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's Third Quarter 2023 Earnings Conference Call. Today is Thursday, December 7, 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 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 Todd Vasos, our CEO; and Kelly Dilts, 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, 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 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, Kevin, and welcome to everyone joining our call. Let me start by saying how excited I am to be back at Dollar General. I have a deep passion for this company and for the customers we are privileged to serve. I continue to believe in this model, our future growth prospects and our ability to deliver value and convenience for our customers, a positive experience for our employees, and long-term value for our shareholders. We take our mission of serving others seriously and know that our customer is facing financial constraints and communities are looking for strong partners in a tough macroeconomic environment. Historically, we've met those challenges head-on and delivered for our customer. And we believe that we are well positioned to do so now. In retail, one of the best ways to diagnose the state of the business is by looking at it through the eyes of the customer. And we know that our customers rely on Dollar General to provide the products they need at great values in convenient, friendly and easy-to-shop stores. We have spent the last several weeks taking a fresh look at all areas of our business as well as the challenges and opportunities in front of us. We believe that we have a good understanding of what we need to do to address those challenges and opportunities, and we're already taking action. To be clear, this is not about rebuilding a team or organization, but about refocusing efforts already underway. This is where I want to spend the majority of our time today. I won't share all the details this morning but I want to provide an overview to highlight our focus on getting back to the basics in our stores, in our supply chain and within our merchandising. After that,…

Thank you, Todd, and good morning, everyone. Now that Todd has taken you through a few highlights of the quarter, 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. For third quarter, gross profit as a percentage of sales was 29%, a decrease of 147 basis points. This decrease was primarily attributable to an increase in shrink, lower inventory markups and increased markdowns. These were partially offset by decreases in LIFO and transportation costs. Turning to SG&A, which was 24.5% of sales, an increase of 183 basis points. This increase was driven by retail labor, including approximately $29 million of our targeted labor investment as well as depreciation and amortization, repairs and maintenance, rent, professional fees, other services purchased, including debit and credit card transaction fees. These were partially offset by a decrease in incentive compensation. Moving down the income statement. Operating profit for the third quarter decreased 41.1% to $433.5 million. As a percentage of sales, operating profit was 4.5%, a decrease of 330 basis points. Interest expense for the quarter increased to $82 million compared to $54 million in last year's third quarter, driven by higher average borrowings and higher interest rates. Our effective tax rate for the quarter was 21.3% and compares to 22.8% in the third quarter of last year. This lower rate is primarily due to increased benefits from federal employment tax credits and an increased benefit from rate-impacting items caused by lower earnings before taxes for the third quarter. These benefits were partially offset by a higher state effective tax rate. Finally, EPS for the quarter decreased 45.9% to $1.26. Turning now to…

Thank you, Kelly. As we wrap up, let me just say again that we're laser-focused on getting back to the basics. As I mentioned in my earlier remarks, some of these actions will take a little bit more time to deliver the desired results. But we expect to demonstrate significant progress over the coming months and look forward to sharing more with you in the quarters ahead. . This team is energized, and we are confident in the actions we're taking to drive operational excellence for our customers and employees and long-term value creation for our shareholders. I want to thank our approximately 185,000 employees for their commitment to doing the work necessary to serve our customers and communities every day. I am proud of this team, and look forward to serving our customers together as we move through this busy holiday season. With that, operator, we'd now like to open the lines for questions.

[Operator Instructions] Our first question comes from Rupesh Parikh with Oppenheimer.

Welcome back, Todd. So I wanted to kick it off just with longer-term operating margins. Do you feel like you can sustain a 6%-plus operating margin level longer term? And do you think you can get back to 8%-plus, where you have historically operated? And then to get to that 8%-plus, where do you see potentially the bigger buckets of opportunity going forward?

Yes. Thanks for the question. I'll take the second part of that and then pass it over to Kelly. We hear a Dollar General have gone back to the basics. You heard that in my prepared remarks, and I have to say, it has truly energized this company at all different levels. Everything starts and stops at the store with the customer. And what we've done is actually, again, nothing rocket science here, we've actually gone in and looked at every element of our business. It touches our consumer from the lens of the consumer. Again, you would think that, that is always an ongoing piece. But sometimes it's good to remind yourself and remind you organization. So we've done that. And with that, and I won't go through all of that because you saw a lot of it in my prepared remarks, but really getting back to the basics, making sure that the labor that we've already have deployed in our stores and yet to come in the fourth quarter, the $150 million of additional labor is spend in the proper way. And again, that redeployment of money from the smart teams directly into our store where it touches our customer each and every day immediately is so important, and that's exactly what we're going to do. And as we do that, and I think it's very important to point out, it also helps the front end of that store. And it helps on the sales line because we've got somebody to meet, greet and ring up the customer. It also helps on the shrink line because you've got somebody at the front end of the store that is always there to monitor the front end of the store. And also, it helps on the convenience side because we…

Thanks, Todd. And just so everybody knows, our goal is certainly to get back to the historic levels of operating margin and profit that we're used to. While we're not going to give guidance, obviously, for '24 today, I do want to give a little bit of color of '24 just around some near-term headwinds that we're seeing. The first of those is around lapping really significantly reduced incentive compensation as well as stock-based compensation. And so that will just be a near-term headwind as we think about 2024. The other thing that we're looking at right now is we're expecting a higher effective tax rate. And that's really due to lower benefits around the stock-based compensation piece as well as we've seen historically just some higher state effective tax rates as we have moved through the last few years. So those are near-term headwinds, certainly not anything long term that we need to worry about. The other thing is around shrink. And so as you know, shrink has been pretty significant for us for a while, and it's definitely going to carry into 2024. As I talked about in the prepared remarks, it just takes a while to start showing up in your financial results. And just to give you a little bit more color of kind of where we are with shrink on a year-to-date basis. Shrink is actually 100 basis point headwind for us. And then as we moved into Q3, it's actually running just a little bit higher than that. And so certainly a pressure near term for us, something that we're looking to hopefully -- we're mitigating along the way, and it'll show up in the financial results later in 2024. And then as we think about just our underserved customers, we're just making sure that we're watching her and whether she gains -- stays gainfully employed. All the actions that Todd just noted and getting back to the basics is certainly going to set us up nicely to be able to serve her and it doesn't matter what economic environment. And we've always been an all-weather brand, and we certainly will continue to be so as we move forward. So that's a little bit of color on '24. We're going to give you a lot more color in March and give you a little bit more holistic view there. But what I'll say is, overall, the fundamentals of this business are absolutely unchanged and this model remains strong. And on a longer-term basis, we believe that we're going to get back to the historic levels that this model is accustomed to delivering.

Our next question is from Simeon Gutman with Morgan Stanley.

Welcome back, Todd. When you rejoined, you talked about you having an opportunity to revisit the financial profile of the business. And if there was a time to look back and reset and invest deeper that you could take that opportunity. As the business looks to be forming a bottom in margin and thinking about getting to 7% or plus in a reasonable time frame, do you have any updated thoughts on that? Does it make sense to lean in so that when you start building back, it builds back sustainably, do you think the business needs a little more investment than you thought 1.5 months ago?

Yes. Thank you for the question. And you're 100% right. The first few weeks back on the deck here, I did take a holistic view across not only our operations, but as you heard, our supply chain, our merchandising areas, looked at everything holistically, and I'll just click off a few. But first, let me say before I click it off, is that I believe that the investments that have been already talked about this year are $100 million and $150 million in totality labor investments were the exact right thing to do. I don't believe at this point that I see a need that we need to make any other larger outsized investments as we move into '24. I believe, as I indicated, that the right thing to do is make sure that the $150 million is being used appropriately and in the right areas that touches the consumer and helps our stores be able to better serve our consumer each and every day. And that's exactly what we've done now over the last few weeks. And that's why I believe taking the smart teams out of the equation, taking that whole bunch of labor that was dedicated to that, putting it directly in our stores to cover the front end of our stores more effectively each and every day, 100% of the time tethered to the front end for customer service and ringing up our customers. And then also one of the first for Dollar General, quite frankly, and that is deploying some of that labor into a work that ensures that we keep our perpetual inventory correct and ongoingly correct each and every day. Because once again, if the system doesn't realize you need product, it won't send you product. And unfortunately, over the last year or…

Our next question is from Matthew Boss with JPMorgan.

Maybe, Todd, at higher level. Could you just help elaborate on some of the recent changes in behavior that you're seeing from the low-end consumer? The traffic versus ticket trends that you cited, I think, are interesting. But maybe asked a different way, traffic is improving, what's constraining the comp through the third quarter? Did comps actually turn positive in November tied to some of these initiatives? And then just lastly, on the new stores and the mindset shift to maybe down shift a bit, could you just elaborate on some of those pieces that you walked through, occupancy costs and some of the other moving parts? And just what you're seeing on the new store return to maybe just take a pause here?

Okay, sure. As we look at our results as we move through the quarter, as we indicated, each of the periods were very similar, but we did see continued uptick in our traffic as we move through the quarter and then into November. Now I'm not going to give you a lot of color in November, but to say that we did see a change in trajectory on our comp as well as we moved into November. So it was great to see. And I would tell you that, again, it was both on the consumable and the nonconsumable side of the equation. Now one would say, "Well, where is it in the comp?" Well, I would tell you the comp actually was much better as we move through the end of October into November, but we still have a lot of work to do, Matt, to get back to some historical comp type rights here at Dollar General. I believe the back to basic work that we're doing is going to help us get there faster as you move into the back half of Q4 and into Q1 of '24. Making sure our stores are stocked each and every day when the consumer walks in the store. They'll be able to find what they need is going to be very, very important. So more to come. We've already started to see that. We've actually have seen our in-stock rates markedly improve over the last few weeks. We check it and watch it each and every week. And I believe that has added to some of that betterment and comp that I talked about in November. So more to come. I believe the macro still has an effect on us as well as others. But what we've always been and…

Yes. No, absolutely. And so an 18% return in this environment is fabulous, and Todd noted it, it's still a great use of capital. The new unit economics are still very strong as we move into '24. And it has a great payback period still of less than 2 years. And the other thing that we haven't seen is any change in the cannibalization rate. The other thing I'd point out and Dollar General is just fantastic at this. Our real estate group is pretty amazing, and we have an extremely high hit rate of success and you've seen that over the years. So we feel really good about the projects. We feel good about the 18% return, and of course, as Todd noted, while we're pleased with all of that in typical Dollar General fashion, we're going to work to improve it as we go through '24.

Our next question is from Seth Sigman with Barclays.

I wanted to talk about inventory a little bit. Just in terms of the progress rightsizing your inventory position. Can you just give us a little bit more perspective on where you sit today with consumables versus nonconsumables? And then is it your expectation to exit the year clean? Or do you feel like you're going to still need some incremental actions into next year? And then I'll just add a second part to the question around the top line. When you look at the improving trends the last few months, to what extent has that been influenced by markdowns and clearance activity?

Yes. No, thanks for the question. And inventory reduction is absolutely a priority of ours this year, and it will be a priority as we move into next year. I think the good news for us is that the quality of our inventory is good, but we've talked a lot in the past about the benefits of inventory reduction and just what that does as you reduce the complexities in both the stores and the distribution centers. So I would say our progress is on track in our reduction efforts, and you saw a little bit of that in the numbers today. So total inventory increase was 3% on a year-over-year basis. But if you look at it on a per store basis, we're down 1.8%. I think the real story here is, is around the nonconsumable piece. And so we are down 15% on a year-over-year basis there, and we're down 19% on a per store basis. I think the other important thing to call out, and we've been calling it out every quarter, but this one is even more significant as we've seen a 58% decrease in our import receipts. And again, that's us buying around that product and making sure that we're selling through it. And so we feel good about where we're headed for the end of the year. Just a little bit longer term, I'd say we have several work streams in place that are working on inventory reduction, but just as important, and this kind of goes to the top line is inventory optimization and making sure that we're going where the customer wants us to go. And so I would say with all of these things in place, we should feel pretty good about where we're landing at the end of '23, but we're going to feel even better as we see continued improvement in inventory levels as we move through '24.

Thanks, Kelly. And as you look at our results in Q3 and how that relates to any activity around clearing this inventory, I would tell you that I feel very good about the balance here. While there was some activity there, actually, some of the bigger activities is really slated for Q4, if needed. And a lot of that will be centered around our sell-through of holiday. So we're watching that very closely. But again, early results would say it's right in line where we thought it would be right now. And actually, in some areas, a little bit better. So we're watching that carefully. But I would also say, as we continue to move forward, what we like and what I've seen since I've been back, is I believe we've done exactly the right thing on moving through some of this inventory. But as I look at the quality of our inventory, it is in very good shape. And actually, as Kelly just indicated, a lot of what we have right now to deal with on an overstock basis is actually more in our core everyday goods. So this isn't about a bunch of screw drivers and hammers or fashion-type items for holiday that we have to move through, this is about having a little bit too much of some basic paper cleaning, food-type items, things like that, that will move through the system pretty naturally as long as we do the right thing with our supply chain and our stores, and that's exactly what back to the basics is meant to address. So feel very good about that and very good about what we see going into the back half of this year and '24.

Our next question is from Michael Lasser with UBS.

Welcome back, Todd. Given everything that outlined this morning, when is it realistic for us as outsiders to hold the team accountable to getting back to consistently producing a double-digit EPS growth algorithm like Dollar General has done in the past? And as part of that, Kelly pointed to a few factors that are going to weigh on Dollar General's profitability in 2024. Could you give more texture and timing around how large those factors are like incentive compensation and shrink?

Yes, thank you, Michael. As both Kelly and I have both said, I don't see anything that gets in the way longer term to getting back to some of our historical ways that we return to our shareholders and our customers. We feel that we're on the right track with our back to basics moves here, both in our labor investments, in our inventory investments as well as in our supply chain and merchandising. So we feel like we've taken the right appropriate actions now, and we're moving with speed and intent. As I said in my prepared remarks, some of it will occur and manifest itself faster and some will take a little bit more time. But rest assured, we are hitting every single item, and we're monitoring every single item every week here to make sure it's on the right track. And if it happens not to move the way we want, we will then make an adjustment to ensure that it does. We are squarely focused on getting this company back to its historical returns that everyone is accustomed to seeing. And most importantly, our customer is used to seeing at store level. Now as Kelly indicated, there are some near-term headwinds. As much as I would love Michael to give you more color right now, we're not here to give '24 guidance. We wanted to though make sure that you can contextualize at least some of those headwinds as we start to move into 2024, but rest assured, we're going to give you more than you need in the components when we come back and give you the guidance for 2024 to make sure that you can build the models out the proper way. But again, I want to make sure you also understand, though, that we're not going to wait till '24. We're taking action now to continue to modify and also continue to ensure that we're addressing any of the gaps that are out there that are well in our control. There'll just be a few things that may not be fully in our control in '24 that will probably be more of a onetime in nature that we'll address at the right time.

Our next question comes from Kate McShane with Goldman Sachs.

We were wondering how you would frame the risk of deflation across your box into next year? And how do you think about the puts and takes across the P&L as a result?

Yes. That's a good question. And there's been a lot written up in certain areas on deflation. We've seen some deflationary pieces starting to show up, especially in our nonconsumable discretionary type areas. Nothing that alarms us at this point as we move into 2024. How we're looking at it is we see some real opportunity to reduce initial costs, especially in our import-related goods, not only from the factory, but also for the transportation side. So ocean freight, fuel cost, bunker fuel cost and such have moderated greatly over the last year. So there's some opportunity to pull cost out. Some of that, we will definitely pass on to the consumer as we continue to watch, especially in those commodity areas of the import side of the business because there's always some good -- even in our nonconsumable areas, there are some good commodity-type items in there. From a consumable perspective, while there's always movement in those areas of commodities: milk, dairy type areas, oils, wheat, we watch that very carefully. We have component pricing here at Dollar General for not only our national brands, but our private brands. We watch that very, very closely and we monitor that. Now in saying that, we haven't seen in center of store, if you will, dry grocery, chemical paper, very, very little deflationary pressures. A little bit on those commodities in dairy, as I indicated, some meat items, which we don't -- are not a huge player in. Produce, we're a little bit of a player there in what we've done. There's some deflation there. But again, I would tell you, in totality, nothing that alarms us or believes that it will adversely affect the top line as we move into '24, at least nothing at this point shows that.

Our final question is from Chuck Grom with Gordon Haskett.

Welcome back, Todd as well. Can you talk a little bit about the out-of-stock issue and perhaps quantify the drag that it's been to comps over the past few quarters? I believe it's probably pretty sizable and the measures you're taking to improve that issue? And then on the SKU rationalization, that's interesting. I was just wondering if you could speak to maybe the number of SKUs you have in an average store today? So say, relative to back in 2019 and how big of an opportunity that can be? And how long do you think you'll take to get back to an optimal level?

Yes, sure. I would tell you that the amount of out of stocks we have in our store are probably some of the largest that I've seen in the 15-plus years I've been here and saying that. There are so many work streams that are now underway, Chuck, that I feel good about where we're headed. As I just indicated a few moments ago, we saw a meaningful change over the last 2 weeks in our in-stock rates at store level. And these are not just on our perpetual inventory system, but this has actually counted inventory from our inventory -- our Washington inventory group that takes our yearly fiscal inventory. So these are real counts, if you will, real out of stocks and not just out of stocks on the shelf, but out of stocks in the back room, too, so meaning it is not in the system for the consumer at all. So we saw a meaningful drop in that, meaning more available to the consumer. We believe as we move through the rest of this quarter and into the first, we're going to make even further meaningful advances. Why? We're putting hours toward the inventory specialist role that I mentioned earlier. This is a first for Dollar General to go in and ensure that we keep our on hand or our perpetual inventories more accurate than we have in the past. We've done this activity in the past, but we have come up with and we are teaching and training individuals to do this in a little bit of a different way, taking a fresh look at it, a fresh approach at it, doing more areas of the store on a weekly basis at a time to ensure that we touch every SKU. And by the way,…

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

Thank you, and thanks for all the questions and your kind words for welcoming me back. As I said last year that serving this team at Dollar General has been the highlight of my professional career, and I feel the same sense of honor today. As you heard this morning, we have some hard work yet ahead of us but we know what to do. We've done it before, and we are absolutely set on doing it again as quickly as possible. I'm excited about the opportunities in front of us and all that we've accomplished together over the years and will continue to do so for our customers, associates and shareholders. Thank you 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.