達樂 (DG) 2019 Q3 法說會逐字稿

Good morning.

My name is Thea, and I will be the conference operator today.

At this time, I would like to welcome everyone to the Dollar General Third Quarter 2019 Earnings Conference Call.

Today is Thursday, December 5, 2019.

(Operator Instructions) This call is being recorded.

Instructions for listening to the replay of the call are available in the company's earnings press release issued this morning.

Now I would like to turn the conference over to Mr. Donny Lau, Vice President of Investor Relations and Corporate Strategy.

Mr. Lau, you may begin your conference, sir.

Thank you, Thea, and good morning, everyone.

On the call with me today are Todd Vasos, our CEO; and John Garratt, our CFO.

And our earnings release issued today can be found on our website at investor.dollargeneral.com under News & Events.

Let me caution you that today's comments include forward-looking statements defined in the Private Securities Litigation Reform Act of 1995, such as statements about our strategy, plans, initiatives, goals, financial guidance or beliefs about future matters.

These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.

These factors include, but are not limited to, those identified in our earnings release issued this morning under risk factors in our 2018 Form 10-K filed on March 22, 2019, and in the comments that are made on this call.

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 unless required by law.

We also will reference certain non-GAAP financial measures.

Reconciliations to the most comparable GAAP measures are included in this morning's earnings release, which, as I mentioned, is posted on investor.dollargeneral.com under News & Events.

At the end of our prepared remarks, we will open the call up for your questions.

(Operator Instructions)

Now it's my pleasure to turn the call over to Todd.

Thank you, Donny, and welcome to everyone joining our call.

We are pleased with our third quarter results, including same-store sales growth of 4.6% and strong performance across the business.

The quarter was highlighted by our best customer traffic and same-store sales increases in nearly 5 years as well as double-digit growth in both operating profit and diluted EPS.

As a result of our performance through Q3 and outlook for Q4, we are raising our full year guidance for 2019.

John will provide these details during his remarks.

In short, we are executing well against both our operating and strategic priorities, and we're confident in our plans to drive continued growth.

On that note, I'm excited to share an update on some of these plans, which we believe will further differentiate Dollar General from the rest of the discount retail landscape.

First, as you saw in our release, we plan to accelerate our pace of new store openings and remodels in 2020.

In total, we expect to execute nearly 2,600 real estate projects next year, which represents an increase of more than 20% over 2019 as we continue to strengthen the foundation for future growth.

In addition, given the sustained and positive performance of our nonconsumable initiative, or NCI, we plan to expand the offering to an additional 2,600 stores next year, bringing the total number of NCI stores to approximately 5,000 by the end of 2020, more than double the current store count.

Finally, we now plan to begin shipping out of our fifth DG Fresh facility by as early as fiscal year-end 2019.

I will discuss each of these updates in more detail later in the call.

But first, let's recap some of the top line results for the quarter.

Net sales increased 8.9% to $7 billion compared to net sales of $6.4 billion in the third quarter of 2018.

We are particularly pleased with the balanced nature of our sales performance this quarter, once again driven by meaningful contributions across many fronts, including sustained positive sales momentum across our new stores and mature store base, strong same-store sales growth in both our consumable and nonconsumable product categories and another quarter of solid growth in average basket size and customer traffic.

Once again, this quarter, we increased our market share in highly consumable product sales as measured by syndicated data with mid- to high single-digit growth in both units and dollars over the 4, 12, 24 and 52-week periods ending November 2, 2019.

Notably, our market share gains increased at an accelerated rate throughout these periods, which we believe speaks to the underlying strength and continued momentum of the business.

Our third quarter results further validate our belief that the actions we've taken and the investments we've made are further enabling sustainable long-term growth while continuing to deliver value and convenience for our customers.

We continue to believe we operate in one of the most attractive sectors in retail.

And with the plans and initiatives we have in place, we are well positioned to drive continued growth in the years ahead.

With that, I'll now turn the call over to John.

Thank you, Todd, and good morning, everyone.

Now that Todd has taken you through a few highlights of the third quarter, let me take you through some of its important financial details.

Unless I specifically note otherwise, all comparisons are year-over-year and all references to EPS refer to diluted earnings per share.

As Todd already discussed sales, I will start with gross profit.

Gross profit as a percentage of sales was 29.5% in the third quarter, an increase of 1 basis point.

This increase was primarily attributable to higher initial markups on inventory purchases, a reduction in markdowns as a percentage of sales and a lower LIFO provision.

Partially offsetting these items were: increased transportation and distribution costs; higher shrink, a greater proportion of sales coming from the consumables category; and sales of lower-margin products comprising a higher proportion of sales within the consumables category.

SG&A as a percent of sales was 22.5% or a decrease of 13 basis points.

The decrease was driven by a year-over-year reduction in hurricane-related expenses, a reduction in expenses for store supplies and lower retail labor costs as a percentage of sales.

These items were partially offset by an increase in utilities costs.

As previously discussed, we are investing in our 4 strategic initiatives this year.

We are pleased with the continued progress on each and remain excited about the long-term transformative potential of these initiatives.

Year-to-date through the third quarter, we have invested $33 million in SG&A expense attributable to our strategic initiatives.

We continue to believe these investments position us well to deliver meaningful benefits to the business over both the intermediate and longer term.

Moving down the income statement.

Operating profit for the third quarter increased 11.1% to $491 million compared to $442 million in the third quarter of 2018.

As a percentage of sales, operating profit was 7%, an increase of 14 basis points, which represents operating margin expansion even as we continue to invest for the long term.

Our effective tax rate for the quarter was 21.7% and compares to a rate of 20% in the third quarter last year.

Finally, EPS for the third quarter increased 12.7% to $1.42.

Overall, we are pleased with the balanced performance the team delivered during the quarter, once again resulting in strong sales and profit growth.

Turning now to our balance sheet, which remains strong, merchandise inventories were $4.5 billion at the end of the third quarter, an increase of 13% overall and up 6.9% on a per-store basis.

We continue to believe the quality of our inventory is in great shape and remain focused over time on driving inventory growth that is in line with or below our total sales growth.

Year-to-date through the third quarter, we generated significant cash flow from operations totaling $1.7 billion, an increase of 9.7%.

Total capital expenditures through the first 3 quarters of 2019 were $518 million and included our planned investments in new stores, remodels and relocations; continued investments in construction of our Amsterdam, New York distribution center; and spending related to the strategic initiatives.

During the quarter, we repurchased 2.5 million shares of our common stock for $400 million and paid a quarterly dividend of $0.32 per common share outstanding at a total cost of $82 million.

With today's announcement of an incremental share repurchase authorization, we have remaining authorization of $1.6 billion under the repurchase program.

Our capital allocation priorities continue to serve us well and remain unchanged.

Our first priority is investing in high-return growth opportunities, including new store expansion and infrastructure to support future growth.

We also remain committed to returning significant cash to shareholders through anticipated share repurchases and quarterly dividend payments, all while maintaining our current investment-grade credit rating and managing to a leverage ratio of approximately 3x adjusted debt-to-EBITDA.

Moving to an update on our annual guidance for fiscal 2019.

As Todd mentioned, we are raising our full year guidance, primarily due to our strong operating performance through the first 3 quarters and expectations for the remainder of the year.

For fiscal 2019, we now expect net sales growth in the low 8% range and same-store sales growth in the mid- to high 3% range.

We are increasing our expectations for operating profit growth to approximately 6% to 8% and expect adjusted operating profit growth of approximately 7% to 9%.

And we are raising our outlook for EPS to the range of $6.46 to $6.56 or adjusted EPS of $6.55 to $6.65, which translates to a range of approximately 10% to 11% growth on an adjusted basis.

Our adjusted operating profit growth and adjusted EPS guidance exclude the $31 million pretax impact related to significant legal expenses that were recorded in the second quarter.

Both our GAAP and adjusted EPS guidance assume an estimated effective tax rate within the range of approximately 22% to 22.5%.

In terms of share repurchases, we now plan to repurchase approximately $1.2 billion of our common stock this year, which represents an increase of about $200 million relative to our previous expectation.

Finally, our 2019 outlook for real estate projects and capital spending remains unchanged.

Let me now provide some additional context on our current expectations.

First, our guidance does not contemplate additional increases in tariff rates or the expansion of products subject to tariffs.

Beyond those which are currently in effect are included in the list 4B China tariff proposal.

As a reminder, we have some sales-related headwinds associated with the shortened holiday selling season and the lapping of an estimated 70 basis point sales comp benefit from the pull-forward of SNAP payments into last year's fourth quarter.

With regards to gross margin, we continue to expect our rate improvement in the second half to be roughly in line with Q2 when compared on a year-over-year basis.

As a reminder, we strategically invested in targeted promotional markdown activity in Q4 of 2018, which at this time, we do not plan to repeat.

Finally, in terms of SG&A, we continue to expect to invest approximately $55 million in our strategic initiatives in 2019.

In summary, we are very pleased with our results through the first 3 quarters of the year and are excited about our outlook for Q4.

As always, we continue to be disciplined in how we manage expenses and capital with the goal of delivering consistent, strong financial performance while strategically investing for the long term.

We remain confident in our business model and our ongoing operating priorities to drive profitable same-store sales growth, healthy new store returns, strong operating cash flow and long-term shareholder value.

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

Thank you, John.

I'm very proud of the progress the team has made in advancing our key strategic initiatives, which we believe better position us for the long-term sustainable growth.

Let us take you through some of the most recent highlights.

Starting with our nonconsumable initiative or NCI.

As a reminder, NCI consists of a new and expanded assortment in key nonconsumable categories, including home, domestics, housewares, party and occasion.

The NCI offering was available in more than 2,100 stores at the end of the third quarter, and we remain on track to expand the offering to a total of approximately 2,400 stores by the end of 2019.

We recently completed our sixth replenishment cycle, and I'm very pleased with the sustained positive sales and margin performance we are seeing across our enhanced product categories.

We also continue to see a positive halo effect in consumable sales.

Overall, this performance is contributing to improvements in both total sales and gross margin rate in these stores.

These results reinforce our belief that NCI can be a meaningful sales and margin driver as we move forward.

In fact, as I mentioned earlier, our plans include accelerating the rollout of NCI to a total of about 5,000 stores by the end of 2020 as we look to further complement our strong and growing consumable business.

Turning now to DG Fresh, which is a strategic multi-phased shift to self-distribution of our frozen and refrigerated goods such as dairy, deli and frozen products.

These goods currently represent approximately 8% of our total sales.

The primary objective of DG Fresh is to reduce product cost on our frozen refrigerated items, thereby enhancing gross margin.

And while still early, we are very pleased with the progress and product cost savings we are seeing.

Three other important goals of DG Fresh are to drive on-time deliveries higher, increase in-stock levels and eventually expand our assortment offering in these categories.

This could include a wider selection of both national and private brands as well as an enhanced offering of Better For You items.

In total, we were self-distributing to approximately 4,900 stores from 4 DG Fresh facilities at the end of fiscal Q3 and now expect to capture benefits from this initiative in more than 5,500 stores by the end of this year.

This compares to our previous expectation of approximately 5,000 stores being serviced by DG Fresh at year-end.

Given the success we are seeing and great progress by the team, we now plan to begin shipping out of our fifth DG Fresh facility by as early as fiscal year-end 2019.

We believe this positions us well to capture additional benefits as we move into next year and as we expect DG Fresh will be accretive to both gross margin and operating profit rate in 2020.

In short, we are very excited about the results we are seeing from this initiative as well as the long-term potential benefit it can deliver for our customers and our business.

With respect to our digital initiative, our efforts remain focused on deploying technology to further enhance the customer in-store experience.

In total, we believe digital can drive additional traffic as well as an increase in basket size.

In turn, our digital engaged customers checkout with an average basket twice as large as the company average.

One important element of our digital strategy is pursuing opportunities to expand our customer relationships, including innovating to meet their increasing desire for convenience.

To that end, some of the more recent highlights include the consolidation of our DG GO!

app into our primary Dollar General app, bringing all our customer-facing digital tools together in one easy-to-use application and furthering our efforts to deliver an even more frictionless shopping experience to our customers.

The further rollout, DG GO!

checkout, now available in more than 700 stores, which allows customers to use their phones to scan items as they shop, and then skip the line by using a DG GO!

checkout.

Expansion of our cart calculator in-app shopping and budgeting tool to approximately 15,000 stores, up from about 12,000 stores at the end of the second quarter.

And finally, we remain on track to pilot DG pickup, which is our buy online, pick up in store offering during the fourth quarter.

Our digital efforts are focused on making things easier for our customers by providing an even more convenient, frictionless and personalized shopping experience.

Importantly, these efforts will continue to be tailored specifically to the Dollar General customer and remain an important component of our long-term growth strategy.

Moving now to Fast Track, where our goal includes increasing labor productivity in our stores, enhancing the customer convenience and further improving on-shelf availability.

There are 2 key components to Fast Track.

First is streamlining the stocking process in our stores through rolltainer optimization and with even more shelf-ready packaging.

These efforts are designed to reduce the amount of time spent stocking shelves during the truck unloading and restocking process, and we're pleased with the labor productivity improvements we are already seeing.

We remain on track to complete our rolltainer optimization efforts by year's end, which is well ahead of schedule and positions us well to drive even greater efficiencies as we move forward.

The second key component of Fast Track is self-checkout, which we believe can further improve speed of checkout, while also reducing the amount of labor hours devoted to this activity.

We recently launched a pilot in select stores and are pleased with the early results.

Overall, we are making great progress with our key strategic initiatives, enabled through focused and disciplined execution.

We believe we are the innovative leader in our channel and remain well positioned to capture market share in a changing retail landscape.

Along with our strategic initiatives, we remain committed to our 4 operating priorities.

Let me take our last few minutes to update you on some of our recent efforts.

Our first operating priority is driving profitable sales growth.

The team has executed against a comprehensive plan to drive continued sales and profit growth with several ongoing initiatives.

Let me quickly highlight just a few.

Starting with our cooler door expansion program, which continues to be the most impactful merchandising initiative.

During the first 3 quarters, we added nearly 35,000 cooler doors across our store base.

In total, we expect to install more than 40,000 cooler doors this year as we continue to build on our multiyear track record of growth in cooler doors and associated sales.

As a reminder, last quarter, we began incorporating higher-capacity coolers into the majority of our new, remodeled and relocated stores.

These coolers provide 45% more holding capacity than traditional coolers, which will allow us to expand our assortment offering by approximately 25%, creating additional opportunities to drive higher on-shelf availability and deliver a wider product selection.

We believe these efforts not only extend our runway for growth in cooler doors, but also better positions us to capture additional sales opportunities, including those associated with DG Fresh.

Turning now to private brands, which continues to be an important area of focus for us.

We know that private brands represents an opportunity to further enhance our value proposition for customers while also benefiting gross margin.

We are executing a variety of tactics to drive additional growth of these brands, including enhancing our current offering as well as introducing new product lines.

One key area of focus is accelerating growth within our existing private brand portfolio, where our plans consist of rebranding and repositioning these products to drive greater customer penetration.

We have seen great success with our efforts to date, including Studio Selection and Gentle Steps, and believe there is significant opportunity with other existing brands as well.

In addition to our rebranding efforts, we have introduced new brands in certain categories where we see sizable opportunities for growth.

Recent examples include the introduction of our popular Believe cosmetic line as well as our Good & Smart brand, which remains an important part of our Better For You offering.

In fact, as a result of its success, Better For You offering is now available in approximately 55 -- 5,400 stores, with plans for further expansion as we move forward.

We are constantly evaluating our private brand portfolio, and we'll look to further enhance our offering when and where we see opportunities.

Importantly, we are seeing some of our best private brand sales performance in several years, which reinforces our belief that we are on the right track to deliver an even greater value to our customers while continuing to drive profitable sales growth.

Finally, a quick update on our FedEx relationship.

During the quarter, we rolled out this convenient package pickup and drop-off service to more than 1,800 stores and expect to be in over 8,000 stores by the end of 2020.

And while still early, we are pleased with the reception this services offering is receiving from our customers and continue to believe it will become a traffic driver over time.

We continue to explore innovative opportunities to serve our customers, and we are excited about and able to deliver the [leverage].

Our unique real estate footprint allows us and also the convenient locations across the country.

Beyond these sales-driving initiatives, we are also focusing efforts on enhancing gross margin.

In addition to the gross margin benefits associated with NCI, DG Fresh and private brand efforts, shrink reduction remains an important area of focus for us.

We added approximately 1,000 additional electronic article surveillance units in the third quarter.

Bringing the total number of stores with EAS to approximately 13,600, and we remain on track to incorporate these units in all stores by the end of the year.

We also continue to make progress in pursuit of further distribution and transportation efficiencies as we recently began shipping from our 17th traditional distribution center in Amsterdam, New York.

Additionally, we remain on track to reach our goal of approximately 300 private fleet tractors by the end of the year.

Finally, while the team has made significant progress with our tariff mitigation efforts, we continue to see opportunities to expand our foreign sourcing penetration while diversifying our countries of origin.

Overall, we're pleased with the great work the team is doing across the business to further drive profitable sales growth.

Our second operating priority is capturing growth opportunities.

We celebrated a significant milestone in the third quarter as we opened our 16,000th store.

This is a testament to the fantastic work of our best-in-class real estate team.

Our proven high-return, low-risk model for real estate continue to be a core strength of the business.

As a reminder, our real estate model continues to focus on 5 metrics that have served us well for many years in evaluating new real estate opportunities.

These metrics include new store productivity, actual sales performance, average returns, cannibalization and the payback period.

Of note, our portfolio of new store openings in 2019 continues to perform very well, consistently beating pro forma expectations.

For 2019, we remain on track to open 975 new stores, remodel 1,000 stores and relocate 100 stores.

Through the first 3 quarters of the year, we opened 769 new stores, remodeled 928 stores, including 480 in the higher cooler count DGTP or DGP formats and relocated 75 stores.

We also added produce to 65 stores during the quarter, bringing the total number of stores which carry produce to more than 600.

As I noted earlier, for fiscal year 2020, we plan to open 1,000 new stores, remodel 1,500 stores and relocate 80 stores, representing nearly 2,600 real estate projects in total.

Additionally, we plan to add produce in approximately 250 stores in 2020.

Notably, we expect more than 1,100 of our remodels to be in the DGTP or DGP format.

The remainder of the remodels will primarily be in the traditional format.

As a reminder, our traditional remodel stores, which has an average of 22 cooler doors delivers a 4% to 5% comp lift on average.

This compares to an average comp lift of 10% to 15% for a DGTP or DGP remodel, which has an average of 34 higher capacity cooler doors.

Given the strong results we continue to see from our remodel program, we are excited about the 50% increase in remodels we are targeting for next year.

Investing in our mature store base to incorporate our best and most impactful initiatives is an important component of our real estate strategy as we continue to leverage recent learnings and format innovation to capture additional market share.

With regards to new stores, we plan to accelerate the rollout of our DGX format next year, targeting about 20 additional stores, bringing the total number of DGX stores to approximately 30 by the year-end 2020.

And the remainder of new store openings will primarily be in the traditional format, the majority of which will include higher-capacity coolers.

I am very proud of the team's ability to execute such high volumes of successful real estate projects, and we are excited about the continued growth opportunities ahead.

Our third operating priority is to leverage and reinforce our position as a low-cost operator.

With the customer always at the center of everything we do, we remain committed to our low-cost approach throughout the organization.

We have a clear and defined process to control spending and are constantly seeking opportunities to reduce cost where possible through a zero-based budgeting mindset.

This process has produced significant cost savings to date, in addition to fee-generating initiatives such as our FedEx relationship.

We believe low cost always drives out high cost, and we are steadfast in our pursuit of these opportunities.

Our fourth operating priority is to invest in our people as we believe they are a competitive advantage.

These efforts continue to yield positive results across the business, as evidenced by continued record low store manager turnover, strong applicant flow and a robust internal promotional -- excuse me, promotion pipeline.

We continue to engage directly with our employees and are pleased with the participation rate and valuable feedback received in our most recent employee engagement surveys.

We value these conversations and look forward to continuing our work together to further enhance our position as an employer of choice.

We believe the opportunity to start and develop a career with a growing company is a unique competitive advantage and remains our greatest currency in attracting and retaining talent.

To that end, in 2020, we plan to create more than 8,000 net new jobs, importantly, our growth continues to foster an environment where employees have opportunities to advance to roles with increasing levels of responsibility in a relatively short time frame.

In fact, more than 12,000 of our current store managers are internal promotes, and we continue to seek innovative opportunities to develop our teams.

In October, we celebrated our 80th anniversary.

A lot of change has occurred in 80 years, but the one constant has been our unique culture, which is deeply rooted in our company mission of serving others.

On that note, we recently completed our annual community giving campaign where employees across the organization come together to raise funds for a variety of important causes.

I'm impressed every year by the generosity and compassion demonstrated by our team members, which reinforces our culture is alive and well and is a competitive advantage for Dollar General.

In closing, we are pleased with another strong quarter and the continued momentum we saw in the business.

As a mature retailer and growth mode, we believe we are uniquely positioned to continue delivering value and convenience for our customers and long-term value for our shareholders.

As we are working through the busiest months in retail, I want to offer my sincere thanks to each of our approximately 140,000 employees across the company for their tireless dedication to serving our customers every day.

Our people truly make the difference at Dollar General.

And as I had mentioned, their dedication to fulfilling our mission of serving others is the bedrock of our culture.

We are excited about our results through the first 3 quarters and are working hard to finish the year on a strong note.

With that, operator, we would now like to open the lines for questions.

(Operator Instructions) The first question will come from Matthew Boss with JPMorgan.

Great.

Congrats on a really nice quarter, guys.

Thank you, Matt.

Todd, maybe to start off, can you speak to the health of the low-income consumer and maybe how you'd handicap your top line strength that you're seeing today as we think about the industry backdrop versus your own offensive initiatives?

Meaning, I guess, how confident are you that you can sustain the drivers of today's top line strength as we look ahead to next year and beyond?

First, Matt, I would tell you that our core consumer, we see her about where we have the last couple of quarters.

She still has a little bit of extra money in her pocket, continues to be employed at a pretty high rate.

But always remember, our core customer is always a little stretched and she looks to us to provide that value and convenience that she's come to known from Dollar General.

And as I look into the future, whether it be this quarter or into next year, I would tell you that the continued strength we see in the top line sales results are really a combination of a good consumer.

But I would tell you that our initiatives are really starting to work for us across the entire portfolio of businesses we have, both consumables and nonconsumables.

So both our shorter-term initiatives around coolers, health and beauty, queue lines, et cetera.

But also, you probably noticed, we've had some of our best nonconsumable results that we've had in many years.

And a lot of that is coming from our longer-term strategic initiatives, mainly NCI, where we've taken a lot of our NCI learnings and not only have got them in the 2,100 stores that we've already launched it in but we've also flushed it back into the entire chain, many of those very successful planograms that we've set, we've actually put them inside of our 16,000 stores, which is really starting to help drive that top line.

So we feel very good about the sustainability of our comps as we go forward.

Great.

And then maybe just a follow-up for John on the gross margin.

I guess, any difference between your gross margin performance versus internal plan this quarter, in the third quarter?

And then with the acceleration of DG Fresh and NCI into next year, is there any reason why your gross margin expansion opportunity, as we think about next year, would not potentially be larger than the performance that we're seeing this year?

Thanks, Matt.

I'll start by saying we feel very good about the balanced Q3 performance as we drove a strong top line, as Todd mentioned, while increasing our margin rate slightly.

I will tell you that we still see the second half gross margin the same as we did on our last call.

We continue to expect rate improvement, as we mentioned, in the second half to be roughly in line with Q2 compared on a year-over-year basis.

And we see the same basic drivers there in play.

As we said we would, we continue to be more targeted in promotional activity.

And as you can see, we continue to drive very strong transaction growth, great balance in our sales and have been growing our share at an accelerating rate.

We also expect to see and are seeing continued growth in benefits from initiatives like DG Fresh and NCI, as Todd mentioned.

And as you look forward, I'm not going to comment specifically on 2020.

We'll be talking about that in our next call.

But just more broadly, as you look over the long term, there's always headwinds there, but we see ourselves in a position to expand our gross margin over the long term.

We see growing impact continuing from initiatives like DG Fresh and NCI.

We're really focused on our initiatives on the top line and the bottom line.

We continue to see opportunity with category management.

As we mentioned in our prepared comments, I see a lot of opportunity around foreign sourcing penetration, a lot of great things going on with private label to drive that penetration on the shrink side.

We're incorporating EAS in the remainder of the stores this year as well as operational focus on that.

It's the opportunity there over the long term.

And the team has done a great job on the supply chain side, driving efficiencies.

So we believe we're making the right investments, and we believe we have a lot of levers to improve operating margin over the long term, while reserving the right when needed to invest in the customer.

The next question will come from Rupesh Parikh with Oppenheimer.

Congrats on a great quarter.

Thank you.

So I also wanted to ask a little bit more about your acceleration in your real estate plans for next year.

So if you can maybe talk a little bit more about your thinking beyond the decision to accelerate your real estate projects and how you feel about the organizational capacity to handle both the acceleration on a real estate front and really all the initiatives that you continue to have underway.

Rupesh, thanks for the question.

I would tell you, we have really, over the years, built the capability to execute against a very robust pipeline of real estate projects.

But even beyond that, we have built the disciplines here and have proven over time that we can handle a lot of complex projects at one time.

We have a great group of individuals that work for this company that work hard every day to make sure that we execute at a very, very high level.

And that's what really gave us the notion to move a little faster here, knowing the success that we have seen in the recent past.

But even more so than that, we want to make sure as we continue to take care of the mature store base of this company and touch every store every 7 to 10 years to make sure it's refreshed and has the best and brightest that we have available, we really need to start to accelerate our remodel programs to help facilitate that every 7- to 10-year touch.

But again, we wouldn't be able to do that without all the great work that this team is able to produce in any given year.

Great.

And then one quick follow-up question.

So any initial thoughts in terms of the SNAP rules -- SNAP rule changes that are going to go into effect next year?

Yes.

There's one that was in the news yesterday around able-bodied work requirements, which will take effect April 1, 2020.

Based on what we know about this proposal, we don't see this as a material impact next year as we see it.

This is something we continue to monitor closely.

We've continued to see a long-term trend of reduced benefits over time gradually.

But over that time, our share has grown as well.

So we're still a little under 5% in terms of tender mix but are really focused on what we can control, and that's making sure we're prepared to serve those customers as they need us.

The next question is from Karen Short with Barclays.

I just wanted to follow up a little bit on the gross margin in general.

So I know you've consistently said, and you've said it twice on this call, that second half gross margin will be similar to 2Q.

So that implies kind of almost 30 basis point improvement in gross margin in the fourth quarter.

So wondering if you could just provide a little color on why you'd see that improvement.

And then you did call out shrink as a pressure point this quarter as well as distribution transportation, but can you elaborate a little bit on what was causing that?

And has that got anything to do with the acceleration of the fresh initiative?

Sure.

I'll start by talking about gross margin.

You're correct in the way you're thinking about the second half, that would imply and that's what we expect, is increased gross margin expansion in Q4.

The reason we see more gross margin expansion in Q4 versus Q3.

The 2 main drivers I would point to is, one, the acceleration of our strategic initiatives.

As fresh scales, as NCI scales, we see that playing a bigger and bigger role.

The other piece is the promotional activity.

We are lapping heightened promotional activity last year.

It was targeted.

It served its purpose, created a lot of momentum in the business, but we don't see a need to repeat that.

And the team has done a really great job being very targeted in the promotional activity, really focused on what moves the needle, and we see ability to do less as a percent of sales this year.

That's the 2 main things I would point to as well as just seeing other opportunities and the other levers that we mentioned there.

In terms of shrink, we've reduced shrink quite a bit over the last 3 years.

But as we've said, it's never a straight line to the top.

In Q3, we were lapping a very challenging lap.

At the time, that was the lowest shrink rate we've had in many years.

What we've been trying to do this year is balance shrink with in-stock improvement levels.

We really look to take our in-stock improvement to the next level, which is great in terms of driving sales, but it does present a little bit more shrink exposure.

But we continue to see opportunity over the long-term to drive further shrink improvement.

And with the incorporation of the EAS units in all the stores by the end of the year, that's been a big benefit to us and we would expect benefits from that as well as leveraging all the other tools and technology and process rigor to drive that down further over the long term.

So my follow-up would be then, as we look to 2020, just generally speaking, it would sound to me, barring anything unforeseen with respect to the competitive environment or the consumer, that the tailwind should be greater than the headwinds overall for next year.

Is that fair?

I'm not going to comment specifically on 2020, I'll just speak to the longer term.

And what I would say is we feel like we have a lot of catalysts in place to drive the top line.

As we've mentioned, we feel like we have a lot of levers within gross margin and SG&A to flow that through.

We're very pleased with where we're at this year, delivering double-digit operating profit growth and EPS growth this quarter while reinvesting in the business.

And as we look forward, we'll continue to look at that.

We want to make sure that we're delivering strong performance, but at the same time, reinvesting in the business to protect the long-term health and growth of the business.

So I would look at it that way.

The next question is from Ed Kelly with Wells Fargo.

This is Anthony on for Ed.

Congrats on a solid quarter.

So clearly, you guys continue to accelerate your share gains given the comp performance and your initial remarks.

Can you just talk about what you're seeing right now in the competitive landscape?

And then is there any specific channel that you think this is coming from?

Or would you say it's been more broad-based?

Yes.

Let me start with the second piece.

First is, I would say that it is more broad-based when you look at the share gains that we've seen.

And our core consumer continues to be, again, a little bit healthy and that she has a bit more money in her pocket.

But I would tell you that as we look out there, a lot of our initiatives are really the key driver behind these share gains and outsized share gains at that and accelerating.

And you can really see it in many of the categories that we've really got the emphasis on health and beauty being one; our food and perishable initiatives, you can really see the initiatives really resonating with the consumer, and she's voting with her wallet on where she shops.

And it's great to see.

Now our goal is to continue to be a fill-in, and that is exactly how our consumers continue to look to us.

But with expanding assortments and fabulous prices, we feel that we give her the opportunity to be able to fill in with confidence.

The next question is from Michael Lasser with UBS.

My question is going to be a little bit of a devil's advocate on the fourth quarter implied gross margin.

You've got a pretty easy compare.

As you mentioned, you engage in some promotional activities in the year ago period that you're not going to repeat.

You've got all these really good gross margin drivers like DG Fresh and the NCI initiative but yet you're only guiding for 30 basis points of gross margin expansion in 4Q to get to like a 31.5% gross margin, which would be below where you've been over the last few years, excluding 2018.

So why wouldn't it be better than that?

Yes.

What I would say, Michael, is as you look at the squeeze on Q4 that, as Karen pointed out, that end point is a pretty healthy gross margin.

But what I would tell you is that, one, there are some headwinds.

We're overcoming tariffs.

The team has done a phenomenal job mitigating that, such that it's not a material impact.

It wasn't a surprise to us.

But still, it is a pressure.

And there's other pressures as well, as well as reinvesting in the business.

That's the way we look at it, if we can deliver double-digit EPS growth, which is what our guidance implies, 10% to 11%, while reinvesting in the business to put more catalyst in place for long-term growth.

We think that's a healthy balance between the 2.

Okay.

And my follow-up question is, it's very not -- very much not apparent from the financial performance that you've reported, but given all that you do have going on, have there been any hiccups with opening any of these new fresh DCs or engaging in NCI or opening new stores that we should be mindful about as you get further into executing some of these strategies over the next few quarters?

Michael, this is Todd.

I would tell you that the team has done a phenomenal job across the board on each of those initiatives you just talked about.

And I would tell you that we have seen no show-stoppers.

Obviously, there's always going to be a bump or 2, but they were very, very manageable.

We learn from those and kept moving down the road.

And I think it's a real testament to your question here is our notion that we're able to accelerate both our nonconsumable initiative into next year, of course, accelerating our -- and growing the Fresh initiative into next year with up to 5 different new facilities as we go into 2020.

So I would tell you that there's been some learnings.

But more -- a whole lot more wins than anything else that we've seen and has given us great confidence to move forward.

The next question is from Simeon Gutman with Morgan Stanley.

This is Xian Siew on for Simeon.

I just wanted to dig in a little bit more on the top line momentum.

Is there any kind of update on maybe basket size or the number of trips?

And then, I guess, within that, you mentioned transactions are growing nicely.

So are you gaining new customers?

Or is it kind of the existing customer just coming more frequently?

Yes.

Thank you.

Yes, I would tell you that our top line was very balanced.

A very good mix of both traffic and ticket.

And I would tell you that the average basket size has upticked a little bit over the last quarter or 2 as we continue to refine our offering and give our customers more choices, as we roll out DG Fresh to more stores.

That also enables, again, an extra item in the basket, if you will.

So we're very pleased with both traffic and ticket as we see it.

As it relates to the consumer, we continue to see that our fastest-growing category of consumer, if you will, is that consumer making $50,000 or above, and we continue to believe that she's shopping more often because of all the work that we've done to refine that box and give her an offering at a great compelling price and she's liking what she sees when she tries us, and she's sticking with us even after the first few trials.

So we're really excited about that.

It gives us great confidence as we move into 2020 and beyond, that we can drive that top line.

Got it.

That makes sense.

And just as a follow-up, I guess, you're lapping this year in this quarter, the hurricane-related expenses you mentioned.

And -- so you had some leverage, but maybe if you ex that out, I mean, there's not as much leverage on the SG&A.

With comps came in so much stronger, I guess, why shouldn't we see more leverage on that?

What I would say is that we're proud of the Q3 and year-to-date cost control that we've put in place while driving strong top line and investing in our strategic initiatives.

Year-to-date, we've invested $33 million in our strategic initiatives yet in Q3 and year-to-date, leveraged on an adjusted basis.

We're laser-focused on cost control, make me no mistake, but we're looking more broadly in operating profit and willing to make those trade-offs that deliver the bottom line.

So we're pleased with delivering double-digit operating profit growth and delivering the double-digit rate increase making those trade-offs.

But as you invest in things like DG Fresh, there is a trade-off between gross margin and SG&A.

You have to spend a little bit more on SG&A to save a lot more on gross margin.

And when you're at the front end of these initiatives, there's more upfront cost.

But as these grow over time and scale, we see these having great returns.

We mentioned in the call, we see DG Fresh as being accretive from a rate and dollar standpoint next year.

So we believe that we're making the right trade-offs here and believe that if we could deliver that kind of leverage while investing in the business, that's the right trade-off for the long term.

And we believe these types of investments is what positions us well to be double-digit EPS growers on an adjusted basis over the long term.

The next question is from Scot Ciccarelli with RBC Capital Markets.

John, I know you've bounced around this topic quite a bit today, but these all fell on margins.

I guess, just kind of taking a step back, we have seen a fairly consistent pattern of the company making pretty sizable investments in the business over the last several years, whether it was price or training, labor initiatives, et cetera.

And while there's been a nice payoff on the sales growth, these investments have weighed on profit growth and flow-through.

So I guess what I'm wondering is, are there any areas, as you kind of sit here today, that seem ripe for incremental investments?

Well, as we look ahead, I would tell you that there's nothing specific we see on the time horizon, which would be a substantial increase in investment.

I think we've got 4 really good investments before us.

Now those are going to scale.

And as we grow those, more money will be spent on those.

But as we've said, we see those hitting a tipping point: See DG Fresh hitting a tipping point where it's accretive next year; we're already seeing accretion from NCI; we're investing in digital; and we're investing in Fast Track.

Fast Track on the labor side, we're seeing benefits there already with what we're doing with making it easier to stock the shelves.

We're investing in self-checkout, which we see as a great return over the long term, but we're just starting there.

So we're pleased with what we're seeing with that test right now in terms of adoption and customer feedback and see that returning over the long term.

So these are various phases, but we see all of these providing catalysts to the top line but also helping the bottom line, helping that margin rate.

And I would tell you, we're not giving any specific guidance for next year, but don't see any major investments on the horizon beyond continuing down the path we're on, which is working very well for us.

That's very helpful.

And then just a quick follow-up here.

You had seasonal goods that were up the same amount as consumables from a growth rate perspective.

Just curious if there was something specific that drove that this particular quarter?

Or is it a function of NCI program?

Any kind of guidance on that?

Because, obviously, it helped you sell a richer mix of goods.

Yes.

Sure.

I would tell you that the team has done a great job in our seasonal programs.

Not only seasonal, but many of our home categories are doing very well.

And I would tell you that NCI has given us a nice shot in the arm as it relates to the overall top line.

It's even gotten us to look at our everyday 16,000 stores a little differently as we continue to scale NCI.

So I would tell you that that's really been the catalyst behind it, and we're very proud of the team's performance and our store team's performance in our nonconsumable categories.

And the other note is apparel did very well, even in a downsizing mode that we're in, in apparel.

We've made that even more productive.

As we expand out on other categories, apparel is still important to our customers in certain areas, and we're capitalizing very well on that.

The next question will come from John Heinbockel with Guggenheim Securities.

Todd, let me start with good-for-you assortment, right?

Where does that stand now in terms of number of items?

Where does that go, do you think, over the next year or 2?

And is that helping you broaden out your demographic appeal?

Yes.

John, I would tell you that right now, we see our Better For You offering in about 5,400 stores.

We see an opportunity to probably double that over time, and eventually into the majority of our stores.

But everything we do here, as you know, it's through the lens of the consumer.

And as the consumer continues to change and her preferences continue to change, and also as we start to see a little bit more of a millennial customer showing up, which we have, Better For You continues to grow with our customer base, and we're going to grow with it.

The great thing is that we've got upwards of 20 feet worth of product today.

The majority of that in our Better For You, Good & Smart label, which is our private brand label, which makes that very, very accretive for us.

But I would tell you that as we continue to scale our fresh initiative, that more and more introductions into frozen, dairy, and deli will also fall into some Better For You-type categories and sales opportunities.

And I agree with you fully, and what we've seen in our data shows it is expanding the reach of consumers that we have today and we'll continue to get into the future.

All right.

And secondly, I know the high-capacity coolers, right, 45% more holding capacity.

When you think about the productivity, right, but the revenue or the volume that a high capacity cooler can do versus a non, is it similarly, 40%, 50% can do that much more business?

Or it's really a function -- you've got to keep it stocked, so maybe it's not that high?

Yes.

I think that's the way to look at it.

It does give us more revenue.

I would tell you that for sure.

Not at a 40% rate.

But this is really being done twofold reasons.

Number one, we are ensuring that we're in stock as we roll out our new Fresh initiative.

We would rather have it in the cooler on the sales floor than any back stock in the back room in a cooler waiting to be stocked.

That's number one.

But it does give us 25% more item capability, and that's where you're going to see the increase in sales come from in this initiative.

And I'm happy to say that the majority of the stores that we put in the ground new next year as well as our remodel and relos will have those higher-capacity coolers in them.

So we feel real good, John, about where this is going to take us.

The next question will come from Chuck Grom with Gordon Haskett.

Just, Todd, can we dig a little bit into NCI a little bit more?

Just maybe the number of SKUs you're adding by store?

What the lift you're seeing in, say, an individual store?

And it seems like the gross margins are starting to nicely contribute.

Maybe just sort of unpack that for us a little bit more?

Because obviously, it's pretty important.

You talk about the remodel look historically, but it sounds like NCI is something that we maybe could start to quantify?

Yes.

I would tell you that, Chuck, that we plan to quantify this a little bit more as we move into next year.

But let me try to shape it up a little bit by saying that it is a complete redo of our nonconsumable categories in general.

And I would tell you that the mix is vastly different in those stores than what you see in our traditional stores.

On top of that, it gets refreshed multiple times a year in many of the areas of NCI, where our planograms are static, if you will, outside of season in our traditional stores.

So it gives something fresh and new to the consumer every time she comes in.

And again, she's been gravitating and resonating to that very, very well.

I would tell you that it has been accretive to our remodel sales.

Again, we'll quantify that probably a little deeper as we move forward.

But both on the sales line and the gross margin rate line, we've seen benefits from this.

And as that continues to grow, it will start to benefit the entire company as we continue to grow that.

But the one point that I did want to again make is that we're taking some of those best of the best planogram learnings and rolling them back into the 16,000 store base, and that's really what's given us some of that strength that you've seen over the last quarter to 2 in our nonconsumable category.

So we feel very good about where it's headed.

And we're only in the third inning here of build to roll this out.

Okay.

That's helpful.

And then just a follow-up.

Along with the potential margin savings from eliminating the middleman, one of the benefits from bringing fresh distribution in-house was, I believe, the ability to get better access to brands.

So just wondering if you could elaborate on progress on that front and anything we should expect over the next couple of years.

Maybe any specific brands that you've been able to bring in recently.

Yes.

Chuck, as we continue to scale fresh, it is a goal of ours to expand the brand offering in areas that our customers are looking for.

A lot of it in the deli and frozen areas of the store.

And the one big area that we see opportunities to move forward as well is even in our own private brand offering, which we were excluded to really play in any significant way in, and that would include Better For You as we continue to move forward.

So that -- while that is a very important piece of the fresh initiative, the most important piece right now is getting the stores up and running seamlessly, making sure we're in stock for the consumer driving that in-stock rate, which will drive our sales higher, and we've already seen that.

And then as we master that within the next upcoming year or more, we'll start to put in these new brands, which will also then help accelerate that top line in the fresh initiative.

So we believe we've got a multiyear pronged approach to this that should drive that top line.

And just a quick follow-up.

I think you said 5,500 stores.

But anyhow, did you say how many you expect to be in by the end of 2020?

Well, I think what we've said, Chuck, is that the pace of rollout is going to be very similar.

We'll probably expand that a little bit more, but we plan to be in close to 12,000 or more stores by the time we leave 2020.

And gentlemen, we have reached the top of the hour.

At this time, this does conclude today's conference call.

You may now disconnect.