Dollar General Corporation — Form 10-Q Summary
Period and filing: The filing covers the 13 and 26 weeks ended July 29, 2011, with comparisons to periods ended July 30, 2010. The request metadata says “2010 Q2,” but the filing itself is for fiscal 2011 Q2. Financial statements are unaudited; the independent accountant performed a review, not an audit.
Business context and reporting period
Dollar General operated 9,641 stores in 35 states as of July 29, 2011, with one reportable segment. It sells consumables, seasonal goods, home products and apparel. Fiscal 2011 is a 53-week year ending February 3, 2012. The company described its customers as value-conscious and cited continued economic uncertainty, elevated commodity and fuel costs, and pressure on discretionary spending.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Net sales | $3.575 billion | $3.214 billion | $7.027 billion | $6.325 billion |
| Gross profit | $1.148 billion | $1.036 billion | $2.236 billion | $2.036 billion |
| Operating profit | $350.0 million | $300.8 million | $671.6 million | $591.5 million |
| Net income | $146.0 million | $141.2 million | $303.0 million | $277.2 million |
| Diluted EPS | $0.42 | $0.41 | $0.88 | $0.80 |
- Sales and margins: Q2 sales grew 11.2%; same-store sales rose 5.9%, reflecting higher traffic and average transaction amounts. First-half sales grew 11.1%, with same-store sales up 5.6%. Q2 gross margin was 32.12% versus 32.23%; first-half gross margin was 31.82% versus 32.18%. Q2 operating margin improved to 9.79% from 9.36%; first-half operating margin was 9.56% versus 9.35%.
- Profit drivers: Q2 SG&A was 22.33% of sales versus 22.87%, benefiting from sales growth, workforce-management savings and other cost initiatives. Interest expense fell to $60.7 million from $69.3 million in Q2, and to $126.2 million from $141.3 million in the first half. A $58.1 million pretax debt-retirement loss materially offset Q2 earnings growth.
- Cash flow: First-half operating cash flow was $398.4 million, up from $279.3 million. Capital expenditures were $218.1 million, versus $163.1 million; operating cash flow less property purchases was therefore approximately $180.3 million, compared with $116.8 million. Cash fell to $113.1 million from $497.4 million at fiscal year-end, principally amid debt repayments and refinancing.
- Balance sheet and liquidity: At July 29, cash was $113.1 million, inventory $1.974 billion, current assets $2.273 billion and current liabilities $1.527 billion. Long-term obligations were $2.779 billion. The company reported $346.0 million drawn on its ABL revolver and $641.6 million available, subject to borrowing-base limits; it stated that cash, operating flows and credit availability should cover obligations and planned spending. Inventory increased 12% during the first half.
Material changes versus the prior comparable period
- Higher sales and lower SG&A as a percentage of sales supported improved operating profit and net income. Consumables increased to 73.03% of Q2 sales from 71.48%, while non-consumables remained pressured.
- Gross margin declined slightly in Q2 and more noticeably for the first half. Management attributed the pressure to a sales mix shift toward lower-margin consumables, higher product, commodity and fuel costs, larger LIFO provisions, and first-quarter markdowns. Q2 LIFO provision was $10.7 million versus $0.7 million; first-half provision was $14.2 million versus $0.7 million.
- The company redeemed its remaining $839.3 million of 10.625% senior notes in July, using cash and ABL borrowings, after repurchasing $25.0 million in April. These transactions generated $60.3 million of first-half pretax losses. Long-term obligations were down $572 million from the prior year, according to management.
- Inventory turnover decreased to 5.1 times from 5.2 times on a rolling four-quarter basis, which management linked partly to expanded merchandise offerings and advance inventory purchases.
Outlook, risks and unusual items
- Plans: Management planned approximately 625 new stores in fiscal 2011; 301 had opened by July 29. It projected fiscal 2011 capital expenditures of $550–$600 million. The company planned entry into Connecticut, New Hampshire and Nevada, and was developing plans for California in 2012. No specific earnings or sales guidance was provided.
- Outlook commentary: Management expected uncertainty in product and transportation-fuel costs to persist and said these, along with a sales mix weighted toward consumables and weak discretionary demand, were likely to pressure gross margin in the second half and full year. It did not expect non-consumables’ share of sales to exceed fiscal 2010 levels.
- Debt and interest-rate exposure: The company had $450.7 million of 11.875%/12.625% senior subordinated notes due 2017, a $1.964 billion term loan, and $346.0 million outstanding under the ABL. Its senior secured debt-to-Adjusted-EBITDA ratio was 1.3 to 1, below the 4.25-to-1 threshold cited for the incurrence test. Three interest-rate swaps had $686.7 million notional value; management estimated $15.4 million of accumulated hedge losses would be reclassified as additional interest expense over the next 52 weeks.
- Legal and tax contingencies: A proposed $18.75 million settlement of the Womack equal-pay matter, including $15.5 million for a class fund and $3.25 million in legal fees and costs, remained subject to court approval. The company expected approximately $15.9 million of insurance reimbursement. The Richter wage-and-hour action could have a material adverse effect, but the company said it could not estimate a potential loss. It likewise could not reasonably estimate potential losses in the Winn-Dixie restrictive-covenant litigation. Uncertain tax reserves totaled $29.4 million; the company said approximately $1.4 million might be reduced within 12 months.
- Other risks: Management cited economic conditions, commodity and fuel costs, inventory shrink and valuation estimates, seasonality, supply-chain disruption, competition, litigation, debt restrictions and credit-rating changes. S&P and Moody’s had upgraded the company’s corporate ratings in July 2011, both with stable outlooks. Disclosure controls were reported effective, with no material change in internal control during the quarter.
Important facts for investors to verify
- Confirm the period: this is fiscal 2011 Q2, not 2010 Q2, and compare results with the intended period.
- Track whether gross-margin pressure from product costs, LIFO and consumables mix continues, and whether sales growth and cost savings offset it.
- Assess cash generation, inventory growth, planned capital spending, and continued reliance on ABL availability after the senior-note redemption.
- Verify court approval and insurance recovery for the proposed Womack settlement, and monitor developments in the Richter and Winn-Dixie cases.
- Review the effect of the remaining high-coupon subordinated notes, variable-rate debt and interest-rate hedges on future interest expense and liquidity.