forward.

And let me say one other thing too. The planogram changes that we made this year are also going to continue into '07 as well, particularly with this finding our balance between branded and nonbranded, increasing our sourcing percentages and also working on where private label fits into the bigger mix.

So we are very excited about what we are seeing close-in on the planograms. We are sobered by the fact that this is a recurring challenge every year, but it drives comp sales. So we are very focused on it.

The changes on -- tweaking on EZstore. I'm sorry. EZstore is a very dynamic program. We finished installing it across our network, but we have nowhere near finished the achievement of all the benefits coming from that.

One of the things that we continually look at is how we staff the stores and remember as part of EZstore, we change the staffing routines for the stores to match when the customers were in the store to improve customer service. Once we freed up some of the material handling requirements in the stores, we were able to then dedicate labor to time periods when customers are in the stores.

The second thing is in the material handling. We continue to make improvements there to lower costs, both in distribution centers and in transportation and I think our merchandising group with our new players have gotten involved in that and made tremendous improvements in that as well. So yes, it will be a very dynamic process. It will continue on through time. We will continue to tweak it and I think we will see some continuing benefits, particularly from damage reduction.

Although let me say something about damages as well. As we go through this inventory sell-off this year, both inventories of shrink and inventories of damages might increase gradually as we go through that process and clean up these back rooms. But over the long term, we expect that the EZstore benefit and also the effort that is underway now will positively impact both shrink and damages as we continue to finish this execution behind EZstore.

If I could just ask one more, which is on the move to a clearance model from a packaway strategy, I just wanted to clarify -- you have the proper systems, the issue is the change in the process. Is that fair to say?

Yes, it is. I think that is a very fair representation. We have just decided that we will put more discipline in the buying process and the merchandising area to make sure that we clear each season's merchandise at the end of that season. We are hopeful and quite frankly very optimistic that the fresh merchandise will sell better when it is not conflicted with the older merchandise from past seasons.

The system's accommodation -- we are all always developing systems. We have adequate systems right now to make this change. I would say the biggest thing is the cultural shift and the discipline that we are putting into merchandising.

Will that entail any change in the way that the buyers are reviewed, evaluated, compensated?

Absolutely. Without going into a lot of detail, in the past, we would look at go-in margins as one of the indicators of success in that area. Today, we are looking at many more variables, including gross margin, sell-throughs and the clearance at the end of the year. Inventory and balance sheet issues have now been brought to the forefront in terms of evaluating success in our merchandising area. So yes, we have changed the entire incentive structure in that area.

Michael Exstein, Credit Suisse.

You touched on the press release and also in your narrative about lower markups in the quarter. Can you sort of explain what that is about and what that signals potentially going forward? Is it a one-time occurrence do you think?

I think that was, more than anything else, due to some of the branded products that we have. We talked earlier in the year about we brought in some more branded products and part of the markup situation is related to that. So I don't -- no, I don't think it is necessarily a sign of anything or a foreshadowing of things going forward. I think it is an adjustment we made as we brought in some branded product and obviously we have talked quite a bit about our private label efforts and the things we have going on there, particularly as we move into '07, that will help us the other way on margin as we get more into private label.

Just following up on the prior conference call, the estimated roughly $300 million worth of inventory, was that actually in-house at the time you made the announcement a week ago or is that in anticipation of some stuff that will come in so that there will have to be an incremental markdown taken?

This is Perdue. That inventory is in-house. It's really -- what we're talking about is holiday '06 and prior inventory. In addition to that, we will have the clearances at the end of spring '07 and then fall and holiday '07 as well, which has been included in our models, but is not included in that $300 million at cost and that was at cost too by the way.

Okay, great. Thanks so much for the clarification.

Thanks, Michael.

John Zolidis, Buckingham Research.

A question on the change in strategy on packaways. One, could you comment on whether you think that is going to have an impact on the top line in 4Q and beyond and then second, do you think that the change in strategy will have an impact on the mix shift that has been occurring on a going-forward basis? Thank you.

Those are key questions and let me address the revenue question first. It is a forward-looking estimate and I really can't comment on that, but I will say that we are hopeful that with this change we will have fresher merchandise each season with a positive benefit to revenue. I think Q4, it is very early to say anything there. We're going to have a lot of markdowns in the quarter as we've said prior to this. So it is going to be a very fluid environment I think as we go through. You know that it is an extremely promotional environment this year, as it has been the last couple of years in Q4.

With regard to the mix, the other benefit of this frankly is that for the past year or two, we have been buying down our seasonal inventory, our new purchases for seasonal inventory, seasonal home and apparel that is, in order to accommodate some of the sell-off of this inventory and some of the tests that we have been doing over the last year or so.

As we go forward, having a fresh mix of products, as I said earlier, we think will help this mix between consumables and non-consumables going forward. We are not ready to make any estimates for you unfortunately, but we do see that stabilizing.

Patrick McKeever, Avondale Partners.

Just wondering if you might elaborate a little bit about the comments about holiday sales thus far being positive, just kind of -- is that the period between Thanksgiving and now. Then as far as the competitive environment, are you thinking about the competitive environment just throughout retail as it relates to Wal-Mart or the competitive environment specifically as it relates to the dollar store industry?

I will take the first half of it and I will let Perdue take the second half. Just factually speaking, the first nine days of our fiscal December is what we were commenting on and the results that we have seen out in our stores over that nine day period and again we did have a circular over that period, but the results were positive. We were again pleased with what we saw over the first nine days of fiscal December.

Again, as I mentioned in the prepared comments, we are still concerned about the competitive environment and we know as you reach closer to the end of the month, it gets more and more competitive. But again, we believe we are off to a very positive start.

Let me add one thing to that just briefly. We are learning a lot about how to use these circulars. This was another major circular for us and we are very pleased with the reaction to it. We now -- it was not discounted as heavily, so it didn't have as big a negative impact in that regard. But in terms of driving traffic and sales, we have been very pleased so far.

The second thing is my comment on the competitive environment really has to do with the promotional environment around holiday this year and enough said. We all read the press. We have been in a lot of our competitors' stores.

It is not anything -- I don't mean to imply anything related to the dollar store industry. Although, I think anybody that looks at historical numbers can see that we have been in a down cycle here for the last couple of years. And I think it has been exacerbated a little bit by the fact that we had rising gas prices and so forth.

Even the reductions in gas prices haven't positively impacted the low-income consumer as much as it has say the mid-tier consumers. But we are making the changes we think that will help us be more competitive even in these highly promotional periods, such as holiday and we made those comments a year ago as well.

Sure. So net net, it is more of a positive comment then. I took it initially as more of a guarded comment about the holidays, but it sounds like you are saying that, thus far, it's positive.

Yes, let me just say this. We have gotten off to a pretty good start in December. That is really all I can say. I was cautioning you about -- it is anybody's guess for the remainder of the month and in January because of the highly promotional environment.

That's very helpful. Thank you.

David Cumberland, Robert Baird.

In following up on that, with the holiday circular ending yesterday, for the remainder of the month, can you talk about any promotional efforts that you have planned?

Really, we have got our normal markdown programs that we have talked about in terms of this revitalization program and so forth. With regard to specifics, I am not prepared to talk about any of that at this point on a close-in basis. But we have established our planograms, our entire merchandising purchasing this year for holiday around the idea of being more competitive on a price point of view and also on a treasure hunt point of view.

So I will guardedly tell you that I am more optimistic this year than last year in terms of our competitiveness in this promotional environment.

Thanks. And then looking to next year, there are expectations of minimum wage increasing. There have been increases in certain states. What would the expected impact be or would you expect the impact of minimum wage increase to be neutral or positive or negative on a net basis?

Well, it is anybody's guess. I read the papers as you do and the press and I see arguments both ways. I mean we know what impact it will have on our SG&A, but we also have optimistic hopes of the positive impact on the revenue. And frankly, when we look at the number of years it has been since we had a minimum-wage increase, there may be some pent-up demand behind that as well. So on balance, we think this might be a positive benefit for the Company.

Scott Mushkin, Bank of America.

This is actually (indiscernible) for Scott here. I just had a quick question. Could you guys -- I am just trying to understand sort of the ongoing business and sort of the underlying business. I mean obviously you gave us the charges, but is could you give us any kind of quantification or color related to the markdowns, the non-charge related markdown activity that is going on in the stores? Also you spoke about sort of hiring additional folks to help in the process. Obviously that is going to impact SG&A. Can we get any color on both SG&A and gross margin, trying to get at the base business apart from the markdown activity?

Really, what we are prepared to say on that and we said this in our last press release and our less conference call when we talked about these changes, we will have markdowns from retail at significantly higher levels for Q4 and throughout '07 than we have had in the previous years. We do have incremental store labor and incremental advertising costs to help with this effort in terms of what we are doing and we are really not prepared to give any quantification of that at this point.

Okay. And then I guess -- I know you talked about it before, but I was just trying to get a little more color, revisiting the decision and the thought process on the approach you are taking with the inventory issues. Just if you could just kind of give us a little color on the thinking on opportunity costs as opposed to just flushing out, giving it to a third-party liquidator trying to sell through in-house.

We looked at that in great, great detail as you might surmise when you make a decision like this and clearly the economic value to the Company and the shareholders comes with the approach that we are taking of selling this through in-season over the next four to five quarters.

Again, when we close our stores on the store closure side, that is a little bit quicker in terms of what we are doing there. Our process is a little different because we have a quicker time period that we are exiting those stores. So we treat that inventory a little bit differently than the other inventory. But we did a good deal of analysis on this before we made that decision and we truly believe we have reached the best decision in terms of how to handle this going forward. And from an economic point of view, it clearly is the best way to do it.

This is Perdue. Let me just add one bit of color to that if I might. Let me just emphasize this is good inventory. We value this inventory every quarter. We looked at alternatives of dumping this inventory and frankly no one would pay what we thought it was worth and we have got 8000 stores through which we can distribute this very efficiently, much more efficiently than a lot of other people. So we think we have taken the lowest risk, highest potential path in getting rid of this inventory. We all would love to just get rid of it today, but it is not problem inventory from that perspective.

Thanks very much and congratulations and good luck.

Charles Grom, JPMorgan Securities.

Thank you. Just to follow up on one of the earlier questions. Is the margin benefit from the 400 store closings embedded in the 27% GPM outlook that you guys outlined?

Yes, it is.

And then just to circle back on that 27%, can you revisit some of the assumptions? You touched on it in the press release in terms of up where you think your mix will be, what you think your private label percentage is going to be and any other color you can add.

No, we really don't have -- I don't think we have specifics that we are willing to come forward with. I mean we've talked about, as we move forward and get away from the packaway, we do believe that we will have lower damages, lower shrink since we will have cleaner stores and stores that are organizationally more solid.

We talked about the better mix of product as we bring in fresh merchandise, particularly in the apparel and home areas that we have discussed for many quarters that we have had issues in terms of the sales in home and apparel. We do expect the better purchasing power and being able to increase our foreign sourcing to help us there and we have talked about having more of a focus on foreign sourcing that will help us going forward.

David talked about the discipline in the open to buy programs and the new procedures that we have there with the new merchants, the new merchandising, what we are doing. And again we talked about -- we did see an increase in the mix of private label as we continue to refine our strategy and what we are doing here going forward and we definitely have more resources on the private label area currently than we had a year ago. So again that is a big emphasis for us.

But in terms of actually giving numbers and quantifying that, any of these items, we are really not prepared to do that beyond the margin assumptions that you know that we gave in the last release.

Just one follow-up there. As your merchants start to buy for spring and summer, I don't know if Beryl is in the room, but I would like to hear kind of how the process is going to change going forward so we don't buy too much and we don't have this packaway problem going forward.

Well, that is the challenge and honestly that is why we have taken so long evaluating this thing. We wanted to ensure ourselves. We wanted to prove to ourselves that we were ready to make the changes to make sure that never happens again.

First of all, we have a planning function now that we didn't have a year ago. We have the efficacy behind the discipline of open to buy management and also the latter plan to start selling this merchandise off in season when sell-throughs decline below a certain level of acceptability.

So we also have added a number of talented people from other retailers in the merchandising area who only know this way of merchandising. So we feel very confident that once we get through this, we will have the disciplines to enforce not having this packaway problem.

Now let me talk about some of the nuances. We have got -- our in-stocks have gotten much better over the last couple of years. We have gotten this replenishment program that we have refined and gotten to a point where we have made significant improvements in our in-store in-stocks both on the consumable side and on the core products on the non-consumable side. So I think between the system changes, the replenishment systems and the planning systems that we have put in, we are very confident that we will be able to accomplish this.

Meredith Adler, Lehman Brothers.

A couple of questions. To kind of follow-on a little bit from the last question, can you just give us some idea of kind of what the timing is, how far along you are in terms of global sourcing and then the private label program? I don't want specifics, but is this a program that is going to take you another three years to fully be developed, both global sourcing, treasure hunt and private label or are you closer to having kind of what you think you can have?

This is Perdue. As you know, we started -- we opened our global sourcing office in Hong Kong in '04. I actually recruited a lady that had worked for me back in the '90s in Asia when I lived over there and we have made great strides over there. A lot of our hard lines have been moved into that buying office. We are moving a lot of our soft lines in there now and the numbers are increasing in terms of percentage. We are also getting more innovative product frankly by being directly related to a lot of these vendors as you might imagine.

With regard to private label, we have recruited a very senior person from a highly respected competitor here this year. Beryl brought her in earlier this year and we are making dramatic plans right now in that private label program. Now let me say this. No, it is not going to take three years to get to where we want to be in both global sourcing and private able. We made dramatic improvements in the last two years there.

Private label is one of these things that we have got to find a balance between the branded emphasis that we have as a company for credibility and because our customers need it, but also to provide a private label opportunity to give us the price point diversification that I think we need. This is not only about margin; it's about the needs of the customer. We have been to Europe; we have studied models over there. We have studied higher-end models here, lower-end of models here in terms of the balance that we think will apply and we are on to implementing that right now. So you will hear a lot more about that as we go through the next, I would say, six to 18 months.

Okay. And then another question, if you could just talk to us a little bit about the actual process of eliminating the packaway inventory. Just how -- what is going on at the stores, who is responsible for making it go away, how do you coordinate this, is there some advertising that is around stores in a region, what is the process?

Really all of that, Meredith. We have a team, as I mentioned, not only do we have this executive committee, but then there is a leadership team underneath that, the people that day in and day out are dealing with these issues. We have regular communication with the stores in terms of identifying the inventory, bringing it out, getting it displayed. We have signage, specific signage that we are using in the stores and then we are putting advertising in addition to signage around this effort as we go forward.

We mentioned in the last call that we have a substantial number of people that will be out in the field in each district, two people per district or about a thousand people, over the next 30 weeks that will be going through all the stores, making sure the product is out, making sure it is displayed properly and then moving product between stores if necessary in terms of if you have a store that is selling inventory better than another store.

So we have continuous monitoring, continuous reporting into Goodlettsville here so we can keep track of it, but it is really an effort that starts at the field and that is where we have got the resources.

Okay. And then I have another question on timing. You have got -- you started with about 125 stores I think David Perdue said with closures. When is the timeframe for finishing the closures?

What we have said on that is there are several ways that we are doing on the closures and we haven't been specific. We are saying we are going to get it done in the fiscal year as we move forward.

Okay.

In '07.

In '07, yes. My final question is just -- you had -- the reason you ended up with excess inventory at the end of the second quarter was in part because you had flyers. It was a learning process. David Perdue said that the flyer you did for holiday was less hot. Were you also in a better position to manage the amount of inventory and is there any reason to believe that basic inventories are going to be up or any inventory is going to be up as a result of the flyer?

No. Meredith, I'm sorry. Did you say that I said that the holiday flyer was less hot?

Yes, I thought you said it was less promotional, less markdowns or something.

I'm sorry. Yes, it was less promotional. I'm sorry. But I think, as David said before, we finished the quarter with inventories moving in the direction that we want. We are optimistic they will continue to do so in fourth quarter. We learned our lesson in the spring and I will tell you it was an act of commission. We got out there and became very aggressive. We've worked through it now and I am very optimistic as we go forward with this planning function that Beryl has worked hard on this year that we will be much more efficient in the next year's inventory management.

We have time for one more question.

Stacy Turnof, Merrill Lynch.

A follow-up question to Meredith. In terms of the process related to the packaway, could you walk us through how you're actually going to do the markdown? Is it going to be sort of a stair-stepping of discounts? That's the first part. And the second part is in a best case scenario, when do you think all the inventory will be removed?

I will take that question. Yes, definitely it is a stair-stepping of markdowns. There is an actual glide path as we call it that is set up for all the different types of inventory that we have. It will be taken to a certain price for a certain time period, a certain number of days and then it will go to the next price.

We will continually monitor that and see what the sell-through is at the various prices and obviously we will make adjustments based on how well it is selling through or in cases where it is not selling through as well as we anticipated, we will have to change the glide path. But again, that is part of this committee and this leadership group that will continuously be monitoring this and we will be making decisions on it. On the timing of it, again, I go back to what we said previously, our goal is to have it all done in fiscal '07.

Okay. And then a second question regarding advertising. Any comment on how toys has been doing as one of your competitors did launch a toy book and when would we expect to see your next circular?

I am not prepared to tell you when you will see our next circular, but we are making plans right now as you might imagine for '07. Not only around this effort with inventory, but in regard to our normal practice that we are developing. I think it is too early to really talk about toys in the quarter. Just suffice it to say, the encouragement we have from the first few days of December is very broad. Let me just say that.

Thanks so much.

Thanks, Stacy. Thanks, everyone.

Thank you very much.

Thank you. You may disconnect at this time.