達樂 (DG) 2013 Q2 法說會逐字稿

Good morning.

My name is Brandy and I will be your conference operator today.

At this time I would like to welcome everyone to the Dollar General second-quarter earnings call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer session.

(Operator Instructions)

Thank you.

Ms. Mary Winn Gordon, Vice President of Investor Relations and Public Relations, you may begin your conference.

Thank you, Brandy, and good morning, everyone.

On the call today are Rick Dreiling, our Chairman and CEO; and David Tehle, our CFO.

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

Our earnings release can be found on our website at dollargeneral.com under investor information, press releases.

Let me caution you that today's comments will include forward-looking statements about our expectations, plans, objectives, anticipated financial and operating results and other non-historical matters.

Some examples of forward-looking statements discussed in this call include our 2013 forecasted financial results and anticipated capital expenditures, our planned operating and merchandising initiatives for fiscal 2013, our share repurchase expectations and statements regarding future consumer economic trends.

Important factors that could cause actual results to differ materially from those reflected in our forward-looking statements are included in our earnings release issued this morning; our 2012 10-K, which was filed on March 25; our first quarter 10-Q, which was filed on May 3; and our second quarter 10-Q, which was filed this morning; and in the comments that are made on this call.

We encourage you to read these.

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

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

We will also reference certain financial measures not derived in accordance with GAAP.

Reconciliation to the most comparable GAAP measures are included in this morning's earnings release, which I mentioned is posted on dollargeneral.com.

This information is not a substitute for any GAAP measures and may not be comparable to similarly-titled measures of other companies.

Now it is my pleasure to turn the call over to Rick.

Thank you, Mary Winn.

Good morning, everyone.

This morning we announced our results for the second quarter of fiscal 2013.

I'm pleased to report that our comp store sales accelerated to 5.1% in the quarter.

This was on top of a 5.1% comp in the second quarter last year and a 5.9% comp the year before.

I really want to emphasize that the acceleration of our traffic in the second quarter above our already strong traffic trends.

Both traffic and average ticket have increased for 22 consecutive quarters.

Total sales grew 11.3% to $4.4 billion.

While Consumables showed strongest gains, I was pleased with the overall sales growth across our non-Consumable categories.

Operating profit, excluding certain items increased by 9% to $421 million, or 9.6% percent of sales, which was down just 24 basis points from last year as we managed the impact of lower margin sales growth through strong SG&A leverage.

Our gross profit rate of 31.3% of sales was 65 basis points less than last year's second quarter, with the majority of the rate compression resulting from our very successful launch of tobacco products across the chain.

Tobacco sales contributed nicely to our sales growth and SG&A leverage.

GAAP earnings per share increased 17% to $0.75.

On an adjusted basis earnings per share increased to $0.77, giving us a strong double-digit growth.

We continue to return cash to our shareholders through $200 million of share repurchases in the second quarter.

We had a strong second quarter and remain on track to meet the full-year expectations we shared with you last quarter.

We continued to increase our overall market share of consumables in units and dollars over the 4-week, 12-week, 24-week and 52-week periods.

Our recent share gains according to Nielsen data actually accelerated during the second quarter.

We see this as a clear sign that we are serving our customers' needs and playing an increasingly important role in their shopping routine.

I'll talk more about our operating initiatives in a moment, but now I'd like to turn the call over to David.

Thank you, Rick and good morning everyone.

Rick covered the highlights of our second quarter sales performance, so starting with gross profit I'll share more of the details.

Our gross profit increased 9% for the quarter.

As a percentage of sales, gross profit decreased by 65 basis points to 31.3%.

As expected, the gross margin rate was impacted by a higher consumables mix and lower initial mark-ups, primarily due to the rollout of tobacco and the growth in sales of perishables.

In addition, our inventory shrinkage rate increased, although at a lower rate than in the first quarter.

This margin compression was partially offset by a benefit from transportation efficiencies, lower mark-downs, primarily due to the later timing of apparel mark-downs and a favorable LIFO credit.

SG&A expense was 21.9% of sales in the 2013 period, or 21.8% excluding an $8.5 million legal settlement.

Our SG&A rate improved by 41 basis points excluding certain items as detailed in our press release.

Further improvements driven by our Workforce Management System resulted in strong retail labor expense leverage in the quarter.

In addition, the year-over-year SG&A improvement reflects a decrease in incentive compensation expense, improved leverage on utilities cost and lower Workers Compensation and general liability expenses.

Costs that increased at a higher rate than our increase in sales, include repairs and maintenance, debit card fees and depreciation and amortization.

Interest expense of $21 million represents a $15 million decrease from the 2012 second quarter, the result of our favorable refinancing transactions over the past year.

The second quarter tax rate was a more normalized 37.4% compared to last year's effective tax rate of 34.1%, which reflected a $14.5 million favorable income tax audit resolution.

Please keep in mind that in the second quarter of 2012, we've called out this tax benefit of approximately $0.04 per share.

Excluding this adjustment from last year, our 2013 effective rate was lower than last year's rate due primarily to federal jobs credits which were not in effect in last year's quarter.

On a reported basis, our net income increased 15% to $245 million or $0.75 per share in the 2013 quarter, from $214 million or $0.64 per share in the 2012 quarter.

Excluding the $8.5 million legal settlement, second quarter 2013 earnings per share was $0.77, in line with our internal expectations when we revised full-year earnings guidance in our first-quarter earnings call.

Adjusted earnings per share in the 2012 quarter was $0.69 as reconciled in our press release for that period.

If you additionally subtract the $0.04 benefit resulting from the tax adjustment in the 2012 period, underlying second-quarter 2013 earnings per share increased 18%.

Year to date we generated cash from operations of $484 million, up $111 million from last year.

Capital Expenditures totaled $309 million including $127 million for upgrades, remodels and relocations of existing stores; $66 million related to new lease stores; $52 million for stores we purchased or built; $49 million for distribution and transportation and $12 million for information systems upgrades.

Year to date we have opened 375 new stores, which puts us well ahead of last year's pace.

We have also relocated or remodeled 377 stores and we've made significant progress on our new distribution center in Bethel, Pennsylvania.

We continue to be pleased with our performance of our new relocated and remodeled stores.

As previously announced, we have repurchased $220 million of our common stock this year, including $200 million in the second quarter.

We have approximately $424 million remaining in the existing authorization.

Since the inception of the share repurchase program in December 2011, we have repurchased approximately $1.1 billion or 22.6 million shares of our common stock, and we plan to remain consistent as well as opportunistic in our share repurchases going forward.

Looking at the balance sheet, as of August 2 total inventories were $2.53 billion, up about 11% on a per-store basis.

We made good progress from last quarter's inventory growth of 14%, even as the second quarter includes more impact from our tobacco rollout.

Higher inventory balances over the last couple of quarters have resulted in a modest decline in inventory turns to 4.9 times; however the quality and aging of our inventory continues to be in good shape and we expect the year-over-year inventory growth rate to decrease as we move through the second half of the year.

As of August 2, we had outstanding long-term obligations of $2.87 billion in line with last year's balance, although with much better rates and terms.

We're very pleased with our current capital structure and the flexibility that it affords us.

Now to guidance.

We continue to expect total sales for the year to increase 10% to 11%.

Same-store sales are expected to increase 4% to 5%.

As a reminder, there are six fewer selling days between Thanksgiving and Christmas, which will likely impact our sales to some extent in the fourth quarter.

We're forecasting gross margin contraction for the full year to be approximately 90 basis points.

As you model gross margin performance in the third and fourth quarter, it's important to keep a couple of factors in perspective.

As I mentioned, we had lower mark-downs in the second quarter primarily due to the timing of mark-downs in apparel, given the way the summer weather played out.

Year over year we're forecasting a shift of some of these mark-downs into the third quarter.

The shift in weather gave us the opportunity to be nimble and maximize our sales of full-price apparel items.

Finally last year, we had our best gross margin performance in the fourth quarter and we expect that comparison to be challenging.

Adjusted operating profit for 2013 is expected to be in the range of $1.73 billion to $1.77 billion.

Interest expense is forecasted to be approximately $95 million.

The full year 2013 effective tax rate is expected to be between 37.5% and 38%.

Adjusted earnings per share for the year are expected to be in the range of $3.15 to $3.22.

Our EPS forecast is based on approximately 324 million weighted-average diluted shares, which assumes approximately $600 million of share repurchases for the full year.

Our full-year operating profit and earnings per share guidance are based on adjustments consistent with those detailed in our earnings release for the year-to-date results.

Capital Expenditures are expected to be in the range of $575 million to $625 million.

We now plan to open approximately 650 new stores for the full year.

That's an increase of 15 stores from our previous guidance.

Remodels and relocations are expected to total approximately 550 stores for the year.

In summary, our outlook for the year is solid.

We remain excited about our organic growth opportunities.

We are committed to returning cash to shareholders through share repurchases and building on our proven track record.

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

Thank you, David.

We had a strong second quarter and while it is still early, the third quarter is off to a solid start and I believe we have a great plan for the remainder of the year.

We remain cautious on our consumer and our spending in the second half of the year, as we have been all year.

But as the result of our customer focus initiatives, we are starting the quarter with momentum.

Let's start with tobacco, our single largest undertaking in the second quarter.

We began the tobacco rollout in mid-March, half way through the first quarter, and we exited the second quarter with the rollout of tobacco complete.

This was a tremendous undertaking and I would like to commend the entire Dollar General team for a remarkably successful implementation of tobacco across nearly 10,500 stores in a period of three months.

With the rollout now complete across the chain, coupled with the experience we have in our stores that had been selling tobacco for several months now, we're gaining greater insights into the tobacco category and our customers.

And as I said earlier, we are seeing a significant increase in our traffic, and tobacco has been a key driver.

Our experience so far reinforces my belief that traffic is the most important metric to watch as we measure the overall success of our decision to add tobacco products in our stores.

Our sales and our traffic are continuing to build each week, along with our customers' awareness.

Tobacco sales are consistently running about one-third tobacco only, and the remaining two-thirds are tobacco plus one or more items.

Next during the second quarter we completed Phase 5 of our evolution in merchandising.

The focus of Phase 5 was to optimize productivity in our legacy stores, many of which are less than 7,000 square feet.

We went into these stores, about 3,000 of them, and reset various planograms to better utilize shelf and floor space by adding more productive items and eliminating less productive items, such as hanging apparel in some of the smaller stores.

We are pleased with the sales comp lift from this initiative, as our customers realize we've expanded our product assortments in key categories.

As a result of this project, we've identified additional opportunities for future productivity gains in these legacy stores.

We continue to be pleased with the results of our cooler expansion for perishable items.

Through the second quarter we have added over 7,000 cooler doors, expanding coolers in over 1,600 existing stores.

Most of these stores are now consistent with our new store standard of 16 cooler doors.

Through the second quarter we opened 375 new stores, including 15 Dollar General Markets and 21 Dollar General Plus formats.

We're well ahead where we were last time this year in the number of stores and operating weeks.

Our new stores are continuing to deliver strong performance.

We now have 69 stores in California stretching over 600 miles from north of Sacramento to south of San Bernardino.

As we enter our second year in California, we're continuing to refine our market-entry strategy to better optimize our overall performance.

We are currently utilizing all three of our store formats in California and we are pleased with our sales results.

As David mentioned, our current store development pipeline is robust and we're raising our new store outlook for this year to 650 stores.

We have remodeled or relocated 377 stores so far this year, including 65 Dollar General Plus stores.

The Dollar General Plus format is a great tool for relocations and the expanded refrigerated and frozen food assortment in these stores is driving a higher basket.

We're continuing to learn and test new ideas in our Dollar General Market, particularly in how to best serve our customers in the fresh meat and produce areas.

In many of our market locations, these stores are providing a much needed option for a broader Dollar General shopping trip.

In our ongoing commitment to helping our customers save time and money and our own journey of elevating sales performance, we have continued to update the appearance and layout of our customer-centric store model.

Freshening the look of the store is something I believe all great retailers should do periodically.

This year we have rolled out a new fresh look to further enhance our customer shopping experience.

We've implemented the new format in more than 550 stores, including new stores, relocations and remodels.

The updated 2013 design has new in-store signage and branding with a refreshed look that leverages our yellow and black color scheme, reconfigured sections such as apparel and seasonal and yet again improved category adjacencies in these stores.

We believe this well-designed format really makes sense and is proving to resonate with our customers.

To date we're excited about the comp sales lift in our remodels and relocations, and we're hearing great feedback from our customers on the new layout and fresh look.

At the end of the second quarter, we had 10,866 stores in 40 states, well on our way to reaching our 11,000 store milestone in October.

And the good news is that we continue to see significant exciting opportunities for organic growth.

Our customers are depending on our convenience and every-day low prices more than ever.

We're focused on meeting their needs with the right merchandise selections at the right prices throughout the entire store.

We're continually expanding our footprint and improving our operations and believe we have a long runway for continued success in both existing and new markets.

Before I open for questions, I want to thank our employees from coast to coast serving our customers and representing the Dollar General brand in our communities every day.

Now Mary Winn, I'll open it up for questions.

All right, Brandy, we'll start out with our first question please.

Matthew Boss, JPMorgan.

Can you speak to the monthly progression and drivers of the traffic acceleration that you spoke to?

And also give us a little bit more color on August, both total sales and some of the discretionary versus consumables.

It sounds like you mentioned it was off to a pretty good start.

Yes, the quarter two, the sales accelerated as we moved through the quarter.

The really encouraging thing was not only did sales accelerate, but unit growth and market share growth accelerated as we moved through the quarter also, which is how we called it and how we anticipated it as we moved through the balance of the year.

In regard to August, I don't want to really get into where we are in the third quarter, other than to really say that we feel pretty comfortable with where we are and where we're heading.

Wow, that's great.

Secondly, can you speak to the rationale behind raising the new store growth target for this year, what you're seeing from some of your younger stores?

And then how we should think about the growth profile ahead, any changes to your thinking?

Yes, actually I think, as I look at the fact that we've raised the number of new stores is driven primarily by robustness of the store pipeline right now.

As you guys remember, last year we got a little bit behind on it and we had to work our way through it.

So we feel pretty good where we're going this year.

Great, thanks.

I should also throw out too, as I sit here and think about the question, we're getting the stores open earlier this year, which I think is helping.

Okay, operator, we'll move on to the next question.

Scott Mushkin, Wolfe Research.

This is actually Brian Cullinane on for Scott.

Thanks for taking our questions.

You highlighted, you showed your comps were accelerated and you highlighted you're gaining share.

Who do you guys think that that share is coming from?

When I look at Nielsen share data it coming from drug first, grocery second and mass third.

And I think the other, Brian, wonderful thing about our format is we compete in that great big world of consumable retailing, which is well over $800 billion.

So we're able to go in and take a little bit from a lot of different spots, and we're one of those guys you don't really feel.

Sure, that's great color, thanks.

And then the second question, saw some good share repurchase activity.

Can you just maybe going forward, prioritize your uses of cash from where you stand now?

Yes, absolutely.

It really hasn't changed from what we've articulated previously.

Our number one priority for cash is investing in the business, as evidenced by adding to the store count for this year.

We're going to open new stores, we're going to do remodels, we're going to do relocations.

And then we're going to make sure we have the infrastructure in the business to support the stores, because that's our number one priority and we think that's the best return for our shareholders.

Then with the cash that's left over, we'll buy back stock with that, as evidenced by the stock buyback you saw in the quarter, the $200 million buyback which we did at $51.28.

So obviously we got in there opportunistically and we were able to get a nice slug of stock bought back.

Those are our priorities for cash.

That's great.

Thanks for taking the questions.

Operator, we'll move to the next question please.

Stephen Grambling, Goldman Sachs.

Just a follow-up on the last one.

Any sense for what you think the appropriate leverage point is in the business?

Yes, right now and again we've mentioned this before, we believe it's best for us to be investment grade, which implies a debt to EBITDAR of about 3.0.

If you look at our statistics over the past several quarters, that's where we've been and that's where we ended up in Q2.

That's the general leverage point that we're aiming for.

And would you be averse to taking on additional debt as you continue to generate excess cash if it comes in above your plan or even within your plan?

Well certainly, if we need to take on additional debt to stay at the 3.0, we would definitely consider doing that, yes.

Okay.

And one more fundamental question which is, when you think about the traffic that's being driven by tobacco, do you have any sense for if that's a new customer versus the existing customer taking additional trip?

Yes, I think it's actually a combination of both.

We don't have a card so it's really kind of hard to go in and measure, Stephen, what's going on.

But our belief is that the customer that's coming in that's primarily buying just tobacco is probably the newer customer.

Okay, great, thanks.

Best of luck.

Operator, we'll move to the next question please.

Edward Kelly, Credit Suisse.

Nice quarter.

I just wanted to follow-up actually first on the last question, on the leverage ratio and the appropriate level of business.

Can you remind us why you think investment grade is so important?

You've obviously operated it at levels below that historically.

Yes, well I think we demonstrated that in the last refinancing that we did, in terms of the interest rates that we were able to get on the debt.

And you heard in my opening comments how much lower interest is this year than what it was last year.

It's really adding to our overall bottom line, so it gives us access to the credit markets in a way that I think is very flexible and healthy for the Company.

It also helps us with our vendors and on the real estate front, being investment grade, in terms of the types of deals that we're able to do.

We take a hard look at this several times a year and discuss it, Rick and I discuss it with the Board.

Clearly we feel like right now that's the best place for us to be.

Okay.

And Rick, a bigger picture question for you, strategically.

I was hoping you could give us your updated view on organic growth versus growing via acquisition.

You've obviously favored organic growth historically.

Why is that?

What would change that going forward?

This doesn't necessarily apply to large deals, because there's smaller guys out there too, that potentially could make sense.

I'm curious as to what your thoughts are there.

It's a really good question, Ed.

We still have over 10,000 opportunities out there in the marketplace today, in the United States today, for Dollar stores.

We have a very proven format that generates the best returns in retail that I have ever seen in my career.

It's much easier to manage that than it is to try and manage an acquisition.

My love of organic growth is the fact that when you go into a new market, you understand the market, but more importantly you understand the player set that's going to launch that for you.

I've always been a lover of organic growth.

Great, thank you.

All right, Operator, we'll move to the next question.

please.

Deborah Weinswig, Citigroup.

Good morning and congratulations.

Thank you.

Sticking on the new-store pipeline, can you talk about what 2014 looks like?

Based on raising your new store activity for this year, does the competitive landscape look any different in terms of who's looking at new stores and what the markets look like?

Yes, our 2014 pipeline is actually ahead of schedule, exactly like 2013.

This is the second year in a row where we'll be able to be in a much stronger position as we enter into the new year.

David and I like that 6% to 7% square footage growth.

It's more, Deb, about organizational capacity than it is anything else.

This Company got itself in trouble several years ago about opening too many stores too fast.

We would rather open a handful of stores that perform well and drive a great return than get ourselves out there and over-extend ourselves.

Okay.

Another question on this topic, are you utilizing a different team?

Are you utilizing better technology?

Is there anything differently that you're doing in terms of getting sites?

No, actually everything is exactly what it has been.

We're just doing a better job of getting ahead of the pipeline curve.

Quite honestly it's like everything else we do at Dollar General, I'm surrounded by a team that continually improves on the processes that had been established over the years.

Great.

Then in terms of the beat this quarter not rolling that, in terms of raising guidance for the year, can we just dig into that a little bit deeper?

Yes, in terms of our -- we generally don't talk about our internal estimates, but actually the quarter came in pretty much as we expected it in our internal guidance that we had given last quarter.

From our perspective, it wasn't really a beat-it, we performed how we thought we would perform.

So there really isn't anything to increase for the rest of the year, as we came out.

Now we did tweak some of our assumptions on interest and tax rate and share count and things of that nature.

In looking forward, given the uncertainty in the macroeconomic environment, we're trying to make sure we're prudent in the things we're doing above the line.

Again, we're pleased with where we are and we're pleased that, again, we're pretty much on where we said we would be when we updated our guidance last quarter.

One last quick one.

Rick, when you look into the market share gains by category, is there anything there that's surprising to you?

Actually, no there's not, Deb.

What's interesting to me, what has surprised me, it's relatively even across most of the categories.

It was interesting, I was talking to Mary Winn yesterday, and it was one of those quarters in which the boat was rising on all of the sides.

Everything is -- it reminds me very much again of 2008 and 2009 where everything is starting to rise evenly.

Great well thanks so much and congratulations.

Thanks, Deb.

Thanks, Deb.

Operator, we'll move on to the next question please.

Charles Grom, Sterne, Agee.

Great quarter.

A few things, David, for us on remodeling.

First would be, can you quantify the list of sales from tobacco?

What do you think the incentive comps accrual reversal was in the quarter?

And then could you quantify the mark-down shift between the second and third quarter for us?

Yes, I don't think we're going to give granular quantification on those, Chuck.

Obviously, the tobacco had a meaningful impact on the quarter overall in terms of what the performance was on the comp sales and particularly in driving traffic into the stores.

It's more than what we've seen in beer and wine overall, which is very positive for us.

Again on the expense side, it was meaningful enough that we wanted to spell out the incentive comp overall but again, not going to give specifics on that or the mark-down.

Except on the mark-down I will say, again for modeling purposes, the reason we bring that up is that is something that was a benefit to second quarter that's going to hit third quarter.

We want to make sure everybody is aware of that as they start putting their third-quarter models together.

Chuck, I'd say one thing on the tobacco that we are really focused on here in the Company.

It is not about the comp sales it's driving, it's about the transactions it's driving.

What we are totally focused on is how we can take that tobacco purchase and lever it up with incremental items when that transaction takes place in the store.

Makes sense.

It's impressive that you roll out tobacco and you see the shrink rate improve.

Can you kind of flesh that out for us?

Yes, I think that the rate of decline of shrinkage is what has improved, Chuck.

I will tell you in regards to shrink, we've installed a lot of defensive merchandising over the course of the last six, seven, eight months, and had a chance to go in and re-inventory those stores.

And while it's still soon, we're very pleased with what we're seeing with the defensive merchandising that's been put in place.

Okay, great.

My last question, just to follow-up on a previous one, when you think about capital allocation versus store growth and you talk about the 6% to 7% square footage growth number that you want to keep.

As the law of large numbers starts to catch up with you, do you think the next three to four years we continue to see 6% to 7% store growth?

Or does organization capacity make you want to think, maybe ratchet that back a little bit and increase the buybacks?

How do you think about the whole pie?

Yes, I think again, you're raising a great question.

We're very comfortable right now at this stage of the game at 6% to 7%.

But again, I want to come back to how I answered the question previously.

We want to open stores that are productive out of the chute and generating a return.

We would rather open stores that are complete, that the customer has an experience when they come in, rather than just come in and look at you all and say -- hey, open a bunch of stores.

Right.

That was the problem back in -- I'm sorry.

(multiple speakers)

I'd say go back to Rick's comment on the continuous improvement we've seen in the real estate area, which helps us, again, to reach that 6% to 7% the way real estate is performing.

Right.

You guys basically track new store productivity and store manager turnover to make sure you don't outgrow, which was the problem 10 years ago?

That's exactly right.

And we, Chuck, actually look at new store growth productivity every week.

Okay, great quarter, thanks.

All right, Operator, we'll move on to the next question please.

Paul Trussel, Deutsche Bank.

It's actually Matt for Paul.

Okay, Matt.

Great quarter.

Had a question, in terms of the competitive environment we've seen some of the mass guys put up disappointing results lately.

Wondering if you saw any kind of change in rhetoric or anything in the marketplace throughout the prior quarter and thus far into this one?

Yes, I look back on quarter two much like quarter one and look at it and would tell you that the share of voice is obviously up.

There's no doubt there's more print advertising out there, more pages of print even within the usual weekly vehicles.

However, it's fair to say that the price competition is not any more intense in quarter two than quarter three.

Okay, great, thanks.

Perfect, Operator, we'll go onto the next question please.

Scott Ciccarelli, RBC Capital Markets.

If you look at the two-year stack comps on the discretionary front, at least the way we calculate it, it looks like Seasonal and Home were basically flat year-over-year versus the first quarter, but Apparel improved pretty nicely.

Then you mentioned there's some mark-downs particularly in apparel that we need to think about for the third quarter.

Can you guys provide us a little bit more color on the discretionary front and specifically on the apparel?

And what your expectations are for those categories going forward?

I, quite frankly, was pleased with what happened on the discretionary side of the ledger in the second quarter.

Quite honestly, very proud of the team on the Apparel side.

I think it definitely too early to declare a victory.

I think that in all honesty, we still need a little bit of help with the economy.

I think it's fair to also say that our consumer is still a little hesitant out there.

But I think as we move through the third quarter, we anticipate the trends will not change significantly.

Got it.

Okay and then a clarification.

Did you say all the gross margin decline in the second quarter was from tobacco?

No, actually what David said was the bulk of it was, but not all of it.

Got it, okay.

It's tobacco, it's mix and it's shrink -- were probably the three biggest negatives.

Okay, got it.

Thanks a lot.

Operator, let's move on to the next question please.

John Heinbockel, Guggenheim Securities.

Let me ask you, DG Market and DG Plus, when do you think, if ever, you begin a more aggressive rollout?

And I guess it would be Plus.

And then is there merit to, as you learn from DG Market, taking top 20 produce items, top five or ten meat items and migrating those into DG Plus?

Yes, I think the -- if I were to look at you and tell you right now, over the course of the last year we've made more progress on the DG Plus side.

I think that particularly as a remodel or a relocation vehicle, and remodel meaning we can knock into a wall next to us, John.

What we're really excited about on the Dollar General Plus is the change in the basket size.

It comes back to the wider aisles, the shopability of the stores.

When you start with a re-lo or a remodel, you start with a significantly higher base, which gets you moving in the right direction faster.

The Dollar General Market, the team is doing, I think, a great job of really understanding produce sales and meat sales, which I think -- by the way, those are living things that we have not had to deal with before.

I've got Todd and Greg Sparks here who are helping to manage the team through that.

Again, I think it's a little soon to declare a victory there.

I do think we are moving in the right direction on the Plus side.

Your comment on perhaps making taking the top 20 produce items and eventually getting those into the regular Dollar General, that is something we're talking about.

Whether or not that will ever happen or not, it's still too soon to tell.

Oranges and apples and potatoes, things like that, grab and go stuff that a consumer forgets on the way home, could play out down the road.

So along those lines what's the biggest challenge to doing that?

Is supply chain being able to do that, to keep it fresh?

Or is it something else?

And secondly, where would you get the space for that?

Yes, actually you nailed it, the supply chain is the issue.

Not only that, on that kind of an item we have to introduce a middle man because we don't warehouse our own produce and meat.

Then you run the risk of having an item that's a little bit higher and depletes your -- your customer doesn't understand that it's coming from somewhere else.

It depletes your price image.

In regards to, what you should remember if you were ever to do this, it wouldn't be like there would be a whole aisle of produce or an end cap of produce.

It would be a very small manageable display.

All right.

Then lastly, you mentioned shrink.

I know that dovetails very close with turnover.

So where is turnover today?

And then do you think turnover will be in a good enough position where shrink actually comes down next year?

Yes, I'm actually -- the team, John, has done a good job with turnover over the last two and a half years.

I have to tell you, our turnover is in essence flat to last year.

We're having -- our best year was 2012, by the way, and to be flat against 2012 I think is a pretty good mark.

And I do agree that turnover is a big component of shrink.

I think that we're working really hard on the turnover and I think the shrink numbers are starting to move our way again.

Okay, thank you.

All right, Brandy, let's move on to the next series of questions.

Dan Wewer, Raymond James.

Incidentally, we totally agree, totally support your view to use your capital for organic growth rather than acquisitions.

(laughter) All right.

Wanted to ask about inventory productivity, regardless of how you measure that, based on GMROI or the amount of gross profits generated from a dollar of inventory.

It peaked last year and again to weaken as the Company began to add 11% to 15% more inventory per store.

Is this a signal that your buyers did it right?

That the first $210,000 of inventory they bought for our store was the most profitable?

And that the incremental $20,000 they've added this year is profitable but not as productive as that initial $210,000 investment?

Yes, actually I think that's a pretty accurate assessment, to be honest about it.

I think it really tells you the power of category management.

The team came in here several years ago, rationalized the SKU base, got the SKU base right.

As we continue to broaden our appeal it means we need to add selective other SKUs.

And I think quite frankly, we got a little over-zealous in quarter one.

What we're doing now is we're spending a lot of time -- the product, by the way, why I'd say we got a little over-zealous, there's nothing wrong with the product that's in the store base.

The decision we've made is we're going to go in and reevaluate it and over a period of time, take some of those SKUs that you were talking about that weren't quite as productive and work them back out of the system.

And then, as a follow-up, this was about probably three or four quarters ago when the tobacco discussion began, the Company was estimating every one percentage of comp sales growth from tobacco would negatively impact gross margin rates by about 20 basis points.

It looks like the algebra has changed based on the comp lift you're getting in tobacco and what's happened with gross margin rates.

Yes, I don't recall giving you that.

If I did, I did.

I would look at you and tell you that the tobacco, the tag-along purchases with tobacco are a little better than we thought they were going to be.

How's that?

I don't know if that helps or not, Dan.

The 65% of the customers that are buying something else has turned out to be higher than what you were expecting?

Exactly.

Yes, okay, great thanks.

All right, Brandy, let's move on to the next please.

David Mann, Johnson Rice.

Nice job on the quarter.

I was curious, elaborating on the comment you just made about some of the SKUs that you added.

I know last quarter you talked a lot about the gross margin hit, when the mix between national brands and private brands got a little bit out of kilter.

I'm curious, were you able to re-pivot into this quarter such that it didn't even become a comment?

Is that -- (multiple speakers)

I'm sorry, Dan.

Actually, Dan, our private brand penetration is actually back up, moving north again.

That would tell you that we're doing a better job of managing the mix.

Okay, great.

And then in terms of tobacco, I know in the past you've given us what that average ticket might be.

Can you update on that?

Also I don't know if you specifically talked about what the shrink experience is and tobacco is relative to what you expected.

If you could comment there as well.

Yes, it's really too soon, Dan, on the shrink, right?

We'll have to cycle a whole year of tobacco.

Right now I will tell you that the supply chain system that keeps track of the tobacco, how it flows from the supplier to the point where it gets stocked on the shelf, is working quite nicely.

We've had a couple issues and been able to identify them immediately.

In regards to cigarettes, our average basket is approximately $10.77, and when cigarettes are in there that basket goes up to almost $13.75.

Okay.

David, one other question.

On the buyback, I think the math would suggest that you might be in the market for up to $400 million for the rest of the year.

I'm just curious, when you made that $200 million purchase it seemed like you didn't buy any more in the rest of the quarter.

Any comment you can make about that?

Yes, quite simply we wanted to keep our debt to EBITDAR at 3.0 and that's exactly where we came in.

Again, we're managing that ratio because of our investment-grade status.

Okay, thank you.

All right, Operator, we'll move on to the next question please.

John Zolidis, Buckingham Research.

A lot of questions on tobacco.

I have one question which may sound a little bit counter-intuitive, but is there any sense at which having tobacco in the stores is causing customers to substitute their spend to tobacco from something else?

Is there any evidence of that occurring?

That's actually, John, a very, very good question.

I would look at you, there's no way I can tell that.

But what I can tell you is that our customer index is at about 135% on cigarettes.

So, John, they are buying those cigarettes somewhere else.

Okay.

On a different topic on the new stores, can you talk a little bit about the real estate prices for new stores?

Are you seeing a lot of pressure?

Is there any change or any intentional change in the quality of the locations you're going into with the new stores?

Yes, the real estate strategy in regards to locations, everything I would call it status quo, over the last couple of years.

There's been no major uptick in commercial real estate at all that we have seen.

We've still committed to the site selection process that we've always had.

We don't put it on the corner of Main and Main.

We're very happy with a C plus, D plus site.

So the biggest call-out with regard to new stores over the last couple years is probably California entry and expanded DG Market, DG Pluses?

That's fair.

Okay, thanks a lot.

Good luck.

All right, next question please.

Patrick McKeever, MKM Partners.

A question on your urban market stores.

Now that you have more exposure to urban markets, having grown in urban markets more aggressively over the past several years, did you see any notable performance differential between urban and more rural stores during the quarter?

To be honest with you, no.

They tend, the urban stores, tend to have a higher sales volume and a little bit higher cost of operation.

At the end of the day they net-net out to about the same.

But is there any sense that the urban store performance is improving?

Also what about tobacco sales in urban markets?

Is it higher than rural markets or is that netting out as well to be pretty neutral?

Yes, I've got to tell you it's pretty much neutral.

I don't see any particularly bigger things in the metro stores, the urban stores versus the rural.

Okay, then another quick one on tobacco.

To go back to what David was saying, so tobacco, the comp lift is more than beer and wine.

And I think you said in the past that beer and wine had about 100 basis point positive impact; is that correct?

That's correct, sir.

But somewhere north of 100 basis points then?

That's correct, sir.

The tobacco impact?

Okay, got it.

Very good.

Thanks very much.

We'll move on to the next question please?

Trish Dill, Wells Fargo Securities.

Congratulations on a really solid quarter.

A question on your Phase 5 initiative.

Wondering if the comp lift that you're seeing in legacy stores is greater or less than the hundred basis-point lift you've previously disclosed.

And then if you could elaborate on the additional opportunities that you mentioned you've identified for productivity gains in those stores.

Thanks.

Yes, I apologize, Trish.

Number one, the comp lift is actually a little bit greater than we thought it was.

You've got to remember we're very new into the cycle here.

As the customer realizes you have the expanded selection in core categories, we anticipate the comp lift will continue to move up as we move through the year.

In regards to the additional opportunities, it's more stepping back and going -- oh, my gosh, these categories did so well, now we need to go in and look at these other categories within the same legacy stores.

We're going to begin to tweak them again as we move through the year.

We think what we're doing actually has ramifications that maybe perhaps we can run a smaller box store, which will put us, if you think in the urban environment, put us in a little bit better position.

Okay, great.

One more quick one on whether or not you're seeing any food price deflation, and how we should think about that as a potential headwind to comps in the back half of the year.

Yes, that is actually another good question.

We are seeing food deflation at this time.

You have to remember that we have a smaller depth in our categories, while we have breadth.

We anticipate the deflationary pressure to continue as we move through the year.

All right.

Trish, that helped?

Great, thanks.

We'll move on to the next question please.

Joe Feldman, Telsey Advisory Group.

Congratulations on the quarter.

Thank you.

Wanted to ask, go back to the health of the consumer a little bit and drill down a little more there.

Is there anything you guys have seen lately, any changes with the paycheck cycle or volatility in the week-to-week trend?

As you look at the consumables business even, what people are buying?

Is it a little more branded versus the private label?

Anything that would give you any inkling to the health of the consumer there?

Yes, my view on the consumer is no different than what it was, Joe, at the beginning of the year.

I think our core customer has never come out of the recession.

I think our core customers continued to manage their way through for years, multiple points where money is a little tight.

I mean the average consumer out there who makes $50,000 a year has $1000 a year in spendable income now, due to the changes that have taken place in the payroll tax.

Albeit I say all that, I think the beauty of our model is we continue to focus on transactions and units.

Our customer is responding to the value proposition that we have.

As long as transactions and units are moving north, we believe we're satisfying their needs.

It is going to be an interesting back half and I think that we're keeping our eye on the consumer and what they're buying.

Got you.

That sort of leads into the next question we had, which was as you do think about the back half, and I know you don't like to give quarterly guidance per se, but how should we think about the cadence?

There's been a lot of debate about whether sales have actually slowed, or are going to slow, for this back-to-school period and into the holiday.

How are you guys thinking about the back half?

We've got our guidance between 4% to 5%, as we will through the total year, which would indicate that comps will accelerate as we move through the year.

Perfect.

That's helpful.

Thanks very much, guys.

Good luck with this quarter.

All right, Operator, we'll move to the next question.

Mark Montagna, Avondale partners.

Question.

I have read recently that government data is showing that commodity inputs for food are up 10%.

Wondering if you think that's accurate, and if so when does that type of thing flow into retail prices for food?

Yes, I think when you look at that, Mark, I think that would probably be focused on meat and produce and more dairy-type items.

My view of how soon it flows in depends on how much pressure a retailer is under in regards to their margin.

We certainly hadn't seen anything of that magnitude here yet, but I would think that's more on the food perishable side of the business.

Okay.

It sounds like the Phase 5 planograms are done for this year.

I thought the goal for this year was 2000 stores.

But then, Rick, in your prepared remarks you mentioned 3000.

Wondering how many you did and is the whole chain complete now or is there more to come?

We got 3000 done.

We originally thought it was going to be -- yes, we got 3000 done.

Mark, that was always our goal.

We had completed about 2,800 after Q1 and then we wrapped that up in Q2.

Okay, and do you plan more phase V for next year?

Next year.

Actually what we want to do now is go back into the 3000 stores which we called out and refine additional categories within that 3000, the ones we've done.

Okay, but looking out to next year, will there be another group that is Phase 5?

And the answer is probably so.

Okay, all right, that was all I had, thanks.

All right.

We're trying to get everybody in that we possibly can, so next question please.

Dutch Fox, FBR Capital Markets.

So just a quick question, and not to beat to death tobacco, but when you see those two-thirds of baskets that are buying tobacco and some other item, is that typically a discretionary item or is it more of a consumable item?

In other words, you had a very good discretionary quarter in 2Q.

How much of that do you think was driven by tobacco?

Do you think that's sustainable going forward as tobacco continues to ramp up?

I think, Dutch, that cigarette purchase tends to gravitate towards the consumable side of the ledger, particularly when you have one or two items going out the door with the cigarettes, it tends to be soda or a Gatorade or a chip.

I think the health of the -- I think it is fair to say one could make the leap, and I can't prove this, that the incremental traffic might be helping the non-consumable side.

I don't think there's any kind of a connection between cigarettes and non-consumables.

So it's fair to say the improvement we saw in discretionary categories in 2Q, that was largely the result of stand-alone initiatives within your efforts towards discretionary, not necessarily just driven by tobacco?

That's correct.

I think that the improvement in the discretionary side is driven by good old-fashioned category management.

That's great to hear.

Good, thank you.

Operator, the next question please.

Denise Chai, with Bank of America.

Congratulations on the quarter.

Wanted to get a little bit more color what you're seeing with cooler items.

Could you talk a bit about trip frequency and also baskets when people are buying cooler items?

And also you're approaching 70% penetration of your stores, where do you think that can go?

70% penetration on coolers?

Yes, you said you've got over 7,000 stores with coolers?

We actually installed coolers in over 7,000 stores, so we still have more cooler upside there.

I will say this, Denise, the perishable side of the business, the frozen food refrigerated is insatiable.

It seems like the more we put in the better we do.

The basket, I'm sitting here trying to think on the basket.

There's no doubt the basket goes up.

I can not remember, Mary Winn, off the top of my head, how much it goes up.

What I'll do, Denise, I'll have Mary Winn call you and give you that number.

But we do see a bump in the basket when frozen food's in there.

It's more a complete shop than the $10.70 shop.

All right, got it, thanks.

Just one more question.

You used to talk about having, say, a 1.5% to 2% embedded comp lift from remodels in your various optimization initiatives.

Could you perhaps update that and let us know how much of that is already cycled?

That's really new stores, remodels and relocations altogether that figure in.

That's still reasonably accurate overall.

Great.

Thank you.

All right, I think, Operator, we'll take our last question now please.

Meredith Adler, Barclays.

We were having some technology problems, which is why I'm so far at the end here.

So a question that hasn't come up yet is, what do you think happens when SNAP benefits get reduced?

I know it's not a huge piece of your revenues, but clearly it takes money out of the pocket of the lower-income customer and could have some impact on, presumably, sales of discretionary rather than sales of consumables.

But I was wondering if you have any thoughts about that?

Yes, I think one of the interesting things that I've observed since I've been here is our percentage of sales that are on SNAP run about 5% to 6%.

In spite of the fact that the government has increased the amount of SNAP benefits that are out there, we've still run at 5% to 6%.

It's my belief right now, Meredith, that which we've said before, our customer spends the bulk of their wallet somewhere else before they come to me.

That somewhere else is going to be where the impact is if there's a pullback in SNAP.

At least that's my view.

But your point is also very well taken in that the impact will probably not come on the consumable side.

It would come on the non-consumable side.

That would be my bet is where we would all feel it.

Do you think that those discretionary sales are being done at the retailers that redeem the most SNAP benefits or is it spread out?

My belief is you have to remember we're the fill-in shop.

We're the place you go when you forgot your T-shirts or you forgot your socks.

We're not the fashion-forward carry place.

We're the place you go to when you forgot a couple Christmas decorations or you didn't get all the Christmas lights you need.

So my belief would be the impact would probably be felt probably where you go for the initial sale to begin with.

Okay, and then I'm sorry to keep the call going on, I just have one more question.

That's all right.

When we think about -- I know you've said your real estate strategy really hasn't changed at all.

But I think there was a goal of the Company to move into more middle-income areas to the extent that you could, or to be able to have more transitional areas where you served customers of multiple income levels.

Is that true and have you had success in terms of, to the extent you know, attracting customers from a more middle-income area?

I think there is -- it's fair to say that we have elevated the quality of the sites that we've chosen, which will tell you we're getting a little closer to the middle-income strata that you're talking about, Meredith.

I would tell you that the appeal of the box in those particular areas where we've chosen to do that, is as strong as when we go into the lower-income areas.

That's great.

Does that increase the potential of stores that you could open?

Someone could certainly make that leap, yes.

Okay, that's cool.

Thank you and congratulations on a fantastic quarter.

Thanks Meredith.

Operator, that wraps up our call from our end.

Everyone on the call, thank you very much for your time and attention.

I'm around all day if anyone needs anything and I look forward to seeing you later.

Thank you for your interest in Dollar General.

This concludes today's conference call.

You may now disconnect.