Dollar General (DG) Todd Vasos on Q3 2015 Results - Earnings Call Transcript

Dec. 03, 2015 4:27 PM ETDollar General Corporation (DG)
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Dollar General Corp. (NYSE:DG) Q3 2015 Earnings Conference Call December 3, 2015 10:00 AM ET

Executives

Mary Winn Pilkington - VP of Investor Relations and Public Relations

Todd J. Vasos - CEO & Director

John W. Garratt - CFO

Analysts

Michael Lasser - UBS

Daniel Binder - Jefferies & Co.

Esteban Gomez - JPMorgan

Meredith Adler - Barclays Capital, Inc.

Andrew Ruben - Morgan Stanley & Co.

Paul Trussell - Deutsche Bank

Matthew Nemer - Wells Fargo Securities

Edward Kelly - Credit Suisse Securities

Dan Wewer - Raymond James & Associates, Inc.

Charles Grom - Sterne Agee CRT

Operator

Good morning. My name is Celica, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dollar General Third Quarter 2015 Earnings Call. Today is Thursday, December 3, 2015. All lines have been placed on mute to prevent any background noise. This call is being recorded. Instructions for listening to the replay of the call are available on the Company's earnings press release issued this morning.

Now I’d like to turn the conference over to Ms. Mary Winn Pilkington, Vice President of Investor Relations and Public Relations. Ms. Pilkington, you may begin your conference.

Mary Winn Pilkington

Thank you, and good morning, everyone. On the call today are Todd Vasos, our CEO; and John Garratt, our CFO. We will first go through our prepared remarks, and then we will open up the call for questions. Our earnings release issued today can be found on our Web site at dollargeneral.com under Investor Information, Press Releases.

Let me caution you that today's comments will include forward-looking statements about our expectations, plans, predictions, and other historical matters, including but not limited to 2015 forecasted financial results and capital expenditures; our planned fiscal 2015 and 2016 operating, merchandising, store growth and prototype initiatives; our capital allocation strategy and expectations, and statements regarding future economic trends.

Important factors that could cause actual results or events to differ materially from those reflected in or implied by our forward-looking statements are included in our earnings release issued this morning, our 2014 10-K, which was filed on March 20, 2015, our 2015 third quarter 10-Q filed this morning, and in the comments that are made on this call. We encourage you to read these documents. You should not unduly rely on forward-looking statements, which speak only as of today's date. Dollar General disclaims any obligation to update or otherwise revise any information discussed in this call. We will also reference certain financial measures not derived in accordance with GAAP. Reconciliations to the most comparable GAAP measures are included in this morning’s earnings release, which as I had mentioned is posted on dollargeneral.com in the Investor Information Press Releases section.

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

Todd J. Vasos

Thank you, Mary Winn, and thanks to everyone for joining our call. This morning we announced our results for the third quarter of fiscal 2015 along with an incremental $1 billion share repurchase authorization. Returning cash to shareholders remains the top priority and we expect to deliver nearly $1.6 billion to shareholders during 2015 through both anticipated share repurchases and quarterly dividends.

Additionally, I’m very pleased to announce John Garratt has been promoted to CFO. I’ve gotten to know John very well over the last 15 months and he is an accomplished executive with significant financial experience. As Interim CFO, John has already played a key role as we look to implement our zero-based budgeting process and execute our new store growth. I look forward to his further and future contributions at Dollar General.

Turning now to the quarter, our initiatives are showing initiatives are showing success relative to our long-term goals as we continued to drive profitable sales growth. We’ve the right team in place to capture high return, low risk, organic growth opportunities. We are aggressively taking steps to position Dollar General to be successful regardless of the retail sales environment.

I’m pleased with the way the team manage the business, given the continued overall weaker retail environment across the sector. For us, our core consumers still struggling, as she continues to face rising costs in major expenditure categories like rent and healthcare with no real income growth. We believe that our core consumer is closely monitoring her spending not just with us, but across all retail.

Turning to some of the highlights for the quarter and year-to-date through the third quarter. Third quarter sales increased 7.3% to $5.1 billion. Year-to-date total sales were $15.1 billion, an increase of 8%. We delivered same-store sales growth of 2.3% for the quarter, adjusting for the Halloween shift to Q4; same-store sales were fairly consistent across all periods of the quarter.

We estimate this Halloween shift was a 20 to 30 basis point negative impact on same-store sales in the third quarter. Same-store sales increased 2.9% year-to-date through the third quarter. Sale per square foot were $225.

For the 31st consecutive quarter, when compared to the prior year quarter, we increased both our customer traffic and average ticket. Gross margin expanded by 19 basis points to 30.3% in the third quarter.

For the quarter, diluted earnings per share increased 10% to $0.86. Adjusted diluted earnings per share increased to 11% to $0.88. During the quarter, we returned $340 million to shareholders through the repurchase of 3.8 million shares of common stock and the payment of a quarterly dividend. Given our performance year-to-date, we’re updating our full-year financial outlook.

We expect same-store sales will likely be in the range of 2.5% to 2.8% for fiscal 2015. Diluted earnings per share for fiscal 2015 is expected to be in the range of $3.87 to $3.92 and adjusted EPS is expected to be in the range of $3.88 to $3.93.

We continue to grow transactions and item units in syndicated share data for the quarter. We experienced consistent mid-single digit growth in both units and dollars for the 4, 12, 24, and 52 week periods.

Let’s turn now to a more detailed review of our growth drivers. Our real estate program is the foundation for our growth with a proven high return, low risk model. We remain disciplined and focused on financial returns. We continue to see our new store productivity at around 85% of our comp base all while driving strong returns of approximately 20%.

For 2015, we’re on track to open 730 new stores and relocate or remodel the combined 875 stores. The average sales performance of our new stores is running ahead of our forecast. Looking ahead for 2016, our pipeline is full as we continue to plan for approximately 7% square footage growth or about 900 new store openings.

The real estate team has continued to build upon this progress with the 2017 pipeline which is starting out at a greater pace in our 2016 pipeline as we look to continue to capitalize on the strength of our real estate model.

With our real estate strategy firmly in place, we continue to support our new store growth through the build out of our distribution network. Our location at San Antonio, Texas, is anticipated to begin receiving product this month and shipping in February of 2016. We just broke ground in November for our 14th distribution center located in Janesville, Wisconsin. These investments are key to driving the efficiency and speed of our network to support our growing store base.

In store, our targeted labor investments to grow market share in a competitive environment are providing positive financial returns. Currently we’ve completed two of the three phases of the labor investment roll out across approximately 2,400 stores. Recall that Phase 1 rolled out in the second quarter, Phase 2 was implemented in the third quarter and Phase 3 is scheduled to roll out during the fourth quarter.

We continue to say same-store sales growth for our Phase 1 stores gain traction since the second quarter roll out. Phase 1 stores are the only stores that have been on the program long enough to really see an impact. Phase 1 stores are on track to deliver on our return expectations, specifically in these stores the key metrics of same-store sales, transactions, average basket, and customer satisfaction scores are all showing significant improvement.

Additionally, across the chain, our store teams are focused on improving our on-shelf availability. The teams are leveraging retail basics, such as stocking and inventory management to make progress. We are validating our on-shelf availability through the use of third-party audits. Since our recommitment to the on-shelf availability, our teams are making great improvement in a very short time as evidenced by our customer satisfaction scores.

Our customer is recognizing our better in-stock position not only in the stores, receiving the incremental labor investment, but across the chain as our scores are at the highest level in over a year. And finally, as an indicator that these actions are resonating, we’re seeing the best performance in three years for improving store manager turnover rates.

During the third quarter, we accomplished a major milestone related to the multiyear roll out of our enterprise resource planning software for our supply chain. This technology platform represents a significant improvement with enhanced integration to allow for demand forecasting from the vendor to shelf. The team executed this initiative without disruption to the business.

On a combined basis, we believe these labor investments and inventory management initiatives are significant steps to improving our in-stock position, which is a critical component of our overall customer satisfaction and a driver of sales performance.

On the merchandising front, we had a positive same-store sales growth across all categories in the third quarter, with higher growth in consumables than in non-consumable categories. This represents the 7th consecutive quarter for improved -- improvement in our non-consumable categories. Strength in consumables was driven by growth in candy and snacks, tobacco, and perishables.

Within the non-consumable categories, sundries, housewares, hardware, and ladies clothing all exhibited strong growth. Consistent with our recent trends, our consumer continued to shop the holiday close to the event. Our sell-through of Halloween harvest merchandise was robust with a 90 basis point improvement year-over-year when taking into account the calendar shift into the fourth quarter this year.

Shrink improvement has been and continues to be one of our largest gross margin opportunities. We remain committed to reduce our shrink on a store-by-store basis. For the quarter, we’re extremely pleased with our shrink improvement. This progress continues to be broad based, year-to-date with shrink declining across nearly 70% of our product departments. Going forward, our teams continue to be focused on leveraging our defensive merchandising tools, technology, and training to further reduce shrink.

Turning to the holiday season, we’ve offers online and in-store for savings on electronic, game items, toys, gift options, small kitchen appliances, food and much more. We had exciting specials in the week leading into Thanksgiving, Thanksgiving Day, and Black Friday weekend that further allowed our customers to the opportunity to stretch their budget and save even more.

Our toy business is off to a strong start. We’re currently offering consumers an immediate 25% discount off of all qualifying toy purchases of $75 or more, both online and in-stores. This year about 70% of our toy offerings are branded or licensed products which resonate with our consumers as being on trend and communicating value.

We are capitalizing on our customer insights to strengthen our merchandising offering across product categories. In turn, this will be supported by a robust print and digital marketing calendar. We continue to capitalize on new ways to wow our consumers. We are focused on expanding high opportunity categories and giving our customers the trend right products she wants at affordable prices.

Now, let me turn the call over to John.

John W. Garratt

Thank you, Todd, and good morning, everyone. It is an honor and a privilege to be the new CFO of Dollar General. I’m excited to have the chance to work with such a great team. To be named CFO, was a tremendous opportunity as we continue to work together to invest for growth and to continue to create shareholder value over time.

As Todd has taken you through the highlights of our third quarter, I’ll share more insights on some of the important financial details and our outlook.

In the third quarter, we took important actions to continue driving the types of returns we expect from our business over time. Gross profit for the third quarter was $1.5 billion or 30.3% of sales, an increase of 19 basis points from last year’s third quarter. As compared to the prior year, the most significant drivers were improved inventory shrink rate and lower transportation cost, partially offset by sales mix.

SG&A expense in the quarter increased by 18 basis points over the comparable 2014 period to $1.1 billion or 22% of sales. The SG&A increase was primarily attributable to our restructuring charge for one-time severance related benefits of $6.1 million or 12 basis points.

The 2015 third quarter also reflects increases in store incentive compensation expenses, repairs and maintenance, occupancy costs and advertising expenses, partially offsetting these items were lower utilities costs and a reduction in employee benefits costs. The 2014 quarter reflects expenses of $8.2 million related to an attempted acquisition that was not completed, partially offset by unrelated insurance proceeds of $3.4 million. Our effective tax rate for the quarter was 37%.

Moving now to our balance sheet and cash flow. At quarter-end, merchandise inventories were $3.1 billion, up 5.1% on a per store basis. Key factors impacting this increase were our on-shelf availability initiative and the timing of receipts coupled with our sales performance. Even with this increase, we believe our inventory is in good shape and we’re comfortable with the quality. Going forward, our goal remains to ensure inventory growth is in line with our total sales growth over time.

Year-to-date, we generate cash from operations of $781 million, $60 million lower as compared to the same period last year. Changes in merchandise inventories and accounts payable were the key drivers of the reduction in cash flows. This was offset in part by increased net income of approximately $80 million. Total capital expenditures were $387 million.

During the quarter, we repurchased 3.8 million shares of our common stock for $275 million. We also paid a dividend of $0.22 per common share outstanding, totaling $64 million. Since the inception of the share repurchase program in December 2011, we repurchased over $3.3 billion of our common stock. With today’s announcement of an incremental share repurchase authorization of $1 billion. We currently have remaining authorization of approximately $1.2 billion under the repurchase program. We remain committed to our disciplined capital allocation strategy.

Our first priority remains investing in new stores and the infrastructure to support our growth. Our goal is to create lasting value for our shareholders through anticipated quarterly dividends and share repurchases, all while maintaining our investment grade rating and managing to a leverage ratio of approximately 3 times adjusted debt-to-EBITDAR.

During the quarter, we issued $500 million of senior unsecured note. The proceeds of which were used to reduce a portion of the term loan. We also increased our revolver size and extended the maturity of our credit facility. Also during the quarter, we’re pleased to note that S&P upgraded our credit ratings to BBB from BBB minus and Moody’s upgraded our outlook to positive from stable.

Turning now to guidance. We are updating our financial guidance ranges for 2015. Details of our guidance are included in our press release. Highlights include, total sales for the year are expected to increase approximately 8%. Expectations for overall selling square footage growth remain at approximately 6%. And for the year, same-store sales are expected to increase by about 2.5% to 2.8%. Please note that it is still very early in the quarter for us and our customer tends to shop closer to events.

We’ve narrowed our expectations for the adjusted diluted earnings per share to a range of $3.88 to $3.93 for the year. This guidance assumes the reinstatement of the work opportunity tax credit back to the beginning of the year, which is always been included in our full-year guidance. The impact of the tax credit is approximately $0.05 per share. There could be no assurance that this tax credit will be retroactively reinstated or reinstated at all in the fourth quarter.

We are deep in the budgeting process for 2016. The team is focused on sales initiative to drive the top line coupled with a zero based budgeting mindset to reduce costs and SG&A. We are committed to getting our leverage point below our recent historical levels of approximately 3.5% for same-store sales growth. I believe our budget actions should help us deliver strong results for our shareholders over time.

With that, I’d like to turn the call back over to Todd.

Todd J. Vasos

Thank you, John. As I look to the future for Dollar General, I’ve a clear vision on where we wanted to be and how to get there. We’ve brought together a great team over the course of the last six months. Since being named CEO in June, I’ve had the opportunity to visit with Dollar General employees at many levels in the organization, travel across the United States visiting stores, and listening to our consumers.

The culture of serving others is meaningful to the employees of Dollar General and it is important to our consumers. We see a real opportunity to continue to save our consumers time and money everyday.

Looking ahead to 2016, the team is focused on four key priorities to improve our overall results for the long-term. First, driving profitable sales growth. Second, capturing growth opportunities. Third, leveraging our position as a low-cost operator and fourth investing in our people as a competitive advantage.

As I mentioned earlier, we’re taking positive steps to position Dollar General for continued success with these four priorities as our guide and our consumer at the center of everything we do. On the consumer front, we’re revisiting our brand archetype to ensure we’re connecting with our consumers and differentiating our brand. This will help us better define how we communicate with our consumers and impact all customer facing communications including circulars, in-store branding and digital advertising. At the same time, we’re updating our consumer segmentation as the foundation for strategies to drive product mix and assortment, marketing and even real estate.

We’ve completed our initial strategic planning process for 2016 and the teams continue to refine our initiatives. First, our actions to drive profitable sales begins and ends with our disciplined approach to category management. This allows -- this also includes expansion of categories that are most likely to drive traffic to our stores, including increased penetration in our legacy stores.

Our ongoing affordability initiative will be front and center with the refreshed approach. We will also leverage operational initiatives such as improving our on-shelf availability. Second, we will focus on initiatives to capture growth opportunities. Examples include our accelerated square footage growth in 2016 with the new store prototype that we will -- we plan to roll out to all new stores, relocations and remodels. The format will allow for high growth, traffic building categories to be expanded all in a more customer friendly layout with faster check out.

A new category optimization tool will also be deployed and we will also make sure that it is optimized our assortments as we go forward into 2016. Third, we will leverage our and reinforce our positioning as a low cost operator. We recently undertook a broad based initiative to proactively improve our efficiencies and reduce expenses over a multiyear timeframe, all while giving us the flexibility to reinvent savings to drive growth.

We eliminated approximately 255 positions across our corporate support functions to improve our flexibility while positioning us to better serve our consumers. Our zero based budgeting approach is a refresh commitment to removing costs from our business. We’re targeting cost savings in specific budget categories.

All of these actions are filtered through three lenses. First, is it customer facing? Two, does it align with our strategic priorities? And finally third, how does it impact our risk profile? Our underlining principles are to keep the business simple, but move quickly to capture opportunities, control expenses and always be a low-cost operator.

Fourth is to invest in our people. We believe that our people are a competitive advantage. Our strategy is focused on talent selection, store management development through great on boarding and training and open communication. Continued improvement in store manager turnover will take time, but the payoff is there through higher sales, lower shrink, and improved store associate turnover.

I look forward to sharing more details about our plans at an Investor Day scheduled for March 23 and 24 here at Nashville. Our goal is to allow plenty of time for interaction with our management team and share insights to our growth drivers for the long-term. At Dollar General, we’re moving fast and investing in the future.

We continue to believe that our future is very bright. Our long-term commitment to growth and shareholder value is unchanged. We’ve a business model that is proven and resilient. Our team is energized to seize growth opportunities. Our business generates significant cash flow and we’re in the position to invest in accelerated store growth, while continuing to return cash to shareholders throughout consistent share repurchases and anticipated dividends.

As we are in the midst of the busiest season of retail, I’d like to extend my appreciation and thanks to the nearly 114,000 Dollar General employees that fulfill our mission of serving others by providing our consumers with the convenience, value, and service everyday.

With that, Mary Winn, we’d now like to open the lines for questions.

Mary Winn Pilkington

Go ahead.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from the line of Michael Lasser with UBS.

Todd J. Vasos

Good morning, Michael.

Michael Lasser

Good morning, Todd. Congrats, John. Thanks a lot for taking my question. Todd, between your discussion of zero based budgeting being the low cost operator, capturing profitable growth, what do you think the right comp rate is in order to generate leverage in the business, if it’s not 3.5%? And how do you get there in a world where consumables are growing faster than discretionary and putting pressure on your gross margin and you face the potential of wage pressure over the long-term?

Todd J. Vasos

Yes. Michael, the way we see the business is, first of all, we’ve a very robust category management process here. And that process that we implemented well over seven years ago has served us very well in being able to balance that consumable and non-consumable mix. While consumables continue to dominate our sales, I’ve to say that I’m very proud of where our non-consumable business has come. We never loss sight of our non-consumable businesses even through some of the real harsh times our consumer was going through back in 2009, ’10, and coming out of that great recession that we had and that continues now. We’ve had a nice string of consecutive quarters that our non-consumable businesses have been pretty strong. And then as you look at being that low cost operator, we’re committed to that and I have to say a little bit more to come as we get into 2016 on that, but I can tell you that it is our goal to ensure that that leverage ratio comes down off of that 3.5% and we will be able to leverage our expenses at a much lower rate than it currently is.

Michael Lasser

Okay. And then my follow-up question is really in two parts. First, on the margin outlook for the fourth quarter -- to get to the midpoint of the range, it looks like you are going to have to assume 50 basis points or so of margin degradation. Is that right? Where is that coming from? And then could you clarify what you mean by consumers are shopping closer to events? Does that mean that -- the quarter start-off a little volatile and you are still expecting trends to pick up as we get closer to Christmas? Thank you so much.

Todd J. Vasos

Yes, sure. Let me answer the -- your second question first and I will pass it over to John to talk through gross margin with you. As we see it, our core consumer, because she is always very cash strapped. She does shop closer to the event, so whether it would be 4th of July during the summer, whether it would be Halloween in the fall, or even holiday time around Christmas, she tends to shop heavier in the days leading into those holidays. Now she is always been that way, but we’ve seen it get a little bit closer to the holiday each and every year now for the last two years. And when you really look at our sales cadence in Q3, it was very evenly paced over the period when you take that day shift that we had of Halloween in the Q4 into account, it was very consistent. So, it’s just the way the consumer is shopping and it’s up to us as retailers to ensure that we supply her with what she needs at the time she needs it and that’s how we look at the business.

John W. Garratt

In terms of your question around margin, I will start by saying we’re very pleased with the quarter to date performance, driving 33 basis points of expansion and it’s been very broad based utilizing many levers such as shrink expense control around distribution, transportation, and we see opportunity to continue driving the favorability on those over the long-term, as well as leveraging the additional levers we mentioned earlier around category management private label and foreign sourcing. We had mentioned previously that the rate of expansion would moderate as we go forward. Looking ahead to Q4, our guidance for Q4 is 8% operating profit growth and we look at -- for the year, I’m sorry, 8% for the full-year and we look to utilize all the levers within SG&A and operating and gross margin to get there. I should note that that is the toughest lap of the year, Q4, and I should also note that we lap the anniversary of our cash back fee, which had been providing benefit year-to-date, as well as the ramp up of labor investment, which does put some pressure on that, but still very comfortable with the 8% full-year operating profit growth guidance and our ability to continue to drive operating profit margin growth over time.

Michael Lasser

Thanks again and have a good holiday.

John W. Garratt

Thank you.

Mary Winn Pilkington

Thank you.

Operator

Your next question is from the line of Dan Binder with Jefferies.

Todd J. Vasos

Good morning, Dan.

Daniel Binder

Hi, thank you. A couple questions. First on the labor investments to get in-stocks up, you noted that you were seeing some benefit from the Phase 1 stores. I was just wondering if you could quantify a little bit more what that looked like and just as a follow-on to that, I’m just curious if you are getting in-stocks up, I’d think fairly quickly once you add the labor in, why does it take a quarter or two to actually see it flow through to sales?

Todd J. Vasos

Yes, Dan, how we see it is first, the labor investments are paying off and I’ve to give a lot of credit to our operators. They’ve done a very, very nice job in ensuring that the labor investments that we’re making are very strategic in nature and they’ve a return. And in saying that, what we’ve seen especially from the ones that we rolled in Q2, so the first initial wave, we’re seeing increased sales at the rate -- actually at an accelerated rate than we had first anticipated. And we’re seeing great customer connection type scores again how we measure our customer and how she looks at the business. So right now we’re very happy with that and it does take a little time though. As we roll this in, it takes some weeks for the customer to recognize if there is something different. Remember, our core consumer shops with us only on average about every five to six weeks. So it takes some time for her to come in and really notice a difference. But after a couple of times coming in, she starts to see it and as she sees that difference, we’re seeing it in on the sales line and we’re seeing it in her satisfaction scores.

Daniel Binder

That’s helpful. My other question was with regard to the tax rate. Last year in the fourth quarter, I think you had a $0.03 benefit from a lower tax rate for a similar reason. So this year, is it an incremental $0.05 over last year, or is it just on an absolute basis a $0.05 benefit?

John W. Garratt

It is absolute $0.05 and last year it was $0.04.

Daniel Binder

Okay.

John W. Garratt

Just $0.01 incremental to last year.

Daniel Binder

Okay, great. Thank you.

Mary Winn Pilkington

And Dan just to clarify, because I’ve got in a lot of questions about that, that’s always been in our guidance and we did say that in our prepared remarks and we said it called it out earlier in the year as well.

Daniel Binder

Great. Thank you.

Todd J. Vasos

Thank you.

Operator

Your next question comes from the line of Matthew Boss with JPMorgan.

Todd J. Vasos

Matthew good morning.

Esteban Gomez

Hey guys this is Esteban on for Matt. Thanks for taking my question. Todd, you commented about an event driven low-end consumer. Can you talk about what you saw specifically during Halloween and Thanksgiving and how you would rank your sales initiatives we should consider as we head into next year?

Todd J. Vasos

Sure. Our Halloween and Harvest, and we rolled those two together preformed very well. Matter of fact both on the sales side and our sell through exceeded last year by 90 basis points. So we feel very good about the events that we put together for that piece. And we put together a very strong program for Q4, of course, holiday and we were very happy with our November overall sales. They came in right on our original forecast, and as we now move into December and into the balance of the quarter we have a lot of shopping ahead of us still, but we feel very good about the plans we have, both in print and in digital as well as in store. So we are very cautiously optimistic on how the holiday season will end up for us.

Esteban Gomez

Great. And then on gross margin, where is your strength today versus historical levels? I mean, what's the best way to think about some of the drivers of gross margin expansion that have helped this year versus areas for upside next year?

Todd J. Vasos

So our shrink, we don’t usually talk about our shrink in the numbers. But I have to give credit to our store operators and our merchants. They’ve been working hand-in-hand now for well, we always work on it, but well over a year on accelerator working on our shrink levels. And I’m very, very proud of the work that they’ve done and those shrink levels continue to come down year-over-year. And shrink is one of the things that has never done; you’re always working on shrink. But I have to say that our store operating team has a real good balanced approach to shrink to ensure that we use all of our technology, tools and training to make sure that we can continue our shrink improvement as we go into 2016.

Esteban Gomez

Great. Thank you.

Mary Winn Pilkington

Operator, we’ll move on to the next call.

Operator

Yes. Your next question is from the line of Meredith Adler with Barclays.

John W. Garratt

Good morning, Meredith.

Meredith Adler

Good morning. Thank you for taking my question. I’d like to go back to the topic of zero -based budgeting which is certainly an expression I’ve heard thrown around. But I’ll be interested in knowing how you’re thinking about implementing it? What is the process that’s involved?

John W. Garratt

Sure. Great question. There’s a couple of key changes when you move to zero-based budgeting, and I’ll say we’ve had great process rigor in discipline in place here. Thus your switch to zero-based budgeting it really is a fundamental process change where you’re doing a bottoms-up budget making trade-offs and forcing prioritization versus building a budget off of a prior year base. It’s also a cost management change focused on dual ownership where you have department -- traditional department budget owners as well as horizontal cost category experts who help drive, increase scrutiny and resource allocation. And then also really driving the ownership mindset where we’re putting our best resources against the best uses to the ones that Todd mentioned of what touches the customer and what's aligned with our strategic priorities, while also mitigating against risk and making sure we’re putting our money where we have the biggest returns. That’s what I would say are the key differences, and we’re well into that process of implementing that. The reduction in force was the first stage of that. Now on a go forward basis we’re focused on driving cost out through indirect spending and continuing to drive a pipeline of savings to continue to drive down that SG&A leverage point and are doing it from a position of strength that positions us very well and solidifies our low cost position and competitive advantage.

Meredith Adler

And then if I could guess, I would be -- play devils advocate or be a little bit of cynic, it would seem that you’d want to lower your leverage point in part because you think that you won't hit the kind of comps you were hitting in the past and that you as the business growth slows or the business matures you just need to lower your leverage point and lower your expenses. Is that too cynical a view?

Todd J. Vasos

Meredith, this is, Todd. You’ve known me for a while, and I have to tell you that, the way we are approaching this and because its coming from a position of strength, our goal is to make sure that we can always offer the consumer the lowest price that she can get. And what better way to be able to do that than to pass the savings on to the consumer that we can say that is non-customer facing today. I can't think of a better way to do that, and that’s our goal. Our goal is to be able to pass on the savings to the consumer at the same time by lowering our leverage point. So I think we can do both. I know we can do both. And again dollar General pretty well, we don’t just usually throw things around. We implement them and we execute them at the top of our game and this will be no different.

Meredith Adler

Very, good. Thank you very much.

Mary Winn Pilkington

Operator, we’ll move on to the next question.

Operator

Yes, sure. The next question is from the line of Vincent Sinisi with Morgan Stanley.

Andrew Ruben

Hi. This is Andrew Ruben on for Vinnie. I just want to ask on the wage side, are you seeing any pressures from either rising minimum wages or from other retailers who are raising their wages and how that might flow through to your labor force?

John W. Garratt

Today we monitor our wages across the United States as you can imagine. And what we’re very proud of is that, we pay a very, very competitive wage in all of the markets that we serve. In saying that we continue to watch as wage pressures in some areas are on the rise, but I have to tell you that our operating team in hiring our ROE employees have done a fabulous job. And we are competitive where we need to be competitive and we’ve seen virtually no difference today than we have in the past year. So we will continue to watch that, but rest assured [ph] that we’ll be in a position through [ph] all of our efforts here including our cost containment that we talked about, to be able to reinvest wherever we need to, to be competitive.

Andrew Ruben

Great. That’s helpful. And also on the labor front, you talked about reduced store manager turnover and that leading to reduced associate turnover. Can you talk about some of the drivers behind that whether it’s related to perhaps higher pay or what some of the other drivers between the reduced turnover could be?

John W. Garratt

The two things that are most -- most, very important aspects of turnover and the reason that people leave. Number one, the relationship with their supervisor, and number two, workload. And we’re addressing both in what we’re doing, and then coupling that with training. So when you look at how we’re approaching it and what we’ve done and I’ve already seen some success is making sure that we have the right people in place at the district manager level. If you remember we did some work many quarters ago to realign our districts, to get them a little tighter, so that they’re in the stores more and that is really helped with our store manager engagement, and as store managers feel better about their district managers they stay longer. And if they stay longer your store employees stay longer and are happier. It is a cascading event. So it takes time. Well you can't wave a wand and have things change overnight. But I have to tell you, we’ve made significant progress in a very short period of time with a lot of initiatives yet to come in 2016 and beyond.

Andrew Ruben

Great. Thanks very much.

Operator

Next question is from the line of Paul Trussell with Deutsche Bank.

John W. Garratt

Good morning, Paul.

Paul Trussell

Good morning, Todd, and congrats John, and hello, Mary Winn. I wanted to just touch base on the top line. A few part question. First just from a competitive standpoint, did you see any disruption in your third quarter results from Family Dollars, significant clearance efforts similarly in areas where they are rebannering, are you sensing that you’re able to pick up share? Also we’ve seen some better results out of the discount space with Wal-Mart, with Target and there is concern that perhaps with lower gas prices they’ll be able to feel more comfortable driving to those boxes and passing up a Dollar store along the way. Just any changes in those specific markets where you are directly competing with some of these competitors would be helpful?

Todd J. Vasos

Paul, the quarter really showed a very tame pricing environment to be very honest with you. No significant promotional activity above last year and I’m happy to say that our price competitiveness is exactly the same as it has been to get all channels at trade. So we’re very happy with that. And we compete every day just like everyone does with a multitude of different retailers. And the great thing about Dollar General is we’ve got some fabulous category management process this year that continue to take advantage of every opportunity that may be out there. And I have to say that we saw nice -- same store sales growth in many categories, if not as you heard already across all of our consumable and non-consumable areas. So we feel very confident about how we take this forward and about the mix and how we deliver same store sales. And rest assured we have a plethora of initiatives coming out for 2016.

Paul Trussell

Got it. Thank you. And, as we think about your new store model, perhaps you can -- just give us a little bit more detail about how you’ve refined the model? And just as we think about your store rollout, over 900 stores next year and expectations for that pace of growth to continue for a few years beyond that, is it necessary for you to go significantly into the urban and suburban markets in order for that to occur?

Todd J. Vasos

So let me answer your first quarter, and we’re very, very excited about our new store format that we’ll be rolling out in 2016. We tested many components, if not all components of it. We actually already have four stores up and running as we speak across different states to test the concept out. But as everything that we do here at Dollar General we spend a lot of time on the front side with our consumers seeing what she wanted in that new store. I’d just give you a couple of little tidbits and you’ll hear more from us as we move into 2016. But the great thing about what we’re able to deliver in this new format is a more convenient front end for our consumer. She’s able to get in, get out quicker, have more products to buy at the front end, and is easily navigated throughout the stores right in the front end, it really opens up the front end of our stores. It expands our coolers from our current offering of about 16 doors up to 22 doors. And those extra doors will house anything from immediate consumption beverages to additional frozen dairy perishable type products. And we’ve done a lot of other work in health and beauty in our $1 offerings throughout the store in our seasonal areas. So more to come, but right now it’s in the early stages, but we’ve very, very encouraged in what we see by how that consumer is shopping that new format versus the old format. And then, as I look to your other question. We’re very -- very, very happy with our real estate program and the way that our real estate folks execute on a quarterly basis to open as many stores as we open and of course remodel and reload as many as we do. In saying that, we’ve announced already that we will open 900 next year, so you think about it, that’s a lot of projects today. But more importantly we don’t see anything structurally that gets in a way of a 6% to 7% square footage growth rate as we go out into the outer years. In saying that those opportunities are a nice fine balance of urban, suburban if you will and our rural locations, and that’s the great thing about how we’ve set this up is that, as we continue to open stores in the outer years it will continue to be a fine balance between those two and there is still tons of opportunities in both urban areas and our metro suburban areas.

Paul Trussell

Thank you. Good luck.

Todd J. Vasos

Absolutely.

Operator

Your next question is from the line of Matt Nemer with Wells Fargo Securities.

Todd J. Vasos

Hi, Matt.

Matthew Nemer

Hi. Good morning. In the seasonal category, your sales per foot slowed from about 2% over the last two quarters to closer to flat this quarter. And I’m just wondering if you can talk to some of the reasons behind that?

Todd J. Vasos

I think one of the biggest differences there is that one Halloween day that shifted in, when you factor that in, it was a little bit more normalized.

Matthew Nemer

Okay. Any impact from weather in your mind, maybe there’s a different trend in some of the southern tier stores?

Todd J. Vasos

No, especially in our seasonal pieces -- in our pure seasonal pieces, we didn’t really see very much weather impact. Obviously like others in some of our payroll categories the warmer weather slowed some of our early apparel, but we’re starting to see finally that cool weather is starting to show up, and as it showed up our apparel sales as well as our other cold weather sales items have increased nicely. So, again we’re again cautiously optimistic on all of that as we move into Q4.

Matthew Nemer

Okay. And then lastly the 10-Q points to some inventory growth in consumables which I think is consistent with your efforts to improve in-stocks, but it also called out the home category as a source of inventory growth this quarter. Could you just talk to that, that change?

Todd J. Vasos

When you look at inventory we had -- we did have a couple of those headwinds that you mentioned. In some of our non-consumable categories the biggest shift probably was attributed to the import items that we had a very difficult time getting last year. As you remember the port slowdown which would have been home in a lot of our non-consumable areas, and this year product flowed as normal. And so when you look at it year-over-year yet it gave us a little bit more inventory than we had last year, but quite frankly a little bit more normalized that we used to see before that 2014 port slowdown that we were all dealing with.

Matthew Nemer

Understood. Thanks, and happy holidays.

Operator

Your next question is from the line of Edward Kelly with Credit Suisse.

Todd J. Vasos

Good morning, Ed.

Edward Kelly

Good morning, guys. Thanks for taking my question and congratulations John as well. Todd, could you just maybe give a little bit of color on the level of inflation that you’re seeing in your stores particularly on the consumable side. We actually have seen deflation in categories like milk for instance. Just curious as to whether this is having any impact at all on the comp performance?

Todd J. Vasos

Like most retailers we haven’t see a lot of inflation. And as you indicated in some key commodity areas like fluid, milk, some coffees et cetera, we’ve seen some deflation. Those are big categories for us. So sure that is a headwind for us in some of our food categories where that deflation has slowed our top line or out the door retail a little bit. But the great thing about Dollar General and how we look at the business is any time we can offer the consumer a lower price, its best for her and it gives her more money to spend elsewhere and hopefully in our stores. And so, we look at it as an advantage as well, and we try to take care of that consumer on our non-consumable goods where she may have a little bit more money to spend during her trip.

Edward Kelly

Okay. And then just one follow-up for you on shrink. Sometimes when you hear retailers talk about focusing on shrink it can't come at the expense of sales. So can you talk just a little bit about the strategy itself, how you ensure that it doesn’t come at the expense of sales, and whether you’ve actually seen any of that at all?

Todd J. Vasos

That’s another very, very good question and I sort of alluded to it a couple of minutes ago, it is a fine balance when you look at shrink especially in our environment. And store managers, and I was one at one time, they tend to make sure that they protect the company’s assets and their assets. So at times that could be an issue and we’re not immune to that, we’re no different, we saw some of that. The great thing is, as we work on our on-shelf availability pieces, we’re addressing those. But keep in mind we also owe our stores tools to make sure that they feel comfortable in putting goods out. So we’re ruling out more and more defensive merchandising tools so that we can keep product on the self for the consumer and yet have our store managers feel comfortable that it will be there for sale for the consumer. So we’re working on both sides of that, and I think in the quarters to come with our efforts around on-shelf availability it should only add to our in-stocks and it should also only add to our comp store sales.

Edward Kelly

Okay. Great, guys. Thank you. Good luck.

Todd J. Vasos

Sure.

Operator

Your next question is from the line of Dan Wewer with Raymond James.

Todd J. Vasos

Hi, Dan.

Dan Wewer

Hi there, Todd. So from 2010 through 2013, the company achieved an operating margin rate I believe it’s like 9.9% to 10.3%. With the expense savings that you’re poised to achieve lets say beginning next year. Do you envision Dollar General operating margin rate returning to that level? Or if I understood your comments earlier, the expense savings that you do achieve you would give back to the customer I guess the lower margin rate and therefore the operating margin probably remains about flat going forward?

Todd J. Vasos

Again we haven’t provided guidance obviously for 2016, but let me make sure that I do emphasize, it is our goal first to make sure that our consumer is taken care of, but also with an eye to our shareholders. So I would tell you that it will be a very balanced approach with our zero-based budgeting activities returning a portion of that back to our shareholders, but also reinvesting in our stores whether it be price, whether it be labor in our stores, whatever that needs to be to be able to continue to drive our same store sales at a very robust level. But stay tuned, more to come as we lay out our 2016 plans.

Dan Wewer

Just a second unrelated question, going back to your comments about your customer. So investors were anticipating the significant drop in gasoline prices potentially benefiting the value retailers. I guess instead there were some other categories at your customer’s shops such as the auto parts retailers that certainly did see a benefit. Maybe we got that wrong. But what happens if gasoline prices were -- begin to increase again? Will we be thinking about that as a headwind for the sector?

Todd J. Vasos

How we look at the business is that, we operate pretty consistently in high gas price or low gas price environment. When that price is high and she is strapped, we’re a great alternative for her. And when its lower and she may have a little bit more money, we’re hoping that she spends it with us. But to your point, she seems to be spending this -- in this savings and gas prices a little differently. I think you almost look at it as; she’s sort of spending on deferred maintenance for her household. So and/or whether it be the automobile they just -- they didn’t quite fix because they didn’t have the money or the refrigerator that they’ve been putting off buying for the last few years, it looks like she’s spending money on that right now. But like everything as cyclical it will come back around and I believe that we’ll be able to service our consumer in either one of those two environments on the energy price levels.

Dan Wewer

Okay. Thank you.

Operator

The next question is from the line of Charles Grom with Sterne Agee CRT.

Charles Grom

Hi. Good morning, everybody. Congrats to John, as well. Just on the inventory, a little bit more heavy than we’re used to seeing. You cited that the sales performance is a factor. I guess, how you’re thinking about inventory levels by the end of the year? And a tie-in to that question, when we look at your margin outlook for the fourth quarter I think Michael asked this in his first question, what should we think about gross margins in the fourth quarter considering inventories are a little bit heavy?

John W. Garratt

Sure. Our goal for inventory growth has been and always is to be, keep it in line with sales growth over time that doesn’t happen every quarter and this was one of those quarters. I’ll start by saying our inventory is in great shape. If you look at the increase it was in consumables and core inventories, so no concerns there and there was actions in place to reduce this. If you look at the third quarter, it was impacted as we said by on-shelf availability initiative as well as timing of receipts which included imports as well as it was impacted by the sales performance. As we look ahead to Q4 there are some continued headwinds as we look at inventory projected levels there we will be again lapping the West Coast port slowdown issue which had inventory unusually low for imports this time last year -- in the fourth quarter last year. We also have an earlier Easter season which will cause an earlier flow of the inventory in the fourth quarter, and we will be stocking up to open our DC in San Antonio. So with the combination there are headwinds which will impact our ability to get inventory all the way back in line with sales, but we do see that coming back in line over time and have actions in place to do so.

Charles Grom

Helpful. And then anything on the gross margins for 4Q.

John W. Garratt

Sure. As I mentioned before in terms of gross margins, we look at gross margins and SG&A together in terms of hitting our goal and we’re very comfortable with the 8% guidance we provided we’ll work both those levels. As we said before, we’re going to deliver better performance this year than last year and the year before on overall operating margin a very comfortable -- was hitting that number for Q4 and growing that going forward leveraging -- the leverage we mentioned on gross margin as well as the strength of the zero-based budgeting actions taken will help us.

Charles Grom

Okay, great. And then just my last question is just on the sales driving initiatives you alluded, Todd to expanding the number of cooler doors in new stores. Can you just remind us, is there a plan to go back to your existing fleet and also expand the number of doors where possible?

Todd J. Vasos

That’s another great question, Chuck and yes, matter of fact we have -- we’ll have a plan and have a plan in place for 2016 to go back to many of our legacy stores. This is very easily backwards compatible if you will, and you’ll see that in 2016 because it is a driver of our traffic and continues to be so. So I look forward to that in ’16.

Charles Grom

Okay. And then if I could sneak one more, and just [multiple speakers].

Mary Winn Pilkington

One more.

Charles Grom

If we reflect back to Rick’s comments back in April about the consumer, he was particularly upbeat, and if you read the press release today you’ve got some language in there, its certainly a little bit more sobering. And just want to clarify that, is that a reflection and I think you’ve alluded to this and answered it, but I just want to make sure that you’re okay with November sales and you’re not seeing anything that’s just more of the -- of a reflection of the overall kind of macro consumer environment that we’ve seen over the past 60 days?

Todd J. Vasos

Yes. Again our November sales were right on our original plan or original forecast. So we feel very strong about November. And when you look at the overall comment, it is the environment that our consumer is in. Our consumer is always under pressure. I mean, she lives that way, but she’s so resilient and she figures it out. But she needs us to help her figure it out, and that’s what we’re here to do. She is facing a lot of headwinds especially in rents. I mean, rents are up tremendously over the past few years. Our core consumer -- our core, core consumer nearly 50% of her take home pay is going to rent today versus just a few short years ago 37%. So you can see the headwind that she’s gotten and quite frankly not a lot of wage growth for her. So there is a lot of other pressures that the core consumer has, but we feel very good about our offering and how we service that consumer. And I think we’ve shown it over the years, and the consumer is voting by coming into Dollar General.

Charles Grom

Okay, good. Thanks Todd, for clarifying and happy holidays.

Todd J. Vasos

Sure.

A - Mary Winn Pilkington

Thank you. So, operator that will wrap up our call today. I just want to say thank you to everyone for joining our call. Please stay tuned for a save the date for our Investor Day as Todd mentioned on March 23, 24, and we’ll look forward to seeing everyone then and thank you for your interest in Dollar General.

Operator

Thank you. And ladies and gentlemen, this does conclude the conference call for today. You may now disconnect.

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