達樂 (DG) 2010 Q3 法說會逐字稿

Ladies and gentlemen, this is the Dollar General Corporation's Third Quarter 2010 Conference Call, on Monday, December 6, 2010 at 9.00 AM Central Time.

Good morning and thank you for participating in today's call.

This call is being recorded by Conference America.

No other recordings or rebroadcast of this session are allowed without the Company's permission.

It is now my pleasure to turn the call over to Ms.

Mary Winn Gordon, Dollar General's Vice President of Investor Relations and Public Relations.

Ms.

Gordon, you may begin.

Thank you, Operator, and good morning, everyone.

On the call today are Rick Dreiling, our Chairman and Chief Executive Officer, and David Tehle, our Chief Financial Officer.

We will first go through our prepared remarks and then we'll open the call up for questions.

Our prepared remarks today will be a little longer than usual as we will share some insight into 2011.

As many of you know we will be hosting an investor meeting on December 15th in New York City.

If you would like to attend please let me know and we would be happy to get you registered.

In addition to issuing our third quarter earnings release and filing our 10-Q this morning, you may have seen we also filed a preliminary prospectus supplement relating to a potential secondary offerings by several of our existing shareholders of up to 25 million shares of our common stock plus up to an additional 3.75 million shares to cover overallotment.

No shares would be sold by the Company.

This offering is pending and there can be no assurances as to when it may be completed if at all.

We will not comment further regarding the offering on this call either in our prepared remarks or in the Q&A session that follows.

So in advance thank you for not asking about this topic.

Before Rick begins I will provide some cautionary comments regarding our forward-looking statements and non-GAAP disclosures.

Today's comments will include forward-looking statements such as those about our expectations, plans, strategies, objectives, and anticipated financial and operating results, including but not limited to our comments regarding our forecasted 2010 financial performance, planned operating initiatives, store growth and capital expenditures, as well as our expectations with regards to consumer trends, anticipated private brand expansion and foreign sourcing opportunities.

You can identify forward-looking statements because they do not pertain solely to historical matters or they contain words such as believe, anticipate, project, plan, expect, forecast, intend, will likely result, or will continue and similar statements.

Because such statements are subject to significant risk and uncertainties, we cannot assure you that they will prove to be correct or that any trends will continue.

Important factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in our 2009 10-K filed on March 31, 2010, in our third quarter earnings release issued this morning and in the comments that will be made on this call.

We caution against undue reliance in these statements which speak only as of today's date.

Dollar General disclaims any obligation to update or revise any information discussed in this call.

In addition, we will reference certain financial measures not derived in accordance with GAAP.

Reconciliations of these measures to the most comparable GAAP measures are included in this mornings earnings press release which can be found on our website at dollargeneral.com under investor information, press releases.

You should not consider any of this information as a substitute for the most comparable GAAP measure.

Because not all companies use identical calculations, these presentations may not be comparable to other similarly titled measures of other companies.

It is now my pleasure to turn the call over to Rick.

Thank you, Mary Winn.

Good morning and thank you all once again for joining us today.

I'm very happy to report that we are continuing to have a great year.

We are executing our plans and delivering excellent performance for our shareholders, even as the macroeconomic environment continues to be volatile.

We achieved superior operating results for the third quarter, generating strong same-store sales growth, gross margin expansion, SG&A leverage, and increased profitability.

We achieved all of this despite the continued significant challenges that consumers faced and the highly promotional retail environment.

David will provide more details on our financial results in a moment, but I wanted to share a few highlights of the third quarter with you.

Our total sales increased 10.1%.

Same-store sales increased 4.2% on top of a 9.2% increase in 2009's third quarter for a two year stack of 13.4%.

I'd like to call out that we saw the Halloween and a payday shift into quarter four from quarter three.

Once again we saw increases in both customer traffic and average ticket in the quarter reflecting our customers' recognition of the superior value and convenience our stores offer.

Gross margin for the quarter expanded 51 basis points to 31.4% of sales.

We leveraged SG&A by 61 basis points.

Our operating profit increased by 27% to $274 million or 8.5% of sales.

Adjusted net income increased by 76% to $133 million or $0.39 per share.

We opened 176 stores in the quarter for a total of 491 new stores as we head into the holidays compared to 386 new stores year-to-date last year.

We ended the quarter with 9,273 neighborhood stores, up 6.3% from a year ago with selling square footage up 7.6%.

We've also remodeled or relocated 458 stores so far this year.

We are on track to have nearly 1,500 stores in our customer centric format by the end of the fiscal year.

Importantly, these results reflect a continued committment to our key operating priorities.

Let me provide some additional details on a few of these key metrics.

Our comp sales growth in the third quarter was driven by consumables with strong sales in nearly every consumable category.

Our efforts to leverage our dollar price point heritage are showing success, as we stay true to our EDLP committment and renew our focus on extreme value offerings.

For example, we currently have 1600 core $1 SKUs, which is up 37% from two years ago and we've been expanding the value offering in non-core as well.

Our efforts in non-consumables are also paying off.

Stationary, summer seasonal, housewares, and toys each contributed meaningfully to our comps during the quarter.

We were very pleased with the success of the back-to-school and Halloween sales during the quarter, with merchandise sell-through for both events once again exceeding our expectations.

We are especially pleased that our home category comps were positive.

We believe these strong sales increases in our discretionary categories are evidence that our improved merchandise selection, quality, packaging and store level execution are appealing to our broad range of customers.

Notably, category management and improved merchandise adjacencies have contributed significantly to our overall sales performance throughout the stores.

We are delighted with the early results of our Rexall program.

During the third quarter we introduced 60 Rexall SKUs in first aid, medicines and cough and cold.

As an example, since then our first aid sales are up 24% versus last year and Rexall has captured over 20% of the first aid category.

It's still very early in the game, but we are encouraged by our customers response, especially because the Rexall brand helps us grow both sales and margin.

We also continue to make great progress in transforming our product offering and merchandising in our True Living brands, across housewares and home decor, as well as our True Living outdoors brand and True Living kits.

During the quarter, we reset our $1 toy program, which has been successful thus far and for the holiday season, we have launched a $5 toy program.

For the second consecutive year, we've had a toy catalog available in stores and online.

While it's still very early in the season for us, we are pleased and excited about our holiday offerings throughout the store and we're getting positive customer feedback on toys, trim a tree and our holiday decor items.

Additionally we are expanding our strategy to get our value and convenience message out to our customers.

Not only are we communicating through in store fliers and newspaper inserts, but we have also significantly enhanced our social media and internet presence.

Finally, in addition to same-store sales growth we're increasing our store base, including new stores, relocations and remodels, we have executed over 900 real estate projects this year, continuing to deliver superior returns as we expand and improve our footprint.

Importantly, our model is proving to have almost universal appeal as we offer stronger and more consistent performance across various landscapes.

In addition to expanding sales, we were able to improve our third quarter gross margin by 51 basis points over last year.

Increased volume, expansion of our private brands, including Rexall, improved sourcing and partnering with our vendors to optimize the impact of our product offerings all contributed to our gross margin expansion during the quarter.

We also continue to work on further shrink reduction and additional leverage in our distribution system.

In summary, I'm very pleased with the results of our third quarter and year-to-date.

Our success has not gone unnoticed.

You may have seen the Grocery Manufactures Association has named Dollar General retailer of the year in recognition of our ability to create growth, customer loyalty, and innovation in the marketplace.

I believe we are in a strong position as we approach the biggest retail season of the year.

Customer response to our Thanksgiving week advertising was very favorable.

Again this year, our stores opened early on both Thanksgiving and Black Friday.

We've added some great toys and gift items at price points attractive to our customers and we believe our holiday gift wrap, lights, and decor are better than ever and offer a great value.

As with the past several years, we expect our customers to make the majority of their holiday purchases late in the season.

Customers are still being frugal, and I expect competition to remain fierce, but I am convinced that we have the right merchandise and the right strategy for the holiday season.

Now, David will walk you through the details of our financial results and provide additional information on our outlook for the rest of the year.

Then, I will share some thoughts about our 2011 plan.

David?

Thank you, Rick, and good morning, everyone.

As Rick said we had another strong quarter.

Sales for the third quarter were $3.22 billion, a 10.1% increase over last year's third quarter.

Same-store sales increased 4.2% on top of a 9.2% increase in the '09 period.

Both customer traffic and average ticket continued to increase.

Our gross profit rate was 31.4%, an increase of 51 basis points over the '09 third quarter mainly due to higher average markups.

Higher markups are primarily the result of our success from reducing overall product costs, including benefits derived from increased volume, as well as the outcome from our significantly improved category management process.

Improved markups were partially offset by increased markdowns in the quarter primarily in consumables.

SG&A as a percentage of sales was 22.8%, a decrease of 61 basis points from the 2009 third quarter.

Incentive compensation, healthcare expense and outside consulting fees all decreased from the prior year.

I want to make a little clarification on incentive compensation.

Based on our strong performance and increased outlook for this year, our incentive compensation accrual has increased from the second quarter.

However, year-over-year incentive compensation has decreased due to the higher bonus accrual in 2009.

We also leveraged both store and administrative payroll.

As a result of increased usage, debit processing fees increased as a percentage of sales.

Operating profit was $274 million, up $58 million or 27% from the '09 third quarter.

As a percentage of sales our operating margin rate was 8.5% up from 7.4% last year.

We are very pleased with this improvement and with our ability to drive both gross margin expansion and expense leverage even as we accelerate our investment in new store development.

Interest expense was $67 million for the quarter, a reduction of $20 million from last year's third quarter, primarily due to our debt repurchases.

Total debt at the end of Q3 was down [$844 million] or 20% from a year ago.

During the third quarter we purchased $65 million of our senior notes with excess cash on hand resulting in a charge of [$8.2 million], primarily related to the premium paid to purchase the notes.

This charge is included in other non-operating income.

Net of tax the impact of the buyback reduced net income by $5 million.

Net income for the quarter was $128 million or $0.37 per share.

Excluding the loss on debt repurchases net income was $133 million, an increase of 76% from the 2009 third quarter.

Adjusted earnings per share were $0.39 compared to [$0.24] in the quarter last year.

While you can find additional details of our year-to-date performance in our press release and 10-Q filings, I want to take a few moments to review the highlights of the year-to-date performance.

For the 39 week year-to-date period net sales were $9.55 billion, up $938 million or 10.9% from last year including a same-store sales increase of 5.3%.

That's a 15.6% two year stack on same-store sales.

Year-to-date gross profit grew by 14% to $3.05 billion or 31.9% of sales, an increase of 96 basis points over the '09 year-to-date period.

This was primarily due to our ability to deliver higher average markups.

Operating profit was $866 million, up $191 million or 28%.

Excluding $15 million of expenses in the first quarter related to our secondary offering, operating profit increased 31% to $888 million or 9.2% of sales compared to 7.8% of sales in '09.

Interest expense was $209 million for the year-to-date period, a reduction of $58 million from last year.

Our effective income tax rate was 36.9% for the 2010 39 week period compared to 38.2% in the '09 period.

The decrease in the tax rate is due principally to the favorable outcome of tax examinations and the reversal of certain reserves.

Turning to our cash flow, year-to-date we generated $399 million of cash from operating activity.

Moving to the balance sheet, as of October 29, 2010 total inventories at cost were $1.89 billion, up 12% in total or 6% on a per store basis.

Health and beauty and toys are the most significant increases over last year, as we rolled out the new 78-inch profile and expanded health and beauty and as we prepared earlier for the holidays.

Overall, we have increased our inventory levels to support store growth, new merchandising initiatives, and increased sales volumes.

Inventory turns are at 5.1 times.

Total outstanding debt at the end of the quarter was $3.29 billion.

As I mentioned, we have repurchased a significant amount of our debt over the past year resulting in a year-over-year decrease of $844 million.

Net of cash, our ratio of long-term obligations to adjusted EBITDA was 2.1 times at the end of the third quarter compared to 3.3 times a year ago.

Importantly, Moody's recently upgraded our credit ratings in recognition of our improved metrics.

We will continue to look at using our excess cash to reduce our leverage, including the potential for additional senior note repurchases with the approaching call date in July of 2011.

Adjusted EBITDA for the last 12 months increased 28% from the comparable year ago period to $1.48 billion.

In summary, we're very pleased with our year-to-date performance which has exceeded our expectations.

Given our success year-to-date, we are updating our full year guidance to reflect our outperformance.

Nevertheless, we do remain cautious about the macroeconomic factors that might affect our customers spending.

We now expect to deliver adjusted earnings per share of $1.78 to $1.81 versus our previous expectation of $1.68 to $1.74.

We now expect total sales for 2010 to increase 10.5% to 11% over last year with a 5% to 5.5% increase in same-store sales.

This is in comparison to our prior expectations of total sales increases of 8.5% to 10.5% and a comp sales increase of 4% to 6%.

For the fourth quarter we expect same-store sales of approximately 5%.

Full year adjusted operating profit growth is now forecasted to increase 23% to 25% versus our prior expectations of 20% to 23% and we expect our full year tax rate to be approximately 38%.

For the year we continue to expect to open 600 new stores and to remodel or relocate a total of approximately 500 stores.

We now expect capital expenditures for the year to be in the range of $410 million to $430 million.

Our current expectation includes the purchases of some of our existing leased stores and the initial cost of a new distribution center in the southeast to support our growth and improve transportation efficiency.

To be certain, we expect the economy to continue to be challenging for consumers as we move forward.

At the same time, we are confident in our ability to execute our plans for the rest of the year.

To summarize, we have continued to deliver strong financial performance in a volatile environment including exceptional cash flow generation and ROIC.

We have an excellent retail management team in place that has made strategic decisions that are driving productive sales growth.

And finally, we believe we have significant opportunities to grow and to continue to improve our performance.

With that I'll now turn the call back over to Rick to discuss our expectations for 2011 and beyond.

Thanks, David.

As we get ready to conclude 2010, we're continuing to build on our track record of success.

We're putting exciting plans in place for 2011 and beyond that build on our continued committment to our four key operating priorities.

That's driving productive sales growth, increasing gross margin, leveraging process improvements and information technology to reduce cost and strengthening and expanding Dollar General's culture of serving others.

These operating priorities will be the focus of our investor meeting on December 15th, but I'd like to share a quick preview of our 2011 plans with you today.

Let's start with our first priority of driving productive sales growth.

In 2011 we plan to accelerate our new store growth and expect to open 625 new stores and execute 550 relocations or remodels.

All in all we expect square footage growth of approximately 7% in 2011.

The returns on our new stores remain some of the best in retail thanks to the capabilities we have developed in our real estate model.

The results we have achieved thus far with the rollout of our customer centric format have been outstanding and our new stores are performing at approximately 90% of our comp base.

As a result of the completion of Phase IV, the 78-inch profile initiative, we will now be able to add 16 feet of core health and beauty products in 2011.

To further drive sales and continue to offer our customers the best value in the marketplace, we will be expanding our extreme value offering.

This new expansion will showcase extreme value products from within categories that our consumers look to us to provide them every day and great price points.

All of the merchandise found in this new 24-foot committment to value will be priced at $1 or less every day.

Additionally, we will further be expanding our cooler presence in over 500 locations to better serve our time conscience customer and at the same time offer great convenience and value.

We're taking aggressive stance toward improving our store in-stock positions, which will help improve our customer service and ultimately we expect will drive increased sales.

This is a comprehensive effort which requires focus on store level perpetual inventory accuracy, as well as improved execution across ordering, fulfillment, stocking, and delivery.

We're focusing on several key initiatives to support this effort, including store employee training, the implementation of new demand forecasting technology, supply chain allocation, as well as other store level distribution and transportation enhancements.

This initiative is one with great potential for us over the next couple of years.

At the same time, we are keenly focused on reducing our overall inventory levels and our in-stock efforts will always be balanced against disciplined inventory control.

Over time, we believe an improved in stock position could be worth at least 100 basis points of improved same-store sales.

Turning briefly to our real estate and new store strategy where we believe we continue to have tremendous opportunity to open new stores with best-in-class returns.

Based on our analytical modeling, we believe we still have approximately 12,000 opportunities for new stores with approximately 8,000 of those in our existing markets.

In 2011 we plan to open 625 new stores, including entrance into three new states, Nevada, New Hampshire and Connecticut.

These markets represent great opportunities and we plan to approach each of them with a cluster strategy to leverage our scale and brand appeal.

Another key part of our long-term growth is our remodel and relocation strategy, which we identify, where we identify potential relocations and remodels applying analysis that is very consistent with our new store identification process.

In 2010 our average relocation has resulted in an increase of about 2000 square foot per store.

Within our chain, we believe there are continued opportunities for over 2500 relocations and over 3000 remodels.

Some of you may remember that several years ago, we began testing a new concept called Dollar General Market.

We currently have 57 stores in this format, which combines our basic Dollar General merchandise offering with expanded food selection.

These stores include additional coolers for more frozen and refrigerated items, including fresh meat items and selective assortment of basic fruits and vegetables.

We put further development of the market stores on hold while we transformed our core stores, but in the middle of 2010 we began to implement category management processes in these stores with great success.

Concurrently, we redesigned the layout and upgraded the look of the stores, including an updated color scheme and improved signage.

We have remodeled three of our stores with these new packages, the new adjacencies and our new category management thoughts and each of these are achieving double digit same-store sales increases.

We expect to make further progress on remodeling and remerchandising these stores in 2011 and we currently believe that this concept can play an expanded role in the future of Dollar General.

Our second operating priority to expand gross margin is a multi-pronged approach.

The key driver for our gross margin expansion is the ability to capture savings from our sourcing program.

We expect direct sourcing to provide us at least 10% savings on our cost of goods and currently we direct source only about 50% of our identified opportunity.

Areas of opportunity for 2011 include automotive, hardware, food, and to a certain extent health and beauty aids.

We are refocusing our sourcing efforts in 2011 to northern and western China, as these are key regions for manufacturing capability growth within China.

Additionally we will further our efforts within our non-consumable strategy.

As an example, after more research with our core customers, we will continue to evolve our apparel strategy and currently plan to redefine our mix to make infant's and children's the hero within the line-up.

Our customers have been saying that they would like to see more variety within this demographic and with our strong global sourcing reach and expertise, we will be delivering on that for the customers' need.

In 2011 we will also intend to take additional steps in our price optimization efforts, including implementing zone pricing and targeted geographically timed markdown.

We have seen successful results from our zone pricing tests in the last year and have gained valuable learnings as how to use this effective tool, while remaining true to our EDLP strategy.

We will also continue to focus on increasing our penetration of private brands, as the ability to grow our private brands represents a significant opportunity to hand source gross margin.

We plan to add 150 new private brand consumable SKUs in 2011 and expect to increase our sales of private brand items by approximately 10%.

Our third priority is to leverage process improvement in IT to reduce cost.

Our goal is to continue to simplify our work flow and focus on removing costs from our systems that do not impact the customer shopping experience.

In addition to our initiatives to increase inventory in-stock levels, which I mentioned earlier, we have several projects in the work to leverage our technology, including the implementation of a workforce management system at the store level, which will allow us to more effectively manage our store labor.

Another area of cost reduction in 2011 is the rollout of a centralized procurement function to leverage spending with suppliers.

We have carefully grown this function over the last six months and believe it will generate exceptional cost savings as we begin to consolidate the purchasing of retail fixtures, store supplies, printing, information systems, and transportation equipment.

Our fourth and final priority is to strengthen and expand our culture of serving others.

Clearly as evidenced by our results, we have been focused on serving our shareholders.

We also remain committed to serving the communities where we operate and beyond and have talked a great deal about how we serve our customers.

But frankly, none of that would be possible without the hard work and dedication of our employees, over 80,000 of them, and I'd like to take this opportunity to thank each of them for helping us reach a new productivity milestone of $200 in sales per square foot and I wish them well as they continue to serve others.

Given our strong growth outlook we expect to create 5500 additional jobs in 2011.

We will continue to elevate and expand our training and development initiatives in 2011, as we work toward our goal of a 50% internal promotion rate.

Building off of our successful Talent Development Center for store managers implemented in 2010, we are launching a Talent Development Center in 2011 for our district managers and continue to improve the capabilities of our leaders with expanded training and development.

We believe that our go forward operating priorities will allow us to capture growth opportunities, as we continue to focus on productive sales growth, increasing gross margins, leveraging process improvements to reduce cost, and strengthening and expanding Dollar General's culture of serving others.

I am excited about the progress that we have made and I am excited about the many significant opportunities that remain ahead of us and I believe I can speak for the entire DG team when I say this.

We're proud of our leadership position in the channel and we're looking forward to continuing to be the first to market with fresh new ideas, as we further grow the Dollar General brand.

Now with that, Mary Winn, I'll open the call up for questions.

Thank you.

Operator, we'll take the first question, please?

(Operator Instructions) Our first question will come from Colin McGranahan with Bernstein.

Good morning.

Wanted to focus on SG&A dollar growth.

The overall rate I think at just over 7% was the lowest we've seen in a while and obviously on a per foot basis it looked like SG&A dollars were down just a fraction.

Understanding that you were able to leverage incentive comp, is this, are you now at the point where you're starting to cycle some of the heavier investments and we might begin to expect an SG&A per foot growth rate much more moderate relative to what we seen in the past?

Yes, we definitely are starting to recycle some of those investments.

Just to give you a few more numbers here.

On a year-to-date basis our SG&A growth was 8.8% compared to our sales growth of 10.9% and somewhere around 70% of that growth is due to new stores.

You need to keep that in mind as we continue to grow our model.

But clearly, some of the investments we made in private brand sourcing, et cetera are behind us now.

We also have a lot of targets in our mining for cost reductions that we're looking at on a go forward basis.

We've talked about some of these before, engineered labor standards, workforce management, energy management systems, we put pay cards in this year.

We have a lot of things that we're taking a look at to try to continue to mine costs out of the system.

And we've also historically talked about being able to leverage SG&A with 3% comps.

We now believe we think that window is 2.5% to 3%.

Okay, that's helpful and then just a quick follow-up on private label and direct sourcing.

Can you tell us what the penetration rate is now in consumables and it sounded like you're going to grow that 10% next year, which sounds like it should be not far off the overall growth rate of the total Company, so would you expect an increase in the penetration rate in either private label or direct sourcing?

Sure.

The penetration for the quarter was 21.4%, which is about flat with what it was last year at 21.7%, but we had a 10% increase in private brand sales over last year in the quarter.

So what we have going on is we're growing our branded sales at the same time we're growing private brand.

And we're happy, we're happy with that, as long as we keep growing both of them at the same time, that's absolutely the outcome we want.

We introduced 88 new items in Q3 in private brand and we've introduced 228 items on a year-to-date basis.

So we continue to be very happy with our private brand efforts.

And it sounds like that's the plan for next year then as well with a 10% anticipated growth rate?

That is correct, sir.

Okay, great.

Thank you very much guys.

Thank you.

Operator, next question please?

Okay, our next question will come from Deborah Weinswig with Citi.

Good morning, Deb.

Good morning and thanks so much for all the color on the call.

You accelerated Phase IV of the 78-inch profile to be ready in time for holiday.

Can you talk about how that is performing so far?

Yes and again the reason we accelerated it was the stores historically come in and alter the fixtures anyway, Deb, so what we said to ourselves let's go in and set the fixtures and get them ready for the expanded HBA items that will be coming in the first quarter and all that really allowed us to do was do a better job of presenting our holiday merchandise in the fourth quarter.

We're very pleased with what we're seeing with holiday merchandise.

I will say it's a very interesting quarter when you look at the sales of merchandise.

If I go back to a week ago, we were selling primarily gifty items.

This past week, as we look at our seasonal sales, Deb, you see everything designed to go around the tree, decorations, trees, light sets.

Not selling a lot of paper and bows, yet, so really bodes well to the customer buying what they need, when they need it.

Thanks so much and then you've previously spoken about gaining traction with a higher income customer.

Can you talk about you've seen the most recent quarter?

Yes, our customer research still indicates the same thing, we are still seeing trade down.

The customer is leaning towards value offerings.

The customer right now is as sensitive as I've ever seen them and we continue to grow our share of wallet with our core customer.

Great and then as you provided your outlook for 2011, it sounds like there's a lot of new technology initiatives.

Can you discuss which ones will be most important to you to hit your goals?

Yes, the one I'm most excited about, quite frankly, is the work that has been done in the last six months with our handheld device for the store managers.

We have completely upgraded that in regards to it's programming and software potential, Deb, and our store managers have and district managers have a better view of their inventory and it's going to help us with our out of stock effort and it's going to help us with inventory control as well.

I think the other two that I would mention would be the workforce management, labor management and that's helped us with both in the distribution centers as well as in the stores on engineered labor standards.

Great.

Well thanks so much and best of luck.

Thank you.

Operator, next question please?

Our next question will come from Scot Ciccarelli with RBC

Hi, guys.

Good morning, Scot

How are you?

Good, sir.

Good.

Last quarter you guys talked a little bit about the cadence of the quarter and I think you described it as a horseshoe with the strongest sales kind of at the end of the quarter and entered into this quarter.

Can you give us any color on kind of what the cadence was this quarter?

Yes, I'd be happy to.

We came into this quarter, quite frankly, with comps having accelerated off of the previous quarter.

We had a very strong August and I was pleased with it because it was really indicative of the back-to-school offering that we had.

When we hit September, to be honest about it, we had that same horseshoe effect and while the comps dipped down, we still, the Company stayed positive and every region in the Company stayed positive.

Then as we moved through the quarter, we started to see an uptick again in October.

So once again, that same horseshoe effect.

As I think about it, I think it's really coming back to we're seeing customers being very need-based.

You think about August, you have to get in there and you have to buy those back-to-school items.

You got to get the stationary, you got to get the backpacks, you got to get the new jeans.

Then I think September kind of represented the opportunity for the customer to take a break and they did.

Well, I guess what's interesting is, that makes sense to me by the way, but if I kind of try and disaggregate what the comp was by category, I'm calculating your discretionary items, in aggregate were basically just barely positive, is there any other color you might be able to provide on that, Rick, and is that relatively accurate?

Yes, I would say that's very accurate, but again, now you have to think about how those comps swung through the quarter.

We saw again that it is more discretionary items in the August timeframe.

We saw some pretty good growth there, but then again it mitigated as we moved through the quarter.

Okay, great.

Thanks a lot guys.

You bet.

Sure thing, Scott.

Operator, next question please?

Our next question will come from Emily Shanks with Barclays.

Hi, Emily.

Good morning.

Hi how are you guys?

Good.

I just wanted to see if you could give us an update on what your customers' average household income is and what the average ticket is right now?

Is that something that you have?

I'm curious how it's moved?

Yes, our average ticket is around $10.50, $10.60 right in that window and we're still appealing to customers anywhere from about, our core customers average income is around $40,000 a year and our averaging comes around 50.

Okay.

So the trade down hasn't swung that number materially yet?

Absolutely not.

I think what we are seeing is a lot of trade down customers trade into the channel at certain times and again, I speak to, Emily, they come in and they are impressed with what they're seeing and they're continuing to say -- and again, when they say it, it is what they're saying.

They are continuing to say they like what they see and they are going to come back.

Okay, great.

And then my final question is just around the balance sheet.

Obviously you guys are throwing off some pretty significant free cash flow.

Can you give us commentary and maybe you'll talk about this next week, but just what your plans for free cash flow are as you look into '11 and even '12?

I'll talk about the capital structure here.

Thank you for bringing that up.

We remain consistent with regards to our plans for our capital structure.

Our number one priority is investing in the businesses, as it always has been.

We want to grow profitable stores and have the infrastructure in place to support those stores.

Part of this priority now is selectively buying some DG lease stores that are on the market at attractive prices, as you probably saw in the quarter, and this has numerous benefits for Dollar General.

It insures the longevity of some of our best performing store locations and it certainly represents an attractive return on capital invested, especially as you can imagine in the current market environment.

It also has the additional benefit of reducing our rent expense and delivering on a balance sheet adjusted basis or lower debt basis.

So we'll continue to opportunistically pursue this strategy as part of our overall real estate and cash management efforts.

At the same time, reducing our debt continues to be a very high priority.

In Q3 we bought back $65 million of our senior notes and we've now bought back $115 million worth of senior notes this fiscal year alone.

Moody's not only upgraded us in the quarter, but put us on a positive watch for additional upgrades.

So our business generates a lot of cash, as you pointed out, and our current thought process is that we'll probably hold some of that cash over the next six months in anticipation of buying back some more of those senior notes in July of 2011 when the call price goes to 105.

So again to summarize, our two priorities for cash remain investing in the business and paying down debt.

Great, thank you.

We'll see you next week.

Thank you.

Thank you.

Operator, next question please?

Our next question will come from William Reuter with Bank of America.

Hi.

A little bit of a follow-up, I guess, on the same question.

Do you guys have a goal for leverage at this point and given what we saw from Moody's, do you have any interest in would becoming investment grade be one of your goals?

Yes, we continue to -- obviously, we have internal goals that we discuss with our Board on a regular basis.

We'll continue to take that paydown, continue to pay down the debt.

We're watching our ratios and certainly at some point we can see that it's becoming a crossover type of investment grade vehicle in the future as the debt comes down.

Okay and in terms of the last couple times you guys have repurchased bonds it was the senior notes.

Can you remind me, is there, are there constraints on your ability to repurchase the 11.875% senior subs?

Yes, there are general baskets that are out there.

Again, a lot of it has to do with the pricing that's available in the marketplace and the return that we can get, vis-a-vis what we have to pay for those bonds, and that really is what determines that decision more than anything else.

Okay, all right, that's it for me, thank you.

Thank you.

Thank you.

Operator, next question?

Our next question will come from Dan Wewer with Raymond James.

Hi, Dan.

Hi, Rick, how you doing?

Good.

So two balance sheet questions.

First, follow-up on the strategy of purchasing some of your leases.

As a public Company in this stage of your life cycle, Dollar General is being valued on growth not underlying asset values.

How do you go about crystallizing the value of these leases that you're buying and creating value for your public investors?

Well, eventually the way you do that is you obviously flip them.

You do some type of lease buyback situation.

Right now we're in the process of buying them and holding them, again, because we believe we're getting them at attractive prices.

And then at some point we'll either individually or through a bundling flip them and the goal, obviously, is to generate a return, a profitable gain when we do that in future time periods.

And again, as I mentioned in my comments earlier, we have a lot of great stores out there that we're very comfortable owning because we hope to be in them for a very long period of time.

So this is just simply a situation of taking advantage of favorable cap rates that have evolved in the real estate market?

Yes, that's correct.

Good way of looking at it.

Yes.

The other question I had on the balance sheet is on inventories.

During the quarter your inventories grew faster than revenues, your inventories per store grew faster than your same-store sales during the third quarter or what's projected for the fourth quarter.

We did see some extra clearance markdowns in consumables.

Is that what was driving that?

You just got caught with a little bit of extra inventory?

I think first of all, we brought in our seasonal inventory a little bit earlier in Q3 to avoid some shipping delays on imports that we had experienced in Q2.

In Q2 we had some freight issues and because fourth quarter is so important, we wanted to make sure we got all the seasonal inventory in.

So we went ahead and took some of it in a little earlier just to make sure we had it on the shelves.

We also added some new items in HBA and the HBA items turn a little bit slower, but they have a very nice gross margin and a very high GIMROI.

So again, we're investing in inventory that we think will help us turn some nice profits in the future.

So I think those are probably the two factors.

And again we turned 5.1 times, which for our business model, the number of stores we have, all the locations and the rest of products we carry, we believe the 5.1 turn is very good.

So the increase in the HBA inventory will continue the earlier receipts for the holiday season.

We should not see that, however, on the year-end balance sheet?

That's correct.

That's correct.

Okay, great.

Thank you.

Operator, next question please?

Our next question will come from Joseph Parkhill with Morgan Stanley.

Hi, good morning.

I was just wondering from a category perspective it looks like the apparel is the only category that decelerated on a two and three year trend, so I was wondering if you could give a little bit more color on that performance and where that's tracking versus your expectations.

Yes, I'd be happy to.

We've thrown a lot of effort at the Bobbie Brooks brand and one of the things we've said to ourselves repeatedly is we have to get trial.

We've gone through a period of time where we on the non-consumable side, especially in apparel, where we kind of confused cheap and inexpensive.

And while we're happy with what's going on with the jeans, it's not creating incremental additional sales with the consumer.

Talking to this consumer, though, and looking at our market research, what we're going to do is continue our efforts with Bobbie Brooks, continue our efforts on trying to get additional trial on female apparel, but we're going to refocus our really intense effort on children's and infant's.

And we're also going to put a bigger process, a bigger push on men's.

And I'm going to go through and give a lot of detail on that on our investor conference on the 15th.

But I'm happy, to be frank, I'm happy with pieces of it, but we still have opportunities in other areas.

Okay, thanks.

And then I was wondering if you could comment on the contribution of relocations and remodels to the comp this quarter.

Basically I'm just looking for if they're performing similar to relative quarters and also did they contribute a similar amount to the total comp this quarter versus the last?

That statement is correct.

Both.

Both.

Okay.

And then on a cannibalization standpoint are you seeing, do you think that it's from new store growth do you think that it's contributing the same amount relative to previous quarters?

Yes, I think it's about the same and remember now, we burden all of our new store projects with the cannibalization number, so when you see those new store returns that's taking that into account.

Okay, thank you.

Thank you.

Operator, next question please?

Our next question will come from Meredith Adler with Barclays.

Hi Meredith.

Hi, thanks for taking my question.

I wanted just first go back to the discussion about apparel.

When you think about where you might not have gotten as much traction as you would have liked with womenswear, do you think it's just a function of the economy improving much more slowly than I think anybody expected at this time?

I think there's some truth to that Meredith, but I still fall back to when I started talking to everybody about non-consumables, I talked a lot about that.

We had to get trial and I think there is a little bit of a halo out there on some of our stuff and your point's well taken, but we're going to continue on focus on getting that product into the basket and I truly believe if we can, we can move that business.

And does that require a different pricing strategy or markdowns or something?

I think we're looking at how we are pricing the product now, that's correct.

Okay.

And then I'd like to talk a little bit more about price optimization.

You talked about zone pricing, which I think about as being price optimization on a geographic basis.

Do you also think about price optimization more by category, trying to understand what items are really traffic generators and which should be profit generators or is that something that you're not going to look at or will come later?

That's a core piece of what we're looking at, to be frank.

And I don't want it to fall off the side of the table here.

The idea being able to do a better job with regional markdowns based on the climate is also a big part of this initiative.

That is not take them too early depending on where you are geographically?

Exactly.

Think in terms of having the markdown summer in the northeast a lot sooner than you have to in the southeast and now we'll have the capability to control that process.

And then there is another question about assortment optimization.

Have you done anything at this point about making the offering vastly different from a regional perspective and what does that mean from category management procurement side of it or for that matter what the distribution centers have to handle.

Yes, Meredith, that's a great question.

I tell you, our assortment is so key to every day basic items across our store base in every region, that's a very, very, very small piece of what we're trying to achieve.

Obviously, there's a certain kind of barbecue sauce that needs to be in Texas or a certain kind of shrimp oil that needs to be in Louisiana, but that's really the extent of it.

You think about limited SKUs, we're really focused on core basics and that's where we're going to stay.

Great, that's wonderful.

Thank you very much.

Thank you.

Our next question will come from Matt Nemer with Wells Fargo.

Hi, Matt.

Good morning, everyone.

Good morning.

My first question is on gross margin.

Could you talk about the impact of transportation and freight expense?

Yes.

Our distribution expenses actually leveraged year-over-year.

Through the quarter we were very pleased with what we saw there and again, we attribute that to all the efforts we've talked about in the past going on with labor, our engineered labor standards, which we now have in some way, shape, or form in all of our distribution centers, the voice pick technology and our continual efforts to work with Cube on the trucks and reducing stem miles.

Transportation is and the other thing backhauls.

Looking at backhauls and trying to make sure that we're doing as much as we can on backhauling products.

Transportation is a little more difficult because diesel prices are up about 15% from where we were last year at this point in time.

And again, we try to counteract that with all of the things we're doing in distribution.

Okay and then secondly, on SG&A expense, are you able to breakout the impact of three of the items or maybe in total that you mentioned, incentive comp, healthcare and consulting?

And I guess what I'm getting at is should SG&A per foot run flattish on a go forward basis or is this kind of a onetime event this quarter?

Well, we don't break those out separately in terms of the impact.

Obviously, we believe they were important enough items to spell out separately.

We, as I mentioned, we have a lot of targets that we continue to look for in our mining for cost reductions and we think there are a lot of things in the future that will help us continue to leverage SG&A and as Rick mentioned, based on a lot of hard work we've put into this, we now believe it takes a comp of somewhere between 2.5% to 3% for us to leverage, whereas before it was 3%.

So I think you can see we've made some pretty good progress there.

Okay, great.

Thanks very much.

Thank you.

Operator, the next call, please?

Our next question will come from Alan Rifkin with Bank of America.

Good morning, Alan.

Good morning, how are you?

Good, sir, thank you.

Rick, the acceleration in both your new store openings as well as relos and remodels is quite encouraging, especially given the fact that it's already on top of a number that's quite large.

Are you seeing greater opportunities for stores within already existing markets?

Yes, I think, it comes back to the identified opportunities.

We had 8,000 opportunities in the 35 soon to be 38 states and we see a great amount of opportunity, Allen, just in the markets we're at where people know us.

Okay.

David, I believe you said that you brought holiday in earlier.

Would you be able to maybe just add a little bit of color as to how much earlier you brought holiday in?

Yes, generally some of those items would have hit later in the quarter or even in fourth quarter, brought in early in fourth quarter and they were accelerated into the third quarter and it was varies, it was mainly import type of items that obviously have a longer lead time.

Okay and then Rick, if I may just ask like a macro question.

If you look at your store base with respect to unemployment rates, would you care to comment on what effect of the potential extension of the unemployment benefits may have on your underlying business?

Alan, that's an outstanding question and I tell you, it's one I noodle on all the time, but it's very hard to come up with something definitive.

I can tell you this.

Obviously, it's going to put more money in the pocket of our base core consumer.

So I think it would be helpful.

I can tell you, though, that we're on the verge of completing our 21st year of same-store sales growth and when our customers have money they spend it and when they don't they need us even more.

So I think it works well for us either way.

Is there a material difference in the performance of your stores in markets where unemployment is significantly below the national average as opposed to well above the national average?

Yes, that's another great question.

Our performance across our regions is pretty consistent everywhere.

That's been one of the -- I look back on the last three years, it's one of the most remarkable things I've seen, because you usually don't see that.

But we do pretty well everywhere.

And one last question if I may.

Any effects at all from the first 200 Family Dollar remodels on your stores that are competing with them?

The great thing about being in retail, there's always something new and there's always something different going on and I think you're all starting to know me well enough.

We're focused on what we can control and that's what we can control is what's in the walls of our stores, so that's where we're working.

Thank you, very much.

Operator, we've got time for one more question please?

Okay, our final question will come from Michael Epstein with Credit Suisse.

Hi, Michael.

Hi, actually this is Chris Su standing in for Michael Epstein.

Okay, Chris.

Hi, how are you guys?

Just two quick housekeeping questions.

One just related to incentive comp.

I know its been asked already, but can you give us a sense of how to think about it for 4Q in terms of whether it will be a similar benefit for SG&A.

And the other question is just depreciation, how you think it might trend given the acceleration in remodels going into 2011?

Yes, our incentive comp, assuming we're successful in what we're doing and we intend to be, will continue to go up.

It goes up every quarter and we'll accrue more into the fourth quarter.

Versus the prior year, there probably will be a benefit because again, the payout percentage this year will be somewhat less than what we paid out last year.

So, yes, you probably will see some benefit in the fourth quarter.

And then on depreciation, yes, depreciation continues to go up as we make investments.

I'm not sure what your question was on depreciation again?

Just in general, the dollars, where you think it's going to trend for 4Q and going into 2011?

We don't give that, Chris, it's Mary Winn.

We don't give specific guidance on depreciation, but depreciation it is increasing year-over-year given as we increase our store base and our capital spending inside.

But we'll give more outlook on 2011 on our initiatives on December 15th and then we'll give our guidance for 2011 in March.

Okay, fair enough.

Appreciate your time.

Well, Mary Winn and the Operator and all of everybody on the call, thank you for your time and I look forward to seeing everybody in New York on the 15th where we lay out 2011.

Thank you.

Thank you for joining us.

This concludes our teleconference.

You may now disconnect your lines.