Good morning. My name is Jennifer, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dollar General Second Quarter 2018 Earnings Call. Today is Thursday, August 30, 2018. [Operator Instructions] This call is being recorded. Instructions for listening to the replay of the call are available on the company's earnings press release issued this morning. Now I would like to turn the conference over to Ms. Jennifer Beugelmans, Vice President of Investor Relations and Public Relations. Ms. Beugelmans, you may begin your conference.

Thank you, Jennifer, and good morning, everyone. On the call with me today are Todd Vasos, our CEO; and John Garratt, our CFO. After our prepared remarks, we will open the call for questions. Our earnings release issued today can be found on our website at investor.dollargeneral.com under News and Events. Let me caution you that today's comments will include forward-looking statements about our expectations, plans, future estimates and other nonhistorical matters, including, but not limited to: our fiscal 2018 financial guidance and store growth plans; our planned investments and initiatives; capital allocation strategy and related expectations; and economic trends or future conditions. Forward-looking statements can be identified because they are not statements of historical facts or use words such as may, should, could, would, outlook, will, believe, anticipate, expect, assume, forecast, estimate, guidance, plans, opportunity, potential, continue, focused on, intend, going forward, goal, over time, look forward, long term, scheduled to, or on track and similar expressions that concern our strategies, plans, intentions or beliefs about future matters. Important factors that could cause actual results or events to differ materially from those projected by our forward-looking statements are included in our earnings release issued this morning under Risk Factors in our 2017 Form 10-K filed on March 23, 2018, and in the comments that are made on this call. We encourage you to read these documents. 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, except as maybe otherwise required by law. At the end of our prepared remarks, we will open the call up for your questions. [Operator Instructions] Now it is my pleasure to turn the call over to Todd.

Thank you, Jennifer, and welcome to everyone joining our call. We are very pleased with our strong second quarter results, which were driven by robust performance on both the top line and bottom line. A key highlight of the quarter was our 3.7% same-store sales growth. Both basket and traffic growth drove these results, demonstrating what we have long believed to be true: by providing the products, convenience and value that our customers want, we can continue profitably growing sales. I also want to note that our second -- that our 2-year same-store sales stack for the second quarter of 2018 was the highest in 10 quarters. Year-to-date through the second quarter of 2018, we posted 2.9% same-store sales growth driven by greater customer productivity. Based on our performance in the first half and our outlook for the rest of the year, we are increasing our net sales and same-store sales guidance for 2018. We are executing against our operating priorities and believe we are well positioned to deliver solid growth in the second half of 2018. Now let's recap some of the top line results for the second quarter. Net sales increased by 10.6% to $6.4 billion compared to net sales of $5.8 billion in the second quarter of 2017. We're very pleased with the new store productivity and performance from our mature stores. Our 3.7% same-store sales increase was led by our strong performance in consumables. We're proud of this performance and believe we are well positioned against all classes of trade as evidenced by our market share gains in the 4-, 12-, 24- and 52-week period ended July 28, 2018. These gains are measured by syndicated data. Within nonconsumables, we also delivered solid overall positive comp growth driven primarily by strong sales in our seasonal category. As we have discussed in recent quarters, overall, we continue to see rational pricing activity across the industry. We know it's always competitive within the discount retail space, but we are committed to being price right for our customer every day. As we continue to execute against our operating priorities, we believe we have opportunities to capture incremental market share. We will continue to work to drive awareness of the value proposition that we offer. After John's comments, I'll provide an update on our growth initiatives. With that, I'll now turn the call over to John to provide you with more detail on our second quarter financial results.

Thank you, Todd, and good morning, everyone. Now that Todd has discussed a few highlights in the second quarter, I will take you through some of the important financial details. Unless I specifically note otherwise, all comparisons are year-over-year. As Todd has already discussed sales, I will start with gross profit. Gross profit as a percentage of sales was 30.6% in the second quarter, a decrease of 7 basis points. This decrease was primarily attributable to the ongoing product category mix shift to consumables as well as higher sales of lower margin consumable products and higher markdowns. Like many other retailers, our business continues to see the effect of increasing transportation costs due to the tight carrier market and higher fuel prices, among other factors. This impact is reflected in the slightly lower gross margin we reported in the second quarter. These factors were partially offset by another quarter of improved inventory shrink as well as positive contributions from initial inventory markup. SG&A expense as a percent of sales was 22.2%, a decrease of 8 basis points. The leverage in the second quarter of 2018 was primarily driven by: lower repairs and maintenance expenses; a reduction in lease termination expenses as we lap the acquisition of the Dollar Express stores in the second quarter of 2017; lower fixed asset impairment costs; and a reduction in retail labor expenses as a percentage of sales. Partially offsetting those decreases were an increase in professional fees, primarily to support a variety of longer-term initiatives; higher incentive compensation expenses; and increased costs to support certain loss prevention initiatives. We are pleased with the leverage we gained in SG&A and our ability to hold operating margin relatively flat this quarter. And we would note that we achieved this margin despite the transportation headwinds we are…

Thank you, John. For the remainder of my remarks, I want to walk through how we are executing against our 4 operating priorities, which has served us well and placed us in a leadership position within our channel. I'll also update you on the progress against certain strategic growth initiatives. Starting with our first priority of driving profitable sales growth. Our most impactful top line initiatives for 2018 revolve around merchandising and store operations. These initiatives are designed to enhance the value and convenient proposition for our customers, offering them the trusted simple solutions they seek from us every day. We continue to strategically invest in our mature store base. As you know, one of our strategies is to increase the average number of cooler doors across the chain. These types of projects drive high returns by encouraging our customers to make more trips and increase their basket sizes. This year, our goal is to install more than 20,000 incremental cooler doors across our mature store base. As of the end of the quarter, we have installed approximately 16,000 cooler doors across the chain, and we are well on our way to reaching our year-end goal. By the end of the fiscal year, we expect to have an average of 20 cooler doors per store, up from 10 in 2012. During the second quarter, we continued to focus on driving impulse purchases. One of the ways we do this is through our enhanced queue lines. During the second quarter, we added the enhanced queue line to more than 400 existing stores, bringing our total for the chain to approximately 6,800 stores. The queue line retrofit performance remains very strong. We expect to have this enhancement in more than 7,500 stores by the end of 2018. In June, we launched Phase…

[Operator Instructions] Your first question will come from Matthew Boss with JP Morgan.

So I guess, first question, John. On gross margins in the back half, is it best to model a back-half gross margin performance pretty similar to the slight contraction that we saw in the second quarter? I guess, just any help on the drivers of gross margin for the back half of the year maybe versus the second quarter, anything to consider would be helpful.

Well, I'll start by saying that we're very pleased with the first half performance, and as you look at the balance we struck with strong top line growth and gross profit expansion, we really focus on overall operating margin as we can manage all the levers within there. And so we've guided folks toward that and said that over the course of the year, we see ourselves in a position to deliver relatively flat operating margin rate year-over-year. There's a lot of puts and takes within there. One of the things we mentioned was increased near-term pressure from carrier rates, which could get a little bit worse before it gets better as well as while we saw it lesson some in the quarter, we do have ongoing mix pressures. But we have a lot of levers within gross margin to help counteract that. We were delighted with the performance of shrink, 7 quarters of sequential improvement there. And with the investments we've made, we see opportunity to continue driving improvement there. The team continues to do a fabulous job with category management. We see a lot of opportunity there. We were pleased with the growth in nonconsumables this quarter, continue to see opportunity around private label and foreign sourcing. And while there are headwinds on supply chain efficiencies, the team's doing a great job mitigating that and helping offset some of that with stem mile reductions. We opened up more DCs. There's 2 under construction right now. They continue to drive efficiencies around load optimization, DC productivity, private fleet expansion. And then we continue to expand and diversify our carrier base to help mitigate those headwinds. So when you put it all together, we feel really good about our ability that we've done thus far and through the year to mitigate those headwinds to deliver relatively flat operating margin rate for the year while importantly investing in high-return, strategic initiatives that we think are going to drive the future growth of this business.

Great. And then, Todd, just a follow-up. On same-store sales, nice to see the return to positive traffic this quarter. I guess, what do you think drove the improvement? Do you see positive traffic as sustainable? And maybe just touch on some of the performance that you're seeing from your more mature stores.

Yes, my hat is off to the -- our merchants and our operators. They have done a fabulous job over the years to set us up for success. And I think you saw that start to come together once again here in the second quarter. When we look at our overall sales performance, we're very encouraged on our -- on all of our initiatives that we have in play, our cooler initiatives, our health and beauty initiatives as well as our new Better For You initiative that we've now got in thousands of stores across the country and more to come. And then when you start to then look at even upcoming initiatives that are in the pipeline, we feel that sustaining positive traffic is exactly what we plan to continue to work toward for the back half of the year. That is always the goal. We know that traffic is key to long-term sustainability of comps, and that's where the team is really focused.

Your next question is from Vincent Sinisi with Morgan Stanley.

Wanted to ask -- we've gotten a question just from a couple of folks today. Very strong sales, of course, this quarter. We've gotten the question though, like, EPS, kind of maintained from a bottom line perspective. So I guess, just how would you respond to that? Is it more of, hey, we feel good, it's a decently wide range. There's the -- kind of the freight, the mix, some of the initiatives that you guys called out as headwinds and it's only at 2Q. Just wondering how you would respond to that question.

Yes, I think a lot of the things you say is the right way to think about that. I want to echo that we're very pleased with the Q2 results with 41% EPS growth, double-digit operating profit growth. We feel we're in a great spot. We feel that range, $5.95 to $6.15, is the right range. It's narrower than it used to be as we bought back shares and have a lower tax rate. But there's a lot of puts and takes within there, and we do see some increased headwinds associated with transportation costs. And again, the mix, while moderating, continues to be a bit of a pressure. And the other thing we mentioned is we want to make sure that we're reinvesting in the business, making targeted investments in strategic initiatives that's going to drive high returns. And we think this is the appropriate range based on all that. I think that's the right tradeoff for the business.

Okay. All right, cool. And then if I could, maybe just going back to when you guys gave the initial outlook for this year. One of, again, just investor questions that we had gotten was, with kind of normal course labor investments, given that you guys had gotten ahead of it several quarters before last year, is that something that's going to be able to kind of stick to the plan? So I guess, in light of this last quarter, with a lot of other retailers kind of stepping that spend up, have you seen any changes? Do you still feel good about kind of in line with your plan and where you are for the rest of this year on labor? That'd be great.

Sure. Vinnie, like many things, we got ahead of this and made sure that we did what was right for our business and, of course, our people last year as we invested over $70 million, as you recall, in both wages and training. That gift is still continuing to give, if you will, in that we're seeing that our turnover rates are lower than last year even after we put this into effect. It's been in effect now for well over a year. And we're also seeing better sales, better shrink results. And I want to also mention that on a percent basis, we have seen the lowest level in recorded history that we can find on a percent basis of open store manager positions across our company. And that really goes to show you that the investments we made are doing well and are sticking very, very well. And then when you couple that with our aggressive pay and our hourly wage that we've always stayed true to and made sure we paid very competitive wages against, we're seeing that applicant flow is the highest that we've seen. And so as you start to see that, the pipeline is full and we have less open positions even at the hourly rate in our stores than we had last year. So all that really goes to show us that we made the right decision on wages, and we continue to make the right decisions as we move forward.

Your next question is from Paul Trussell with Deutsche Bank.

Congrats on a very solid comp performance in 2Q. Just also following up on the guidance comment. I know you don't give specifics on a quarterly basis, but could you just help us think about some of the puts and takes in 3Q versus 4Q on overall revenues, comps and margins? Just given the more challenging comparisons, the cycling of the hurricanes, the timing of the Express store openings, just what should we keep in mind as we model?

Yes, so a couple of things there. We -- in Q3, we do lap the impact of the hurricane, which is obviously reflected in our guidance and I think most people have modeled that in. And in Q4, we do lap the closure of stores last year. But I think the other thing we've mentioned, as you look at the back half of the year, one thing that gives us confidence in the sales number we've put out there is not only the initiatives, the traction we're seeing in the initiatives and the performance of the mature stores as well as the existing stores, but also, one of things we mentioned as you get into the back half of the year, while the laps get more difficult, the benefit of the Dollar Express stores roll into that comp base. As we opened an unusually large number stores in the second half of last year, that rolls into the comp base and we see the performance of those, that will help your comp and offset those tougher laps. And I think the other thing we mentioned is just with transportation costs. That's a bit of a wild card and who knows where fuel rates will go, but we are seeing, in addition to that, just a tightening, further tightening of the carrier base, which could make things a little bit worse before they get better around transportation costs. So that's a headwind we wanted to point out in the second half. And then the other thing we just talked about is the investments. While we're making very targeted investments, we do want to make sure we're investing in what we see as very high return prospects for the business, the strategic initiatives, other initiatives. And I think if we can -- when we deliver the EPS range that we've guided to here, we believe we can. And while we're investing in the business, we think that's a fantastic EPS growth and operating profit growth for the year while investing in the future. So we feel really good about our ability to mitigate the headwinds, invest in the business and deliver a great year.

That's helpful. And then just to follow up, if you could just speak to the performance of the new stores and how you're thinking about the waterfall as stores mature. And then separately, just the apparel performance. I know you're working on some initiatives there. But that was still lacking, I guess, apparel and home in the first half relative to how well you're performing in consumables. Just how should we think about the timetable of getting the return on those strategic investments?

I'll take the first question with regard to new unit performance. We continue to see great results out of our new units. As we've mentioned in the past, we manage -- we measure a basket of metrics, including new store productivity, where we continue to see our new stores opening at 80% to 85% productivity range of mature stores. We continue to see the actual sales track very closely to our pro forma model expectations. The team does a phenomenal job picking great sites and projecting the sales of those and they continue to deliver. We continue to see returns at the high end of our 20% to 22% range. And again, bear in mind, that's after tax and includes the impact of cannibalization, which we also track closely and continue to see that to be as expected and consistent. And we continue to see a payback period of less than 2 years. So we're very pleased with the performance we continue to see in those new stores. In terms of their contribution to comp, what we've said in the past is the impact of new stores, reloads, remodels and now cannibalization is in that 150 to 200 range, we continue to see that and with a great performance lately actually at the higher end of that.

And Paul, when you take a look at the sales initiatives, as we had mentioned, a lot of them are in and around consumables, but there are quite a few around nonconsumables as well. And as you take a look at our longer-term strategic initiatives around nonconsumables, we're very pleased with our early results there. We've got over 300 stores now that we've remodeled with the new nonconsumable look and feel, and they are doing very, very well. So it gives us great confidence that the 700 that we've got planned into this year that they'll have the same results as we continue to move forward. Now, these are longer-term initiatives. So as we move into 2019, with this confidence that we're seeing in the sales, we'll be able to put that into more stores and stay tuned into 2019 on how many we do. But at this rate, we believe we could do quite a lot of them in 2019 to help continue to move the needle in our nonconsumables. But even past that, in all of our stores, I think our team has done a fabulous job in being very relevant on our nonconsumable offering and also continue to show the value. And I think that showed, especially in our seasonal categories, in 2000 -- I'm sorry, in Q2 here that we just ended, where we had a very strong positive comp in seasonal, which drew a positive comp for the entire nonconsumable category as whole. So we feel good about the back half in nonconsumables and we'll continue to push hard to balance that mix out.

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

So it looks like home and apparel -- the home and apparel category just still kind of comping negative. Todd, with the retail environment that we have today, I guess, I would think that you'd have a bit more top line momentum in these discretionary categories. And obviously, it sounds like you're making some merchandise changes as you previously described. But do you have a view as to why even in this environment, it seemed to be such a struggle to drive positive comps in these categories?

Yes, I think as you continue to take a look at nonconsumables, a few things that we have done, we are making changes, to your point, in our current lineup. And one of the changes we started to make even last year was a reduction in our apparel offering. And that was very intentional to give more room for some consumable areas but also some other nonconsumable areas as like, for instance, in some seasonal categories, which you saw pretty good strength in. So there is a trade-off there, we knew that going in. But when you look in totality, you always have to remember, too, while the economy is doing very well, our core customer continues to struggle because normally, her expenses outstrip her wage growth. And that's what we're really seeing here is that when you -- when you take a look at our core customer, the headwinds of rents as well as health care increases, that they are real for our core customer. And she continues to buy a little bit more because she does have just a small amount of income more, but not a lot. And we continue to offer her great values, both in consumables and nonconsumables. And we're seeing the effects in many, many areas where she is buying more, but a lot of it is to benefit her family and to feed her family.

Your next question is from Michael Lasser with UBS.

If you look at the performance of your store base in this most recent quarter, were there themes or trends that you saw, whether it was from a geographic perspective, urban, rural, suburban, or from a competitive overlap perspective? And the question really is to get at are you seeing some evidence that those discretionary -- incremental discretionary dollars that most consumers have at this point are flowing into some of your competitors and there may be a bit of a procyclical trade up, and you may not feeling as much of a benefit from that?

Yes. Let me start by saying that we are very pleased with our sales overall. That 3.7% comp was very strong. And we saw benefit from all across the country, every division across the country benefited in that. So that was great to see. That really shows that not only the consumer has a little bit more money, but also, our initiatives in totality are really paying off. Again, 3.7% comp is pretty strong. And then, as you look at our customer segmentation, and that's the second part of your question, what we're seeing is that while our core customer, which we call our best friends forever, or BFFs, they continue to stay very solid and are very good loyal customers of ours. The interesting thing here we're seeing is that some of our largest, on a percent basis, growth in customers is coming from higher income, which is very interesting. So even though the economy's doing better, what it really shows us is that all the work that we've done with the offering inside of our box over the years is even more relevant than ever and is even more relevant to a higher end consumer. Even in a good economy, she is still looking for value and convenience and she's finding it at Dollar General. So that's great to see, and we have seen no sign of trade out or trade up from our core customers. So that all adds up to that strong 3.7% comp.

And the higher income consumer, are they coming in mostly buying consumables?

Well, we can see them buying a little bit of both. But consumables, especially in food, paper, cleaning categories and, by the way, one of the biggest growths that we've seen from that consumer base is in health and beauty. And that makes a lot of sense to us in all the work that we've done around that.

And then just a quick follow up for John. How much incremental transportation cost pressure have you factored into your guidance for the rest of the year? And should we expect a wide variance in your comp between the third quarter and the fourth quarter?

In terms of carrier rates, we've factored in basically what we see on the horizon as the anticipated costs there. That's all captured in the guidance. And as mentioned, we do anticipate that getting a little bit worse before it gets better and have factored that in, but again, have a lot of mitigating actions that we've also played in to help counteract the impact of that. So that's all played in. In terms of sales comps, we don't get into quarter-by-quarter. But would say that the impact of what we see from the large number of units rolling into the comp base helps counteract some of the laps to smooth it out somewhat over the back half of the year.

Your next question is from John Heinbockel with Guggenheim.

Todd, so 2 things I wanted to get into. First, produce. When that brings the remodel benefit up to 15%, is that evenly split between traffic and ticket, the incremental piece you're getting from produce, number one? Two, how many stores do you think ultimately can have produce? And then what's your shrink experience with that?

Yes, those are all great questions, John. And those are the same questions that we continue to monitor here at Dollar General as we continue to learn more about selling produce outside of our market stores and now into some of our, call it, traditional and/or DGTP stores. But as you look at it, you can definitely see an increase in both ticket and traffic across these remodels, and you can see an even larger traffic increase when you have produce because you're at the top end of the 10% to 15% scale of increase. So it's great to see that it helps drive both traffic and ticket. And to your point, what we're managing right now is these are live goods. This is different than selling cans of corn as we all know. And so we're continuing to learn how to manage this in the stores. Our operators have done a great job in working through new processes. So the shrink is probably a little bit higher than where it will end up being, but I think you know us pretty well over the years, we won't do anything that isn't very accretive at the end. So we're pretty bullish about where those gross margins in produce could end up as we get more and more developed. And then your last question, well, how many could you do, well, we're not prepared yet to say, but we believe that there could be thousands of stores that could have this lineup. And we'll continue to work toward that as we learn more and more about produce.

And then one last thing, this obviously is the first holiday season without Toys "R" Us. So -- and you can do a lot of business in toys. How do you think about what you want to do differently, without giving your playbook, this year versus past years? And is that -- do you think that's a very significant opportunity to acquire new customers?

I believe that overall, that our category management team has done a fabulous job in our seasonal categories and especially in our toy categories. And we continue to make progress there. And we're seeing benefits right now from that progress. Is some of it from a competitor that's no longer with us? That could be some of it. But I do have to say that our category management team in and around toys has done a great job. And I've seen the lineup for holiday, and it's very, very strong.

Your next question is from Chuck Grom with Gordon Haskett.

Most of my questions have been answered, but just on the acceleration in traffic here from 1Q to 2Q, just wondering if you could unpack that for us across the chain. And then on the pricing front, how are you guys feeling about your positioning vis-à-vis Walmart? Based on our work, it looks like you're pretty tight. Do you agree with that? And given that you are in a position of strength and given that you do have some advantages on the margin line, how are you thinking about the ability to chase units and to invest more in price given your positioning today?

Yes, as you look at, we're, first of all, very happy with the 3.7% comp and very happy to see both traffic and ticket on the positive side. As you take a look at traffic, obviously, our consumable business drove a lot of our traffic gains and that's by design. We've always said that our consumable business will drive the traffic and our nonconsumable business will continue to enhance the basket and enhance our margin, and that's exactly how we saw Q2 unfold. And we believe that over time, that's how we'll continue to drive both traffic and ticket within our store. And as you look at our prices, we are as good at price today as we ever have been. I've been saying that for multiple quarters now, and we're looking very, very good across all classes of trade. And it's really evidenced by our market share gains and if that -- those market share gains are across all classes of trade and across the 4-, 12-, 24- and 52-week period. So this isn't a new phenomenon. We've been stealing share for quite a while. And it's again, I believe, because of that competitive box that we've put together. And I believe we've got the best execution at retail that's out there when you go across 15,000 stores and the ability to execute at the high level that we do. So those are all very additive for us as we look to continue to drive sales and comps in the future. And then lastly, in price, we've always said we'll continue to work the price lever where we believe it's necessary to continue to drive traffic and/or where our consumers are feeling the pinch. And so we continue to do that today. We're working the price lever in many different parts of the country today to continue to engage our consumer and to continue to have her shop with us more often, and just -- you'll continue to see that as we move forward. That's part of the playbook and has been for as many years as I've been here, Chuck.

Okay, great. And then just one quick one for John. Just on the comp here in the quarter. Can you frame out on how the comp trended by the month-by-month? And then in terms of August, anything you'd like to share on the start to the third quarter?

What I would say is we just feel very good about the balance we saw in the quarter. Each one of the periods was strong. And as we mentioned, we saw a good balance across consumables and nonconsumables, too. So I think it was a very balanced performance for the quarter. And we feel great where we are right now with the initiatives in place, firing on all cylinders and building momentum.

Thank you, ladies and gentlemen. This does conclude today's conference call. A replay of today's earnings release will be available shortly. Instructions for listening to the replay are available in the company's earnings press release issued this morning. This does conclude today's call. You may now disconnect.