Good morning. My name is Robert, and I will be your conference operator today. At this time, I'd like to welcome everyone to Dollar General's Second Quarter 2023 Earnings Conference Call. Today is Thursday, August 31, 2023. [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 your host, Mr. Kevin Walker, Vice President of Investor Relations. Kevin, you may now begin your conference.

Thank you, and good morning, everyone. On the call with me today are Jeff Owen, our CEO; and Kelly Dilts, our CFO. Our earnings release issued today can be found on our website at investor.dollargeneral.com under News & Events. Let me caution you that today's comments include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, such as statements about our financial guidance, strategy, initiatives, plans, goals, priorities, opportunities, 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 2023 Form 10-K filed on March 24, 2023 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 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. Before we discuss the quarter, I want to address the tragic event of last Saturday. On August 26, we lost 1 member of the DG family and 2 customers to a senseless and hate-filled active violence in our store in Jacksonville, Florida. We extend our deepest sympathies to their families and friends as well as to the greater Jacksonville community. It is in times of tragedy when community matters more than ever. Right now, we are focused on providing support, counseling and resources to our teams and their loved ones. We are evaluating how we can best support the local community during this difficult time, and we stand with our team in Jacksonville and across the organization who are leading with empathy and courage. We are appreciative of local law enforcement's quick response in Jacksonville, and their continued support in protecting our associates, customers and communities every day across this country. Thank you. And with that, we'll now begin today's call. We made significant progress in the second quarter, advancing several important goals. I'd like to give you an update on the actions we have taken to improve execution and better serve our customers. While we are pleased with our progress, we are not satisfied with our overall financial results. So I also would like to walk you through how we plan to do even more in pursuit of these goals in the coming months and how we plan to get there more quickly. We are continuing to improve execution in our distribution centers and stores, providing our customers with even lower prices and an improved shopping experience and working towards rightsizing our inventory levels. Within our supply chain, we are pleased to note that our service levels, in-stock levels…

Thank you, Jeff, and good morning, everyone. I want to say again that all of us at Dollar General are heartbroken over the Jacksonville tragedy and our thoughts remain with all of those impacted. Now let me take you through some of the important financial details. 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. Jeff already discussed sales so I'll start with gross profit. For Q2, gross profit as a percentage of sales was 31.1%, a decrease of 126 basis points. This decrease was primarily attributable to lower markups as well as increases in shrink, markdowns and inventory damages and a greater proportion of sales coming from the consumables category. These were partially offset by a decreased LIFO provision and decreased transportation costs. SG&A as a percentage of sales was 24%, an increase of 136 basis points. This increase was driven by retail labor, including approximately $40 million of our targeted labor investment as well as utilities, depreciation and amortization and rent. These were partially offset by a decrease in incentive compensation. Moving down the income statement. Operating profit for the second quarter decreased 24.2% to $692 million. As a percentage of sales, operating profit was 7.1%, a decrease of 262 basis points. Interest expense increased to $84 million in Q2 and that compares to $43 million in last year's second quarter, driven by higher average borrowings and higher interest rates. Our effective tax rate for the second quarter was 22.9% and compares to 22.1% in the second quarter last year. Finally, EPS for the quarter decreased 28.5% to $2.13. Turning now on to our balance sheet and cash flow. Merchandise inventories were $7.5 billion at the end of…

Thank you, Kelly. Last quarter, we introduced our DG Forward strategy, which is how we will position Dollar General to be a force for opportunity for our customers, associates, communities and shareholders. DG Forward is an execution and innovation strategy, and we remain focused on driving execution through our operating priorities, including driving profitable sales growth, capturing growth opportunities, leveraging and reinforcing our position as a low-cost operator and investing in our diverse teams through development, empowerment and inclusion. We will sharpen our strategic focus in 4 key ways. First, we are focused on winning in rural. Today, approximately 80% of our stores serve rural communities with fewer than 20,000 residents. Our high-return, low-risk real estate model continues to serve us well as a core strength of the business. In the second quarter, we completed 849 real estate projects, including 215 new stores, 614 remodels and 20 relocations. For 2023, our plan remains to execute 3,110 real estate projects in total in the U.S., including 990 new stores, 2,000 remodels and 120 relocations. We now expect over 80% of our new stores in 2023 and nearly all of our relocations will be in one of our larger store formats, which continue to drive increased sales productivity per square foot as compared to our traditional store. With regard to remodels, approximately 80% will be in our DGTP format, which provides the opportunity for a significant increase in cooler count as well as the ability to add fresh produce to many stores. One way we continue to serve these locations is through DG Fresh, where our current focus is increasing sales in frozen and refrigerated categories through enhanced product offerings and building on our multiyear track record of growth in cooler doors and associated sales. During Q2, we added more than 19,000…

[Operator Instructions] Our first question comes from Michael Lasser with UBS.

So you've taken your labor investment for this year from $100 million to $150 million. The perception is that, that is not enough and it will take more than that to resume the type of performance that the market has been accustomed to from Dollar General. How -- what evidence would you provide to refute the skepticism that this $150 million is not the right amount, it's going to be much more than that? And as you think about these investments, how is this going to impact the long-term operating margin for Dollar General given that it's on pace this year to be much lower than it's been previously. And then I have one quick follow-up.

Thank you, Michael. This is Jeff. On the labor front, I'll start with that. We feel really good about the labor investments that we've made. I think you got to keep in mind at Dollar General, we've invested in wages and have a strong foundation for quite some time. And really at store level, what's important is stability in the supply chain. And when you have stability in the supply chain, that leads to stability inside the store. And so now that we're seeing our supply chain which, quite frankly, we've had some significant challenges over the last couple of years stabilizing, we're seeing that show up in more stability inside the store. And then you combine that with the labor investment that we've made, plus in the second quarter, one of the things we deployed which is new for Dollar General is a smart team in every single district in our company. And what a smart team is, is dedicated teams that are at the disposal of a district manager to deploy where they need to be deployed most. And we've been very pleased with what we've seen there with that new tool in our toolbox. The stores that these teams have been able to touch, we've seeing the sales accelerate and continue and they haven't plateaued. So we feel real good about that. We see our store standards improving. And we believe now by making the smart team, which is now going to be permanent with this new investment, when you combine that with the other investments we just announced, which is reducing inventory certainly through the markdowns we discussed and also investing in technology to further pull more inventory out of the system, when we have optimized inventory, a stable supply chain, that equals stability inside the store. And so what we're beginning to see also is our store manager turnover has been benefited from these investments as well. So we're starting to see the theme of stability, I guess, is what I'm trying to share with you. So that's showing up inside the store, which gives us great confidence that the announcement today of the investments we're making, while we've seen some progress and we're not pleased with the results we've achieved, we believe these are the right amount to get us to excellence that we're accustomed to achieving much faster as we go through the back half of 2023 and, more importantly, in 2024.

That's absolutely right, Jeff. And just to give you a little bit more color on the labor and what gets us comfortable there. We did pull forward a significant amount of our investment into Q2 so that we could do what we always do here at Dollar General, which is test and learn. And so as we went through that process, we really like, to Jeff's point, the smart teams and what that was paying off. But on the labor hours piece, we did a lot of work around just various store attributing, understanding what the optimal level was of the inventory -- of the labor hours associated with the stores. And so we feel like we did get to that optimal level of investment. On the inventory side, I would say we've made some really good progress on the inventory piece already. And so if you look at Q2 versus Q1, we're down 8.5% on a year-over-year basis, much better than we were in Q1. But what I really want to highlight is our nonconsumable inventory was actually a decline of 4% on a year-over-year basis. So a lot of good work done there. We actually saw a 40% reduction in the inventory receipts for the second quarter as well. And so that's a lot of good work from our merchandising group, just buying around what the inventory we already had and getting that out to the store and certainly feel good about quality of that inventory. But we are excited to be able to take this accelerated action as we move through that inventory, specifically nonconsumable inventory as we go through the year. And as Jeff noted, for many reasons, driving sales is probably the top of the list and then inventory reductions is certainly next on that. So we feel really good about the level of both of those investments.

My follow-up question is, historically, Dollar General has targeted an algorithm of mid-single-digit unit expansion, 2% to 4% comp growth, stable to growing margins and then buying back 4% to 5% of the stock to get to double-digit EPS growth. So if you take all of the different pieces of that algorithm, especially store growth, is it realistic that Dollar General can get back to that algorithm by 2024 based on what you know now?

Yes. I'd say, as usual, we won't give '24 guidance. But what I can say is everything that we're doing is focused on the long term and delivering results and delivering what we need to deliver for our customers. So we feel good about the investments that we're making, the ability for those to set us up for '24 and beyond. I'd say this model got, and you pointed it out, just an incredible history of delivering results. And so we feel good about getting back to driving profitable sales. And we're going to strengthen our foundation and continue to focus on being a low-cost operator. I think that the actions we're taking are really only going to strengthen that great business model. You know us well. So we've got a lot of existing initiatives as well as some of these new initiatives that will support that. So we've got significant number of new stores that we still have opportunities in to open in the U.S., and we're still seeing the same fantastic returns of 20% IRRs and cash paybacks of less than 2 years. We do think we can drive a 2% to 4% comp with our real estate investments and the impact of the actions and the initiatives. And then just when we think about the gross margin rate, even in the second quarter with all the pressures that we felt specifically around shrink, we were still 30 basis points ahead of where we were in 2019. And I think that's a testament to all work we've done. And we've still got DG Media network that's going to keep contributing, private fleet that Jeff talked about. We've got some private brand opportunities as well. We've got supply chain efficiencies. And as we lower that inventory, that's only going to benefit us even more. And we're still in the middle innings of Fresh. We've got the health initiative assortment that's still delivering well for us. And then you should see us resume back to lower shrink over time. And then I'd say just on the SG&A side of things, we're going to continue to lower our cost to serve. We're ramping up that Save to Serve initiative, and we expect to see those benefits next year. And then we talked just a little bit about taking that end-to-end view of our operating model, and that's really around driving efficiencies and lower costs, but even more importantly, simplicity in our store operations. And so we're excited about all of that. I'd say in the near term, we do have some pressures. So we've got some pressure from interest expense and from share repurchases. But what we absolutely believe is that we will get back to historic levels of operating profit growth and that our long-term view of this business is excellent.

Our next question is from Chuck Grom with Gordon Haskett.

Just to build off your last comment, new store productivity came in a little bit below 80%, which outside of the pandemic, was really the lowest in maybe 10 years. So bigger picture, how are you thinking about store growth given some of these issues over the past few quarters, on one hand, volume growth would allow you to fix things currently; but on the other hand, it would obviously impair the compound to a degree. So just any thoughts on store growth over the next few years.

Yes. Thanks, Chuck. This is Jeff. Our real estate model continues to be the core strength of this business. And I am very, very pleased with the new store returns we're seeing, also the pipeline that we have. And our format innovation really is what's allowed us to really cater to communities. This larger store, we like the productivity we're seeing. And I'm going to tell you, the operational excellence that we're going to return to, especially with the investments we just announced, is only going to benefit not only the core, but it will benefit our new store opportunities as well. So I feel great about the long-term prospects of our real estate model and feel even better that these investments we're talking about, when you think about the value proposition which we feel great about in our stores today since the pricing investments we've made, you think about the stability in the supply chain, we still have a ways to go, but I'm very pleased with what we're seeing. Optimizing our inventory levels, and then that will all lead to consistent and excellent execution at store level. And you combine all those 4 things together and that's how we achieve the operating profit, which will certainly allow us to continue to lean into our real estate model as we go forward.

Okay. Great. And then for Kelly, just looking at the change in the guide, can you help us think about the shape of the back half in a little bit more detail and a little bit more context between the third and the fourth quarter? I guess, would you expect the third quarter comps to be outside of the band that you provided, the down 1 to up 1? And any help on how much compression we should expect to see in both the gross margin line and operating margin line in the third and fourth quarter just so we can true up our models.

Yes. No, absolutely, happy to help. So I'd say, first, obviously the actions that we're taking to drive sales and lower our costs will set us up for '24. And our revised guide is really a function of the slower transactions that we're seeing and higher expected shrink. We did give a pretty wide range of the negative 1% to 1%. Net sales range is really a function of how quickly our customer responds to our actions and really how they respond, honestly, to their own financial situation in the back half of the year. When you think about the EPS range, it's flow-through of the sales, obviously, the higher shrink in the investments. And we also have a little more pressure around damages and then around the markdowns associated with the lower sales. So it's probably going to take a couple of quarters just to get -- make sure that we're taking all the actions and we get back to that operational excellence. If I break down the quarters, to your point, starting with the third quarter, we should see comp sales lower than -- within our range. What we're seeing now is with Q2, comp decelerated sequentially by period. But we did see traffic trends improve. What we're getting pressure from, and we talked about this a little bit in the prepared remarks, is that we're starting to lap the more significant price increases in the back half of last year. This is going to pressure Q3 more than any other quarter in particular. And so to your point, we do expect comp sales to be negative in Q3, and we're running as expected to date. Just on the margin piece of Q3, that's also going to be more pressured than what we are seeing in Q4 with our inventory actions as well as shrink. And so right now, we're expecting Q3 gross margin to be below 30%. And obviously, that would put pressure on Q3 EPS. On the Q4 side, we believe that we're going to start to see the benefit of our actions and our investments a little bit more. In Q4, we've also got a tailwind around lapping winter storm Elliott. So we'll see stronger Q4 comp than we would think for Q3 as well as EPS. And then just touching on the timing of the investments, especially the inventory actions that we're taking. We're going to give ourselves a little bit of wiggle room and make sure that we can react to the customer response, and we may choose to pull some of those investments forward into Q3, if it makes sense.

Our next question is from Matthew Boss with JPMorgan.

So Jeff, maybe to break down the macro versus micro. I guess, first, how would you assess the low-end backdrop today notably tying in July and August relative to 3 months ago? Or any change in purchase intentions noted from the customer survey work that I know you guys do? And then on the macro, any change in the competitive landscape as you assess relative comp performance or market share by category?

Thanks, Matt. On the customer, she still is challenged, and we talked about that in the first quarter and that continues. Our customer, what she's telling us is that certainly as gas prices are less than last year, but they're accelerating throughout 2023, and she's still feeling the headwinds of the SNAP reduction and also the lack of tax refunds. And her savings are gone. And so certainly, she is still living with the inflationary pressure. So certainly, the customers are challenged. But quite frankly, our customers is frequently challenged and we know that. And we've made actions, and I'm very pleased with the actions we took to help her in her time of need, which is exactly why we did it in the first quarter. So we feel good about our ability to offer value to her and also be there for her. And when you think about the execution opportunity we have in front of us, where we've seen initial signs of our progress but also with the actions that we just announced to accelerate that progress, that's only going to allow us to further serve this customer. And she's going to lean on Dollar General even more, like she typically does in times of challenge like this. And we are going to be even better positioned to serve her. Certainly, as we improve our in-stock levels, our store standards and certainly, as I said earlier, love what we're seeing with the smart teams we've just deployed. So as we think about the competitive landscape, Dollar General has been able to compete quite well for quite some time. And this team knows exactly where we need to course correct, we know how to course correct, and we've announced today the actions that are going to of course correct. So we feel great about our ability to return to the excellence that we're accustomed to achieving even faster than we were before. And we don't take it lightly that our sales performance right now is not where we want it to be. But we're pleased with the actions that we're going to see show up and the early signs that we're seeing already. So looking forward to back half of this year and then certainly into 2024.

Great. And then, Kelly, with EBIT margin this year forecasted roughly 200 basis points below pre-pandemic, how do the back half investments structurally impact the margin profile for next year or just your margin recapture ability next year? And then secondly, with the balance sheet leverage remaining above your targeted 3x, how does that impact the historical double-digit bottom line algorithm?

Yes. So I'll start with the structural piece first and break it down a little bit between gross margin and SG&A. And so we really think that the current headwinds are more transitory, specifically when we talk about shrink and damages and markdowns. We think we're well positioned on supply chain efficiencies with structural improvements on the horizon, as we talked about a little bit with the automation piece of that and certainly the private fleet continuation. DG Media Network should provide significant gross margin opportunity as well and, again, DG Fresh and NCI as we move forward and maybe mix into more nonconsumables over the next couple of years. We also continue to see some opportunities in private brands. On the SG&A side, I'd say the labor investment is embedded now in our baseline. But as we go forward, we are really looking at an end-to-end operating model to make sure that we're driving efficiencies in the store and lowering our cost to serve. And as Jeff said, we're also looking at inventory management as well to lower our cost to serve over the next couple of years. I think that, that will help us take some cost out of the system. And then we're ramping up our save-to-serve initiative and expect to see benefit of that next year. So we feel like -- again, not specifically speaking to '24 but to the future, that we'll be able to get back to that operating profit growth. But we do -- we will have some near-term headwinds just on the financial strategy side of things around share repurchases in the near term. On the -- remind me again on the balance sheet question?

Just with the balance sheet leverage above your target at 3x, maybe what's the time line to get back there and how best to think about priorities for cash flow?

Yes, absolutely. So I think just going through priorities, we still believe in the capital allocation priorities that we've laid out, making sure that we're investing in the business and high growth opportunities, as obviously our first priority. Next would be dividend payments and then, of course, any share repurchases with the remaining cash available for that. You're right on the leverage ratio. Right now, we're above our target. The good news here is that this model has a strong history of generating significant cash flow, and we continue to believe that, that strength will continue over time. We think this leverage ratio will probably be with us for a little while, but we are working to get back to our targeted leverage ratio in the near future.

Our next question comes from Simeon Gutman with Morgan Stanley.

I wanted to first ask around the comps and where they're performing. If you could put it all together and summarize what you attribute to some of the underperformance, too. It does sound like traffic is underlyingly okay and it's just lapping some tickets. Curious how you diagnose or rank pricing, if it's merchandising, anything related to the stores. So how should we think about that?

Yes. Simeon, this is Jeff. What I would say is that when you look at our comps, our opportunities are in driving our in-stock levels inside the store. And that is certainly going to help and we are seeing improvements there. But as we've deployed more labor in the stores and as our supply chain gets more stable, we're going to be able to get much more consistent in the stores. And so I feel really good about the plan on driving continued performance. And I can't underestimate again the labor investment we've made, the signs that we're seeing and, more importantly, that dedicated team that helps a store that might fall off track, get back on track quicker because. That's one of the really exciting things about this model is that we're able to get stores back fast. So I'm pleased with that. But as we think about it, in my experience, this is how the comp will show up. It starts with units. And so I was pleased with our unit share trends and, quite frankly, pleased with unit share gains. And then as units improve, and those generally improve through our in-stock levels and our store standards improving, which we're seeing and our customers saying -- she's seeing it as well, but we have more to do there. It will then -- word of mouth gets out and then traffic will come after that. And then once you see traffic, that's when you really start to see the comps show up. So as Kelly mentioned, we're lapping some significant price increases. But the underlying trends, it starts with units, and then traffic is the next opportunity that I believe the announcement we just announced today with the promotions, specifically around our NCI inventory, we really like what we saw when we've run those this year. This isn't something new. This is stuff we've been testing. And so we'll have to wait and see. But as you think about the back half, our customer will be pressured. But as we move into the holiday, we're excited to offer her these values. And she's really shown up and responded very well to them earlier this year. So hopefully, as we look to the back half of this year and into next year, the stability in the store will help us drive continued traffic, and that's one of the metrics we're most focused on improving as we go forward.

Fair enough. And then as a follow-up, there's labor investments and you're going to clear some merchandise, it sounds like, in a couple of places. It sounds like the new stores are doing well and the prototypes are great. Just thinking about managing the business from a practicality standpoint. Is slowing stores even a consideration just temporarily so that the leverage is managed properly? Nothing to do about how the stores perform in the out years, but just thinking about balancing the SG&A to make the leverage point a little bit lower.

Simeon, that's a great question. I can tell you, first and foremost, we're focused on returning to operational excellence. And this model is tremendously successful when we're able to do that. And we have a great value proposition with a stable supply chain, with consistency at store level. That generates tremendous operating profit and allows us, quite frankly, the ability to invest back in the business at a rate we're very pleased with. And the new stores, I continue, we're very, very pleased. And we have an opportunity to be first mover and we want to take advantage of that. And so we are always balancing, and we will and we'll continue to do that. Because we base everything on returns and return on capital, and that's very important to us. But the nice thing here at Dollar General is, is that we're confident we can return to the operational excellence level that we have accustomed to achieving, and you combine that with a tremendous pipeline for growth that we have, and that recipe is incredibly successful and something that I'm very excited to see as we progress through '23 and '24 and our ability to continue to perform at the levels we're accustomed to performing. So I feel great about the pipeline, and I also feel great about our return to operational excellence.

Our next question comes from Rupesh Parikh with Oppenheimer.

So I wanted to go back to the commentary on the $170 million of investments. I was curious what you view as more onetime in nature versus permanent.

Yes, Rupesh, I'll start and Kelly -- but certainly, we've said this before, we believe these investments are going to accelerate our progress. I think as you look at the investments, when we look at reducing inventory, we've made progress on our inventory. It will make it even better. We're impressed with the, as I said before, the test we've run around this. So certainly on the inventory side, I don't think that you'll see us having to do that as we look forward. But certainly, the labor, as you think about the labor, that is certainly something that is going to be embedded and permanent in our model and we like the returns that we're seeing. I think that's the key point there. And the other investments are investing in the ability to really be more efficient long term. Specifically, as you think about the demand forecasting tool that we're investing in, that, we believe, will have a tremendous opportunity to make our working capital even more efficient. And over the next, call it, 12 to 18 months, we believe we will be able to pull out meaningful inventory. I mean, ballpark $500 million or more. And we're very, very excited about how all that's going to play throughout the P&L.

Great. And then maybe just one follow-up question. So the guidance range is much wider going forward for the annual guide. Just curious what's driving those and just your confidence in being able to deliver within this range.

We have a high confidence level that we're going to deliver in this range. And really, the width is around the sales piece primarily, Rupesh. And just how quickly the customers are going to respond to the actions that we're taking. I mean, we feel good about getting back to operational excellence, that we're doing all the right actions and taking all the right actions that we need to take. And it will just be a function of her response to us. But we'll be ready, and we think after a couple of quarters we'll be back to it in 2024.

Our final question comes from Paul Lejuez with Citi.

Curious, what was the inflation impact in 2Q versus 1Q? And what are your expectations for inflation in 3Q and 4Q and the consumables business specifically? And just how has that changed versus how you were thinking 3 months ago? And then just one clarification. I'm sorry if I missed it, but are you expecting a positive comp in 4Q? And I'm just curious what your transaction versus ticket assumptions are around that.

Yes. So starting with inflation, certainly much less than we saw last year. So inflation over the front half of the year has been about 1.5%. Right now, we expect it to be pretty similar as we go into Q3 and Q4. On the comp piece of that in the sales for Q4, we're certainly expecting it to be better than Q3. It could be positive and we'll just see how this customer reacts to what we're doing.

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

Thank you for all the questions, and thanks for your interest in Dollar General. If I could summarize our discussion today, I'd like to leave you with this. We've had our share of challenges in recent quarters and some of those have been self-inflicted, but the actions that we're taking in response are gaining traction and we're making good progress against our goals. We're taking key steps in making investments to accelerate our progress over the back half of the year as we look to drive sales and lower our cost to serve while solidifying the foundation for growth in 2024 and beyond. We have a tremendously strong foundation and an incredibly bright future and a strong track record of doing what we say we're going to do. And we believe we are well positioned to do so again. Before we sign off, I want to again express that our hearts are with the victims, their families and the community of Jacksonville. We are proud of our Dollar General family, we're coming together to support each other and our customers during this difficult time. Thank you again for joining us this morning.

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