美元樹 (DLTR) 2003 Q4 法說會逐字稿

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Today's 'call is beginning.

Welcome to the Dollar Tree earnings release conference call.

Today's conference is being recorded for replay purposes should you object, you may disconnect at this time.

Today's presentation will be in a listen-only mode, following the presentation there will be a question-and-answer session.

Instructions will be given at that time if you would like to ask a question.

I would now like to introduce the host of today's call, CEO of Dollar Tree, Mr. Bob Sasser.

Sir you may begin.

Thank you.

Welcome and thanks to all of you for joining this afternoon.

With me today and available for questions is Erik Coble, our CFO.

Erik's going to lead off with a review of our press release and financials.

I will review some operational details and then we will open the call for your questions, which we ask that you limit to two.

Erik.

Thank you, Bob.

Before we begin, we would like to remind everyone that various remarks that we make about our future expectations, plans and prospects for the company constitute forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors included in our most recent press releases, most recent current report on form 8-K, quarterly report on form 10-Q and annual report on form 10-K, which are on file with the SEC.

We have no obligation to update our forward-looking statements and you should not expect us to do so.

Sales for the fourth quarter of 2003 were $893 million, representing a 14.7% increase over last year's fourth quarter on a 1.6% comparable store sales increase.

This year's fiscal fourth quarter contained 91 days versus 93 days in last year's reported fourth quarter.

As a reminder, we are measuring our [inaudible] based on 91 comparable days.

The pace of business was fairly consistent across all three months of the quarter and we had positive comps each month.

Over the past three years, the stores we've opened have predominantly been in the 10 to 15,000 square foot range and stores of this size continue to be our best comp performers, both for the quarter and for the year.

For the fourth quarter, earnings per share was 69 cents.

Gross margin increased 86 basis points to 37%, compared to 36.1% in last year's fourth quarter.

Mark downs were much improved compared to last year's fourth quarter, owing to a better seasonal sell through, better management of our buy using point of sale data and better allocation of merchandise across store classes, using our almost two--year-old supply chain system.

Shrink also improved for the quarter again partially because of better systems at the stores and centrally.

Modest improvements in other gross margin components were offset by an increase in occupancy expense as a percent of sales.

Which was pressured by two fewer selling days in this year's quarter.

Again, as a reminder, cost of sales in each quarter of 2003 includes approximately 1 million dollars of additional noncash expense from the adoption of Fin 46, where by we consolidated our distribution centers synthetic lease.

There's another 1 million dollars of additional interest expense per quarter associated with FIN 46.

We anniversaried these items in January.

Operating expenses were 22.3% of sales, compared to 22.1% of sales in the same quarter last year, up 18 basis points.

We continue to experience improvements in labor productivity and store operating expenses.

These expenses improved as a result of continued improvements in store level labor productivity, general expense controls and higher comparative store sales.

Offsetting these improvements, total depreciation increased in line with plans.

Our larger stores, both new and expanded are depreciated over shorter lease lives of five to seven years.

Our new technology assets including the cost of converting 725 stores to point of sales this year, have short depreciable lives which means we are depreciating these assets relatively quickly compared to our base.

Our longer term projections show that these non-cash expenses will peak as a percent of sales in 2006 and then begin to decrease as a percent of sales.

Operating income margin was 14.7%, in line with our guidance and 67 basis points above last year's fourth quarter.

Capital expenditures of 227 million dollars for the year came in a bit better than our forecast of 230 to 250 million, primarily due to savings in our two distribution center projects and our cash flow from operations grew to 234 million dollars, up 17% year over year.

As you can see on our cash flow statement, we bought back approximately 1.3 million shares of stock during the fourth quarter for a total of about 38 million dollars.

These were the first repurchases against the 200 million dollar authorization granted by our board of directors in November of 2002.

At this point, we are not modeling any additional purchase -- repurchases in 2004.

For the year, sales increased 18.7% to 2.8 billion dollars on comparative store sales increases of 2.9%.

We continue our commitment to improve sales per square foot productivity in all our stories and as we open new stores.

Gross margin decreased by 6 basis points to 36.2% for the year.

All components of gross margin were relatively consistent with last year's results.

The major difference was the consolidation of our synthetic leases, which added 3.7 million or 13 basis points to cost of sales for the year.

SG&A improved by five basis points to 25.7%.

Improvements in personnel and related costs and general operating expenses were offset by the cost of improvements in the stores, which show up as maintenance and depreciation.

Earnings per share increased to $1 .54.

Our balance sheet remains strong.

Despite paying 100 million dollars for Green Back and an additional 38 million dollars for share repurchases, cash and equivalence stand at 169 million dollars.

Long-term debt is only 143 million dollars, which represents the consolidation of the synthetic leases.

Inventory of 525.6 million grew less than 20% compared to last year, even after adding a distribution center and 28% more square footage.

We see another strong year ahead for Dollar Tree with square footage growth of 20%, sales of 3.2 to 3.3 billion dollars on low single digit comps.

With depreciation expected to increase by more than 20 basis points year over year, it will be a challenge to improve operating margin percents but that is certainly our goal.

We expect capital expenditures for 2004 to be in the 200 to 210 million dollar range, reflecting the investments we will make in supply chain systems and infrastructure, most of which is depreciated very quickly.

Cash flow from operations will be strong.

This year and beyond, even as we wrap up our supply chain roll out and complete two new distribution centers.

We also reiterate our guidance for first quarter sales of 700 to 720 million dollars.

On comparative stores increase...sales increases of slightly positive to 3%.

Since price changes are not part of the comp equation for us, we have long believed that two to 3% is a reasonable long-term comp rate for our business.

In the first quarter also keep in mind that Easter moves up a week and we have included a 5 to 10 million dollar effect in our guidance.

I'm pleased to report that our business in February is off to a good start.

We will hold our regular mid quarter update call on April 6th and the dial in information is available in today's press release.

As a final reminder, our quarters will be 91 days versus 91 days comparisons going forward.

I'll now turn the call over to Bob Sasser.

Thanks, Erik.

As Erik said, our business was consistent throughout the quarter and we had positive comp store sales each month but the real rush of shopping did come late this year and our product is just what the customers want and need in those last few weeks prior to Christmas and our stores were well prepared for the holiday season and for that late holiday surge.

Our in stock on gift wrap and ribbons and bows and wrap supplies was well balanced and it was really the best ever right up through the of week of Christmas.

Our seasonal sale through was excellent allowing for a quick seasonal transition.

This year we really got out in front of the Valentine's Day holiday and I am pleased to tell that we had excellent Valentine's Day sales results.

That holiday is becoming more and more important to us every year.

Our stores are now converted and ready for Easter as well as the spring lawn and garden season and the merchandise is already selling.

As always, I'm particularly proud of our stores and our store associates.

This year is no different.

Initiatives and support of their efforts included more productivity displays and we intend to continue this.

That's preloaded shippers, clip strips and power panels to allow our stores to move more product to the sales floor faster.

Our store teams have spent a lot of time on best practices for freight flow and they've developed and trained these best practices which have resulted in labor cost improvements.

Additionally, the new biopted scanners and belted check outs that we've begun to use in our POS stores are increasing our casher productivity while improving customer satisfaction by reducing their waiting time.

Store supplys, just as a note including bags and the other store use items, this year show dramatic improvement.

I just got to tell you, our team did a great job there and it's unbelievable almost through our side and focus, they were able to spend the same amount of dollars and fiscal year '03 as in fiscal year '02, which is a remarkable achievement when you consider that our store growth this year and at a -- when you consider our store growth this year and the addition of the Green Back stores.

Just a note on Greenbacks, in 2003, prior to the Christmas rush, we converted 40 of the 100 green back stores to Dollar Trees.

And that included varying amounts of fixtures, it included new signage and decor, improved merchandise presentation, and new systems which also included our POS and our store ordering.

We're now in the process of converting the remainder of these stores and we will finish this by mid-year.

Through the holiday season, we were also selling through on the existing Greenbacks merchandise and replacing it with the Dollar Tree mix, which in most cases is of superior quality and carries higher margins.

Green Back sales in the fourth quarter met our expectations and we're looking for continued sales and margin improvement from these stores as we complete the conversions this year.

I'd like to give you an update on technology and we're proud to say that we currently have 1,855 stores with POS scanning and our wide area network.

We expect to complete the POS project this year, 2004, with this technology in virtually every store that will benefit from it.

In addition to POS, we will complete installation of our new back office and our wide area network into all stores by the end of third quarter.

This is enabling technology that allows the use of additional solutions to aid the stores in increasing productivity.

Things like e-mail and time and attendance and labor scheduling and auto replenishment and more.

A new solution using the network that we just recently installed is a retail payment switch.

This has dramatically improved our customer service and our credit debit stores by making the transactions faster and it's reducing our transaction costs.

Additionally, the payments switch allows to us accept electronic benefit transactions.

As you may know, many states are adopting this method of payment to recipients of government checks.

We will begin EBP cards next month in California, and we will be anal to take advantage of it in many states and locations going forward.

Our automatic replenishment system that we piloted in 2003 is on target to begin roll out to more categories and more stores in 2004.

This system will automatically re-order key items based on the actual sales at each store and free up our store associates to devote more time to stocking shelves and giving customer service.

This will be a measured roll out throughout the year on select categories and stores as we complete the network.

We do need the network to roll this out.

Another initiative that we're rolling out is a web-based management dashboard.

This technology will deliver store level sales, inventory payroll and other critical information to our field managers, allowing them to access the most current and actionable information required to run the business.

As Erik said earlier, our supply chain systems had a positive impact on mark downs last year by helping us get the right product to the right store.

By being able to better distinguish between no sellers and slow sellers, we saved approximately 5 million dollars in retail mark downs as compared to the previous year.

Turning now to marketing, as many of you know, we concluded a successful advertising test in the first and second quarter of 2003 and we were encouraged by the results.

We feel confident that a bit more advertising in marketing will have a positive impact on our sales.

Our plans for in year, 2004, are to use broadcast and print to drive customer traffic, especially during key seasons in support of key markets where our spend can go be efficient and to support our grand opening promotions in new and expanded markets.

We're keenely focused on the amount of spending and on the return from that spending and for this reason our plans remain modest.

Our plan is flexible and dollar spent will be determined by our results.

We continue to grow the company and we met our growth goals for the year with a 28% increase in square footage, including the Greenbacks acquisition.

For 2004, we expect to open more than 200 net new stores and expand more than 100 existing stores.

This represents as Erik said earlier, 20% growth in square footage for the year.

So far in February, period one, we have opened 30 new stores, and we're well under way to achieve our 2004 new store opening plan.

Just a side note, we all right have a store on the books in North Dakota which when opened this year will put us into all 48 of the contiguous states.

We continue to grow our logistics capacity in support of our store growth and our new Richfield Washington distribution center commenced operations on February 2nd.

This facility opened on time and under budget and is operating extremely well as usual.

Our second D.C. project for 2004 is in Joliet, Illinois.

We expect it to open on schedule mid year.

We look forward to realizing the stem mileage savings this year from these two new distribution centers and also the operating efficiencies to be gained from the automation of Joliet.

The savings will more than offset anticipated increases in fuel costs.

We now have a distribution center network of 9 facilities that efficiently serves the 48 contiguous states and as a result we have no new buildings planned for 2005.

We will be expanding one of our existing buildings, Briar Creek, in 2005 to improve our capacity in the northeast.

I'd like to make just a few comments in general before I turn the call over for questions.

While I am proud of what we have accomplished this year and the year just reported, as the new CEO, I am even more excited about the opportunities that lie ahead.

I'm especially proud of our merchant organization and their ability to create value and so many different ways at the 1dollar price point.

Our merchandise opportunities continue to be amazing.

I recently returned from a buying trip with our merchants in China and the merchandise just keeps getting better to better.

You've heard me say it before but it just does.

Over all they are developing a higher value, more on trend and coordinated products, while maintaining costs.

And most of this merchandise will be available only at Dollar Tree.

Our assortment of fast turning domestic product continues to grow and our larger stores are becoming more complete with things that people need every day.

And we continue our focus on high value close outs to offer the customer that thrill of the hunt that Dollar Tree is known for.

There is so much more merchandise available now at our price point, than ever before.

Going forward, we're going to continue to grow Dollar Tree through a combination of opening new stores and expanding the size of existing stores.

In the foreseeable future, our plan is to increase selling square footage by about 20% annually and I believe that we can easily grow to over 5,000 locations.

We will continue to open stores in the 12 to 15,000 square foot range because we believe that size offers the best shopping experience for the customer and the best long-range ROI for the company.

In that regard, we're going to improve the sales productivity of our large stores.

We can use the space better by expanding our merchandise selection and improving our presentation, we will improve our sales per square foot in these stories offer time.

It's my number priority as we go forward.

I plan to continue our investment in technology to lever future growth and to improve our cost structure.

Investments in supply chain technology, our distribution network, our communications network, point of sale systems and our back office systems will allow us to be more efficient and improve our SG&A expenses over time.

Again, we will complete POS roll out in year and the benefits of having the whole company on this system will be plentiful.

Better buying, better allocations, better store level replenishment will help us improve sales and we'll increase inventory turns.

I'm excited because our management depth, our strength in the field are solid and scalable infrastructure and our financial strength all give us the ability to sustain industry leading sales and earnings growth for many years to come.

We're now ready for questions so that we can accommodate as many callers as time permits we ask that you limit your questions to two.

Thank you, sir.

If you would like to ask a question at this time, press star one on your touch-tone telephone keypad.

If you are using speaker phone equipment, please pick up the handset before pressing star one to register your question.

You will be asked to record your name for pronunciation purposes only.

Our first question is Mark Mandel with Blaylock & Partners.

You may begin.

Thanks.

Good afternoon.

I was wondering if you could update us on the pre-unit economics of your proto-typical store.

You know, what kind of cash investment do you make and what do you see as first year sales and a contribution margin?

Sure.

The -- in the stores that we're opening now, which are a growth of 10 to 15,000 square feet, a selling of about 8 to 12,000 square feet, our sales range in that class on average from 1.4 to 1.6 million dollars, a cash contribution margin of 22 to 23% and an investment including inventory, net of payables of approximately 350 thousand dollars might be a little bit higher than that.

Is it my understanding that most of the stores or all of the stores on a going forward basis will be in the 12 to 15,000 square foot range?

Yes.

Okay.

And my second question, as far as the Greenbacks acquisition, what is your projection in terms of accretion, has it changed much or has it deviated from your original outlook?

We're right on target with our Greenbacks acquisition and again, as we continue to remodel, relay, refixture, remerchandise most importantly, that remaining 60 stores and really all stores, this is... the first quarter will be the first real true -- where they've had all the new seasonal merchandise from Dollar Tree, we're going to see sales and margin improvements in those stores as we've done it - as we've remodeled these stores, we've seen the indication of that, so we're we right on track.

Just one quick follow-up, was your original plan to open just two stores in this fourth quarter or did you have some slippage?

We met our 28% square footage goal.

Mark, so there was no slippage.

Okay.

Thanks alot.

Good luck.

Thank you.

Thanks Mark.

Thank you, sir.

Our next question is from Stacy Turnoff with Merrill Lynch.

You may begin.

Good afternoon.

It's great to hear that February business is off to a good start.

Would you be able to give us a little bit more color in terms of by category or by region how sales are going right now through February?

Well, I can -- I can tell you that we were real excited with our Valentines results.

Again, Valentine's Day continues to be more and more important to us and I think it has to do with the dominance really that we're making with our party statement, the helium baloons and the cards and the silk floral and the vases and the candy and all the things that you need for only a buck and it's really become an important holiday.

We made a great transition this year because of our sell through, our excellent sell through on Christmas.

We were able to move straight into our big game snacks categories as well as get set up for Valentines.

So all of that and some good weather really helped us with our Valentines seasonal sales.

Great.

Thank you.

You're welcome.

Thank you.

Thank you.

Our next question is from Stan Wewer with CIBC.

You may begin.

It's Dan.

I agree your Valentine department looked great this year.

I have just one question this evening.

Bob, that's on the inventory productivity, which on a number of fronts looks like its diminishing, looking at inventory, up about 20% but revenues are up only 14.

It looks like inventory turns had declined and then finally the ratio of interfinancing to inventory levels dropped fairly significantly year over year and as a result the -- it looks like it's having a fairly significant pressure on your return on capital.

I was curious as to what you see the prospects are for improving inventory productivity in 2004 an those different measures?

Well, let me -- I can speak to the first part of that, Dan, and, you know, we really look at our inventory turns as a function of what we need going forward and part of what you see with the 20% -- I was actually real pleased with our less than 20% inventory growth year over year because in doing that, we opened up one brand new distribution center, we actually merchandised that in the end of '03 and didn't start shipping until February of this year, so as you're building these new distribution centers, you do tend to build a little more inventory and you're not shipping it until certain times.

So that's all part and parcel to improving our logistics network and supporting our store growth.

I'll let Erik speak to the payables.

Sure.

The payables issue's really is an end of quarter issue, Dan.

Our merchandise receiving was timed a little bit differently this January than the previous January and it made the timing of payments very different.

But when you look over a week by week analysis of accounts payable and inventory, we're still maining a days outstanding payables of about 30 days on merchandise that's not covered by an import letter of credit.

So we still have those same metrics.

I was thinking that the lower inventory turns you know, mathematically, does translate to a lower payable inventory ratio and perhaps that was reason.

Dan, just a side note, our inventory turns this year we expect to improve.

We did build the inventory for the new D.C. and that was an impact there at the end of the year but with our new technology and with our replenishment and the more faster turning inventory that we're putting into these larger stores, I think you're going to see some inventory turns--

You'll rebound this year?

That's right.

Great, well thanks a lot and good luck.

You're welcome, thank you.

Thank you, sir.

Our next question comes from Sherri Eberts with J.P. Morgan.

You may begin.

Hi, everybody.

Just a question in terms of the outlook.

If I remember correctly, when you gave your first '04 outlook you were talking about a 10 to 20 basis point improvement in the operating margin and if I heard you correctly now you're talking about sort of flattish.

I was just wondering what the change was there if in fact there is a change.

Well, I think it's just a -- an overall refinement once we got all of our fourth quarter information in and as we're putting our budget together.

We -- we are still seeing growth in depreciation expense.

Going forward and we still are keeping fairly modest improvements in... prudent improvements in comparative store sales increases, and, you know, we just think that there's going to be pressure on operating margin to continue to improve over what we did this year in 2004.

But as we go and refine the year and see what the year is going, we will be able to release more information but that's what we're seeing right now.

Were there specific costs that increased,is it really just the D&A or something other than that?

It's primarily depreciation.

Okay.

As we finalized our capital expenditure plans and then forecasted our depreciation out.

Okay.

And then second question I'm sure you've heard Target is testing a little bit after dollar store concept in the front of its stores.

I just wondered if you had any initial reaction to that?

This is Bob.

You know, I've heard that and I haven't found one of the stores yet.

I keep asking around.

I've heard that they were putting up to a hundred stores, small assortments up near the front, all at a dollar or less but I really haven't seen one yet and I've got -- if you find out where they've got one, I would like to go see it but I haven't seen it yet.

Obviously we've felt no impact from it.

Okay.

Great.

Thank you.

Thank you.

Our next question comes from Meredith Adler with Lehman Brothers.

You may begin.

Yeah, hi.

I'd like to go back to the last question about operating margins because there was something I wasn't sure that you -- that I understood you saying.

I have you not improving the operating margin at all for this year that just ended.

Did I get that right?

Yes.

So okay, so do you think that this coming year is going to be better or worse than the year that we're having because I thought you had heard you just say it won't be as good as this year but then I said it was going to be flat?

No, I said that it was going to be a challenge to improve it from in year and the improvements that I was talking about earlier was really in what we've seen in personnel costs and store operating expenses, that offset a huge increase in depreciation as a percent of sales.

That -- that rate of increase in depreciation is going to slow down in 2004 but that would still be requiring us to have those same kinds of improvements in personnel costs and store operating costs and right now we're not seeing that it's going to be worse than last year, we're of course have a goal to better last year but we're just saying it's going to be a challenge given the 20 basis points increase in depreciation.

Okay.

Got it.

And I was just wondering if we could talk a little bit about the stores, the new stores that you're building.

Are you -- you're still continuing to lease all those stores.

Are you changing because you're building the biggers stores, are you changing the kind of real estate you're getting and also the length of time on those leases?

The length of time, we've always sought five-year leases with three or four-five year options and that's still what we're doing.

So we haven't changed the length of time that we're leasing the larger stores.

We are depreciating them over that same length of time too, by the way, so it's a little higher investment that we're appreciating over the same length of time.

As far as the type of real estate, it requires a little larger foot print.

Our stores are -- the larger stores do give us the opportunity to be more destination so that we're finding we can be across the street maybe from the big bucks retailer or maybe we also like strip centers with neighborhood grocery so if anything, it gives us options that -- at different types of real estate.

What do you mean you're depreciat ing?

I'm not -- you mean the fixtures that are inside the store?

Yes.

Okay.

The stores.

All right.

Great, thank you.

Thank you.

Our next question is from David Cumberland with Robert W Baird.

You may begin.

Good afternoon.

Can you comment on the buying environment for reorderable items, seasonal items and also close outs and -- are there any key categories where you're seeing much inflation?

You know, we're -- I will tell you that our buying opportunities are stronger than ever.

I mentioned earlier in my comments that I'd just had gotten back from China and our buying team is -- continues to offer better value at the same cost and we're doing more product development and we're really increasing the value to the customer.

I also went to toy fair and working with a lot of the toy vendors but also with a lot of the trim a tree vendors there and looking for opportunistic buys and close outs and we continue to find more close outs that we can really take advantage of, because what we look for, you know, we're not just looking for close outs that are worth a dollar.

We're looking for things that are worth more than a dollar that we can really wow our customers with.

The -- that along with the fact that, you know, the domestic suppliers have really found our sector and are looking to it as growth opportunities.

So there's more and more of the domestic people that are making product for us and for the other stores in our sector.

So there's more product available than ever before.

Our folks are doing a great job of putting that all together into more value for the customer.

No inflation that I've seen.

Thanks and a question for Erik.

In Q4, what was the approximate rise in the depreciation expense ratio included within SG&A?

The store level depreciation went up about 28 basis points.

Thank you.

Yep.

Thank you, sir.

Our next question is from Patrick McKeever with SunTrust Robinson & Humphry.

You may begin.

Thank you.

Bob, just an FYI.

My understanding is that you've got to go to somewhere between Minnesota and Texas in order to find one of those target test dollar stores.

You got to go west.

Somewhere between Minnesota and Texas, okay.

That's my understanding.

Okay.

Thank you.

Question on advertising and that, is are you assuming any benefit to same store sales from advertising in 2004 or would you say you're looking at that as more of a neutral factor in 2004?

We're looking at it as some benefit.

We're probably conservative on the benefit and that's kind of the way we planned our -- we continue to plan our business.

Okay.

And then Erik, just on your tentativeness around the operating margin for 2004 and the guidance that you're giving, you're saying that but we're also hearing a lot of positive things about Greenbacks and opportunities on the margin side at Greenbacks.

It sounds like point of sale helping you realize better margins at the store level through fewer mark downs and better allocation and also you're going to be cycling accounting change for synthetic leases.

How should I reconcile the somewhat maybe, bullish sounding tone of those comments versus your somewhat cautious sounding operating margin guidance?

Right.

I would say that our -- our projections don't include very much benefit from any of those items you just mentioned.

There is basically no mention -- I mean, no benefit from the synthetic lease because we've anniversaried it so it's the same effect next year as we had this year, full year.

But as far as the Greenbacks improvements for example, further improvements from using our point of sale systems is better.

Those really are not -- there isn't very much benefit in our projections for those items.

I mean, as we see -- our -- Patrick our philosophy is as we see them as the year rolls out, then -- and as we report them, then can forecast those effects for the year much better.

And just as Bob said, Greenbacks hasn't had our full complement of merchandise yet and that's coming this year.

Okay.

Very helpful.

And just one final question on your shipping contracts.

I think that usually come up for renewal sometime in the late spring.

Can you discuss those as it might relate to shipping costs as -- and the trends in shipping costs?

If it seems that they're going up.

What are you expecting there and is that an issue that you're expecting to be a negative in 2004 or a neutral or how would you look at that?

The -- Patrick.

Shipping cost as you said, we are right in the midst of as we always are on renegotiating our ocean fright contracts .

We'll finish it in April and They'll be effective May 1.

The -- as always, the pressure is upward on the shipping contracts and we've -- we are -- we're well aware of the pressure upward but we feel very confident that we can manage through it and we have sort of worked into our budget some -- some degree of increase in our ocean freight.

It's very manageable and we can get through it so we're not really overly concerned about it.

Okay.

Well, thanks, Bob.

Thank you.

Our next question is from David Campbell with Davenport.

You may begin.

Thank you.

I have a question about the gross margins.

You had an impressive increase in the fourth quarter.

I'm wondering how much of that you think might be sustainable and in addition, can you talk about the supply chain improvements and what categories you saw in particular were improved by that and how you might be focusing your inventory investments going forward as a result?

With the gross margin improvements we had on the -- I'm going to turn it over to Bob on some of the supply chain improvements and the effect on merchandise.

Basically, the improvements that we're seeing in shrink and mark downs will help us maintain our gross margins going forward as we open larger stores and we turn to a merchandise mix that has pressure on the actual merchandise margin, the savings that we have, whether they're an outbound freight because of our distribution network or markdowns in shrink because of better systems and controls out of the stores, we're definitely going to use those as ways to improve the value of the merchandise in the stores and improve the mix, rather than take that all in as an improvement in gross margin.

So we're still looking at gross margins in the 36 to 36.5% range as we go forward with our improvements over all.

The -- our buying team has grown to be very reliant, I gets guess on their POS sales and we've begun to look at that daily and what the best selling items are and what the slowest selling items are and of course our replenishment and allocation people are using to that to flow the product to the stores.

Our seasonal product for example now, we can make an initial allocation of a set amount to our stores holding back some quantity waiting for sales to begin to occur and then putting the additional merchandise into the stores that are selling it.

So that the stores that are selling it get more and the stores that are selling less get less.

So that helps our sales.

It, it...it was helpful during this past Christmas season to improve our sales and stores and also to help us reduce our mark downs of it's always good to know too when you get an item in and it really checks and our buyers sometimes can go back and buy more product and sometimes they can't, sometimes it was a one-time buy or sometimes it's -- there's something better coming around the horn but it certainly is an improvement to know when you send something out there that it's selling at expectation or ahead of expectations.

So I expect that it continue to be -- help us improve our inventory turns, number one, and our sales and margin secondly.

Bob, are there any specific categories that you might highlight that you're able to improve or is it -- do you think it's across the board?

You know, it is across the board when you start off with just the fresh information.

Obviously, the -- our -- the parties that we are -- or the departments like party that we stand for and have been sort of known for, our seasonal mix and our party mix, we are able to see now and get in and see more of the details of the opportunities by color and by type of item and those kind of things.

I can't tell you that it's helping us identify one over the other.

Sometimes it's a surprise from one week to the next or from one month to the next, as we look at our business and where it's coming from.

But overall, I don't think there's any real changes or anything new.

Our mix is pretty consistent with where it's been for the past few years, our sales and our mix.

Great.

Thanks and congratulations.

Thank you .

Thank you, sir.

Our next question is from Michael Baker with Deutsche Bank.

You may begin.

Hi, thanks.

Just...not to beat a dead horse but I did want to do one more follow-up in the operating margin and then one or two other questions.

On the margins Erik you had said that you're not including any up side to those items.

Just to clarify is that because you don't think you're going to get benefits from those items or is it more you just sort of being appropriately conservative and don't want to count on anything until you actually see it?

We are being appropriately prudent and have not included in our projections any benefit from that.

We do see that there will be a benefit but we definitely, you know, want to experience more of it before we put it into the projections for the year and, you know, let me clarify again, our operating margin excluding depreciation is going to improve but the 20 basis points from depreciation is going to make it very difficult for our operating margin over all to improve.

Right.

Okay.

Fair enough.

Then just two quick other questions.

I don't know if you look at it in way, but in my model, sales per square foot continue to be down but at least in my model, the magnitude of the decline appears to have peaked in this quarter and then starts to trend better, in other words, less declines in '04 and '05 and then ultimately increasing in '06.

Is that still the way you guys are seeing the business?

That basically our point modeling is showing about the same thing where in 2006 or early 2007 we see the sales per square foot actually increasing, yes.

And paces of declines perhaps slowing a little bit here?

I don't know if that's consistent also.

Then finally, last question, you've given some outlook for the comps for the full year.

Are you looking at any sort of differential as the quarters play out with some of the comparisons a little bit more difficult in the second quarter and then, you know, easier comparisons in the second half or is the plan going to be that slightly positive to 3% number throughout the year?

I think it will be throughout the year and then adjusted for seasonal changes, like at Easter or Christmas time.

Great.

Got it.

Thank you.

Thank you.

Thank you, sir.

Our next question is from Joan Storms with Wedbush Morgan.

You may begin.

Hi, good afternoon.

Bob, I was wondering if you could just go over for us on the automatic replenishment as you roll out the network and you're able to add more categories, approximately how many categories do you have on auto replenishment right now and how will that kind of roll out during the year?

We have one department on automatic replenishment in region of our company, so it's about 100 to 125 stores, something like that.

We did that as a pilot last year, getting the -- getting it down so that we had confidence in it working and working as we wanted it to and some of the things that we've found is that we needed to improve our SKU integrity so we spent the last several months doing that, putting in things in place to improve our SKU integrity so that we can begin rolling it out.

We feel really good about beginning the roll out, starting next month and our plan -- it's easier to say how many we have now than what our plan is because it does Joan, depend on -- I have to have the network in place and we're still rolling that out.

We won't finish the complete network until third quarter and so have you to have that in place but -- and brief, our plans are to start on the west coast by distribution center.

All the stores serviced in that one category still, that one department all stores serviced out of our Stockton D.C. and new Richfield D.C. and also our Marietta, Oklahoma D.C.

would be -- with that one category rolling that out first.

Then we would jump over to the east coast and begin in Briar Creek, store service out of Briar Creek, and at the same time go back to the west coast and begin adding categories where we saw the opportunity to do that.

So it's a very planned and measured approach.

It does have to be done in conjunction with other systems roll out that we have so it's going to take us over time, over a few years really to get that probably where all we want it to be and where we see the opportunity.

We'll see benefit from it immediately but there is a measured roll out to that.

Great.

Thank you.

And then just quickly on the depreciation, if we also see a reversal in the increase in the percent of sales there starting in '06, is '06 a good target year to begin see more operating margin growth?

Everything else being the same Joan, that's what I...that's what I would see, yes.

Okay.

Thank you.

Thank you.

Our next question comes from Wayne Hood with Prudentialal Financial.

You may begin.

Wayne?

Hello.

Hello, Wayne?

Yeah, can you here me know?

Yes, I can hear you.

Sorry about that.

I just wanted to come back to Dan's question a minute because I wasn't sure I heard a good explanation, Erik, as to why that payable to inventory ratio dropped to a new low five year low and why that turn actually dropped and specifically why you think it's going to improve in '04?

Right.

And then my second question is, you're talking about D&A that's actually going up but yet your capital spend something dropping by 10% and you're talking about D&A peaking to '06.

I mean, there's -- where the connection there with declinings D&A and yet you're -- your CapEx is dropping like that?

Sure.

On accounts payable -- I mean one of the biggest reasons we're seeing different numbers is we changed our year end, so we're now looking at January numbers rather than December numbers in the past.

So our payables to inventory number has always fluctuated on a month by month basis depending on whether or not we're getting foreign merchandise or domestic merchandise.

Foreign merchandise, paid mostly by letters of credit, does not have the same kind of effect on accounts payable that domestic does and basically you should -- well, you can't, but we have to subtract import merchandise from the month to really calculate a good accounts payable or days outstanding payable number.

And because January we start building up for Valentines, there's a lot more foreign merchandise in our merchandise inventory than at the end of December when we just sold it all for Christmas.

So when you look at the mix of the merchandise, we are now going to be at a slightly lower accounts payable to inventory mix at an end of a January than we ever were at the end of December.

So it's a permanent change.

On depreciation and amortization, our main supply chain systems were put into effect in April 2002.

So it will not be until April 2005 through April 2007 that most of those supply chain investments which were over 25 million dollars will start becoming fully depreciated.

We started rolling out point of sale last year, this past year, and we will continue it this year.

They all have approximately a five-year life because of the leases that are underlying them and also because their computer equipment could be as little as three.

So it will still take time for those layers of point of sale conversions which was a huge investment for the company, to finally cycle through and flatten out or be fully depreciated.

Probably past 2007.

So we're seeing as we're modeling through generally lower capital expenditures, even if you lower capital expenditures like we did by 10% or more from last year, we still see depreciation as a percent to sales increasing through 2006 and then begin to decrease because of the layering effect of previous years investment.

If I could just ask one other question.

I just want to make sure I'm thinking about this correctly.

If you're talking about operating margins being flat, that would imply maybe $1.78 for '04, but if you strip out the accretion from Greenbacks, which was 7 cents or thereabouts in '04 and compared that to an apples to apples numbers with '03, you're looking at about 13% earnings growth.

Am I looking at that right, if you strip out the accretion in both years?

I have not looked at the accretion in year for 2004 for Greenbacks.

We basically built the model on a store by store basis.

So, you know, I really can't answer that question.

Okay.

That way.

Okay, alright, thanks Erik.

Yeah.

Thank you.

Sir, I show no other questions at this time.

I'd like it turn it back to you for any closing remarks.

Okay.

Well, thank you everyone and our next call will be May 26th.

Thank you very much.

Thank you for participating in today's teleconference call.

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