UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

QUARTERLY REPORT

PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended October 28, 2016

 

Commission File Number: 001-11421

 

DOLLAR GENERAL CORPORATION

(Exact name of Registrant as specified in its charter)

 

 

100 MISSION RIDGE

GOODLETTSVILLE, TN  37072

(Address of principal executive offices, zip code)

 

Registrant’s telephone number, including area code:  (615) 855-4000

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).  Yes ☒  No ☐

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

 

The registrant had 276,264,260 shares of common stock outstanding on November 28, 2016.

 

 

 

 

PART I—FINANCIAL INFORMATION

 

ITEM 1.FINANCIAL STATEMENTS.

 

DOLLAR GENERAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

 

 

See notes to condensed consolidated financial statements.

 

DOLLAR GENERAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(In thousands, except per share amounts)

 

 

See notes to condensed consolidated financial statements.

 

DOLLAR GENERAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(In thousands)

 

 

See notes to condensed consolidated financial statements.

 

DOLLAR GENERAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

 

See notes to condensed consolidated financial statements.

DOLLAR GENERAL CORPORATION AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.Basis of presentation

 

The accompanying unaudited condensed consolidated financial statements of Dollar General Corporation and its subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and are presented in accordance with the requirements of Form 10-Q and Rule 10-01 of Regulation S-X. Such financial statements consequently do not include all of the disclosures normally required by U.S. GAAP for annual financial statements or those normally made in the Company’s Annual Report on Form 10-K, including the condensed consolidated balance sheet as of January 29, 2016 which has been derived from the audited consolidated financial statements at that date. Accordingly, readers of this Quarterly Report on Form 10-Q should refer to the Company’s Annual Report on Form 10-K for the fiscal year ended January 29, 2016 for additional information.

 

The Company’s fiscal year ends on the Friday closest to January 31. Unless the context requires otherwise, references to years contained herein pertain to the Company’s fiscal year. The Company’s 2016 fiscal year is scheduled to be a 53-week accounting period ending on February 3, 2017, and the 2015 fiscal year was a 52-week accounting period that ended on January 29, 2016.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the Company’s customary accounting practices. In management’s opinion, all adjustments (which are of a normal recurring nature) necessary for a fair presentation of the consolidated financial position as of October 28, 2016 and results of operations for the 13-week and 39-week accounting periods ended October 28, 2016 and October 30, 2015 have been made.

 

The preparation of financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Because the Company’s business is moderately seasonal, the results for interim periods are not necessarily indicative of the results to be expected for the entire year.

 

The Company uses the last-in, first-out (“LIFO”) method of valuing inventory. An actual valuation of inventory under the LIFO method is made at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels, sales for the year and the expected rate of inflation or deflation for the year. The interim LIFO calculations are subject to adjustment in the final year-end LIFO inventory valuation. The Company recorded a LIFO (benefit) of $(3.8) million and $(1.7) million in the respective 13-week periods, and $(8.1) million and $(2.3) million in the respective 39-week periods, ended October 28, 2016 and October 30, 2015. In addition, ongoing estimates of inventory shrinkage and initial markups and markdowns are included in the interim cost of goods sold calculation.

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued comprehensive new accounting standards related to the recognition of revenue, which specified an effective date for annual reporting periods beginning after December 15, 2016, with early adoption not permitted. In August 2015, the FASB deferred the effective date to annual reporting periods beginning after December 15, 2017, with earlier adoption permitted only for annual reporting periods beginning after December 15, 2016. The new guidance allows for companies to use either a full retrospective or a modified retrospective approach in the adoption of this guidance. The Company is currently evaluating these transition approaches, as well as the potential timing of adoption and the effect of adoption on its consolidated financial statements.

 

In February 2016, the FASB issued new guidance related to lease accounting, which when effective will require a dual approach for lessee accounting under which a lessee will account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability on its balance sheet, with differing methodology for income statement recognition. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after

December 15, 2018, and early adoption is permitted. A modified retrospective approach is required for all leases existing or entered into after the beginning of the earliest comparative period in the consolidated financial statements. The Company is currently assessing the impact that adoption of this guidance will have on its consolidated financial statements and is anticipating a material impact because the Company is party to a significant number of lease contracts.

 

In March 2016, the FASB issued amendments to existing guidance related to accounting for employee share-based payment affecting the income tax consequences of awards, classification of awards as equity or liabilities, and classification on the statement of cash flows. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is permitted. The Company adopted this guidance in the first quarter of 2016. The Company has elected to continue estimating forfeitures of share-based awards. The amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement were applied prospectively resulting in a benefit for the 39 weeks ended October 28, 2016 of approximately $10.9 million, or $0.04 per diluted share. The Company has elected to apply the amendments related to the presentation of excess tax benefits on the statement of cash flows using a retrospective transition method, and as a result, $28.6 million of excess tax benefits related to share-based awards which were previously classified as cash flows from financing activities for the 39 weeks ended October 30, 2015 have been reclassified as cash flows from operating activities.

 

In October 2016, the FASB issued amendments to existing guidance related to accounting for intra-entity transfers of assets other than inventory. These amendments require an entity to recognize the income tax consequences of such transfers when the transfer occurs and affects the Company’s historical accounting for intra-entity transfers of certain intangible assets. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted subject to certain guidelines. The amendments should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company is currently assessing the impact that adoption of this guidance will have on its consolidated financial statements, but expects such adoption will result in an increase in deferred income tax liabilities and a decrease in retained earnings.

 

 

2. Earnings per share

 

Earnings per share is computed as follows (in thousands, except per share data):

 

 

 

Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is determined based on the dilutive effect of share-based awards using the treasury stock method.

 

Share-based awards that were outstanding at the end of the respective periods, but were not included in the computation of diluted earnings per share because the effect of exercising such awards would be antidilutive, were

1.9 million and 1.6 million in the 2016 and 2015 13-week periods, respectively, and were 1.6 million and 1.2 million in the 2016 and 2015 39-week periods, respectively.

 

3.Income taxes

 

Under the accounting standards for income taxes, the asset and liability method is used for computing the future income tax consequences of events that have been recognized in the Company’s consolidated financial statements or income tax returns.

 

Income tax reserves are determined using the methodology established by accounting standards for income taxes which require companies to assess each income tax position taken using the following two-step approach. A determination is first made as to whether it is more likely than not that the position will be sustained, based upon the technical merits, upon examination by the taxing authorities. If the tax position is expected to meet the more likely than not criteria, the benefit recorded for the tax position equals the largest amount that is greater than 50% likely to be realized upon ultimate settlement of the respective tax position.

 

The Company’s 2011 and earlier tax years are not open for further examination by the Internal Revenue Service (“IRS”). Due to the filing of an amended federal income tax return for the 2012 tax year, the IRS may, to a limited extent, examine the Company’s 2012 income tax filings. The IRS, at its discretion, may choose to examine the Company’s 2013 through 2015 fiscal year income tax filings. The Company has various state income tax examinations that are currently in progress. Generally, the Company’s 2012 and later tax years remain open for examination by the various state taxing authorities.

 

As of October 28, 2016, the total reserves for uncertain tax benefits, interest expense related to income taxes and potential income tax penalties were $6.3 million, $1.0 million and $0.9 million, respectively, for a total of $8.2 million. This total amount is reflected in noncurrent Other liabilities in the condensed consolidated balance sheet.

 

The Company believes it is reasonably possible that the reserve for uncertain tax positions may be reduced by approximately $5.2 million in the coming twelve months principally as a result of the effective settlement of uncertain tax positions. As of October 28, 2016, approximately $6.3 million of the reserve for uncertain tax positions would impact the Company’s effective income tax rate if the Company were to recognize the tax benefit for these positions.

 

The effective income tax rates for the 13-week and 39-week periods ended October 28, 2016 were 36.2% and 36.1%, respectively, compared to rates of 37.0% and 37.6%, respectively, for the 13-week and 39-week periods ended October 30, 2015. The tax rate for the 2016 13-week period was lower than for the comparable 2015 period primarily due to the retroactive enactment in 2015 of federal jobs tax credits (principally the Work Opportunity Tax Credit or “WOTC”) for employees hired after December 31, 2014.  The tax rate for the 2016 39-week period was lower than for the comparable 2015 period primarily due to the retroactive enactment of the WOTC as well as the 2016 adoption of amendments to accounting guidance for share-based payment discussed in Note 1. While the Company eventually did benefit from the WOTC associated with employees hired in the 13-week and 39-week periods ended October 30, 2015, the benefit could not be recognized until the federal laws authorizing the credits were retroactively reenacted in December 2015.

 

4.Current and long-term obligations

 

The Company’s senior unsecured credit facilities (the “Facilities”) consist of a $425.0 million senior unsecured term loan facility (the “Term Facility”) and a $1.0 billion senior unsecured revolving credit facility (the “Revolving Facility”) which provides for the issuance of letters of credit up to $175.0 million. The Facilities are scheduled to mature on October 20, 2020.

 

As of October 28, 2016, the entire balance of the Term Facility was outstanding, and under the Revolving Facility, the Company had no outstanding borrowings, outstanding letters of credit of $15.5 million, and borrowing availability of $984.5 million that, due to reserved borrowing availability related to the commercial paper program described below, could contribute incremental liquidity of $531.5 million. In addition, as of October 28, 2016 the Company had outstanding letters of credit of $33.6 million which were issued pursuant to separate agreements.

 

On August 1, 2016, the Company established a commercial paper program under which the Company may issue unsecured commercial paper notes (the “CP Notes”).  Under this program, the Company may issue the CP Notes

from time to time in an aggregate amount not to exceed $1.0 billion outstanding at any time.  The CP Notes have maturities of up to 364 days from the date of issue and rank equal in right of payment with all of the Company’s other unsecured and unsubordinated indebtedness.  The Company has agreed to maintain available commitments under the Revolving Facility in an amount at least equal to the amount of CP Notes outstanding at any time. As of October 28, 2016, the Company had outstanding CP notes of $453.0 million classified as long-term obligations on the consolidated balance sheet due to its intent and ability to refinance these obligations as long-term debt.

 

The Company also has multiple series of senior notes (collectively, the “Senior Notes”) outstanding with varying maturity dates through 2025 which had an aggregate book value of $2.3 billion at October 28, 2016 and January 29, 2016. As of October 28, 2016, the Company’s $500.0 million 4.125% Senior Notes due July 15, 2017 are classified as Current portion of long-term obligations.

 

5.Assets and liabilities measured at fair value

 

Fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, fair value accounting standards establish a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). The Company does not have any fair value measurements categorized within Level 3 as of October 28, 2016.

 

The following table presents the Company’s assets and liabilities disclosed at fair value as of October 28, 2016, aggregated by the level in the fair value hierarchy within which those measurements are classified.

 

 

 

6.Commitments and contingencies

 

Legal proceedings

 

In September 2011, the Chicago Regional Office of the United States Equal Employment Opportunity Commission (“EEOC” or “Commission”) notified the Company of a cause finding related to the Company’s criminal background check policy.  The cause finding alleges that the Company’s criminal background check policy, which excludes from employment individuals with certain criminal convictions for specified periods, has a disparate impact on African-American candidates and employees in violation of Title VII of the Civil Rights Act of 1964, as amended (“Title VII”).

 

The Company and the EEOC engaged in the statutorily required conciliation process, and despite the Company's good faith efforts to resolve the matter, the Commission notified the Company on July 26, 2012 of its view that conciliation had failed.

 

On June 11, 2013, the EEOC filed a lawsuit in the United States District Court for the Northern District of Illinois entitled Equal Opportunity Commission v. Dolgencorp, LLC d/b/a Dollar General in which the Commission alleges that the Company’s criminal background check policy has a disparate impact on “Black Applicants” in violation of Title VII and seeks to recover monetary damages and injunctive relief on behalf of a class of “Black Applicants.”  The Company filed its answer to the complaint on August 9, 2013.

 

The court has bifurcated the issues of liability and damages for purposes of discovery and trial.  Fact discovery related to liability is to be completed on or before April 17, 2017. In response to various discovery motions, the court has entered orders requiring the Company’s production of documents, information and electronic data for the period 2004 to present.

 

Currently pending is the EEOC’s Motion for Partial Summary Judgment relating to two of the Company’s defenses challenging the sufficiency of the Commission’s conciliation efforts and the scope of its investigation.

 

The Company believes that its criminal background check process is both lawful and necessary to a safe environment for its employees and customers and the protection of its assets and shareholders’ investments.  The Company also does not believe that this matter is amenable to class or similar treatment.  However, at this time, it is not possible to predict whether the action will ultimately be permitted to proceed as a class or in a similar fashion or the size of any putative class.  Likewise, at this time, it is not possible to estimate the value of the claims asserted, and no assurances can be given that the Company will be successful in its defense of this action on the merits or otherwise.  For these reasons, the Company cannot estimate the potential exposure or range of potential loss.  If the matter were to proceed successfully as a class or similar action or the Company is unsuccessful in its defense efforts as to the merits of the action, the resolution of this matter could have a material adverse effect on the Company’s consolidated financial statements as a whole.

 

On May 23, 2013, a lawsuit entitled Juan Varela v. Dolgen California and Does 1 through 50 (“Varela”) was filed in the Superior Court of the State of California for the County of Riverside.  In the original complaint, the Varela plaintiff alleges that he and other “key carriers” were not provided with meal and rest periods in violation of California law and seeks to recover alleged unpaid wages, injunctive relief, consequential damages, pre-judgment interest, statutory penalties and attorneys’ fees and costs and seeks to represent a putative class of California “key carriers” as to these claims.  The Varela plaintiff also asserts a claim for unfair business practices and seeks to proceed under California’s Private Attorney General Act (the “PAGA”).

 

On November 4, 2014, the Varela plaintiff filed an amended complaint to add Victoria Lee Dinger Main as a named plaintiff and to add putative class claims on behalf of “key carriers” for alleged inaccurate wage statements and failure to provide appropriate pay upon termination in violation of California law.

 

The Company filed answers to both the complaint and amended complaint.  The court recently vacated the deadlines for the filing of motions related to class certification in light of other discovery matters pending before the court.  No new deadlines have been set.   

 

On January 15, 2015, a lawsuit entitled Kendra Pleasant v. Dollar General Corporation, Dolgen California, LLC, and Does 1 through 50 (“Pleasant”) was filed in the Superior Court of the State of California for the County of San Bernardino in which the plaintiff seeks to proceed under the PAGA for various alleged violations of California’s Labor Code.  Specifically, the plaintiff alleges that she and other similarly situated non-exempt California store-level employees were not paid for all time worked, provided meal and rest breaks, reimbursed for necessary work related expenses, and provided with accurate wage statements and seeks to recover unpaid wages, civil and statutory penalties, interest, attorneys’ fees and costs. The court has stayed proceedings in this matter until resolution of the Varela matter.  

 

On February 20, 2015, a lawsuit entitled Julie Sullivan v. Dolgen California and Does 1 through 100 (“Sullivan”) was filed in the Superior Court of the State of California for the County of Alameda in which the plaintiff alleges that she and other similarly situated Dollar General Market store managers in the State of California were improperly classified as exempt employees and were not provided with meal and rest breaks and accurate wage statements in violation of California law.  The Sullivan plaintiff also alleges that she and other California store employees were not provided with printed wage statements, purportedly in violation of California law.  The plaintiff seeks to recover unpaid wages, including overtime pay, civil and statutory penalties, interest, injunctive relief, restitution, and attorneys’ fees and costs.

 

On April 8, 2015, the Company removed this matter to the United States District Court for the Northern District of California and filed its answer on the same date.  On April 29, 2015, the Sullivan plaintiff amended her complaint to add a claim under the PAGA.  The Company’s response to the amended complaint was filed on May 14, 2015.

 

The plaintiff’s motion for class certification was filed in March 2016.  Plaintiff subsequently conceded that her exemption claim is not amenable to class certification but continued to pursue her individual misclassification claim and class certification of her wage statement claim.

 

On June 14, 2016, the parties reached a preliminary agreement to resolve this matter for an amount not material to the Company’s consolidated financial statements as a whole, which has been submitted to, and received preliminary approval from, the court.  The final fairness hearing is scheduled for February 23, 2017.

 

At this time, although probable, it is not certain that the court will grant final approval to the settlement.  If the court does not approve the settlement and the case proceeds, it is not possible to predict whether Sullivan ultimately will be permitted to proceed as a class action with respect to the wage statement claim, and no assurances can be given that the Company will be successful in its defense on the merits or otherwise.

 

On July 8, 2016, a lawsuit entitled Eric Farley and Dane Rinaldi v. Dolgen California, LLC (“Farley”) was filed in the Superior Court of the State of California for the County of San Joaquin.  The Farley plaintiffs allege they and other similarly situated “key carriers” in California were not provided with meal and rest periods, accurate wage statements, and appropriate pay upon termination in violation of California law. The Farley plaintiffs also assert a claim for unfair business practices and seek to recover alleged unpaid wages, injunctive relief, consequential damages, pre-judgment interest, statutory penalties and attorneys’ fees and costs. 

 

On September 15, 2016, the Farley plaintiffs filed an amended complaint seeking to recover penalties under the PAGA.

 

On October 19, 2016, the Company removed the matter to the United States District Court for the Eastern District of California.  Currently pending is the Company’s motion to dismiss and to compel arbitration.

 

 The Company believes that its policies and practices comply with California law and that the Varela,  Pleasant,  Sullivan, and Farley actions are not appropriate for class or similar treatment.  The Company intends to vigorously defend these actions; however, at this time, it is not possible to predict whether the Varela,  Pleasant,  Sullivan or Farley action ultimately will be permitted to proceed as a class, and no assurances can be given that the Company will be successful in its defense of these actions on the merits or otherwise. Similarly, at this time the Company cannot estimate either the size of any potential class or the value of the claims asserted in the Varela,  Pleasant,  Sullivan or Farley action. For these reasons, the Company is unable to estimate any potential loss or range of loss in these matters; however, if the Company is not successful in its defense efforts, the resolution of any of these actions could have a material adverse effect on the Company’s consolidated financial statements as a whole.

 

On August 2, 2016, a lawsuit entitled Matthew Debinder v. Dolgencorp, LLC (“Debinder”) was filed in the Circuit Court of the Seventeenth Judicial Circuit in and for Broward County, Florida.  The Debinder plaintiff alleges on behalf of himself and a putative class of “applicants” that certain of the Company’s background check procedures violate the Fair Credit Reporting Act (“FCRA”).

 

The parties reached an agreement in October 2016 to resolve this matter for an amount that is not material to the Company’s consolidated financial statements as a whole. 

 

In December 2015 and February, March, May and June 2016, the Company was notified of several lawsuits in which the plaintiffs allege violation of state consumer protection laws relating to the labeling, marketing and sale of Dollar General private-label motor oil.  Each of the lawsuits was filed in, or removed to, various federal district courts of the United States (collectively “the Motor Oil Lawsuits”). 

 

On June 2, 2016, the United States Judicial Panel on Multidistrict Litigation (“JPML”) granted the Company’s motion to centralize the Motor Oil Lawsuits in a matter styled In re Dollar General Corp. Motor Oil Litigation, Case MDL No. 2709, before the United States District Court for the Western District of Missouri (“Motor Oil MDL”).  As a

result of the JPML’s order, the following cases have been transferred to, and are currently part of, the Motor Oil MDL: Bradford Barfoot and Leonard Karpeichik v. Dolgencorp, LLC (filed in the Southern District of Florida on December 18, 2015) (“Barfoot”); William Flinn v. Dolgencorp, LLC (filed in the District Court for New Jersey on December 17, 2015) (“Flinn”); John Foppe v. Dollar General Corporation and Dolgencorp, LLC (filed in the Eastern District of Kentucky on February 10, 2016) (“Foppe”); Miriam Fruhling v. Dollar General Corporation and Dolgencorp, LLC (filed in the Southern District of Ohio on February 10, 2016) (“Fruhling”); Kevin Gadson v. Dolgencorp, LLC (filed in the Southern District of New York on February 8, 2016) (“Gadson”); Bruce Gooel v. Dolgencorp, LLC (filed in the Eastern District of Michigan on February 8, 2016) (“Gooel”);  Janine Harvey v. Dollar General Corporation and Dolgencorp, LLC (filed in the District Court for Nebraska on February 10, 2016) (“Harvey”); Chuck Hill v. Dolgencorp, LLC (filed in the United States District Court for the District of Vermont on February 8, 2016) (“Hill”); John J. McCormick, III v. Dolgencorp, LLC (filed in the District Court of Maryland on December 23, 2015) (“McCormick”); Nicholas Meyer v. Dollar General Corporation and DG Retail, LLC (filed in the District of Kansas on February 9, 2016) (“Meyer”); Robert Oren v. Dollar General Corporation and Dolgencorp, LLC (filed in the Western District of Missouri on February 8, 2016) (“Oren”); Brandon Raab v. Dolgencorp, LLC and Dollar General Corporation (filed in the Western District of North Carolina on July 15, 2016); Scott Sheehy v. Dollar General Corporation and DG Retail, LLC (filed in the District Court for Minnesota on February 9, 2016) (“Sheehy”); Will Sisemore v. Dolgencorp, LLC (filed in the Northern District of Oklahoma on December 21, 2015) (“Sisemore”); Gerardo Solis v. Dollar General Corporation and DG Retail, LLC (filed in the Northern District of Illinois on February 12, 2016) (“Solis”); James Taschner v. Dollar General Corporation and Dolgencorp, LLC (filed in the Eastern District of Missouri on March 15, 2016) (“Taschner”); Roberto Vega v. Dolgencorp, LLC (filed in the Central District of California on February 8, 2016) (“Vega”); Matthew Wait v. Dollar General Corporation and Dolgencorp, LLC (filed in the Western District of Arkansas on February 16, 2016) (“Wait”); and Jason Wood and Roger Barrows v. Dollar General Corporation and Dolgencorp, LLC (filed in the Northern District of New York on May 9, 2016) (“Wood”).

 

On August 29, 2016, as directed by the court, the plaintiffs in the Motor Oil MDL filed a consolidated amended complaint, in which they seek to certify two nationwide classes and 16 statewide sub-classes and for each putative class member some or all of the following relief: compensatory damages, injunctive relief, statutory damages, punitive damages and attorneys’ fees.

 

The Company’s responsive pleading to the consolidated amended complaint is due to be filed on or before December 5, 2016.

 

The Company believes that the labeling, marketing and sale of its private-label motor oil complies with applicable federal and state requirements and is not misleading.  The Company further believes that these matters are not appropriate for class or similar treatment.  The Company intends to vigorously defend these actions; however, at this time, it is not possible to predict whether any of these cases will be permitted to proceed as a class or the size of any putative class.  Likewise, at this time, it is not possible to estimate the value of the claims asserted, and no assurances can be given that the Company will be successful in its defense of these actions on the merits or otherwise.  For these reasons, the Company is unable to estimate the potential loss or range of loss in these matters; however if the Company is not successful in its defense efforts, the resolution of any of these actions could have a material adverse effect on the Company’s consolidated financial statements as a whole.

 

In February 2014, certain California District Attorneys’ Offices (“California DAs”), representing California’s county environmental authorities, informed the Company that they were investigating the Company’s hazardous waste handling and disposal practices in certain of its California stores and its California distribution center.  On September 22, 2016, the California DAs provided a settlement demand to the Company that included a proposed civil penalty and certain injunctive relief.  The Company does not believe that the resolution of this matter is likely to have a material adverse effect on the Company's consolidated financial statements as a whole. Nonetheless, SEC regulations require disclosures of certain environmental matters when a governmental authority is a party to the proceeding unless the Company reasonably believes the proceeding will result in no monetary sanctions or in monetary sanctions, exclusive of interest and costs, of less than $100,000.  As noted above, it now appears that this matter is likely to result in monetary sanctions, which the Company expects to exceed $100,000.

 

From time to time, the Company is a party to various other legal actions involving claims incidental to the conduct of its business, including actions by employees, consumers, suppliers, government agencies, or others through private actions, class actions, administrative proceedings, regulatory actions or other litigation, including without limitation under federal and state employment laws and wage and hour laws. The Company believes, based upon

information currently available, that such other litigation and claims, both individually and in the aggregate, will be resolved without a material adverse effect on the Company’s consolidated financial statements as a whole. However, litigation involves an element of uncertainty. Future developments could cause these actions or claims to have a material adverse effect on the Company’s results of operations, cash flows, or financial position. In addition, certain of these lawsuits, if decided adversely to the Company or settled by the Company, may result in liability material to the Company’s financial position or may negatively affect operating results if changes to the Company’s business operation are required.

 

7.Segment reporting

 

The Company manages its business on the basis of one reportable operating segment. As of October 28, 2016, all of the Company’s operations were located within the United States with the exception of certain subsidiaries in Hong Kong and China and a liaison office in India, which collectively are not material with regard to assets, results of operations or otherwise, to the condensed consolidated financial statements. The following net sales data is presented in accordance with accounting standards related to disclosures about segments of an enterprise.

 

 

 

8.Common stock transactions

 

On August 29, 2012, the Company’s Board of Directors authorized a common stock repurchase program, which the Board has since increased on several occasions. Most recently, on August 24, 2016, the Company’s Board of Directors authorized a $1.0 billion increase to the existing common stock repurchase program. As of October 28, 2016, a cumulative total of $5.0 billion had been authorized under the program since its inception and approximately $1.2 billion remained available for repurchase. The repurchase authorization has no expiration date and allows repurchases from time to time in the open market or in privately negotiated transactions.  The timing and number of shares purchased depends on a variety of factors, such as price, market conditions, compliance with the covenants and restrictions under the Company’s debt agreements and other factors.  Repurchases under the program may be funded from available cash or borrowings including under the Facilities and issuance of CP Notes.

 

Pursuant to its common stock repurchase program, during the 39-week periods ended October 28, 2016, and October 30, 2015, the Company repurchased in the open market approximately 8.2 million shares of its common stock at a total cost of $679.4 million and approximately 13.4 million shares at a total cost of $1.0 billion, respectively.

 

The Company paid quarterly cash dividends of $0.25 per share during each of the first three quarters of 2016. On November 30, 2016, the Company’s Board of Directors approved a quarterly cash dividend of $0.25 per share payable on January 4, 2017 to shareholders of record as of December 21, 2016. The declaration of future cash dividends is subject to the discretion of the Company’s Board of Directors and will depend upon, among other things, the Company’s results of operations, cash requirements, financial condition, contractual restrictions and other factors that the Board may deem relevant in its sole discretion.

 

9. Acquisition of facilities

 

In July and August of 2016, the Company acquired 42 former Walmart Express store locations. Most of these stores are located in rural markets where the Company had existing stores. During the 13-week period ended October 28, 2016, the Company closed 40 of its existing store locations after their operations were relocated into these new store locations. The Company incurred pretax selling, general, and administrative expenses of $11.0 million during the third quarter of 2016, primarily for lease termination costs related to the existing stores that were closed upon relocation of their operations.

Review Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of

Dollar General Corporation

 

We have reviewed the condensed consolidated balance sheet of Dollar General Corporation and subsidiaries (the Company) as of October 28, 2016, and the related condensed consolidated statements of income and comprehensive income for the thirteen and thirty-nine week periods ended October 28, 2016 and October 30, 2015, and the condensed consolidated statements of cash flows for the thirty-nine week periods ended October 28, 2016 and October 30, 2015.  These financial statements are the responsibility of the Company’s management.

 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Dollar General Corporation and subsidiaries as of January 29, 2016 and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for the fiscal year then ended (not presented herein) and we expressed an unqualified opinion on those consolidated financial statements in our report dated March 22, 2016. In our opinion, the accompanying condensed consolidated balance sheet of Dollar General Corporation and subsidiaries as of January 29, 2016, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

 

 

 

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

General

 

This discussion and analysis is based on, should be read with, and is qualified in its entirety by, the accompanying unaudited condensed consolidated financial statements and related notes, as well as our consolidated financial statements and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations as contained in our Annual Report on Form 10-K for the fiscal year ended January 29, 2016. It also should be read in conjunction with the disclosure under “Cautionary Disclosure Regarding Forward-Looking Statements” in this report.

 

Executive Overview

 

We are among the largest discount retailers in the United States by number of stores, with 13,205 stores located in 43 states as of October 28, 2016, geographically concentrated in the southern, southwestern, midwestern and eastern United States. We offer a broad selection of merchandise, including consumable products such as food, paper and cleaning products, health and beauty products and pet supplies, and non-consumable products such as seasonal merchandise, home decor and domestics, and basic apparel. Our merchandise includes high-quality national brands from leading manufacturers, as well as comparable quality and value private brand selections with prices at substantial discounts to national brands. We offer our customers these national brand and private brand products at everyday low prices (typically $10 or less) in our convenient small-box locations.

 

Because the customers we serve are value-conscious, many with low or fixed incomes, we are intensely focused on helping them make the most of their spending dollars. We believe our convenient store format and broad selection of high-quality products at compelling values have driven our substantial growth and financial success over the years. Like other retailers, we have been operating for several years in an environment with ongoing macroeconomic challenges and uncertainties. Our core customers are often among the first to be affected by negative or uncertain economic conditions and are among the last to feel the effects of improving economic conditions, where recent trends have been inconsistent and their duration is unknown. Our core customers have experienced both positive and negative general economic factors over the past year, such as lower gasoline prices and unemployment rates coupled with rising rents and medical costs, a continued reduction in governmental Supplemental Nutrition Assistance Program participation rates and benefit levels and varying wage growth. We believe the overall effect of these factors negatively impacted our traffic and consequently same-store sales, particularly in the second and third quarters of 2016.

 

We remain committed to our long-term operating priorities as we consistently strive to improve our performance while retaining our customer-centric focus. We are keenly focused on executing the following priorities: 1) driving profitable sales growth, 2) capturing growth opportunities, 3) enhancing our position as a low-cost operator, and 4) investing in our people as a competitive advantage.

 

We seek to drive profitable sales growth through initiatives such as improvement in our in-stock position, as well as an ongoing focus on enhancing our margins while maintaining both everyday low price and affordability.

 

We expect our net sales growth to continue to be driven primarily by consumables and we expect non-consumables sales to continue to contribute to our profitable sales growth. However, in recent periods deflationary pressure resulting in lower prices has negatively affected our sales performance. Same-store sales growth is key to achieving our objectives, and in light of the current operating environment we have made certain pricing adjustments as well as labor and marketing investments in designated geographies with a focus on the consumables category. We will continue to evaluate and refresh these pricing adjustments across various items, categories and markets as we move through the remainder of the year. These steps are being taken in an attempt to further grow our market share by increasing both item units sold and customer traffic, although it will likely take time to achieve the full benefit of these initiatives.

 

During 2016 we have made significant progress with the rollout of other initiatives designed to drive sales, such as the expansion of coolers in existing stores and the expansion of certain product classes including health and beauty care and party and stationery. We have updated our customer segmentation information and have been able to gain deeper insights into the spending habits for each of our core customer segments. This helps drive our category

management process, as we optimize our assortment and expand into those products that are most likely to drive traffic to our stores.

 

Our in-stock improvement initiative is designed to ensure the right products are available on the shelf when our customers shop in our stores. We have selectively increased our incremental labor investment in those stores where we believe such increases will generate positive financial returns. We believe this will continue to improve overall customer satisfaction and convenience, in addition to driving same-store sales in these stores.  We have a disciplined approach to this labor investment and are able to quickly evaluate whether it delivers on our profitability expectations, reallocating resources as necessary.

 

We demonstrate our commitment to the affordability needs of our core customer by pricing more than 80% of our stock-keeping units at $5 or less as of the end of the third quarter of 2016.  However, as we work to provide everyday low prices and meet our customers’ affordability needs, we also remain focused on enhancing our margins through effective category management, inventory shrink reduction initiatives, private brands penetration, efforts to improve distribution and transportation efficiencies, global sourcing, and pricing and markdown optimization. With respect to category management, the mix of sales affects profitability because the gross margin associated with sales of products within our consumables category generally is lower than that associated with sales of products within our non-consumables categories.  Even within each category, however, there are varying levels of gross margin associated with the specific items. We strive to consistently balance inventory shrink with our in-stock position. To further support our efforts to reduce inventory shrink, we continue to implement additional in-store defensive merchandising and technology-based tools, such as Electronic Article Surveillance and video-enabled exception based reporting in select stores.

 

To support our other operating priorities we are also focused on capturing growth opportunities and innovating within our channel. We continued to expand our store count, opening 258 stores and remodeling or relocating a total of 267 stores during the 2016 third quarter. Of these 267 remodels and relocations, 40 projects involved relocating an existing Dollar General store location into a former Walmart Express store location, in connection with our acquisition of a total of 42 former Walmart Express store locations during July and August of 2016.  In conjunction with the purchase and relocations, we incurred incremental pre-tax selling, general and administrative (“SG&A”) expenses of $13.0 million in the 2016 third quarter.

 

For fiscal 2016, we plan to open 900 stores and remodel or relocate approximately 900 additional stores. We intend to accelerate square footage growth in 2017 with plans to open approximately 1,000 stores and to relocate or remodel an additional 900 stores.  We also plan to continue investing in our existing store base through targeted merchandising initiatives and labor investments with a goal to drive increased trips, basket and same-store sales.  We continue to innovate within our channel, and during 2016 we began the implementation of the DG16 store layout. This new store layout offers a total of 22 cooler doors, an increase of six cooler doors as compared to our previous new store layout, and is being utilized for all new stores, relocations and remodels. The DG16 store layout also offers a redesigned queueing area and other enhancements that are focused on meeting the evolving demands of our core customer while also delivering on our operating priorities. We also continue to test a smaller format store (less than 6,000 square feet) which we believe could allow us to capture growth opportunities in metropolitan areas as well as rural areas with a low number of households. To support our new store growth and drive productivity, we continue to make investments in our distribution center network. Our Janesville, Wisconsin distribution center is nearing completion with a goal to begin shipping from this facility in early 2017. Our 15th distribution center in Jackson, Georgia is also under construction with a goal to begin shipping from this facility in late 2017.

 

We have established a position as a low-cost operator, continuously seeking ways to reduce or control costs that do not affect our customer’s shopping experience. We have enhanced this position during 2016 through our zero-based budgeting initiative, streamlining our business while also reducing expenses. Our goal is to lower the same-store sales growth required to leverage SG&A expenses. This initiative has been successful in 2016, as evidenced by reductions in advertising, administrative payroll and other costs, and we believe this initiative has the momentum to leverage SG&A expenses over the long-term. In addition, we remain committed to simplifying or eliminating various tasks so that those time savings can be reinvested in other areas such as enhanced customer service, higher in-stock levels, and improved store standards.  Conversely, SG&A expense may be increased in December 2016 and going forward if we are required to implement our plan to address potential changes to the overtime exemption regulations under the Fair Labor Standards Act. If implemented, we anticipate incremental annualized expense of approximately $60 to $70 million, and the impact

on diluted EPS for fiscal 2016 would be a reduction of approximately $0.03. Given existing legal challenges to these regulations, the timing of such implementation, if any, is uncertain.

 

Our employees are a competitive advantage, and we are always searching for ways to continue investing in them. During the third quarter, we implemented a new store manager training program that incorporates a formal e-learning process. Our training programs are continually evolving, as we work to ensure that our employees have the tools necessary to be successful in their positions. We invest in our employees in an effort to create an environment that attracts and retains talented personnel, as we believe that, particularly at the store level, employees who are promoted from within generally have longer tenures and are greater contributors to improvements in our financial performance.

 

Furthermore, we believe that reducing our store manager turnover likely results in improved store financial performance in key areas such as shrink and sales. We have also implemented training programs for high-potential employees, and believe that these and other efforts will produce a more stable, engaged workforce.

 

We also plan to continue to repurchase shares of our common stock and pay quarterly cash dividends, subject to Board discretion, to further enhance shareholder return in 2016.

 

The following include highlights of our 2016 third quarter financial results compared to the comparable 2015 period. Basis points amounts referred to below are equal to 0.01% as a percentage of sales.

 

 

 

 

 

 

Additional highlights for the 39-week period ended October 28, 2016 include:

 

 

 

 

 

The above discussion is a summary only. Readers should refer to the detailed discussion of our operating results below for the full analysis of our financial performance in the current year period as compared with the prior year period.

 

Results of Operations

 

Accounting Periods. We utilize a 52-53 week fiscal year convention that ends on the Friday nearest to January 31. The following text contains references to years 2016 and 2015, which represent the 53-week fiscal year ending February 3, 2017 and the 52-week fiscal year ended January 29, 2016, respectively. References to the third quarter accounting periods for 2016 and 2015 contained herein refer to the 13-week accounting periods ended October 28, 2016 and October 30, 2015, respectively.

 

Seasonality. The nature of our business is seasonal to a certain extent. Primarily because of sales of holiday-related merchandise, sales in our fourth quarter (November, December and January) have historically been higher than sales achieved in each of the first three quarters of the fiscal year. Expenses, and to a greater extent operating profit, vary by quarter. Results of a period shorter than a full year may not be indicative of results expected for the entire year. Furthermore, the seasonal nature of our business may affect comparisons between periods.

 

The following table contains results of operations data for the most recent 13-week and 39-week periods of 2016 and 2015, and the dollar and percentage variances among those periods:

 

 

13 WEEKS ENDED OCTOBER 28, 2016 AND OCTOBER 30, 2015

 

Net Sales. The net sales increase in the 2016 quarter reflects a same-store sales decrease of 0.1% compared to the 2015 quarter. Same-stores include stores that have been open for at least 13 months and remain open at the end of the reporting period. For the 2016 quarter, there were 12,203 same-stores which accounted for sales of $5.0 billion. The decrease in same-store sales reflects a decline in customer traffic due to the factors discussed above in the Executive Overview, partially offset by an increase in average transaction amount.  Same-store sales results reflect positive results in the consumables category, offset by negative results in our seasonal, apparel, and home products categories. We

believe deflationary pressure resulted in lower prices on many items and negatively affected our sales for the quarter, along with other factors discussed above in the Executive Overview. The net sales increase was positively affected by sales from new stores, modestly offset by sales from closed stores.

 

Gross Profit. Gross profit increased by 3.3%, and was 29.8% in the 2016 quarter as a percentage of net sales, which represents a decrease of 49 basis points over the comparable 2015 period. Higher markdowns, primarily for inventory clearance and promotional activities, a greater proportion of sales of consumables, which have a lower gross profit rate than our other product categories, and an increased rate of inventory shrinkage all reduced the gross profit rate, and these factors were partially offset by higher initial markups on inventory purchases.

SG&A Expense. SG&A expense was 22.5% as a percentage of net sales in the 2016 quarter compared to 22.0% in the comparable 2015 period, increasing by 48 basis points. The 2016 quarter results reflect retail labor and occupancy costs which increased at a rate greater than the increase in net sales. In addition, we incurred charges of $13.0 million, or 25 basis points of net sales, in the 2016 period associated with the acquisition of the former Walmart Express store locations and related closure of existing stores, $11.0 million of which was for lease termination and other exit and disposal costs related to the transfer of operations to the newly purchased stores. In addition, we experienced a $7.7 million, or 14 basis points of net sales, increase in disaster-related expenses in the 2016 period over the comparable 2015 period, most of which were related to hurricanes that impacted our stores in the southern and eastern United States. Partially offsetting these items were reductions in administrative payroll costs, incentive compensation expenses and advertising costs. The 2015 period results reflect a charge of $6.1 million related to a corporate restructuring for severance-related benefits costs.

Interest Expense. Interest expense increased by $2.5 million to $23.9 million in the 2016 period reflecting an increase in average debt outstanding and higher average interest rates primarily due to the issuance of long-term debt, net of prepayments under our credit facility, in October 2015. See Liquidity and Capital Resources. Total outstanding debt (including the current portion of long-term obligations) as of October 28, 2016 was $3.17 billion.

Income Taxes. The effective income tax rate for the 2016 period was 36.2% compared to 37.0% for the 2015 period which represents a net decrease of 0.8 percentage points. The tax rate for the 2016 period was lower than for the 2015 period primarily due to the retroactive enactment in 2015 of federal jobs tax credits (principally the Work Opportunity Tax Credit or “WOTC”) for employees hired after December 31, 2014. While the Company eventually did benefit from the WOTC associated with employees hired in the 2015 period, the benefit could not be recognized in our financial statements until the federal laws authorizing the credits were retroactively reenacted in December 2015. WOTC benefits have been enacted through 2019.

 

39 WEEKS ENDED OCTOBER 28, 2016 AND OCTOBER 30, 2015

 

Net Sales. The net sales increase in the 2016 period reflects a same-store sales increase of 0.9% compared to the 2015 period. In the 2016 period, our 12,203 same-stores accounted for sales of $15.1 billion. An increase in average transaction amount was the primary contributor to the increase in same-store sales. The remainder of the net sales increase was attributable to new stores, modestly offset by sales from closed stores.

 

Gross Profit. For the 2016 period, gross profit increased by 5.6%, and as a percentage of net sales decreased by 10 basis points to 30.6% compared to the 2015 period. Higher markdowns, primarily for promotional activities and inventory clearance, a greater proportion of sales of consumables, which have a lower gross profit rate than our other product categories, and an increased rate of inventory shrinkage each reduced the gross profit rate, and were partially offset by higher initial markups on inventory purchases and lower transportation costs partially attributable to lower fuel rates.

SG&A Expense. SG&A expense increased by 5 basis points over the comparable 2015 period and was 21.9% of net sales in the 2016 period. The 2016 results reflect retail labor and occupancy costs which increased at a rate greater than the increase in net sales. As noted in the discussion of the 13-week periods above, we incurred lease termination and other expenses associated with the acquisition of former Walmart Express stores and the related relocations of stores from existing locations, and an increase in disaster-related expenses in the 2016 period. Partially offsetting these items were reductions in administrative payroll costs, incentive compensation expenses and advertising costs. The 2015 period results reflect a charge of $6.1 million related to a corporate restructuring for severance-related benefits costs.

Interest Expense. Interest expense increased by $8.6 million to $72.3 million in the 2016 period reflecting an increase in average debt outstanding and higher average interest rates primarily due to the issuance of long-term debt as discussed above.

Income Taxes. The effective income tax rate for the 2016 period was 36.1% compared to 37.6% for the 2015 period which represents a net decrease of 1.5 percentage points. The tax rate for the 2016 period was lower than for the 2015 period primarily due to the retroactive enactment in 2015 of federal jobs tax credits (principally the WOTC) for employees hired after December 31, 2014 as well as the 2016 early adoption of amendments to accounting guidance for share-based payment. While the Company eventually did benefit from the WOTC associated with employees hired in the 39-week period ended October 30, 2015, the benefit could not be recognized in our financial statements until the federal laws authorizing the credits were retroactively reenacted in December 2015. WOTC benefits have been enacted through 2019.

 

Due to the fact that the majority of the Company’s share-based awards typically vest in the first quarter, adoption of the amended accounting guidance is anticipated to have the most significant impact in the first quarter of 2016 and subsequent years.

 

Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued comprehensive new accounting standards related to the recognition of revenue. The effective date is annual reporting periods beginning after December 15, 2017, with earlier adoption permitted only for annual reporting periods beginning after December 15, 2016. The new guidance allows for companies to use either a full retrospective or a modified retrospective approach in the adoption of this guidance. We are currently evaluating these transition approaches, as well as the potential timing of adoption and the effect of adoption on our consolidated financial statements.

 

In February 2016, the FASB issued new guidance related to lease accounting, which when effective will require a dual approach for lessee accounting under which a lessee will account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use asset and a corresponding lease liability on its balance sheet, with differing methodology for income statement recognition. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. A modified retrospective approach is required for all leases existing or entered into after the beginning of the earliest comparative period in the consolidated financial statements. We are currently assessing the impact that adoption of this guidance will have on our consolidated financial statements and we are anticipating a material impact because we are party to a significant number of lease contracts.

 

In October 2016, the FASB issued amendments to existing guidance related to accounting for intra-entity transfers of assets other than inventory. These amendments require an entity to recognize the income tax consequences of such transfers when the transfer occurs and affects our historical accounting for intra-entity transfers of certain intangible assets. This guidance is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted subject to certain guidelines. The amendments should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We are currently assessing the impact that adoption of this guidance will have on our consolidated financial statements, but expect such adoption will result in an increase in deferred income tax liabilities and a decrease in retained earnings.

 

Liquidity and Capital Resources

 

We have a five-year $1.425 billion unsecured credit agreement (the “Facilities”), and we have outstanding $2.3 billion aggregate principal amount of senior notes. During the third quarter of 2016, we established a commercial paper program that may provide borrowing availability of up to $1.0 billion. At October 28, 2016, we had total outstanding debt (including the current portion of long-term obligations) of $3.17 billion, which includes balances under the Facilities, commercial paper and senior notes, all of which are described in greater detail below.

 

We believe our cash flow from operations and existing cash balances, combined with availability under the Facilities, the commercial paper program and access to the debt markets will provide sufficient liquidity to fund our current obligations, projected working capital requirements, capital spending and anticipated dividend payments for a

period that includes the next twelve months as well as the next several years.  However, our ability to maintain sufficient liquidity may be affected by numerous factors, many of which are outside of our control.  Depending on our liquidity levels, conditions in the capital markets and other factors, we may from time to time consider the issuance of debt, equity or other securities, the proceeds of which could provide additional liquidity for our operations.

 

For the remainder of fiscal 2016, we anticipate the combined potential borrowings under the Revolving Facility (as defined below) and the commercial paper program to be a maximum of approximately $700 million outstanding at any one time, including any anticipated borrowings to fund repurchases of common stock.

 

Facilities

 

The Facilities consist of a $425.0 million senior unsecured term loan facility (the “Term Facility”) and a $1.0 billion senior unsecured revolving credit facility (the “Revolving Facility”) which provides for the issuance of letters of credit up to $175.0 million. The Facilities are scheduled to mature on October 20, 2020.

 

Borrowings under the Facilities bear interest at a rate equal to an applicable interest rate margin plus, at our option, either (a) LIBOR or (b) a base rate (which is usually equal to the prime rate). The applicable interest rate margin for borrowings as of October 28, 2016 was 1.10% for LIBOR borrowings and 0.10% for base-rate borrowings. We must also pay a facility fee, payable on any used and unused commitment amounts of the Facilities, and customary fees on letters of credit issued under the Revolving Facility.  The applicable interest rate margins for borrowings, the facility fees and the letter of credit fees under the Facilities are subject to adjustment from time to time based on our long-term senior unsecured debt ratings. The weighted average all-in interest rate for borrowings under the Facilities was 1.6% as of October 28, 2016.

 

The Facilities can be voluntarily prepaid in whole or in part at any time without penalty. There is no required amortization under the Facilities. The Facilities contain a number of customary affirmative and negative covenants that, among other things, restrict, subject to certain exceptions, our (including our subsidiaries) ability to: incur additional liens; sell all or substantially all of our assets; consummate certain fundamental changes or change in our lines of business; and incur additional subsidiary indebtedness. The Facilities also contain financial covenants that require the maintenance of a minimum fixed charge coverage ratio and a maximum leverage ratio.  As of October 28, 2016, we were in compliance with all such covenants.  The Facilities also contain customary events of default.

 

As of October 28, 2016, under the Revolving Facility, we had no outstanding borrowings, outstanding letters of credit of $15.5 million, and borrowing availability of $984.5 million that, due to reserved borrowing availability related to the commercial paper program described below, could contribute incremental liquidity of $531.5 million at October 28, 2016. In addition, as of October 28, 2016 we had outstanding letters of credit of $33.6 million which were issued pursuant to separate agreements.

 

Commercial Paper

 

On August 1, 2016, we established a commercial paper program under which we may issue unsecured commercial paper notes (the “CP Notes”).  Under this program, we may issue the CP Notes from time to time in an aggregate amount not to exceed $1.0 billion outstanding at any time.  The CP Notes have maturities of up to 364 days from the date of issue and rank equal in right of payment with all of our other unsecured and unsubordinated indebtedness.  We have agreed to maintain available commitments under the Revolving Facility in an amount at least equal to the amount of CP Notes outstanding at any time.  We had $453.0 million of CP Notes outstanding at October 28, 2016 which were classified as long-term obligations in the consolidated balance sheet due to our intent and ability to refinance these obligations as long-term debt, at a weighted average borrowing rate of 0.7%.

 

Senior Notes

 

We have $500.0 million aggregate principal amount of 4.125% senior notes due 2017 (the “2017 Senior Notes”) which are scheduled to mature on July 15, 2017; $400.0 million aggregate principal amount of 1.875% senior notes due 2018 (the “2018 Senior Notes”), net of discount of $0.1 million, which are scheduled to mature on April 15, 2018; $900.0 million aggregate principal amount of 3.25% senior notes due 2023 (the “2023 Senior Notes”), net of discount of $1.6 million, which are scheduled to mature on April 15, 2023; and $500.0 million aggregate principal amount of 4.150% senior notes due 2025 (the “2025 Senior Notes”), net of discount of $0.7 million, which are scheduled

to mature on November 1, 2025. Collectively, the 2017 Senior Notes, the 2018 Senior Notes, the 2023 Senior Notes and the 2025 Senior Notes comprise the “Senior Notes”, each of which were issued pursuant to an indenture as supplemented and amended by supplemental indentures relating to each series of Senior Notes (as so supplemented and amended, the “Senior Indenture”).  Interest on the 2017 Senior Notes is payable in cash on January 15 and July 15 of each year. Interest on the 2018 Senior Notes and the 2023 Senior Notes is payable in cash on April 15 and October 15 of each year. Interest on the 2025 Senior Notes is payable in cash on May 1 and November 1 of each year. We expect to refinance the 2017 Senior Notes prior to their maturity utilizing proceeds from the issuance of additional senior notes, revolver borrowings or commercial paper.

 

We may redeem some or all of the Senior Notes at any time at redemption prices set forth in the Senior Indenture. Upon the occurrence of a change of control triggering event, which is defined in the Senior Indenture, each holder of our Senior Notes has the right to require us to repurchase some or all of such holder’s Senior Notes at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to, but excluding, the repurchase date.

 

The Senior Indenture contains covenants limiting, among other things, our ability (subject to certain exceptions) to consolidate, merge, or sell or otherwise dispose of all or substantially all of our assets; and our ability and the ability of our subsidiaries to incur or guarantee indebtedness secured by liens on any shares of voting stock of significant subsidiaries.

 

The Senior Indenture also provides for events of default which, if any of them occurs, would permit or require the principal of and accrued interest on our Senior Notes to become or to be declared due and payable, as applicable.

 

Current Financial Condition / Recent Developments

 

Our inventory balance represented approximately 55% of our total assets exclusive of goodwill and other intangible assets as of October 28, 2016. Our ability to effectively manage our inventory balances can have a significant impact on our cash flows from operations during a given fiscal year. Inventory purchases are often somewhat seasonal in nature, such as the purchase of warm-weather or Christmas-related merchandise. Efficient management of our inventory has been and continues to be an area of focus for us.

 

As described in Note 6 to the unaudited condensed consolidated financial statements, we are involved in a number of legal actions and claims, some of which could potentially result in material cash payments. Adverse developments in those actions could materially and adversely affect our liquidity. We also have certain income tax-related contingencies as disclosed in Note 3 to the unaudited condensed consolidated financial statements. Future negative developments could have a material adverse effect on our liquidity.

 

On June 1, 2016, Moody’s Investors Service upgraded our senior unsecured debt rating to Baa2 from Baa3, and on August 3, 2016, assigned to us a commercial paper rating of P-2 and affirmed our existing senior unsecured debt rating of Baa2, both with a stable outlook.  On August 4, 2016, Standard & Poor’s assigned to us a short-term corporate credit and commercial paper rating of A-2 and affirmed our existing long-term corporate credit and senior unsecured rating of BBB, all with a stable outlook. Our current credit ratings, as well as future rating agency actions, could (i) impact our ability to finance our operations on satisfactory terms; (ii) affect our financing costs; and (iii) affect our insurance premiums and collateral requirements necessary for our self-insured programs. There can be no assurance that we will maintain or improve our current credit ratings.

 

Unless otherwise noted, all references to the “2016 period” and the “2015 period” in the discussion of “Cash flows from operating activities,” “Cash flows from investing activities,” and “Cash flows from financing activities” below refer to the 39-week periods ended October 28, 2016 and October 30, 2015, respectively. 

 

Cash flows from operating activities.   Cash flows from operating activities were $1.12 billion in the 2016 period, which represents a $315.3 million increase over the 2015 period. Changes in merchandise inventories resulted in a $405.5 million decrease in the 2016 period as compared to a $317.3 million decrease in the 2015 period. Changes in accounts payable resulted in a $439.3 million increase in the 2016 period compared to a $75.9 million increase in the 2015 period, due primarily to the timing of receipts and payments which was impacted by increases in payment terms. The increase in net income was due primarily to greater net sales and operating profit in the 2016 period as described in more detail above under “Results of Operations.”

 

On an ongoing basis, we closely monitor and manage our inventory balances, and they may fluctuate from period to period based on new store openings, the timing of purchases, and other factors. Merchandise inventories increased 13% in the 2016 period compared to an 11% increase in the 2015 period.  In the 2016 period compared to the 2015 period, changes in inventory balances in our four inventory categories were as follows: the consumables category increased by 16% compared to a 15% increase; the seasonal category increased by 10% compared to an 11% increase; the home products category increased by 23% compared to a 15% increase; and apparel decreased by 5% compared to a 7% decrease. The increase in inventory was concentrated in our year-round planogram inventory as opposed to seasonally related items. Factors impacting the changes in inventory include our efforts to improve our in-stock position of core products, levels of inventory shrinkage, the timing of receipts, and sales performance.

 

Cash flows from investing activities. Significant components of property and equipment purchases in the 2016 period included the following approximate amounts: $136 million for distribution and transportation-related capital expenditures; $116 million for improvements, upgrades, remodels and relocations of existing stores; $92 million related to new leased stores, primarily for leasehold improvements, fixtures and equipment; $38 million for stores purchased or built by us and $18 million for information systems upgrades and technology-related projects. The timing of new, remodeled and relocated store openings along with other factors may affect the relationship between such openings and the related property and equipment purchases in any given period. During the 2016 period, we opened 768 new stores and remodeled or relocated 861 stores.

 

Significant components of property and equipment purchases in the 2015 period included the following approximate amounts: $142 million for improvements, upgrades, remodels and relocations of existing stores; $94 million for distribution and transportation-related capital expenditures; $79 million related to new leased stores, primarily for leasehold improvements, fixtures and equipment; $41 million for stores built by us; and $26 million for information systems upgrades and technology-related projects. During the 2015 period, we opened 634 new stores and remodeled or relocated 857 stores.

 

We anticipate funding 2016 capital requirements with existing cash balances, cash flows from operations, availability under our Revolving Facility and the issuance of commercial paper. We plan to continue to invest in store growth and development of new stores and stores to be remodeled or relocated. Capital expenditures in 2016 are anticipated to support our store growth as well as our remodel and relocation initiatives, including capital outlays for leasehold improvements, fixtures and equipment; the construction of new stores; costs to support and enhance our supply chain initiatives including construction of new and investments in existing distribution center facilities; technology initiatives; as well as routine and ongoing capital requirements.

 

Cash flows from financing activities. Net (repayments) borrowings under the Revolving Facility during the 2016 and 2015 periods were $(251.0) million and $388.0 million, respectively. We had net commercial paper borrowings in the 2016 period of $453.0 million. We repaid $500.0 million of the Term Facility in the 2015 period. During the 2016 and 2015 periods, we repurchased 8.2 million and 13.4 million shares of our common stock at a total cost of $679.4 million and $1.0 billion, respectively. Also during the 2016 and 2015 periods, we paid cash dividends of $212.2 million and $195.2 million, respectively.

 

Share Repurchase Program

 

On August 24, 2016, our Board of Directors authorized a $1.0 billion increase to our existing common stock repurchase program.  Following such increase, our common stock repurchase program had a total remaining authorization of approximately $1.2 billion at October 28, 2016. Under the authorization, purchases may be made in the open market or in privately negotiated transactions from time to time subject to market and other conditions. The authorization has no expiration date and may be increased or terminated from time to time at the discretion of our Board of Directors. For more information about our share repurchase program, see Note 8 to the condensed consolidated financial statements.