Dollar General Q2 2022 Earnings Report

Dollar General EPS Results

• Actual EPS: $2.69
• Consensus EPS: $2.59
• Beat/Miss: Beat by +$0.10
• One Year Ago EPS: $3.12

Dollar General Revenue Results

• Actual Revenue: $8.65 billion
• Expected Revenue: $8.59 billion
• Beat/Miss: Beat by +$61.08 million
• YoY Revenue Growth: -0.40%

Dollar General Announcement Details

• Quarter: Q2 2022
• Date: 8/25/2021
• Time: Before Market Opens
• Conference Call Date: Wednesday, August 25, 2021
• Conference Call Time: 8:00PM ET

Dollar General (NYSE:DG) is a U.S.-based variety and discount retailer operating a large network of small-format stores that serve primarily rural and suburban communities. The company is publicly traded on the New York Stock Exchange under the ticker DG and is headquartered in the Nashville/Goodlettsville, Tennessee area. Founded in 1939, Dollar General has grown from a regional operation into one of the nation’s prominent low-price retailers focused on convenience and value.

Dollar General’s stores offer a wide assortment of everyday consumables and household goods, including food and beverage items, cleaning supplies, health and beauty products, paper goods, apparel basics, seasonal merchandise and small household items. The company also operates larger-format Dollar General Market stores that emphasize grocery assortments. A significant portion of the assortment is supplied through private-label brands designed to deliver value and drive customer loyalty.

The business model centers on a compact store footprint, low operating costs and a dense distribution network to support rapid replenishment and broad geographic coverage in underserved locations. Dollar General combines in-store merchandising with digital tools for promotions and coupons to attract price-conscious shoppers. Its operating infrastructure includes regional distribution centers and logistics systems intended to keep inventory flowing to thousands of local outlets.

Originally founded by J.L. Turner and his son Cal Turner, the company has a long history of incremental expansion and adaptation to consumer needs. Today Dollar General is managed by an executive leadership team and board of directors that oversee strategy, store growth, merchandising and supply-chain investments aimed at maintaining the retailer’s value-oriented positioning and reach into small-town and suburban markets across the United States.

Dollar General Q2 2022 Earnings Call Transcript

Key Takeaways

• In Q2, net sales slightly declined 0.4% to $8.7 billion and same-store comps fell 4.7% year-over-year (though up 14.1% versus Q2 2019), while diluted EPS decreased 13.8% to $2.69.
• For fiscal 2021, Dollar General raised its full-year outlook to 0.5–1.5% net sales growth (same-store comps –3.5% to –2.5%, or +13–14% on a two-year basis) and EPS of $9.60–$10.20, plus plans for $2.4 billion in share repurchases and $1.1–$1.2 billion in capital spending.
• The company completed the DG Fresh self-distribution rollout to 17,500 stores about six months ahead of plan, driving lower product costs and higher margin in frozen and refrigerated categories.
• The Non-Consumables Initiative reached 8,800 stores—adding 1–2.5% to comps—and the Pop Shelf concept grew to 16 locations (targeting up to 50 by year-end), both contributing stronger sales and margins.
• Digital engagement continues to grow, with nearly 4 million mobile app monthly active users (+28% y/y), self-checkout in 4,300+ stores, and an expanded DG Media Network advertising platform.

Presentation

[Operator]

Good morning. My name is Robert, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Dollar General second quarter 2021 earnings call. Today is Thursday, August 26, 2021. All lines have been placed on mute to prevent any background noise. This call is being recorded. Instructions for listening to the replay of the call are available in the company's earnings press release issued this morning. I'd like to turn the conference over to your host, Mr. Donny Lau, Vice President of Investor Relations and Corporate Strategy. Mr. Lau, you may begin your conference.

[Donny Lau, VP of Investor Relations and Corporate Strategy at Dollar General]

Thank you, 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 and 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, priorities, opportunities, investments, guidance, expectations, or beliefs about future matters and other statements that are not limited to historical fact. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections.

[Donny Lau, VP of Investor Relations and Corporate Strategy at Dollar General]

These factors include, but are not limited to, those identified in our earnings release issued this morning under Risk Factors in our 2020 Form 10-K filed on March 19, 2021, 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 obligations to update or revise any information discussed on this call unless required by law. We also will reference certain non-GAAP financial measures. 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 and Events. At the end of our prepared remarks, we will open the call up for your questions. Please limit your questions to one and one follow-up question if necessary. Now it is my pleasure to turn the call over to Todd.

[Todd Vasos, CEO at Dollar General]

Thank you, Donny, and welcome to everyone joining our call. We are pleased with our second quarter results and continue to be grateful to our associates for their dedication to fulfilling our mission of serving others. Despite what remains a challenging operating environment, including additional uncertainties brought on by the Delta variant and pressures on the global supply chain, our teams continue to successfully adapt and deliver for our customers. Because of their efforts during the quarter, we saw an improvement in customer traffic as compared to Q1, and once again increased our market share in highly consumable product sales as measured by syndicated data. Looking ahead, we remain focused on controlling the things we can control and believe we are well-positioned to navigate the current inflationary environment and global supply chain challenges.

[Todd Vasos, CEO at Dollar General]

As always, the health and safety of our employees and customers is our primary focus while meeting the needs of the communities we serve. With more than 17,500 stores located within 5 mi of about 75% of the U.S. population, we believe we are well-positioned to continue supporting our customers through our unique combination of value and convenience. To that end, we recently hired our first chief medical officer. Going forward, our plans include further expansion of our health offering with the goal of increasing access to affordable healthcare products and services, particularly in rural America. Overall, we remain focused on our operating priorities and strategic initiatives as we continue to meet the evolving needs of our customers and further position Dollar General for long-term sustainable growth. Turning now to our second quarter performance.

[Todd Vasos, CEO at Dollar General]

As we continue to lap difficult quarterly sales comparisons from the prior year, net sales decreased 0.4% to $8.7 billion, followed by a 24.4% increase in Q2 of 2020. Comp sales declined 4.7% compared to the prior year period, which translates into a robust 14.1% increase on a two-year stack basis. Our Q2 sales results include a year-over-year decline in customer traffic, which was partially offset by the growth in average basket size. From a monthly cadence perspective, comp sales were lowest in May, with July being our strongest month of performance. I'm pleased to report that Q3 is off to a great start. Importantly, we continue to be very pleased with the retention rates of new customers acquired in 2020, underscoring the broadening appeal of our value and convenience proposition.

[Todd Vasos, CEO at Dollar General]

We believe we will ultimately exit the pandemic with a larger, broader, and more engaged customer base than when we entered it. Resulting in an even stronger foundation from which to grow. Overall, our second quarter results reflect strong execution across many fronts as we continue to strengthen our position, while further differentiating and distancing Dollar General from the rest of the discount retail landscape. We operate in one of the most attractive sectors in retail, and we believe our unique store footprint, further enhanced through our multi-year initiatives, provides a distinct competitive advantage and positions us well for continued success. As a mature retailer in growth mode, we are also laying the groundwork for future initiatives, which we believe will unlock significant growth opportunities as we move forward.

[Todd Vasos, CEO at Dollar General]

In short, I feel very good about the underlying strength of the business. We're confident we are pursuing the right strategies to enable balanced and sustainable growth while creating meaningful long-term shareholder value. With that, I'll now turn the call over to John.

[John Garratt, CFO at Dollar General]

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 we specifically note otherwise, all comparisons are year-over-year, all references to EPS refer to diluted earnings per share, and all years noted refer to the corresponding fiscal year. As Todd already discussed sales, I will start with gross profit. As a reminder, gross profit in Q2 2020 was positively impacted by a significant increase in sales, including net sales growth of 41% in our combined non-consumables categories. For Q2 2021, gross profit as a percentage of sales was 31.6%, a decrease of 80 basis points, but an increase of 87 basis points compared to Q2 2019.

[John Garratt, CFO at Dollar General]

The decrease compared to Q2 2020 was primarily attributable to increased transportation costs, a higher LIFO provision, a greater proportion of sales coming from the consumable categories, and an increase in inventory damages. These factors were partially offset by higher inventory markups and a reduction in shrink as a percentage of sales. SG&A as a percentage of sales was 21.8%, an increase of 138 basis points. This increase was driven by expenses that were greater as a percentage of sales, the most significant of which were retail labor and store occupancy costs. Moving down the income statement, operating profit for the second quarter decreased 18.5% to $849.6 million. As a percentage of sales, operating profit was 9.8%, a decrease of 219 basis points.

[John Garratt, CFO at Dollar General]

While the unusual and difficult prior year comparison created pressure on our operating margin rate, we're very pleased with the improvement in our profitability on a two-year basis. Our effective tax rate for the quarter was 21.4% and compares to 21.5% in the second quarter last year. Finally, EPS for the second quarter decreased 13.8% to $2.69, which reflects a compound annual growth rate of 27.7%, or 24.3% compared to Q2 2019 adjusted EPS over a two-year period. Turning now to our balance sheet and cash flow, which remain strong and provide us the financial flexibility to continue investing for the long term while delivering significant returns to shareholders.

[John Garratt, CFO at Dollar General]

Merchandise inventories were $5.3 billion at the end of the second quarter, an increase of 20% overall and 13.7% on a per store basis, as we continue to cycle unusually low levels of inventory in Q2 2020, which were driven by extremely strong sales volumes in that quarter. Similar to Q1, we strategically pulled forward certain inventory purchases during the quarter, particularly in select non-consumable categories in anticipation of longer lead times. As a result, we were pleased with our strong inventory position for the back-to-school shopping season, and our teams continue to work closely with suppliers to ensure delivery of seasonal and other goods in the remaining back half of the year. Year to date through Q2, we generated significant cash flow from operations totaling $1.3 billion.

[John Garratt, CFO at Dollar General]

Total capital expenditures for the quarter were $518 million and included our planned investments in new stores, remodels, and relocations, distribution and transportation projects, and spending related to our strategic initiatives. During the quarter, we repurchased 3.3 million shares of our common stock for $700 million and paid a quarterly dividend of $0.42 per common share outstanding at a total cost of $98 million. At the end of Q2, the remaining share repurchase authorization was $979 million. 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 excess 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 about 3x adjusted debt to EBITDA.

[John Garratt, CFO at Dollar General]

Moving to an update on our financial outlook for fiscal 2021. We continue to operate in a time of uncertainty regarding the severity and duration of the COVID-19 pandemic, including its impact on the economic recovery, global supply chain, consumer behavior, and our business. Despite continued uncertainty, including additional pressure throughout the supply chain and cost inflation, we are updating our full-year sales and EPS guidance, which reflects our strong first half performance. For 2021, we now expect the following. Net sales growth of 0.5%-1.5%, a same-store sales decline of 3.5%-2.5%, but which reflects growth of approximately 13%-14% on a two-year stack basis.

[John Garratt, CFO at Dollar General]

EPS in the range of $9.60-$10.20, which reflects a compound annual growth rate in the range of 20%-24%, or approximately 19%-23% compared to 2019 adjusted EPS over a two-year period. Our EPS guidance assumes an effective tax rate in the range of 22%-22.5%. Our expectations for real estate projects remain unchanged from what we stated in our earnings release on May 27th, 2021. With regards to share repurchases, we now expect to repurchase approximately $2.4 billion of our common stock this year, compared to our previous expectation of about $2.2 billion.

[John Garratt, CFO at Dollar General]

Finally, we are increasing our expectations for capital spending in 2021 to a range of $1.1 billion-$1.2 billion to reflect higher equipment costs for store projects and the pull forward of select supply chain investments. Let me now provide some additional context as it relates to our outlook. In terms of sales, we remain cautious in our 2021 outlook given the current continued uncertainties arising from COVID-19 pandemic and the impact of the expected end of additional federal unemployment benefits. Turning to gross margin, please keep in mind we will continue to cycle strong gross margin performance from the prior year, where we benefited from a favorable sales mix and a reduction in markdowns, including the benefit of higher sell-through rates.

[John Garratt, CFO at Dollar General]

Much like our Q2 results, we expect continued pressure on our gross margin rate in the second half due to a less favorable sales mix compared to prior year, an increase in markdown rates as we cycle the abnormally low levels in 2020, and higher LIFO provisions as a result of cost of goods increases. We also anticipate higher supply chain costs in the second half compared to our previous expectations. Like other retailers, our business is seeing the effects of higher costs due to transit and port delays, as well as elevated demand for services at third-party carriers. However, despite these challenges, our team was able to meet strong customer demand during the quarter, and we're confident in our ability to continue navigating these transitory pressures.

[John Garratt, CFO at Dollar General]

Finally, please keep in mind that the third quarter represents our most challenging lap of the year from a gross profit rate perspective, following an improvement of 178 basis points in Q3 2020. With regards to SG&A, we now expect about $70 million-$80 million in incremental year-over-year investments in our strategic initiatives as we further their rollouts. This amount includes $40 million in incremental investments made during the first half of the year. In aggregate, we continue to expect our strategic initiatives will positively contribute to operating profit and margin in 2021, driven by NCI and DG Fresh, as we expect the benefits to gross margin from our initiatives will more than offset the associated SG&A expense. In closing, we are proud of our second quarter results, which are a testament to the performance and strong execution by the entire team.

[John Garratt, CFO at Dollar General]

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 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.

[Jeff Owen, COO at Dollar General]

Thank you, John. Let me take the next few minutes to update you on our operating priorities and strategic initiatives. Our first operating priority is driving profitable sales growth. The team continues to drive strong execution against a robust portfolio of growth initiatives. Let me take you through some of our more recent highlights. Starting with our Non-Consumables Initiative, or NCI. The NCI offering was available in more than 8,800 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 store base. In fact, this performance is contributing to an incremental 1%-2.5% total comp sales increase in NCI stores and a meaningful improvement in gross margin rate as compared to stores without the NCI offering.

[Jeff Owen, COO at Dollar General]

Overall, we remain on track to expand this offering to a total of more than 11,000 stores by year-end, including over 2,100 stores in our lite version, with the goal of completing the rollout of NCI across nearly the entire chain by year-end 2022. Moving to our newer store concept, pOpshelf, which further builds on our success and learnings with NCI. pOpshelf aims to engage customers by offering a fun, affordable, and differentiated treasure hunt experience delivered through continually refreshed merchandise, a differentiated in-store experience, and exceptional value with the vast majority of our items priced at $5 or less. During the quarter, we opened eight new pOpshelf locations, bringing the total number of stores to 16, including four conversions of a traditional Dollar General store into our pOpshelf concept.

[Jeff Owen, COO at Dollar General]

While still early, we remain extremely pleased with our results, which continue to exceed our expectations for both sales and gross margin. We also recently opened our first two store-within-a-store concepts, which incorporates a smaller footprint pOpshelf shop into one of our larger Dollar General Market stores, and we're encouraged by the initial results, including positive reaction from customers. For 2021, we remain on track to have a total of up to 50 pOpshelf locations by year-end, as well as up to an additional 25 store-within-a-store concepts as we continue to lay the foundation for future growth. Overall, we remain very excited about the significant and incremental growth opportunities we see available for this unique and differentiated concept. Turning now to DG Fresh, which is a strategic multi-phase shift to self-distribution of frozen and refrigerated goods.

[Jeff Owen, COO at Dollar General]

I'm very pleased to report that during the quarter, we completed the initial rollout of DG Fresh across the entire chain and are now delivering to more than 17,500 stores from 12 facilities. This important milestone is a direct reflection of the hard work and dedication of the team, and I want to thank them for their incredible execution over the past 2.5 years. Notably, the rollout was completed about six months ahead of our initial rollout schedule. As a reminder, the primary objective of DG Fresh is to reduce product costs on our frozen and refrigerated items, and we continue to be very pleased with the savings we are seeing.

[Jeff Owen, COO at Dollar General]

In fact, DG Fresh continues to be the largest contributor to the gross margin benefit we are realizing from higher inventory markups, and we expect additional benefits going forward as we continue to optimize our network and further leverage our scale. Another important goal of DG Fresh is to increase sales in these categories, and we are pleased with the success we are seeing on this front, driven by higher overall in-stock levels and the introduction of additional products, including both national and private brands. For example, we recently introduced about 25 new and exclusive items under the Armour brand as we continue to optimize our assortment while further differentiating our product offering from others.

[Jeff Owen, COO at Dollar General]

While produce was not included in our initial rollout plans, we believe DG Fresh provides a potential path to accelerating our produce offering in up to 10,000 stores over time as we look to further capitalize on our extensive self-distribution capabilities. Moving to our cooler expansion program, which continues to be our most impactful merchandising initiative. During the first half, we added more than 34,000 cooler doors across our store base and remain on track to install approximately 65,000 cooler doors this year. 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, all enabled by DG Fresh. In addition to the gross margin benefits associated with NCI and DG Fresh, we continue to pursue other gross margin-enhancing opportunities, including improvements in private brand sales, global sourcing, supply chain efficiencies, and shrink.

[Jeff Owen, COO at Dollar General]

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. In the second quarter, we completed a total of 772 real estate projects, including 270 new stores, 477 remodels, and 25 relocations. For the full year, we remain on track to open 1,050 new stores, remodel 1,750 stores, and relocate 100 stores. In addition, we now have produce in more than 1,500 stores, with plans to expand this offering to a total of more than 2,000 stores by year-end. As a reminder, we recently made key changes to our development strategy, including establishing our larger 8,500 sq ft format as our base prototype for nearly all new stores going forward. We're especially pleased with the sales productivity of this larger format, as average sales per square foot continue to trend well above an average traditional store.

[Jeff Owen, COO at Dollar General]

In total, we expect to have nearly 2,000 stores in this format by the end of the year as we look to further enhance our value and convenience proposition, particularly in rural America. Next, our digital initiative, which is an important complement to our brick-and-mortar footprint as we continue to deploy and leverage technology to further enhance convenience and access for customers. Our efforts remain centered around building engagement across our digital properties, including our mobile app, which continues to grow in popularity. In fact, we ended Q2 with nearly 4 million monthly active users on the app, a 28% increase over prior year. Importantly, as we continue to drive higher levels of digital engagement, our DG Media Network, which we launched in 2018, has become an increasingly more relevant platform for connecting our brand partners with our customers.

[Jeff Owen, COO at Dollar General]

Of note, during the first half, the number of campaigns on our platform increased 65% compared to the prior year period. We are very excited about the growth potential of this business as we look to further enhance the value proposition for both our customers and brand partners. Overall, our strategy consists of building a digital ecosystem specifically tailored to provide our customers with an even more convenient, frictionless, and personalized shopping experience. We are pleased with the growing engagement we are seeing across our digital properties. 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 continues to govern 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.

[Jeff Owen, COO at Dollar General]

Our Fast Track initiative is a great example of this approach, where our goals include increasing labor productivity in our stores, enhancing customer convenience, and further improving on-shelf availability. The first phase of Fast Track consisted of optimizing our roll containers and case pack sizes, resulting in the more efficient stocking of our stores. The second component of Fast Track is self-checkout, which provides customers with another flexible and convenient checkout solution while also driving greater efficiencies for our store associates. Self-checkout was available in approximately 4,300 stores at the end of the Q2, and we continue to be pleased with our results, including customer adoption rates and higher overall satisfaction scores in stores that include this offering.

[Jeff Owen, COO at Dollar General]

Our plans consist of a broader rollout this year, and we remain focused on introducing self-checkout into the vast majority of our stores by the end of 2022, as we look to further extend our position as an innovative leader in small box discount retail. 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 investing in our diverse teams through development, empowerment, and inclusion. As a growing retailer, we continue to create new jobs in the communities we serve. As evidence, we recently launched a national hiring event with the goal of hiring up to an additional 50,000 employees by Labor Day. I am pleased to note that we are on track to meet our goal.

[Jeff Owen, COO at Dollar General]

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. Because over 75% of our store associates at or above the lead sales associate position were internally placed, employees who join Dollar General know they have an opportunity to grow their career with us. We also continue to innovate on the development opportunities we can offer our teams, including continued expansion of our private fleet and those associated with DG Fresh, as well as pOpshelf. Importantly, we believe these efforts continue to yield positive results across our store base, as evidenced by a robust internal promotion pipeline and staffing above traditional levels. We also held our annual leadership meeting earlier this month, resulting in a rich and virtual development experience for more than 1,500 leaders of our company.

[Jeff Owen, COO at Dollar General]

This is one of my favorite events every year, and I was once again inspired by the incredible talent and dedication of our people. In closing, I am proud of our team's performance as we continue to advance our operating priorities and strategic initiatives. Overall, we are very pleased with our position as we head into the back half of the year, and I'm excited about the significant growth opportunities ahead. I want to offer my sincere thanks to each of our more than 159,000 employees across the company for their unwavering commitment to fulfilling our mission of serving others. With that, operator, we would now like to open the lines for questions.

[Operator]

Thank you. At this time, we'll be conducting a question-and-answer session. If you'd like to ask a question, please press star one on your telephone keypad. We ask that you please limit to one question and one follow-up if necessary. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it's necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from Rupesh Parikh with Oppenheimer. Please proceed with your question.

[Rupesh Parikh, Analyst at Oppenheimer]

Good morning. Thanks for taking my question. Todd, I wanted to go back to one of the comments you made in the script. You said Q3 is off to a good start or a great start, you said. Any more color you can provide in terms of what you guys are seeing?

[Todd Vasos, CEO at Dollar General]

Yeah, Rupesh, we are happy with the way Q3 started out. Back to school is doing very well for us. We got all of our product that we anticipated getting from overseas, as well as domestically. The consumer has a little extra money in their pocket. As evidenced by our guidance in the back half, we feel pretty good about our sales line as we go forward.

[Rupesh Parikh, Analyst at Oppenheimer]

Okay, great. Maybe just one follow-up just on the gross margin line for John. Any more color you can provide in terms of the puts and takes to think about on the gross margin line in the back half of the year? If you look at the distribution and freight pressures, would you expect them to persist into next year?

[John Garratt, CFO at Dollar General]

In terms of gross margin, and I'll start by saying we're very pleased with the performance, up 62 basis points year-to-date, while down 80 basis points in Q2. We're up 87 basis points over Q2 2019 as we continue to see initiatives like DG Fresh, NCI, and others really contributing. Like with our Q2 results, we do expect some continued pressure on gross margin in the second half, due primarily to inflation, which we believe to be transitory but related to higher transportation costs.

[John Garratt, CFO at Dollar General]

Higher than previously expected. Of course, we're seeing elevated demand with the great sales, and that's resulting in some transportation and supply capacity challenges with our third-party carriers. On top of that, we did mention a higher LIFO provision as a result of product cost increases. Some others have seen similar inflation and passed some of that along. Of course, we have a very challenging lap, as we talked about with the year-over-year mix. In Q2, we lapped 40% non-consumable sales, and so while non-consumable business is still doing fabulously, it's a very difficult lap in the back half. Certainly, you have a very favorable last year mix profile with that mix. You also had unusually low clearance activity associated with non-consumables on that high sell-through. While we expect to continue to do well, it provides a challenging lap.

[John Garratt, CFO at Dollar General]

A difficult lap, near-term inflationary pressures, which again, we believe to be transitory. As you look ahead, we believe still that with the growing benefit from initiatives, with all the levers at our disposal between private brands, foreign sourcing, shrink, supply chain efficiencies as we get through the near-term pressures, and of course, category management and of course, our scale, we believe we're in a great position to continue to expand margins over the long term and believe we're in a great spot right now in terms of price too, and don't see the need to invest there. Near-term pressure for sure, but the fundamentals of the business, I would say, are stronger than ever, and we feel very good about the future.

[John Garratt, CFO at Dollar General]

In terms of how long this persists, we said that we expect this to be elevated through the end of the year, at least through Chinese New Year. It's hard to say how long beyond that. This is really a supply and a demand issue. We would expect this to start to normalize, but it's hard to say. Hopefully as we push through next year, but hard to say exactly when that will happen.

[Rupesh Parikh, Analyst at Oppenheimer]

Great. Thank you. Best of luck for the balance of the year.

[Operator]

Our next question comes from Matthew Boss with JPMorgan. Please proceed with your question.

[Matthew Boss, Analyst at JPMorgan]

Todd, could you speak to new customer acquisition that you're seeing today coming out of this crisis? Maybe if we compared it to customer acquisition or customers that shop Dollar General for the first time coming out of the financial crisis. With that, if you think about the behavior that you're seeing near term, how would you map out traffic versus basket moving forward, just again, given the current customer behavior that you're seeing today?

[Todd Vasos, CEO at Dollar General]

Yeah, Matt, that's a great question, and I tell you what, we are very pleased with what we are seeing with that consumer, especially that new consumer. When you think about we launched that retention program back last summer and really pushed the pedal down, if you will, as we moved through the back half of last year, and we never took our foot off the accelerator. I'm happy to say that right now through second quarter, what we're seeing is double our expectation of that retention rate of that newfound consumer. That is higher by a long shot, quite frankly, than what we saw in 2008 during the financial crisis. I attribute that, quite frankly, to the relevancy of this box that we have today.

[Todd Vasos, CEO at Dollar General]

While we made some really nice changes in coming out of that 2008-2009 timeframe, this box now is much more relevant, I think the important piece is much more relevant across a broad spectrum of the consumer base. I believe that's why we're keeping that consumer. When you think about how that mix is looking, as John indicated, we are very pleased with our non-consumable or discretionary side. That is really enhanced compared to 2008 when you really go back to take a look at it. Not only our consumable business, but our non-consumable business is doing very well. As I look at how some of the other components are looking, think about units for a moment. On a two-year stack basis, our units are up 11.5%. That is very strong.

[Todd Vasos, CEO at Dollar General]

That's, again, a real testament to the ability for us to drive that top line with these new consumers. Our existing consumers still see that value, obviously, that she needs. We'll continue to watch that as we go forward. Our goal, as you know, long term, is always to drive that traffic number. This consumer, especially our core consumer, acts a little different when she has a little extra money. Just as a reminder, when she has extra money in her pocket, we saw it in 2008, we see it now. She comes a little less often, spends more when she comes in, and we've seen that on our numbers. Matter of fact, our two-year stack traffic number is up about 25%. Again, very robust.

[Todd Vasos, CEO at Dollar General]

We believe when things start to normalize and some of this extra money that is in the system through government stimulus may start to wane here, we believe that she'll start coming more often and probably spending a little less, getting back to a normal shopping pattern most likely, Matt.

[Matthew Boss, Analyst at JPMorgan]

That's great color. Maybe just as a follow-up, Todd, or maybe even Jeff, I guess by category, where do you see the most low-hanging fruit remaining on the market share front as we think about where you're focusing your initiative efforts coming out of the pandemic from here?

[Jeff Owen, COO at Dollar General]

Thank you, Matt. This is Jeff. I'm really proud of the team's ability to really, as you know, they do such a great job of knowing what the customer wants, talking to our customers, but also our category management skills and our supply chain and our operators give us a lot of flexibility to be able to serve that customer the way she wants to be served. Very pleased with our DG Fresh rollout and the ability that gives us to continue to broaden that assortment in that very important category for that customer. Very pleased at the gains that we're seeing there. Of course, also, very pleased at our ability to continue to grow our health and beauty business, and very pleased at the share we've seen there as well.

[Jeff Owen, COO at Dollar General]

Quite frankly, as you think about it, very pleased overall at our ability to grow share in the quarter. When you look at it on a two-year basis as well, very pleased and strong results. I would say as we look forward, our goal is always to make this box the most relevant it can be and to serve the customer the way she wants to be served and, quite frankly, our teams do that better than anybody.

[Matthew Boss, Analyst at JPMorgan]

That's great color. Best of luck.

[Todd Vasos, CEO at Dollar General]

Thank you.

[Jeff Owen, COO at Dollar General]

Thank you, Matt.

[Operator]

Our next question comes from Simeon Gutman with Morgan Stanley. Please proceed with your question.

[Simeon Gutman, Analyst at Morgan Stanley]

Hi, good morning, everyone. I wanted to ask on the algorithm into 2022. I know it's early and we're not talking guidance, maybe just some of the puts and takes on the top line. Compares will start to ease when you get into next year, we're also going to be lapping all the stimulus. Margin picture, some of the pressures could linger into next year. Curious if, I don't think you'll commit to any algo, how the puts and takes look in relation to the long-term algo for this business.

[John Garratt, CFO at Dollar General]

Yes, Simeon. I'll start by saying that we feel great about the fundamentals, and I've never felt better about the algorithm. I'm not going to, obviously, give any specific guidance on 2022, as we don't normally at this point, and obviously things are fluid in terms of the duration and depth of the pandemic and how long these inflationary pressures persist. As we said, we do believe these are transitory. The team's doing a great job to mitigate these, and that would provide a tailwind at some point as these, we believe, normalize, as well as we get to more normalized mix levels. Again, that's the other big pressure this year is just lapping unusually high non-consumable sales and unusually low clearance activity.

[John Garratt, CFO at Dollar General]

As you look at the fundamentals, as we've said before, we were at the high end of our 2%-4% algorithm going into this. We are delighted with what we've seen in terms of the stickiness of the new customers we've brought in, even above expectations, as well as how we've been able to hold onto these larger baskets. I think the brand's never been more relevant, and I think this really bodes well going forward on the sales momentum with the initiatives really coming together to help the bottom line and the top line. Again, what we're doing to hang on to these new customers and bigger baskets with this fuller fill-in trip we've been able to provide with the initiatives.

[John Garratt, CFO at Dollar General]

In terms of the gross margin, would say we still see growing benefit from our strategic initiatives, with more to come, and still have all the levers I mentioned at our disposal and see a lot of opportunity there as things normalize. As we push through these, again, what we believe to be transitory pressures, we see ourselves in a position to continue to expand our gross margin. Again, when you tease out the impact of the strategic initiatives to leverage our SG&A at the rates that we have done in the past. Again, the business generates a tremendous amount of cash, which allows us to buy back shares. We feel good all around with the outlook for the business and believe the algorithm is very well intact.

[John Garratt, CFO at Dollar General]

When you look at real estate, that's the other piece I would point to that bodes very well for the future in terms of upping the potential units for everybody in our space to 17,000 units. We're seeing unit-level economics as good as ever. We continue to innovate with new formats that continues to extend the runway. Feel great about the algorithm. We'll comment on the specifics of 2022 as we go into the next year.

[Simeon Gutman, Analyst at Morgan Stanley]

Okay. Thanks for that. The follow-up is regarding the second half, the SNAP and childcare tax credits, how much, if any, is factored into your second half top-line guide?

[John Garratt, CFO at Dollar General]

Yeah, what I would say is we've considered all of that, and I would say there's a lot of moving pieces here that seemingly are directionally offsetting. You do have the roll-off of the enhanced unemployment benefits, which is a bit of a headwind, you have the child tax credit, which is a bit of a tailwind. When you look at SNAP, there's puts and takes there that are directionally offsetting. The 15% benefit expires on October 1st, with the USDA's action with the Thrifty Food Plan, that puts back some enhanced benefits. They did extend the emergency supplemental benefits, which allows waivers. Waivers allows folks to get maximum benefits regardless of income.

[John Garratt, CFO at Dollar General]

As you look at all the pieces, it's hard to say exactly what the net impact would be, but right now it looks directionally offsetting, and that's contemplated in the guidance, and we feel very good about the guidance based on what we know now.

[Simeon Gutman, Analyst at Morgan Stanley]

Thanks. Appreciate it.

[Operator]

Our next question comes from Karen Short with Barclays. Please proceed with your question.

[Karen Short, Analyst at Barclays]

Hi. Thanks very much. On guidance and the implied second half, you obviously raised your top-line guidance for the full year, but not obviously raised the second half. When we look at the guidance for the EBIT margin implied guide for the second half come down despite the higher sales. I realize you did call out one or two things, but I still can't get it to quite account for the change in what the implied EBIT margin guidances for the second half. Maybe a little more color there. I had another bigger picture question.

[John Garratt, CFO at Dollar General]

Okay. No, good question, Karen. I'll start by saying we feel good about the updated guidance based on the strong first half results. As you mentioned, we did raise our sales outlook. We raised the floor on EPS, held the ceiling on the EPS guidance. I think when you look at the two-year lap, it's important to look at what this implies in terms of a two-year CAGR, and that's a CAGR of 20%-24%. We feel great about that outsized performance relative to the algorithm. What I would tell you is we have seen, as we mentioned, increased pressure from freight, and so that is the limiting factor here in terms of the ability to take that up. As others saw, we did see heightened pressures around transportation to a lesser extent.

[John Garratt, CFO at Dollar General]

We mentioned with our LIFO provision, we did see higher costs in terms of product cost, and that's largely a function of some transportation costs being passed through. Really that's the driver of that. Again, I would tell you we feel great about the fundamentals of the business. Never been better. We're going to wait and see how things play out. That's really the pressures as we look at the back half of the year. Again, we believe them to be transitory in nature, and very pleased with the performance based on the guide that the guidance would indicate in terms of being a step change to the top line and the bottom line over the normal algorithm.

[Karen Short, Analyst at Barclays]

Okay. That's helpful. Then I guess there's kind of this view in general that the lower-end consumer will really struggle next year as all these benefits lap. I think there's some perspective that that will negatively impact you disproportionately. I'm not sure I agree with that. How do you think about the puts and takes to DG if that is true in general in terms of your core customer feeling much more challenged?

[Todd Vasos, CEO at Dollar General]

Yeah, Karen, this is Todd. I'll take that one. I would tell you, we feel very good about this core customer. Also remember the customer that we've retained during this pandemic and continue to retain. We feel very good about keeping her well engaged into next year as well. You couple that with all the initiatives that we have in front of us, both in play and, as you heard from Jeff, some newer ones like healthcare that will in fact start to play out as we go into next year, but even longer term than that. When you start to think about who we are, right, and who we serve, we're an all-weather brand and always have been, and it's even more pronounced now, I believe, than ever before, right? When times are good, we do pretty well.

[Todd Vasos, CEO at Dollar General]

When times aren't so good, that consumer needs us more, and now we've got that new trade-in customer that we've gotten that seemingly will have a little bit more money even when times turn a little negative for our core customer. Once again, we feel good about it. We're not prepared to give guidance yet for 2022. We here always control what we can control. We feel good about that algorithm over time growing the comp set 2%-4% over the long term. That is still our vision, and we work toward that each and every day.

[Karen Short, Analyst at Barclays]

Great. Thanks very much.

[Todd Vasos, CEO at Dollar General]

Sure.

[Operator]

Our next question comes from Michael Lasser with UBS. Please proceed with your question.

[Michael Lasser, Analyst at UBS]

Good morning. Thanks a lot for taking my question. Todd, do you feel like you've worked off some of the excess that a lot of the consumable retailers experienced during the heart of the pandemic? Another way to look at it is your guidance for the back half of the year implies two-year compound annual sales growth rate of 9%-10%, which is largely consistent with what you were doing in 2019 prior to the pandemic. As other consumable retailers are experiencing a drag from a further return to normalcy and less meal occasions at home, perhaps you'll face less of a drag because your workers have been working at a work site the whole time. You've got new customers and you've got your initiatives such that you've entered into a sustainable sales rhythm from here.

[Todd Vasos, CEO at Dollar General]

Well, we look at all that, as you say, Michael. I would tell you that we do feel good about where this consumer is and how she lines up, if you will, based on what is ahead of her. Again, that whole notion of what we can control is really what we're squarely focused on. Yeah, I would tell you the implied number that you're talking about is in that 4%-5% type of a comp rate. Whether we hit that or not, that's still well on top of our algorithm, if you will. We feel good about it. I don't want to get ahead of our skis and say that it'll be even better.

[Todd Vasos, CEO at Dollar General]

I would tell you with the initiatives that we have and the retention rates we're seeing from that new consumer, that's what gives us the confidence to raise that sales guidance in the back half of this year and will propel us into 2022.

[Michael Lasser, Analyst at UBS]

Okay. My follow-up question is on the gross margin, the 87 basis points increase over 2019. Is it fair for us to assume half of that was due to your initiatives like DG Fresh and NCI, and the other half is from still a favorable environment where promotions have not returned to the level of 2019? Can you quantify, just for simplicity's sake, John, how much gross margin pressure you are expecting because of these elevated freight costs?

[John Garratt, CFO at Dollar General]

Yeah. When you strip out the noise of the freight costs, it is the same fundamental drivers, and we continue to see huge benefits from initiatives like DG Fresh, NCI. Again, we've been talking for several quarters around, as we kept calling out the three biggest drivers, it was lower product cost associated with DG Fresh. It was lower markdowns and favorable mix, and a big driver of that was NCI. We're continuing to see those benefits. They're continuing to grow. I don't want to give a specific number on that, but I would say that continues to be the biggest drivers of when you strip out the noise of what's been the biggest levers to improve our gross margin. That's not changed.

[John Garratt, CFO at Dollar General]

What has changed is, one, the much more difficult lap of NCI of the 40% non-consumable growth we lapped in this quarter, then the heightened pressures associated with freight and, to a lesser extent, product cost. The fundamentals are unchanged. That's really the drivers. We didn't give a specific number on freight, but what I would tell you is, as we listed out the headwinds, that was the number one headwind that we called out. Then we did say, as we look in the back half of the year, that similar to Q2, although we think it's transitory over the longer term, that continued to be a growing headwind for us versus what we previously thought.

[Michael Lasser, Analyst at UBS]

Got it. Thank you so much.

[Operator]

Our next question comes from John Heinbockel with Guggenheim Partners. Please proceed with your question.

[John Heinbockel, Analyst at Guggenheim Partners]

Hey, Todd, I got two, but I want to start with, you guys have always said the biggest share donor to you are the drugstores. I'm curious about your thoughts on healthcare, and then in particular, when you think about services, product, maybe is there an opportunity to partner with independent pharmacists in a way? How do you think about the sources and magnitude of that opportunity? Does that rise to a NCI-type of opportunity, do you think, in magnitude?

[Todd Vasos, CEO at Dollar General]

Yeah, John, that's a great question, and thanks for asking it because we're pretty excited about what this healthcare initiative could hold. I want to caution everybody, this will be a journey over many years. What we're going to be squarely focused on here is exactly what you talked about, those services that rural America today, especially, doesn't have access to. We talk a lot about grocery deserts or food deserts. There's as equal healthcare deserts out there across the U.S., and we're in all of these communities. When you step back from that, with my background in health, we really know that there's an opportunity for these services.

[Todd Vasos, CEO at Dollar General]

Whether it be eye care, as an example, whether it be telemedicine, whether it be prescription delivery, by the way, not pharmacies in our stores, but be able to order and maybe pick up inside of our store, those type of things, mail order. Could we benefit with a partnership? Possibly. We're going to be fishing all that out over the next many quarters. Could it be bigger than NCI? I think this could easily eclipse NCI. I don't want to get in front of our skis, but it could be a really big deal, not only for our top line and bottom line at Dollar General, but even more so, making that box even more relevant to those consumers in rural America that have to drive now 30-40 minutes for an eye exam, as an example, or even to see a doctor.

[Todd Vasos, CEO at Dollar General]

We believe that there's some real opportunity here. You can probably tell in my voice, I'm pretty excited about it, but the journey is just beginning.

[John Heinbockel, Analyst at Guggenheim Partners]

Maybe just as a follow-up to that, when you think about doing the store within a store in the DG Market, and I ask this all the time, but the box getting bigger, does a small version of DG Market eventually come on the radar screen again as another format, or you'd rather use the 8,500 sq ft to accomplish that?

[Todd Vasos, CEO at Dollar General]

No, John, we've got a smaller version of the DG Market already. Matter of fact, we continue to grow that. The genesis of that was the Walmart Express stores that we bought back a few years ago. We've cultivated those 44 stores we bought and have grown that format as well. We don't talk about it a lot because we believe that over time, it could be a big piece, though, of our rural strategy, especially as you just mentioned in that combo piece. Because we already have 75% of our stores within 5 mi radius of the overall population. If we could give her even more options, including healthcare, including pOpshelf inside of a smaller box, I believe it could be really powerful. I know Jeff believes that as well. We'll be working toward that over the next few years.

[John Heinbockel, Analyst at Guggenheim Partners]

Thank you.

[Todd Vasos, CEO at Dollar General]

You're welcome.

[Operator]

Our next question comes from Kelly Bania with BMO Capital. Please proceed with your question.

[Kelly Bania, Analyst at BMO Capital]

Hi. Good morning. Thanks for taking my question. Just in terms of freight, just to be clear, how much of that is domestic versus ocean freight? How much are you passing along or not passing along in the current environment?

[Todd Vasos, CEO at Dollar General]

Yeah. I would tell you that the majority of the headwind is coming from the import side of that equation. We have seen some tightness in the domestic market, pretty manageable overall there. It really is the import side that we feel is the headwind here. As far as passing along, what we do here at Dollar General probably better than most is negotiate with our vendors. With our size and scale, we've been doing that for many years. It's second nature to us, if you will. I would tell you that we've been able to offset some of these inflationary pressures that you've seen out there. Yet we have taken price in some instances. What I'm happy to say is that our price positioning is as good as it's ever been.

[Todd Vasos, CEO at Dollar General]

As you may remember, over the last few quarters, I've been very bullish on our positioning, and it's just as good as ever. I would tell you, we've been very thoughtful on passing along price because we know that our core consumer can ill afford very many price increases. We have the ability with just 10,000-12,000 SKUs to also pick and choose the SKUs that we offer our consumer. If we have some price increases that we don't believe we should pass on to her, we'll drop the SKU and move on to something else that, in fact, she'll need also, and we've done that a lot in the last quarter to two quarters.

[Kelly Bania, Analyst at BMO Capital]

Great. That's very helpful. Just also wanted to follow up on a comment you made. You talked about some of the puts and takes in terms of the macro in the back half, including the end of the extended unemployment benefits. I'm just curious what you are seeing in some of those states, both from impact on the top line when those states ended the benefits and also just in the wage and employee environment.

[John Garratt, CFO at Dollar General]

Yeah. What we have seen is when you look at the employee environment, I'll start with that. What we initially saw as those states rolled off the enhanced unemployment benefits, what we did see was an initial nice pickup in applicant flow and staffing. The good news now is we're seeing that across the system, and so it's hard to discern that impact now because everything is up, and so that's been helpful. We did see a little bit, not a huge impact, but we did see a little bit of a negative impact in states when the enhanced unemployment benefits rolled off. As I mentioned, then you have the benefit of the child tax credit, and that's why we said as we look at all the puts and takes, the way we see it now, we think it's directionally offsetting.

[Kelly Bania, Analyst at BMO Capital]

Thank you.

[Operator]

Our last question comes from Michael Montani with Evercore ISI. Please proceed with your question.

[Michael Montani, Analyst at Evercore ISI]

Thank you. Just had two things to ask on. One was just a little bit surprised on some of the discretionary headwind, given the strength that we've seen from some other retailers in that area. Just hoping you could help explain a little bit more why that would be a headwind, what's the timing for that to kind of roll off. The follow-up was on traffic.

[Todd Vasos, CEO at Dollar General]

Yeah. I would tell you, Michael, I think the discretionary headwind that we talk about really stems from the robust number we had last year. Last year, other retailers were either shut down still, limited hours, one-way aisles. I think you remember all of that. We were pretty much in full swing last year helping out all the communities that we serve. It was really on a two-year stack basis, we couldn't be more happier or proud of our discretionary business, and matter of fact, feel very robust about it going into the back half of the year and in years to come because of our NCI initiatives, because of our pOpshelf initiatives, and many other things that we're working on. Yeah, I wouldn't characterize it any other way other than on a year-over-year basis is really the headwind.

[Todd Vasos, CEO at Dollar General]

I would tell you that starts to subside as we move into 2022, right? Watch out for that as we move into 2022. Right now, we feel good about where we are on a discretionary platform basis.

[Michael Montani, Analyst at Evercore ISI]

Okay, great. Just wanted to clarify on the two-year traffic stack for 2Q and 1Q. Was 2Q a high single-digit decline on traffic if you do a two-year stack? Just trying to see how that's been trending.

[Todd Vasos, CEO at Dollar General]

Yeah. I would tell you, we really haven't said what those numbers were, as I mentioned earlier, just have to remember on the traffic side, you got two things that are in play here. Number one, you still have a consumer that is contracting her shopping patterns due to COVID-19, right? You still have some of that dynamic going on. Not as much as we saw last year, obviously. We're starting to see those traffic numbers come back, and I'll explain that in a second. What we're starting to see now is as stimulus starts to wane, COVID-19 in many states starting to wane. I know it's flaring in certain states a little less than others. The consumer's getting out more, and we're seeing our traffic numbers start to rebound.

[Todd Vasos, CEO at Dollar General]

What normally happens with our core consumer as that dynamic takes place, especially around her income levels, what we'll start to see is smaller basket sizes and more traffic. That's exactly what we're starting to see occur over the last couple of months, and we anticipate that to continue as we move through the back half of the year.

[Michael Montani, Analyst at Evercore ISI]

Got it. Thank you, and good luck.

[Operator]

We have reached the end of the question and answer session. At this time, I'd like to turn the call back over to Todd Vasos for closing comments.

[Todd Vasos, CEO at Dollar General]

Well, thank you very much for all the questions, and thanks for your interest in Dollar General. I want to start by saying how proud I am of this team, which continues to execute at a high level, resulting in another great quarter. As you heard today, we have a number of exciting initiatives in place, and we believe we are well-positioned to grow same-store sales, new stores, operating profit margins, and market share over time while providing a strong employee proposition. Overall, I'm proud of the year-to-date results, feel very good about the underlying business, and very optimistic about the future. Thank you for listening. I hope you have a great day. Thank you.

[Operator]

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

Participants

Executives

• Donny Lau, VP of Investor Relations and Corporate Strategy
• Jeff Owen, COO
• John Garratt, CFO
• Todd Vasos, CEO

Analysts

• John Heinbockel, Analyst at Guggenheim Partners
• Karen Short, Analyst at Barclays
• Kelly Bania, Analyst at BMO Capital
• Matthew Boss, Analyst at JPMorgan
• Michael Lasser, Analyst at UBS
• Michael Montani, Analyst at Evercore ISI
• Rupesh Parikh, Analyst at Oppenheimer
• Simeon Gutman, Analyst at Morgan Stanley