Dollar General (DG) Todd J. Vasos on Q4 2015 Results - Earnings Call Transcript

Mar. 10, 2016 4:19 PM ETDollar General Corporation (DG)
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Dollar General Corp. (NYSE:DG) Q4 2015 Earnings Call March 10, 2016 10:00 AM ET

Executives

Mary Winn Pilkington - Vice President of Investor Relations and Public Relations

Todd J. Vasos - Chief Executive Officer & Director

John W. Garratt - Chief Financial Officer

Analysts

Matthew Robert Boss - JPMorgan Securities LLC

Vincent J. Sinisi - Morgan Stanley & Co. LLC

John Zolidis - The Buckingham Research Group, Inc.

Meredith Adler - Barclays Capital, Inc.

Edward J. Kelly - Credit Suisse Securities (USA) LLC (Broker)

Peter Jacob Keith - Piper Jaffray & Co (Broker)

Paul E. Trussell - Deutsche Bank Securities, Inc.

Dan R. Wewer - Raymond James & Associates, Inc.

Stephen Grambling - Goldman Sachs & Co.

Operator

Good morning. My name is Josephine and I will be your conference operator today. At this time, I would like to welcome everyone to the Dollar General Fourth Quarter 2015 Earnings Call. Today is Thursday, March 10, 2016. 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 in the company's earnings press release issued this morning.

Now, I would 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 - Vice President of Investor Relations and Public Relations

Thank you, Josephine, 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 website 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 non-historical matters, including but not limited to, our 2016 forecasted financial results and capital expenditures, our planned fiscal 2016 operating, merchandising, store growth, prototype and other initiatives, our capital allocation strategy and expectations, our long-term financial growth models and statements regarding future economic trends or conditions.

Forward-looking statements can be identified because they are not statements of historical fact, and they use words such as outlook, may, should, could, believe, anticipate, expect, estimate, forecast, goal or intent and similar expressions that concern the company's strategy, plans, intentions or beliefs about future occurrences or results.

Important factors that could cause actual results or events to differ materially from those projected 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, and our most recent 10-Q filed on December 3, 2015, 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 revise any information discussed in this call except as follows. We intend to update our diluted EPS guidance only if we no longer reasonably expect diluted EPS to fall within the 10% to 15% range outlined in the growth model announced today. We do not intend and specifically disclaim any duty to update our expectations regarding where in the range of guidance fiscal 2016 net sales, same-store sales or diluted EPS may fall or to update any component of the growth model other than diluted EPS as just specified.

We also do not intend and specifically disclaim any duty to update our dollar range for expected fiscal 2016 capital expenditures unless otherwise required by applicable securities laws. We intend to use the financial growth model in discussions of our business beginning in 2016 and in future years. And by doing so, we do not undertake to update any portion of the growth model except as just specified.

We will also reference certain financial measures not derived in accordance with GAAP. Reconciliations to the most comparable GAAP measure included in this morning's earnings release, which as I just mentioned, is posted on dollargeneral.com in the Investor Information, Press Releases section.

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

Todd J. Vasos - Chief Executive Officer & Director

Thank you, Mary Winn, and thanks to everyone for joining our call. Today, we reported record results for the fourth quarter of 2015 and the full year. 2015 was an exciting year for Dollar General as we reached over $20 billion in sales and celebrated the milestone of opening our 12,000th store location. Today's announced 14% increase in our quarterly cash dividend reaffirms our continued confidence in our long-term growth prospects. For the year, we had our most balanced financial growth since 2011 and delivered results that are in line with the long-term financial model that we announced today. The team is energized by the strong performance in 2015 and is focused on capturing the significant long-term growth opportunities that lie ahead.

Let's recap some of the additional highlights of 2015. Full year net sales increased 7.7% to a record $20.4 billion and sales per square foot increased to $226. Same-store sales for the year increased by 2.8%, marking our 26th consecutive year of same-store sales growth. Our same-store sales for the fourth quarter increased 2.2%. In the quarter, same-store sales growth was balanced across both consumables and non-consumables.

For the year, operating profit increased about 10% with diluted earnings per share up 13%. Earnings per share improved 11% in the quarter to $1.30 per share. For the 32nd consecutive quarter-over-quarter, we increased both customer traffic and average ticket. During the year, we returned nearly $1.6 billion to shareholders through the repurchase of 17.6 million shares of common stock and the payment of dividends.

We opened 730 new stores, increasing our selling square footage by 6% and exceeded our combined remodels and relocation targets with 881 stores. For seven years now, our real estate projects have had strong performance. The class of stores in 2014 and 2015 continued to run ahead of our projections, and we are pleased with the performance in the new states we entered in early 2015. Our distribution center in San Antonio, Texas was completed in January and started shipping to stores in February. We also broke ground on our 14th distribution center in Janesville, Wisconsin to help us serve our growing store base in the Midwest. These investments are key to driving the efficiency and speed of our network and to support our growing store base, all while reducing our stem miles (7:03).

In 2015, we accomplished the multi-year rollout 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. Importantly, the team executed this initiative without disruption to our business. The rollout of our targeted labor investment has been implemented across more than 3,100 stores. Since the rollout of this initiative, in the second quarter, we have continued to see same-store sales growth for our stores gain traction.

Phase 1 and Phase 2 stores have been on the program long enough to see an impact. We are pleased that they are delivering on our return expectations. Specifically, in these stores, the key metrics of same-store sales, transactions, average basket and customer satisfaction scores, all are showing significant improvement.

We also had continuing success in improving our shrink performance. Shrink improvement has been and continues to be one of our largest long-term gross margin opportunities. We remain committed to reducing our shrink on a store-by-store basis. This progress continues to be broad-based, with shrink declining across nearly 70% of our product departments for the year. Going forward, our teams continue to be focused on leveraging our defensive merchandising tools, technology and training to further reduce shrink.

We are constantly striving to fill the needs to meet the changing demands of our customers. We continue to increase our overall market share of consumables in both units and dollars across all markets over the 4-week, 12-week, 24-week and 52-week period ending January 29, 2016. In the 2015 fourth quarter, we had very solid same-store sales growth of 2.2% particularly considering the 2014 fourth quarter same-store sales growth of 4.9%.

In consumables, growth was driven primarily by candy and snacks, tobacco and perishables. Growth in the non-consumable categories was broad-based with notable strength across seasonal and home, offset by a modest decline in apparel. Even as apparel had a modest decline given the unseasonably warm weather, we had strong growth across holiday events, housewares, home décor, toys and stationary. Our offerings in non-consumables are on trend and priced right for the key Christmas holiday season. This represented the eighth consecutive quarter of year-over-year improvement in our non-consumable categories.

Everything we do at Dollar General is centered around our customers. The good news is that our customers are noticing the improvements we are making in our stores, especially as it relates to our on-shelf availability. As we exited 2015, we had our highest customer satisfaction scores in two years. As these results indicate, we made excellent progress on a number of fronts in 2015.

As we move into 2016, we have updated our customer segmentation to gain deeper insights into the most relevant groups as the consumer continues to change at a rapid pace. This customer segmentation helps guide our strategies to grow with each of our core customer segment. This was the first re-cut of our customer segmentation since 2012.

The new segmentation of our customer, one of the most exciting findings is that we are growing with our most productive customers. These are exciting developments that confirm we are improving our core shopper productivity while also attracting new key segments, and, importantly, retaining our trade-down customers. These updated customer segmentation findings are integrated across merchandising and pricing, marketing, site selection and store operations and design. We look forward to sharing more insights at our upcoming Investor Day. The goal is to grow transactions and item units which continue to be key to our market share performance.

Our operating priorities continue to include: driving profitable sales growth; continuing growth opportunities; enhancing our position as a low cost operator; and fourth, investing in our people as a competitive advantage.

Our first priority is continuing to drive profitable sales growth. As we look to attract and grow new customers and trips and capture share with existing customers, the insights gained from our customer segmentation work are incorporated into our disciplined approach to category management. In this process, we have assessed the expansion of categories that are most likely to drive traffic to our stores. Health and beauty, perishables, party and stationery are areas where we are expanding in 2016.

For 2016, the team is very focused on implementing these sales-driving initiatives across not just new stores, relocations and remodels, but also to our mature store base to a greater degree than we have in the last several years. Our ongoing affordability initiative will be front-and-center with a refreshed approach.

We will also leverage operational initiatives, such as improving our on-shelf availability. We have ongoing opportunities for gross margin expansion through improvements in shrink, global sourcing, private brands, distribution and transportation efficiencies and non-consumable sales.

Second, we will focus on initiatives to capture growth opportunities. Examples include our accelerated square footage growth in 2016, with a new store layout that we started utilizing in February for all new stores, relocations and remodels. The layout is designed to expand high-growth traffic-building categories in a more customer-friendly format with faster checkout. While it's still early, the results of this DG16 (13:57) layout are very encouraging as our sales performance is meeting our expectations.

In addition, we have been conducting a test and learn for our smaller format store that allows us to capture growth opportunities in more densely populated metropolitan areas. Currently, we have opened approximately 30 stores with selling space of less than 6,000 square feet, or about 20% smaller than our traditional stores.

Sales productivity and returns based on the early results are very encouraging. By eliminating less productive product segments and adding or expanding product departments to meet the needs of our urban customers, we believe this smaller format store will allow us to have higher capture rate per site selection. Additionally, we believe this smaller format will work in rural locations with lower household counts. With this smaller format, we have even greater confidence in our real estate strategy for metro sites and smaller, lower household rural sites.

Looking ahead, we anticipate opening 900 new stores, including about 80 of the smaller format stores, and relocating or remodeling an additional 875 locations in fiscal 2016. Our real estate program is the foundation of our growth, with a proven high-return, low-risk model. We are disciplined and focused on financial returns. We are very optimistic about our new store outlook for 2016 and our pipeline is full.

Third, we will leverage and reinforce our positioning as a low cost operator. We recently adopted zero-based budgeting to proactively improve our efficiencies and reduce expenses over a multi-year timeframe, all while giving us the flexibility to reinvest savings to drive growth. Our zero-based budgeting approach is a refreshed commitment to removing costs from our business.

Our 2016 budget was built through a zero-based budgeting perspective with a clear and defined process to address spending. All of these actions are filtered through three lenses. One, is it customer-facing? Second, does it align with our strategic priorities? And finally, third, how does it impact our risk profile?

Over the last several years, our SG&A leverage point on comp sales has been running at approximately 3.5% and was trending at a rate that would have been higher in out years if we had not taken action. Today, our zero-based budget initiatives, we have lowered the SG&A leverage point on comp sales to about 2.5% to 3%. Our underlying principles are to keep the business simple, but move quickly to capture opportunities, control expenses and always be a low cost operator.

Our fourth operating priority is to invest in our people. We believe that our people are a competitive advantage. Our strategy is focused on talent selection, store manager development through great on-boarding and training, and open communication.

In 2015, we had our lowest level of store manager turnover in three years. To build on these improvements going forward, we have been focused on aligning our talent with the right skill set required for success based on store characteristics in addition to revamping our store manager training. We believe that continued improvements in store manager turnover will take time, but the payoff is there through higher sales, lower shrink, and improved store associate turnover.

For our customer, we continue to be cautiously optimistic about economic conditions but acknowledge that it is always challenging for our core consumer given the pressures on her income and spending. Regardless of the economic outlook for our consumers, we will do everything we can to provide them with the value and convenience they expect from Dollar General.

Now, let me turn the call over to John.

John W. Garratt - Chief Financial Officer

Thank you, Todd, and good morning, everyone. While Todd has taken you to the highlights of 2015 and our strategic initiatives for 2016, let me now take you through some of the important financial details of the quarter and year. I will also spend some time discussing our long-term financial growth model and our guidance convention going forward.

Gross profit as a percentage of sales was 31.8% in the fourth quarter, an increase of 12 basis points from last year's fourth quarter. Lower transportation costs and improved rate of inventory shrink were the primary factors of the improved performance, while increased markdowns were a partial offset. This quarter represented our fourth consecutive quarter of year-over-year improvement in gross margin. For the quarter, total SG&A as a percentage of sales was even with last year's fourth quarter at 20.2%. The 2015 fourth quarter results reflect increases in incentive compensation expenses, retail salaries and occupancy costs, offset by lower utility costs and administrative salaries as a percentage of sales.

The 2014 quarter results reflect expenses of $6.1 million or 12 basis points as a percentage of sales related to the acquisition that was not completed. Our tax rate for the quarter was 36.1% compared to 34.8% in the 2014 quarter. This included a $16.5 million or $0.06 per share benefit from the reenactment of the Federal Work Opportunity Tax Credit which is retroactive to January 1, 2015. The fourth quarter of 2014 also benefited from the deductibility of expenses incurred in prior quarters associated with the acquisition that was not completed.

Moving on to the balance sheet and cash flow, cash and cash equivalents at year-end were $422 million lower than the prior year as we did not buy back shares in the second half of 2014 due to the pending acquisition. Merchandise inventories were $3 billion at fiscal 2015 year-end, up about 4.3% on a per store basis year-over-year. Key factors impacting this increase included our on-shelf availability initiative, the load in for the new distribution center in San Antonio and the timing of receipts due to an early Easter, coupled with our sales performance. Even with this increase, we believe our inventory is in good shape and we are comfortable with the quality. Near-term, we would expect our ongoing on-shelf availability initiative to impact our inventory level.

Going forward, however, our goal remains to ensure inventory growth is in line with our total sales growth over time. In 2015, we generated cash from operations of $1.4 billion, an increase of $63 million from the prior year. Total capital expenditures were $505 million in 2015 and included the majority of the cost for our new San Antonio distribution center. For the quarter, we repurchased 4.1 million shares of our common stock for $290 million. We also paid a quarterly dividend of $0.22 per common share outstanding totaling $63 million.

Since the inception of the share repurchase program in December 2011, we have repurchased $3.6 billion or 62 million shares of our common stock. We have a remaining share repurchase authorization of approximately $920 million 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 store 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 by managing to a leverage ratio of approximately three times adjusted debt-to-EBITDAR.

We are modifying our guidance convention going forward to more closely align with how we are managing the business for a long-term shareholder value creation. This is a tremendous business. We have compelling new store economics with significant runway for growth across channel, customer and product segments that we intend to capture. From our vantage point, the gross mile we announced today is more of an articulation of how we have been managing the business to deliver consistent profitable growth and not a change in strategy.

In addition, we have heard from our investors that they would like to know what we think our business is capable of over the long-term. We believe that this long-term focus is the best way to model our business. Key components of the model include the following annual targets.

Net sales increase of 7% to 10% with square footage growth of 6% to 8% and same-store sales improvement of 2% to 4%. Operating profit growth of 7% to 11%, diluted earnings per share growth of 10% to 15%, cash from operations to be 7% to 8% of sales, capital expenditures to be 2% to 3% of sales and annual shareholder returns of 11% to 17% defined as EPS growth plus dividend yield. In 2016, we anticipate share repurchases of approximately $1 billion. This represents about 5% of our market capitalization as of today.

Since the inception of our share repurchases in December of 2011, we have reduced our outstanding share count by about 15%. Given that fiscal 2016 is a 53-week fiscal year for us, we expect the 53rd week to contribute approximately 200 basis points to our net sales performance and $0.09 per diluted share to EPS.

Including the impact of the 53rd week in fiscal 2016, we expect our net sales and diluted EPS results to be at the high end of the growth ranges provided in our financial growth model as I just outlined. We anticipate that same-store sales growth will be near the middle of the model's 2% to 4% growth rate.

As we move into 2016, please keep in mind our most challenging sales overlaps are in the first and second quarters. We do pick up two additional sales days between Thanksgiving and Christmas. Also for 2016, we expect capital spending to be in the range of $550 million to $600 million. At the beginning of today's call, Mary Winn outlined our intentions with respect to updating our 2016 guidance. This information is also in our earnings release issued today. We are confident that we are positioning Dollar General for profitable, long-term growth to drive shareholder returns.

Now, I'd like to turn the call back to Todd.

Todd J. Vasos - Chief Executive Officer & Director

Thanks, John. In summary, 2015 was a great year for Dollar General. We were able to deliver record financial performance while positioning the company to capture accelerated square footage growth. We continue to have significant opportunities for high return, low risk organic growth. I look forward to sharing more details about our long-term strategies at our Investor Day scheduled for March 24 here in Nashville where we plan to further discuss our growth drivers for the long-term.

Our long-term commitment to growth and shareholder value is unchanged. Our business generates significant cash flow and we are in a position to invest in store growth while continuing to return cash to shareholders through consistent share repurchases and dividends. I would like to thank the more than 113,000 Dollar General employees for all their hard work during the fourth quarter and fiscal 2015, all while fulfilling our mission of serving others. As a team, we are looking forward to 2016 as we build on our performance from 2015.

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

Mary Winn Pilkington - Vice President of Investor Relations and Public Relations

All right. Josephine, we'll take our first question.

Question-and-Answer Session

Operator

Your first question comes from Matthew Boss from JPMorgan.

Todd J. Vasos - Chief Executive Officer & Director

Hi, Matt.

Matthew Robert Boss - JPMorgan Securities LLC

Thanks. Congrats on a great quarter.

Todd J. Vasos - Chief Executive Officer & Director

Thank you.

Matthew Robert Boss - JPMorgan Securities LLC

So on square footage growth, 6% to 8% growth in the long-term algorithm is definitely an uptick. Can you talk about productivity levels, four wall return profile that you are seeing in some of the newer stores? And is the key here the smaller store format and the metro store opportunity? Is that the driver to include 8% at the top of the range now?

Todd J. Vasos - Chief Executive Officer & Director

Well, Matt, this is Todd. So just real quick, I think the way to look at this is a couple of things. Number one, we're very confident in our real estate model as we go forward. As a matter of fact, our returns are still some of the highest that I've seen at consumable retail at 18% to 20% and still running there. We don't see that changing in the near-term at all. As a matter of fact, I believe you hit on it, some of the newer opportunities that have been unlocked in metro and in smaller rural areas with smaller household counts, because of our new smaller store, it gives us the confidence as we go forward that we can actually expand that square footage growth if we think we need to as we go forward. So not only are we confident about where we've been, but where we're going with new store growth.

Matthew Robert Boss - JPMorgan Securities LLC

Great. And then just a follow-up on margins. Todd, you laid out, I think, four to five drivers of continued gross margin opportunity here going forward. And the fixed cost hurdle rate, as you called out, is now reduced to 2.5% to 3% – 3.5%, yet the long-term model calls for very little in the way of EBIT margin expansion. Any structural headwinds I'm missing that you can't potentially beat given these targets that you just laid out?

John W. Garratt - Chief Financial Officer

No, we don't see anything structurally changing, Matthew. And as you alluded to, we really look to manage our gross margin and SG&A in tandem and we continue to have numerous levers within gross margins. We were delighted with the performance this year on gross margin, delivering our fourth consecutive quarter of gross margin expansion. And we continue to see benefits from the numerous levers. We continue to drive shrink rates lower over the quarter. We continue to see transportation efficiencies. We continue to grow our non-consumables business eight quarters of consecutive improvement, which, as you know, carries a higher margin rate with it and we continue to effectively manage all the additional levers of category management, private label penetration, foreign sourcing penetration and distribution efficiencies.

And we continue to see opportunities for growth on the gross margin side and on the SG&A side, with the introduction of zero-based budgeting, we've always had a very disciplined cost management process here with work elimination, but with zero-based budgeting implemented from a position of strength, that's one more tool at our disposal to manage that.

So as we look at the two in tandem, we continue to see operating profit margin expansion growth over time. That's contemplated in our model. And as you look at the opportunity to drive total shareholder returns of 11% to 17% each year and the potential and we're really focused on the long-term growth as well. So the ability to drive those types of returns in a consistent manner and deliver long-term value creation is really what we're focused on and what we've built into the model.

Matthew Robert Boss - JPMorgan Securities LLC

Great. Great quarter and I'll see you guys in a couple weeks.

Todd J. Vasos - Chief Executive Officer & Director

Great.

Operator

Your next question comes from Vinnie Sinisi from Morgan Stanley.

Todd J. Vasos - Chief Executive Officer & Director

Hi, Vinnie.

Vincent J. Sinisi - Morgan Stanley & Co. LLC

Hey. Good morning, guys. Thanks very much for taking my question and congratulations as well on a very nice release.

Todd J. Vasos - Chief Executive Officer & Director

Thank you.

Vincent J. Sinisi - Morgan Stanley & Co. LLC

Wanted to, I guess, first ask – just go back to the small format store commentary. Can you just give us a little bit more of a sense for, with the initial, I guess, you said 30 or so today, how close to urban markets – what's the definition of urban for you? Are they literally in cities or are they just closer to those areas? How far from your core stores? Maybe just a little further color there would be helpful.

Todd J. Vasos - Chief Executive Officer & Director

Yeah, sure. The 30 obviously are dispersed in many different locations because we wanted to make sure we tested it in a lot of different urban settings. But I think the key here is it is in urban areas. So not satellite city as much as true urban-type areas where dense populations, condominium-type living, those type areas. And that's where we've tried to test this and we've seen that success.

And again, what this also unlocks for us is it unlocks some real estate for us, because again, the 7,400 square foot box, while very, very productive, it's a little tougher in metro, true metro areas, to get that size of a location. And this gives us the flexibility to also get into some smaller spaces in some of those densely-populated areas. So it's really been a win-win on both sides, both from our sales and productivity and as well as from our real estate side.

Vincent J. Sinisi - Morgan Stanley & Co. LLC

Okay. And maybe just a quick follow-up to that, with the store plans for 80 of these things out of the total next year, at this point, do you think that's kind of the – at least the proportion of the new stores that would be in the smaller format going forward?

Todd J. Vasos - Chief Executive Officer & Director

Yeah, the 7,400 square foot store is still going to be our workhorse. I want to make sure you realize that. That is still the most productive box that we put out there and will continue to be. So I would think it would be fair to say that that proportion is probably pretty close over the next couple years, where it's at today. And if that changes, we'll definitely let everyone know.

Vincent J. Sinisi - Morgan Stanley & Co. LLC

Okay. And if I can just slide one fast one in there, regarding shrink, you continue to have very nice improvement there, yet it's of course fairly consistent commentary that it's one of your real opportunities still going forward. Can you tell us if there's anything overly different that you are doing today, whether it's types of things in store, category work, just anything further there?

Todd J. Vasos - Chief Executive Officer & Director

Well, Vinnie, you know that shrink at retail for sure is always a challenge and a battle, right? It never ends. But I have to tell you that our team, both on the operational side of the equation and on the merchandising side of the equation, are very focused on working together to make that box not only productive from a sales standpoint, but also to make sure that we have as much defensive merchandising tools in place that we can have. Not only some of the cabinets that we put in, but also where we place product.

And as we go into 2016 and beyond, what you're going to see from us is more of an opportunity in high, high shrink stores, to take our merchandising mix and maybe change it a little bit, especially as it relates to where you place product in these higher shrink stores to ensure that we can continue to show some type of shrink progress. But again, make no mistake, it's always going to be a challenge and we continue to work it from all sides.

Vincent J. Sinisi - Morgan Stanley & Co. LLC

Perfect. Thanks very much, best of luck.

Mary Winn Pilkington - Vice President of Investor Relations and Public Relations

Thank you, Vinnie. I am going to ask if you could please keep it to one question and maybe a follow-up question. We've got a lot of people in the queue that we want to make sure we get to as many people as possible.

Operator

Your next question comes from John Zolidis from Buckingham Research.

Todd J. Vasos - Chief Executive Officer & Director

Hi, John.

John Zolidis - The Buckingham Research Group, Inc.

Hi. Good morning and thanks for taking my question.

Todd J. Vasos - Chief Executive Officer & Director

Absolutely.

John Zolidis - The Buckingham Research Group, Inc.

I'm also going to ask about the stores. And I noted that in the press release, you talked about some of the stores being financed by leases and others being built by the company. I was wondering if you could talk about your approach going forward to capital investment in the stores and how that potentially impacts the return on invested capital going forward. Thanks.

John W. Garratt - Chief Financial Officer

Yeah. Our strategy is really unchanged there. We're predominantly lease. We're less than 5% owned and so that will continue to be our vehicle is the build-to-suit lease stores, no change there.

John Zolidis - The Buckingham Research Group, Inc.

Okay, great. So then for a follow-up, could you just talk a little bit more on the labor pressures that are out there in the market? I know that's a concern of many investors. And we'd like to hear a little bit more about how you're seeing that impact your hiring of employees at the store level. Thanks.

Todd J. Vasos - Chief Executive Officer & Director

Yeah. We're monitoring, and we always have, our wages, both from our hourly rates as well as our store managers. And while we remain very committed to ensure that we pay competitive rates out there, and we'll continue to do that. But I have to tell you, what we have seen as we exited 2015 and now entering 2016, our critical staffing at the hourly level is at the highest levels that we've seen in a couple years. And that's very good because what that shows is that our pool of candidates coming in are very, very robust.

So while we'll always monitor it and we will definitely pay competitive wages, which we have and will continue to do so, we haven't seen the overwhelming pressure as of yet that some have been talking about. But at the end of the day, for our hourly folks, the great thing about it is that they can quickly move up from being an hourly associate to being a key carrier and even an assistant manager in very short order. And we like to say here and when we recruit people that we can actually take someone from a job to a career in less than a couple years. And you don't really find that very often, especially in consumable retailing.

John Zolidis - The Buckingham Research Group, Inc.

Thanks and good luck.

Todd J. Vasos - Chief Executive Officer & Director

Sure.

Operator

Your next question comes from Meredith Adler from Barclays.

Todd J. Vasos - Chief Executive Officer & Director

Hi, Meredith.

Meredith Adler - Barclays Capital, Inc.

Hey, guys. Hello. Two questions for you, if I could. The first is just to talk a little bit about as you continue to grow somewhere square footage growth of, let's say, 7%, you are opening a lot of stores and I know you've said you need to open a distribution center pretty frequently. I think it used to be you were saying every year, now maybe you are saying every 18 months. Have you done anything to improve the productivity of the distribution centers so that you don't have to open as many as frequently?

Todd J. Vasos - Chief Executive Officer & Director

Yeah, we have, Meredith. And we have done that over the years. I think what we have said in the past that about every 1,000 stores to 1,100 stores give or take, we would need to open a DC. But we've seen that grow over the last few years, maybe now 1,200 stores, 1,250 stores. So the productivity and size of that four-wall continues to improve. And so we see that probably it's going to average out to almost one a year based on our current square footage growth. But again, that's because of that probably closer to 1,200 stores to 1,250 stores.

Meredith Adler - Barclays Capital, Inc.

Okay, great. And then just a quick question about SNAP, which I know is not a huge piece of your revenues. But I think the FDA is talking about making some changes to qualifying for SNAP. And I'm wondering if you guys are looking at that and kind of what you think that means for your business.

Todd J. Vasos - Chief Executive Officer & Director

Yeah, Meredith, yeah, we are watching that and we – as you know and you mentioned earlier, SNAP for us is approximately 5% of our sales. So it really has – it's not a huge piece of the business but yet our core consumer does rely on SNAP benefits in a lot of cases. But in saying that, the great thing here about Dollar General and we'll continue to monitor it, is that we offer her a great value proposition at the price. So whether she's pinched a little bit with SNAP or not, she can definitely come here to Dollar General and get all her needs. And we'll continue to deliver on that promise to her because she actually comes to us to make sure we can deliver on it.

Meredith Adler - Barclays Capital, Inc.

So you'll adjust your offerings if you need to, to satisfy any new rules?

Todd J. Vasos - Chief Executive Officer & Director

Absolutely. We think that we're in pretty good shape right now and if we need to add an item or two, a couple lines, then we're very willing to do that. As you know, we've got our Plus store and our market stores out there and they're a great test bed for all that. And so we know exactly what sells in there and if we need to add some things into our traditional stores, we'll add the best items based on those sales that we already know in our existing stores.

Meredith Adler - Barclays Capital, Inc.

That's very helpful. Thank you.

Todd J. Vasos - Chief Executive Officer & Director

Absolutely.

Operator

Your next question comes from Edward Kelly from Credit Suisse.

Todd J. Vasos - Chief Executive Officer & Director

Hi, Ed.

Edward J. Kelly - Credit Suisse Securities (USA) LLC (Broker)

Yeah, hi. Good morning, guys, and good quarter. So my question for you – one question here just on the cost side and zero-based budgeting. Could you just talk a little bit about sort of what you've learned as you've gone through the process here? And then your guidance of leverage on 2.5% to 3%, is that what you think is now like a reasonable place to be? Or is there opportunity to do more than that or do better than that, I guess, long-term? Or is that just like you are a responsible retailer today, that's what the environment sort of brings?

John W. Garratt - Chief Financial Officer

Well, I can say that the zero-based budgeting has really been embraced by the team here. It's an extension of our culture where we've always had a robust budgeting process and cost discipline. But by undertaking this from a position of strength, it really enabled us to go deeper and to uncover additional savings opportunities that we're able to capture in our bottoms-up budget. And again, as we went through this and because we did it from a position of strength, we were really able to go through it with the filter that Todd mentioned of moving out those costs that didn't touch the customer, that weren't aligned with our strategic priorities and didn't present risk and allowing us to put it in the most productive places. And the team has really rallied upon that.

It's really changed the mindset in terms of how we look at the business and people apply this filter in everything we do and we're delighted with having actions in place coming into this year built into the budget that allows us to move that leverage point from 3.5% to 2.5% to 3% while allowing for some targeted reinvestments in the business to keep that consistent growth going. We think that's a good place to be. We see in our ability to continue that the team is very hard at work, working on the future pipeline of savings projects to keep that leverage point low, and we'll get it as low as we can.

Edward J. Kelly - Credit Suisse Securities (USA) LLC (Broker)

And then just one quick follow-up. Todd, I heard you mention expansion of perishables or focus on perishables. Could you just maybe give a little bit more color on what you are talking about there?

Todd J. Vasos - Chief Executive Officer & Director

Sure. Our core consumer continues to tell us that one of the main drivers for a trip to Dollar General is the frozen and refrigerated offerings that we have. So what we have planned for 2016 is in all of our new remodel and relocation stores taking our cooler count from about 16 doors up to 20 doors to 22 doors. Along with that, we had put together a very strong backward-compatible program to add additional coolers into our existing same-store base. Now, it won't be all of our stores right away but we see this as probably a two-year to three-year horizon as we go back to add more coolers to our existing base, all while adding up to 22 doors in all of our new stores. So it's really a combination of both refrigerated and frozen offerings that we can put forth to our consumer.

Edward J. Kelly - Credit Suisse Securities (USA) LLC (Broker)

Excellent. Thanks, guys.

Todd J. Vasos - Chief Executive Officer & Director

Sure.

Operator

Your next question comes from Peter Keith from Piper Jaffray.

Peter Jacob Keith - Piper Jaffray & Co (Broker)

Hi. Good morning, Todd and John.

Todd J. Vasos - Chief Executive Officer & Director

Good morning.

Peter Jacob Keith - Piper Jaffray & Co (Broker)

I want to focus in on the outlook for same-store sales at the midpoint of that 2% to 4% range. So it kind of implies 3%. Just looking at the last two quarters you guys were running in the low 2%s, so the guidance suggests some acceleration in 2016. I guess I was hoping you could expand upon that, if you think some of the company-specific initiatives will help get you there or do you see something on the macro front or even near-term that looks encouraging?

Todd J. Vasos - Chief Executive Officer & Director

Yeah. I think as you look at this, first of all, I want to say our merchandise initiatives should gain traction as it goes through the year. The laps are a little tougher in the beginning of the year and get a little easier towards the back. But make no bones about it, our initiatives that we've got this year are the strongest that I've seen here in the last two years to three years. Not only the perishable that I just talked about but as I talked about in my prepared remarks, our health and beauty initiative as well as our party and stationary pieces really should help drive some of those initiatives as we go forward.

You couple that with the work that our operators are doing on on-shelf availability and making product available when the consumer comes in the door at a very high rate, we think that guiding in where we did makes a lot of sense. But we feel very confident as we go forward this year into 2016 where that comp is headed.

Peter Jacob Keith - Piper Jaffray & Co (Broker)

Okay, that's helpful. Maybe on a related note too, so Walmart had closed a number of the Express stores over a month ago. Those look to be quite close to a lot of Dollar General stores. I was wondering if you could provide maybe or even quantify if there's been some benefit or anything that you think actually might move the needle on a total company basis for 2016.

Todd J. Vasos - Chief Executive Officer & Director

Well, any time you have a competitor that leaves the space, you do get some benefit. The one thing that we're squarely focused on is making sure that any dislocation that happens from those closings that as they come into Dollar General, we have got a superior box to offer her the right products at the right price and have it available when she needs it. So we're working real hard on that. But keep in mind, it's only about 100 stores plus or minus that they've closed and with our vast now 12,000 stores, almost 12,500 stores, it is a smaller number on our total store base but we are really looking to control what we can control and that is if she comes in, we've got an offering that we hope that will keep her for life.

Peter Jacob Keith - Piper Jaffray & Co (Broker)

Okay. Sounds great. We will see you guys in two weeks.

Todd J. Vasos - Chief Executive Officer & Director

Absolutely.

Operator

Your next question comes from Paul Trussell from Deutsche Bank.

Todd J. Vasos - Chief Executive Officer & Director

Hi, Paul.

Paul E. Trussell - Deutsche Bank Securities, Inc.

Hey. Good morning and congrats. Want to just go back to margins. I look back and I don't think you guys have leveraged expenses since 2013 perhaps. So getting that leverage threshold down is quite an accomplishment. But I did want to be very clear on how we should be modeling this year. As we look at your comps accelerating in the back half of the year, should we be thinking that you will have the ability to leverage expenses? Or maybe you can just give a little bit more clarity around gross margins versus SG&A expectations for this year?

John W. Garratt - Chief Financial Officer

Yeah. And again, I think the best way to look at it is in terms of looking at operating margin, looking at gross margin and SG&A in tandem as that's the way we manage it, managing all the levers within that. And I think the best thing I can point you to is, again, our annual target of the operating profit growth. We're going to work both those levers to deliver that operating profit growth and we feel comfortable with where we sit right now with the continued opportunities around gross margin with where we've lowered the leverage point on SG&A to deliver that operating profit growth, which is a very strong operating profit growth this year and in the foreseeable future.

Paul E. Trussell - Deutsche Bank Securities, Inc.

Got it. Got it. It's dangerous leaving these types of things to our imagination, but I will run with that. Just following up also on the top line, in addition to the expanded categories, you mentioned, I believe, a refreshed affordability initiative. If perhaps you can just give a little bit more color on what we should expect to see there. And also just give us an update on what the results have been in that value valley.

Todd J. Vasos - Chief Executive Officer & Director

Yeah. And, Paul, that is the real piece there and that is the value valley area. In our new remodels and relocations, we have got a new fresh approach there; expanded the section, but also moved it to the front of the store, so it's more prevalent and can be seen a lot more and also signed it a little differently for the stores. And then what we'll do is some of the best of the best of that expansion, we'll start to put it into our same-store sales base as we move further into the year to ensure that we can take advantage on a same-store sales base as well.

Now, the key for our value offering that we have is it really – what it does, it gives the consumer trial. You have to remember, our core consumer can ill afford to make a mistake. So she can't afford to take a flyer, if you will, to go out and buy something on a national brand basis that may be a little larger size without ever having tried it. But if we can offer her a national brand offering, as an example, at a very small size that she can afford, say at a $1, it gives her that trial. And once she has the trial, what we've seen is it becomes then, it migrates into acceptance, and she moves from that $1 offering and actually trades up to the larger sizes. So our national brand folks really like what they're seeing there, and of course, we do as well, and it's great for our consumer.

Paul E. Trussell - Deutsche Bank Securities, Inc.

Thank you and I look forward to the barbecue.

Todd J. Vasos - Chief Executive Officer & Director

Thank you.

Mary Winn Pilkington - Vice President of Investor Relations and Public Relations

We will have a barbecue, Paul.

Operator

Your next question comes from Dan Wewer from Raymond James.

Todd J. Vasos - Chief Executive Officer & Director

Hi, Dan.

Dan R. Wewer - Raymond James & Associates, Inc.

Hey, Todd. On the 6,000 square foot prototype, you noted that you would be eliminating less productive inventory for that smaller box, presumably that's apparel. Have you considered making that same change in the 7,400 square foot store?

Todd J. Vasos - Chief Executive Officer & Director

Yeah, again, it's more than apparel, Dan, as you can imagine, but apparel does get pulled down somewhat in this model. But to answer your question, we consistently and constantly look at every year going in with our robust category management system what areas we need to contract and what areas we need to continue to expand on. And the great thing about apparel, at least in the last couple years, is we've seen some nice growth in apparel. Now, obviously, we had a little bit of a weather hiccup here in Q4, but we don't see our apparel business slowing down as we go into 2016. Matter of fact, we're pretty bullish on apparel. Cindy Long and her team have done a real nice job in giving us a very competitive offering there, but again, we'll continue to monitor all categories. And if we feel we need to contract at times and expand in other areas, we'll definitely do so.

Dan R. Wewer - Raymond James & Associates, Inc.

It looks like the sales per square foot in the 6,000 square foot store could be considerably higher, given the difference in the merchandise mix and the more densely-populated markets. What would be the offset? Is it a lower margin rate because you have less apparel or do you expect expenses to be higher, particularly in the urban locations?

Todd J. Vasos - Chief Executive Officer & Director

Yeah. I think you've hit on a couple of things, Dan, is that expenses are a little higher there because of that urban nature. But again, because of that 6,000 square foot box, we can keep that also from getting too far out of bounds, because again, trying to manage 6,000 square feet versus the 7,400 square foot workhorse that we have is a little less complex. Then you couple that with the changing of the mix and, depending on the area that we put these stores, the consumable mix does increase a little bit, which does put a little pressure on gross margin rate. But again, when you look at overall return, because of the smaller box, it costs less to get into it, costs less to – or it doesn't cost as much to operate it from a lot of different areas, and then couple that with some good sales and sales per square foot, which is higher than our normal box, then the whole equation works pretty nicely.

Dan R. Wewer - Raymond James & Associates, Inc.

And just real quickly, of the 80 (54:04) you opened this year, how many will actually be in the very small rural markets?

Todd J. Vasos - Chief Executive Officer & Director

Yeah. I don't know if we really have talked about that, but I could tell you that it's going to be a nice balance because what we want to do is really look at how it works. And of the 30 that we have opened, I can tell you that we've got a few open in, in the rural markets and we've got the majority of them right now open up in the metro markets. And so that balance is probably going to still be heavily weighted right now to metro, but as we go forward, we're seeing some real opportunities in the rural markets with those lower households. And again, that's why we're guiding long-term upwards of 8% square footage growth because there could be some real benefit as we go out in outer years.

Dan R. Wewer - Raymond James & Associates, Inc.

Great. Thank you.

Todd J. Vasos - Chief Executive Officer & Director

Sure.

Operator

Your next question comes from Stephen Grambling from Goldman Sachs.

Todd J. Vasos - Chief Executive Officer & Director

Hi, Stephen.

Stephen Grambling - Goldman Sachs & Co.

Hey. Good morning. So you mentioned the expansion in coolers, but can you also help us size the expansion in health and beauty as well as perishables and maybe where the space is potentially coming from? And also address how the expansion in these areas are being balanced with the shrink initiatives you cited, given some of the challenges inherent with these categories?

Todd J. Vasos - Chief Executive Officer & Director

Yeah. As we look at health and beauty, it is one of our categories that we're the least penetrated in today. And with that said, there's really a lot of opportunity. And again, because of our convenient nature, our consumers are asking us for more and more of our health and beauty offering. Now in saying that, as we look at our new stores, where a lot of the health and beauty initiatives will be put into place, the new store design opened up some opportunity for us in that we didn't have to take out a lot of product to be able to put some of that health and beauty initiative in.

It's somewhere in that six feet to eight-plus feet. It depends on the store. It could go upwards of 16 feet in some areas, but what we're doing is we're not – this isn't a one-size-fits-all either. We're taking a look at shrink, we're taking a look at where the stores are located. And the other nice thing about this is it has a healthy balance of private brands. And as we all know, private brands, very good profitability, but also doesn't shrink near as much as your national brand. So I think when you couple all that together, I think this should be a real win for our consumers at Dollar General.

Stephen Grambling - Goldman Sachs & Co.

That's helpful. And then one quick follow-up, if I may. You had talked about the Digital Coupon platform, I think, last quarter. Can you just provide us an update on what you are seeing there and the potential opportunities to maybe leverage that platform as you've re-segmented the customer?

Todd J. Vasos - Chief Executive Officer & Director

Yeah, we've been pleasantly surprised. My goodness, we're up to now over 2.5 million subscribers, if you will, users, and we continue to see sign-ups very robust. The great thing that we're seeing here is that the basket size is significantly larger than our normal basket size without using digital coupons. And the other thing that our marketeers along with our IT department have recently done has made sign-up at the store very, very, very easy. As a matter of fact, we went from – to over three minutes to four minutes to sign up to now we can sign up in a minute or less. And that has really helped propel the sign-ups at store level.

So we're very bullish on what that will bring us into 2016 and beyond. And you have to remember some of this newfound money that our consumer has gotten over the last year to year-and-a-half between going back to work and less gas – and the gas prices being a little lower, she's reinvested some of that findings for her into smartphones, and we have seen that our smartphone usage from our core consumer has gone up a lot. As a matter of fact, it now has crested over 85% where just a few short years ago we were in the 40% some range on usage. So you couple all that, she is now ready to really go digital and we're on the forefront of that for her.

Stephen Grambling - Goldman Sachs & Co.

All very helpful. Thanks so much. Look forward to seeing you all in a few weeks.

Todd J. Vasos - Chief Executive Officer & Director

Thank you.

Mary Winn Pilkington - Vice President of Investor Relations and Public Relations

So we have hit the top of the hour, so I think we'll call it a day right here, but we do look forward to seeing everybody in Nashville in a couple of weeks. If you have any questions, please let me know and we're around all day for questions. Thank you very much.

Operator

That does conclude today's conference call. You may now disconnect.

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