達樂 (DG) 2011 Q2 法說會逐字稿

Ladies and gentlemen, this is the Dollar General Corporation's second-quarter 2011 conference call on Tuesday, August 30, 2011, at 9 o'clock AM Central Time.

Good morning and thank you for participating on today's call, which is being recorded by Conference America.

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

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

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

Ms.

Gordon, you may begin.

Thank you, and good morning, everyone.

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

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

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

Today's comments will include forward-looking statements such as those about our expectations, plans, strategies, objectives, and anticipated financial and operating results including, but not limited to, our comments regarding our forecasted 2011 financial performance; planned merchandising, operating, and expense control initiatives; store growth and capital expenditures; as well as our expectations with regards to certain consumer and economic trends.

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

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

Important factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in our second-quarter earnings release issued this morning, our 2010 10-K filed on March 22, 2011, and in the comments that will be made on this call.

You should not unduly rely on these statements, which speak only as of today's date.

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

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

Reconciliations to the most-comparable GAAP measures are included in this morning's earnings press release, which can be found on our website at DollarGeneral.com under investor information press releases.

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

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

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

Thank you, Mary Winn; and good morning and thank you all for joining us today.

We had yet another great quarter.

I am very pleased with our financial results as well as the operational progress the Dollar General team delivered.

Sales exceeded our expectations as we expanded our overall share of the consumables market.

Our most recent Nielsen data shows that we have continued to increase our market share in units and dollars on a four-week, 12-week, 24-week, and 52-week basis.

Our comp store sales accelerated from the first quarter, and we continued to successfully expand our store base.

However, the macroeconomic environment has remained difficult for consumers, who continue to face high unemployment rates, high gasoline, and high food costs.

Our results give us confidence that we are continuing to meet our customers' expectations even though we have had to pass through some of our unavoidable cost increases.

I am very pleased that we have been able to grow market share profitably while balancing the challenges of pricing and rising input costs.

Key financial highlights of the second quarter include total sales growth of 11.2% over last year's second quarter to $3.6 billion, including a same-store sales increase of 5.9%.

As you would expect in this environment, sales growth was primarily driven by consumables, with our strongest results in food, snacks, and perishables.

Pet supplies and health and beauty care performed very well also.

On an annual basis, our sales reached $205 per square foot.

That is up from $199 a year ago.

Our gross margin rate declined 11 basis points from last year to 32.1% in the second quarter.

SG&A as a percentage of sales was down 54 basis points.

Our operating profit increased by 16% to 9.8% of sales, a 43 basis point improvement over last year and a new second-quarter record.

Our strong cash flow has enabled us to repurchase all of our senior notes, significantly decreasing our interest expense, with an even more dramatic effect going forward.

Adjusted for the impact of the debt repurchase, second-quarter net income grew by 25% over the prior year to $181 million or $0.52 per share.

Overall, sales in our consumable categories were very strong and a direct result of our ongoing category management efforts which include a significant focus on increasing our offerings of private brands.

Our private brands continue to perform well, as they help us answer our customers' demands for low prices on quality products while also boosting our gross margin rate.

Our basic non-consumable categories -- home, apparel and seasonal -- remain extremely important to our general store business model and are contributing significantly to our profit growth, even as customers continue to limit their discretionary spending.

We have updated our non-consumables offerings and adjusted to our customers' needs and demands.

We are seeing some encouraging results in several areas including children's apparel, car care, men's work wear, DVDs, toys, party supplies, and stationery.

Now I will ask David to walk you through the rest of the financial results, and then we will talk about our expectations for the second half of the year.

Thank you, Rick, and good morning, everyone.

We are very pleased with our second-quarter sales growth, our gross margin results, strong SG&A leverage, interest reduction, and net income growth.

Across-the-board it was a great quarter for Dollar General.

Consumables sales were very strong in the quarter.

All of our food and snack categories increased significantly, including a strong increase in perishables.

Pet care increased nicely as we continue to become a destination for pet care supplies.

Health and beauty benefited year-over-year from the launch of the Rexall brand and the completion of phases 3 and 4 of our 78-inch profile initiative which impacted cosmetics, skin care, dental, medicine, and first aid.

Our gross profit rate was 32.1% for the quarter, down 11 basis points from last year's second quarter.

Our mix of sales in the quarter continued to trend more toward consumables, which generally have a lower gross profit rate than non-consumables.

We also recorded a LIFO charge of approximately $11 million primarily driven by cost increases in food, cotton apparel, plastics, and motor oil.

This adjustment is based on the year-to-date pro-rated portion of a $30 million full-year estimate of LIFO.

Due to additional cost increases, our LIFO estimate increased over the estimate made in the first quarter.

In addition, transportation costs were up due to higher fuel cost.

As a percentage of sales, lower markdowns, shrink reduction, and distribution leverage helped to offset the effect of rising costs.

SG&A as a percentage of sales improved by 54 basis points to 22.3%, primarily due to our strong sales performance and the leverage on store labor enabled by our new workforce management program and engineered labor standards.

Other factors contributing to SG&A leverage in the quarter include decreases in incentive compensation and net advertising costs, in addition to other cost-reduction and productivity initiatives.

These improvements were partially offset by higher depreciation expense, primarily related to our increased investment in store fixtures and equipment as well as the purchase of stores.

Operating profit was $350 million, up 16% from the prior year, resulting in an operating margin rate of 9.8%, a 43 basis point improvement over last year.

For the quarter, interest expense was down $9 million from the prior year, resulting from lower average borrowings and the impact of reduced amounts on our interest rate swaps.

In July, we repurchased the remaining $839 million of our senior notes, which allow us to further reduce interest expense going forward.

The repurchase resulted in a pretax loss of $58 million or about $0.10 per share.

Net income for the quarter excluding the impact of the debt repurchase was $181 million or $0.52 per share, an increase of 25% over adjusted net income of $145 million or $0.42 per share in the 2010 quarter.

For the 26 weeks year-to-date period, net sales were $7 billion, an 11.1% increase over last year.

Same-store sales increased 5.6%.

Year-to-date increases have been driven by our strong consumables performance and reflect an increase in both traffic and average ticket.

The year-to-date gross profit rate was 31.8% in 2011 compared to 32.2% in 2010, a decrease of 36 basis points attributable to the higher mix of consumables, increased product and fuel costs, and higher markdowns taken in the first quarter.

The charge for LIFO year-to-date was $14.2 million compared to $700,000 last year.

Distribution efficiencies and lower inventory shrinkage partially offset the year-to-date gross margin decrease.

SG&A expense decreased by 57 basis points on a year-to-date basis, or 53 basis points excluding certain non-comparable items as described in our press release.

The majority of the year-over-year improvement was due to increased sales and a significant impact from our new workforce management program and engineered labor standards.

Lower incentive compensation and net advertising costs along with other cost savings and productivity initiatives contributed to the SG&A rate reduction, which was partially offset by increased depreciation expense.

Adjusted operating profit was 9.7% of sales in the 2011 period compared to 9.6% of sales in the 2010 period.

Year-to-date interest expense decreased by $15 million from last year to $126 million in the 2011 period.

The pretax loss on debt repurchases totaled $60 million in the 2011 period compared to a pretax loss of $6 million in the 2010 period.

Our effective income tax rate was 37.5% in both 2011 and the 2011 26-week period.

Finally, adjusted net income increased 20% to $348 million or $1.01 per diluted share.

Our strong operating performance resulted in strong cash flow from operating activities of $398 million year to date, which we will utilize to further invest in the business and to pay down debt.

As of July 29, total inventories at cost were $1.97 billion, up 7% on a per-store basis from the prior year.

The increase is primarily due to the addition of new items as part of our 78-inch profile expansion and additional purchases within our product assortment which we expect to help us avoid further cost increases later in the year.

Total outstanding debt at the end of the quarter was $2.8 billion, down $572 million from a year ago.

Net of cash, our ratio of long-term obligations to adjusted EBITDA was 1.6 times at the end of the second quarter compared to 2.2 times a year ago.

Since the Company went private in 2007, we have paid down $1.8 billion in debt.

Given our success to date, we are updating our full-year guidance to reflect our first-half performance and our cautious optimism for the remainder of the year.

We're over halfway through the year, and we have better insights on the second half.

We are increasing the low end of our previous earnings per share guidance by $0.02.

We currently expect adjusted diluted earnings per share for the 53-week fiscal year to be in the range of $2.22 to $2.30, assuming 346 million weighted average diluted shares and a full-year effective tax rate of approximately 38%.

The 53rd week is expected to contribute approximately $0.06 per diluted share.

We now expect total sales to increase 12% to 14%, including sales in the 53rd week which are expected to be approximately 200 basis points of the total increase.

Same-store sales based on a comparable 52-week period are expected to increase 4% to 6%.

This is an increase from our previous expectation of total sales increase of 11% to 13% and a same-store sales increase of 3% to 5%.

Adjusted operating profit for the 2011 53-week period is expected to increase 14% to 16% over the 2010 52-week adjusted operating profit.

Gross margin will likely be impacted in the third and fourth quarter by several factors.

We expect the pressure on discretionary spending to continue to challenge us in the second half of the year, resulting in an acceleration of our mix of sales into consumables.

Full-year guidance includes an estimated charge for LIFO of $30 million for the year.

The increased magnitude of commodity cost pressures now included in our update full-year guidance was not contemplated in our previous guidance.

For the third quarter, we currently expect markdowns as a percent of sales to be in line with the prior year.

But keep in mind third-quarter markdowns are typically higher than the second quarter due to the seasonality of our sales.

With regard to pricing, we plan to remain very strategic in our efforts to balance gross margin while protecting unit sales.

We plan to open approximately 625 new stores and to remodel or relocate 575 stores in 2011, including up to 25 Dollar General Market stores.

Capital expenditures are expected to be in the range of $550 million to $600 million, with approximately 55% of capital spending for store growth and development; 25% for special projects, including approximately $90 million for a new distribution center in Bessemer, Alabama; and the remaining 20% for maintenance capital.

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

Thanks, David.

We have an exciting second half of the year planned to build upon our momentum in the business.

We are pleased with the start to the third quarter, including a solid back-to-school performance.

There is no doubt that the prolonged economic pressure on consumers, such as high employment, higher fuel costs, and uncertainty about the future, have created more of our core customers -- those who depend on the value we offer.

In addition to creating new core customers, we also believe the economy is encouraging more trial in our stores from other consumer segments.

Some of our new customers are trade-down, those with higher incomes than our core customers and who are now coming into our stores for everyday low prices on consumables and brands they recognize.

We believe we are seeing another category of new customers, who are trading-in, and who are choosing to come to our stores because they like not only our pricing but also the shopping experience and the product offerings they are finding in Dollar General.

We believe these trade-ins reflect the new consumerism which values frugality and smart shopping.

We are committed to earning all of our customers' trust so that they continue to count on us long after the economy improves.

One of the key areas we have been focusing on improving is our store in-stock levels.

I am pleased to tell you that for the second quarter in a row that we have seen positive results from our efforts.

More importantly, our customers are noticing our progress.

Customer satisfaction scores on this metric have improved in every division year-over-year.

As I mentioned earlier, private brands continue to be a significant opportunity for us.

Sales of private brands have increased over 15% year-to-date, outpacing our overall sales growth.

We are very pleased with the performance of our expanded health and beauty offering, which includes strong growth in the Rexall brand.

We now have over 1,400 private-brand SKUs including nearly 300 Rexall SKUs; and we believe we still have significant opportunity to grow.

We opened 301 new stores through the second quarter and continue to expect to grow square footage by about 7% for the year.

We are pleased with the performance of our new stores, remodels, and relocations as we move forward with the transition to our customer-centric format.

Over 2,100 stores now have our new look and layout.

We are on track to expand into Nevada, Connecticut, and New Hampshire in the second half of the year and open our first cluster of stores in California in the first half of 2012.

As we have mentioned before, we are also ramping up our efforts on our Dollar General Market concept.

Our Market stores offer customers a selection of fresh produce, meats, and other refrigerated and frozen foods alongside the typical Dollar General offerings.

These stores are creating a shopping experience that customers are responding to.

They are now delivering the highest same-store sales increases in the Company this year.

To date we have remodeled 16 of our existing 57 Dollar General Market stores.

In the remodels we are reinforcing the message of freshness with our updated interior and exterior color scheme, signage, and new power alley.

We are also seeing an increase in traffic, transactions, and basket size in the remodels; and as a result we plan to remodel an additional 12 Market stores in the second half of the year.

In addition to the remodels, we now plan to open about 10 new Market stores this year, including several as part of our initial entrance into Nevada in October.

This morning we announced our planned launch on September 8 of an e-commerce site, DollarGeneral.com.

We are excited about this new opportunity for growth, which will initially offer over 1,000 of our current SKUs to customers who, like many of you, may not have a convenient Dollar General.

We plan to sell single items that you would find in our stores as well as larger quantities that we stock in our stores; and from time to time we will also feature limited quantities of special buys.

So to wrap it up, we are very pleased with our second quarter and we believe that we are well positioned for the second half of the year.

At Dollar General we remain focused on controlling what we can control and delivering strong financial results for our shareholders.

We will continue to closely monitor how our customer is reacting to the current economic challenges in the retail environment, where we believe the value message is key.

We know that with the sustained period of unemployment and underemployment our customers need us more than ever.

Before I close, I would like to give my sincere thanks to the nearly 90,000 Dollar General employees who were key, delivering a great quarter.

So with that, Mary Winn, I will turn it over for questions.

We will go ahead and take the first question, please.

(Operator Instructions) Deborah Weinswig, Citi.

In terms of the gross margin performance, I would have to argue the competitive environment has gotten more difficult since last quarter but your performance has definitely gotten better.

If you think about the non-consumables effort, can you -- I think you highlighted children's and men's work wear.

Can you talk about what your -- you know, strengths you have there?

And then can you talk about the impact as you shift into the consumables in the quarter?

Yes, I will take the non-consumable and let David talk to you a little bit about the mix.

The first thing I would like to say, Deb, as I think about this, you have got to remember -- a lot of our customers, the recession has not ended.

They are still dealing with a lot of pressure.

As we said, I believe, in the fourth quarter, we have gone in and looked really hard at the non-consumables side of the business, and we have shifted our focus.

One of the first things -- one of the first moves we made was shifting to infants and toddlers, that apparel mix being 50% now versus where it was.

And quite honestly the customer is responding to that.

If you think about it, when you can come in and buy a creeper for $6 or $8 and know that your child is going to grow out of that, you can come back and get it yet again, it really is resonating well with the customer.

Men's basic work wear, we talked about the fact that we were going to emphasize work shirts, jeans, and work boots, T-shirts with a pocket on them.

And again, that is starting to resonate.

I would also like to say that we have done an overhaul of Party and that Party is doing exceptionally well.

And it is all branded Dollar General.

So while we are making strides, I want to continue to reinforce it is still a discretionary purchase that people are being very cautious about.

That is why David has spent a lot of time reflecting on what he is going to see on the mix the balance of the year.

Yes.

We see continued pressure on gross margin in the back half of the year due to mix.

Our current view is that the consumable mix will continue to grow versus the prior year the back half of 2011.

Obviously that represents a bit of a headwind to margin since consumables are generally lower margin than the non-consumables.

That is our call on the economy right now.

But I want to stress all this is included in our guidance.

And in spite of the margin pressure our net outlook on earnings per share for the year has actually improved from our previous guidance of $2.20 to $2.30.

As we mentioned, we raised that this morning to $2.22 to $2.30, raising the bottom end of our guidance.

That is due to our improved outlook on sales.

We raised our comp sales guidance from 3% to 5% previously to 4% to 6% currently.

So again we are seeing a little better sales.

This increase is due to our superior category management and strong execution at our stores.

Does that help, Deb?

Great.

Then just lastly, can you update us on the new Dollar planogram?

How far has it rolled out, and what has been the response from the consumer?

It is rolled out to the chain now.

It is in about 5,700 stores, and the response has been great.

To be honest, Deb, we are selling more of the product than we thought we were going to sell.

All right.

Operator, we will take the next question.

Scot Ciccarelli, RBC Capital Markets.

You guys have talked about consumer challenges -- and you are not alone, obviously -- for quite a while.

I guess I am curious; are you seeing anything different than what you have been seeing?

Or is it just more of the same and not necessarily seeing the recovery you hoped for?

Yes, excellent question.

I would categorize it as more of the same.

I continue to see customers who are still struggling.

Our customer, the recession hasn't ended, Scot.

Gasoline prices are down from where they were, but they are still $0.85 a gallon higher than last year, so there is still a lot of economic pressure.

And the unemployment rate.

Right, okay, got it.

Then, obviously you guys talked about some of the gross margin pressure last quarter.

It sounded like you were going to be raising prices a bit more aggressively in this quarter.

How much did -- whether it is raising prices or inflation, however you want to think about it -- impact this quarter in terms of the comp store performance?

Yes, we think inflation is approximately 1.5%.

I want to reinforce to you too, Scot, on raising prices, there are still prices we haven't raised.

We believe this is a unit growth story.

And I can honestly tell you too that there are some prices we raised we had to back that down, because we saw unit decline.

And we are intensely focused right now on unit growth.

Got it.

Very helpful.

All right, thanks guys.

Thanks again.

We will take the next question, please.

Colin McGranahan, Bernstein.

Good morning, guys.

Thanks for taking the question.

You betcha.

First question, just following up on pricing.

It sounds like maybe there was a little bit of a philosophical change here over the course of -- let's call it the last three to six months.

Can you help us understand how much more you are seeing the ability to raise price, and what has happened to your price gaps versus the competition?

Specifically the traditional grocers and vis-a-vis Walmart.

Yes.

There has philosophically been no change.

I think if you go back, Colin, to the first quarter, I said the price changes are going to have to work their way through the system sooner or later.

But we have taken a very methodical approach, and what we are trying to do is continue to build on the sustainability of our brand and how the customer perceives us.

So what we have done is we are passing our price changes through but at a slower rate, and maybe taking just a piece of the price change two or three times rather than trying to take it all at once.

I will tell you also we continue to be very comfortable with our pricing gaps with drug; very comfortable with them with grocery; and we continue to maintain our price parity with the big-box operators.

Okay, that's very helpful.

Then just second on the balance sheet, now that you've gotten the senior notes out.

Can you give us maybe a 12- to 24-month view on what the balance sheet is going to look like?

What your next moves are?

Remind us any restrictions you have around cash usage.

Right, yes.

Our number-one priority for cash continues to be investing in our business.

By that I mean opening up new stores, as evidenced by the 625 stores we intend on opening this year and the 600 we opened last year.

Focus on remodels and relocations because of the lift we get on sales from that.

And then having the infrastructure to support the stores.

The best example of that is the new distribution center in Alabama that we are building right now.

We are also investing inside our stores.

The 78-inch profile obviously is an example of that, and many other things that we have done to boost sales and help provide service to our customers.

We did pay down the $839 million of senior notes in July as we had mentioned that we would.

The next area of debt that we'll focus on, that we will look at, is the $450 million of subordinated notes that are at 11 1/8%.

That is obviously our highest cost debt out there on the balance sheet.

Next July, July of 2012, we can buy those back at $105, very similar to the price we had on the $839 million of senior notes.

So we will take under consideration buying back those notes at that point in time.

After that, right now I don't see a lot more change in the debt structure.

We will shift our focus to our opportunity to return cash to shareholders.

In general that will be either a share buyback or a dividend, depending upon what our Board sees fit and when they decide the right time is to take that under consideration.

So to summarize -- number-one priority, investing in the business; number two, paying down debt, which we've substantially done; and then number three, looking in the future for opportunities to return cash to our shareholders.

Great.

Thank you very much.

Operator, we will take the next question, please.

Emily Shanks, Barclays Capital.

Good morning.

Great quarter, guys.

I just had two questions, one is actually a follow-up to the prior caller.

Can you let us know what your RP capacity is to allow for open market repurchases of those senior subs?

Emily, could you repeat the question?

Yes, we had a little hard time hearing you, Emily.

I apologize.

No problem.

Let me try that again.

Can you hear me?

Yes, that is much better.

Thanks.

Okay, apologies.

I was curious as a follow-up to the prior question what your current RP capacity is to execute open market repurchases of the senior sub bonds.

Yes, right now at this point in time we don't have enough capacity to make that purchase.

But again as we get into next year and the time period when we would be doing it, our current modeling shows that we would have plenty of capacity to make that buyback.

Okay, so it's literally at zero right now?

No, it's not at zero; but it is just not enough to buy back the whole $450 million.

Again we wouldn't do that anyway because the price is too high right now.

Again, they are trading pretty handily in the market.

We would wait until -- our current thought process is that we would wait until that price came down to $105 next July or approached the $105.

If you remember we did buy back some of the senior notes before $105 because our models showed that it was accretive to us to buy them back a little bit earlier.

Okay, got you.

Thank you for the details.

Then my second and last question is, as we look at the inventory increase for the quarter, I know that you indicated a portion of that was effectively forward buy, if I am summarizing it correctly.

Can you give us a sense of what portion of that growth is attributable to forward buy?

Yes, what I would rather say to you, Emily, you had the 78-inch profile which has allowed us to put in a higher-ticket item for the customer.

It is attributable to that and then our forward buy activity.

And I would rather not be that specific if it is okay.

Okay, that's great.

Thanks and good luck.

All right.

Thank you.

Operator, we will take the next question, please.

Meredith Adler, Barclays.

Good morning.

I feel like everybody has asked my questions, including Emily.

Hey, I will take anything you want to ask.

Okay.

Maybe I would just like to talk a little bit more about forward buy.

I know you don't want to quantify it; but generally are you finding that vendors are making inventory available for forward buy?

Yes.

The answer to that is correct.

Now, I don't want anybody to think we are out there just buying anything that is out there.

It is very strategic.

It is items that generate a lot of volume for us, which are obviously a little more sensitive to our customer.

And we are doing it in an attempt to mitigate having to raise the price at the shelf.

Okay.

Then maybe you could just talk about what -- you said that August was going well and back-to-school was going well.

Does that mean that you are in the range that you gave us of guidance for the year for comps?

Well done.

I am very pleased with where our sales are as we start the quarter.

How's that?

Okay.

I guess just my final question would be about markdowns.

I think markdowns of apparel were a big issue in the first quarter.

It sounds like they were much less of an issue in the second quarter.

Is that fair?

And then I think it should be even better going forward.

Yes, if you look at the difference between Q1 and Q2, the primary difference -- we deleveraged 63 basis points in Q1; in Q2 we delveraged 11.

The primary difference is markdown.

But let me explain how this works.

In Q1 we experienced higher markdowns in apparel and home versus Q1 of the prior year due to the tougher macroeconomic environment.

In Q2, we experienced improved markdowns versus Q2 last year due to having fewer competitive price reductions -- what we call TPRs or temporary price reductions, which take place primarily in the consumable area.

Again, this is versus what we saw in Q2 of 2010.

This was really the biggest difference in markdowns for the differences between Q1 and Q2.

Additionally, we did have improvement in both shrink and distribution in Q2 which helped take away some of that negative on margin.

And apparel and home markdown this quarter?

Consistent with plan.

Yes.

Okay, great.

Thank you.

Operator, we will move on to the next question, please.

Joseph Parkhill, Morgan Stanley.

Good morning.

Congrats on a nice quarter.

Thanks for the clarity on gross margin performance.

I was just wondering a different look at it.

I'm assuming it perhaps came in a little bit better than your internal projections; so what would be the biggest delta between where it came out versus what you were expecting?

Rather than -- I know your commentary before was the difference between Q2 and Q1.

Yes, I think three things.

The shrink again continues to do very, very well.

We have got a lot of great things going on in shrink right now.

If you look at that we are very, very pleased with our exception-based reporting, our focus on high-shrink stores.

Scan-based trading has been helping us.

Defensive merchandising, fixtures, etc.

etc.

There is a lot of hard work going on in shrink and it is paying off.

We also had distribution come in and help us again in the quarter versus last quarter.

Engineered labor standards, voice pick, cube on the trunk.

Just general efficiencies.

Inbound load optimization, etc.

So we got some help also from those items.

And then the markdowns.

Again a little bit better on markdowns.

When you go into a quarter, you have estimates of your sellthrough, and you're never quite sure how those are going to come out until the quarter ends.

That was helpful.

Thanks.

Then just quickly on the inventory, I was looking through the Q.

Everything seems to be in good shape except apparel is up, I think, about 10% year-over-year versus sales growth of 1%.

Are you comfortable with where your apparel inventory is?

Yes, Joe.

The reason I would say we are comfortable, that reflects this realignment where we made the commitment to infants and toddlers and shifted the mix around.

We also did some forward buys on apparel.

You are probably aware that cotton prices have been increasing astronomically, and we were trying to get a little bit ahead of the power curve on cotton.

Okay, that's great.

Thanks.

Operator, we will move on to the next question, please.

Wayne Hood, BMO Capital.

Good morning.

A couple of questions.

One is back on the gross margin.

You outlined or said that you expected third-quarter markdowns to be equal to last year.

You have shrink that is kind of a tailwind and DC costs that are a tailwind.

That would imply, I guess, that the FIFO gross margin could be flat if you put the mix to shift aside.

So are we to assume that the FIFO gross margin might be flattish to down a little bit, but the LIFO will be down more?

And it is really the adjustment to LIFO that is putting the pressure on gross margin more than even mix?

Or how should we think about third-quarter FIFO gross margin?

No, I think you really have to look at the mix more than anything else.

Again as I mentioned, our current call on it -- again, our call on the economy is for the back half of the year we think that consumable mix will continue to grow and continue to be above what it was last year at this time.

You're right, LIFO impacts us also.

But again I think the mix that we see is the bigger issue.

You would expect, David, I guess, the home apparel and seasonal categories to have a sales increase?

It is not that they are declining; is that correct?

Yes, we see increases again versus prior year in total in all of our categories for total sales.

Okay.

Then my final question related to costs.

You mentioned that the advertising costs were lower year-over-year and incentive comp was lower.

Can you outline how that looks for the third and fourth quarter?

Is there any shifting with advertising we should be aware of?

Also how incentive costs unfolds in the back half of the year.

Thank you.

Yes, no real -- again, I'm reluctant to give too much guidance on line items, but no real overall shift in advertising.

The point on the incentive comp is simply we had a tougher budget this year; and again, every year our budgets get a little bit tougher.

Okay, great.

Thanks, guys.

Next question, please.

John Zolidis, Buckingham Research Group.

Hi, good morning.

Nice results.

Thank you very much.

I thought I would ask a question about the workforce management program and the software that helped out the SG&A in the quarter.

I was wondering if you can give us a little bit more color on exactly what that does for you.

And then where are we in the lifecycle of that program?

Are there more gains yet to come?

Yes, the workforce management system is an industrial engineering program that helps us better allocate the hours in the store based on the flow of the customer traffic.

It also, John, helps us identify how many hours we should use for stocking, how many hours for checkout.

But the real win for us is the proper allocation of the workforce into the store at the right time based on the flow of the customer.

As far as the program, it has rolled out and we continue to believe that we still have upside in it going forward.

The key thing is it really gives us a feel by store, as opposed to just standing up and laying it out across the whole chain.

We're about three-quarters implemented on it now.

About 75% of the chain it is implemented in.

Great.

Any other new programs coming in that are systems-driven that are going to help, that you are excited about?

Well, we continue to -- we have started rolling out our new procurement system.

That is going to take us a couple years to get done, though.

The exciting thing about that, John, is that it will give us a real-time look in regards to allocating product rather than having to rely on the previous 10 or 12 weeks.

So we think we are going to be able to do a better job of laying the right amount of product into the store at the right time, particularly on promotional items.

We have had some improvements in our handhelds in the stores, our HHT as we have called them, some software improvements there, which add to the -- try to make the life a little easier for the store employees.

We are also in the process of doing DSL WiFi in the stores.

Again that helps in that whole process.

Then we had an announcement this morning on e-commerce which we're excited about.

Obviously there are a lot of systems behind e-commerce and making that happen.

The other thing, we've got some new point-of-sale registers that are being put in.

Again this will ease the -- hopefully make the workload a little bit easier for the store employees.

Great.

Thanks a lot and continued success.

Hey, thank you, John.

All right, we will move to the next question, please.

Matt Nemer, Wells Fargo.

Good morning, everyone.

My first question is -- could you just comment on the mix within consumables in terms of good, better, best?

Are you seeing customers trading down to private label?

Any color you can give there?

Yes, that is a great question.

No doubt we are seeing more private-brand sales.

They were up 15%; they are growing faster than the total sales now.

For what it is worth, Matt, really seeing the private-brand conversion in health and beauty.

It really speaks well, we think, to the future of the Rexall brand, in fact that the customer perceives that as a national brand.

Where is that brand in terms of product rollout?

Is there still -- I know there was a new packaging initiative earlier this year.

But can you just give us an update on that?

Yes, I mean the new private brands, essentially that look, that feel, that placement in the store is rolled out.

We have expanded the private-brand commitment now into the non-consumables side as well.

I am very pleased with what the team has done with the Party.

I have got to tell you guys the new automotive set with the private brands is doing really well.

In regards to Rexall, Matt, I would tell you we might still have -- we might be able to get maybe 50% more SKUs in there when it is all said and done.

But we are taking our time with that.

And again like we have always said, we are letting the customer make that choice.

Okay, great.

Then just lastly, can you help us gauge the potential size of an e-commerce channel for you in terms of how much traffic you are getting to your websites and what people are doing on your site and what they are asking for?

Yes, what I would rather do is give you an update on that when it has been up and running for a while.

This is brand new for us.

We do know that there has been requests for it.

We do know there is demand for it.

But I just don't know enough yet about how it is going to -- what it is going to generate.

You know, with the world of social media today -- I mean, it is a great hook-up for us now.

Great, fair enough.

Thanks very much.

All right, next question, please.

Mark Montagna, Avondale Partners.

Hi, good morning.

A couple questions about home and apparel.

I was wondering, at what point in the second quarter did you have apparel fully set to the new format with all your markdowns taken?

Then also with the home, just walk us through what changes you made.

Was it across-the-board inventory reductions, or did you slice out certain lines?

Well, let's come back to apparel.

I mean about the time we hit the beginning of the second quarter it was pretty well rolled out into the chain.

Again that commitment to the placement of infants and toddlers being 50% of the department and being placed up front.

So we had that benefit on that side of the table all the way through the quarter.

I would say the same thing with the basic men's work apparel.

It was in place in the stores the whole quarter.

And I can't remember the second half of your question, Mark.

I apologize.

Yes, the other part was -- how did you alter home?

Was it -- I know you reduced the inventory.

But did you slice out certain lines?

Or you just -- across-the-board cuts in inventory?

Yes, basically it is just all SKU rationalization.

As we were looking at home, we have made changes in the store that have affected other pieces of the business.

In our category management process, Mark, we go in and eliminate unproductive SKUs.

And that is what you saw in the quarter.

Okay.

Then just lastly, what percent of consumables sales was private-label merchandise?

Our penetration was 21.8%.

Okay, great.

Thanks.

Operator, next question, please.

Mark Mandel, ThinkEquity.

Hey, good morning and congratulations.

Thank you very much.

I was wondering if you could just update us on the real estate environment, what you are seeing out there.

Obviously you seem to be able to get your stores open without any issues.

And your discussion of depreciation, I think you mentioned that you were owning more of your sites.

Could you just clarify that point?

Sure, I will answer the first part and let David answer the second.

The real estate environment is relatively what it has been over the last 18 months.

So it is affording us the opportunity to get a little bit better site.

We are pleased, the site selection is paying off in the volume that comes out of our stores initially out of the chute.

I think David would say we are purchasing stores because the environment is very opportunistic right now.

Yes, it is an opportunistic environment.

We are getting very nice cap rates when we do this purchase of stores.

We will continue to do it.

But again I want to emphasize this is not an all-consuming, huge effort for the Company.

This is just a way for us to buy some of our better stores that we know we want to keep because they are performing very, very well; employ some of our cash in a way that we believe in a future time period we will be able to turn these stores and sell them for a pretty good profit.

And again we are just taking advantage of a market right now that has cap rates that are very attractive to us.

And we want to put our cash to work for our shareholders.

What percent of your stores do you currently own?

Oh, it is very, very small.

Very small.

My second question is on your fresh food initiative.

Could you just update us on where you stand in terms of rollout of cases?

Is that complete, or are you expanding the number of cases in your existing stores and so on?

Yes, that is a great question.

I will give it to you two ways here.

First off, we are continuing to expand refrigerated and frozen.

What I would say to you is that our customer, our frozen food and refrigerated offering to them is almost like it is insatiable.

The more we put in, the better we do with the initiative.

I think it is pretty fair to tell you all that we will continue to push frozen food cases going forward probably for a very long period of time.

It is a matter of us just finding sufficient space.

On the Market store side, I am very pleased with what the team has done in refining the mix of frozen food and more specifically the fresh meat -- the limited fresh meat and produce we carry.

So we are very excited on what is happening on that side of the ledger also.

Okay.

Thanks and good luck.

You bet.

Thank you very much.

Operator, next question, please.

Joe Feldman, Telsey Advisory Group.

Hey, guys, this is actually Kelly filling in for Joe.

Congrats on a great quarter.

First of all, just could you give us a little bit more color on sales cadence throughout the quarter?

Also, were there any regional callouts that you could highlight?

I'm sorry, I missed the first part.

I didn't hear you.

Could you talk a little bit more about sales cadence throughout the quarter?

Some of our other retailers have talked about how it started off a little bit slower and kind of accelerated as the quarter went on.

Just wondering if you guys saw the same thing.

Yes, there is no doubt that sales accelerated through the quarter.

Our acceleration, I would say why there is a difference between the first period and the last, it is not like it is a major difference.

I would think more of a gentle hockey-stick rather than a radical move to the upper right-hand corner of the chart.

Regionally, I am pleased to say once again every region that we deal in had positive comps.

Again, really speaking to the breadth and depth of the model all across the economic spectrum.

Great.

Thank you.

That's helpful.

Then second question, just in relation to Dollar General Market.

I know it is early, but you guys sound very excited about the results.

It's generating strong sales.

How did the margins compare to the rest of the chain?

Are you finding that it is attracting a different customer?

Then when you guys have talked about in the past the opportunity for 12,000 new stores, is that inclusive of the Dollar General Market?

Or how should we think about that?

Yes, I would think of the 12,000 opportunities as including Dollar General Markets as well as Dollar Generals.

It is interesting; where we do very well as a Dollar General, that morphs into a Dollar General Market very nicely.

And yes, we continue -- the margin, obviously, the mix with the addition of more produce and more meat, while the margin is going to be a little lower the team has worked very hard on putting us in a position where the dollars we are generating out of that box is very impressive.

And that is what we are going to go with.

Great, thank you.

We will move to the next question, please.

Anthony Chukumba, BB&T Capital Markets.

Good morning.

Two questions.

First one was on Hurricane Irene.

Wanted to see if you had any thoughts on whether that had a negative impact on your sales or maybe even a positive impact as people stocked up ahead of that.

Then the second question, I just wanted to understand what the difference was between a trade-down and a trade-in customer.

Sure.

That is a great question.

First of all, in regards to Hurricane Irene, like all other retailers out there -- hey, we suffered some store closures.

We had no store losses.

We had a little bit of tree damage, a little bit of water damage.

We still have a handful of stores that are operating without power.

But overall, we came through the disaster quite frankly very nicely.

Again having spent my entire life in retail, a threat of a natural disaster is great.

And then when that disaster is not quite as bad as forecasted, sales usually do pretty well.

I look at a trade-down customer as someone who it is experimenting.

Someone who is coming in and driven by the fact -- in fact, I'm going to rephrase that even a little more differently.

What I would like to say, Anthony, is I think as I look at consumer spending today there are those who have to shop in our channel.

There are those who want to shop in it because it is enticing.

And then those that are -- boy, I am doing a terrible job here.

Let me just back up.

I had this all in my mind.

Listen.

Trade-down people are going to come in because they have to for a period of time.

I think the economy is creating an entire new customer that values the new consumerism, that really and truly wants to shop with us.

They have come in, and they have seen an experience that is totally different.

We actually think this trade-in customer represents the new change in the environment today.

It reminds me very much of the '70s when the warehouse stores came up.

I ran a warehouse store in the '70s, and I can remember people standing in line with a fur coat trying to save a few dollars.

That is that trade-in, those people that are coming in and liking what they are seeing.

Okay, thank you.

Does that help, Anthony?

Yes.

No, that is helpful, thank you.

Great, all right.

Operator, I think we have got one other person in the queue there?

Michael Exstein, Credit Suisse.

Good morning and thank you.

I'm sorry -- the last question or last person in the queue.

I think very early on Deb asked about promotions.

In the old days we used to see promotions where we'd see fliers or something like that.

But it looks like we are seeing more couponing off the Internet.

Can you just talk about that, how you see that going forward?

Yes, I mean -- I think every retailer right now is dealing with the whole social media issue.

I don't think any doubt going forward that there is not going to be more of it.

What is good about it, Michael, is you can target your audience.

You don't have to blanket everybody like you do when you put something in a newspaper.

You are able to strategically hit your customer.

So again, while our focus is on Every Day Low Price, our focus is what transpires at the point-of-sale, there is no doubt that we need to have some sort of Internet presence, some sort of social media presence.

And we think we are on -- we are doing enough things I think we are on the right track.

Can you just talk about also the $25 purchase coupons, getting $5 off and the bounce back, and how that all plays out?

Yes, we use that strategically at different times of the month on different occasions.

It is another form of EDLP pricing.

What we're trying to do is stretch the consumer's budget at different times of the month.

Hey, it is something that we use occasionally, and we are pleased with what we are seeing.

You have to also remember, you put that out there; the redemption on it, that it's very targeted.

It is not like the masses are running in to redeem it.

It is a very strategic element for us.

Okay, great.

Thank you very much.

Thank you.

Okay, with that, that concludes our call.

Operator, I think --

Thank you all very much for your interest in Dollar General and look forward to talking to you all soon.