Good morning. My name is Robert, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Dollar General Third Quarter 2023 Earnings Call. Today is Thursday, December 1, 2022, [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'd like to turn the conference over to Mr. Kevin Walker, Vice President of Investor Relations. Kevin, you may now start your conference.

Thank you, and good morning, everyone. On the call with me today are Jeff Owen, our CEO; and John Garratt, our CFO. 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 include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, such as statements about our financial guidance, strategy, initiatives, plans, goals, priorities, opportunities, investments, expectations or beliefs about future matters and other statements that are not limited to historical fact. 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 2021 Form 10-K filed on March 18, 2022, and any later filed periodic report, 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. 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 Jeff.

Thank you, Kevin, and welcome to everyone joining our call. I want to begin by thanking our entire team for their ongoing commitment to serving our customers, communities and each other. The quarter was highlighted by strong performance on the top line, led by comp sales growth of 6.8% and included increases in traffic and in market share of both consumable and nonconsumable product sales. During the quarter, we experienced significantly higher-than-anticipated cost pressures, including challenges within our internal supply chain, sales mix pressures and higher inventory damages and shrink, all of which impacted gross margin. We will elaborate more on these cost pressures in a bit. But despite these challenges, we delivered a double-digit increase in diluted earnings per share, along with strong same-store sales growth. As the economic environment continued to evolve during the quarter, we remain focused on serving the needs of our core customer. We continue to see customer behaviors in Q3 that we believe indicate they are feeling increased financial pressure, including reductions in the number of items purchased per basket and in discretionary spending, which was softer than anticipated during the quarter. Customers also continued to shift spending to more affordable options, such as items that are dollar price point and private brands, while also shopping closer to payday at the first of the month. Importantly, we are growing more productive with our core customer as well as seeing an increase in customers with annual household incomes up to $100,000. This growth underscores our belief that our value and convenience proposition resonates with a broad spectrum of customers and will continue to be important to all customers in this challenging economic environment. In turn, we remain focused on delivering value and convenience and continue to feel good about our pricing position relative to competitors…

Thank you, Jeff, and good morning, everyone. Now that Jeff has taken you through a few highlights of the quarter, let me take you through some of its important financial details, beginning with gross profit. Unless we specifically note otherwise, all comparisons are year-over-year, all references to EPS refer to diluted earnings per share and all years noted refer to the corresponding fiscal year. For Q3, gross profit as a percentage of sales was 30.5%, a decrease of 27 basis points. This decrease was primarily attributable to a higher LIFO provision, a greater proportion of sales coming from the consumable category as well as increases in distribution costs, markdowns, inventory shrink and damages partially offset by higher inventory markups. Of note, product cost inflation was greater than anticipated, resulting in a LIFO provision of approximately $148 million during the quarter. And while we believe cost increases are beginning to moderate, we anticipate LIFO will continue to pressure Q4 as well. SG&A as a percentage of sales was 22.7%, a decrease of 23 basis points. This decrease was driven by expenses that were lower as a percentage of sales, the most significant of which were retail labor, incentive compensation, hurricane-related disaster expenses and occupancy costs. These were partially offset by expenses that were greater as a percentage of sales, including utilities, repairs and maintenance and travel and training costs. Moving down the income statement. Operating profit for the third quarter increased 10.5% to $736 million. As a percentage of sales, operating profit was 7.8%, a decrease of 4 basis points. Our effective tax rate for the quarter was 22.8% and compares to 22.2% in the third quarter last year. Finally, EPS for the third quarter increased 12% to $2.33. Turning now to our balance sheet and cash flow, which remains strong…

Thank you, John. Let me take the next few minutes to update you on our operating priorities and strategic initiatives. Our first operating priority is driving profitable sales growth. We are continuing to make significant progress executing against our robust portfolio of initiatives. Let me take you through some of the recent highlights. Starting with our nonconsumable initiative, or NCI, which was available in more than 16,000 stores at the end of the third quarter. With over 75% of the assortment at $5 or less, this treasure hunt offering continues to resonate with customers who are seeking value. We continue to be pleased with the sales and margin performance we are seeing from our NCI offering, including market share growth in nonconsumable product categories. Looking ahead, we expect to realize ongoing benefits from this initiative throughout the remainder of the year and remain on track to complete the rollout across nearly the entire chain by year-end. Moving to our pOpshelf store concept, which further builds on our success and learnings with NCI. As a reminder, pOpshelf aims to engage customers by offering a fun, affordable and differentiated treasure hunt experience delivered through continually refreshed merchandise, a differentiated in-store experience and exceptional value with the vast majority of our items priced at $5 or less. We recently celebrated the 2-year anniversary of the first pOpshelf store, along with our 100th store opening. And we are pleased to see the concept continuing to resonate with customers. During the quarter, we opened 23 new pOpshelf locations, bringing the total number of stores to 103 located within 9 states. Additionally, we opened 15 new store-within-a-store concepts during Q3, bringing the total number of Dollar General market stores with a smaller footprint pOpshelf store included to a total of 40. We remain on track to…

[Operator Instructions] Our first question comes from Matthew Boss with JPMorgan.

Great. So Jeff, maybe first, could you elaborate on what you think is driving the sequential acceleration in same-store sales? I think traffic has now sequentially improved for the second straight quarter. What are you seeing across the income cohort? And then maybe just looking back at past periods of consumer pressure, how sustainable do you see the market share opportunity in front of us?

Thanks, Matt. We are very pleased with our 6.8% comp sales increase. And as you mentioned, seeing traffic accelerate again for the second consecutive quarter was very nice to see, and also continuing to grow market share. We grew market share in our consumables and our nonconsumable business. And so when you think about that, our outperformance on sales really was driven in the consumables business, and it really is a testament to our going where the customer wants us to go. And that is something we've always done here at Dollar General. And I think it's a testament to the relevance of our box. When you think about our box and how we've continued to make it a fuller fill in shop, it really speaks to our ability to serve a broad spectrum of customers. And as you mentioned, with customers -- our core customer, one thing that is encouraging to see is she's still gainfully employed. And we've long said that is the single greatest factor in her economic health. So it's encouraging to see that, and it's encouraging to see us grow productivity and share with her. And also the encouraging thing we saw this quarter is we grew share in all income levels. And so that's particularly good to see when you think about the higher income levels. One of the things we've been very pleased at is our ability to retain that COVID customer higher than we expected to over the course of several quarters, and we continue to see that here. And we also saw us grow share and customers in the $100,000 income level. So when you step back and think about it, it again just points to our ability to serve multiple income cohorts. And that will set us up extremely well…

That's great. And then maybe, John, on gross margin and just to break down some of the components. So do you see these warehouse costs and supply chain efficiency is more transitory and contained to the fourth quarter? Help us to think about LIFO going forward relative to the material gross margin headwind this year, should we anticipate should transportation as a tailwind now from here? And just what inning do you see the drivers of inventory markup in today?

Sure, Matt. I'll start with the question around the supply chain costs. And as we called out versus previous expectations, the supply chain costs were a significant headwind more than $40 million above our previous expectations for Q3. And we do see this as near-term. And we're making very good progress toward resolving our storage capacity constraints as more capacity comes online. And we do believe some of these cost pressures, nonetheless, will carry over into Q4. However, we do expect this will largely be resolved in Q1 of next year. So as we look ahead, we anticipate supply chain costs, both internal and external in 2023 to be down quite a bit. We're obviously seeing it improving as others market for carrier costs as well. And so that as a potential tailwind going forward. And then LIFO as well. We're seeing the pace that while it will continue to pressure, Q4, we are seeing the pace of cost increases continue to moderate. And as we look at next year, we'd expect less pressure from LIFO. So certainly, some near-term pressures between LIFO between the supply chain cost. We also mentioned the sales mix shift and shrink and damages. But as we look to 2023 and beyond, we feel good about, as Jeff mentioned, one, the sales momentum in the business; but also moderating product cost and inflation, particularly around supply chain and LIFO. And as you look at the initiatives, we have that continue to contribute the other levers we have, not to mention our scale and where we're at in price, we don't see a need to invest. We feel that we're very well positioned as we look ahead to the future to continue expanding gross margin over the long-term.

That's a great color. Best of luck.

You asked about markdowns as well. I didn't want to miss that question. As you look at markdown risk, while up from the unusually low levels last year, markdowns are still well below pre-pandemic levels. If you look at the majority of the inventory growth, it's really driven by inflation. The team has done a good job anticipating the mix shift in consumer demand and has proactively been adjusting orders. And as a result, we feel very good about the quality of the inventory, ability to mitigate the markdown risk. As always, we've set aside, what we believe is an appropriate markdown level for the upcoming Christmas season. And of course, this is all reflected in our guidance.

Our next question comes from Simeon Gutman with Morgan Stanley.

I think a follow-up, John, for you. So this year, you were going to grow earnings sort of in line with [indiscernible] excluding the 53rd week, and now it's going to be below and yet you're doing more sales. So there's clearly something coiled up here in the model. I know you're not going to guide next year, but the theoretical framework is there should be some recapture. If there is recapture, are you inclined to let that flow? Or do you manage -- do you think the business just manages towards [indiscernible] and I don't know if it's to reinvest or maybe we don't see all the recapture that I'm hinting at?

Sure. So as you mentioned, we won't be giving specific guidance on this call. We'll certainly share that on the March call. But I'll just start by reiterating that we feel great about the fundamentals of the business, the sales momentum, coupled with the moderating cost pressures that I just articulated. And as you called out, it is a 1 less week next year that's important to bear in mind. But again, as you look at the fundamentals of the business, they're very strong. We continue to see ourselves as 10% EPS growers over the long-term. Now we will always balance that with investing back in the business for the long-term, but feel we're very well positioned. And more to come for next year, but feel great about the momentum of the business fundamentals.

Okay. And maybe my follow-up, maybe sticking with you on fourth quarter gross margin. I guess, we're trying to build to the pieces, supply chain, mix, shrink. And we're having trouble getting to the entire magnitude. Are you willing to share a little more magnitude by item, by driver? Because it doesn't feel like the consumables mix goes up enough to justify the mix. So there seems like there's something like markdown in there as well.

So as you look at the drivers of the additional pressure on Q4, it's the same drivers as Q3, the order is a little bit different. As you look at what we anticipate as the key pressures on Q4 margins is still healthy flow-through, but less than previously expected. The big difference is, first the mix shift. We did see a mix shift in the consumables as customers face financial pressures. We want to go where the customer goes, and like the sales we're seeing, but it does pressure your margin a little bit with the mix of the sales. The other piece -- we did see -- we mentioned as we progressed through Q3 is a greater headwind from inventory shrink and damages. And that shrink can have a tail to that. Rest assured, the team knows how to deal with this and is taking actions to address it. But it does have a tail to it. And then while we are making good progress resolving our storage capacity constraints with the capacity online, we do believe, as we mentioned, that some of this will carry over into Q4, but be largely resolved by Q1. So that's the big versus our previous expectations. Obviously, the other big one is LIFO. As you look at LIFO, we called out $148 million in Q3, while we believe the product cost headwind is beginning to moderate. The prior cost increases will continue to pressure Q4 LIFO, and you could do the math as you do -- as you spread that across the year. So that's really the key drivers. But again, I'll just reiterate, many of these are transitory in nature. And as we look ahead to the future, we feel we're well positioned to resume growing our gross margin over the long-term with the initiatives, the levers, our scale and the pricing position we're in.

Our next question comes from Corey Tarlowe with Jefferies.

Congrats on the continued top line momentum and share gains that you've witnessed. So with that in mind, maybe could you parse out a little bit what you're seeing in terms of how the customer is behaving because it's clear that traffic is up. The customer is visiting the store more and should -- maybe shifting a little bit into private label. Could you talk a little bit about what you're seeing in that regard and how you're investing to continue to support the growth in that segment? And then secondarily, as you see that mix shift happen more to the consumable side, how do you marry that with the continued growth that you're likely to see in NCI, which should actually help to underpin, I would say, better profitability as we look ahead?

Corey, this is Jeff. Thank you for your question. And I'll start with the customer. I'll reiterate the fact that her gainfully being employed is, again, a very important factor to economic health. And so when we talk to our customers, and I feel like our teams do that better than just about anybody. What we hear is she's feeling the pressure of energy prices and fuel and just the everyday needs are -- it's hard to -- for her to make ends meet. And so she's behaving pretty much exactly the way we would expect her to in times like this. So what we're seeing from her is, as you alluded to, she's coming to us more often. She's buying fewer items on each occasion. And one of the things that we're very pleased is we're being able to help serve her needs through affordability. And our leaning into the dollar price point, our customer is responding incredibly well to that. And I just -- a testament to our team and to our ability to go where the customer wants us to around our $1 price point and affordability. But when you think about the consumable business, as you mentioned before, you got again, really step back and think about the strategic initiatives and how that has allowed us to really have a more profitable business there. And we've long used consumables to drive traffic and nonconsumables to build the basket. And so as we think about our -- excuse me, the nonconsumable, as you mentioned, certainly, we continue to be pleased with what we're seeing on NCI, and its ability to really provide that value. When you think about NCI, 80% of the items are $5 or less. And so when you think about our ability to drive…

That's great. And then thanks for laying out the new store plans for next year. I think that helps to really provide a little bit more color as to the predictability and stability that we should expect ahead. Could you talk a little bit more about the strong returns that you're continuing to see on those new stores? And what we should expect more so from a continued ROIC standpoint as it relates to some of these new stores as we look ahead?

Yes, Corey, I'll start and then I'll let John fill in on some of your questions around returns. But our real estate model continues to be a huge strength of this business. I mean the low-risk and high-return model is incredibly powerful. And when you think about the retail landscape today, when you think about some of the challenges other retailers have talked about on the real estate front, I'm just very, very excited and proud of the fact that we're going to deliver more projects than we ever have at Dollar General in 2023. And with 1,050 new stores, it continues to just highlight our ability to serve the customer and our ability through format innovation, our real estate model, our technology, we're able to go where the customer needs us to go. And so feel great about that. And really pleased at the fact, through format innovation, this larger store we're opening, our new store performance has been incredibly positive. And I'm very, very pleased at our ability to exceed our pro formas, and we continue to see that. So that larger store format is continuing to deliver higher sales per square foot, which is excited. And as you know, the large majority of our openings are in that larger footprint. But as you think about the next year in the future, I think the other thing that excites us here is the pipeline that we have. And on the U.S. alone, we have 16,000 additional opportunities, and we feel great about our ability to capture those. And certainly, our fair share, which we've certainly demonstrated, but 12,000 additional for DG, 3,000 for pOpshelf and then 1,000 for DGX. So stepping back, you can probably hear in my excitement about the real estate and our ability to continue to grow here. And we feel like we're being very prudent in this environment, I'm very, very pleased with the team's performance here. So I'll kick it over to John for your return question.

Yes. And just -- echoing Jeff's comments, we're very pleased with the results we're seeing. As he mentioned, we're above pro forma in sales, which puts us ahead of schedule in terms of the IRRs. Again, we target a 20% to 22% after-tax IRR based on the sales. And as we outperform in sales, that puts us a little ahead on the returns as well. And feel not only great about the -- and again, it's always important to bear in mind that it includes the impact of cannibalization, which is very minimal, has been very consistent, just given the localized nature of the shop. We continue to see paybacks less than 2 years. So it continues to be a fantastic investment that we continue to hit the gas on. And we're also really pleased with returns we get on our remodels as well, and we're doing not only a record number of overall projects this year, but a record number of remodels, which really helps drive the comp.

Our next question is from Michael Lasser with UBS.

John, I want to hopefully get some frame of reference on 2 factors that are impacting the gross margin. So, a, you mentioned $40 million of supply chain costs that are above and beyond what you expected, does that go to $30 million in the fourth quarter? And if that's in the right ballpark, you used the term of beat, which you can interpret a lot of different ways. I think what most of the market wants to know is, does abate mean you're going to incur $70 million this year that will go away because those are extraordinary costs next year? And as part of that, the other piece of it is the LIFO, which the LIFO headwind because that's needs to be $450 million or so if we just add $100 million for the fourth quarter. If there's a linear path of this inflation, meaning it goes from 9, 8, 7, 6 so forth, would that LIFO headwind that's going to be, call it, $450 million this year, be like $300 million next year, so you get a $150 million benefit? Sorry for so many numbers and so much confusion.

No. No. Thank you, Michael. I'll try and tackle each of these. In terms of the carryover impact of the supply chain costs. We didn't give a specific number on that. It will be less, but still a meaningful impact to us. In terms of LIFO, the way to think about that is even though we don't anticipate -- we anticipate a slowdown in the number of price increases. The way you do that number is at a point in time, we project the full year impact of all the price increases we're aware of, and we spread that across the year. So that gets you in the game of what Q4 looks like. And as we look ahead to next year, it remains to be seen, but would anticipate a considerable reduction to that LIFO number. So as you look at -- as I mentioned, as you look ahead to next year, we think the supply chain costs will be down considerably because we won't have these near-term onetime costs, we don't anticipate because we think that will be resolved in Q1. And then the market is favorable in terms of just overall transportation costs, both foreign and domestic. And of course, we continue to stand up our private fleet, which we're going to -- every time we convert, we take 20% out and we're going to double that in size this year. So that's certainly a significant savings driver for us as well. And so as you look ahead to next year, I think it's safe to assume that there's a number of tailwinds. There's certainly some headwinds we mentioned. We'll have to wait and see what the mix does. We want to be there for the customer, and we'll go where she goes. So we have to see where that goes. As we said, shrink has a tail to it. And we're all over it. We know how to attack that, but it does have a bit of a tail. So as you look ahead to next year, there's some puts and takes. But again, we feel like there's a lot of tailwinds when you think of LIFO, when you think of the supply chain costs and all the other levers that we've talked about, not to mention the initiatives.

Okay. My follow-up question will be less a bit picky. I'm sorry. The -- we've seen now some cost pressure at Dollar General. This follows a significant decline in profitability your largest competitor. Should we take these as onetime event? Or is there anything to say that just the overall profitability of the small box value convenience sector is permanently under pressure or long-lasting under pressure because of some of the competitive dynamics? Because of the shift to consumables and other factors? Or would you expect that this is not a trend that's going to be long lasting?

Yes. I'll just reiterate, we see most of the pressures as transitory. When you look at the LIFO, when you look at the supply chain, we see that as transitory. We still feel very good about our nonconsumable products, and see this more as a transitory macro pressure. Again, we're growing share. We're just kind of following the market trend, which people are just shopping more toward consumables versus discretionary items. But we're taking share and feel that will certainly do very well there as the economy improves. And just structurally, we feel we're well positioned in terms of -- as we look at wages, we feel we're well positioned in terms of applicant flow and staffing levels. We feel we're investing appropriately in the business. We feel that our pricing is very appropriate. And again, I think it's important to mention that as you look at Q3, yes, we were down 27 basis points in gross margin, but we're still about 1 point above pre-pandemic levels despite all these transitory pressures I mentioned. We're still a point above where we were back in 2019 and Q3.

Our next question is from Paul Lejuez with Citi.

Curious on the storage capacity and supply chain inefficiencies. If there was a sales impact during the quarter as well as the cost impact that you talked about. Maybe if you could frame that, also, same question, if you expect there to be a sales impact in 4Q? And related to that, was the pressure any region in particular where you saw the cost and/or sales impact? And how much of a differential was there in terms of the performance of that region versus your others?

Yes. Thanks. I'll tell you, as we said before, the delays of our temporary storage facilities, certainly, that unexpected delay did impact the quarter from a profitability standpoint. But again, I reiterate how pleased we were with the strong sales performance we saw. And the nice thing is like it normally is at DG, it's pretty broad-based. And so I think, again, that goes to the consistency of our ability to serve a customer across, not only a broad swath of the United States, but also around the income levels I mentioned earlier. And we're very pleased and excited that our temporary storage facilities are now online. We're also excited that our 2 new permanent regional hubs that are going to serve us extremely well. As we look to the future, they're also online. And of course, those things will take some time to get fully productive and to allow us to catch-up. So again, I would also mention we're pleased that we had in stock improvement year-over-year in Q3. So again, when you kind of bundle it all together, I think the team did a nice job of overcoming some of these challenges, to deliver for the customer, go where she wants us to go. I think that translated into our strong comp, our strong market share gains in both consumables and nonconsumables and a second consecutive quarter of sequential traffic increases. So again, feel pleased about the top line and feel pleased about where we have opened up our capacity. And finally, I'll just mention, as you look forward over the next 18 months, bringing on 4 permanent facilities, that will increase our capacity by 20%. And is something we factored into our strategic plan and feel great about how that's going to serve us well and allow us to continue to grow this business in the years ahead.

Our last question will be from Rupesh Parikh with Oppenheimer.

So just going back to your commentary on shrink. I was curious if you can provide more color in terms of what's driving the higher shrink lately opportunities you guys see to reduce that going forward? If there's any way to quantify how you think about the headwind for Q4 or even what you saw in Q3?

Yes. So as we mentioned, we saw increased shrink later in Q3. We believe this is largely -- Rupesh, largely attributable to the inflationary environment, coupled with higher inventory levels. Overall, as you know, retail is seeing higher shrink in this environment. Now this can have a tail. So we did say we expect this to carry over into Q4. I think it's instructive as we listed out the gross margin drivers, I think that was the last on the list of drivers for Q3. But bear in mind, that was later in Q3. So we anticipate a larger -- probably a larger impact if you have a full quarter of that in Q4. But in Q3, it was the smallest of the items we called out. But again, we've done this drill many times. If you look at our shrink levels, they're still very low from a historical perspective, just not quite as low as we were at record levels recently. But the team knows how to execute against this, and I think we're putting the right tactics in place to address it. We're increasing the amount of tagging with -- for our EAS units. We're leveraging technology like exception-based reporting, and we have very good process rigor and focus on this to tame it. But we'll have a little bit of tail until these actions take hold.

Great. And then maybe just one quick follow-up question. So just on trade-in, I know your team expect to trade in to continue into Q3, and I believe Q4 as well. At this point, the trade-in that you're seeing, is that consistent with what you'd see in a recession? Or is it -- would you say it still below what you typically see in downturn?

Yes. Rupesh, as I said earlier, we're very pleased to be able to see that we're growing share in customers across all income levels. So that's encouraging. And really, again, I go back to the relevance of our brand of our box and our tremendous ability to listen and respond to what our customers are looking for. And certainly, I would tell you, the core customer is certainly behaving the way we expected her to. And also, as you think about it, one of the things that we continue to be pleased with is the fact that when we were introduced to that new customer during COVID, we continue to retain her at higher-than-expected levels. So I would say that as we sit here today, we feel real good about what we're seeing across all the income brackets. We feel real good about seeing the growth there. And I think we're very well positioned to continue to serve them. And I think if you step back and think about Dollar General, we're an all-weather brand, and we've been doing this for many, many years, and we continue to do that. And so -- and we will continue to do that. We'll go where the customer wants us to go, which we did this quarter. And we're also positioned to continue to do that as we move forward and continue to deliver on our strategic initiatives that really makes a more well-rounded shop and a greater appeal for a broad swath of customers.

We have reached the end of the question-and-answer session. I'd now like to turn the call back over to Jeff Owen for closing comments.

Well, thank you for all the questions and your continued interest in Dollar General. I just wanted to wrap up with 3 points. First, while we had some unanticipated challenges within our supply chain during the quarter, we're confident in the actions we've taken to address these near-term issues and expect continued improvement as we move through Q4 and into next year; second, we believe we are well positioned to keep growing market share, especially in an environment where customers are even more focused on value; and third, we believe our strong value and convenience proposition combined with our robust portfolio of strategic initiatives sets us up for a very long runway of growth. And we couldn't be more excited about where the future is headed. I want to thank you again for listening, and I hope you have a great day.

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.