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Executives

Mary Winn Gordon - VP, IR

Rick Dreiling - Chairman and CEO

David Tehle - EVP and CFO

Analysts

John Heinbockel - Guggenhiem Partners

Charles Grom - Deutsche Bank

Deborah Weinswig - Citi

Aram Rubinson - Nomura Securities

Matthew Boss - JPMorgan

Dan Wewer - Raymond James

Joe Parkhill - Morgan Stanley

Meredith Adler - Barclays Capital

Scot Ciccarelli - RBC Capital Markets

John Zolidis - Buckingham Research

Matt Nemer - Wells Fargo Securities

David Mann - Johnson Rice

Emily Shanks - Barclays Capital

Trey Schorgl - Credit Suisse

Joe Feldman - Telsey Advisory Group

Dollar General Corporation (DG) Q1 2012 Earnings Conference Call June 4, 2012 4:30 PM ET

Operator

Ladies and gentlemen this is the Dollar General Corporation First Quarter 2012 Conference Call on Monday June 04, 2012 at 3:30 p.m. Central Time. Good afternoon and thank you for participating in today’s call which is being recorded by Conference America, no other recordings or rebroadcast of this session are allowed without the company’s permission.

It is now my pleasure to turn the conference over to Ms. Mary Winn Gordon, Dollar General’s Vice President of Investor Relations and Public Relations.

Mary Winn Gordon

Thank you, Jeff and good afternoon everyone. On the call today are Rick Dreiling, our Chairman and CEO; and David Tehle, our CFO.

A couple of things before Rick begin, this afternoon we filed a preliminary prospective supplement relating to a potential secondary offers by several of our existing shareholders of up to 25 million shares of our common stock plus up to an additional 3.75 million shares to cover over allotment. No shares would be followed by the company. This offering is pending and we can see no assurance as to when it may be completed if at all. We will not comment further on our prepared remarks regarding the offering, nor will we address in the Q&A session that follows. So, (inaudible) thank you for not asking about this topic.

Next I’d like to remind you all, our upcoming investor conference in Nashville on June 25 and 26. If you would like to register please feel free to call me or send me an email and we will get you the information.

Now to the first quarter results. We will go first through our prepared remarks and then we will open up the call for questions. Let me caution today’s comments will include forward-looking statements about our expectations, plans, objectives, anticipated financial and operating results and other matters. For example, our 2012 forecasted financial results and initiatives, expectations regarding potential debt and share repurchases, debt refinancing and capital expenditures and comments regarding expected consumer economic trends are forward-looking statements. You can identify forward-looking statements because they do not relate solely to historical matters or they contain words such as belief, anticipate, project, plan, expect, forecast, guided, intent will likely results or will continue.

Important factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in our first quarter earnings release issued this afternoon, our 2011 10-K which was filed on March 22, and in the comments that are made on this call. You should not unduly rely on these statements which speak only as of today’s date. Dollar General disclaims any obligation to update or revise any information discussed in this call. We will also reference certain financial measures not derived in accordance with GAAP. Reconciliation to the most comparable GAAP measures are included in this afternoon’s earnings press release which can be found in our website under investor information press releases. This information is not a substitute for the GAAP measures and may not be comparable to similarly titled measures of other company.

Now it's my pleasure to turn the call over to Rick.

Rick Dreiling

Thank you, Mary Winn, good afternoon and thank you all for joining us today. We had another record first quarter and we are on-track for a great year at Dollar General. David will provide more details on our financial results in a moment, but I want to share just a few highlights from the quarter.

Our total sales increased 13% over last year to $3.9 billion. Same-store sales grew 6.7%, both customer traffic and average ticket increase for the 17th consecutive quarter. Operating profit excluding a $13 million litigation charge in 2011 and a secondary offering expenses in 2012 increased 15% to $385 million or 9.9% of sales.

Interest expense was down $28 million and adjusted net income increased 29% to $215 million. Our adjusted earnings per share increased 31% to $0.63 per share. Sales were strong in every department in our consumables and seasonal category. And the positive sales momentum in home continued.

We are very pleased with the sell through of our holiday, seasonal merchandise including Valentine’s Day and Easter. Spring and summer seasonal sales had a strong and early start due to warmer weather and or improved product quality and assortment from our global sourcing initiatives.

I’ll talk more about our operating initiatives in a moment, but now I’d like to turn the call over to David.

David Tehle

Thank you, Rick and good afternoon everyone. Rick covered the highlights of our first quarter sales performance, so I will start with gross profit. Gross profit dollars increased 13% for the quarter with a 2 basis point decrease in gross profit rate or essentially flat year-over-year at 31.5% of sales. This performance was better than we had anticipated going into the quarter for a number of reasons.

First, we leveraged distribution and transportation cost, even though average diesel fuel rates were up about 7% and we brought two new distribution centers online in the quarter. Also year-over-year shrink was favorable and markups on beginning inventory were higher than last year. Finally, the LIFO provision in the quarter was $1.6 million compared to $3.6 million in the 2011 quarter, about 6 basis point favorable impacts. These factors were offset by higher markdown and a greater mix of consumables; in part the increased markdown resulted from our new apparel strategy and were anticipated.

We were very pleased with the gross profit rates for the quarter. Our two new distribution centers ramped up more efficiently than we anticipated and our category management processes have continued to be very effective.

SG&A expense was 21.6% of sales in the quarter a 20 basis point improvement after excluding $1 million in secondary offering expenses in 2012 quarter and $13.1 million related to certain litigation settlement in the 2011 quarter. The 20 basis point improvement was primarily the result of our increased sales in more effective utilization of store labor which was due to benefits from our workforce management system. Also our mining for cost reductions mindset continues to pay benefit. For example, our cost reduction efforts effecting store rent and other expenses contributed to the overall decrease in SG&A as a percentage of sale.

Several expense items increased at a higher rate than our increase in sales including fees associated with the increased use of debit cards, cost associated with opening our new distribution centers and higher worker’s compensation and general liability insurance and advertising cost, even though our worker’s comp cost increased year-over-year due to more stores and labor hours and higher medical cost, our incident rate continues to decrease, thanks to safety efforts in our stores in DC. Again we are pleased with our ability to effectively balance sales, gross margin and SG&A resulting in strong operating profit growth.

Interest expense decreased to $37 million in the 2012 quarter compared to $66 million in last year’s first quarter as a result of our debt reduction and refinancing. The effective income tax rate for the quarter was 38.2% compared to 38.1% in the 2011 quarter.

First quarter net income increased 36% to $213 million compared to net income of $157 million in the 2011 quarter. On an adjusted basis net income increased 29% to $215 million compared to $166 million last year. Adjusted earnings per share was $0.63 per share a 31% increase. We generated $193 million of cash from operating activity down $31 million from last year’s first quarter. Net income was higher partially offset by higher income tax payment. In addition, there were timing and mix differences and our domestic merchandise payable. There were no policy changes or significant business trends that caused this shift. Partially offsetting these items were reduced bonus and interest payment.

Our 53 week fiscal year in 2011 in also affecting certain of our working capital accounts, but we expect [income tax] to be minimal by the end of 2012. As of May 04 total inventories were $2 billion up 13% in total and 7% on a per store basis in line with our sales growth. Our inventory turns were 5.3 times. We have seen improving in stock levels even as we continue to focus on inventory reduction.

Capital expenditures for the quarter totaled $146 million including $33 million related to new fleet stores, $36 million for stores we purchased or build $41 million for upgrades, remodels and relocations of existing stores, $31 million for distribution and transportation and $4 million for information systems upgrade.

During the quarter we opened 128 new stores and remodeled or relocated 224 stores.

On April 2, we purchased 6.8 million shares of our common stock to $300 million concurrent with the closing of the secondary offering funding the repurchase with $300 million in borrowings under our revolver. Given the seasonality of our cash flows and ability to execute additional share repurchases, we currently expect (inaudible) Board of Directors for additional authorization in the fourth quarter of this year.

At the end of the quarter we had outstanding long-term obligations of $2.88 billion down $382 million from the year prior with a much lower average borrowing rate. We continue to take steps to positively manage our debt structure and maturity ladder.

On March 30, 2012 our term loan facility was amended and restated to extend the maturity on $880 million of the total $1.96 billion facility to July 2017 from July 2014. In addition, the new terms provide for the ability to refinance our existing senior subordinated notes with senior notes and provide additional capacity to make investments, restricted payment and debt prepayment.

Further, in April S&P rates our credit rating to BBB minus the first level into investment grade. There are numerous benefits of the investment grade rating which should favorably impact our borrowings, rental rates and our collateral and covenant requirement.

Now to guidance, we’ve had a strong start to the year. Based on our first quarter results, we are raising our full-year earnings guidance by $0.03, earnings per share adjusted is now expected to be approximately $2.68 to $2.78 based on approximately 336 million weighted average diluted shares. Previous guidance was $2.65 to $2.75 based on 335 million shares.

We currently expect total sales to increase between 8 and 9% over the 53 week 2011 fiscal year or between 10 and 11% on a comparable 52 week basis.

Same-store sales based on a comparable 52 week period are expected to increase 3 to 5%. Adjusted operating profit is now expected to be in the range of 1.62 to $1.66 billion compared to previous guidance of 1.60 to $1.65 billion.

Interest expense is still expected to be in the range of $145 million to $155 million based on our intent to redeem our senior subordinated note for refinancing at the first scheduled call dating July 2012.

The full-year 2012 effective tax rate is expected to be between 38 and 39%. For the year we plan to open approximately 625 new stores and to remodel or relocate a total of approximately 550 stores. Capital expenditures are expected to be in the range of 600 million to $650 million.

As our first quarter performance indicate, I believe we are well positioned for future growth. Our employees are executing on our plans to win with our customers as we state through to our EDLP strategy. This results in a bright financial outlook for 2012 allowing us to continue to invest in the business for sustainable growth drive returns and generate significant operating free cash flow.

I look forward to seeing everyone and sharing more insights about Dollar General at our upcoming Investor Day. With that I will turn the call back over to Rick.

Rick Dreiling

Thank you, David. We had yet another great quarter and we are focused on growing and improving everyday as we continue to build loyalty with our customers.

In our investor conference later this month we intent to share some new insights into our customer for spending habits and a few things that have changed in recent years. But the ultimate measure of customer trend shows up in our continued strong market share performance as measured in syndicated data.

Over the last 12 weeks, 24 weeks and most importantly 52 weeks, our consumables consistently gained share in both units and dollars against food, drug in the mass retail channel. In our year-end conference call, we discussed our most significant operating initiatives for 2012 and here is the quick update.

First, store growth. To the first quarter we opened 128 new stores including eight Dollar General market and seven Dollar General pluses with our new larger format stores. The DG plus stores have an expanded cougar section for convenience, wider aisles for shopability and increased linear space for better in stock position. This larger format layout is driving a higher basket as we continue for customers both value and convenience.

In addition, we remodeled or relocated 224 stores in the quarter including 12 Dollar General market remodels and 20 Dollar General plus stores. We opened 11 new stores in California and also added our first store in Massachusetts. These new states are all off to a great start. At the end of the first quarter, we had 10,052 stores in 40 states.

To support our stores we opened a new distribution center in Bessemer, Alabama and another in Lubbock, California in the first quarter. We are very pleased with how well these DCs are performing.

Currently, we are shifting approximately 700 stores out of Bessemer and 100 stores out of Lubbock. Later this year, we plan to begin construction on our distribution center to support our store growth in the Northeast.

Our category management efforts are ongoing. We made great progress on implementing Phase 5 our initiatives aimed at optimizing shelf space to reflect demand in the stores based on geography, demographics and actual customer experience. In typical DG fashion, we began a test and learnt of this concept in 2011 and have already impacted more than 5,000 store specific [plantogram] changes out of the potential for 40 to 50,000 opportunities. This is a multiyear initiatives designed to drive productive sales growth that our store managers and teams are excited about implementing for our customers.

We continue to move forward with adding items at a $1 price point. Currently about 26% of the items in our stores are $1 or less. That’s up 150 basis points from the beginning of 2011. We are very pleased with the results of our cougar expansion. Most of our new stores have been built with 16 cougar doors and we expanded the number of cougars in over 500 of our traditional stores in the first quarter.

As I mentioned earlier, we had strong performance in many of our non-consumables departments in the quarter including hardware, toys, summer seasonal, house wears and domestic. Apparel sales overall continue to struggle but there were several positives in the quarter including infants and toddlers, ladies sleep wear and under garments and accessories. Hanging apparel in particular continues to be an area where we believe we can improve our results. We are executing our fresh approach to apparel pricing as we are adding in season promotional events and we are flowing new apparel to the stores more frequently, so that our customer sees fresh merchandised more often.

We are making further progress and improving our in-stock levels contributing to enhanced customer shopping experience overall. Out of stocks in the first quarter were down 30% from a year ago. This is an ongoing effort and we believe that our focus in this area can continue to drive sales growth going forward. we believe the initiatives is contributing to the positive results we are seeing in our customer service scores.

The success of the Dollar General business model has always been based on everyday low price commitment and we are unwavering in that commitment. We are convinced that the EDLP strategy is one of the things that distinguish Dollar General in the mind of a loyal customers. With only 10,000 SKUs we believe that our customer is incredibly sensitive to all of our price movements. We have used our price optimization tool in support of the EDLP strategy since 2009 to help us deliver our margin targets while also maintaining that strong competitive price position. But we are very careful in the way we use this tool. In support of its own pricing the tool generates both price decreased and increases, but we always make sure we ultimately protect our unit growth. So, that is the critical measure of success of our pricing approach in the long run.

We currently have eight zones for pricing and generally our approach to its own pricing is to keep it simple, supporting a consistent price and need to cross our stores. As David mentioned our store workforce management system has been instrumental in helping us more effectively manage labor cost while improving our store execution and overall customer experience. We are continuing to improve the quality of reports and communications between the store managers and the district managers. We believe we have additional opportunities to utilize this system, to help streamline work in the stores.

We are also moving forward with the implementation of our new supply chain system which we expect to complete over a multiyear timeframe. As we said before this project spans the entire organization with the goal to reduce cost, increase efficiency and improve margins. From master data management, merchandising assortments and in-store operations to forecasting and replenishments, distribution and supplier management, we will have an end-to-end capabilities for our supply chain.

In summary, we are improving our operations across the board and believe we have long run way for continued success. While it's still early I’m pleased with the start of the second quarter. We are building our systems and our teams to support to long-term consistent and sustainable growth.

Before we take your questions, I want to thank our over 90,000 Dollar General employees and our new teams in Bessemer, Alabama and Lubbock, California. We have a great team now for coast-to-coast. Now we will take your questions. Mary Winn.

Mary Winn Gordon

Great. Thank you. So, Jeff, take first question please.

Question-and-Answer Session

Operator

Thank you. Our first question comes from John Heinbockel from Guggenhiem Securities.

John Heinbockel - Guggenhiem Partners

If you look at SG&A, so the run rate had been in the high single-digits bumped up here to 12. So, how about your value do you look at as timing and were transitory versus something that’s more structural. And I guess how much of that was the growth initiatives in the DC in California?

Rick Dreiling

Definitely a piece of that has to do with the growth initiatives both in terms of incremental advertising cost that we had in the quarter that we will continue to have in the second quarter to support our California effort and then the cost as we mentioned before as the distribution centers come up to speed before they start shipping piece of that cost goes to SG&A because it can’t be capitalized into inventory. And that’s definitely hitting in the quarter also. For the full-year our goal remains to leverage SG&A as we told you before and again we don’t give specific quarterly guidance on that, but clearly there are few items hitting there that we mentioned that are causing SG&A to be a little bit higher that won’t be there as we get on an ongoing basis more back to average run rate for the business.

John Heinbockel - Guggenhiem Partners

Nothing has changed when you look at the various expense items, nothing has changed structurally.

Rick Dreiling

That’s correct. Nothing has changed structurally.

John Heinbockel - Guggenhiem Partners

And secondly, Rick can you talk about DG plus versus DG market in terms of differences in returns. How you think about where you put a plus versus a market; distinguish types of locations between the two. And do you think DG plus has more potential when you looked out over 5 to 10 years than market would.

Rick Dreiling

It's still really early as far as the returns are and we are continuing to work our way through them. I will tell you I’m pleased with the progress we are making on both the plus and the Dollar General market. I view the Dollar General plus, John, as the opportunity where we anticipate doing larger volume. I think if you think in terms of the 7300 square foot store that store gets really constrained when you start doing a 1.7 million, 1.9 million a door in the DG plus, [look forward] to see opportunity with incremental refrigerated space, wider aisles of two carts can get by and of course, an additional linear footage to help us with our in-stock. The DG market we are still very excited about. We think I get to see opportunity to differentiate ourselves in rural markets as well as perhaps the urban environment down the road. So, what we promise to do is keep you guys at the data as we move through the year on all of this.

John Heinbockel - Guggenhiem Partners

When you look at non-consumables, do any categories jump out where you think you need to increase assortment where you think there is a market opportunity, be it house wares or toys is there something that jumps out as unique opportunity to add assortment.

Rick Dreiling

I’d say, John, as I look across the non-consumable side I’m very pleased with where we are going in seasonal. We are doing a lot of hard work on and again as much improvement as we made getting it really hard again toward the end of the year. And you have to say what we are seeing in home décor what we are seeing with window treatments items like that, I’m pleased with what I’m seeing there. Our struggle continues to be hanging apparel and we are still working on that.

Operator

Our next question comes from Charles Grom from Deutsche Bank.

Charles Grom - Deutsche Bank

What you guys think the market potential is for plus stores. And just to clarify are those remodels or they actually new stores that you guys are opening.

Rick Dreiling

Ts actually a combination of both. We have remodeled some higher volume Dollar General, see if we get a bigger leap with the additional space or relocate it them rather, then of course some of them are out of the ground. And in terms of what is the long-term potential we really haven’t called that out yet other than to say, Chuck, we are pleased with what we are seeing at this stage of the game.

Charles Grom - Deutsche Bank

And on the comp just a little bit of clarity of the traffic and ticket during the quarter and also have a trended. And my follow-up, given the strength why not raise the comp guidance for the full-year and keep it to 3 to 5?

Rick Dreiling

We saw traffic and ticket both increase through the quarter. It came through the quarter as you can imagine with the shift in Easter. We had a good start in February, had a great March and of course it slowed a little in April. If I add March and April together and divide it by two you state yourself you had a really good April and March.

Charles Grom - Deutsche Bank

And follow-up on that, any major changes on the competitive landscape whether with FDO or with Wall-Mart?

Rick Dreiling

If I look at the overall competitive landscape, I’d say it's actually a little calmer than we have seen in previous couple of quarters. You look at our numbers that we posted in the first quarter where we are certainly controlling what we can control.

Operator

Our next question comes from Deborah Weinswig from Citi.

Deborah Weinswig - Citi

What do you think you are in with regards to improving out of stock?

Rick Dreiling

I’d say first quarter.

Deborah Weinswig - Citi

And then can you update us on your new apparel strategy?

Rick Dreiling

We started the apparel strategy, we are doing compared the more promotional pricing, we are pricing very much like you see when you would go into a more traditional seller of product. I can say that we have seen some traction in the infants and toddlers, we are doing little bit better than men’s. The important thing is that we are seeing units improved, while we are still struggling on the overall sales number. We start to sell more of it. And I think we are going to have to give it a few more months to unwind and our new [VP] stuff doesn’t really start to show up until September.

Deborah Weinswig - Citi

How should we think about the current margin benefit from global sourcing?

David Tehle

We continue to work on our sourcing effort overall receipts grew in the first quarter versus the year ago. It continues to be one of our largest items in terms of where we are going to get long-term margin growth. We have opened up, we are in the process of opening office in Turkey and one in Northern China. We continue to work on ways to increase that effort. So, I think we are getting a little bit more into consumables also on sourcing. So, we are pretty pleased with that effort right now.

Operator

Our next question comes from Aram Rubinson from Nomura Securities.

Aram Rubinson - Nomura Securities

Two questions. First, if you can give us some line of sight into fresh and how the supply chain is perhaps being reworked to allow that overtime to find its way into the 10,000 stores that you got out there?

Rick Dreiling

In regards to the fresh items we are still using the outside companies that we have dealt with before. While we are moving a lot of product overall, it's still a small amount of product on the store-by-store basis. And we used two companies to help us, we use (inaudible) in the base stores in the plus stores and we use (inaudible) on the DG market.

Aram Rubinson - Nomura Securities

And then just a follow-up, if you can give us a little line of sight in the LIFO that was little bit more favorable than it's been. Any idea on how we should think about full-year there.

Rick Dreiling

The LIFO charged in the quarter was $1.6 million versus $3.6 million in the prior year. And right now again this changes obviously every quarter and changes depending upon what vendors are doing on prices, but our best thought process is somewhere between 8 and $10 million in total for the full-year.

Operator

Our next question is from Matthew Boss from JPMorgan.

Matthew Boss - JPMorgan

You guys mentioned earlier that the mix of $1 price point items has increased to 150 basis points since 2011, what would be the total mix today and what’s the initial impact on the overall basket.

Rick Dreiling

It's right about slightly north of 26% now. And in terms of the change in the basket, I don’t know what that is off the top of my head. I can’t tell you this though that we added the $1 items and we are not suffering any kind of cannibalization what are the items we added in. So, to give you an example, we put in anywhere from 12 to 16 foot with a $1 HBA and assorted items, and it didn’t wrote our margin and it didn’t cost us any sales. So, it's all incremental. So, our feel is it's a purchase we weren’t getting.

Matthew Boss - JPMorgan

And then second question, can you talk about the initial performance from your California store, be it California store rollout.

Rick Dreiling

Yes. We have right at 10 stores in California and they are exceeding our real estate performers, so we are doing much better than we thought we would be doing.

Operator

Next question comes from Dan Wewer from Raymond James.

Dan Wewer - Raymond James

Wanted to follow-up on your comments about that market share capture from the drug stores, big retailers and mass market. So thinking about the drug stores, you are obviously winning on pricing advantage. I’m assuming breakeven on the convenience niche. On the other hand when you are taking share from the mass market you are probably winning on convenience breaking even on price. Is that the way you think about it, and are those three channels, which one do you think is the most vulnerable to yourself and your competitors.

Rick Dreiling

I think you called it perfectly. If you look at the Neilson data we are gaining share from grocery first, drug second and mass third.

Dan Wewer - Raymond James

So, grocery winning on the convenience niche?

Rick Dreiling

I’d think on grocery you are winning on price and convenience to be honest with you. I can see both.

Dan Wewer - Raymond James

How do you see those three channels responding to your success. I can’t imagine they just kind of sit there and not do anything to defend their market share.

Rick Dreiling

I think the issue is we deal if you look at all consumable retailing it's in $800 billion pie. And I think what’s going on is that, Dan, we are taking a little bit from a lot of different spot and it's really hard to really focus on just us. So, I think as long as we (inaudible) which is everyday low price and convenience and don’t get into the trap of going high low. I really believe that we are going to be able to move the business.

Dan Wewer - Raymond James

The last question I have is on the sales productivity as a plus on the market stores. When you think about the extra 2 or 3,000 square feet in a DG plus, are you seeing any diminishing return on sales per square feet or is it actually increasing because the space you are devoting is primarily in consumables.

Rick Dreiling

Yes, the sales per square foot is going up and it's a question now thus managing our way through what to build them and the marketing team is continuing to work on the mix so it's a matter of fine tuning the vehicle.

Operator

Our next question comes from Joe Parkhill from Morgan Stanley.

Joe Parkhill - Morgan Stanley

I was just wondering if you could maybe talk about your comps accelerating over the last 12 months, where do you think from income level perspective that’s coming from. Are you seeing incremental trade down from a higher income consumer or do you think the lower income consumer is feeling a little better and maybe talk about paycheck cycle if you are seeing how that compares to the prior years?

Rick Dreiling

I’d say we are still growing our share of wallet with our existing customer. And there has been no change in the fastest growing customer segment we have is $70,000 or more per year. So, I’d say you are continuing to appeal to your core customer and at the same time the changes we made over the last four years are continuing to be recognized by the trade down and trade in customers. I apologize I forgot the second part of your question.

Joe Parkhill - Morgan Stanley

And if you could comment on the paycheck cycle if you are seeing it.

Rick Dreiling

I will tell you the paycheck cycles or as pronounced as they have been in the last 18 months and there has been no change in that. Every indication is that our customer is still very much affected by what’s going on. And there has been no change in their sentiment at all just to be straight.

Operator

Our next question comes from Meredith Adler from Barclays Capital.

Meredith Adler - Barclays Capital

Just following on last set of questions about the consumer and the paycheck cycle. Do you accept food stamps in most of your stores, are you seeing any increase in the utilization of food stamps.

Rick Dreiling

We accept food stamps in all of our stores and the growth we have seen in food stamps mirrors the growth that’s taking place in the country. It's not like growing significantly faster than anything else in the stores today.

Meredith Adler - Barclays Capital

And then you talked a little bit about store specific planograms, I was wondering if you could talk a little bit more about that. I’m wondering whether you are talking about this allocating space differently to the same product maybe not having some products in stores. Are you or are you actually buying unique products that will only go into some source. And what do you think that means for the efficiency especially the distribution centers and the buying process.

Rick Dreiling

And to answer your question is one and two and not a lot of three. We are going in and I used the example of when you fill the store in a more matured neighborhood you would expand (inaudible). Basically the bulk of it sets the same, you know that’s slower moving out and expand on the faster moving and perhaps even add just a couple of additional SKU. We are also looking at the fact that there might be some categories that we don’t need in certain stores. But in terms it's going in and altering the mix and really change in the number of SKU that would be a logistics nightmare .

Meredith Adler - Barclays Capital

And can you comment on customer reaction. I guess to some extent this must go with the in-stock efforts you have got, right?

Rick Dreiling

And actually where we are seeing where it gets done is in improve in in-stock numbers, that’s exactly right. The fun about it all is that the store managers are excited about it. Every time I go into a store it's been done, the store manager is like, why it take it so long to get it done. It's pretty neat.

Meredith Adler - Barclays Capital

Final question is just about, [we ever state] in California are you seeing any changes is it difficult to get some high store that you want. It sounds like you do buy some real estate and build your own stores is that more the case in California or less maybe just comment on changes in cost as well.

Rick Dreiling

Yes, I mean the real estate program the supplies we’ve had in California has been the price of real estate. I said we said the couple of times. And in terms of build-to-suit programs and all that is very typically in what we are doing in other market there is no significant difference there.

Meredith Adler - Barclays Capital

When you say [prices] and the pricing mean high.

Rick Dreiling

Low. There is abundance of real estate out there that’s small, which is what we want.

Operator

Our next question comes from Scot Ciccarelli from RBC Capital Markets.

Scot Ciccarelli - RBC Capital Markets

Can you talk about any changes in your inflation expectations, getting conversations with vendors at this stage.

David Tehle

It's definitely come down if you remember in fourth quarter we were like 200 basis point hit on inflation and now it's more like 50 basis points or for the full-year like 0.5%. So, it's definitely come down.

Rick Dreiling

We are seeing it broad across the water commodities sugar, and flower and oil everything is coming down.

Scot Ciccarelli - RBC Capital Markets

Okay. And your reaction will you actually, how will you react. Are you trying to lower the price point or increase the value to the consumer’s?

Rick Dreiling

That’s a case-by-case item, but I will tell you when we reinforce we are really committed to EDLP. So, we will do what we need to do.

Scot Ciccarelli - RBC Capital Markets

Second question is regarding the [UTCs] in the quarter. Were they a drag on a net basis and as they ramp up how should we think about the financial benefit as they should deliver?

David Tehle

Yes, clearly anytime you are opening up a new distribution center there is going to be somewhat of a drag because it's just not addition when you first start out. As we get down the learning curve and as we add more stores to each of the distribution centers they will get more efficient and ultimately obviously the reason we did it, it helps us particularly on our transportation cost cutting down the transportation, cutting down stem miles. So, yes it will absolutely help us in the long-term once we get with our initial startup period.

Scot Ciccarelli - RBC Capital Markets

And how long does that typically take?

David Tehle

It varies by individual DC as we go, yes probably six to eight months. And again we believe in the February, March timeframe.

Operator

Our next question comes from John Zolidis from Buckingham Research.

John Zolidis - Buckingham Research

Two questions. One is you just mentioned that inflation seems to be coming down, yet comps have been accelerating for five consecutive quarters. What do you attribute the sequential improvement in comp.

Rick Dreiling

We have been relentlessly focused on unit growth. I think it's translating into more customers. I’d tell you this time last year we made a pretty big call and I think it's worked out as they look back to last year.

John Zolidis - Buckingham Research

And by unit growth you mean the items that people are putting in their baskets?

Rick Dreiling

Well, what I mean is if you go back and you look at the last year, you had all of this inflation taking place and people were passing it all on to the customer and it slowed their unit growth. You recall we took our price increases a little bit at a time and actually didn’t have some on and we kept our unit growth going and what you created more market share for us.

John Zolidis - Buckingham Research

And then my second question is on SG&A. I don’t know if you can give us any more color regarding some of these other items you decided in the press release the debit card usage, the pre-opening cost, the higher worker’s comp, general liability insurance, advertising all of these items that serve to dampen the SG&A leverage in 1Q. I don’t know if you can quantify those. And then secondly going forward are there any of those that don’t continue?

David Tehle

Again we really don’t get that granular in terms of quantifying individual line items with SG&A. When we started the year we made the comment that for the full-year our goal is to leverage SG&A and that remain to be our goal as we go through the year, we don’t see that changing. So, one item that goes away in SG&A is those DC cost that we talked about. Again as you are starting up the distribution center and you are not shipping yet SG&A does take a bit of it for that and that will go away.

Operator

Our next question comes from Matt Nemer from Wells Fargo Securities.

Matt Nemer - Wells Fargo Securities

Couple of questions; one your seasonal business had a nice acceleration and you call that it's a non-consumables categories like summer seasonal and toys. How much this you think is attributable to the weather and maybe how much could be the early results of Phase 5?

Rick Dreiling

I think the weather no doubt affected particularly the summer seasonal sales, we had a good Easter we had a good Valentine’s but I will tell you there has also been a serious change in the product mix again this year not only in terms of what we have got but the quality and we have been managed the whole the retail on it. We are still seeing really good seasonal sales as we move through the quarter.

Matt Nemer - Wells Fargo Securities

And then secondly, could you give us an update on some of your new merchandised categories, maybe an update on beer and wine and the tobacco test in Las Vegas market. And one of your competitors announced the deal today a rollout of video rental machines in the stores and I’m wondering if there is an opportunity for vending or type machines in the front of the stores.

Rick Dreiling

We are actually doing some work with red box as we speak also. And we have been working with it for few months now. We are happy with what we see, it does take a lot of transaction to make the red box thing work. I can’t tell you that. In regards to beer and wine we are at about 3900 stores with a goal of trying to get to 5000. It's on-track we are still pleased with what we see in regards to what happens to the basket and we are pleased with what we see how it affect store comp. regards to cigarettes in Nevada, I’d say it's unchanged we are seeing what we have seen since we have been doing it in November, we continue to work with it, but again we will wait until it plays out a little longer.

Operator

Our next question comes from David Mann from Johnson Rice.

David Mann - Johnson Rice

Couple of questions. Comment you made earlier about SG&A, can you just clarify in terms of the advertising deleverage. Was all of that due to the increases spend in California or you doing some other spend throughout the company?

David Tehle

The vast majority is due to what we were doing in California.

David Mann - Johnson Rice

And at what point in time would you expect that to not have the deleveraging impact?

David Tehle

Well, we continue to grow California and experiment, so I guess it's little early to make that call yet.

Rick Dreiling

David, when you enter a new market the money you spend out of the chute is going to be the least expensive long-term. And we really want to come out, we have a lot of thoughts on California, we are trying to come out of the box really stronger.

David Mann - Johnson Rice

And then in terms of gross margin, on the last call you talked about seeing a slight gross margin contraction in the first half, given the results in the first quarter how should we think about that comment now with second quarter ahead of us

David Tehle

Yes, still a valid comment. For the full-year again our goal remains to leverage gross margin, I want to be clear on that. We don’t see that happening in the second quarter because f the depreciation and some other expenses for the two new DCs that are going to impact the margin in Q2. And again as we talked about on the call in Q1, some of these expenses hit SG&A because they were pre-opening expenses from a timing perspective. Also for Q2 there will be a full quarter of depreciation hit for the DCs they weren’t opened the first quarter they will opened second quarter. So, we will have somewhat of an impact there. As you want to stress again, once the new DC is get up to a full capacity their efficiency improves quite a bit and ultimately this will be a positive for Dollar General down the road, but we clearly still see that margin hit the first half of the year.

David Mann - Johnson Rice

One last question on gas prices, obviously in the latter part of the quarter you saw there is continued ramp up now they are coming down. Can you just elaborate any change in consumer behavior as that was going on that you could parse out or is it been not impact you too much?

Rick Dreiling

I’d say I have looked at this really hard over the last four years trying to ascertain that when gas prices go up does this affect our business or when they go down. And all David and I can come up with is when gas prices are high people need us more often and when they come down they have more to spend.

Operator

Our next question comes from Emily Shanks from Barclays Capital.

Emily Shanks - Barclays Capital

I have one question, around the hang apparel mix, where do you think it's is that you guys are missing. I recognize it's been a volatile category for you for a number of years. Do you think it's a competitive issue, do you think that your consumer this is a fine. What are your views there?

Rick Dreiling

I think that we are going to need a little help with the economy before we really get that piece going. I can’t tell you when we look at our market research, our customers buys for their child first, their husband second and themselves third. And I think since we are seeing a little bit of improvement now infants and toddlers and men’s and boy’s that might actually be varying out.

Operator

Our next question comes from Trey Schorgl from Credit Suisse.

Trey Schorgl - Credit Suisse

We were just wondering we have been seeing one of your primary competitors doing a lot of promotional activity, lot of buy one get one, 50% off. So we were interested in your comment about the competitor’s intensity. I was just wondering do you think you have different price message as far as your focused on EDLP versus hi low. Do you think it's making your value proposition more meaningful for your customers.

Rick Dreiling

We are really committed to everyday low price. That’s been the backbone of this company for all of the years we have spend here and I think if you listen to customers today, while they do recognize certain prices they are getting a little armory about not knowing what the price is going to be when they come in because they are promotional activity. So we are focused on EDLP, we think that’s the right way to go and we think our numbers in the first quarter show that a successful strategy.

Operator

We are taking a question now from Joe Feldman Telsey from Advisory Group.

Joe Feldman - Telsey Advisory Group

Just one more thing I wanted to ask was about freight cost actually, have you guys seen any issues there in terms of increased freight expenses and is there any pressure that you are seeing or is it just being offset by the distribution infrastructure?

David Tehle

Our freight cost have actually been down if we look at where we are as a percentage of sales. Some of that is due to our efforts reducing stem miles, improving cartons for load and things of that nature, but we have also done a very good job in negotiating our contracts and feel pretty good about where we are in freight right now.

Mary Winn Gordon

Well, thank you everyone for joining us today and always we appreciate your interest and hopefully we will see many of you in Nashville at the end of the month, and please come in if you have any questions. Thank you.

Operator

Thank you. This does conclude our teleconference for today, you may now disconnect.

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