Home Flat at Dollar General

Goodlettsville, Tenn. —Hit by the $79.2 million cost of getting out of its failed “packaway” inventory model and shutting down unprofitable doors, Dollar General recorded a third-quarter loss of $5.3 million, compared with a year-before profit of $64.4 million.

Sales at the low-price neighborhood retailer moved up by 7.6%, to $2.2 billion from $2.1 billion during the same period a year ago. Same-store sales rose by 2.0%.

Home category sales remained weak, inching up just 0.5% during the quarter, compared with a 13.7% gain in seasonal products and an 8.4% boost in consumables. The only weaker category was basic clothing, which declined by 0.3%. Through the first nine months of the year, sales of home goods were flat.

Acting as a drag on the bottom line, margins were squeezed as average gross margin was throttled down by 436 basis points, or 4.4%, to 23.8% from 28.1% a year ago, hit by a $63.5 below-cost inventory adjustment for the packaway program, and a further $7.8 million inventory charge tied to the store closings.

In addition to the inventory charges, the retailer said margins were hurt by a greater sales mix of lower-margin products, a decrease in markups, more promotional markdowns and higher inventory shrink.

Operating costs were modestly higher, rising by 40 basis points, or four-tenths of a percentage point, to 23.6% from 23.2% during the same period a year ago. Driving costs higher was an $8.0 million charge tied to store closings and additional labor pegged to various store initiatives. Putting further upward pressure on costs were higher store rental rates and higher administrative salaries as the company beefed up management and reorganized its merchandising and real estate teams. Providing some relief and acting as an offset was $7.9 million in insurance proceeds settling claims from Hurricane Katrina.

Caught between the falling margins and higher costs, operating profits plunged by 96.7%, to $3.3 million from $101.6 million during the same period a year ago.

The retailer’s operating margin — operating profits measured as a percentage of sales — approached the vanishing point, falling to 0.2% from 4.9% the preceding year.

Putting further pressure on the bottom line, interest costs more than doubled, soaring higher by 104.9%, to $10.9 million from $5.3 million due to higher borrowings and an increase in income tax-related interest of $3.2 million. Long-term debt shot up by 43.8%, or $150.9 million, to $495.3 million from $344.4 million a year ago.

On the plus side, inventories were held in check, rising at a slower pace than sales. After the $71.2 million in below-cost markdowns that put margins under pressure, stockpiles rose by 6.4%, to $1.7 billion, compared with the 7.6% increase in sales. The retailer said it “made substantial progress in its efforts to sell through the higher than anticipated level of highly consumable promotional inventory” held at the end of the second quarter.