Dollar General Corporation (DG) Q2 2011 Earnings Report, Transcript and Summary

Ladies and gentlemen, this is the Dollar General Corporation Second Quarter 2011 Conference Call on Tuesday, August 30, 2011 at 9 o’clock AM Central Time. Good morning and thank you for participating in today’s call which is being recorded by Conference America. No other recordings or rebroadcast of this session are allowed without the company’s permission. It is now my pleasure to turn the call over to Ms. Mary Winn Gordon, Dollar General’s Vice President of Investor Relations and Public Relations. Ms. Gordon, you may begin. Mary Winn Gordon – Vice President of Investor Relations and Public Relations: Thank you and good morning everyone. On the call today are Rick Dreiling, our Chairman and Chief Executive Officer and David Tehle, our Chief Financial Officer. We will first go through our prepared remarks and then we’ll open the call up for questions. Before Rick begins, I will provide some cautionary comments regarding our forward-looking statements and non-GAAP disclosures. Today’s comments will include forward-looking statements such as those about our expectations, plans, strategies, objectives, and anticipated financial and operating results, including, but not limited to our comments regarding our forecasted 2011 financial performance, planned merchandizing, operating and best control initiatives, store growth and capital expenditures, as well as our expectations with regards to starting consumer and economic trends. You can identify forward-looking statements because they do not relate solely to historical matters or they contain words such as believe, anticipate, project, plan, expect, forecast, guidance, experience will likely result, or will continue and similar statement. Because they have subject to significant risks and uncertainties, we cannot assure you that forward-looking statements will prove to be correct or that any trends will continue. Important factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in our second quarter earnings release issued this morning, our 2010 10-K filed on March 22, 2011, and in the comments that will be made on this call. You should not unduly rely on these statements, which speak only as of today’s date. Dollar General disclaims any obligation to update or revise any information discussed in this call. In addition, we will reference certain financial measures not derived in accordance with GAAP. Reconciliations to the most comparable GAAP measures are included in this morning’s earnings press release, which can be found on our website at dollargeneral.com under Investor Information press releases. You should not consider any of this information as a substitute for the most comparable GAAP measure, because not all companies use identical calculations. These presentations may not be comparable to other similarly titled measures of other companies. It’s now my pleasure to turn the call over to Rick. Rick Dreiling – Chairman and Chief Executive Officer: Thank Mary Winn and good morning and thank you all for joining us today. We had yet another great quarter. I am very pleased with our financial results as well as the operational progress the Dollar General team delivered. Sales exceeded our expectations as we expanded our overall share of the consumables market. Our most recent Nielsen data shows that we have continued to increase our market share in units and dollars on a four-week, 12-week, 24-week, and 52-week basis. Our comp store sales accelerated from the first quarter and we continued to successfully expand our store base. However, the macroeconomic environment has remained difficult for consumers who continue to face high unemployment rates, high gasoline, and high food cost. Our results gives us confidence that we are continuing to meet our customer’s expectations even though we have had to pass-through some of our unavoidable cost increases. I am very pleased that we have been able to grow market share profitably while balancing the challenges of pricing and rising input cost. Key financial highlights of the second quarter include total sales growth of 11.2% over last year’s second quarter to $3.6 billion including a same-store sales increase of 5.9%. As you would expect in this environment, sales growth was primarily driven by consumables with our strongest results in food, snacks, and perishables. Pet supplies and health and beauty care performed very well also. On an annual basis, our sales reached $205 per square foot, that’s up from $199 a year ago. Our gross margin rate declined 11 basis points from last year to 32.1% in the second quarter. SG&A as a percentage of sales was down 54 basis points and our operating profit increased by 16% to 9.8% of sales, a 43 basis point improvement over last year and a new second quarter record. Our strong cash flow has enabled us to repurchase all of our senior notes significantly decreasing our interest expense with an even more dramatic effect going forward. Adjusted for the impact of the debt repurchase, second quarter net income grew by 25% over the prior year to $181 million or $0.52 per share. Overall, sales in our consumable categories were very strong and a direct result of our ongoing category management efforts, which include a significant focus on increasing our offerings of private brands. Our private brands continue perform well as they help us answer our customer’s demands for low prices on quality products while also boosting our gross margin rate. Our basic non-consumable categories, home, apparel, and seasonal, remain extremely important to our general store business model and are contributing significantly to our profit growth even as customers continue to limit their discretionary spending. We have updated our non-consumables offerings and adjusted to our customer’s needs and demands. We are seeing some encouraging result in several areas including children’s apparel, car care, men’s work wear, DVDs, toys, party supplies, and stationery. Now, I’ll ask David to walk you through the rest of the financial results and then we’ll talk about our expectations for the second half of the year. David Tehle – Chief Financial Officer: Thank you Rick and good morning everyone. We are very pleased with our second quarter sales growth, our gross margin results, strong SG&A leverage, interest reduction, and net income growth. Across the board, it was a great quarter for Dollar General. Consumables sales were very strong in the quarter. All of our food and snack category has increased significantly including a strong increase in perishables. Pet care increased nicely as we continue to become a destination for pet care supplies and health and beauty benefited year-over-year from the launch of the Rexall brand and the completion of the Phases III and IV of our 78-inch profile initiative which impacted cosmetics, skin care, dental, medicine, and first aid. Our gross profit rate was 32.1% for the quarter, down 11 basis points from last year’s second quarter. Our mix of sales in the quarter continued to trend toward – more toward consumables, which generally have a lower gross profit rate than non-consumables. We also recorded a LIFO charge of approximately $11 million, primarily driven by cost increases in food, cotton apparel, plastics, and motor oil. This adjustment is based on the year-to-date pro rata portion of the $30 million full year estimate of LIFO. Due to additional cost increases, our LIFO estimate increased over the estimate made in the first quarter. In addition, transportation costs were up due to higher fuel cost. As a percentage of sales, lower markdowns, shrink reduction, and distribution leverage come to offset the effect of rising costs. SG&A as a percentage of sales improved by 54 basis points to 22.3% primarily due to our strong sales performance and the leverage on store labor enabled by our new workforce management program and engineered labor standards. Other factors contributing to SG&A leverage in the quarter include decreases in incentive compensation and net advertising costs in addition to other cost reduction and productivity initiatives. These improvements were partially offset by higher depreciation expense primarily related to our increased investment in store fixers and equipment as well as the purchase of stores. Operating profit was $350 million, up 16% from the prior year resulting in an operating margin rate of 9.8%, a 43 basis point improvement last year. For the quarter, interest expense was down $9 million from the prior year resulting from lower average borrowings and the impact of reduced amounts on our interest rate swaps. In July, we repurchased the remaining $839 million of our senior notes, which allow us to further reduce the interest expense going forward. The repurchase resulted in a pre-tax loss of $58 million or about $0.10 per share. Net income for the quarter excluding the impact of the debt repurchase was $181 million or $0.52 per share, an increase of 25% over adjusted net income of $145 million or $0.42 per share in the 2010 quarter. For the 26 weeks, year-to-date period net sales were $7 billion, an 11.1% increase over last year. Same-store sales increased 5.6%. Year-to-date increases have been driven our strong consumables performance and reflecting increase in both traffic and average ticket. The year-to-date gross profit rate was 31.8% in 2011 compared to 32.2% in 2010, a decrease of 36 basis points attributable to the higher mix of consumables, increased product and fuel costs, and higher markdowns taken in the first quarter. The charge for LIFO year-to-date was $14.2 million compared to $700,000 last year. Distribution efficiencies and lower inventory shrinkage partially offset the year-to-date gross margin decrease. SG&A expense decreased by 57 basis points on a year-to-date basis or 53 basis points excluding certain non-comparable items as described in our press release. The majority of the year-over-year improvement was due to increased sales and a significant impact from our new workforce management program and engineered labor standard. Lower incentive compensation and net advertising costs along with other cost savings and productivity initiatives contributed to the SG&A rate reduction which was partially offset by increased appreciation expense. Adjusted operating profit was 9.7% of sales in the 2011 period compared to 9.6% of sales in the 2010 period. Year-to-date interest expense decreased $15 million from last year to $126 million in the 2011 period and the pre-tax loss and debt repurchases totaled $60 million in the 2011 period compared to a pre-tax loss of $60 million in the 2010 period. Our effective income tax was 37.5% in both 2011 and the 2011 26-week period. And finally, adjusted net income increased 20% to $348 million or $1 per diluted share. Our strong operating performance resulted in strong cash flow from operating activities of $398 million year-to-date, which we utilized to further invest in the business and to pay down debt. As of July 29, total inventories at cost were $1.97 billion, up 7% on a per store basis from the prior year. The increase is primarily due to the addition of new items as part of our 78-inch profile expansion and additional purchases within our product assortment, which we expect to help us avoid further cost increases later in the year. Total outstanding debt at the end of the quarter was $2.8 billion, down $572 million from a year ago. Net of cash, our ratio of long-term obligations to adjusted EBITDA was 1.6 times at the end of the second quarter compared to 2.2 times a year ago. Since the company went private in 2007, we’ve paid down $1.8 billion in debt. Given our success to-date, we are updating our full year guidance to reflect our first half performance and our cautious optimism for the remainder of the year. We are over halfway through the year and we have better insights on the second half. We are increasing the low end of our previous earnings per share guidance by $0.02. We currently expect adjusted diluted earnings per share for the 53-week fiscal year to be in the range of $2.22 to $2.30 assuming $346 million weighted average diluted shares and a full year effective tax rate of approximately 38%. The 53rd week is expected to contribute approximately $0.06 per diluted share. We now expect total sales to increase 12% to 14% including sales in the 53rd week, which are expected to be approximately 200 basis points of the total increase. Same-store sales based on the comparable 52-week period are expected to increase 4% to 6%. This is an increase from our previous expectation of total sales increase of 11% to 13% and a same-store sales increase of 3% to 5%. Adjusted operating profit for the 2011 53-week period is expected to increase 14% to 16% over the 2010 52-week adjusted operating profit. Gross margin will likely be impacted in the third and fourth quarter by several factors. We expect the pressure on discretionary spending to continue to challenge us in the second half of the year resulting in an acceleration of our mix of sales into consumables. Full year guidance includes an estimated charge for LIFO of $30 million for the year. The increased magnitude of commodity cost pressures now included in our updated full year guidance was not contemplated in our previous guidance. For the third quarter, we currently expect markdowns as a percent of sales to be in line with the prior year, but keep in mind, third quarter markdowns are typically higher than the second quarter due to the seasonality of our sales. With regard to pricing, we plan to remain very strategic in our efforts to balance gross margin while protecting unit sales. We planned to open approximately 625 new stores and remodel or relocate 575 stores in 2011 including up to $25 general markup stores. Capital expenditures are expected to be in the range of $550 million to $600 million with approximately 55% of capital spending for store growth and development, 25% for special projects including approximately $90 million for our new distribution center in Bessemer, Alabama; and the remaining 20% for maintenance capital. With that, I will turn the call back over to Rick. Rick Dreiling – Chairman and Chief Executive Officer: Thanks David. We have an exciting second half of the year plan to build upon our momentum in the business. We are pleased with the start to the third quarter including a solid back-to-school performance. There is no doubt that the prolonged economic pressure on consumers such as high employment, higher fuel cost, and uncertainty about the future has created more of our core customers. Those who depend on the value we offer. In addition to creating new core customers, we also believe the economy is encouraging more trial in our stores from other consumer segments. Some of our new customers are trade-down, those with higher incomes and our core customers and who are now coming into our stores for everyday low prices on consumables and brands they recognize. We believe we are seeing another category of new customers who are trading in and who are choosing to come to our stores because they like not only our pricing, but also the shopping experience and the product offerings they are finding in Dollar General. We believe these trade-ins reflect a new consumerism, which values frugality and smart shopping. We are committed to earning all of our customer’s trust, so that they continue to count on us long after the economy improves. One of the key areas we have been focusing on improving is our store in stock levels and I am pleased to tell you that for the second quarter in a row that we have seen positive results from our efforts. More importantly, our customers are noticing our progress. Customer satisfaction scores on this metric have improved in every division year-over-year. As I mentioned earlier, private brands continue to be a significant opportunity for us. Sales of private brands have increased over 15% year-to-date outpacing our overall sales growth. We are very pleased with the performance of our expanded health and beauty offering which includes strong growth in the Rexall brand. We now have over 1400 private brand SKUs including nearly 300 Rexall SKUs and we believe we still have significant opportunity to grow. We opened 301 new stores in the second quarter and continued to expect to grow square footage by about 7% for the year. We are pleased with the performance of our new stores, remodels, and relocations as we move forward with the transition to our customer-centric format. Over 2100 stores now have our new look and layout. We are on track to expand into Nevada, Connecticut, and New Hampshire in the second half of the year and opened our first cluster of stores in California in the first half of 2012. As we have mentioned before, we are also ramping up our efforts on our Dollar General market concept. Our market stores offer customers a selection of fresh produce, meat, and other refrigerated and frozen foods alongside the typical Dollar General offerings. These stores are creating a shopping experience that customers are responding to and they are now delivering the highest same-store sales increases in the company this year. Today, we have remodeled 16 of our existing 57 Dollar General market stores. In the remodels, we are reinforcing the message of freshness with our updated interior and exterior color scheme, signage, and new power alley. We are also seeing an increase in traffic, transactions, and basket size in the remodels and as a result, we plan to remodel an additional 12 market stores in the second half of the year. In addition to the remodels, we now plan to open about 10 new market stores this year including several as part of our initial entrance into Nevada in October. This morning, we announced our planned launch on September 8 of an e-commerce site dollargeneral.com. We are excited about this new opportunity for growth, which will initially offer over 1000 of our current SKUs to customers who like many of you may not have a convenient Dollar General. We plan to sell single items as you would find in our stores as well as larger quantities that we stock in our stores. And from time-to-time, we’ll also feature limited quantities of special buys. So, to wrap it up, we are very pleased with our second quarter and we believe that we are well-positioned for the second half of the year. At Dollar General, we remained focused on controlling what we can control and delivering strong financial results for our shareholders. We will continue to closely monitor how our customers reacting to the current economic challenges in the retail environment, where we believe the value message is key. We know that with the sustained period of unemployment and underemployment, our customers need us more than ever. Before I close, I’d like to give my sincere thanks to the nearly $90,000 general employees who are key delivering a great quarter. So, with that Mary Winn, I will turn it over for questions. Mary Winn Gordon – Vice President of Investor Relations and Public Relations: (Jay Lee) we’ll go ahead and take the first question please.

At this time, we’ll open the floor for questions. (Operator Instructions) Our first question comes from Deborah Weinswig with Citi. Deborah Weinswig – Citi: Hi, Dave. How are you?

Good morning Deb. Deborah Weinswig – Citi: So, in terms of the gross margin performance, I would have to argue the competitive environment has gotten more difficult since last quarter, but your performance has definitely gotten better. If you think about the non-consumables effort, can you – I think you highlighted children’s and men’s work wear. Can you talk about what are strengths you have there? And then can you talk about the impact as you shift into the consumables in the quarter?

Yeah, I will take the non-consumable and let David talk you a little bit about the mix. First thing I’d like to say Deb is I think about this you got to remember a lot of our customers, the recession has not ended. There is still dealing with a lot of pressure. As we said, I believe in the fourth quarter, we’ve gone in and look really hard at the non-consumables side of the business and we have shifted our focus. And one of the first things, one of the first moves we made was shifting to infants and toddlers. That apparel mix being 50% now versus where it was, and quite honestly, the customers responding to that. And if you think about it, when you can come in and buy a creeper for $6 or $8 and know that your trial is going to go out of that, you can come back and get it yet again. It really is resonating well with the customer. Men’s basic work wear, we talk about the fact that we were going to emphasize work shirts, jeans, and work boots, T-shirts with a pocket on them. And again, that’s starting to resonate. I’d also like to say that we have done an overhaul of party and that party is doing exceptionally well and it’s all branded Dollar General. So, while we are making strides, we want to – I want to continue to reinforce it’s still a discretionary purchase that people are being very cautious about. And that’s why David has spent a lot of time reflecting what he is going to see on the mix, the balance of the year.

Yeah. We see continued pressure on gross margin in the back half of the year due to mix. And our current view is that the consumable mix will continue to grow versus the prior year the back half of 2011. And obviously that represents a bit of a headwind to margin since consumables are generally lower margin than non-consumables. And that’s our call on the economy right now. But I want to stress all this is included in our guidance and in spite of the margin pressure, our net outlook on earnings per share for the year is actually improved from our previous guidance of $2.20 to $2.30 as we mentioned we raised that this morning to $2.22 to $2.30 raising the bottom end of our guidance. And that’s due to our improved outlook on sales. We raised our comp sales guidance from $3 to $5 to $4 to $6 currently. So, again, we are seeing a little better sales. And this increase is due to our superior category management and strong execution at our stores.

Does that helped, Deb? Deborah Weinswig – Citi: Great. And then just lastly, can you update us on the new Dollar planogram? How far has it rolled out and what has been the response from the consumer?

It is rolled out to the chain now. It’s in about 5700 stores and the response has been great. To be honest, Deb, we are selling more of the product than we thought we were going to sell.

All right. Operator, we will take the next question.

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

Good morning Scot. Scot Ciccarelli – RBC Capital Markets: Good morning guys. How are you?

Good, sir. Thank you. Scot Ciccarelli – RBC Capital Markets: Excellent. You guys have talked about consumer challenges and you are not alone obviously for quite a while. I guess, I am curious, are you seeing anything different than what you have been seeing or is it just kind of more of the same and not necessarily seeing the recovery you kind of hoped for?

Yeah, excellent question. And I would categorize it as more of the same. I continue to see customers who are still struggling. Our customer, the recession hasn’t ended Scot. And gasoline prices are down from where they were, but they are still $0.85 a gallon higher than last year. So, there is still lot of economic pressure and the unemployment rate. Scot Ciccarelli – RBC Capital Markets: Right, okay, got it. And then, obviously, you guys talked about some of the gross margin pressure last quarter. It sounded like you’re going to be raising prices a bit more aggressively in this quarter. How much did – whether it’s raising prices or inflation, however, you want to think about it, impact this quarter in terms of the comp store performance?

Yeah. We think inflation is approximately 1.5%. I want to reinforce to you too Scot on raising prices. There is still prices we haven’t raised. We believe this is a unit growth story. And I can honestly tell you too that there is some prices we raised. We had to back that down, because we saw unit decline. And we are intensely focused right now on unit growth. Scot Ciccarelli – RBC Capital Markets: Got it. Very helpful. All right, thanks guys.

Hey, thanks again.

(Jay Lee) we’ll take the next question please.

Our next question comes from Colin McGranahan with Bernstein.

Good morning Colin. Colin McGranahan – Bernstein: Good morning, guys. Thanks for taking the question.

You bet. Colin McGranahan – Bernstein: First question, just following up on pricing, it sounds like maybe there was a little bit of a philosophical change here over the course, let’s call it the last three to six months. Can you help us understand how much more you are seeing the ability to raise price and what’s happened to your price gaps versus the competition, specifically the traditional grocers and vis-à-vis Wal-Mart?

Yeah. There has philosophically been no change. I think if you go back call into the first quarter, I said, the pricings are going to have to work their way through the system sooner or later. But we have taken a very methodical approach. And what we are trying to do is continue to build on the sustainability of our brand and how the customer perceives us. So, what we have done is we are passing our price changes through, but at a slower rate, and maybe taking just a piece of the price change two or three times rather than trying to take it all at once. I will tell you also we continue to very comfortable with our pricing gaps with drug, very comfortable with grocery and we continue to maintain our price parity with the Big Box operators. Colin McGranahan – Bernstein: Okay, that’s very helpful. And then just second on the balance sheet, now that you’ve gotten the senior notes out. Can you give us kind of maybe a 12-month to 24-month view on what the balance sheet is going to look like? What your next moves are? Remind us any restrictions you have around cash usage?

Really, yeah. Our number one priority for cash continues to be investing in our business. And by that, I mean, opening up new stores as evidenced by the 625 stores we intend on opening this year and the 600 we opened last year focused on remodels and relocations because of the lift we get on sales from that, and then having the infrastructure to support the stores. The best example of that is the new distribution center in Alabama that we are building right now. We are also investing inside our stores the 78-inch profile obviously is an example of that and many other things that we have done to boost sales and help provide service to our customers. We did pay down the $839 million of senior notes in July as we had mentioned that we would. The next area of debt that we’ll focus on that we’ll look at is the $450 million of subordinated notes that are at 11% and 7% to 8%. That’s obviously our cost debt out there on the balance sheet. Next July of 2012, we can buy those back at $105 million, very similar to the price we had on the $839 million of senior notes. So, we will take under consideration buying back those notes at that point in time. After that, right now, I don’t see a lot more change in the debt structure. We will shift our focus to our opportunity to return cash to shareholders. And in general, that will be either a share buyback or dividend depending upon what our Board sees fit and when they decide that the right time is to take that under consideration. So, to summarize, number one priority investing in the business; number two, paying down debt which we’ve substantially done; and the number three, looking in the future for opportunities to return cash to our shareholders. Colin McGranahan – Bernstein: Great. Thank you very much.

Thank you.

Operator, we will take the next question please.

Our next question comes from Emily Shanks with Barclays Capital.

Good morning Emily. Emily Shanks – Barclays Capital: Good morning. Great quarter, guys.

Thank you very much. Emily Shanks – Barclays Capital: I just had two questions. One is actually a follow-up to the prior caller. Can you let us know what your RP capacity is to allow for open market repurchases of those senior subs?

Emily, could you repeat the question?

Yeah. We had a little hard time hearing, Emily, I apologize. Emily Shanks – Barclays Capital: No problem. Let me try that again. Can you hear me?

Yeah, that’s much better. Thanks. Emily Shanks – Barclays Capital: Okay, apologies. I was curious as a follow-up to the prior question what your current RP capacity is to execute open market repurchases of the senior sub bonds?

Yeah. Right now, at this point in time, we don’t have enough capacity to make that purchase, but again as we get into next year in the time period when we would be doing it, our current modeling shows that we would have plenty of capacity to make that buyback. Emily Shanks – Barclays Capital: Okay, so it’s literally at zero right now?

No, it’s not at zero, but it’s just not enough to buyback the whole $450 million. And again, we wouldn’t do that anyway because the price is too high, right now. Again, they are trading pretty handily in the market and we would wait until the current thought process is that we wait until that price came down to $105 million next July or $105 million. If you remember we did buyback some of the senior notes before $105 million because out models show that it was accretive to us to buy them back a little bit earlier. Emily Shanks – Barclays Capital: Okay, got you. Thank you for the details. And then my second and last question is as we look at the inventory increase for the quarter, I know that you indicated a portion of that was effectively forward buy if I am summarizing it correctly. Can you give us a sense of what portion of that growth is attributable to forward buy?

Yeah. What I rather say to you Emily, you had the 78-inch profile, which has allowed us to put in a higher ticket item for the customer. It’s attributable to that and then our forward buy activity. And I’d rather not be that specific if it’s okay. Emily Shanks – Barclays Capital: Okay, that’s great. Thanks and good luck.

All right, thank you.

Operator, we will take the next question please.

Our next question comes from Meredith Adler from Barclays.

Hey, good morning Meredith. Meredith Adler – Barclays: Good morning. I kind of I feel like everybody has asked my questions, including Emily.

Hey, I’ll take anything you want to ask. Meredith Adler – Barclays: Okay. Maybe I would just like to talk a little bit more about forward buy, I don’t know you don’t want to quantify it, but generally are you finding that vendors are making inventory available for forward buy?

Yeah, the answer to that is correct. And I don’t want anybody to think who are out there just buying anything that’s out there. It’s very strategic. It’s items that generate a lot of volume for us, which are obviously a little more sensitive to our customer and we are doing it in an attempt to mitigate having to raise the price at the shelf. Meredith Adler – Barclays: Okay. And then maybe you could just talk about what – you said that August was going well and back-to-school was going well. Does that mean that you are in the range that you gave us the guidance for the year for comps?

Well done. I am very pleased with where our sales are as we start the quarter. How is that? Meredith Adler – Barclays: Okay. And I guess just my final question would be about markdowns, I mean, I think markdowns of apparel were a big issue in the first quarter. It sounds like they were much less of an issue in the second quarter. Is that fair? And then I think it should be even better going forward.

Yeah. If you look at the difference between Q1 and Q2, the primary difference and we deleveraged 63 basis points in Q1. In Q2, we deleveraged the 11. The primary difference is markdown. So, let me explain, how this works. In Q1, we experienced markdowns in apparel and home versus Q1 of the prior year due to the tougher macroeconomic environment. In Q2, we experienced improved markdowns versus Q2 last year due to having fewer competitive price reductions what we call TPRs or temporary price reductions, which take place primarily in the consumable area. And again, this is versus what we saw in Q2 of 2010. And this is really the biggest difference in markdowns for the differences between Q1 and Q2. Additionally, we did have improvement in both shrink and distribution in Q2 which helped takeaway some of that negative on margin. Meredith Adler – Barclays: And apparel and home markdown this quarter?

Consistent with plan.

Yeah. Meredith Adler – Barclays: Okay, great. Thank you.

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

Our next question comes from Joseph Parkhill from Morgan Stanley.

Good morning Jo. Joseph Parkhill – Morgan Stanley: Good morning. Congrats on a nice quarter. Thanks for the clarity on gross margin performance. I was just wondering a different look at it. I am assuming it perhaps came in a little bit better than your internal projections, so what would be the biggest delta between where it came out versus what you were expecting rather than I know your commentary before was the difference between Q2 and Q1?

Yeah, I think three things. The shrink again continues to do very, very well. We’ve got a lot of great things going on in shrink right now. If you look at that, we are very pleased with our exception-based reporting, our focus on high shrink stores, scan-based trading has been helping us, defensive merchandising fixtures etcetera, etcetera. There is a lot of hard work going on in shrink and it’s paying off. We also had distribution coming in to help us again in the quarter versus last quarter, engineered labor standards, voice pick, cube on the truck, just general efficiencies, inbound load optimization, etcetera. So, we got some help also from those items and then the markdowns. Again, little better on markdowns, and when you go into a quarter, you have estimates of your sell-through and you’re never quite sure how those are going to come out until the quarter end. Joseph Parkhill – Morgan Stanley: That was helpful. Thanks. And then just quickly on the inventory, I was looking through the Q and everything seems to be in good shape except apparel is up, I think, about 10% year-over-year versus sales growth of 1%. Are you comfortable with where your apparel inventory is?

Yeah, Jo. And that the reason I say we are comfortable that reflected as realignment, well we made the commitment to infants and toddlers and shifted the mix around.

We also did some forward buys on apparel. You’re probably aware that cotton prices have been increasing economically and we are trying to get a little bit ahead of the power curve on cotton. Joseph Parkhill – Morgan Stanley: Okay, that’s great. Thanks.

Thank you.

Operator, we will move on to the next question please.

Our next question comes from Wayne Hood with BMO Capital.

Good morning Wayne. Wayne Hood – BMO Capital: Good morning. Couple of questions, one is back on the gross margin, you outlined or said that you expected third quarter markdowns to be equal to last year. You have shrink that’s kind of a tailwind and DC costs that are a tailwind. That would imply I guess that the FIFO gross margin could be flat if you put the mix shift aside. So, are we to assume that the FIFO gross margin might be flattish to down a little bit, but the LIFO will be down more? And it’s really the adjustment to LIFO that’s putting the pressure on gross margin more than even mix or how should we think about third quarter FIFO gross margin?

Now, it’s I think, you really have to look at the mix more than anything else. And again as I mentioned our current call on it, again, our call in the economy is for the back half of the year. We think that consumable mix will continue to grow and continue to above what it was last year at this time. You are right, LIFO impacted us also, but again, I think the mix that we see is the bigger issue. Wayne Hood – BMO Capital: And you would expect, David, I guess, the home apparel and seasonal categories to have a sales increase, it’s not that they are declining, is that correct?

Yeah. We see increases again versus prior year in total in all of our categories for total sales. Wayne Hood – BMO Capital: Okay. And then my final question related to the costs, you mentioned that the advertising costs were lower year-over-year and incentive comp was lower. Can you kind of outline how that looks for the third and fourth quarter? Is there any shifting with advertising we should be aware of, also how incentive costs kind of unfolds in the back half of the year? Thank you.

Yeah. No real, again, I am reluctant to give too much guidance on line items, but no real overall shift in advertising in the point on the incentive comp is simply, we had a tougher budget this year and again every year our budgets get a little bit tougher. Wayne Hood – BMO Capital: Okay, great. Thanks, guys.

Thank you.

Next question please.

Our next question comes from John Zolidis with Buckingham Research Group.

Good morning John. John Zolidis – Buckingham Research Group: Hi, good morning. Nice results.

Thank you very much. John Zolidis – Buckingham Research Group: I thought I would ask a question about the workforce management program and the software that helped out the SG&A in the quarter. I was wondering if you can give us a little bit more color on exactly what that does for you. And then kind of where are we in the lifecycle of that program? Are there more gains yet to come?

Yeah. The workforce management system is it’s an industrial engineering program that helps us better allocate the hours in the store, based on the flow of the customer traffic. It also John helps us identify how many hours we should use for stocking, how many hours for check-out. But the real win for us is the proper allocation of the workforce into the store at the right time based on the flow of the customer. As far as the program, it has rolled out and we continue to believe that we still have upside in it going forward. And the key thing is it really give us a feel buy store as opposed to just standing up and laying it out across the whole chain.

And we are about three quarters implemented on it now, about 75% of the chain is implemented in. John Zolidis – Buckingham Research Group: Great. Any other new programs coming in that are systems-driven that are going to help that you are excited about?

Well, we continue to – we have started rolling out our new procurement system that’s going to take us a couple of years to get done well. The exciting thing about us that John is that it will give us a real-time look in regards to allocating product rather than having to rely on the previous 10 or 12 weeks. So, we think we’re going to be able to do a better job of laying the right amount of product into the store at the right time, particularly on promotional items.

We’ve had some improvements in our handhelds in the stores, our HHT as we have called them some software improvements there, which add to the – try to make the life a little easier for the store employees. We are also in the process of doing DSL, Wi-Fi in the stores and again that helps in that whole process. And then we had an announcement this morning on e-commerce, which we are excited about and obviously there are lot of systems behind e-commerce in making that happen. The other thing, we’ve got some new point-of-sale registers that are being put in. And again, this will ease hopefully make the workload a little bit easier for the store in place. John Zolidis – Buckingham Research Group: Great. Thanks a lot and continued success.

Hey, thank you John.

All right. We will move to the next question please.

Our next question comes from Matt Nemer with Wells Fargo.

Hey, good morning Matt. Matt Nemer – Wells Fargo: Good morning, everyone. My first question is could you just comment on the mix within consumables in terms of good, better, best? Are you seeing customers trading down to private label? Any color you can give there?

Yeah. That’s a great question. No doubt we are seeing more private brand sales, I mean, they are up 15%. They are growing faster than the total sales now. And for what it’s worth, Matt, really seeing the private brand conversion in health and beauty. And it really speaks well we think to the future of the Rexall brand. In fact, if the customer proceeds that as a national brand. Matt Nemer – Wells Fargo: And where is that brand in terms of product rollout? Is there still – I know there was a new packaging initiative earlier this year, but can you just give us an update on that?

Yeah. I mean, the new private brands, essentially that look, that feel, that placement in the story is rolled out. We’ve expanded the private brand commitment now into the non-consumable side as well. I am very pleased with what the team has done with the party or I got to tell you guys, the new automotive set with the private brands is doing really well. In regards to Rexall, Matt, I’d tell you we might still have – we might be able to get maybe 50% more SKUs in there when it’s all said and done, but we are taking our time with that. And again, like we have always said we are letting the customer make that choice. Matt Nemer – Wells Fargo: Okay, great. And then just lastly, can you help us gauge the potential size of an e-commerce channel for you in terms of how much traffic you’re getting to your websites and what people are doing on your site and what they are asking for?

Yeah, John or Matt, excuse me, what I’d rather do is give you an update on that when it’s been up and running for a while. This is brand new for us. We do know that there has been request for it. We do know there is demand for it, but I just don’t know enough yet about how it’s going to – what it’s going to generate. And with the world of social media today, I mean, it’s a great hookup for us now. Matt Nemer – Wells Fargo: Great, fair enough. Thanks very much.

You bet, Matt.

All right. Next question please.

Our next question comes from Mark Montagna with Avondale Partners.

Good morning, Mark. Mark Montagna – Avondale Partners: Hi, good morning. A couple questions about home and apparel. I was wondering at what point in the second quarter did you have apparel fully set to the new format with all your markdowns taken? And then also with the home, just walk us through what changes you made, was it across-the-board inventory reductions or did you slice out certain lines?

Yeah, let’s come back to apparel. I mean, about the time we hit the beginning of the second quarter, it was pretty well rolled out into the chain. And again, that commitment to the placement of infants and toddlers being 50% of the department and being place upfront. So, we had that benefit on that side of the table all the way through the quarter. I would say the same thing with the basic men’s of work apparel. It was in place in the stores the whole quarter. And I can’t remember the second half of your question, Mark, I apologize. Mark Montagna – Avondale Partners: Yeah, the other part was how did you alter home? Was it – I know you reduced the inventory, but did you slice out certain lines or you just across-the-board cuts in inventory?

Yeah, basically it’s just all SKU rationalization. As we were looking at home, we have made changes in the store that have affected other pieces of the business. In our category management process, Mark, we go and eliminate unproductive SKUs and that’s what you saw in the quarter. Mark Montagna – Avondale Partners: Okay. And then just lastly, what percent of consumables sales was private-label merchandise?

Our penetration was 21.8%. Mark Montagna – Avondale Partners: Okay, great. Thanks.

Okay, thank you.

Operator, next question please.

Our next question comes from Mark Mandel with ThinkEquity.

Good morning Mark. Mark Mandel – ThinkEquity: Hey, good morning and congratulations.

Thank you very much. Mark Mandel – ThinkEquity: I was wondering if you could just update us on the real estate environment, what you are seeing out there. Obviously, you seem to be able to get your stores open without any issues. And your discussion of depreciation, I think you mentioned that you were owning more of your sites, could you just clarify that point?

Sure. I’ll answer the first part and let David answer the second. I mean, the real estate environment is relatively what it’s been over the last 18 months. So, it is affording us the opportunity to get a little bit better site. And we are pleased the site selection is paying off in the volume that comes out of our stores initially out of the shoot. I think David would say we are purchasing stores because the environment is very opportunistic right now.

Yeah. It is an opportunistic environment. We are getting very nice cap rates when we did this purchase of stores. We’ll continue to do it. But again, I want to emphasize this is not a all-consuming, huge effort for the company, this is just a way for us to buy some of our better stores that we know we want to keep, because they are performing very, very well, employ some of our cash in a way that we believe in a future time period, we’ll be able to turn these stores and sell them for a pretty good profit. And again, we are just taking advantage of a market right now that has gap rates that are very attractive to us and we want to put our cash to work for our shareholders. Mark Mandel – ThinkEquity: What percent of your stores do you currently own?

It’s very small.

Very small. Mark Mandel – ThinkEquity: My second question is on your fresh food initiative, could you just update us on where you stand in terms of rollout of cases? Is that complete or are you expanding the number of cases in your existing stores and so on?

Yeah, that’s a great question. I will give it to you two ways here. First of, we are continuing to expand refrigerated and frozen. And what I would say to you is that our customers, our frozen food and refrigerated offering to them is almost like it is insatiable. The more we put in the better we do with the initiative. And I think it’s pretty fair to tell you all that we will continue to push frozen food cases going forward probably for a very long period of time. It’s a matter of us just finding sufficient space. On the market store side, I am very pleased with what the team has done in refining the mix of frozen food and more specifically the fresh meat, the limited fresh meat and produce we carry. So we are very excited on what’s happening on that side of the ledger also. Mark Mandel – ThinkEquity: Okay, thanks and good luck.

You bet. Thank you very much.

All right. Operator, next question please.

Our next question comes from Joe Feldman with Telsey Advisory Group.

Good morning Joe. Kelly – Telsey Advisory Group: Hey, guys, this is actually Kelly filling in for Joe. Congrats on a great quarter.

Thanks Kelly. Kelly – Telsey Advisory Group: First of all, just could you give us a little bit more color on sales cadence throughout the quarter? And also were there any regional callouts that you could highlight?

I am sorry, I missed the first part. I didn’t hear you. Kelly – Telsey Advisory Group: Could you talk a little bit more about sales cadence throughout the quarter? Some of our other retailers have talked about how it started off a little bit slower and kind of accelerated as the quarter went on, just wondering if you guys saw the same thing?

Yeah. There is no doubt that sales accelerated through the quarter. And our acceleration I would say why there is a difference between the first period and the last is not like it is a major difference. I would think more of a gentle hockey stick rather than a radical move to the upper right hand corner of the chart. Regionally, I am pleased to say once again every region that we are dealing had positive comps. Again, really speaking to the breadth and depth of the model all across the economic spectrum. Kelly – Telsey Advisory Group: Great, thank you. That’s helpful. And then second question, just in relation to Dollar General Market, I know it’s early, but you guys sound very excited about the results. It’s generating strong sales. How did the margins compare to the rest of the chain? And are you finding that it’s attracting a different customer? And then when you guys have talked about in the past the opportunity for 12,000 new stores, is that inclusive of the Dollar General market or how should we think about that?

Yeah, I would think of the 12,000 opportunities as including Dollar General markets as well as Dollar General’s. It’s interesting where we do very well as a Dollar General that morphs into a Dollar General market very nicely. And yeah, we continue the margin obviously the mix with the addition of more produce and more meat, while the margin is going to be a little lower. The team has worked very hard on putting us in a position where the dollars were generating that box is very impressive and that’s where we are going to go with. Kelly – Telsey Advisory Group: Great, thank you.

Anyway, we’ll move to the next question please.

Our next question comes from Anthony Chukumba with BB&T Capital Markets.

Good morning Anthony. Anthony Chukumba – BB&T Capital Markets: Good morning. Two questions. First one was on Hurricane Irene, wanted to see if you had any thoughts on whether that had a negative impact on your sales or maybe even a positive impact as people sort of stocked up ahead of that? And then the second question, I just wanted to understand what the difference was between a trade-down and a trade-in customer?

Sure. That’s a great question. First of all, in regards to Hurricane Irene, like all other retailers out there, hey, we suffered some store closures. We had no store losses. We had a little bit of tree damage, a little bit of water damage. We still have the handful of stores that are operating without power, but overall we came through the disaster quite frankly very nicely. Again having spent my entire life in retail, a threat of a natural disaster is great and then when that disaster is not quite as bad as forecasted, sales usually do pretty well. I look at trade-down customer as someone who is experimenting, someone who is coming in and driven by the fact. In fact, I am going to rephrase that even a little more differently. What I would like to say Anthony is I think as I look at consumer spending today, there are those who have to shop in our channel. There are those who want to shop in it, because it’s enticing. And then those that are, well, I am not – I am doing a terrible job here, let me just backup. I had this all in my mind. Listen, trade-down people are going to come in because they have to for a period of time. I think the economy is creating an entire new customer that values the new consumer as that really and truly wants to shop with us. And they have come in and they have seen an experience that’s totally different. And we actually think this trade-in customer represents the new change in the environment today. It reminds me very much of the 70s when the warehouse stores came up. I ran a warehouse store in the 70s. And I would remember people standing in line with a fur coat trying to save a few dollars. And that’s that trade-in. Those people that are coming in and liking what they are seeing. Anthony Chukumba – BB&T Capital Markets: Okay, thank you.

Yeah.

Does that help, Anthony? Anthony Chukumba – BB&T Capital Markets: Yeah. No, that is helpful, thank you.

Okay.

Great. All right. And operator, I think we got one other person in the queue there.

Our next question comes from Michael Exstein with Credit Suisse.

Good morning Michael. Michael Exstein – Credit Suisse: Good morning and thank you. I am sorry, the last question or the last person in the queue. I think very early on Deb asked about promotions. And in the old days, we used to see promotions where we’d see fliers or something like that, but it looks like we are seeing more couponing off the Internet. And can you just talk about that how you see that going forward?

Yeah. I mean, I think every retailer right now is dealing with the whole social media issue. I don’t think any doubt going forward that there is not going to be more of it. And what’s good about it Michael is you can target your audience. You don’t have to blanket everybody like you do when you put something in a newspaper you’re able to strategically hit your customer. So, again while our focus is on everyday low price, our focus is what transpires at the point of sale, there is no doubt that we need to have some sort of Internet presence, some sort of social media presence. And we think we are on – we are doing enough things. I think we are on the right track. Michael Exstein – Credit Suisse: Can you just talk about also the $25 purchase coupons getting $5 off and the bounce back and how that all plays out?

Yeah. We used that strategically different times of the month on different occasions. And it’s another form of EDLP pricing. And what we are trying to do is stretch the consumer’s budget at different times of the month. And hey, it’s something that we use occasionally and we are pleased with what we are seeing. And you have to also remember you put that out there the redemption on it, that it’s very targeted. It’s not like there is the masses are running into redeem and it’s a very strategic element for us. Michael Exstein – Credit Suisse: Okay, great. Thank you very much.

Thank you. Mary Winn Gordon – Vice President of Investor Relations and Public Relations: With that, that concludes our call. Operator, I think….