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Fred’s, Inc. (NASDAQ:FRED)

F3Q08 Earnings Call

November 26, 2008 11:00 am ET

Executives

Pat Watson - Corporate Communications

Jerry A. Shore - Chief Financial Officer, Executive Vice President

Bruce A. Efird - President

Rick A. Chambers - Executive Vice President - Pharmacy Operations

Michael J. Hayes - Chairman of the Board, Chief Executive Officer

Dennis K. Curtis - Executive Vice President, General Merchandise Manager

Analysts

Paul Trussell - J.P. Morgan

Mark Miller - William Blair & Company, LLC

David Magee - SunTrust Robinson Humphrey

Joan Storms - Wedbush Morgan Securities, Inc.

John Lawrence - Morgan, Keegan & Company, Inc.

Jillian Caruthers - Johnson Rice & Company

Patrick McKeever - MKM Partners LLC

Andrew Wolf - BB&T Capital Markets

Operator

Welcome to the Fred’s third quarter conference call. This call is being recorded. At this time for opening remarks I’d like to turn the call over to Mr. Pat Watson.

Pat Watson

This is Pat Watson with Corporate communications. Thank you for joining Fred’s this morning to review the company’s financial and operating results for the third quarter and first nine months of fiscal year 2008 which ended on November 1, 2008.

Before we begin I would like to remind everyone that management’s comments in this conference call that are not based on historical facts are forward-looking statements. These statements are made in reliance on the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to uncertainties and risks. It should be noted that the company’s future results may differ materially from those anticipated and discussed in the forward-looking statements. Some of the factors that could cause or contribute to such differences have been described in the news release issued earlier this morning and the company’s annual report on Form 10K and in other filings with the Securities and Exchange Commission. We refer you to these sources for more information.

Lastly I would like to point out that management’s remarks during this conference call are based on information and understandings that are believed accurate as of today’s date. Because of the time sensitive nature of this information it is Fred’s policy to limit the archived replay of this conference call webcast to a period of 30 days. This call is the property of Fred’s. Any distribution, transmission, broadcast or rebroadcast of this call for commercial purposes in any form without the express written consent of the company is prohibited.

With those announcements, I’ll turn the call over to Jerry Shores, the company’s Chief Financial Officer.

Jerry A. Shore

Thanks to all of you for joining us this morning for our discussion of the third quarter results for fiscal 2008. With me this morning and available for questions are Michael Hayes, Chief Executive Officer, Bruce Efird, President, Keith Curtis, Executive Vice President and General Merchandise Manager, and Rick Chambers, EVP of Pharmacy Operations.

As the company reported in its press release this morning, total sales for the third quarter were $418 million compared with $419.9 million last year, a 0.4% decrease. These sales reflect the company’s previously-announced program to close 75 underperforming stores and 22 underperforming pharmacies in 2008. Excluding these stores closed, total sales from ongoing stores increased 4% in the third quarter. On a comparable store basis sales increased 1.4% for the quarter versus 1.1% in the same period last year.

The sales mix for the period was 21.7% household goods, 16.4% food and tobacco, 8.2% health and beauty aids, 9.9% paper and chemical, 7.7% apparel, 33.7% pharmacy and 2.4% franchise. This compares with the following mix in the same quarter last year: 22.4% household goods, 14.8% food and tobacco, 8.2% health and beauty aids, 9.2% paper and chemical, 9.2% apparel, 33.9% pharmacy and 2.3% franchise.

For the quarter comparable store customer traffic increased approximately 1.9% over last year while the average customer ticket decreased 0.5% to $18.58.

For the first nine months of 2008 total sales increased to $1.329 billion compared to $1.287 billion in the year earlier period reflecting a 3% increase in total sales and a 2.9% increase in comparable store sales. Again, these sales results include the closing of 74 underperforming stores and 22 underperforming pharmacies in 2008. Excluding these closed stores, total sales from ongoing stores increased 6% in the year-to-date period.

The sales mix for the year-to-date period was 23.9% household goods, 15.7% food and tobacco, 8.1% health and beauty aids, 9.4% paper and chemical, 8.6% apparel, 32.0% pharmacy and 2.3% franchise. This compares to the following mix for the same period last year: 23.1% household goods, 14.4% food and tobacco, 8.2% health and beauty aids, 9.1% paper and chemical, 9.9% apparel, 33.2% pharmacy and 2.1% franchise.

On a year-to-date basis comparable store customer traffic increased 2.4% while the average customer ticket increased approximately 0.5% to $18.80.

For the third quarter Fred’s net income was $6.1 million or $0.15 per diluted share compared with net income of $4.6 million or $0.12 per diluted share in the year earlier period representing an increase of 32% in net income and 25% in earnings per share. For the first three quarters of 2008 net income was $14.4 million or $0.36 per diluted share versus net income of $15.1 million or $0.38 per diluted share in the first three quarters of 2007 representing a decrease of 5%.

However included in these year-to-date results are the costs associated with the closing of 74 stores and 22 pharmacies during the year as part of the company’s previously-announced strategic plan which included the closing of 75 underperforming stores and 22 underperforming pharmacies in 2008. The net cost associated with these store and pharmacy closings in 2008 are $6.7 million on a pre-tax basis compared to $1.4 million last year.

Excluding these net costs associated with the store restructuring program, year-to-date net income was $18.9 million or $0.47 per diluted share, an increase of 18% over the adjusted EPS of $0.40 for last year.

Operating income was $9.4 million or 2.2% of sales in the third quarter compared with $7.2 million or 1.7% of sales in the year earlier period. Operating income increased 31% in the third quarter of 2008. For the first three quarters of 2008 operating income decreased 4% to $23.1 million or 1.7% of sales compared with $24 million or 1.9% of sales in the same period of 2007. Again excluding the net cost associated with the store restructuring program, year-to-date operating income was $29.8 million, an increase of 24% over the operating income of last year.

Gross profit for the third quarter decreased 0.6% to $124.2 million compared with $124.9 million in the same period last year. Gross profit for the first three quarters of 2008 increased 2% to $380.5 million over the $373.4 million in the same period of 2007.

Gross margins for the quarter were flat with last year at 29.7%. This gross margin reflects the continued product mix shift towards basic and consumable products offset by controlling of our inventory and markdowns and higher pharmacy department margins during the quarter. Gross margins for the year-to-date period was 28.6% versus 29% last year with the decrease attributed to the ongoing product mix shift toward basic and consumable products.

SG&A expenses for the quarter favorably decreased to 27.4% of sales compared with 28% of sales last year. The improvement of 60 basis points is attributable to managing our costs in our stores while experiencing the increase in comparable store sales. Labor was favorable by 20 basis points, advertising favorable by 20 basis points and occupancy costs favorable by 20 basis points. They were the primary contributors to the operating expense leverage. In the quarter distribution expenses leveraged by 18 basis points despite the higher fuel year-over-year.

On a year-to-date basis SG&A expenses have decreased to 26.9% of sales compared with 27.2% of sales in 2007. Again excluding the cost associated with the store restructuring program, expenses were 26.3% of sales. The improvement is primarily attributable to leveraging the store operating expenses.

Depreciation and amortization expense totaled $6.4 million in the third quarter and $20.2 million for the year-to-date period.

For the third quarter of 2008 net interest expense was $59,000 versus $353,000 in 2007. The decrease in interest expense is primarily the result of improved cash flow from the closings of our stores and pharmacies and better management of assets. On a year-to-date basis net interest expense totaled $309,000 in 2008 compared with expense of $494,000 in 2007.

Our income tax expense rate increased to 34.8% pre-tax earnings in the third quarter compared with 32.6% in the third quarter of last year. On a year-to-date basis the income tax rate was 36.9% compared with 35.9% last year. We expect to end the year in the range of 35% to 37% for our income tax rate.

Capital expenditures for the third quarter totaled $3.4 million compared with $6.3 million in the third quarter of 2007. On a year-to-date basis capital expenditures totaled $14.7 million compared with $25 million in the first three quarters of last year.

The breakdown of year-to-date capital expenditures were $5.3 million for new stores and pharmacies, $6.4 million for existing and remodeled stores, $1.1 million for DC equipment and $1.9 million for corporate and technology upgrades. Additionally there was $1.3 million related to the acquisitions of pharmacies as compared to $50,000 in the third quarter of last year. Year-to-date expenditures for acquisition of pharmacies were $2.7 million in 2008 compared to $745,000 last year.

Total inventories were $372.8 million compared with $387.9 million in the third quarter of 2007. The decrease in inventories is attributed to the 7% fewer stores at the end of the quarter as compared to the same period in 2007 somewhat offset by our initiatives to improve our in-stock performance and quality of our inventory. Inventory turns improved to 3.8 turns from 3.7 at the same time last year and it’s anticipated we will end this year at 3.9 turns.

Total debt at the end of the quarter was $5.2 million compared with $54.7 million last year. The decrease in debt is due to our improvements in cash flow resulting from store and pharmacy closings, better management of accounts payable and managing operating expenses.

The company operates 658 discount general merchandise stores including 24 Fred’s franchise stores and during the third quarter the company opened one store and two new pharmacies. On a year-to-date basis the company has opened 17 stores and five new pharmacies. The company’s total selling space has decreased 8.7% so far this fiscal year to 9.3 million square feet and compared to the same period last year total selling space has decreased by 7.7%.

Our financial guidance for the remainder of the year is as follows. Total sales are expected to decrease 2% to 4% in the fourth quarter reflecting the closing of the 75 stores and 22 pharmacies in line with the company’s planned restructuring program. Comparable store sales are expected to be flat in the fourth quarter.

Earnings per share is expected to be $0.17 to $0.21 in the fourth quarter and for the full year the company continues to expect total earnings per share for 2008 to be in the range of $0.54 to $0.57 which includes the costs in 2008 related to the store closings. Excluding the cost associated with store closings earnings per share in 2008 are expected to be in the range of $0.72 to $0.76.

This concludes our financial summary and we will be happy to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Paul Trussell - J.P. Morgan.

Paul Trussell - J.P. Morgan

First I just wanted to touch on the comp guidance for the fourth quarter. Can you speak to the trend you saw in the last couple of weeks and what makes you a bit more cautious looking over the next three months?

Jerry A. Shore

Starting out the month of November we’ve really been on our plan. The first two weeks everything has been fine. We always start our month because of the shift with a higher number so not to mislead but we were in the mid singles in our comps.

Now going to the rest of the month November is so influenced by the Black Friday or as we refer to it the Green Friday sales. My guidance had been flat for the month of November. Flat for the remainder of the quarter is primarily based on the fact that the fourth quarter is not as heavily basic and consumable in our mix as it is in the other quarters. That’s primarily the reason. Bruce, any other comments on that? It was really the mix that brought that.

Bruce A. Efird

We’re continuing to see pressure on our core customer relative to their discretionary spending that we anticipate throughout the fourth quarter.

Paul Trussell - J.P. Morgan

In regards to gross margin, I know obviously the product mix shift was offset by the move to generics and pharmacy but by itself what was the negative mix impact to gross margin?

Jerry A. Shore

The negative mix to the margin overall, all departments, is in the range of 100 basis points on our margin. We were able to then make that up by higher pharmacy margins and controlling our margin.

Paul Trussell - J.P. Morgan

In regards to pharmacy offsetting this mix shift, could you just speak a little bit to where we are in that cycle? In regards to the move from branded to generics, how many are on tap for next year? How long can you potentially receive this benefit to your gross margin?

Rick A. Chambers

As we look at 2009 in terms of the generic picture, for planning purposes we did back off slightly from where we have seen historical trends. We don’t see the blockbuster drugs that we’ve historically seen back in ’06, ’07 and the first part of ’08. So we did back off of that in terms of planning.

To your question we are seeing somewhat of a flattening in terms of our IMU gross margin as we look at it. It’s not something that can continue forever to your point but in 2010, ’11 and ’12 when we see some of the bigger names coming off we would expect that to ramp back up slightly to the numbers that we’re seeing currently as well as in the last year or two.

Operator

Our next question comes from Mark Miller - William Blair & Company, LLC.

Mark Miller - William Blair & Company, LLC

I’m hoping you can just fill in the blank here. We’ve got a reported EPS estimate of $0.17 to $0.21 and then bridging that to your operating EPS plan of $0.72 to $0.76, it looks like and can you confirm about $0.08 of nonrecurring expenses. I think if I understand it, it’s for stores to be closed in ’09. When did you determine you were going to close those stores and what are the main differences in the future closings versus those that were closed this past year and also the cost for those to be closed? It looks like it might be a little bit higher cost than those that were closed earlier in the year. A lot of questions there but hopefully you can shed light on that.

Jerry A. Shore

When we announced our restructuring program back in February of which all led to the closing of unproductive stores, the generation of cash flow and the improving of our operating margin, we said that we would have evaluate at the end of each year store closings. We put in that projection closings for each year. You’re right. It is in the $0.07 range for Q4. That was part of the plan.

What we didn’t change in this forecast because of the unknown, and that decision will not be made until later on until we evaluate more of what’s going on, we left that in there as something that will be evaluated after we see what November and December sales are. We didn’t change that number so accordingly that’s where that reconciliation comes in between the $0.53 to $0.57 and the $0.72 to $0.76.

Mark Miller - William Blair & Company, LLC

That should be added back to the $0.17 to $0.21 then?

Michael J. Hayes

Not all of it Mark because part of that number in the original when we did it was to end up with a net lease reconciliation number. We only can put an estimate in as we go to deal with what we’ll be able to buy out all these leases at. You’ve got 75 or 76 stores plus whatever stores are determined to be closed this year and you can put an estimate out there for your leases but you will end up with a better sense on it because we’ve been negotiating our way out of them throughout. Part of that was at the end of the year we expect that they’ll be some number at least maybe $0.02 or $0.03 of that for the final reconciliation.

The other part of that number is for other issues that are off balance sheet that are not normal operating issues that we have that were associated with the closings of the stores and the management transition issues that we’ve had this year as Bruce has upgraded his team. There are some other issues so I wouldn’t be quick to put all $0.07 back in.

Mark Miller - William Blair & Company, LLC

Can you just clarify Mike then the consensus number is $0.25? I think people are taking out nonrecurring costs in that projection. Can you just clarify that?

Michael J. Hayes

If you stay with that term nonrecurring, you’re okay. If you apply it solely and exclusively to the go-forward closed stores, it wouldn’t be appropriate. That’s what I was trying to say. But it’s nonrecurring. That’s right.

Jerry A. Shore

Our operating range is 24 to 28.

Mark Miller - William Blair & Company, LLC

And differences on the next 20 stores versus the past 75?

Jerry A. Shore

There’s not a big difference Mark. We had about $16 million on 75. That’s not much difference.

Michael J. Hayes

And part of that goes back to lease reconciliations.

Mark Miller - William Blair & Company, LLC

Can you grade yourselves on the elements of your strategic plan that you laid out in February ’08? Where have you had the greatest success? Where do you think you have the most work to do? I think you laid out multiple planks on this from merchandising, the restructuring and also service level in-stock; just to bring us up-to-date on where you think you are?

Michael J. Hayes

I’m going to turn that to Bruce but let me give you a preference. I think that they exceeded my expectations.

Bruce A. Efird

As you noted we outlined in February our transformation plan which had components of both short-term and long-term strategic initiatives to position us for the future.

The focus of most of these initiatives was really on improving the fundamentals starting out with a focus on expense reductions. The team as Jerry noted has done a great job of controlling costs and improving efficiencies while maintaining our customer service focus. We see that continuing going forward. However we will not sacrifice the Fred’s brand or our relationships with the customers, but at the same time we will maintain strong cost control and continue to evaluate the operations across the company for even more efficiencies.

Another key component of our plan was improving our inventory productivity. Overall inventory position and quality of inventory continues to be healthy. The team has focused on balancing the service level or in-stock position while reducing our future inventory exposure. As noted in the previous comments, one of the key indicators is improved turns which we have improved. Our average inventory throughout the quarter per store is running slightly below prior year.

That’s tied closely to our service level or our in-stock position in our stores which throughout the quarter we saw a 4% improvement year-over-year in our in-stock and specifically on our top selling items; the top selling 750 items that make up 46% of our sales were running at over a 92% service level throughout as well as focusing in on private label which is running above 92%.

Also on own brand or private label which was a key initiative throughout the quarter we added over 100 new items as far as own brands and we’re currently running just over 200 basis points in penetration of consumables above where we were in March. We started the year at roughly half the penetration of what you would consider best-in-class Tier 1 drug and Tier 1 grocery, so we continue to improve there.

As far as our top performing store program, or we call it our battleship program, it’s a focus of a number of initiatives in our top 50 stores. We are seeing the comp sales in those stores run 2% above the balance of the fleet. As I noted in previous calls, we were behind plan on contributions. However in the third quarter we’ve seen an improvement in the contribution within those stores. Again, just the highlights on battleship stores. We are running above plan on our comp sales and still making improvement on the contribution side.

As far as the surprise and delight and treasure hunt infusion that we’ve put back in our stores, we’ve established ourselves back into the closeout market. We’ve had a number of programs that we put in stores and they continue to perform to expectations.

That’s just a highlight on a few. Rick, why don’t you give an update on the initiative around leveraging pharmacy at the competitive advantage?

Rick A. Chambers

One of the core components of that initiative is obviously our file by program going into this year and beyond. We’re on track to meet and exceed that plan for 2008 as Jerry alluded to. The dollars that we put into acquisition premiums and so forth, we have had several opportunities present themselves over the last six or seven months. But it’s been a changing landscape out there as we see more and more pressure on the state budgets and so forth. Again, we’re on plan there.

The marketing initiatives we put forth under that initiative as well have been performing as planned and generating the comps on the script side that we are pleased with.

Operator

Our next question comes from David Magee - SunTrust Robinson Humphrey.

David Magee - SunTrust Robinson Humphrey

Bruce to hit on that last question, could you just give us a little color on what you tweaked within the battleship stores to improve the contribution there?

Bruce A. Efird

We have a focus on leveraging as much as possible the sales increase, number one, and a focus on managing the labor and reducing the expenses within the stores. We have incremental incentives for those store teams as well as have expanded their capability to order merchandise to improve their in-stocks. But the bottom line is the improved contribution is predominantly from a combination of SG&A reduction and some to a lesser degree margin improvement.

David Magee - SunTrust Robinson Humphrey

Those are tweaks you’ve done in the past quarter to improve the contribution from say the second quarter?

Bruce A. Efird

Yes.

David Magee - SunTrust Robinson Humphrey

Do you see an opportunity to take that program deeper within the fleet of stores overall or to do more at that group of stores next year?

Bruce A. Efird

We are evaluating expanding that into additional stores but I want to ensure that we’ve nailed these top 50 stores before we expand it any further.

David Magee - SunTrust Robinson Humphrey

Separately are you all seeing a differential in your sales performance with the stores that might be in areas that have noticeably higher unemployment or are the sales pretty stable across the board?

Bruce A. Efird

We don’t break that data out clear enough to do that. We haven’t gone back and researched the unemployment rates by group. We do know that the areas that are having tougher times, areas such as the lower part of the delta, have been a little slower. Dramatically I wouldn’t say but a little slower. We don’t cut our data out to match it up with unemployment so I don’t think we could accurately answer that for you.

Jerry A. Shore

I think over time we’ll be able to segregate urban from rural which is probably where we see more of that.

Dennis K. Curtis

But that may or may not influence unemployment. You’ve got places where for example the GM factory is. We will be monitoring that region very closely where some of these auto factories in our region do exist. We don’t see that right now as an exciting issue.

Operator

Our next question comes from Joan Storms - Wedbush Morgan Securities, Inc.

Joan Storms - Wedbush Morgan Securities, Inc.

A couple questions on the real estate. I want to make sure I have this right. The 75 stores that were on plan for this year were included in the original restructuring numbers. I think Mark had mentioned something earlier about additional store closings for ’09. Have you talked about that specifically?

Jerry A. Shore

Really the way the accounting of it works, last year in the fourth quarter we took a reserve for the impaired inventory and impaired assets of those stores in the fourth quarter of those 75 stores. Then as we’ve gone through this year we have recorded the lease liability and the actual closing costs of those stores. When we announced our plan for the year in the fourth quarter, we said that we were going to put costs in there related to the going forward stores that would be closed in 2009 where a reserve would be taken in 2008.

Joan Storms - Wedbush Morgan Securities, Inc.

When Mike had referred to the $0.02 to $0.03, is that just that $0.07 in there and obviously you negotiate these leases so it’s not going to be exact?

Jerry A. Shore

Yes. There may be some impact in that number related to 2008 lease related if the -

Joan Storms - Wedbush Morgan Securities, Inc.

It’s better or worse than you estimated?

Jerry A. Shore

Yes.

Joan Storms - Wedbush Morgan Securities, Inc.

For ’09 have you talked about preliminary store openings? I thought there had been some comment about that. Also on the relo program where you might plan to accelerate that in ’09?

Jerry A. Shore

At this point our growth plan is to remain fairly conservative in 2009. We will open stores comparable to this year and next year real estate will emphasize continued testing of the formats that we’ve done a few of this year that we’ve performed well in and some other tests. We are making good progress. We do have a new VP of Real Estate so we’re looking forward to 2009 and improving the performance of our real estate program.

Joan Storms - Wedbush Morgan Securities, Inc.

I was just curious because at the end of last year you talked about as you had worked with the consultants and figured that there might be a number of relo’s where it might be possible at smaller cost?

Jerry A. Shore

Yes, and that is part of our program as well. If we’re not getting performance to our required hurdle rate, then relo’s and remodels are the alternative and the options.

Joan Storms - Wedbush Morgan Securities, Inc.

Bruce can you comment preliminarily on the apparel test?

Bruce A. Efird

The reintroduction of the children’s apparel test, we began shipments in the store in late August and we ran our first promotion at the end of September and another promotion the end of October. Again this is a test in 100 stores. Sales are running slightly under plan on the children’s apparel and we’re not seeing the lift in overall apparel or the overall store.

Just to remind you, the test of the addition back was really to see what impact it would have on overall apparel sales and we’re not seeing the lift. Again, very early preliminary stages. It will really be the end of first quarter until we get enough data to have a solid indication as to what direction we should go with that program.

Joan Storms - Wedbush Morgan Securities, Inc.

Is there a different theme or focus in the kids’ apparel? More closeout? How did you position that?

Bruce A. Efird

Predominantly there are two changes. It’s really a focus on lower price points under $10 as well as more of a closeout focus as well and limiting our exposure as far as inventory in those stores. 100 stores and the sales aren’t performing up to plan; however with the reduced space the sales per square foot have been on plan. Again early and more to come on that.

Operator

Our next question comes from John Lawrence - Morgan, Keegan & Company, Inc.

John Lawrence - Morgan, Keegan & Company, Inc.

Would you talk a little bit about if you can Bruce the merchandise that’s out there in the channel in this environment? How quickly can you find things? A lot of opportunistic inventory I would assume?

Bruce A. Efird

I’m going to turn that over to Keith Curtis.

Dennis K. Curtis

We are as Bruce alluded to earlier back into the opportunity market and there have been some very good opportunities out there for us. So we’re in that market in a very controlled manner and we’re measuring what we do very controlled.

We mentioned the battleship stores earlier. We have purchased some smaller closeouts to feature in those battleship stores and we will be increasing our presence there in the first quarter. We look for the next few weeks, the months of December and January, to be very active in that area and we are in a positive inventory position to take advantage of good opportunities and help increase our margins there. Actually we’re looking across the board; not in any particular department. But we’re back in the market and we’re in contact with those vendors who can help us achieve our goals there.

John Lawrence - Morgan, Keegan & Company, Inc.

Am I correct that you’re using a different source than you were say a couple years ago for that type of product?

Dennis K. Curtis

We are. We went back into some of the same sources that were tried and true, and we do have some new sources that we are using. We made a large closeout with a new vendor that we had earlier this year and we just completed our sell-throughs on plan and at the margin that we anticipated. We look to go back to some new vendors that we’ve tried this year that were successful and as I said increase our presence there and be very controlled in the manner that we handle our supplies [inaudible].

John Lawrence - Morgan, Keegan & Company, Inc.

Bruce as you look to ’09, sort of year two of the strategic plan, what are the major issues that you want to try to accomplish in ’09?

Bruce A. Efird

I would see a continued focus on some of the fundamentals that we have in place; the inventory productivity, service level, own brand growth; I envision those continuing coupled with as Jerry alluded to we have new format stores that we’re testing and see that as being a major initiative going into 2009.

Operator

Our next question comes from Jillian Caruthers - Johnson Rice & Company.

Jillian Caruthers - Johnson Rice & Company

Could you talk about your stance heading into the holiday season? What are your marketing spend plans projected versus last year? And given the consumer’s more focused on consumables versus discretionary, are you changing the focus on items you’re presenting to the consumer through the ads then?

Bruce A. Efird

Currently our plan is to maintain comparable to last year’s promotional and advertising spending activity and our focus will continue to be on traffic generating consumables. We do anticipate the promotional environment to intensify as we move throughout the quarter but no significant changes in our promotional activity throughout the balance of the quarter. Keith, I don’t know if you had anything to add.

Dennis K. Curtis

We do have a strong seasonal business and I feel like we’re very well prepared in our seasonal business as well as in the basic consumables and our in-stock positions are much improved at an all-time high going into the highest traffic period for our stores. So we’re really pleased at that and the basic consumable side and we feel like we’re very strong in the more discretionary seasonal areas also.

Jillian Caruthers - Johnson Rice & Company

Could you update the cost savings anticipated or have seen year-to-date from the 75 underperforming stores that you closed? I know you’d previously anticipated about $5.5 million of cost savings in 2009 and thrown out a number around $10 million for ’09. Can you just update that how it’s tracking and what you anticipate for next year?

Jerry A. Shore

We said $9 million on an annualized basis and about $5.5 million this year. This quarter was the first example of that where we leveraged our expenses extremely well especially in the stores. We did achieve in the stores what we anticipated and expect to get the full quarter of that in the fourth quarter. [Earl Taylor] and the store operations people have done extremely well getting those stores closed with a minimal amount of closing costs, and now in the fourth quarter we’re set with that. I’m not changing what we anticipate for next year on a full-year basis as we’re into our planning season.

Operator

Our next question comes from Patrick McKeever - MKM Partners LLC.

Patrick McKeever - MKM Partners LLC

Did the hurricanes have some material impact one way or the other on the quarter’s results either sales or earnings? I know you have a fair amount of stores that were affected by Gustav certainly. Were the hurricanes an issue?

Jerry A. Shore

I’ll comment from the earnings side. They were not a major factor. We were extremely fortunate. We did have costs associated with boarding up the windows and some loss of some cooler type food but it was nowhere material to the financial performance.

Michael J. Hayes

You had some closed days but you got some bump in your sales.

Jerry A. Shore

Right.

Bruce A. Efird

First of all I want to say that the operations team specifically did a great job of being one of the last retailers to close and one of the first to open; however having said that typically the sales is a wash because you do get a bump or a pickup on the front end as people stock up and leave town and then you’re closed a few days and you get most of that back. So it’s basically a wash.

Patrick McKeever - MKM Partners LLC

On same-store sales guidance for the fourth quarter going back to the first question, the flat guidance. Jerry you said that that was primarily because of the mix of sales being less driven by consumables in the fourth quarter. Are you seeing any incremental weakness or have you seen any incremental weakness in some of your more discretionary merchandise categories over the past few weeks?

Jerry A. Shore

I’ll talk about from the number side and Keith and the others may want to comment. We really have not yet seen it there other than we had the delay of Thanksgiving and Black Friday. So it’s extremely hard to tell but I do believe that competitively and with signs of trim-a-home, I’ll let these guys talk about that.

Bruce A. Efird

I anticipate in the fourth quarter as the demand environment remains soft in higher ticket or more discretionary items we’re seeing that trend specifically in our home and house wares area. It’s interesting that there are some areas of home that are less discretionary such as plastic storage sheets and towels, that continue to perform well; however those more discretionary items such as room size rugs and bath accessories are softer.

Overall again the consumables are very strong specifically in pets, food, beverage, snack, paper and chemical as well as health and beauty care and we’re seeing apparel weakness commensurate with what we’re seeing in the overall apparel sector. That’s a little color commentary on the outlook for the fourth quarter.

Patrick McKeever - MKM Partners LLC

For Black Friday what are we going to see this year? Any change in store opening hours? I think some retailers are starting off at even 4:00 in the morning. What do you expect the big items to be both on Black Friday and then over the holidays as well? Are you doing much in electronics this year for example?

Dennis K. Curtis

We have executed our plans very well for the holiday toys and our trim-a-home merchandise and our six-hour special goods. We did strategically change toward more electronics and more toys, which is where our customers had gone with us in the past. We didn’t include any extra hours.

Our plans are to have our regular day-after-Thanksgiving sales. We’re very pleased. I think we’re better poised for this than we have been in the years past. Every bit of our execution in store is there and we have daily checks to make sure that all of our items are there and ready. We feel like we have a strong presentation to make to our consumers on the day after Thanksgiving.

Operator

Our next question comes from Andrew Wolf - BB&T Capital Markets.

Andrew Wolf - BB&T Capital Markets

I’m still a little confused on the reserve and just what’s in there. It looks like you took a lesser reserve earlier in the year to close 67 stores. Now you’re finishing up with seven or eight and it’s a bigger reserve. I know some of that is the lease adjustment of a few pennies but could you give a little more detail on how and why those reserves came out that way?

Jerry A. Shore

Earlier on the call I separated the inventory and fixed asset accounting, how that results from the lease. Comparing with the lease effect of the first three quarters to the fixed assets and inventory in the fourth quarter is not right. I can go through what I said earlier. The amount we had planned in the fourth quarter is very similar per store to what we did in the fourth quarter last year. There’s not a big change but I’ll be glad to go through that with you. I had already separated that out earlier.

Andrew Wolf - BB&T Capital Markets

I’ll go back through the transcript then. Did you allude to doing this kind of program next year?

Jerry A. Shore

In our transformation plan that we talked about we said that each year would have evaluation of stores.

Michael J. Hayes

The theory behind it is really you have 800 or 700 stores, 3% or 4% of your stores you should be looking at to whether they’re effectively should be closed or not. It’s just a relationship we’re trying to build back in instead of ever letting it drift over a period of time.

Andrew Wolf - BB&T Capital Markets

If you did 3% to 4% or whatever the number was let’s say a normal number, would that also be separated out in a charge or would that just be sort of the way you’d view it as running the business more the way you want to run it?

Jerry A. Shore

It just depends on the accounting of it as to whether they’re impaired assets or not.

Michael J. Hayes

But typically it’s always separated out. We did it because that brings out operational versus non-operational. Even in these numbers they’ve been included in our filings; they’ve been included in the operating income. We’ve been separating them out for being able to understand the operating performance.

Andrew Wolf - BB&T Capital Markets

You probably said this, but I’ll ask. Did you close seven or eight stores and it was in the third or the fourth quarter?

Jerry A. Shore

We closed seven stores in the third quarter. We closed 67 earlier, seven in the third, and one to go in the fourth.

Operator

At this time we have no other questions. I’d like to ask management if they’re ready for me to turn the call back to them at this time.

Michael J. Hayes

Two things that I want to point out. Number one, one of the struggles that Bruce is working with in bringing all of our inventory in line and also at the same time bringing our in-stock positions up, on the purchasing side which has a margin impact we’re putting more pressure on the consumable purchases and will throughout the fourth quarter which will not be a recurring issue for 2009, in turn keeping your discretionaries down because of the uncertainty, we have slowed down the purchases in that area dramatically going into the fourth quarter. So again it has an unusual margin impact as we go through.

Going back to the comp issue, understand that when you look at consumables their percentage of sales are significantly greater the first, second and third quarter than they classically are in the fourth quarter. That’s why where we’ve had the strength in comp performance as we outlined in the press release you’re talking about a flat potential because the discretionary side has been really well managed by Keith and his team with Bruce.

It’s not without recognition when I say this because you’re looking at a company who exactly at this time last year had $50 million difference in our cash position putting us really in an extremely strong position in 2009 for what we want to accomplish.

The last thing I’d bring up and remind everybody is that if Jerry seemed to be a little bit hesitant in talking over the growth rate for 2009 in his real estate program, there is no reluctance to us to commit to opening 15, 20 or 30 stores.

What they’ve done a really outstanding job of is they brought in a new senior person to run the real estate program and he’s a very talented man. They’ve also completed and spent the better part of two and a half months completing the program with tactician and integrating pharmacy into the program, which had not been done before. So when we do our forecasting now pharmacy will be a much more integrated part for 2009.

The reason we’re a little reluctant as to being able to give you the exact number, Tom is building together and meeting as we speak and has been meeting with the developers and resetting the pricing structures that he wants because Bruce has challenged them to bring down the operating costs of opening our new stores for 2009.

He has a very successful I think model out there that is going to probably be influenced particularly in 2009 and they don’t want to race in and say, “We want to have 23 in the first quarter or eight in the first quarter.” They want to be able to take advantage of his experience, the developers that we put together and the fact that the market and commodities in these crises has softened a little bit so that we can see a better opportunity.

So it’s really their hard work. It’s not a reluctance that the capital won’t be committed to it. The capital will be there for them to do it. It’s knowing when they’ll be able to say, “We’re comfortable. We’ll be opening seven, eight or 10.” But by the time the year ends the 20 stores will be there. I’m pretty comfortable saying that. Would you guys not agree with me on that?

Bruce A. Efird

Yes.

Michael J. Hayes

Enjoy yourselves and have a happy Thanksgiving.

Operator

That does conclude today’s call. Thank you to everyone who has attended. Have a good day.

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