Good morning. My name is Brandy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dollar General's Second Quarter Earnings Call. [Operator Instructions] Ms. Mary Winn Gordon, Vice President of Investor Relations and Public Relations, you may begin your conference. .

Thank you, Brandy, and good morning, everyone. On the call today are Rick Dreiling, our Chairman and CEO; and David Tehle, our CFO. We will first go through our prepared remarks and then we will open up the call for questions. Our earnings release 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, objectives, anticipated financial and operating results and other nonhistorical matters.

Some examples of forward-looking statements discussed in this call include our 2013 forecasted financial results and anticipated capital expenditures, our planned operating and merchandising initiatives for fiscal 2013, our share repurchase expectations and statements regarding future consumer economic trends.

Important factors that could cause actual results to differ materially from those reflected in our forward-looking statements are included in our earnings release issued this morning; our 2012 10-K, which was filed on March 25; our fourth -- first quarter 10-Q, which was filed on May 3; and our second quarter 10-Q, which was filed this morning; and in the comments that are made on this call.

We encourage you to read these. 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..

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 I mentioned is posted on dollargeneral.com.

This information is not a substitute for any GAAP measures and may not be comparable to similarly titled measures of other companies. Now it is my pleasure to turn the call over to Rick. .

Thank you, Mary Winn. Good morning, everyone. This morning, we announced our results for the second quarter of fiscal 2013. I'm pleased to report that our comp store sales accelerated to 5.1% in the quarter. This was on top of a 5.1% comp in the second quarter last year and a 5.9% comp the year before.

I really want to emphasize that the acceleration of our traffic in the second quarter above our already strong traffic trends..

Both traffic and average tickets have increased for 22 consecutive quarters. Total sales grew 11.3% to $4.4 billion. While consumables showed the strongest gains, I was pleased with the overall sales growth across our non-consumable categories.

Operating profit, excluding certain items, increased by 9% to $421 million, or 9.6% of sales, which was down just 24 basis points from last year as we managed the impact of lower-margin sales growth through strong SG&A leverage..

Our gross profit rate of 31.3% of sales was 65 basis points less than last year's second quarter, with the majority of the rate compression resulting from our very successful launch of tobacco products across the chain. Tobacco sales contributed nicely to our sales growth and SG&A leverage..

GAAP earnings per share increased 17% to $0.75. On an adjusted basis, earnings per share increased to $0.77, giving a strong double-digit growth..

We continue to return cash to our shareholders through $200 million of share repurchases in the second quarter. We had a strong second quarter and remain on track to meet the full year expectations we shared with you last quarter.

We continue to increase our overall market share of consumables in units and dollars over the 4-week, 12-week, 24-week and 52-week periods..

Our recent share gains according to Nielsen data actually accelerated during the second quarter. We see this as a clear sign that we are serving our customers' needs and playing an increasingly important role in their shopping routine..

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

Thank you, Rick, and good morning, everyone. Rick covered the highlights of our second quarter sales performance, so starting with gross profit, I'll share more of the details..

Our gross profit increased 9% for the quarter. As a percentage of sales, gross profit decreased by 65 basis points to 31.3%. As expected, the gross margin rate was impacted by a higher consumables mix and lower initial markups, primarily due to the rollout of tobacco and the growth in the sales of perishables.

In addition, our inventory shrinkage rate increased, although at a lower rate than in the first quarter. This margin compression was partially offset by a benefit from transportation efficiencies, lower markdowns, primarily due to the later timing of apparel markdowns and a favorable LIFO credit..

SG&A expense was 21.9% of sales in the 2013 period, or 21.8%, excluding an $8.5 million legal settlement. Our SG&A rate improved by 41 basis points, excluding certain items as detailed in our press release. Further improvements driven by our workforce management system resulted in strong retail labor expense leverage in the quarter.

In addition, the year-over-year SG&A improvement reflect the decrease in incentive compensation expense, improved leverage on utilities costs and lower workers' compensation and general liability expenses..

Costs that increased at a higher rate than our increase in sales includes repairs and maintenance, debit card fees and depreciation and amortization. Interest expense of $21 million represents a $15 million decrease from the 2012 second quarter, the result of our favorable refinancing transactions over the past year..

The second quarter tax rate was a more normalized 37.4% compared to last year's effective tax rate of 34.1%, which reflected a $14.5 million favorable income tax audit resolution. Please keep in mind that in the second quarter of 2012, we called out this tax benefit of approximately $0.04 per share.

Excluding this adjustment from last year, our 2013 effective rate was lower than last year's rate due primarily to federal jobs credits, which were not in effect in last year's quarter..

On a reported basis, our net income increased 15% to $245 million, or $0.75 per share in the 2013 quarter from $214 million, or $0.64 per share, in the 2012 quarter.

Excluding the $8.5 million legal settlement, second quarter 2013 earnings per share was $0.77, in line with our internal expectations when we revised full year earnings guidance in our first quarter earnings call..

Adjusted earnings per share in the 2012 quarter was $0.69, as reconciled in our press release for that period. If you additionally subtract the $0.04 benefit resulting from the tax adjustment in the 2012 period, underlying second quarter 2013 earnings per share increased 18%..

Year-to-date, we generated cash from operations of $484 million, up $111 million from last year.

Capital expenditures totaled $309 million, including $127 million for upgrades, remodels and relocations of existing stores; $66 million related to new leased stores; $52 million for stores we purchased or built; $49 million for distribution and transportation; and $12 million for information systems upgrade.

Year-to-date, we have opened 375 new stores, which puts us well ahead of last year's base. We have also relocated or remodeled 377 stores, and we've made significant progress on our new distribution center in Bethel, Pennsylvania. We continue to be pleased with our performance of our new, relocated and remodeled stores..

As previously announced, we have repurchased $220 million of our common stock this year, including $200 million in the second quarter. We have approximately $424 million remaining in the existing authorization.

Since the inception of the share repurchase program in December 2011, we have repurchased approximately $1.1 billion, or 23.6 million shares of our common stock, and we plan to remain consistent, as well as opportunistic, in our share repurchases going forward..

Looking at the balance sheet as of August 2, total inventories were $2.53 billion, up about 11% on a per-store basis. We made good progress from last quarter's inventory growth of 14%, even as the second quarter includes more impact from our tobacco rollout..

Higher inventory balances over the last couple of quarters have resulted in a modest decline in inventory turns to 4.9x. However, the quality and aging of our inventory continues to be in good shape, and we expect the year-over-year inventory growth rate to decrease as we move through the second half of the year..

As of August 2, we had outstanding long-term obligations of $2.87 billion, in line with last year's balance, although with much better rates and terms. We're very pleased with our current capital structure and the flexibility that it affords us. Now, to guidance..

We continue to expect total sales for the year to increase 10% to 11%. Same-store sales are expected to increase 4% to 5%. As a reminder, there are 6 fewer selling days between Thanksgiving and Christmas, which will likely impact our sales to some extent in the fourth quarter..

We're forecasting gross margin contraction for the full year to be approximately 90 basis points. As you model gross margin performance in the third and fourth quarter, it's important to keep a couple of factors in perspective.

As I mentioned, we had lower markdowns in the second quarter, primarily due to the timing of markdowns in apparel, given the way the summer weather played out. Year-over-year, we're forecasting a shift of some of these markdowns into the third quarter.

The shift in weather gave us the opportunity to be nimble and maximize our sales of full-priced apparel items..

And finally, last year, we had our best gross margin performance in the fourth quarter, and we expect that comparison to be challenging. Adjusted operating profit for 2013 is expected to be in the range of $1.73 billion to $1.77 billion..

Interest expense is forecasted to be approximately $95 million. The full year 2013 effective tax rate is expected to be between 37.5% and 38%. Adjusted earnings per share for the year are expected to be in the range of $3.15 to $3.22.

Our EPS forecast is based on approximately 324 million weighted average diluted shares, which assumes approximately $600 million of share repurchases for the full year..

Our full-year operating profit and earnings per share guidance are based on adjustments consistent with those detailed in our earnings release for the year-to-date results..

Capital expenditures are expected to be in the range of $575 million to $625 million. We now plan to open approximately 650 new stores for the full year. That's an increase of 15 stores from our previous guidance. Remodels and relocations are expected to total approximately 550 stores for the year..

In summary, our outlook for the year is solid. We remain excited about our organic growth opportunities. We are committed to returning cash to shareholders through share repurchases and building on our proven track record..

For now, I'll turn the call back over to Rick. .

Thank you, David. We had a strong second quarter, and while it is still early, the third quarter is off to a solid start, and I believe we have a great plan for the remainder of the year. We remain cautious on our consumer and our spending in the second half of the year, as we have been all year.

But as the result of our customer-focused initiatives, we are starting the quarter with momentum. Let's start with tobacco, our single largest undertaking in the second quarter..

We began the tobacco rollout in mid-March, halfway through the first quarter, and we exited the second quarter with the rollout of tobacco complete. This was a tremendous undertaking, and I would like to commend the entire Dollar General team for a remarkably successful implementation of tobacco across nearly 10,500 stores in a period of 3 months..

With the rollout now complete across the chain, coupled with the experience we have in our stores that have been selling tobacco for several months now, we're gaining greater insight into the tobacco category and our customers. As I said earlier, we are seeing a significant increase in our traffic, and tobacco has been a key driver..

Our experience so far reinforces my belief that traffic is the most important metric to watch as we measure the overall success of our decision to add tobacco products in our stores. Our sales and our traffic are continuing to build each week, along with our customers' awareness..

Tobacco sales are consistently running about 1/3 tobacco-only, and the remaining 2/3 are tobacco plus one or more items..

Next, during the second quarter, we completed Phase 5 of our evolution in merchandising. The focus of Phase 5 was to optimize productivity in our legacy stores, many of which are less than 7,000 square feet..

We went into these stores, about 3,000 of them, and reset various planograms to better utilize shelf and floor space by adding more productive items and eliminating less productive items, such as hanging apparel in some of the smaller stores.

We are pleased with the sales comp lift from this initiative as our customers realize we've expanded our product assortments in key categories..

As a result of this project, we've identified additional opportunities for future productivity gains in these legacy stores. We continue to be pleased with the results of our cooler expansion for perishable items. Through the second quarter, we have added over 7,000 cooler doors, expanding coolers in over 1,600 existing stores.

Most of these stores are now consistent with our new store standard of 16 cooler doors..

Through the second quarter, we opened 375 new stores, including 15 Dollar General Market and 21 Dollar General Plus formats. We're well ahead of where we were this time last year in the number of stores and operating weeks. Our new stores are continuing to deliver strong performance..

We now have 69 stores in California, stretching over 600 miles from north of Sacramento to south of San Bernardino. As we enter our second year in California, we're continuing to refine our market entry strategy to better optimize our overall performance.

We are currently utilizing all 3 of our store formats in California, and we are pleased with our sales results..

As David mentioned, our current store development pipeline is robust, and we're raising our new store outlook for this year to 650 stores. We have remodeled or relocated 377 stores so far this year, including 65 Dollar General Plus stores.

The Dollar General Plus format is a great tool for relocations, and the expanded refrigerated and frozen food assortment in these stores is driving a higher basket..

We're continuing to learn and test new ideas in our Dollar General Market, particularly in how to best serve our customers in the fresh meat and produce areas. In many of our market locations, these stores are providing a much needed option for a broader Dollar General shopping trip. .

In our ongoing commitment to helping our customers save time and money and our own journey of elevating sales performance, we have continued to update the appearance and layout of our customer-centric store model. Freshening the look of the store is something I believe all great retailers should do periodically.

This year, we have rolled out a new fresh look to further enhance our customer shopping experience. We've implemented the new format in more than 550 stores, including new stores, relocations and remodels. The updated 2013 design has new in-store signage and branding, with a refreshed look that leverages our yellow and black color scheme.

We configured sections such as apparel and seasonal and yet again, improved the category adjacencies in these stores. We believe this well-designed format really makes sense and is proving to resonate with our customers.

To date, we're excited about the comp sales lift in our remodels and relocations, and we're hearing great feedback from our customers on the new layout and fresh look..

At the end of the second quarter, we had 10,866 stores in 40 states, well on our way to reaching our 11,000 store milestone in October. And the good news is that we continue to see significant, exciting opportunities for organic growth..

Our customers are depending on our convenience and everyday low prices more than ever. We're focused on meeting their needs with the right merchandise selections at the right prices throughout the entire store.

We're continually expanding our footprint and improving our operations and believe we have a long runway for continued success in both existing and new markets..

Before I open for questions, I want to thank our employees from coast to coast, serving our customers and representing the Dollar General brand in our communities every day. Now, Mary Winn, I'll open it up for questions. .

All right, Brandy, we'll start out with our first question, please. .

So our first question comes from the line of Matthew Boss with JPMorgan. .

Can you speak to the monthly progression and drivers of the traffic acceleration that you spoke to? And also, give us a little bit more color on August, both total sales and maybe some of the discretionary versus consumables? It sounds like you mentioned it was off to a pretty good start. .

Yes. The -- quarter 2, the sales accelerated as we moved through the quarter. The really encouraging thing was not only did sales accelerate, but unit growth and market share growth accelerated as we moved through the quarter also, which is kind of how we called it and how we anticipated as we move through the balance of the year.

In regard to August, I don't want to really get into where we are in the third quarter other than to really say that we feel pretty comfortable with where we are and where we're heading. .

Wow. That's great. And then secondly, can you speak to the rationale behind raising the new store growth target for this year, what you're seeing from some of your younger stores and then how we should think about the growth profile ahead.

Any changes to your thinking?.

Yes. Actually, I think, as I look at the fact that we raised the number of new stores, it's driven primarily by the robustness of the store pipeline right now. As you guys remember, last year, we got a little bit behind on it, and we had to work our way through it. So we feel pretty good where we're going this year.

And I should also throw out, too, as I sit here and think about the question, we're getting the stores open earlier this year, which I think is helping. .

And our next question comes from the line of Scott Mushkin with Wolfe Research. .

This is actually Bryan Cullinane on for Scott. You highlighted -- you showed -- your comps were accelerated, and you highlighted that you're gaining share.

Who do you guys think that, that share is coming from?.

Yes. When I look at Nielsen share data, it's coming from drug, first; grocery, second; and mass, third. And I think the other, Brian, wonderful thing about our format is we compete in that great, big world of consumable retailing, which is well over $800 billion.

So we're able to go in and take a little bit from a lot of different spots, and we're kind of one of those guys you don't really feel. .

And then the second question -- we saw some good share repurchase activity.

Can you just, maybe going forward, prioritize your uses of cash from where you stand now?.

Yes, absolutely. It really hasn't changed from what we've articulated previously. Our #1 priority for cash is investing in the business, as evidenced by adding to the store count for this year.

We're going to open new stores, we're going to do remodels, we're going to do relocations, and then we're going to make sure we have the infrastructure in the business to support the stores because that's our #1 priority, and we think that's the best return for our shareholders.

And then with the cash that's left over, we'll buy back stock with that, as evidenced by the stock buyback you saw in the quarter, the $200 million buyback which we did at $51.28. So obviously, we got in there opportunistically, and we were able to get a nice slug of stock bought back. So those are really our priorities for cash. .

Our next question comes from the line of Stephen Grambling with Goldman Sachs. .

Just a follow-up on the last one.

Any sense for what you think the appropriate leverage point is in the business?.

Yes. Right now -- and again, we've mentioned this before -- we believe it's best for us to be investment-grade, which implies a debt-to-EBITDA of about 3.0. And if you look at our statistics over the past several quarters, that's where we've been, and that's where we ended up in Q2. So that's the general leverage point that we're aiming for. .

And would you be averse to taking on additional debt as you continue to generate excess cash as it comes in kind of above your plan or even within your plan?.

Well, certainly, if we need to take on additional debt to stay at 3.0, we would definitely consider doing that. Yes. .

Okay.

And then one on -- just more fundamental question, which is when you think about the traffic that's being driven by tobacco, do you have any sense for -- if that's a new customer versus the existing customer just taking an additional trip?.

Yes. I think it's actually a combination of both. And I -- we don't have a card, so it's really kind of hard to go in and measure, Stephen, what's going on. But our belief is that the customer that's coming in, that's primarily buying just tobacco, is probably the newer customer. .

Your next question comes from the line of Edward Kelly with Crédit Suisse. .

I just wanted to follow up actually first on the last question on the leverage ratio and the appropriate level of business. Can you just maybe remind us why you think investment grade is so important? You've obviously operated at levels below that historically. .

Yes. Well, I think we demonstrated that in the last refinancing that we did in terms of the interest rates that we were able to get on the debt. And you heard in my opening comments how much lower interest is this year than what it was last year. I mean, it's really adding to our overall bottom line.

So it gives us access to the credit markets in a way that I think is very flexible and healthy for the company. It also helps us with our vendors and on the real estate front being investment grade in terms of the types of deals that we're able to do. So we take a hard look at this several times a year and discuss it.

Rick and I discuss it with the board. And clearly, we feel like right now, that's the best place for us to be. .

Okay. And, Rick, just a bigger-picture question for you strategically. I was hoping maybe you could just give us your updated view on sort of organic growth versus growing via acquisition. You've obviously favored organic growth historically.

Why is that, I guess? And could -- what would change that going forward? And this doesn’t even necessarily apply to large deals because there are smaller guys out there too that potentially could make sense. So I'm just curious as to what your thoughts are there. .

Yes, it's a really good question, Ed. I -- we still have over 10,000 opportunities out there in the marketplace today, in the United States today, for Dollar stores. And we have a very proven format that generates the best returns in retail that I have ever seen in my career.

And it's much easier to manage that than it is to try and manage an acquisition. And my love of organic growth is the fact that when you go into a new market, you understand the market but more importantly, you understand the player set that's going to launch that for you. So I've always been a lover of organic growth. .

Your next question comes from the line of Deborah Weinswig with Citi. .

Taking on the kind of new store pipeline, can you talk about what 2014 looks like? And based on raising your new store activity for this year, does the competitive landscape look any different in terms of looking at new stores and what the markets look like?.

Yes. Our 2014 pipeline is actually ahead of schedule, exactly like '13. And this is the second year in a row where we'll be able to be in a much stronger position as we enter into the new year. David and I like that 6% to 7% square footage growth. It's more, Deb, about organizational capacity than it is anything else.

And this company got itself in trouble 7 years ago about opening too many stores too fast, and I -- we would rather open a handful of stores that perform well and drive a great return than get ourselves out there and overextend ourselves. .

Okay.

And another question on this topic, are you utilizing a different team? Are you utilizing better technology? Is there anything differently that you're doing in terms of getting sites?.

No. Actually, everything is exactly what it has been. We're just doing a better job of getting ahead of the pipeline curve. And quite honestly, it's like everything else we do at Dollar General. I'm surrounded by a team that continually improves on the processes that have been established over the years. .

Great.

And then in terms of the beat this quarter not rolling that in terms of raising guidance for the year, can we just dig into that a little bit deeper?.

Yes. In terms of our -- and we generally don't talk about our internal estimates. But actually, the quarter came in pretty much as we expected it in our internal guidance that we had given last quarter. So from our perspective, it wasn't really a beat. We performed how we thought we would perform.

So there really isn't anything to increase for the rest of the year as we came out. Now we did tweak our -- some of our assumptions on interest and tax rate and share count and things of that nature.

I'm looking forward -- given the uncertainty and the macroeconomic environment, we're trying to make sure we're prudent in the things we're doing above the line. So again, we're pleased with where we are, and we're pleased that, again, we're pretty much on where we said we would be when we updated our guidance last quarter. .

Okay. And then one last quick one.

Rick, when you look into the market share gains by category, is there anything there that's surprising to you?.

Actually, no, there's not, Deb. What's interesting to me, what has surprised me, it's relatively -- it's even across most of the categories. It was interesting, I was talking to Mary Winn yesterday, and it was one of those quarters in which the boat was rising on all of the sides.

Everything is -- reminds me very much again of 2008 and 2009, where everything is starting to rise evenly. .

Our next question comes from the line of Charles Grom with Sterne Agee. .

Just a few things, David, for us on just for modeling.

I guess, first, would be can you quantify the list of sales from tobacco? What do you think the incentive comp accrual reversal was in the quarter? And then could you quantify the mark down shift between the second and third quarter for us?.

Yes. I don't think we're going to give granular quantification on those, Chuck. I mean, obviously, the tobacco had a meaningful impact on the quarter overall in terms of what this performance was on the comp sales and particularly in driving traffic into the stores. It's more than what we've seen in beer and wine overall, which is very positive for us.

And then again, on the expense side, it was meaningful enough that we wanted to spell out the incentive comp overall. But again, not going to give specifics on that or the markdown.

Except on the markdown, I will say, again for modeling purposes, the reason we bring that up is that is something that was a benefit to second quarter that's going to hit third quarter. And we want to make sure everybody's aware of that as they start putting their third quarter models together. .

Chuck, I'd say one thing on the tobacco that we are really focused on here in the company. It is not about the comp sales it's driving, it's about the transactions it's driving. And what we are totally focused on is how we could take that tobacco purchase and lever it up with incremental items when that transaction takes place in the store. .

Makes sense. And then I guess it's kind of impressive that you roll out tobacco and you see the shrink rate improve.

Can you kind of flush that out for us?.

Yes. I think the rate of decline and shrink is what has improved, Chuck. I will tell you, in regards to shrink, we've installed a lot of defensive merchandising over the course of the last 6, 7, 8 months and had the chance now to go in and reinventory those stores.

And while it's still soon, we're very pleased with what we're seeing with the defensive merchandising that's been put in place. .

Okay, great. And then just my last question, just a follow-up on a previous one.

When you sort of think about capital allocation versus store growth, and you talk about the 6% to 7% square footage growth number that you want to keep, as the law of large numbers starts to catch up with you, do you think the next 3 to 4 years we continue to see 6% to 7% store growth? Or does organization capacity make you want to think -- maybe ratchet that back a little bit and increase the buybacks? I mean, how do you kind of think about the whole pie?.

Yes, I think -- again, you're raising a great question. We're very comfortable right now at this stage of the game with 6% to 7%. But again, I want to come back to how I answered the question previously. We want to open stores that are productive out of the chute in generating a return.

And we would rather open stores that are complete, that the customer has an experience when they come in, rather than just come in and look at you all and say, "Hey, open a bunch of stores.".

I said go back to Rick's comment on the continuous improvement we've seen in the real estate area, which helps us, again, to reach that 6% to 7% the way real estate's performing. .

Right.

So you guys are like basically tracking new store productivity and store manager turnover to make sure that you don't sort of outgrow, which was a problem, I guess, 10 years ago?.

That's exactly right. And we, Chuck, actually look at new store growth productivity every week. .

Your next question comes from the line of Paul Trussell with Deutsche Bank. .

It's actually Matt for Paul. I just had a question. In terms of the competitive environment, we've seen some of the mass guys put up some disappointing results lately.

Just wondering if you saw any kind of change in rhetoric or anything in the marketplace throughout the prior quarter and thus far, into this one?.

Yes. I look back on quarter 2 much like quarter 1 and look at -- and would tell you that the share of voice is obviously up. There's no doubt there's more print advertising out there, more pages of print even within the usual weekly vehicles. However, it's fair to say that the price competition is not any more intense in quarter 2 than quarter 3. .

Our next question comes from the line of Scot Ciccarelli with RBC Capital Markets. .

So if you look at kind of the 2-year stock comps on the discretionary front, at least the way we calculate it, it looks like seasonal and home were basically flat year-over-year versus the first quarter, but apparel improved pretty nicely.

But then you mention there are some markdowns, particularly in apparel, that we need to think about for the third quarter.

Can you guys provide us a little bit more color on the discretionary front and specifically on the apparel, and kind of what your expectations are for those categories going forward?.

Yes. I mean, I, quite frankly, was pleased with what happened on the discretionary side of the ledger in the second quarter. And quite honestly, very proud of the team on the apparel side. I think it's definitely too early to declare a victory. I think that, in all honesty, we still need a little bit of help on -- with the economy.

And I think it's fair to also say that our consumer is still a little hesitant out there. But I think as we move through the third quarter, we anticipate the trends will not change significantly. .

Got it. Okay. And then just a clarification.

Did you say all of the gross margin decline in the second quarter was from tobacco?.

No. Actually, what David said was the bulk of it was, but not all. .

Tobacco, its mix and its shrink were probably the 3 biggest negatives. .

Your next question comes from the line of John Heinbockel with Guggenheim Securities. .

Let me ask you, DG Market and DG Plus, when do you think, if ever you begin a more aggressive rollout -- I guess it would be plus.

And then is there a merit to, as you learn from DG Market taking, I don't know, Top 20 produce items, top 5 or 10 meat items and migrating those into DG Plus?.

Yes, I think the -- if I were to look at you and tell you right now -- over the course of the last year, we've made more progress on the DG Plus side.

I think that, particularly as a remodel or relocation vehicle -- and remodel meaning we can knock into a wall next to us, John -- what we're really excited about on the Dollar General Plus is the change in the basket size. And it comes back to the wider aisles, the shopability of the stores.

And when you start with a relo or a remodel, you start with a significantly higher base, which gets you moving in the right direction faster.

The Dollar General Market, the team is doing, I think, a great job of really understanding produce sales and meat sales, which I think -- by the way, those are living things that we have not had to deal with before. And I've got Todd and Greg Sparks here, who are helping to manage the team through that.

So I -- again, I think it's a little soon to declare victory there. I do think we are moving in the right direction on the Plus side. Your comment on perhaps making -- taking the Top 20 produce items and eventually getting those into the regular Dollar Generals, that is something we're actually talking about.

Now whether or not that'll ever happen or not, it's still too soon to tell. But oranges and apples and potatoes, things like that, grab-and-go stuff that a consumer forgets on the way home, could play out down the road. .

So along those lines, what's the biggest challenge to doing that? Is it supply chain, being able to do that -- keep it fresh? Is it something else? And then secondly, where would you get the space for that?.

Yes. I mean -- actually, you nailed it. The supply chain is the issue.

And not only that, on that kind of an item, we have to introduce a middleman because we don't warehouse our own produce and you run the risk of having an item that's a little bit higher and depletes your -- your customer doesn't understand that it's coming from somewhere else, and it kind of depletes your price image.

In regards to -- what you should also remember, if we were ever to do this, it wouldn't be like there would be a whole isle of produce or an end cap of -- It would be a very small, manageable display. .

All right. Then lastly, you mentioned shrink, and I know that dovetails very close with turnover.

So where is turnover today? And then do you think turnover will be in a good enough position where shrink actually comes down next year?.

Yes. I'm actually -- the team, John, has done a good job with turnover over the last 2.5 years. And I have to tell you, our turnover is, in essence, flat the last year. And we're having our -- our best year was 2012, by the way. And to be flat against 2012, I think it's a pretty good mark. And I do agree that turnover is a big component of shrink.

And I think that we're working really hard on the turnover, and I think the shrink numbers are starting to move our way again. .

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

We totally agree, totally support your view to use your capital for our organic growth rather than acquisitions. I want to ask about inventory productivity.

Regardless of how you measure that based on GMROI, or the amount of gross profits generated from $1 of inventory at peak last year and, again, to weaken as the company began to add 11% to 15% more inventory per store, is this a signal that your buyers did it right, that the first $210,000 of inventory they bought for our store was the most profitable, and that the incremental $20,000 that you've added this year is -- it's profitable but not as productive as that initial $210,000 investment?.

Yes. Actually, I think that's a pretty accurate assessment, to be honest about it. I think it really tells you the power of category management. The team came in here several years ago, rationalized the SKU base, got the SKU base right. As we continue to broaden our appeal, it means we need to add selective, other SKUs.

And I think quite frankly, we got a little overzealous in quarter 1. And what we're doing now is we're spending a lot of time -- the product, by the way, while I say we got a little overzealous, there's nothing wrong with the product that's in the store base.

And the decision we've made is we're going to go in and reevaluate it and, over a period of time, take some of those SKUs, Dan, that you were talking about, that aren't quite as productive, and just work some way back out of the system. .

And then -- just as a follow-up, it was definitely 3 or 4 quarters ago when the tobacco discussion began. The company was estimating that every 1 percentage of comp sales growth from tobacco would negatively impact gross margin rates by about 20 basis points.

It looks like the algebra has changed based on the comps that you're getting in tobacco and what's happened with gross margin rates?.

Yes. I don't recall giving you that. If I did, I did. I would look at you and tell you that the tobacco, the tag-along purchases with tobacco are a little bit better than we thought they were going to be. How's that? I don't know if that helps or not, Dan. .

The 65% of the customers that are buying something else has turned out to be higher than what you were expecting. .

Exactly. .

Your next question comes from the line of David Mann with Johnson Rice. .

I was curious, just elaborating on the comment you just made about some of the SKUs that you added, I know last quarter you talked a lot about the gross margin hit when the mix between national brands and private brands sort of got a little bit out of kilter.

So I'm just curious, were you able to -- since -- were you able to re-pivot into this quarter such that you -- it didn't even become a comment? I mean, is that what you've been working through?.

I'm sorry, Dan. Actually, Dan, our private brand penetration is actually back up, moving north again. So that would tell you that we're doing a better job in managing the mix. .

Okay, great. And then in terms of tobacco, I know in the past you've given us what that average ticket might be. Can you update on that? And also, I don't know if you specifically talked about what the shrink experience is in tobacco is relative to what you expected.

If you could comment there as well?.

Yes. It's really too soon, Dan, on the shrink. Right? I have -- we'll have to cycle a whole year tobacco. Right now, I will tell you the supply chain system that keeps track of the tobacco, how it flows from the supplier to a point where it gets stocked on the shelf, is working quite nicely.

We've had a couple of issues and have been able to identify them immediately. In regards to cigarettes, the average -- our average basket is approximately $10.77. And when cigarettes are in there, that basket goes up to almost $13.75. .

Okay. And then, David, one other question on the buyback. I think the math would suggest that you might be in the market for up to $400 million for the rest of the year. I'm just curious, when you made that $200 million purchase, it seemed like you didn't buy anymore in the rest of the quarter.

Any comment you can make about that?.

Yes. Quite simply, we wanted to keep our debt-to-EBITDA at 3.0, and that's exactly where we came in. Again, we're managing that ratio because of our investment-grade status. .

Our next question comes from the line of John Zolidis with Buckingham Research. .

A lot of questions on tobacco.

I have one question, which may sound a little bit counterintuitive, but is there any sense at which having tobacco in the stores is causing customers to substitute their spend to tobacco from something else? Is there any evidence of that occurring?.

That's actually, John, a very, very good question. I would look at you, there's no way I can tell that. But what I can tell you is that our customer index is at about 135% on cigarettes. So, John, they're buying those cigarettes somewhere else. .

Okay.

And then on a different topic, on the new stores, can you talk a little bit about the real estate prices for new stores? Are you seeing a lot of pressure? Is there any change or any intentional change in the quality of the locations you're going into with the new stores?.

Yes. Our -- the real estate strategy in regards to locations, everything -- I would call it status quo over the last couple of years. There's been no major uptick in commercial real estate at all that we have seen, and we're still committed to the site selection process that we've always had.

We don't put it on the corner of Maine and Maine, and we're very happy with a C Plus, D Plus site. .

So the biggest call-out with regard to new stores over the last couple of years is probably California entry and expanded DG Market, DG Plus?.

That's fair. .

Your next question comes from the line of Patrick McKeever with MKM Partners. .

A question on your urban market stores now that you have, I guess, more exposure to urban markets, having grown in urban markets more aggressively over the past several years.

Did you see any notable performance differential between urban and more overall stores during the quarter?.

To be honest with you, no. I mean, they tend -- the urban stores tend to have a higher sales volume and a little bit higher cost of operation. And at the end of the day, they net-net out to about the same. .

But there's -- is there any sense that maybe the urban store performance is improving? Also, what about tobacco sales in urban markets? Is it higher than rural markets? Or is that kind of netting out as well to be pretty neutral. .

Yes. I've got to tell you that it's pretty much neutral. I don't see any particularly bigger things in the metro stores, the urban stores, versus the rural. .

Okay. And then just another quick one on tobacco, just to go back to what David was saying. So tobacco, the comp lift is more than beer and wine.

And I think you said in the past that beer and wine had about a 100-basis-point positive impact? Is that correct?.

That's correct, sir. .

Somewhere north of 100 basis points then?.

That's correct, sir. .

Your next question comes from the line of Trish Dill with Wells Fargo Securities. .

Just a question on your Phase 5 initiative. Just wondering if the comp lift that you're seeing in legacy stores is greater or maybe less than 100 basis points like you've previously disclosed? And then if you could maybe just... .

Is that -- I'm sorry. .

And then if you could just elaborate on the additional opportunities that you mentioned, you've identified for productivity gains in those stores. .

Yes. I apologize, Trish. Number one, the comp lift is actually a little bit greater than we thought it was. And you've got to remember, we're very new into the cycle here. So as the customer realizes you have the expanded selection in core categories, we anticipate the comp lift will continue to move up as we move through the year.

In regards to the additional opportunities, it's more stepping back and going, "Oh my gosh, these categories did so well. Now, we need to go in and look at these other categories within the same legacy stores." So we're going to begin to tweak them again as we move through the year.

And we think what we're doing actually has ramifications that maybe -- perhaps we can run at a smaller box store, which will put us, you think, in the urban environment, put us in a little bit better position. .

Okay, great.

And then just one more quick one on whether or not you're seeing any food price deflation and how we should think about that as a potential headwind to comps in the back half of the year?.

Yes. That is actually another good question. We are seeing food deflation at this time. You have to remember that we have a smaller depth in our category, and -- while we have breadth. And we anticipate the deflationary pressure to continue as we move through the year. .

Your next question comes from the line of Joe Feldman with Telsey Advisory Group. .

I wanted to ask -- go back to the health of the consumer a little bit and just drill down a little more there.

Is there anything you guys have seen lately? Any changes with like maybe the pay check cycle or volatility in the week-to-week trend? Or maybe, as you look at the consumables business even, what people are buying? Is it a little more branded versus the private label? Anything that would give you any inkling to the health of the consumer there?.

Yes. My view on the consumer is no different than what it was, Joe, at the beginning of the year. I think our core customer has never come out of the recession. I think our core customers has continued to manage their way through, for years, multiple points where money is a little tight.

I mean, the average consumer out there who makes $50,000 a year has $1,000 a year and less in spendable income now due to changes that have taken place in the payroll tax.

Albeit I say all that, I think the beauty of our model is we continue to focus on transactions in units, and our customer is responding to the options -- the value proposition that we have. And as long as transactions and units are moving north, we believe we're satisfying their needs.

It is going to be an interesting back half, and I think that we're being -- we're keeping our eye on the consumer and what they're buying. .

Got you.

That sort of leads into the next question we have, which was, as you do think about the back half, and I know you don't like to give quarterly guidance per se, but how should we think about the cadence? I mean, there's been a lot of debate about whether sales have actually slowed or going to slow for this back-to-school period and into the holiday.

I guess how are you guys thinking about the back half?.

We got our guidance between 4% to 5% as we look through the total year, which would indicate that comps will accelerate as we move through the year. .

Your next question comes from the line of Mark Montagna with Avondale Partners. .

A question. I have read recently that government data is showing that commodity inputs for food are up 10%.

Wondering if you think that's accurate? And if so, when does that type of thing flow into retail prices for food?.

Yes. I think -- when you look at that, Mark, I think that would probably be focused on meat and produce and more dairy-type items.

And my view of how soon it flows in depends on how much pressure are retailers under in regards to their margin, right? So we certainly haven't seen anything of that magnitude here yet, but I would think that's probably more on the true perishable side of the business. .

Okay. And then it sounds like the phase 5 planograms are done for this year, and I thought the goal for this year was 2,000 stores. But then, Rick, in your prepared remarks, you mentioned 3,000.

So wondering how many did, and is the whole chain complete now? Or is there more to come?.

We got 3,000 done. We originally thought it was going to be -- yes, we got 3,000 done. .

Mark, that was our -- that was always our goal. We had completed 2,800 after Q1, and then we ramped that up in Q2. .

Okay. So do you plan more phase 5 for next year? Or is this... .

Really next year. And actually, what we want to do now is go back into the 3,000 stores which we called out and refine additional categories within that 3,000 -- those wins we've done. .

But looking out to next year, will there be another group that is phase 5?.

And the answer is probably so. .

Your next question comes from the line of Dutch Fox with FBR Capital Markets. .

So just a quick question and not to beat to death tobacco, but when you see those 2/3 of baskets that are buying tobacco and some other item, is that typically a discretionary item? Or is it more of a consumable item? In other words, you had a very good discretionary quarter in 2Q.

How much of that do you think was driven by tobacco? And do you think that's sustainable going forward as tobacco continues to ramp up?.

Yes. I think, Dutch, that cigarette purchase tends to gravitate towards the consumable side of the ledger, particularly when you only have 1 or 2 items going out the door with the cigarettes. That tends to be a soda or a Gatorade or a chip.

I think the health of the -- I think it is fair to say -- one could make the leap, and I can't prove this, that the incremental traffic might be helping the nonconsumable side. I don't think there's any kind of a connection between cigarettes and non-consumables. .

So it's fair to say that your -- the improvement we saw in discretionary categories in 2Q, that was largely the result of standalone initiatives within your efforts towards discretionary, not necessarily just driven by tobacco?.

That's correct. I think the improvement in the discretionary side is driven by good old-fashioned category management. .

Your next question comes from the line of Denise Chai with Bank of America. .

Just wanted to get a little bit more color on what you're seeing with cooler items? Could you talk a bit about trip frequency and also baskets, when people are buying cooler items? And also, you're approaching 70% penetration of your stores.

Where do you think that can go?.

70% penetration on coolers?.

Yes.

You said that you've got over 7,000 stores with coolers?.

Yes. We -- well, we actually installed coolers in over 7,000 stores. So we still have more cooler upside there. I will say this, Denise. The perishable side of the business, the frozen food, refrigerated is insatiable. It seems like the more we put in, the better we do. The basket -- I'm sitting here trying to think on the basket.

There's no doubt the basket goes up. I cannot remember, Mary Winn, off the top of my head how much it goes up. And what I'll do, Denise, I'll have Mary Winn call you and give you that number. But we do see a bump in the basket when frozen food's in there. It's more of a complete shop in the $10.70 shop. .

And just one more question.

You used to talk about having, say, a 1.5% to 2% embedded comp lift from remodels and your various optimization initiatives? Could you perhaps update that and just let us know how much of that has already cycled?.

Yes, that's really new stores, remodels and relocations all together that -- that figure and that's still reasonably accurate overall. .

And your final question comes from the line of Meredith Adler with Barclays. .

So a question that hasn't come up yet is kind of what do you think happens when SNAP benefits get reduced? Now I know that it's not a huge piece of your revenues, but clearly, it takes money out of the pocket of the lower income customer and could have some impact on, presumably, sales of discretionary, rather than sales of consumables.

But I was wondering if you have any thoughts about that?.

Yes. I think one of the interesting things that I've observed since I've been here is our percentage of sales that are on SNAP run about 5% to 6%. In spite of the fact that the government has increased the amount of SNAP benefits that are out there, we still run at 5% to 6%.

It's my belief right now, Meredith, that -- which we've said before, our customer spends the bulk of their wallet somewhere else before they come to me. That somewhere else is going to be where the impact is if there's a pullback in SNAP. At least, that's my view.

But your point is also very well taken in that the impact will probably not come on the consumable side. It would come on the nonconsumable side.

That would be my bet as where we would all feel it?.

And do you think that those discretionary sales are being done at the retailers that redeemed the most SNAP benefits, or is it spread out?.

Yes. See, my belief is you have to remember, we're the fill-in shop. We're the place you go when you forgot your T-shirts or you forgot your socks. We're not the fashion-forward carry place. We're the place you go to when you forgot a couple of Christmas decorations or you didn't get all the Christmas lights you need.

My belief would be the impact we probably felt, probably where you go for the initial sale, to begin with. .

Okay. And then I -- I'm sorry to keep the call going on, I just have one more question. When we think about -- I know you've said that your real estate strategy really hasn't changed at all.

But I think there was kind of a goal of the company to move into more middle income areas, to the extent that you could or to be able to have more transitional areas where you served customers of multiple income levels.

Is that true? And have you had success in terms of -- to the extent you know -- attracting customers from a more middle income area?.

Yes. I think there is -- it's fair to say that we have elevated the quality of the site that we've chosen, which would tell you that we tend -- we're getting a little closer to that middle income strata that you're talking about, Meredith.

And I would tell you that the peel of the box in those particular areas where we've chosen to do that, is as strong as when we go into the lower income areas. .

Does that increase the potential of stores that you could open?.

Someone can certainly make that leap. Yes. .

All right. Operator, that wraps up our call from our end. Everyone on the call, thank you very much for your time and attention. I'm around all day if anyone needs anything, and I look forward to seeing you later. And thank you for your interest in Dollar General. .

This concludes today's conference call. You may now disconnect..