Good morning. My name is Robert, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Dollar General Second Quarter 2020 Earnings Conference Call. Today is Thursday, August 27, 2020. [Operator Instructions] This call is being recorded.

Instructions for listening to the replay of this call are available in the company's earnings press release issued this morning. .

Now I'd like to turn the conference over to Mr. Donny Lau, Vice President of Investor Relations and Corporate Strategy. Mr. Lau, you may begin your conference. .

Thank you, Rob, and good morning, everyone. On the call with me today are Todd Vasos, our CEO; Jeff Owen, our COO; and John Garratt, our CFO. Our earnings release issued today can be found on our website at investor.dollargeneral.com under News & Events. .

Let me caution you that today's comments include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 such as statements about our strategy, plans, initiatives, goals, guidance or beliefs about future matters, including, but not limited to, beliefs about COVID-19's future impact on the economy, our business and our customer.

Forward-looking statements can be identified because they are not limited to statements of historical fact or use words such as may, will, should, could, would, can, believe, anticipate, expect, assume, intend, outlook, estimate, guidance, plan, opportunity, focus, confident, long term, look to, committed to, continue, ahead, seek or go and similar expressions.

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These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.

These factors include, but are not limited to, those identified in our earnings release issued this morning under Risk Factors in our 2019 Form 10-K filed on March 19, 2020 and our Form 10-Q filed this morning and in the comments that are made on this call. You should not unduly rely on forward-looking statements, which speak only as of today's date.

Dollar General disclaims any obligation to update or revise any information discussed in this call, unless required by law. .

We also will reference certain financial measures that have not been derived in accordance with GAAP. Reconciliations to the most comparable GAAP measures are included in this morning's earnings release, which, as I mentioned, is posted on investor.dollargeneral.com under News & Events.

At the end of our prepared remarks, we will open the call up for your questions. [Operator Instructions].

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

Thank you, Donny, and welcome to everyone joining our call. I'd like to start by thanking our associates for their exceptional work over the past several months as we continue to navigate this challenging and dynamic operating environment.

Throughout this period, our team has remained steadfast in its focus on employee and customer safety, while providing affordable, convenient and close to home access to everyday essentials. I could not be more proud of our team's efforts to serve our customers, our communities and each other. .

For over 80 years, Dollar General has served our customers through a unique combination of value and convenience. But it has never been more evident just how essential our role is as our customers depend on us now more than ever for their everyday household needs.

We remain committed to being part of the solution during these difficult times and believe we are uniquely positioned to continue supporting our customers through our expansive network of nearly [ 17,000 ] within 5 miles or more than 75% of the U.S.

population, our convenient small box format, providing for a quick in and out access, our broad assortment of everyday household essentials -- essential items, our ongoing commitment to everyday low price, our flexible supply chain, our growing digital capabilities and most importantly, our talented and committed associates. .

Let me now highlight some of the actions we've taken to further protect our employees and customers while keeping our operations running with minimal disruption.

As we discussed on last quarter's call, with the onset of COVID-19, we quickly and proactively implemented numerous safety protocols across the company based on recommendations by federal state and local government agencies.

We continue to monitor CDC and other government guidelines regarding COVID-19 and are adapting our protocols and policies as that guideline evolves. .

As announced in today's release, we invested approximately $13 million in employee appreciation bonuses during the quarter, bringing our total incremental investment and appreciation bonuses to about $73 million through the end of Q2.

Additionally, we expect to invest up to $50 million in additional financial incentives in the second half of the year. Overall, these actions have helped to further ensure the continuity of our business at a time when our customers need us most, while recognizing our employees for their extraordinary efforts. .

While navigating the challenging times of COVID-19, our country has simultaneously entered a period of deep reflection on its societal values, including racial equality and other matters of social justice. Our mission at Dollar General is serving others and our core values include respecting the dignity and differences of others.

We are committed to ensuring these values are evident in all we do, including working to promote racial equality and social justice across our communities. .

To further advance these efforts, we recently expanded our diversity and inclusion team and announced the combined $5 million pledge with the Dollar General Literacy Foundation to support racial and social justice and education.

Additionally, during the quarter, we published our most recent Serving Others report, which highlights many of our efforts on the ESG front. We first published this report in 2019 and expect that it will evolve and expand as we move into the future. .

Beyond these efforts, we remain focused on advancing our operating priorities and strategic initiatives as we continue to meet the evolving needs of our customers and better position Dollar General for continued long-term growth.

To that end, and from a position of strength, we are pleased to announce the acceleration of several value-creating initiatives, including DG Pickup, DG Fresh and our nonconsumable initiatives. We are also increasing our expectation for remodels and relocations in 2020. We will discuss each of these updates in more detail later in the call. .

Turning now to our second quarter performance. The quarter was once again highlighted by extraordinary growth on both the top and bottom lines as some of the consumer trends we experienced in Q1 related to the pandemic continued in Q2.

More specifically, and as we discussed on our Q1 earnings call, we experienced significant growth in our nonconsumable business in the month of April and through May 26.

These trends continued through the end of Q2, and we're pleased to note that for the second quarter, our 3 nonconsumable product categories in total delivered a combined comp sales percentage increase well in excess of our consumable businesses..

In terms of our monthly comp cadence, sales increased 21.5% in May, 17.9% in June and 17.2% in July. While we do not typically disclose monthly comp sales, we believe it's helpful in this environment. Overall, second quarter net sales increased 24.4% to $8.7 billion, driven by comp sales growth of 18.8%.

These results include significant growth in average basket size, particularly -- partially, excuse me, offset by a decline in customer traffic, as we believe customers consolidated trips in an effort to limit social contact. .

During the quarter, our highly consumable market share trends, as measured by syndicated data, continued to exhibit strength, including strong double-digit increases in both units and dollars over the 4, 12, 24 and 52-week periods ending July 25, 2020.

Importantly, our data suggests another meaningful increase in new customers this quarter compared to Q2 2019, underscoring the broadening appeal of our value and convenience proposition.

We are very focused on retaining these new customers and the incremental spend of current customers through the acceleration of several key initiatives, which I noted earlier.

We're particularly pleased that we once again delivered significant operating margin expansion, which contributed to second quarter diluted EPS of $3.12, an increase of 89% over the prior year.

Collectively, we view these results as further validation that we are pursuing the right strategies to enable balance and sustainable growth while creating meaningful long-term shareholder value. .

We continue to operate in one of the most attractive sectors in retail. And with the plans and initiatives we have in place, we believe we are well positioned to serve an even broader set of consumers, even in a challenging economic environment. .

With that, I'll now turn the call over to John. .

Thank you, Todd, and good morning, everyone. Now that Todd has taken you through a few highlights of the quarter, let me take you through some of its important financial details. Unless I specifically note otherwise, all comparisons are year-over-year and all references to EPS refer to diluted earnings per share.

In addition, please note that Q2 2019 adjusted results exclude a $31 million pretax impact related to significant legal expenses recorded in the quarter, as discussed in today's earnings release. .

As Todd already discussed sales, I will start with gross profit, which was positively impacted in the quarter by a significant increase in sales, including the impact of COVID-19. Gross profit as a percentage of sales was 32.5% in the second quarter, an increase of 167 basis points.

This increase was primarily attributable to higher initial markups on inventory purchases, a greater proportion of sales coming from nonconsumable categories and a reduction in markdowns as a percentage of sales.

These factors were partially offset by increased distribution and transportation costs, which were driven by increased volume and our decision to incur employee appreciation bonus expense. .

SG&A as a percentage of sales was 20.4%, a decrease of 205 basis points or 161 basis points compared to Q2 2019 adjusted SG&A. Although we incurred incremental costs related to COVID-19, these costs were more than offset by the significant increase in sales.

Expenses that were lower as a percentage of sales in the quarter include retail labor, occupancy costs, utilities, employee benefits, depreciation and amortization and taxes and licenses. These items were partially offset by increased incentive compensation and charitable giving expenses.

As I mentioned, we also recorded expenses of $31 million in Q2 2019, reflecting estimate the settlement of certain legal matters. .

Moving down the income statement. Operating profit for the second quarter was $1 billion, an increase of 80.5% or 71.3% compared to Q2 2019 adjusted operating profit. As a percentage of sales, operating profit was 12%, an increase of 373 basis points or 329 basis points compared to Q2 2019 adjusted operating profit.

Operating profit in the second quarter was positively impacted by COVID-19, primarily through higher sales.

The benefit from higher sales was partially offset by approximately $38 million of incremental investments that we made in response to the pandemic, including additional measures taken to further protect our employees and customers and approximately $13 million in appreciation bonuses for eligible frontline employees.

Our effective tax rate for the quarter was 21.5% and compares to 22.9% in the second quarter last year. Finally, as Todd noted earlier, EPS for the second quarter was $3.12, which represents an increase of 89% or 79% compared to Q2 2019 adjusted EPS. .

Turning now to our balance sheet and cash flow, which remains strong and provide us the financial flexibility to further support our customers' employees during these challenging times while continuing to invest for the long term.

Merchandise inventories were $4.4 billion at the end of the second quarter, essentially flat overall and down 6% on a per-store basis. Year-to-date through Q2, we generated significant cash flow from operations totaling $2.9 billion, an increase of $1.8 billion or 157%.

This increase was primarily driven by strong operating performance combined with lower levels of inventory as our supply chain teams continue to work closely with our vendor partners to improve in-stock levels for high demand products.

Total capital expenditures through the first half were $424 million and included our planned investments in new stores, remodels and relocations and spending related to our strategic initiatives. .

Moving on to liquidity and capital structure. We continue to have ample liquidity as a result of the measures we took earlier in the year to further bolster our liquidity position, coupled with our extremely strong cash flow in the quarter.

As a result, we finished the quarter with $3 billion of cash and cash equivalents and $1.1 billion of availability under our undrawn revolving credit facility. As one of the measures to preserve liquidity at the onset of COVID-19, we temporarily suspended share repurchases during Q1.

We continue to evaluate business conditions and our liquidity, and as a result of this evaluation, we resumed share repurchases in the second quarter. During the quarter, we repurchased 3.2 million shares of our common stock for $602 million and paid a quarterly dividend of $0.36 per common share outstanding at a total cost of $90 million.

With today's announcement of an incremental share repurchase authorization, we have remaining authorization of approximately $2.5 billion under the repurchase program. .

Our capital allocation priorities continue to serve us well and remain unchanged. Our first priority is investing in high-return growth opportunities, including new store expansion and our strategic initiatives.

We also remain committed to returning significant cash to shareholders through anticipated share repurchases and quarterly dividend payments, all while maintaining our current investment-grade credit rating and managing to a leverage ratio of approximately 3x adjusted debt to EBITDAR. .

Moving to an update on our financial outlook for fiscal 2020. We continue to operate in a time of significant uncertainty regarding the severity and duration of the COVID-19 pandemic, including its impact on the economy, consumer behavior and our business. As a result, we are not providing guidance for fiscal 2020 sales or EPS at this time.

With regards to share repurchases, we now expect to repurchase approximately $2.5 billion of our common stock this year, reflecting our strong liquidity position and confidence about the long-term growth opportunity for our business. .

As Todd noted earlier, we are increasing our expectations for remodels and relocations in 2020. Overall, we now expect to open 1,000 new stores, remodel 1,670 stores and relocate 110 stores, representing 2,780 real estate projects in total.

Finally, we are increasing our expectations for capital spending in 2020 to a range of $1 billion to $1.1 billion as we accelerate key initiatives and continue to invest in our core business to support and drive future growth. .

Let me now provide some additional context as it relates to our full year outlook. Given the unusual situation, I will elaborate on our comp sales trends thus far in August. Since the end of Q2 and through August 25, we have continued to experience elevated same-store sales, which have increased by approximately 15% during this time frame.

That said, we remain cautious in our sales outlook and recognize the significant uncertainty that still exists concerning the duration of the positive operating environment. In particular, we can't speculate as to whether there will be additional government stimulus, or if so, to what degree our business would benefit.

Ultimately, we expect to see our comp sales trends moderate as we move through the back half, but believe we are very well positioned to deliver positive sales growth for the balance of the year, even if broader economic conditions deteriorate. .

With regards to our strategic initiatives, we continue to anticipate they will improve operating margin over time, particularly as benefits to gross margin continue to scale and outpace the associated expense with both NCI and DG Fresh expected to be accretive to operating margin in 2020.

However, our investment in these initiatives will pressure SG&A rates in the back half, particularly as we further accelerate their rollouts.

Finally, we expect to make additional investments in the second half as a result of COVID-19, including up to $50 million in employee appreciation bonuses, which Todd mentioned, as well as investments in additional safety measures. .

In closing, we are very proud of the team's execution and service, which resulted in another quarter of exceptional results. As always, we continue to be disciplined in how we manage expenses and capital with the goal of delivering consistent, strong financial performance while strategically investing for the long term.

We remain confident in our business model and our ongoing financial priorities to drive profitable same-store sales growth, healthy new store returns, strong free cash flow and long-term shareholder value. .

With that, I will turn the call over to Jeff. .

Thank you, John. Let me take the next few minutes to update you on our 4 operating priorities..

Our first operating priority is driving profitable sales growth. The team did an outstanding job this quarter, executing against a portfolio of growth initiatives, while keeping the customer at the center of all we do.

Let me highlight a few of our recent efforts, starting with our cooler door expansion program, which continues to be our most impactful merchandising initiative..

During the first half, we added more than 30,000 cooler doors across our store base. In total, we now expect to install more than 60,000 cooler doors this year compared to our previous target of 55,000 cooler doors in 2020.

Notably, the majority of these doors will be in high capacity coolers, creating additional opportunities to drive higher on-shelf availability and deliver an even wider product selection..

Turning now to private brands, which remains a priority as we pursue opportunities to further enhance our value proposition. During the quarter, we made great progress with our rebranding and repositioning efforts, including the recent relaunch of our office products brand.

Looking ahead, our plans include the continued expansion of existing brands as well as the rebranding of several additional product lines as we seek to drive greater category awareness and even higher customer adoption..

Moving to our Better For You offering, which is especially important for our customers as more food continues to be consumed at home. This offering is now available in approximately 6,400 stores, with plans to expand more than 7,000 stores by year-end..

Finally, a quick update on our FedEx relationship. This convenient package pickup and drop-off service is now available in over 8,000 locations. We now expect to complete our initial rollout to more than 8,500 stores by the end of Q3, further advancing our long track record of serving rural communities..

Beyond these sales-driving initiatives, enhancing gross margin remains a key focus area for us. In addition to the gross margin benefits associated with our NCI, DG Fresh and private brand efforts, foreign sourcing remains an important gross margin opportunity for us.

During the quarter, the team once again did a phenomenal job working with our global supply partners to ensure product availability. Looking ahead, we continue to see opportunities to increase our foreign sourcing penetration while further diversifying our countries of origin..

We also continue to pursue supply chain efficiencies through the further reduction of stem miles and accelerated expansion of our private fleet. To this end, we recently announced the purchase of our 18th traditional distribution center in Walton, Kentucky.

We anticipate this facility will begin shipping early next year, enabling us to drive additional efficiencies as we move ahead..

Finally, shrink remains an opportunity as we continue to build on our success with the electronic article surveillance. Over the past year, we've increased the number of items tagged by more than 40%, and we continue to focus on leveraging technology to drive even higher levels of in-store execution..

Our second priority is capturing growth opportunities. Our proven high return, low-risk real estate model continues to be a core strength of our business. During the first half, we opened 500 new stores; remodeled 973 stores, including 704 in the higher cooler count DGTP or DGP formats; and relocated 43 stores.

We also added produce in more than 120 stores, bringing the total number of stores which carry produce to more than 870. As John noted, we now expect 2,780 real estate projects in total this year as we continue to deploy capital in these high-return investments while delivering an expanded assortment offering to an additional 200 communities in 2020.

Overall, our real estate pipeline remains robust, and I am very proud of the team's ability to execute such high volumes of real estate product -- projects despite the added complexities as a result of COVID-19..

Our third operating priority is to leverage and reinforce our position as a low-cost operator. We have a clear and defined process to control spending, which governs our disciplined approach to spending decisions.

This zero-based budgeting approach, internally branded as save to serve, keeps the customer at the center of all we do, while reinforcing our cost control mindset. Our operational initiatives consist of building on our success with Fast Track, which Todd will discuss in more detail.

As a result of our efforts to date, our store associates are able to better serve our customers during this period of heightened demand, as evidenced by recent customer survey results, which we are seeing overall satisfaction at all-time highs.

Beyond enhancing our ability to serve, this process has also generated significant savings across the business. Our underlying principles are to keep the business simple, but move quickly to capture growth opportunities, while controlling expenses and always seeking to be a low-cost operator..

Our fourth operating priority is to invest in our people as we believe they are a competitive advantage.

In total, for fiscal 2020, we now expect to invest up to $123 million in appreciation bonuses for eligible frontline employees to provide them with further support and demonstrate our continued appreciation for their exceptional efforts during these difficult times.

As a reminder, these bonuses follow our 2017 investment of nearly $70 million in store manager compensation and training as well as prior and continued investments in employee training, benefits and wages.

Importantly, these investments continue to yield positive results across our store base, including continued record low store manager turnover, strong applicant flows and a robust internal promotion pipeline as well as record staffing levels over the first half of the year..

We believe the opportunity to start and develop a career with a growing and purpose-driven company is a unique competitive advantage and remains our greatest currency in attracting and retaining talent.

We also held our annual leadership meeting earlier this month, and I was amazed by the team's ability to seamlessly transition to a virtual event, resulting in continued development for more than 1,500 leaders of our company. This meeting was once again a testament to how our people truly embrace the Serving Others culture..

In summary, we are executing well from a position of strength, and our operating priorities continue to provide a strong foundation from which we can continue to provide continued growth in years ahead..

And with that, I'll turn the call back over to Todd. .

Thank you, Jeff. I'm very proud of the progress the team has made in advancing our key strategic initiatives, which we believe better positions us for long-term sustainable growth. Let me take you through some of the most recent highlights..

Starting with our nonconsumable initiative or NCI, as a reminder, NCI consists of a new and expanded product offering in key nonconsumable categories.

The NCI offering was available in approximately 4,300 stores at the end of Q2 and we continue to be very pleased with the strong sales and margin performance we are seeing across our NCI product categories.

In fact, this performance is contributing to an incremental 8% comp sales increase in total nonconsumable sales compared to stores without the NCI offering as well as a meaningful improvement in gross margin rate in these stores..

We also continue to realize meaningful benefits from incorporating select NCI products and planograms throughout the broader store base, resulting in positive sales and margin contributions across the chain.

As a result of our strong performance and learnings to date, our plans now include accelerating the rollout of our NCI offering to more than 5,400 stores by the end of 2020, by incorporating a light version of this initiative into approximately 400 stores.

The light version provides for a more streamlined approach as the full NCI assortment is incorporated into space already dedicated to nonconsumable products, resulting in less disruption to the stores and the ability to more aggressively scale this initiative as we move ahead.

We believe NCI will continue to be a meaningful sales and margin driver as we move forward. And I'm very excited about the additional opportunities to further leverage our success and learnings with this important initiative..

Turning now to DG Fresh, which is a strategic, multiphase shift to self-distribution of frozen and refrigerated goods. As a reminder, the primary objective of DG Fresh is to reduce product cost on our frozen and refrigerated items by removing the markup paid to third party distributors, thereby enhancing gross margin.

And we continue to be very pleased with the product cost savings we are seeing. In fact, DG Fresh continues to be the largest contributor to the gross margin benefit we are seeing from higher initial markups on inventory purchases, which John noted earlier, and we expect this benefit to grow as we continue to scale this transformational initiative. .

Another important goal of DG Fresh is to increase sales in these categories. We are pleased with the success we are seeing on this front, driven by higher overall in-stock levels and the introduction of more than 55 additional new items, including both national and private brands in select stores being serviced by DG Fresh.

In total, we were self-distributing to more than 12,000 stores from 8 -- excuse me, from 8 DG Fresh facilities at the end of Q2. Given our success and strong execution to date, we now expect to capture benefits from DG Fresh in approximately 14,000 stores from at least 10 facilities by the end of this year.

This compares to our previous expectation of approximately 12,000 stores by year's end..

Turning to our digital initiative, where our strategy consists of building a digital ecosystem specifically tailored to provide our customers with an even more convenient, frictionless and personalized shopping experience, all of which have become even more important as a result of COVID-19.

Today, customers are seeking safe, familiar and convenient experiences in many aspects of their lives. And in that regard, we believe our unique store footprint, combined with our digital assets, are a distinct competitive advantage..

During the quarter, we accelerated the rollout of DG Pickup, our buy online, pick up in the store offering to more than 2,500 stores compared to about 40 stores at the end of Q1, with plans for even more aggressive expansion as we move ahead. In fact, we now expect to introduce this offering into essentially all of our stores by the end of Q3.

In addition to DG Pickup, our plans include the further expansion of DG GO! mobile checkout as we look to combine this feature with self-checkout, providing an even more convenient and contactless shopping experience..

Moving now to Fast Track, where our goals include increasing labor productivity in our stores, enhancing customer convenience and further improving on shelf availability. We continue to be pleased with the labor productivity investments we are seeing as a result of our efforts around rolltainer optimization and even more shelf-ready packaging..

The second component of Fast Track is self-checkout, which represents added flexibility for customers who may seek to limit face-to-face interactions while also driving greater efficiencies in the store for our associates. Self-checkout is currently available in approximately 400 stores compared to more than 30 stores at the end of Q1.

And our plans consist of a broader rollout later this year as we look to further enhance our convenience proposition..

Overall, we are focused on controlling what we can control, while taking action, including the acceleration of our strategic initiatives, to further differentiate and distance Dollar General from the rest of the discount retail landscape..

As a mature retailer in growth mode, we are also laying the groundwork for future initiatives as we are constantly evaluating what lies ahead for our customers and our business. We continue to believe we are pursuing the right strategies to drive long-term sustainable growth while creating value for our shareholders..

In closing, we are excited about our position midway through the year. Our extraordinary first half results are a testament to the strong execution and disciplined approach of our team.

We are very proud of our people, especially those serving on the front lines, and I want to offer my sincere thanks to each of our approximately 157,000 employees across the company for their tireless dedication of fulfilling our mission of serving others..

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

[Operator Instructions] Our first question comes from Simeon Gutman with Morgan Stanley. .

My first question is, any way you can parse through thinking about the trade-down effect and -- which is bringing more customers to your store, what you mentioned, versus the timing of stimulus? And so I don't know how you sort through both of those factors. .

Sure. Yes. We obviously talk to our customers each and every quarter. So we've got real good data from that. But also through our credit card data, we can see that we're getting a trade down at a pretty good clip. And we saw that in Q1, and that continued into Q2. And of course, as we just talked about the first period up to just here in Q3..

So as we continue to watch this evolve, what we see is very reminiscent to what we saw during the Great Recession, even though it was more of a financial recession versus where we are today. This one is starting to turn more into and look a little bit like that recession. And during that time, obviously, we saw a pretty good trade down.

And we've got a nice track record and the playbook to hopefully be able to retain those customers as we continue to move through COVID and hopefully, post COVID..

But we're really focused on servicing those customers right now that are coming in.

And I would tell you that the information we're getting back through our customer work, our proprietary custom work, really speaks to the additional stuff that we've done inside of our store over the last 18 months to 2 years, DG Fresh being the big one, our cooler expansions, and obviously, our NCI, in our nonconsumable initiatives over the last 18 months to 2 years have been very, very fruitful for this customer.

So we're very optimistic that we'll continue to see that trade down, and we're as optimistic that we'll be able to keep a great deal of them as we continue to move forward. .

And related to it, can you talk about how you saw the discretionary mix of product evolve during the quarter? And then if you can, into the third quarter?.

Sure. As we mentioned in the previous call, it started with consumables stock up at the beginning of the pandemic. Then in April, as we saw the stimulus money in play and people sheltered in place, we saw a pretty significant shift into discretionary categories like home doing phenomenally, toys seasonal.

And that continued all the way through Q2, and it's continued to remain very strong..

I think it's important to note our discretionary business was doing very well coming into this. We've had 9 straight quarters of nonconsumable growth, and I think it really is a testament to what we've done with NCI. Stimulus certainly helped as well as the changing in shopping patterns where people were sheltered in place.

But I think what we've done to make this part of the store more relevant than ever with the rotation of goods, the greater variety and aspirational products has really made it relevant and really helped us capture this additional business. .

Our next question is from Matthew Boss with JPMorgan. .

And congrats on a nice quarter.

Maybe first on the margin side, how best to think about the drivers of gross margin as we think about the third quarter or the back half of the year? As we think about IMU, nonconsumables and markdowns, which drove outsized expansion in the second quarter?.

Thanks, Matt. Good question. I'll maybe start by talking about the drivers of Q2, and that may help inform the balance of the year. We're not giving specific guidance on Q3, but I think it gives you an idea.

And I'll start by saying how pleased we are with the performance, 167 basis points of gross margin expansion in Q2 was phenomenal, and that marks our fifth consecutive quarter of year-over-year gross margin expansion..

The initiatives like DG Fresh and NCI, in particular, are really contributing. If you look at the drivers, the top 3 drivers in Q2, #1 was higher initial markups, and that was driven primarily by DG Fresh. And that's a benefit. We expect to continue to grow as we scale. The second one was mix.

We saw the benefit, of course, of stimulus and the changes to shopping behavior I mentioned, but I also believe that, as I said, NCI is playing a meaningful contributor to getting more of that nonconsumable business.

And with that higher nonconsumable mix, that was a big driver of the favorable mix as well as we saw a good mix within the mix with categories like health and beauty doing very well within our consumables. And then the third one was higher initial markups -- I'm sorry, rather, the third one was lower promotional activity.

We've been talking about it for a few quarters now. We've been more and more targeted with the tools we've put in place to get more bang for the buck with our promotional activity in this environment. It wasn't as necessary..

one, keeping up with the volume; two, the additional bonuses that we've put in place; and then three, there is some carrier rate pressure, but the team is doing a phenomenal job mitigating that with the actions they have in place..

So -- and then the last thing is we'll always watch price but we feel very good about where we're priced now. So not commenting specifically on Q3, but just in general, we feel very good about what we've done to drive this continued growth and gross margin expansion.

And over the long term, I think we're very well positioned in making the right investments to drive gross margin expansion over the long term and have a lot of levers. .

That's great. And then a follow-up on unit growth from here. So with the consolidation of brick-and-mortar retailers laterally, and then tying this to the acceleration of real estate projects that you guys cited for this year.

Maybe, Todd, what are you seeing from new store productivity or metrics out of your new stores? And how best to think about the expansion opportunity or long-term saturation, just given the market share in the white space opportunity that this current crisis seems to be opening up. .

Yes, Matt, that's a great question.

And I would tell you that we're very pleased with the continued improvements that we continue to make each and every quarter in our store, in the box, making it more relevant to a broad-based amount of consumers in many different type of settings, all the way from our rule, which is our bread and butter, all the way into vertical living with our DGX box.

And I would tell you that we still believe we got 12,000-or-so opportunities to place a Dollar General out there across the Continental United States.

And obviously, with some of the recent COVID activity and some of the displacement that we've seen, that opportunity continues to expand as far as I'm concerned, and we continue to watch that very carefully.

And we have actually done a lot of work into -- we're not ready yet to talk about '21, but we've done a lot of work into our '21 pipeline as well. So we feel good about where we are. We feel good about that ability to continue to build stores and attract and retain those customers. .

Our next question is from Karen Short with Barclays. .

Just a couple of things to elaborate on. So first of all, within the NCI, that 8%, I just want to clarify.

So those stores that were currently comping 27%, is that how I'm interpreting that statement? And then I guess what I was wondering is, could you talk a little bit about how that's trended over time? And then also how those stores are looking into August? And then I had another separate question. .

Yes. So Karen, I think that your back of the envelope is pretty close because we're seeing an outsized benefit in our NCI stores. And the great thing is not only that top line, but of course, that margin line. And the lines will get more and more blurred as we go.

And the reason being is that we're moving a lot of the great learnings from NCI into the bulk of the chain as well, which is great because then we're getting benefit in the rest of the chain at the same time that we're growing the NCI piece. And we're taking the best of the best there.

So we really like what we see and we continue to be very bullish, and that's the reason why we're expanding that extra 400 stores and doing it in that light version and that light version will give all the items that you see in NCI without all the movement inside the store for that disruption.

And we believe that, that may be the unlock as we move into next year to do more of these remodels. .

Okay. And then in terms of the buy online, pick up in store, I mean, that seems like, obviously, a pretty -- being at all stores by year-end is a massive acceleration from, what, the 40 that you're at, at 1Q. So I'm actually wondering if you could talk to what the impact is on the comps for the stores that currently have buy online.

And then maybe any color you could give in terms of what the basket looks like at those stores, with the specifically the buy online, pick up in store. .

Sure, sure. Well, first of all, we have to say we're at the very start of this journey, right? So football field, we're on our own 10-yard line so we've got a ways to go here. But again, because of the acceleration, you can imagine, we like what we've seen in the early data. But again, it's so early to draw any large or broad-based conclusions.

But I would tell you that what we've seen early on in a couple of anecdotes is that the consumer is enjoying the experience, rating the app very high..

What we're seeing, we saw a little bit in the test stores, and we're seeing it even in the expanded stores now that we're up to over a couple of thousand and soon to roll out to the chain, is that we're seeing -- when the customer comes in to pick up her order, she's actually buying additional items inside the store, which then is increasing that basket size to above where we normally would see our basket size.

So we like what we see early on, but we're just -- what we like to say, we're running water through the pipes right now to make sure everything is working, make sure the customer experience is right.

And then we'll really start to market it heavy as we move to the backside of this quarter and into Q4, but also into next year to really start to drive some awareness into it..

We -- lastly, we believe this will be a very big benefit for that trade-down customer I talked about earlier. Because that trade-down customer that we've seen is a little -- skewed a little younger, more digitally savvy with families.

And we believe that this will be right up her alley as well as she continues to learn about Dollar General and grow with Dollar General. .

Our next question is from Peter Keith with Piper Sandler. .

Great quarter.

I was wondering just if you could comment on the geography of the store base with the urban versus rural exposure, if you saw any meaningful differences between the 2?.

Yes. This is Todd again. Actually, what we experienced, which was great to see, is pretty even performance across our rural store base and more of our city setting store base. So once again, we've done a lot of work around our city and/or more urban settings, with much work being done around those type of stores, including our DGX stores.

But in saying that, we were very pleased with the overall sales and margin performance was very, very similar in both sides of that. So it was great to see. .

Okay. Helpful. And then it might be the wrong time to ask, but I do want to kind of circle back on your long-term guidance, and it's been a couple of years since you put out that 10% to 15% EPS growth range that you wanted to achieve annually.

How are you thinking about that today? Because it seems like you have a number of initiatives that are all working in conjunction. And perhaps, if anything, that range at this point, looks a bit conservative. .

Great question. I'm not going to comment specifically on 2021 or give you any specific predictions. But what I will tell you is we are extremely excited about the fundamentals of the business. We are extremely well positioned.

We continue to see ourselves as 10%-plus EPS growers over the long term as you look at the unit growth opportunity we have and the long runway there and the type of performance we're seeing from these new units. It's the best performance we've seen in years.

When you look at our sales with all the levers that we have, all the initiatives, really clicking to drive the top line and meaningfully the bottom line when you look at our strategic initiatives and the momentum on the comps. And when you look at gross margin, all the levers that we have and the initiatives going after that..

Obviously, with the cash we generate, substantial cash flow we've been producing, that allows us to reinvest in what we announced was accelerating these initiatives. So we really believe we're extremely well positioned with the initiatives.

We really believe what we've been doing to the box has made it more relevant than ever and believe that we're now providing a fuller fill in trip for customers coming in.

So as we look to make these larger baskets stick to the extent possible, as we look to keep these new customers that we've attracted coming back, we think we're very well positioned with the initiatives we've put in place and more relevant than ever and very excited about the future. .

Our next question is from Kelly Bania with BMO Capital. .

Was hoping you could maybe just help quantify. You called out a little bit of SG&A pressures as you accelerate some of your initiatives in the back half. I think that was separate from the $50 million in COVID-related costs.

So maybe you can just give us a little color, if you can, in just in terms of dollars that you're thinking in the second half there?.

We didn't divulge the exact dollar amount. What we did do is we gave new guidance around capital, and so you can kind of extrapolate. That's where a lot of that capital was going toward was these new -- accelerating the initiatives as well as accelerating real estate.

On the expense side, I would look at it more as an acceleration of money we were already going to spend as opposed to additional investments. And so you could kind of think about the proportionality of what we're doing in terms of advancing these.

So Todd mentioned the 400 additional NCI stores we're doing, we're going to be serving more fresh stores as we going to be serving 14,000 at the end of the year instead of 12,000 stores. We're going to be scaling DG Pickup across the chain in Q3 and adding 200 more projects..

So I would really look at it more in terms of just proportionately pulling those expenses forward, not additional expenses. And again, all these things we do are aimed at high-return projects where we're really focused on pulling that benefit forward.

So there is some front-end pressure of cost with the start-up and the initial costs associated with that, but the benefits far outpace that, and that's really what we're focused on, is pulling more of that benefit forward. .

Okay. That's very helpful. And then just another quick one on margins. Obviously, DG Fresh going really well. And in order of magnitude, it sounds like the gross margin benefit from that is larger than mix, which is quite incredible.

So just was curious if you could just talk about, as you look at your supply chain today, how much more opportunity is there to bring more in-house versus what you have at third parties? You gave some metrics on stores, but maybe just talk about it a little bit bigger picture. .

As we continue to always look to be a low-cost operator, we're always looking at opportunities. While we're still working DG Fresh, our goal is still by the end of next year to be essentially fully self-distributed on our perishable side of the business. But there are some other areas in nonconsumables that we'll be looking at.

But also DG Fresh unlocks even greater opportunity down the road of ensuring that our dry network is efficient as possible..

And that may look like some goods coming out of our traditional DCs and moving into Fresh, leaving more room for other goods in our main DCs. So think of things like candy and water. Some of the things that we can move into our Fresh facilities that makes a lot of sense.

And those areas will loosen up a lot of other areas inside of our DCs to make room for other type of goods. So we're looking at all that right now. But as you can imagine, we're squarely focused on ensuring we roll out Fresh at the highest level of execution we can..

And I can't be more prouder of the team, especially through a very, very dynamic first half, I think, would be the best way to put it, especially with COVID and everything going on. They have executed at a very high level to include our stores and our operators to ensure that we're servicing the customer at a very high level.

So couldn't be more happy with DG Fresh, but there's always more room for opportunity as we continue to move forward in distribution. .

Our next question is from Michael Lasser with UBS. .

Todd, when you make the analogy from the current environment to '08, '09, do you see any major differences? And the reason why I asked the question is in '08, '09, you saw a big spike of sales initially after the recession set in. And then you saw a really healthy comp growth for years even after that.

So to use that parallel, wouldn't you expect similar growth in the years ahead even after you've anniversary-ed some of the really big comp growth that you've seen recently?.

It's a great question, Michael. And I want to frame it up to make sure we all remember, and I was the merchant at that time back in '08, '09, '10. And then there, we did a lot of other work to the box, right, to start to really make it very relevant to the consumer. So at the same time we were seeing a trade in, we were also growing the amount of SKUs.

We doubled the amount of SKUs from 2009 to 2011 as an example, right, going from 5,700 to 10,000 to 11,000 SKUs, pretty much where we sit today..

But I think it's important to also note, we continue to refine that box, and that box is even more relevant today. Now we don't expect to see probably the same amount of outside sales comps for that long of a time, just because of the initiatives that we had then versus now.

But the important thing here is we've got some great initiatives that will, in my opinion, make her much more stickier today than she would have been even in '08, '09 because of DG Fresh, because of our digital initiatives, because of NCI and really showing her a real treasure hunt opportunity on the nonconsumable side of the business..

So very bullish on being able to keep that consumer, probably at a higher rate. We'll just have to see if we get as many of those consumers over the long haul. I'd say we're probably, what, who knows how far we're into COVID.

So we'll have to wait until we get to the backside of COVID before we know exactly how many customers we have received or gotten into the brand. And then we're going to do everything possible to continue to keep as many as we can. .

Hopefully, we get to the other side soon. .

I'm with you. .

Yes, right? My follow-up question is on -- speaking of these new customers, as you look at your credit card data, are you seeing more of the growth in the nonconsumable, in the discretionary area coming from those new customers? Because the core DG customer historically has really lived in a tight budget.

It doesn't have the excess funds necessarily to buy those nondiscretionary goods -- or those discretionary goods, I should say.

And is that the way we should read it? So more of the growth coming in the discretionary categories from those new customers?.

Yes. I would tell you that we were very pleased with our core customers' ability to buy nonconsumables. I would tell you that's more the driver. And now some of that was stimulus related.

But again, I believe a lot of it had to do with our ability to attract new customers as well, but also showing her something different because of our nonconsumable initiatives that we've got moving..

Now as we all know, some of the stimulus has started to wane but as you can tell by our numbers that we've posted through Q2 and into the -- just about the full force period of Q3, that we continue to see a pretty robust customer on both sides of the equation. So she's liking what she sees. She has a little bit of money in her pocket.

I think we're seeing a good trade down, which is helping. But our core customer is spending there as well. And I think it really goes to, again, the amount of work we've done. But plus, she's at home a little bit more. She has a little bit more probably disposable income because she's not doing other things.

And with that, she really likes what she sees and buying a lot of our products. .

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

So obviously, overall sales trends were strong through the quarter, remains strong right now, but really being driven by ticket rather than transactions.

So how should we think about the concept of gaining market share and the new customers that you've referenced versus lower overall transaction levels?.

Yes. Thank you for the question. Yes, our traffic was down, and I'll give you a little anecdote. It was low single digits, so not dramatically down, but down. And we like to see that up, and we strive for that, obviously, all the time.

Now in saying that the -- between our core customer having money to be able to do a fuller shop and the trade down that we've got will offset any of that. So we like what we see from the customer base we have. And she is just consolidating her trips, not as much at Dollar General as we may see in other places, but yet, she's consolidating.

And so we continue to offer her more and more so that when she's in, she can do a fuller shop and she doesn't feel compelled to have to go elsewhere. So I think that's really what you're seeing from our brand. And we'll continue to show her products that she wants and needs, but also products that may be a surprise and delight. .

Todd, should we think about the surge that you've seen in discretionary sales as really a function of that fuller shop then? Again, I think a lot of us are trying to get our arms around you always had consumables not outpace discretionary and first time in 10-plus years, you saw that kind of reverse this quarter.

So I guess I'm just trying to figure out what drove that and maybe it's the fuller shop, maybe it's something else. .

No. When you look at it, and I don't want anybody to take the opinion that our consumable business wasn't very healthy, it was very healthy. It was just outpaced by our nonconsumable or discretionary side of the equation..

I would tell you, I believe fully that it's a couple of things. One, we are seeing that trade down, and she likes what she sees. And we're seeing repeat in the trade down. We can see it in the credit card data. So not only is she shopping at Schwan's, she has shopped us multiple times during this COVID outbreak and pandemic that we've seen.

So it tells us that she likes what she sees, and she's coming back. So she's helping drive and propel that nonconsumable business. But also our core consumer likes what she sees. And she was buying some of that product possibly elsewhere. And I think she now sees the benefit of shopping Dollar General there from all the work that we've done..

So I'm very bullish on what that looks like as we get to the backside of the pandemic because of all the work we've done. But we are continuing to ensure that working both sides of the equation, meaning the new customer as well as our existing customer. .

Our last question comes from Rupesh Parikh with Oppenheimer. .

So Todd, I guess, to start out.

So as you look at the COVID crisis, how is your team thinking about some of the permanent benefits that's coming out of this for DG?.

Well, we're taking it one day at a time, as you can imagine, just like most people. We're hoping that the pandemic winds down sooner than later. But in saying that, we have seen that new customer. So we believe that's paramount is to keep her and continue to work that. But also, we're seeing real opportunity on a few other fronts.

One is to enable us to accelerate our strategic initiatives, which you heard from both myself and John on as well as Jeff..

And we're very excited about that because, first of all, these initiatives were working well prior to COVID. Now they're working very well, and we know that the consumer is looking both for the goods that we are offering through these initiatives.

But also because of being on the forefront of this, not that we knew COVID was coming, but knew that the customer is always looking for more of a convenient and frictionless shopping experience.

And we were well out in front of this, right, 18 -- 12 to 18 months ago to create what we've created around our digital efforts and our NCI products and many other things..

So we see real opportunities there. Karen talked to -- asked about real estate. We see opportunities there, that there'll be some real estate opportunities opened up, we believe, because of this that we'll take advantage of as well. So there's a lot of areas where we know we can take advantage of.

But where we're squarely focused on right now is servicing those customers that are coming in because she still really needs us because of this raging pandemic that we hope, again, winds down soon. .

Great. And one follow-up question, just on the supply chain. So one of your competitors called out some challenges with out of stocks during their quarter. So just curious where you guys are from a supply chain, especially in categories like home, where you just had really stellar growth during the quarter. .

Rupesh, thank you. This is Jeff. First of all, we've said this before, but our teams are out in front of this very early. So I think it's a testament to the collaboration of our merchant team, supply chain and the operators and also the great relationships we have with our vendor partners. So we're seeing steady progress.

And we still have, obviously, work to do, but what I can tell you is that the team has been very creative in finding solutions to get product on the shelf for the customer..

You've heard us say before, we've stood up new SKUs during this, items we never carried before. We've looked at different pack sizes. And so real pleased with the progress of the team. And as we look forward, and we're still suffering from some constraints. But as we look forward, we see that the supply chain that we have is incredibly nimble.

And many of the initiatives we have in place have allowed us to get products in and out of the supply chain and distribution center fast. So we'll be ready for that customer when that -- when the inventory is ready for us to distribute to them. So we're pleased with the progress. .

This concludes Dollar General Corporation's conference call. You may disconnect your lines at this time, and we thank you for your participation..