Good morning. My name is Sia, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dollar General Third Quarter 2018 Earnings Call. Today is Tuesday, December 4, 2018. [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 Ms. Jennifer Beugelmans, Vice President of Investor Relations and Public Relations. Ms. Beugelmans, you may begin your conference, ma'am.

Thank you, Sia, 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 up the call for questions. Our earnings release today -- issued today can be found in our website at investor.dollargeneral.com under News & Events. Let me caution you that today's comments will include forward-looking statements about our expectations, plans, future estimates and other non-historical matters, including, but not limited to our fiscal 2018 financial guidance, our fiscal 2018 and 2019 real estate plans; our planned investments, initiatives and 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, will, believe, anticipate, expect, assume, outlook, estimate, guidance, plans, opportunity, continue, focused on, or goal 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 may be 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 pleased with our third quarter results, particularly given the 2 major hurricanes that devastated communities in some of our most heavily penetrated areas in the South Eastern United States. We stayed focused on our initiatives, kept the customer at the center of everything we do, and our financial performance during the quarter demonstrated what this type of focus can produce. Before discussing our third quarter results, I want to express my gratitude to all of our teams who have worked so diligently in very difficult circumstances to serve the communities we call home. We recently visited with our field teams in the Carolinas and the Florida Panhandle where the damage was the greatest. I say it frequently but it bears repeating, I am so inspired by our team's consistent dedication to our mission of Serving Others. Turning now to our third quarter performance. We delivered another solid quarter with strong growth on both the top and bottom lines. On the top line, our same-store sales growth of 2.8% resulted in our highest 2-year stack in 11 quarters. This quarter, our comp growth was primarily driven by our customers checking out with larger baskets. We believe this is a reflection of all the work we have done to make the box more relevant for our customers. As our customer's needs evolve, they are telling us they want a fuller shop from us and we're delivering with even more of the products they want at the values they need. Year-to-date, through the 2018 third quarter, we posted 2.9% same-store sales growth, which continue to be driven by greater customer productivity. We feel good about our 39-week performance as well as the outlook for the rest of the year. We did,…

Thank you, Todd, and good morning, everyone. I will now take you through some of the important financial details for the quarter and year-to-date. 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 29.5% in the third quarter, a decrease of 39 basis points. This decrease was primarily attributable to an increase in the LIFO provision, the ongoing product category mix shift to consumables as well as higher sales of lower margin consumable products, higher markdowns and increased transportation costs. We recorded a $12.5 million LIFO provision in the third quarter of 2018 compared with a $0.5 million LIFO provision in the third quarter of 2017. This LIFO increase was attributable to cost increases, which were primarily due to direct and indirect impacts of both tariffs and the increased transportation cost pressures. As you've heard from us and other retailers throughout the year, our business has continued to see the effect of higher transportation costs due to the tight carrier market and higher fuel prices, among other factors. While we have navigated sales mix challenges and markdowns as part of the retail landscape for many years, the headwind from transportation cost is a relatively more recent challenge impacting our gross margin. We anticipate this trend to continue primarily as a result of higher carrier rates. These factors were partially offset by another quarter of improved inventory shrink. SG&A as a percent of sales was 22.6%, a decrease of 21 basis points. The leverage in the third quarter of 2018 was primarily driven by reductions in incentive compensation, lower advertising and supplies expenses, and lower repairs and maintenance expenses as a percentage of sales. Partially offsetting those decreases were an estimated…

Thank you, John. We are pleased with our financial results and are proud of the team's focus. I want to take the next few minutes to walk through how we are executing against our operating priorities and give you an update on the progress we are making on our long-term strategic growth initiatives. Starting with our first priority of driving profitable sales growth. Our portfolio of top line initiatives is contributing to the strong year-to-date performance we have seen through the third quarter of 2018. These initiatives are designed to enhance the value and convenience proposition for our customers, offering them the trust and simple solutions they seek from us every day. Our cooler expansion continues to be an important sales initiative, particularly in mature stores. The team has done a fantastic job increasing the average number of cooler doors across the chain, and we are seeing a great return on this investment. As of the end of the third quarter, we have installed more than 20,000 cooler doors across our mature store base in fiscal 2018. Based on the success of this initiative, we anticipate continuing our cooler expansion efforts in 2019. During the third quarter, we also continued to ramp up optimized queue lines throughout select stores. The performance of these queue lines remained very strong, exceeding our own expectations. We now have the queue line enhancement in approximately 7,500 stores across the chain. Given the continued success of this rollout, we anticipate expanding this initiative in 2019 as well. We continue to be very excited about the early results from our Better For You initiative, which is performing well above our initial goals. We launched Better For You just a few months ago in response to feedback from our customers who are starting to look for healthier…

[Operator Instructions] The first question will come from Rupesh Parikh with Oppenheimer.

So on the gross margin line, I was hoping for a more color in terms of some of the puts and takes as you look out for Q4 and also just some initial thoughts on what headwinds you think could continue into next year?

Yes, so I'll talk about the performance thus far and then talk about -- address your question in terms of what we see looking forward. As you look year-to-date, our gross margin is down 10 basis points. In Q3, we did see some increased near-term pressures from carrier rates, tariffs, coupled with the ongoing headwinds -- we always manage through with mix and markdown pressures. As we look to -- ahead in the near term, I think these pressures will continue with the carrier rates and tariffs. The team continues to mitigate those, and it's done a really great job of that, but it's hard to say how long those pressures will persist. But I would say, as I look over the long term, we still see an opportunity to grow our gross margin, enhance it, reinvest in the business as needed. As we look at the levers, there's multiple levers within gross margin and SG&A. As you look at gross margin, we continue to see great performance from shrink, 8 consecutive quarters of sequential improvement there, and with the investments we've made, the process rigor, we see that continuing. We just completed putting 10,000, growing our EAS units from 5,000 to 10,000 and seeing great results there. Team does a great job of category management. We continue to see opportunity to increase our private label penetration, our foreign sourcing penetration and our non-consumable sales. We're pleased to see positive comps again on our non-consumables. And as Todd mentioned, pleased with what we're seeing from the non-consumable initiatives. On the supply chain side, while we do have the headwind of transportation costs facing everybody, the team is doing a great job, has been proactively mitigating that. We continue to open new DCs, 2 opening this year, which will reduce stem miles, continue to reduce load optimization, drive DC productivity. Very pleased with the results we're seeing from our private fleet as we step that up from 80 to 200 tractors based on the success we've seen and continue to expand and diversify our carrier base. So a lot of levers here within gross margin. And as we look at SG&A, we're pleased to leverage our SG&A again for the second consecutive quarter since we anniversaried the investment we made last year in our store manager compensation, which is paying off very nicely for us. So as you look across all these, while there are some near-term headwinds, over the long term, we see an ability to enhance our gross margin and operating margin overall as we balance all the levers within operating margin.

Great. And a quick follow-up, so LIFO provision seem to be a bigger headwind this quarter. Do you expect that to continue into Q4?

Yes, if you look at the key drivers of the LIFO provision, the $12.5 million we recorded, it was primarily attributable to direct and indirect impacts of tariffs and increased transportation cost pressures. Those do persist, but I will say, as you look at Q3 because you're looking at the end of the year, because a lot has occurred in Q3, you had to reflect the impact to the first 3 quarters there. There will be an impact in Q4, a proportionate amount of that and to the extent anything else increases or decreases that will change the LIFO provisions. And all this, of course, is contemplated in our guidance.

The next question is from Karen Short with Barclays Capital.

Just wanted to follow up on that a little bit. So in terms of looking forward, I guess, I mean, I'm talking about '19, it seems that transport should mitigate slightly. And it doesn't sound like you will have -- be making any labor investments into '19. Can you maybe just give a little color on that if that's an accurate way to think about '19?

Yes, you know what I'll say is, as we look forward -- we'll be coming out with guidance later for next year -- but what I would say is, as we look forward, we continue to see ourselves as a double-digit adjusted EPS grower. To your point, it's hard to say how long the carrier rate pressure will continue, but we feel we're very well positioned with the mitigating actions that we're taking as that stabilizes. To your point on labor, as we look at labor costs, we're very well positioned right now with the investment we made in store manager compensation last year, now we've anniversaried that, we're seeing great results in terms of we're on pace for the best we've seen around store manager turnover and applicant flows and staffing levels. And we see throughout the organization, at the store level, we're very well positioned in terms of staffing and applicant flows. And as we look at it, we're competitive, not just on wages, but the other benefits that Todd mentioned that we've added this year for the overall compensation as well as when you just look at the growth opportunity within Dollar General, that's a real compelling driver for people who want to join Dollar General as they can advance rapidly through the organization if they're really looking at the career, so as we look at it, we're well positioned, we'll look market-by-market to make sure we stay competitive as we are now, but we don't see a major investment on the horizon like we had to make -- we made last year proactively. So as you look at the levers, the fundamentals of the business remain very strong. We continue to see a long runway for growth. With new unit development, we continue to see great store-level economics and great returns, we continue to see our returns at the high end of that 20% -- [ to 20%] after-tax IRR, which again is burdened with the impact of cannibalization. The sales initiatives continue to perform well. We continue to grow units and share. And we have multiple levers, as I mentioned, within gross margin, SG&A, and in turn the business generates a tremendous amount of cash, which we can reinvest in high-return projects, like new store growth, strategic initiatives and the infrastructure. So it's a very strong business model, a very resilient business model, and we still see ourselves as 10% growers over the long-term.

Okay. Thanks for that And I just wanted to ask quickly about traffic. I mean, traffic obviously was positive in the third -- or second quarter and then it went flat this quarter. Maybe just a little color on how we should think about traffic in 4Q? And I'm just wondering if there was any hurricane impacts on the traffic?

Yes, as you look at traffic, we're squarely focused on driving that top line to include that the traffic that you mentioned. Being flat, we would like to have seen a little bit more on the traffic side, but I have to say, the actions that the team has taken to drive that top line is really paying benefits in a fuller basket shop and that's really where we're seeing the benefit right now. But I could tell you that the team, right now, as I mentioned in my prepared remarks, are squarely focused on 2019. As you can imagine, we're 6 months out or longer. And stay tuned as we roll-out our '19 initiatives, there are some really good initiatives around driving both that top line and that traffic number into '19. We feel that that long-term, that traffic number being positive is one of our most important currencies.

The next question will come from Michael Lasser with UBS.

Year-to-date, your comp is trending just below 3% and you have an easier comparison in the fourth quarter, and you're guiding to maybe a 2% to 2.5% as implied by your outlook. Why wouldn't it be better than that? Have you seen a slowdown to start the fourth quarter?

Yes, what I would say is, as you look at, you're first looking at Q3, we saw stable performance throughout the quarter. If you look at the first period of the quarter versus last period of the quarter, they were comparable and solid throughout -- and positive on both consumables and non-consumables. As you look at the full year guidance, it was a minor adjustment. We had said previously that we're looking at mid- to high on comp growth and anchored [folks] towards the middle of that. And I think if you do the math on that that would suggest a material change in the trajectory there. And again, we feel very good about the initiatives in place and how they're performing, the fundamentals of the business and continuing to take share from all channels of retailers.

And then my follow-up is, you did tweak your guidance on the cost side because -- largely because of the hurricanes. Can you give us some more depth on what's specifically driving the $0.09 incremental headwind? How many stores were impacted? Is this mainly due to store damage and lost sales? And is there something else going on?

Yes, so as you alluded to with the guidance change, it was primarily driven by the $0.09 impact of the unanticipated disaster-related expenses. As we called out, that was primarily driven by Hurricanes Florence and Michael. And within that, the type of -- we haven't disclosed the number of stores impacted. But what I will say is as you look at our footprint, we're particularly dense in coastal Carolinas and coastal Florida as well as in rural areas where lot of the heaviest damage was. So we had a high store concentration there. As you look at the nature of the cost, it was store damage and repairs, inventory damage were the key drivers there. As we did mention, while hurricanes were the primary driver here, that cost figure that we provided also included the impact of other disasters, most notably floods and fires, again, that were of an unusual nature above and beyond the normal run rate that we -- has been. So that was the primary driver of the guidance change as well as just other miscellaneous puts and takes.

Were there any other significant call-outs that motivated you to adjust the guidance? Or maybe give us a little bit more detail on those?

So I would say if not for the impact of the disasters, the $0.09 impact we wouldn't have seen the need to adjust guidance. Within the other $0.01 there, there's various puts and takes that I mentioned, including the higher transportation costs and tariffs net impact on LIFO. But obviously within there a lot of puts and takes on that other $0.01.

The next question will come from Paul Trussell with Deutsche Bank.

Still a lot of moving parts regarding the tariff conversation. But could you just give a little bit more detail on how your business has prepared for the potential of incremental tariffs, the impact you're seeing in the P&L today? And what -- to what extent you have already mitigated some of those additional potential costs in 2019? And maybe just taking a step back on gross margins. You outlined earlier, John, a number of positives and tailwinds on the gross margin front. But if we look back over the last 5 years, I think gross margins are down roughly 90 to 100 basis points. How should we think about maybe the longer-term opportunity on gross margin and where that can get back to?

Sure, Paul. So as you look at the tariffs, obviously we, like a lot of folks out there in retail, we're very proactive around the possible tariff impact that we saw coming down. We took a lot of proactive steps, including as we talked about, mitigating steps to order some products in a little bit early. So some opportunity to move some products in a little earlier, we did that. We've been working diligently with our community overseas, particularly in China, our offices there and our vendor community to ensure that we can reduce some costs. We've got great relationships, big relationships with those vendors over there, those factories and players. And we've been able to do a lot around reducing some of the costs to also move around some of these tariffs. And then lastly, we continue to move products and look for ways to move product out of China. That's not a phenomenon that happens overnight. But if you go back, we've been talking about moving products out of China for quite a while and not being so China-centric. We've been working hard at that. So I believe we are a little bit ahead of the game there. We continue to work hard to move our product lines and different opportunities to move things out of China itself. As you look at gross margins, just in general, I would say the team has done a really good job in the environment that is out there right now. I can tell you that we've got a lot of levers that we continue to pull in gross margin, as John has indicated, and we continue to work really hard around making sure that whatever we do at the end of the day, is that we've got the right price for the consumer, and that's always top of mind for us. And I believe you see through our surveys that we are in very, very good shape on pricing. Because at the end of the day, in long-term, that will be the real litmus test on -- for the consumer on your health as a company. And we believe our share gains as of late have come because of our pricing and our pricing activity, and that's always been there and always will continue to be there. But we stayed really focused on margins to deliver both at top line and the bottom line. But operating margin is really where our focus is and we'll continue to work all the levers.

And just a quick follow-up. I appreciate you giving your forward guidance regarding store expansion and remodel opportunities. Maybe just quickly, give a little bit more detail around what you see as the white space opportunity? Are these stores being opened, and mostly these are backfilling current markets, to what extent are you looking to penetrate urban markets? And also what have you seen in terms of your latest class of stores from a productivity and return standpoint?

Sure. As you take a look at it, the team's done a great job over the years. It's one of our core strength is finding the right opportunity out there, the right real estate and then opening stores. And over the years, Paul, we have done a very good job in really watching the key metrics that we talked about. I can tell you that the latest class of stores in 2018 had been coming right out of the ground just where we thought it would. So again, right in that upper 90s to 100% of pro forma range and that continues to be right where we believe the sweet spot is. And as we continue to look out, we think there's a tremendous amount of runway still to open up stores in the continental United States. The class of 2019 will look very similar to the class of 2018 as far as the makeup between rural, metro and more urban-type settings. So again, heavily driven toward the -- a little bit more driven toward the rural communities. But yes, over time, we believe that opening more and more stores in metro is the right thing to do. And we have strategic goals and opportunities and initiatives centered around that that we're going to talk about a little bit further as we move into 2019. But suffice to say that our formats that we've developed over the years has really given us the opportunity to open the white space up, and we still believe there's 12,000 to 13,000 opportunities to put a Dollar General store out in the continental United States and in areas that are not as familiar as evidenced by opening 10 next year, DGX stores, is what our goal is. And those are in vertical living, more densely populated areas in some key cities out there across the U.S. So we feel as good as ever about our real estate portfolio. And to include our remodel program, which is very, very strong and continues to throw off fabulous comps as we continue to move forward too. So we've got a great runway ahead of us and we're capitalizing on that very quickly.

The next question will come from Vincent Sinisi with Morgan Stanley.

Just wanted to go back 1 second just to the revised outlook. Kind of the puts and takes and tell me if I'm thinking about this correctly as well, right? If you kind of take the mid-point of your new guidance on the EPS lines in the commentary around the EBIT, you have done a great job of telling kind of what the hurricane impact is. And then if you kind of though add the lower tax rate benefit in there, it seems like there's still a little bit just kind of more of a core EBIT decline there. From the commentary, it sounds like that's largely really around the growth side with the transportation costs and tariffs. I guess, is that kind of a good sum-up? Is that true? And are there any other factors for 4Q specifically that we all should be thinking about?

I think that is a good summary. As you stated, the biggest driver there was the hurricane, disaster-related expenses. And as you look at that other $0.01 there were puts-and-takes. In retail, you're always battling through mix and markdowns and we've been doing that for years very well. I think the piece that added a little extra pressure this quarter is -- and for the near term is the higher transportation costs and tariffs. But I think that was a good summary overall. And again, over the long-term, we see a lot of levers to not only mitigate these but enhance our gross margin and operating margin.

For sure, okay, that's helpful. And then maybe just as a follow-up. This is a kind of more of a big picture thought. When we're thinking about kind of the future of how you continue to generate solid ticket and traffic, you talked about numerous initiatives, of course as well as kind of mix changes and tests and formats. It seems at least like with some of the store growth plan and different formats on the smaller ones and the plus -- I guess the basic question here is, what are some of the bigger learnings so far? And while maybe '19 store growth is going to be similar to '18, kind of how do you see the mix and also may be the makeup of the sizes of the stores may be changing going forward?

That's a great question. We look at that obviously very often internally, and we actually build our initiatives around those very thoughts. And I can tell you that we intentionally develop these additional formats to be able to move into certain demographics across the U.S. where a one-size-fits-all mentality is really not the way to be productive and to make the most of your real estate portfolio and of course, driving top line and traffic as you indicated. So having those opportunities to put stores, for instance, with a produce selection in areas that are more food deserts in the United States, both in the rural communities and by the way, in more metro settings, we find that we can drive a tremendous amount of traffic that way. Same thing with our cooler expansion that we've been very, very open about over the last many years. I would tell you that if you're thinking about a baseball game here, we're still probably only in the bottom of the fifth inning when it comes to our cooler expansion opportunities, both in our mature store base, and of course, as we continue to refine our Dollar General Plus and DGTP concepts with broader cooler expansions in them. And again, I think once you look at this, our consumers are voting with their pocketbooks and we're driving nice comps through the box today. And when you look at these remodels throwing up 10% to 15% comp lift in DGTP with these additional coolers and then the high end with produce, we feel that we've got a real good runway ahead of us to continue to drive both traffic, ticket and overall sales very profitably, which is our first priority out there is driving that profitable sales growth. So overall, we believe the portfolio is very strong. Now as you move in the outer years, you will see a mix change to a -- it won't be a radical change, it will be a slow, methodical change to a little bit more of a heavier metro mix as we continue to build the portfolio out. But it will be -- we'll signal that very well over time and we'll make sure that, in fact, we do it very methodically. And again, as I indicated, we'll talk about in 2019 some initiatives we have around our urban setting and our urban initiatives that we're working on very hard right now out there.

The next question is from Matthew Boss with JP Morgan.

This is Aaron Grey on for Matt Boss. As we think about your underlying EPS profile, are we right to think that ex the impact of hurricanes and tax reform, we're still on track to hit roughly around 10% EPS growth for the year? And then as we look forward, any change to your ability to drive double-digit EPS growth for the next few years?

No, I think that's the way to look at it. As you look at this year, we feel very good with the guidance we provided that, that provides a very strong top line, bottom line performance for the year, while reinvesting in our initiatives that is consistent with that long-term goal of driving double-digit adjusted earnings per share growth. And as I mentioned earlier, as we look over the long-term, we continue to see ourselves as a double-digit EPS grower with the strong fundamentals of the business on new store growth with the performance Todd mentioned, driving comp growth with the initiatives in place, continuing to grow units and share with the number of levers we have within operating margin I mentioned and the tremendous amount of cash this business generates to reinvest. We see this as a strong resilient business model with the fundamentals and change, and I think that's the right way to think about it.

Okay, great. And then on SG&A, are we still right to think about 2.5% to 3% as the underlying fixed cost hurdle for the fourth quarter and then also as we look into 2019?

Well, we don't break down guidance specifically between SG&A and gross margin by quarter. We did give the overall guidance for the year. But I would say our goal remains to leverage SG&A in that 2.5% to 3% range, and we're pleased to have done that -- the 2 quarters, the last 2 quarters as we anniversaried that important investment in our store manager compensation and over the long-term, a lot of levers to do that and that's our goal and intention.

The final question is from Greg Badishkanian with Citi.

It's actually Garrett Klumpar for Greg. Just wanted to touch on the DG GO! app continue to see pretty good growth there. Just wondering, you called out improving the in-store experience is the biggest near term on digital but what -- just wondered if we could get a little more color on what specifically you think are the other key areas of improving that convenience offering for customers?

Sure. As we talk to our customers all the time and as you know, convenience is measured differently depending on what customer you ask. But I could tell you that we're squarely focused on making the convenience offering within our 4 walls even more convenient. Again, we're very convenient as far as where we're located, we're convenient you can park at the front door, walk in, you can get in and out of stores with a 5 or 6 item shopping experience in less than 10 minutes, 5 in the most -- in most cases. But you know what, our consumers are also saying, how do you even get more convenience. So the DG GO! app does that. Where she can skip the checkout line by checking herself out. And what we've seen is good adoption so far with that app. Again, only 250 stores, like everything here at Dollar General, we test and we learn before we move and roll out, and we want to make sure that the return is as strong as we believe it will be for this initiative. So stay tuned, more to come. We believe that we're on the right track because again, it's about making sure that our consumers have a frictionless shopping experience, quick in and out, and we give her exactly what she wants here at Dollar General.

Ladies and gentlemen, we've reached the end of the allotted time for the Q&A session. We thank you for your participation. You may now disconnect.