達樂 (DG) 2008 Q2 法說會逐字稿

This is the Dollar General Corporation's second quarter 2008 conference call on Wednesday, September 3, 2008 at 9 a.m.

Central Time.

Good morning, ladies and gentlemen.

Thank you for participating in today's call.

This call is being recorded by Conference America, and shareholder.com.

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

It is now my pleasure to turn the call over to Emma Jo Kauffman, Dollar General's Senior Director of Investor Relations.

Ms.

Kauffman, you may begin.

Thank you, operator.

Good morning, everyone.

In a moment, Rick Dreiling, our Chief Executive Officer and David Tehle, Chief Financial Officer, will discuss the Company's 2008 second quarter financial results and update you on our operating priorities.

After they speak, you will have an opportunity to ask questions.

Before they begin, let me take a moment to reference the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Our comments on this call will include forward-looking statements such as those about operating initiatives, expectations with regard to growing sales, expanding gross margin and managing expenses, our outlook regarding future operating and financial performance and expectations regarding inventory levels, store growth and capital expenditures.

Although we believe the forward-looking statements are reasonable, they are subject to significant risks and uncertainties.

Accordingly, we cannot assure you they will prove to be correct or that any trends noted in today's call will continue.

Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in our Form 10-K filed with the SEC on March 28, 2008, and our press release issued this morning and in the comments that will be made on this call.

Statements made in today's call are accurate only as of today's date.

You should not assume the statements will remain correct at a later time.

Dollar General undertakes no obligation to update any information discussed in this call.

In addition, we will refer to certain measures not derived in accordance with GAAP including EBITDA and adjusted EBITDA.

Reconciliations of these measures to net income are included in this morning's press release which can be located on our website at dollargeneral.com under Investor Information, Press Releases.

EBITDA and adjusted EBITDA should not be considered alternatives to net income, operating income, operating cash flows or any other performance measure determined in accordance with GAAP.

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

We encourage you consult our most recent Form 10-Q for our definition of EBITDA and adjusted EBITDA along with the limitations on the use of these measures as analytical tools.

Now I will turn the call over to Rick Dreiling.

Rick?

Good morning, and thank you for joining us today to discuss our second quarter financial results.

Following a very solid first quarter, we had an excellent second quarter reporting double-digit comps, significant gross margin expansion, SG&A leverage, and EBITDA growth.

We also continue to make significant progress in implementing the operating priorities we outlined at the beginning of the year.

David will go into more detail on the results in a moment, but let me first discuss a few key financial highlights from the quarter.

Same-store sales increased 10.1% with strong increases in both customer traffic and average ticket.

Comps were positive in every geographic region in which the Company operates and in all four of our merchandising categories.

We expanded gross margin from the quarter to 29.1% representing 250 basis points of year-over-year improvement.

We reduced SG&A expenses by 111 basis points year-over-year and we generated year-over-year adjusted EBITDA growth of 55%.

While we are certainly encouraged by the continuing momentum in our business, we are fully aware of the uncertainties this challenging economic environment presents.

As we've said before, Dollar General has proven itself to be resilient over the years performing well in both good and bad economic times.

We are leveraging that proven operating strength and we were working hard to maintain that historical trend.

Most importantly, we are focused on controlling the areas of our business that we can in order to mitigate the impact of the pressures facing Dollar General and our customers.

The best business strategy for us is to continue to help our customers make the most of their spending dollars and to gain and keep their trust in Dollar General by offering them quality, low prices and convenience.

We believe our current strategy is the right strategy and we will continue our focus on serving the customer.

Before I turn the call to David for a detailed review of our financial results I would like to acknowledge the efforts of the Dollar General team.

Our strong results would not be possible without the contributions of our store operations, merchandising and store support teams.

While there is much more work to do, it's great to know that we have a team of very talented and dedicated individuals.

They are working hard to serve our customers and to position the business to not only navigate the current economic environment, but also to take advantage of a stronger market when conditions normalize.

Now I'd like to turn the call over to David and then I will return to update you on the progress we continue to make on our operating initiatives.

David?

Thank you, Rick.

Good morning, everyone.

As Rick said, we had a strong second quarter and we are very encouraged by our year-to-date financial results.

So far this year our efforts to increase sales, improve gross margin and leverage expenses while improving our store standards and serving our customers have proven to be successful.

Our 2007 numbers are reported for the pre and post-merger periods, but we believe a discussion of the combined numbers is more meaningful for understanding our underlying business operations.

Our press release includes the pre and post-merger statements as well as the combined results.

Now I would like to make some comments about the second quarter.

Sales for the second quarter were $2.61 billion, up $261.8 million or 11.2% from last year.

Highly consumables increased 13.8%, seasonal sales increased 5.2%, home products increased 5.6% and basic clothing was up 7.1% from last year.

Same-store sales increased 10.1% with positive comps in every geographic region and all four of our merchandising categories.

Both customer traffic and average ticket contributed significantly.

Gross profit.

Gross profit was 29.1% in the '08 quarter compared to 26.5% in the '07 quarter, an increase of 250 basis points.

This increase was the result of improvements in inventory shrink, lower mark downs, and improved transportation and logistics efficiencies which more than offset fuel cost increases, and a $16 million LIFO charge.

The adjustment to our LIFO reserve was necessary to reflect our estimate of the impact of inflationary merchandise cost pressures.

If you follow the major consumer products manufacturers I'm sure this is not news to you.

We continue to work closely with our vendors to eliminate unnecessary costs, but some cost increases have been unavoidable.

We have been effective in taking some price increases in the quarter to offset rising product costs.

Our shrink was down not only as a rate to sales, but also on a dollar basis from the year ago period so we believe we are making good progress here.

Mark downs in the '08 quarter were in line with our expectations.

Of course, mark downs in the '07 period were higher than historical levels primarily because of our focus of eliminating our pack-away strategy.

On the transportation front, the average price of diesel in the '08 second quarter was $4.60 per gallon.

That's up 63% from the '07 quarter average price of $2.82 per gallon.

We continue to offset much of the impact of the fuel price increase through better trailer space utilization, expansion of back haul opportunities and improved fleet management.

Higher sales volumes also contributed to our ability to leverage transportation and distribution costs.

SG&A.

SG&A decreased as a percentage of sales to 23.6% in the '08 quarter from 24.7% in the '07 quarter or, 111 basis points of improvement.

SG&A includes $17 million of expenses in the '08 quarter and $30.5 million in the '07 quarter that are not comparable.

Excluding these items SG&A decreased 47 basis points from '07.

Noncomparable SG&A items in the '08 quarter were $10 million of non-cash amortization of leasehold intangibles and $7.1 million of other new ownership costs such as the management fee, consulting, executive recruiting and legal expenses.

Noncomparable SG&A in the '07 quarter included $17.7 million of Project Alpha store closing and inventory clearance expenses, $8.6million for the accrual for probable losses on restructuring of the distribution center leases, $3.4million of leasehold intangible amortization and $0.8 million of management fees.

Excluding the impact of these items, the remaining 47 basis points of improvement was attributable to leverage on occupancy costs resulting from higher sales volumes in addition to lower depreciation, advertising, worker's comp and employee benefits expense.

These lower expenses were partially offset by higher incentive compensation associated with our 2008 financial performance.

As expected, interest expense increased by $58.8 million in the '08 period due to the full quarter of interest on long-term obligations incurred to finance the merger.

The '07 second merger results reflected several significant items related to the merger including $96.1 million of merger transaction costs, but I won't spend time discussing these today since they happened last year.

For the second quarter of '08, we reported net income of $27.7 million compared to a net loss of $68.8 million in the '07 quarter.

And EBITDA increased by $194.3 million to $200.1 million.

Adjusted EBITDA, which is defined in our credit facility and considered a material component to the calculation of certain covenants, was $225.7 million, up $80.5 million or approximately 55% from last year's second quarter.

Now I would like to comment briefly on our year-to-date results for the full 26 weeks.

First of all sales.

Year-to-date net sales were $5.01 billion, up 8.4% from the prior year including a same-store sales increase of 7.8% on top of a 2.4% same-store sales increase in the '07 period.

Gross profit.

Year-to-date gross profit increased by $194.8 million and as a percentage of sales increased 177 basis points to 28.9% in '08 from 27.2% in '07.

Major contributors to gross margin expansion included a decrease in inventory shrink, lower mark downs and leverage on our distribution and transportation costs partially offset by the $16 million LIFO reserve adjustment.

SG&A.

SG&A decreased as a percentage of sales to 23.9% in the '08% period from 24.9% in the '07 period, or 103 basis points.

Again, there was some noncomparable SG&A components in each of the two periods.

Excluding those items, which totaled $37.4 million in '08 and $60.8 million in '07, SG&A as a percentage of sales decreased 46 basis points.

Noncomparable SG&A items year-to-date in '08 include $20.3 million of leasehold intangibles amortization, $7.1million of severance costs, and $10 million of cost related to the change in ownership, such as management and consulting fees, executive recruiting and legal expenses.

Noncomparable items reflected in the '07 period include $47.3 million of Alpha-related store closing and inventory clearance expenses, $8.6 million related to the probable restructuring of D.C.

leases, $3.4 million of leasehold intangibles amortization and $1.5 million of management fee and other expenses.

Net income and EBITDA.

We reported year-to-date net income of $33.6 million in the '08 period compared to a net loss of $35.2 million for the combined pre and post-merger '07 period.

Year-to-date '08 EBITDA was $368.9 million compared to $109.6 million in the '07 period.

Adjusted EBITDA was $408.4 million in the '08 period, up 42% from the '07 period.

Now moving to the balance sheet.

Inventories.

As of August 1, total inventories were $1.49 billion, that's up $84.8 million from the year ago period and $201.4 million from our '07 fiscal year end.

The vast majority of the increase in inventories relates to the rollout of new planograms primarily in highly consumables including those rolled out in the second quarter, as well as some of the items to be rolled out in the third quarter.

Also, our basic stock levels are based on actual sales results.

So inventories have been increased to support higher sales volumes.

Our sell through of seasonal and apparel items and the related mark downs have been essentially on track with our expectations so far this year, but we remain cautious with regard to adding discretionary items.

More than offsetting the increased inventories is a significant increase in our accounts payable.

Our accounts payable to inventory ratio increased to 55% at the end of the second quarter compared to 43% at the end of fiscal '07 year end and 39% in the year ago period.

Inventory turns on a four-quarter basis were 5.0 times compared to 4.5 times a year ago.

And we have improved in each of our four major merchandising categories.

Inventory is currently planned to build during the third quarter as we prepare for the holidays.

And we will continue to manage our inventory levels closely.

Long term obligations.

We had total outstanding debt at the end of the quarter of $4.18 billion including $2.3 billion outstanding under our senior secured term loan.

We paid off our asset-based revolver in the first quarter and have had no additional revolver borrowing since then.

Our ratio of long-term obligations to adjusted EBITDA has fallen to 5.2 times from 7.1 times at the close of the merger in July of '07.

We currently have excess availability under the revolver of $966.2 million in addition to approximately $111 million of invested cash.

Cash flow.

Year-to-date, we generated $296.5 million of cash from operating activities.

This reflects our strong operating performance and improvements in working capital management.

We have spent $80.1 million for capital expenditures year-to-date including $41 million for improvements in upgrades to existing stores and $16 million for remodels and relocations, $10 million for new stores, $6 million for distribution and transportation related CapEx, and $5 million for systems related capital projects.

We opened 125 new stores to date and closed 11 bringing our total store count at the end of the quarter to 8,308.

We also have remodeled or relocated 249 stores.

Now a few comments about our outlook.

We are committed to achieving our previously announced operating initiatives with regard to growing sales, expanding gross margin and managing expenses in 2008.

We've already made great progress toward those goals.

We are cautious as we move forward into the second half of the year, especially with regard to discretionary sales.

We remain well positioned to meet our customers' needs and we believe our stores look better than ever.

We continue to plan to open approximately 200 new stores and relocate or remodel 400 stores before the end of the year.

Lastly, we continue to anticipate our capital expenditures will be in the range of $200 million to $220 million for the year.

With that, I will now turn the call back to Rick.

Thank you, David.

We had a good first half in 2008 and we believe this performance is directly related to key changes we are making in the business.

We continue to move forward with the implementation of the four basic operating priorities that we outlined at the beginning of the year.

And as our results show, customers are responding well to our efforts.

Let me briefly walk you through some of the progress we are making.

Our first priority is to drive productive sales growth.

In order to do this, we are focused on increasing shopper frequency, driving basket size and improving our square-foot productivity.

To drive basket size and improve shopper frequency, we are responding to our customers' needs for convenience.

For example, we have expanded and improved our convenience food offerings and we have been testing our customers' response to extended store hours.

We have added brand new impulse racks at the check stands in over 5,000 stores and expect to complete the rollout to all of our stores by the end of the third quarter.

We have added new items throughout the store.

We've expanded our consumable offering and freshened up our home and apparel and seasonal categories by adding items that are more trend relevant to our customers.

We have completed the reset of 43 planograms and expect to complete over 20 additional planogram resets before the holiday.

To date, we have added approximately 500 net new items through these upgraded planograms, each of which has gone through a rigorous review process to determine its expected contribution to overall store productivity.

To improve our-square-foot productivity we continue to free up end displays, eliminate flex space and improve merchandise adjacencies.

Finally, we are also working to improve our store standards and achieve consistency across the chain which we believe is critical to driving sales growth.

We have established model stores in each of our 563 districts and we are methodically implementing these model store criteria in all stores across the chain through planogram resets and targeted weekly action plans.

We believe we are making very good progress setting the appropriate standards for our stores going forward.

Our second priority is to enhance our gross margin.

As David discussed, while we saw significant improvement in our inventory shrink in the quarter, there is still much work to be done.

We continue to aggressively implement our shrink reduction initiatives including the expansion of closed circuit television coverage in our stores.

So far this year, we have added CCTV to 1,625 stores increasing our coverage to almost 70%.

We plan to implement this system in an additional 600 to 800 stores in the second half of the year.

We have also begun to improve our sourcing capabilities.

We continue to participate in online auctions and are beginning to make progress on expanding (inaudible.) Importantly, we are adding to the team that will lead this effort.

Rod Birkins has joined us as our Senior Vice President of Sourcing bringing with him over 30 years experience at J.C.

Penney, Sears and most recently QVC.

Rod was part of the team credited with dramatically elevating the success of the global sourcing efforts at J.C.

Penney.

He will bring the additional focus we need to further expand our opportunities in this key area.

In addition, we have continued to move forward with enhancing our private label offering.

By the end of the year, we will have a total of 885 private label consumable items, an increase of over 40% for the year.

We have revamped our private label packaging which now communicates our product message much more effectively and we continue to focus on quality.

As an example, we are very excited about the upcoming launch of our new Clover Valley soda products with fresh packaging and a great new reformulated taste.

We are continuing to refine our pricing strategy.

We've accelerated the speed at which we are able to respond to competitive pricing opportunities and we had been able to react more quickly to recent unavoidable cost increases from our vendors resulting from the current economic environment.

While we intend to continue to grow our strong consumable business, we are also striving to increase our higher margin nonconsumables.

We are beginning to make progress in this effort and have begun to see the results reflected in second quarter sales increases in home, apparel and seasonal.

We have not only enhanced our merchandise selection in these departments, but our improved store conditions give us the opportunity to merchandise much better and improve visibility of the product.

Our third priority is to leverage process improvement and information technology in order to reduce cost.

We continue to identify expenses that are not critical to our customers or our operations in order to eliminate unnecessary costs and streamline our work processes.

As one example, in the second quarter we implemented cardboard recycling across the chain which resulted in immediate reductions in the net cost of our waste management activities.

Not only are we saving money, but we are recycling cardboard across 8,300 stores that can make a real impact on the environment.

We have another reason to be proud of this accomplishment.

In March, we identified recycling as a go-forward initiative and on July 1 we began training our store associates and executing our plan.

By July 31, just 30 days later, we were recycling in 100% of our stores.

This is a great illustration of our increased ability to expedite change throughout the organization.

In addition, we continue to work on reducing distribution and transportation costs and as David mentioned we were able to leverage our distribution costs in the second quarter through multiple initiatives.

Our final priority is to strengthen and expand Dollar General's culture of serving others in order to make Dollar General a retailer and employer of choice.

We are focusing more attention on merchandising to our diverse customer base.

For example, we've added global food programs in the majority of our stores and we continue to refine our Hispanic-American and African-American focus planograms to respond to our customers' needs in specific stores.

We are also pleased that we continue to see improved employee turnover at every level in the organization.

This is a good indicator that we have been successful in making Dollar General a desirable place to work.

Finally, we've continued with our rich history of being very active in responding to the needs of our communities.

Earlier this year, the Dollar General Literacy Foundation celebrated helping its one-millionth person.

So far in 2008, through corporate giving and the Dollar General Literacy Foundation we have contributed to 744 schools and nonprofit organizations in support of literacy programs.

As you can see, we are making progress against the goals and priorities we set for Dollar General at the beginning of the year.

However, we believe it is prudent to remain cautious about the back half of 2008 given the uncertainty of the economic environment facing our country.

We expect that continuing to execute our operating priorities will have a positive impact on our business over the long term.

We remain intently focused on offering our customers the quality products, convenient locations and value prices that they expect and deserve from Dollar General.

We believe this is a powerful combination and we are excited about the long-term future of the business.

With that, I'd like to open up the call for questions.

Operator?

(OPERATOR INSTRUCTIONS) Our first question comes from Carla Casella at JPMorgan.

Carla, you have the floor.

Hi.

Sorry about that.

I'm wondering, you mentioned shrink as part of the reason we've seen the margins increase.

Can you give us any more detail in terms of shrink and then also what you are looking at for the coming quarters?

Are we nearing a cycle where you've already improved or do you think you have room to go?

Carla, as we look at shrink, we anticipate more room for improvement.

The organization has responded to this.

While I have never disclosed the shrink, we believe it continues to be a major opportunity going forward for us.

We are putting in place some electronic IT issues that will help us do a better job of monitoring it.

And with the addition of the CCTV we believe we are headed in the right direction.

Great.

And then are you seeing any competitive responses to any of your merchandising changes, private label, consumables, anything?

You know, I think as you look across consumable retailing, we consider everybody who sells what we sell to be a competitor.

I think a lot of the different channels now are getting more promotional.

We were seeing that.

And we are seeing a lot of focus on front end on a lot of the different channels also.

Okay.

And then any impacts from the hurricanes?

Yes.

In regards to the hurricane, things are still a little sketchy down there, so I will tell you what I know.

At the height of the storm Monday morning, Labor Day, we had 381 stores that were closed.

158 of those stores have now been opened and 223 remain closed.

I'm sure, as you've heard, some of the parishes are still closed and they are not allowing the evacuees to come back in.

Consequently, that means our employees are not able to return to their homes or their works.

It would be my [guesstimate] that the bulk of the 223 stores are lacking electrical power.

As the mayor has said, they are not going to let anybody into any area until power is restored.

So we haven't really had the chance to go in and assess the remaining 223 stores.

So that's kind of where we are at right now.

Okay.

And just a reminder, I -- there was nothing last year that was closed, right?

I can't remember if there were storms that closed last year this quarter?

Absolutely not.

Okay.

And then one just housekeeping item.

I noticed in -- one of the add backs for EBITDA, the indirect merger-related cost, it's $4.6 million this quarter, $12.4 million for the first half.

I don't recall seeing that in the first quarter.

Did you restate something or do you know where that number was included in the first quarter release?

It should have been in there.

That's severance, recruiting and legal expenses.

I think it was in there.

Okay.

Thanks a lot.

Thank you.

Our next question comes from Grant Jordan of Wachovia.

Good morning.

Thank you for taking the questions.

Good morning, Grant.

I believe on the last call you talked about May trends through the first month of the quarter were up 9.3%.

With the number you put up for the quarter we saw trends accelerate throughout the quarter.

Can you talk about what impact maybe the rebate program had on spending during the quarter?

Grant, there is no way for me to really tell you what the impact was.

I mean, I have been exposed to what you have.

Everything you read says the consumer was buying more durable goods, but they were also buying more consumable items.

What I can tell you is the acceleration in our comp sales took place prior to the rebate checks.

And as the quarter unfolded, we did not see any sales comp decrease as the rebate checks started to dry up.

Okay.

Since then, I guess I'm trying to frame kind of current trends that we saw in the quarter versus the rest of the year.

It looks like third quarter you are up against a little more of a difficult comp.

Then fourth quarter it starts to flatten off some?

We -- we don't want -- we want to get back to being focused on reporting the quarter we are in.

And we were in this for the long haul.

So I'd rather stay away from telling -- or talking about where we are right now in the third quarter, other than to say that we are happy with our sales comp.

Okay.

And, Grant, your numbers are correct.

In the third quarter last year we had a 3.7 comp, in the fourth quarter a .4 comp.

You know, you got your -- you have your numbers correct there what you are looking at.

Okay.

Great.

My next question, obviously, with the really strong results since the deal was done, has that, I guess, just give us an update on your priorities in terms of growing the store base aggressively or repurchasing bonds or paying down bank debt.

You know, our first priority, and we have been pretty consistent on this, is investing in our business.

Because we believe it's the highest return on investment right now for our money.

So we will continue to invest in our capital expenditures and in our inventory, and given what our sales are, we believe it's prudent to make investments in inventory as long as we can keep the inventory turns up.

We are okay holding some excess cash right now because of the volatile environment that we're in.

We don't mind being a little bit conservative as we mentioned.

We have $111 million that we are investing right now and we think that's prudent.

Clearly, if we continue to see the trends that we have seen in Q1 and Q2 for two or three more quarters, we will consider some debt buyback and take a look at that more seriously.

Right now we are investing in the business and we think it's prudent to hold a little bit of cash.

Okay.

Thanks.

That's helpful.

My last question, so just so I understand the LIFO charge during the quarter, that's basically saying that on a go-forward basis those items will be more expensive, so thinking forward looking based on what you are paying for goods your gross margin would have been slightly lower than what you recorded in the quarter.

Is that right?

Really what LIFO is, Grant, it's kind of a tax play.

And we set up a -- we set up a reserve at the end of last year based on what we thought the inflationary trends were.

In essence you establish a LIFO layer.

We generally just do that once a year.

But because we were in a period of unprecedented cost increases we thought it would be a good idea to take a look at it in the middle of the year.

What we did was we increased to that reserve that we hold on the balance sheet for LIFO.

All of the expenses for that inventory have already hit the P&L.

In other words, we are taking it in at the right expenses and LIFO is just a reserve that will adjust and will continue to adjust as we go through the back half of the year.

It could go up.

It could go down.

Based on the current cost trends it appears it will continue to go up.

But again it's a reserve that we hold on our balance sheet.

So strictly non-cash.

We won't see it come on as a cash expense somewhere down the line?

It's strictly non-cash.

Great.

Thank you very much.

Thanks, Grant.

Our next question comes from Karen Eltrich at Goldman Sachs.

You guys mentioned that your new system is enabling you to take pricing more aggressively or I should say more frequently.

Is this also now indicative that you are rolling out zone pricing or is that still in the test phase?

No, Karen, we have not rolled out zone pricing.

It is just the ability to take pricing more quickly?

Yes, we just modified our systems and more importantly our processes to respond to pricing pressure that we can't push back on.

Great.

And can you give us an update on where you are for the SKU rationalization?

The project has been a great success.

The 90 plus categories we're rolling out all reflect not only the rationalization, but the addition of replacement SKUs.

So by the end of the third quarter we should have rolled the program out.

Great.

Thank you very much.

Thank you.

Our next question comes from Mary Gilbert of Imperial Capital.

Given the strength in sales that we are seeing, should we be expecting inflationary pressure, too, as we saw with the LIFO charge, we should probably be expecting working capital to increase year-over-year?

Or have there been opportunities to reduce working capital otherwise in terms of efficiency?

We continue to work on the accounts payable side of the house.

As you saw, we discussed how those percentages had come up and we we're doing had a nice job in comparison to last year.

On the inventory side, yes, as we mentioned our inventory going up in the third quarter and again we are make strategic investments in mainly highly consumables, areas where we have high turn of the inventory and we believe it's items that our customer really wants and needs right now.

So we think it's prudent to make inventory investment in those areas at this point in time.

So yes, that will cause some increase in our working capital as we invest in that inventory.

We continue to monitor our inventory turns.

As we mentioned, our inventory turns are still up over our last year's level so we feel comfortable adding that inventory as long as we keep the turns rolling.

Okay.

But the net effect should be along with the accounts payable, would we -- because I was previously looking for just a slight decrease of working capital year-over-year, but I'm thinking it will be more like an increase year-over-year kind of weighing all these pieces together.

Does that sound about right?

Again, I think with our inventory investment you probably will see some increases in working capital.

Great.

Great.

That's what I thought.

And then also with regard to shrink, you know, where do you rate currently?

Are you near the industry average?

Still above the industry average and, therefore, that's where you are getting the improvement?

And then do you think you can improve sort of beyond that?

As I look at shrink, it's a definite opportunity for improvement for us.

And what we have put together is a series of initiatives that will roll out over a period of time that are designed to drive that number down.

And I think what we are seeing right now is the shrink improvement we are seeing not only in terms of dollars but as a percentage of sales represents the initiatives we have identified or quite frankly bull's eye, right on.

Okay.

But do you know how -- where do you stand with regard to the industry?

Yes, we do have a shrink number, but we have historically stayed away from that, reporting that.

What we do is we focus internally on the improvement and talk about that in the gross margin.

Okay.

Great.

Thank you.

Our next question comes from Colleen Burns at Oppenheimer.

Hi.

Good morning.

Nice quarter.

Thank you.

Can you give a little more color on the distribution and logistic efficiencies that benefited gross margin in the quarter, either how much of that benefit and do you see additional opportunity there as you go forward?

Yes, I will start and I'm sure David will want to finish this.

We work very hard on stem miles.

Work very hard on cubing out the truck.

And we have also been working on increasing our back haul opportunities.

And all of those combined, a little better fuel management has allowed us to reduce our cost.

I think the other thing is we have gotten some leverage with the higher sales because of the fixed cost component of distribution and transportation.

We continue to have new initiatives and we do believe there is room for improvement in distribution and transportation over the next two years and it continues to be a priority for us.

Okay, thanks.

With regard to the new merchandise planograms, of the ones that have been completed, what have you seen in terms of the consumer response?

Have you seen real improvement of the sales as a result?

We've seen improvement in sales and we've also seen improvement in the margin in the category .

Okay.

Great.

That's helpful.

Lastly, is there any color you can provide with kind of early color on what you are seeing in back to school.

Is that a big category for you guys?

Yes.

Our back to school, our sell through right now is right on plan, right where anticipated.

Believe it or not, back to school actually goes two or three weeks past the school holiday.

The consumable items, notebook paper, pens and pencils, our sell through is actually a little ahead of plan.

We did a much better job this year on what I would call college home decor-type items.

Very trend relevant and these plastic baskets that kids store stuff on.

We have done good on that.

Some of the more durable goods like backpacks and things like to are a little slower than last year.

Okay.

Thanks.

That's it for me.

Thanks a lot.

Thank you.

Our next question comes from [Carew Mortenson] at Deutsche Bank.

Good morning.

It's [Carew] at Deutsche Bank.

Hey, [Carew], how are you doing?

Doing good.

Just to follow up on Colleen's question here on the back to school.

With most of the office supply categories down, I mean, do you feel you guys are taking share from these larger players?

Is that where this traffic is coming from?

Or what are you seeing there?

All I would say is would be that we are happy with our back to school sell through.

We are obviously taking share from somebody.

You know, again, the team here has done a marvelous job of upgrading the offering and still being able to put it out there at a very competitive price point.

Okay.

And with diesel now down about $0.40 from a month ago and still up considerably from a year ago, but we are seeing that ease off, what is the swing factor for you?

How much does that equate to savings that drops to the bottom line?

Well, I think a better way to look at it is obviously, and you said it, if you look at where we are versus last year, even though diesel has come down it's nowhere near the levels it was last year.

So we are still battling that issue.

Again, we believe the improvements we have made in distribution and transportation have done a lot to offset the majority of those increases.

And just in terms of the sourcing, as you've added to the team, what's the ultimate goal here for the person you want to be in direct sourcing on that side?

What I rather do on that is I would rather let Rod have about 100 days to get his feet wet and really decide.

We know this.

We have a huge opportunity on being able to source offshore.

And it's an initiative we plan to bake into the Company's performance next year.

Thank you very much, guys.

Thanks, again.

Our next question comes from [Ann Wareheim] at Van Kampen.

Hi.

Congratulations on the quarter.

Good morning, Ann.

Just a few questions.

First, to follow-up on the foreign sourcing.

I was wondering if you could give us an idea of what percentage of your total inventory is currently being sourced from foreign suppliers?

I'm sorry, Ann.

I think it's -- it's 9%.

Yes.

About 9% in costs.

Okay.

And then on your home products category, I was wondering if you could comment a little bit about the the changes you have made to the merchandise within that category and what products in particular you are seeing strengthen?

Yes, we are looking across all of the general merchandise categories.

The nonconsumable.

We are doing a lot of work in what I would call housewares right now.

Kitchen gadgets.

Things like that.

We are doing a lot of work in domestics.

And we also think that we have huge upside on the soft goods side.

Okay.

And then lastly just to follow up on your pricing model, is market pricing something that you are still considering doing?

Or are you just going to focus on a national pricing model, but work on, I guess, increasing or shrinking the time?

What we are focused on right now is just being priced right for our consumer.

And we are going to kind of let our whole pricing model unfold as we move through the next couple of quarters and next year.

It's a little premature for me to comment on that.

Okay.

That's all I had.

Thank you.

Thank you.

Our next question comes from [Peter Law] at Admiral Capital.

Good morning, Peter.

Good morning.

It's Steve [Parkowitz.] Can you refresh for me your CapEx numbers again for this year forecast?

$200 million to $220 million.

Okay.

Thank you very much.

If I understand you correctly, two to three more quarters of comparable operating results, if achievable, you will start targeting debt repayment?

We will have discussions with our board and consider having some debt buy down, that's correct.

Can you give me a range in terms of what you are potentially looking at here?

I think it's too preliminary to give a range.

We really have to see how our performances over the next two to three quarters and how we do at generating cash and then we'll make decision based on that.

Okay.

Thank you very much.

Thank you.

Our next question comes from Emily Shanks at Lehman Brothers.

Hi.

Good morning.

Good morning.

I was hoping you could give us a little color around, specific to the basic clothing performance?

What some of the sub categories were that performed good versus bad?

Yes.

As I think about clothing, we are really focused right now on -- we break our clothing into three areas.

Men's, ladies and infants.

And we can continue to see good growth in men's, good growth in infants and we continue to stay focused on the ladies.

Okay.

Great.

And then in terms of the working capital, you did a terrific job around accounts payable leverage.

Were you able to renegotiate some of the terms of your vendors or how should we think about that?

At the end of last year we had discussions with vendors and we did go in and renegotiate terms with vendors and that continues to roll out, and I think we were seeing the impact of that year-over-year now in those numbers that we gave you.

So, yes, there have been discussions with vendors.

Okay.

Great.

And then some of your competitors, specifically Wal-Mart, has spoken to the paycheck cycle being more prevalent for them.

Do you guys see that at all as you look week-to-week during the month?

Yes, we certainly do.

Have you also seen that become more pronounced as the stimulus checks rolled off?

We have seen actually no change in the way the business has been behaving as the stimulus checks have dried up.

Okay.

Great.

That's helpful.

Then, if I could, just one last question.

Can you give us an update as to where you stand on any potential systems upgrade?

We continue to invest mainly in our merchandising systems.

We believe most of the major expenditures in the business are behind us.

However, we want to focus on merchandising and help manage our products better so ultimately we can serve our customers more efficiently.

Okay.

So it sounds like should we think of it more as continual upgrade as opposed to a large rollout that will be happening over the coming months?

Yes, I think that's accurate in the short term.

Thank you.

Thank you.

Our next question comes from [Bob Wettenhaul] of Royal Bank of Canada.

Hi.

Good morning.

Good morning, Bob.

I know you guys finished the quarter with $261 million in cash on your balance sheet.

And if I understand it correctly, don't you have a 50% cash flow sweep on your term loan?

We do have a cash sweep on our term loan that's calculated at the end of the year, that's correct.

Okay.

And on a relatively same assumption, you can continue to generate sizable cash during the balance ever the year.

Is there going to be a very material pay down in your term loan as opposed to any buyback of bonds?

You know, it all depends on how the calculation comes out at year end.

It's a rather complicated calculation and we only do it at the end of the year, seeing what our cash is and where we come out.

So I think it's a little preliminary.

Let us get through the fourth quarter and see how we come out.

And certainly we will have a little more intelligence as we see how we come through the holiday season and where we are on cash at the end of the year.

That makes sense.

How much cash do you need to run the business?

We have, in terms of in the stores we have about $75 million of cash.

So you have $185 million to $190 million excess cash just on the balance sheet.

What do you intend to do with that?

As we said, our first priority is investing in our business.

And making sure that we fuel the capital expenditures and the strategic inventory expansion.

And we are okay holding some excess cash right now because of the volatile economic environment that we are in.

We don't mind being a little bit conservative on that.

That's a lot of belt and suspenders, but it answers the questions.

Thanks.

Thank you.

(OPERATOR INSTRUCTIONS) Our next question comes from Ryan Bloom at the Hartford.

Good morning.

I just wanted to go back and clarify on the issue of year-over-year reduction in mark downs.

I thought a substantial portion of those mark downs was captured in the LCM and the Alpha program.

There is still a meaningful delta on the business away from those add-backs in the prior year?

That basically is what I was trying to say is that last year because of the Alpha efforts on the getting away from the pack away strategy we did have some additional mark downs that we are not doing this year because we don't have that inventory.

Okay.

You are correct.

So it pretty much has normalized?

That's correct.

Got it.

Can I ask your perspective on the competitive environment.

Do you feel that, forget about what your customer is doing, do you feel that you are more price competitive, the gap has narrowed?

I know you have always been fiercely competitive with Wal-Mart.

Such that you are driving such strong comps or do you think you are doing what you have always done?

I think that the Company has a rich history.

I mean 18 years of consecutive same-store sales growth.

I think the Company is more focused on what it has done in the past.

And those principals, those projects have been supplemented.

And the customer is responding.

And, I mean, would you rank your planogram program if you had a rank priority listing of what's driving that, do planograms register pretty high in your sort of order of priorities?

We have a lot of initiatives that are in the air right now of which the planograms are one of them.

And I have never really sat down and tried to thoughtfully rank them.

But I would tell you any time you alter the mix and replace unproductive SKUs with productive SKUs, the customer is going to respond.

And I think that is exactly what we are seeing.

Okay.

And on the SKU rationalization, I know you've talked about the replacement SKUs that are in process, I guess if, versus 100% completion, eliminating the unprofitable SKUs if you could sort of put boundaries around it, percentage of completion on the unprofitable SKUs?

We intend it to have our -- the planograms that have been through the business review process all implemented by the end of the third quarter.

I would look at you and say we are probably 75% or 80% along the way.

Okay.

And then, if I could ask a sort of housekeeping item, the prior year sales for the nonconsumable categories, in general, were they low single-digits?

Was it a weak comparison?

Clearly these are pretty -- very healthy numbers have accelerated from the prior quarter and I just want to get a sense of the prior year comparison?

We will have to get back to you on that one.

The one thing I do want to throw on the table is last year we had a lot of Alpha merchandise that we were working our way through the system.

And which would command a lower retail.

And consequently would probably affect the comp sales.

We can get back to you today on that and give you the exact number.

Okay.

And who should I contact?

Emma Jo Kauffman.

Okay.

Thank you very much.

Thank you.

Our next question comes from Carla Casella at JPMorgan.

Hi, just a couple quick follow-ups.

Did you say what percentage of your merchandise now is private label and where you think that could go?

No.

I will tell you this.

I will give you our penetration number and I look at our private label as a penetration across the entire business.

Our penetration right now is at 18.7%.

We think we have considerable upside on that and I really don't want to commit to a number there, Carla.

But I will tell you that it's up 200 basis points since the end of last year.

Okay.

That's great.

And then last call you had talked a bit about the Coca-Cola rollout.

Can you talk about how that's going and if you've got anything else lined up similar to that?

Yes.

The Coca-Cola once again represents our desire to be more convenient to more customers.

We are incredibly happy with what has happened with the warm product.

We were now in the process of rolling out the cold single serve across the chain.

We have the 5,000 new check stand units in.

I believe approximately 1,700, 2,000 of them have the single serve and will continue to roll that out through the year.

Okay, great.

Did you -- you may have commented on this.

The restricted payment basket in the bonds.

Do you know where that stands?

There are several restricted payment baskets related to the bonds, and so again it's a little bit of a complicated calculation and again when it comes time for us to decide whether we will be doing any buyback, we will clearly take a hard look at that.

Okay.

Thanks.

Our last question comes from Mary Gilbert of Imperial Capital.

Yes, could you give us an idea of August comps, if they are running similar to the 10% that we saw?

Mary, I'm really trying to keep us focused on the second quarter and we gave everybody a view into the second quarter when we reported the first quarter to try to give you a feel for how comps were accelerating.

All I would really say about August is that we are happy with the comp number and we look forward to reporting that in about 12 weeks.

Okay.

The other thing is with regard to the Alpha program last year and the fact that it sort of benefited in terms of year-over-year comparison, you know, meaning the 10% improvement, will that also have an impact going forward in Q3?

Or will it have sort of a similar impact or less of an impact?

I don't -- I don't understand the question.

Well, because of the mark downs that you had a year ago and then this year we have less mark downs so we have inflation, we have less mark downs.

All of that along with the merchandise assortment being right has benefited comps.

I was just wondering how much of that year-over-year comparison we will see on a go-forward basis in looking at Q3 and Q4?

I think you to be careful in that analysis because we also had a lot of units that were sold last year and even though they were at a lower dollar amount you had a lot of units that were going out the door.

It's hard to really quantify the -- what the Alpha impact was on the business overall.

And keep in mind most of the Alpha products were not in the consumable area.

As we have mentioned to you, a huge piece of our growth in the business is in consumables and that has very little to do with the Alpha impact.

And you need to remember, too.

Our transactions are up.

Okay.

Which means we are driving more people through the store.

Okay.

Yes.

So you are saying even though you do have sort of -- you know I'm looking at the Alpha impact with these mark downs at the lower dollar price, you are still benefiting from better assortment and that better assortment is driving the growth and is more than offsetting that comparison?

That's correct.

And could you just talk about and maybe you did before, but could you give us a couple of examples of replacing unproductive SKUs with productive SKUs?

Yes.

Again, a perfect example is you take out a cracker or a cookie that's unproductive and replace it with a Nabisco item.

I can sit here and talk about adding, changing the mix in our soda set by adding SKUs into leading unproductive ones out.

It's really a very -- it's actually almost a mathematical calculation when you go in and look at a category, you look at every individual SKU.

You analyze how productive it is.

And then you do your market research and drop that in favor of something is that more productive.

Great.

Thank you.

And our final question comes from Lawrence Weiss of Citigroup.

Yes, hi.

What's your credit agreement's EBITDA LTM?

And leverage calculation?

I'm not sure I understand your question?

According to your credit agreement what is your EBITDA on an LTM basis and what is your leverage?

Our EBITDA for the -- we have it here for the LTM 52 weeks -- $803.8 million is the 52 weeks looking back from August 1.

It's in the press release.

Okay, so whatever is in the press release is as calculated by your credit agreement?

That's correct.

Okay.

That's fine.

Thank you very much.

Okay.

There are no more questions in the questioning queue at this time.

Thank you again for joining us today.

We appreciate your interest in Dollar General and we look forward to updating you on our progress next quarter.

This concludes today's teleconference.

Please disconnect at this time.