Dollar General Corp

NYSE:DG

Earnings Call Transcript 2018-Q1

[Operator]

Good morning. My name is Jennifer and I will be your conference operator today. At this time, I would like to welcome everyone to the Dollar General First Quarter 2018 Earnings Call. Today is Thursday, May 31, 2018. 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.

Now I would now like to turn the conference over to Ms. Jennifer Beugelmans, Vice President of Investor Relations and Public Relations. Ms. Beugelmans, you may begin your conference.

[Jennifer Beugelmans, VP, IR & Public Relations]

Thank you, Jennifer and good morning everyone. On the call today are Todd Vasos, our CEO and John Garratt, our CFO. After our prepared remarks, we will open the call up for questions. Our earnings release issued today can be found on our website at dollargeneral.com under Investor Information, News & Events.

Let me caution you that today’s comments will include forward-looking statements about our expectations, plans, future estimates and other non-historical matters including, but not limited to our fiscal 2018 financial guidance and store growth plans, our planned investments and initiatives, capital allocation strategy and related expectations and future economic trends or conditions.

Forward-looking statements can be identified because they are not statements of historical facts or use words such as may, should, could, would, optimistic, objectives, outlook, will, believe, anticipate, expect, forecast, estimate, guidance, plan, opportunity, continue, focused on, intend, looking ahead, or goal and similar expressions that concern our strategy, plans, intentions or beliefs about future matters.

Important factors that could cause actual results or events to differ materially from those projected by our forward-looking statements are included in our earnings release issued this morning under Risk Factors in our 2017 Form 10-K filed on March 23, 2018 and in the comments that are made on this call. We encourage you to read these documents.

You should not unduly rely on forward-looking statements which speak only as of today’s date. Dollar General disclaims any obligation to update or revise any information discussed in this call, except as maybe otherwise required by law.

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]

Thank you, Jennifer and welcome to everyone joining our call. We had a solid first quarter and we're off to a good start in the second quarter here. Here in the first quarter, we delivered strong net sales growth, gross margin expansion, and expense containment.

We remain on-track with our full year guidance, specifically with regard to first quarter EPS, we believe we are right where we need to be. During the first quarter, we delivered 2.1% same store sales growth driven by fundamental improvement in customer productivity as illustrated by increases in both average units and dollars per basket.

Importantly, we achieved this growth despite facing unseasonably cold and damp weather which created a sales headwind. We also built momentum within each of our four operating priorities and we believe that our execution on these and our progress against key strategic initiatives are laying the foundation for long term growth.

Now let's recap some of the top line results for the first quarter. Net sales increased 9% to $6.1 billion compared to net sales of $5.6 billion in the first quarter of 2017. Our same store sales increase of 2.1% reflect strong performance in the consumable category. We continued to gain market share and highly consumables over the 4, 12, 24 and 52 week periods and the May 5th, 2018 according to syndicated data.

We are committed to being priced right for our customer every day and believe we remain well positioned against all classes of trade and across all geographic regions in which we operate. We believe our everyday low price has contributed to our share gains.

Well it's always competitive in discount retail, we continue to see rational pricing activity across the industry. As we continue to execute against our operating priorities, we believe we have the opportunities to continue to capture market share.

Our first quarter comp included the impact of unseasonable weather in late March and April, which we believe negatively impacted our non-consumable categories, particularly among Spring and Summer products. Consumables which represent 75% of our business were also impacted by weather, although still comped at a very healthy rate during the first quarter.

To give you a little more insight into the magnitude of the weather impacts, midway through the first quarter, our comp sales, we're tracking ahead of our full year guidance in fact we achieved our highest comp sales for the quarter in March. our comp sales in April, however, were negative. As we moved out of April and through now into May, the unfavorable weather subsided and we are encouraged by the strong start to our second quarter.

Based on our year-to-date results and our outlook for the remainder of the year we are reiterating our full year 2018 financial guidance in its entirety. After John's comments, I will share some further insights on how we plan to continue driving growth in 2018 and beyond.

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

[John Garratt, CFO]

Thank you Todd and good morning everyone. Now that Todd is taking you through a few highlights of the first quarter, let me take you through important financial details. I will also spend time reviewing our 2018 guidance, unless I specifically note otherwise, all comparisons are year over year. As Todd has already discussed sales, I will start with gross profit.

We were pleased to deliver gross profit expansion in the first quarter. Gross profit as a percent of sales was $3.5% in the first quarter, an increase of 17 basis points. This increase was primarily attributable to higher initial markups that inventory purchases and improved rate of inventory shrink.

These factors were partially offset by a greater proportion of sales of consumables which generally have a lower gross profit rate that our other product categories, the sales of lower margin projects - products comprising a higher proportion of consumable sales and increased transportation costs.

SG&A expense as a percent of sales was 22.4%. This was an increase of 60 basis points. The first quarter of 2018 SG&A results were driven by increased retail labor expenses, occupancy costs, utilities expenses and property taxes on lease stores, each of which increased at a rate greater than the increase in net sales.

The vast majority of the deleverage in the SG&A rate was primarily due to two factors. First, the previously announced expenses associated with the store manager investments and the ramp up of the stores opened in the second half of 2017.

And second to the unseasonably cold and damp weather that negatively impacted sales and drove higher than expected utilities expenses. The operating margin rates for the quarter would've been flat, if not for those investments in the weather.

Moving down the income statement or effective tax rate for the quarter was 21.6%. This was largely aligned with our full year guidance of 22% to 23%, which we are reiterating for the full year. This compares to 37.2% in the first quarter of 2017.

Finally, diluted earnings per share for the first quarter were $1.36. We have a solid balance sheet and a track record of generating strong cash flow from operations. Merchandise inventories were $3.6 billion at the end of the first quarter of 2018 up 8.9%, but slightly below our net sales growth.

Inventory growth was relatively flat on a per store basis. We believe our inventory is in great shape and we remain focused on managing inventory growth to be in-line with or below our sales growth.

In the first quarter, we generated strong cash flow from operations totaling $549 million, an increase of $38 million or 7.5%. The strong growth was on top of the 26% year over year increase we reported in the first quarter of 2017.

Total capital expenditures for the quarter were $165 million and included our plan investments in new stores, remodels and relocations, continued investments in our two distribution centers under construction and spending related to the previously announced acceleration of some key initiatives.

During the quarter, we repurchased 1.6 million shares of common stock for $150 million and paid a quarterly dividend of $0.29 per common share outstanding at a total cost of $78 million. Till the e end of the first quarter, we return cash to shareholders totaling $228 million to the combination of these share repurchases and quarterly dividends.

From the inception of our share repurchase program in December 2011 through the first quarter of 2018, we have repurchased $5.3 billion or 83 million shares of our common stock. At the end of the first quarter, the remaining repurchase authorization was approximately $1.2 billion.

Our capital allocation priorities remain unchanged, as we continue to be disciplined and focused on financial returns. Our first priority is investing in high return growth opportunities, including new store expansion and infrastructure to support future growth.

We remain committed to returning significant cash to shareholders through anticipated share repurchases in quarterly dividends while maintaining our current investment grade rating and managing to a leverage ratio of approximately three times adjusted debt to EBITDA.

Turning now to our guidance, as Todd highlighted we are off to a solid start during the first four months of 2018. Based on this performance and our outlook for the rest of the year, we are reiterating our fiscal 2018 full year guidance, including net sales growth of approximately 9% comp growth in the mid 2% range, operating margin rate relatively unchanged compared to the 2017 fiscal year and diluted earnings per share for the full year in the range of $5.95 to $6.15.

Given the puts and takes of sales growth and margin rate this year, we want to provide a little more insight on the trajectory of our expectations. First starting with sales, we're off to a good start in the second quarter, but bear in mind the second quarter comp last does get tougher relative to the first quarter.

Also, as a reminder in the second half of 2017, we opened 741 new stores driven by the acquisition of the Dollar Express locations, which is a much higher number than our typical cadence.

As a result, in the second half of 2018 we will have an unusually high number of stores rolling into the comp space. The anticipated positive impact of these stores helps offset the tougher comparisons we face in the second half. This positive impact is contemplated in our full year guidance.

Seconds, looking at gross margin, we continue to see freight and fuel headwinds, but as a reminder, we begin to laugh these pressures and the second half of the year. The team is executing strategies that we believe can help mitigate the impact of these headwinds overtime.

We remain committed to our everyday low price strategy, which we believe is a competitive advantage. To that end and as part of our ongoing operating philosophy, we routinely monitor our price position and make adjustments as necessary.

Our full year outlook includes the expected gross margin impact of any known challenges in these areas. Turning to SG&A, as reminder for modeling purposes, our long term goal is to leverage SG&A on an annual basis in the range of 2.5% 3% same store sales growth.

It is not our strategy to leverage SG&A at lower comp levels as we expect to continue to make targeted investments in the business. Additionally, as we have said previously, we are focused on operating margin growth, which allows us to dynamically make choices that enable us to do is write for the longer term health of the business.

Finally, regarding EPS, I would remind you that in the third quarter of 2017, we saw $0.05 estimated net negative impact to diluted EPS due to the hurricane. As always, we are focused on carefully controlling costs even as we make targeted proactive investments.

We continue to be disciplined in how we manage expenses and capital with the goal of delivering consistent, strong financial performance, while positioning our business for long term growth.

We remain confident in our business model and our ability to drive profitable same store sales growth, deliver healthy new store returns, generate strong cash flow from operations and create long term shareholder value.

With that, I will turn the call back over Todd.

[Todd Vasos, CEO]

Thank you, John. Let me now walk through how we are executing against our operating priorities and initiatives for 2018, as well as updates you on the progress on our long term strategic initiatives.

Our first priority is to continue to drive profitable sales growth. With the focus on driving both the top and bottom lines, we expect our most impactful topline initiatives for 2018 to revolve around merchandising and store operations.

These initiatives are designed to enhance the value and convenience proposition for our customers, offering them the trusted simple solutions they seek from us every day. We continue to strategically invest in our mature store base. We are particularly focused on remodeling stores that have fewer than 12 cooler doors. These store remodels typically drive among the highest returns.

By the end of fiscal 2018, we anticipate that across our store base we will have an average of 20 cooler doors up from 10 in 2012. Through the end of the first quarter, we had installed nearly 7,000 additional cooler doors across our mature store base.

In total, we expect to install over 20,000 additional cooler doors across our mature store base this year. We know the expansion of coolers tends to drive trips and basket size. As a result, we expect to build on our multi-year track record of growth in cooler doors and associated sales.

We have been enhancing the in store experience by adding shoppable queue lines. This update allows us to merchandise the check lane with compelling point of purchase items that we believe are interesting to our consumers.

During the first quarter, we added this enhancement to over 500 stores bringing our total for the chain to approximately 6,000 stores. The queue line retrofit performance has been very strong. We expect to have this enhancement in over 7,000 stores by the end of 2018.

Building on the success of Phase I launch of our health and beauty initiative in 2017, we're launching Phase II in 2018. As reminder, during Phase I, we focused on building awareness among our current customers, with our special combination of value and convenience within health and beauty items, we believe we can do even a better job marketing these products to customers who routinely come to Dollar General for their shopping needs.

In Phase II, we want to build on the increased category awareness we created during Phase I, by further enhancing the quality perception of the health and beauty products we offer. Some of our actions include improving our display quality, connecting our in-store merchandising with our print and digital media, and creating an easier shopping experience.

Given our price position compared to other channels we believe we can capture share of wallet with our existing customers as well as identifying innovative ways to drive new customers into our stores. We plan to execute Phase II in about 7,000 stores in 2018.

Another initiative I want to mention within merchandising is our efforts in private brands. Our private brand strategy focuses on enhancing product perception and demonstrating the unique nature, superior value and quality compared to national brands.

We intend to use our in-store merchandising expertise to highlight the value pricing and our 100% satisfaction guarantee as we believe both resonate with our customers. We currently have approximately 40 unique private brand product lines.

Our goal is to ensure that we are offering compelling value priced alternatives to national brands given the significant price gap compared to national brands and other channels, private brands play an important role in helping our customers stretch their budgets.

Within our merchandising initiatives, we also have many new and exciting research plan for 2018. Let me briefly highlight two of them. First, we recently launched a better for you offering intended to provide our customers with healthier consumable options at affordable prices.

Over time, we expect this offering to include more than 130 products within better for you, we're launching a new private brand called Good and Smart, which will represent approximately 75% of the total Better For You portfolio.

Our goal is to build Good and Smart into a unique private brands that becomes a go-to-product line for our customers when they look for good food choices at smart prices. Second, we are rebranding our private beauty product portfolio under the name Studio Selection.

Our goal with Studio Selection is to create an aspirational, yet affordable line of products that will help us further build loyalty and excitement among key demographics. We believe these attractively packaged quality products can help us capture even more market share.

These are just two of the exciting launches we have planned throughout the rest of the year. We look forward to updating you on the success of our merchandising initiatives throughout the rest of 2018.

Let's now turn to the important work of our store operations team. A large part of their current focus is increasing on shelf product availability. This critical metric is paramount for our customer and is directly tied to sales right.

The team has done an excellent job of improving on shelf availability and has further improved store cleanliness and speed of checkout. All important parts of the in store experience. As a result of this execution, we have seen customer satisfaction grow since we began measuring this metric. This is one of our most important metrics and we believe we can drive it even higher and cultivate even more affinity from our customers over time.

Turning for a moment to gross margin, over the long term we believe there are several opportunities to enhance gross margins. These include further reductions in shrink, additional contribution from global sourcing, private brands, and not consumable sales as well as achieving additional distribution and transportation efficiencies.

Inventory shrink reduction remains our largest near term gross margin opportunity and we are executing on multiple fronts. Our comp initiatives include deploying defensive merchandising tactics, leveraging technology, and new process controls and expanding article electronic article surveillance or EAS.

This year, we're on track to deploy 5,000 new units bringing the total stores with this technology to about 10,000 locations. The majority of this year incremental units were completed during the first quarter.

EAS is a proven high return project for us to help further reduce shrink and drive sales by improving on shelf availability. We believe that our EAS investments can deliver multiple years of benefits.

While we have seen carrier rates and fuel costs on the rise, we believe our ongoing efforts to improve efficiencies and reduce expenses can partly offset our expense and exposure to these headwinds. Some of our ongoing initiatives include reducing our stem miles, improve our load optimization, growing and diversifying our carrier base and expanding our private fleet.

Our 16th and 17th distribution centers are currently under construction in Longview, Texas and Amsterdam. New York. We anticipate that both of these DCs will open in the 2019 calendar year and then we will see relatively quick and positive impact on stem miles.

I was recently at our newest distribution center in Jackson, Georgia for their grand opening celebration. The team in Jackson is excited and engaged and we look forward to their contribution to our future performance.

We also remain on pace to expand our private fleet to over 200 tractors by year-end up from an 80 tractors at the end of 2017. Over time, we believe this will give us added flexibility and help insulate us from future carrier rate fluctuations.

Our second priority is capturing growth opportunities. We have a proven real estate growth model that is high return, low cost, and low risk. While our real estate model has strict return thresholds, it provides us with the flexibility necessary to dynamically invest in both growing our new store base and remodeling our mature store base.

These strategic investments have allowed us to enter new markets and store formats while extending our runway for long term growth. As a reminder, we closely monitor five core metrics to ensure that new store growth continues to be the best use of our capital; first, new store productivity as a percent of our comp store sales, which continues to average in the range of 80% to 85%.

Second actual sales performance compared to our proforma models. Third, average returns of 20% to 22%. And forth, cannibalization of our new stores on our comp store base, which has remained relatively consistent in our measurement. And then finally new stores must have a payback period of two years or less.

We have consistently hit our goals for these metrics. We are very pleased with her overall new store returns and we remain committed to investing our capital effectively to drive strong financial.

For 2018 we expect to open 900 new stores, remodel 1000 of our mature stores and relocate approximately 100 stores. That's about 2000 stores in total. Of the 1,000 plan remodels, we expect approximately 400 locations to be in the Dollar General Traditional Plus format or DGTP for short. This format has a higher cooler count that can accommodate more perishable items.

We're on track to achieve these goals by the end of the year. During the first quarter, we opened 241 stores, remodeled 322 stores and relocated an additional 31 stores. 125 of the stores remodeled in the first quarter were in the DGTP format. We included a fresh produce section in 45 of these remodels.

As a reminder, our remodel store delivers a 4% to 5% comp lift on average, and a DGTP remodel delivers an average of 10% to 15% comp lift. Our third operating priority is to leverage and reinforce our position as a low cost operator. Over the years, we have established a clear and defined process to control spending.

All of our spending is filtered through three criteria. First is a customer facing. Second, does it align with our strategic priorities. And third, how does it impact our risk profile. At the store level our operational initiatives for 2018 are centered on space optimization and ongoing efforts to simplify our operations by reducing unproductive inventory, operating complexity and product movement within the stores.

These actions are designed to control costs and allow our store managers and their teams to provide better customer service as well as fast, clean and in store, in store shopping experience. All of these actions can help drive higher sales.

We are tracking customer satisfaction scores at the individual employee level, which increases accountability and creates opportunities for employee recognition at the store, support center, work elimination, and process improvement or ongoing efforts to take cost out of the business. Our underlying principles are to keep the business simple, but move quickly to capture growth opportunities, control expenses, and always seek to be a low cost operator.

Our fourth operating priority is to invest in our people as we believe they are a competitive advantage. We believe we are well positioned from a wage perspective across our employee base. That said, we monitor market by market and act as needed to ensure we remain competitive in the labor markets where we operate.

This proactive strategy coupled with the career opportunities we offer associates continues to reinforce dollar general's position as an employer of choice. The career opportunity we offer is our most important currency and attracting and retaining talents.

With our business growing each year, we are providing opportunities for individuals around the country to grow their careers and make improvements in their lives and the lives of their families. Career development is an integral part of the Dollar General culture and we are focused on helping our employees reach their full potential.

Approximately 70% of corporate leadership positions are filled with internal candidates and over 10,000 of our current store managers have been internally promoted. This year with our plan to open 900 new stores, we expect to create over 7,000 new jobs in the United States. We are confident that we will continue to re-track, excuse me, and retain the right talent and we are prioritizing investments in our people.

Finally, before I opened the call for questions, I want to quickly touch upon our recent progress executing against two of our strategic growth initiatives that we talked about last quarter. Starting with our digital initiatives, in the near term we are strategically investing in our business to help our customers utilize digital tools and resources to create a more personalized and convenient in store shopping experience.

With nearly 75% of the US population currently within five miles of a Dollar General, we have a unique opportunity to help shape our customers digital shopping behavior all while leveraging our nearly 15,000 Brick and Mortar stores to help them save time and money.

Last quarter we shared our plans to launch our new DG go App, which allows customers to use their phones to scan items as they shop and then skip the line by using the self checkout. Not only this app save our customers time, but it also allows them to see a running total of their baskets.

Additionally, as they scan each item, they receive alerts to potential savings on the items they are purchasing. All of this makes staying on budget easier. The DG go App went live in the Apples, The Apple App store and Google Play Store earlier this month and the service is being piloted in 10 stores. We intend to roll it out to another 100 stores in the second quarter.

As we continue to develop this app, we intend to integrate more functionality to deliver an even more personalized shopping experience. We are excited about this new technology and look forward to sharing updates with you as the year progress.

To compliment these efforts we are continuing to push forward and other digital initiatives such as our digital coupons and personalized marketing campaigns that will help our customers save even more time and money.

We know that our customers who more frequently engaged with our digital tools tend to checkout with average baskets about twice as large as our chain wide average. With more than 12 million subscriber accounts we are excited about the foundation we have built for the future.

With our unique real estate footprint and model of value and convenience, we believe we own the last mile. As such, we have an opportunity to use our understanding of our customers' digital shopping behavior to create an even better in store experience and develop online tools that will help them save time and money.

Turning to our non consumable initiative. In recent weeks, we began our tests have a bold new and expanded assortment in key categories. Our model enhances the treasure hunt experience by first offering a new differentiated and limited assortment that will change throughout the year.

Second, displaying the new offering in high traffic areas with improved adjacencies and increased focus on key categories to enhance the in store experience and create a sense of purchase urgency.

And third, continues to develop exceptional value by pricing the majority of the offerings at $5 or less. While we're expanding our assortment and select categories, the amount of space currently dedicated to non consumables within our stores remains the same.

We plan to implement this set and approximately 700 store locations this year as we look to further compliment are strong and growing consumer business. We are excited about our plans and believe we are well positioned to capture market share in a changing retail landscape.

In closing, we delivered a solid first quarter and we are excited about the business and the outlook for the remainder of 2018. We believe we operate in the most attractive sector and retail and our business model is differentiated by a real estate and operating model that delivers best in class new store growth, steady comp growth, solid earnings, and strong cash growth generation.

I want to thank each of our over 130,000 employees across the company for all of their hard work and dedication to fulfilling our mission of serving others. As a team we are excited about our position and we look forward to building on our progress and delivering strong performance throughout the rest of 2018.

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

[Operator]

[Operator Instructions] Your first question will come from Michael Lasser with UBS.

[Todd Vasos, CEO]

Good morning Michael.

[Michael Lasser, UBS]

Good morning Todd. Thanks for taking my question. Has traffic been positive in the second quarter to date now negative in the last quarter. So how much are you willing to accept it or might have to step on some price investments or other initiatives in order to drive that?

[Todd Vasos, CEO]

Yeah. Michael, we feel real good about our star to our second quarter. One Stat that whether headwind that we saw a baited and we got back to some normalized weather patterns at the very tail end of April, but mainly now in the month of May.

We really feel good about our position. We really feel as great about where we are on our pricing, competitiveness in. It gets us all against all classes of trade and in all the areas that we operate in, a couple of those with our initiatives to grow both traffic and our sales and baskets.

I think that as we continue to move throughout the rest of this year, we'll see. We'll see continued momentum in our, in our top line, in our comp stores and in our traffic.

[Michael Lasser, UBS]

And then my follow up side, you mentioned that the contribution toward ramping to productivity should help a front, upper back half here. So you quantify what you're expecting to ramp the, in what it's been over the last quarter, going to provide us better and teaching of how you're more mature. Stores are performing and I still have been inevitable store gross sense for what the overall growth might?

[John Garratt, CFO]

Yeah. In terms of the back half of the year, what we wanted to point out is we opened an unusually large number of stores in the second half of last year, 741 stores. I believe that's about 80 percent increase over the prior year.

And when you have that many stores rolling into the base, it delivers a considerable tailwind, which helps offset, as you'll see higher comp lamps in the second half of the year. So we do see that as a tailwind.

In terms of new stores and mature stores, we continue to see solid contribution from both. As we've said in the past are a new store, a real estate contribution for both new stores, remodels, net of cannibalization delivers about 150 to 200 basis points.

Obviously as you're opening new stores that moves you toward the higher end of that range. But we continue to see a cost benefit from our mature stores as well. So, as we look at our, a comps for the year and the guidance that we provided, both in terms of where we're at in terms of the initiatives performing well in terms of the fundamentals of the business coupled with this gives us confidence in the guidance we provided.

[Michael Lasser, UBS]

Okay. Thank you. And Best of luck.

[John Garratt, CFO]

Thank you.

[Operator]

Your next question is from Paul Trussell with Deutsche Bank.

[Paul Trussell, Deutsche Bank]

Good morning. On gross margins I mean, sounds like shrink remains a strong opportunity. I'm just wondering if it's enough to key gross margins actually up all year or should we just expect that that second half comparison just gets too difficult on that front? And also just wondering if you are seeing any incremental pricing or freight headwinds versus your initial a guide?

[Todd Vasos, CEO]

Sure. A couple of questions there. I'll try and hit all those along the way. I will start by saying that, we're very pleased with the performance in Q1, delivering 17 basis points of margin expansion, despite the -- we also called out that, if you look at overall operating margin would have been level if you exclude the impact of the weather.

And we really look at it that way. We really look at as we look at the full year operating margin rate, which we said would be even with last year over the for the full year in our guidance. And we believe that's the right way to look at it so that we can manage all the levers within gross margin and SG&A make the right trade offs in the best interest of the long term growth of the business.

With that said, it's in gross margin specifically, we had a lot of levers within their shrink that you mentioned is one that we're very excited about. We've delivered six consecutive quarters of sequential improvement with shrink. We've made investments in EAS and it's, we talked about which are performing very well as well as all their targeted investments in defensive merchandising.

We have a lot of process rigor in place around this leveraging technology such as video enabled exception based reporting. So a lot of tools and process rigor to help drive shrink. But in addition to that, we have other levers within gross margin to partly offset the pressures you mentioned.

We as others have seen pressures on fuel and freight rates, but I think the team has done a phenomenal job managing all the levers within our disposal there as we continue to see those headwinds, as we continue to open new distribution centers, we have two under construction now that reduces the stem miles.

We're also driving improve efficiencies around load optimization and productivity improvements throughout the supply chain. We're expanding our private fleet. We're expanding and diversifying our carrier base so a lot of tools at play here to help offset that.

In addition to that, there's other levers within growth margin team does a phenomenal job with category management. We see opportunity to increase our private label penetration for insourcing, penetration and grow our non-consumables business. So as you look at all those both within gross margin and the ongoing rigor around SG&A, we feel good about the guidance that we provided for the full year.

[Paul Trussell, Deutsche Bank]

Got it. And I appreciate all the commentary on a cadence early on the call, but, but just to kind of clarify your 2Q comments, you're off to a good start but have tougher compare sequentially. I don't want to put words in your mouth.

Are you outlining that we should think about the second quarter has the opportunity to be better than 1Q, but the second half just given the new stores, could, should be better than the first half? You can just circle back in detail that? Thank you.

[John Garratt, CFO]

Yeah. So two things there. One, we just want to point out if you look at the cadence of the month, we started out with solid comps in February and March. And as we said running ahead of our full year guidance for comp then as we got into the end of March and into April, we saw a dip negatively and then we saw those returned a strongly positive with a great start to Q2.

So we wanted to make sure people are well aware of that cadence where we're starting up the quarter. Why that gives us confidence on the full year guide? Just pointing out thethe, the lap in q Tutu and the balance of the year, we just wanted to remind people of that.

I think people were trying to figure out the case, just want to remind them that, while we're off to a great start, the lab does get tougher, but as we get into the back half of the year in particular, as we mentioned, with all those new stores getting into the space, that gives us confidence that we can lap those nicely and deliver the full year guidance.

[Paul Trussell, Deutsche Bank]

Got It. Best of luck. Thank you

[Operator]

Your next question is from Vincent Sinisi with Morgan Stanley.

[John Garratt, CFO]

Good morning Vinny.

[Vincent Sinisi, Morgan Stanley]

Hey, good morning guys. Thanks very much for taking my question and thanks for us some of the quantification around that, the headwinds this quarter. First question, I just wanted to ask about the labor expenses. If I just want to kind of make sure that I, that I heard you guys properly.

So, one of the consistent questions we've gotten from folks since last quarter was, like the full year outlook, sounds good. Are they going be able to hold to it now from what you've said in terms of the margin guidance and in terms of even margin this quarter X whether it would have been flat?

So is it fair to say that just from a labor perspective kind of costs were in line with where you were thinking last quarter and that you still do feel good about that particular component of the outlook for this year?

[Todd Vasos, CEO]

Yeah. Absolutely. just as a reminder, we had one period in Q1 that we were still yet not lapped our investment in our store manager compensation and training. And so when we add, we add detail that out, when you look past that. I'm on labor. We're, we're seeing the benefits from our labor investments last year.

And our turnover rates are, are well in well in check and our applicant flows or are as strong as ever in matter of fact stormy than we've seen in recent years. So right now we feel very good about where we are in labor. But as I indicated, we continue to watch that and we monitor it market by market and we'll make adjustments if needed. But right now we see that we're in really good shape.

[Vincent Sinisi, Morgan Stanley]

Perfect. And then just a quick followup. I think we're roughly maybe a year and now into some of the smaller format tests, both the, DGX in this kind of 6,000 foot range. Just kind of what have you learned over the, over the past year. Should we still think of it as tests or kind of what are you seeing from those, those smaller formats and maybe kind of thoughts as we look forward here from a store growth perspective?

[Todd Vasos, CEO]

That's a great question. As you take a look at it, I'll address the smaller format store first, that, that concept is doing very well for us. We're using that concept in deeper urban areas as well as very rural areas that are are perhaps more crossroads than they are cities or towns. And we continue to open those and we continue to be very pleased with the results of those.

On the DGX front we've got three stores that are up and running. We're looking for two more sites for this year, so we should have five by the end of the year. I would consider that still more in the test phase.

As we continue to play with the mix a little bit to see what resonates and what doesn't with the consumer. but I have to tell you the three stores, we're very happy with what we see so far and it could be a nice unlock for our deep urban type areas across many of our metro us cities that we have out there.

[Vincent Sinisi, Morgan Stanley]

All right, great. Best of luck.

[Operator]

Your next question is from Matthew Boss with JP Morgan.

[Matthew Boss, JPMorgan]

Thanks. Hey, Todd. Any change in the larger picture view doesn't happen with the low income consumer and as you talk about the tailwinds versus the headwinds. And I think more recently we've talked about that when exceeding headwinds. Just maybe how best to think about where you see that today and going forward?

[Todd Vasos, CEO]

Yeah, I'm Matthew as we really are probably some of the best out there at knowing our core customer and really looking at her each and every quarter and I can tell you that, still today, I would tell you that her economic outlook is more of a tailwind than it is a headwind.

But there are those expenses that continued to rise for our core consumer. We continue to watch fuel rates, but right now that isn't too much of a headwind for, but we continue to watch that. But, rents and healthcare are the two big ones.

Especially rents in rural areas. It's, there's not an abundance of homes and housing there and in rents have escalated a, at a pretty good clip in the rural area. So we continue to watch that because that becomes a headwind obviously for our core consumer.

But right now she's back to work. Wages are up a little, her competence levels are up a little, so all that is really positive and gives us confidence in our full, your full year outlook on that top line.

[Matthew Boss, JPMorgan]

And then just a follow up how would you measure the competitive backdrop versus how that's the thing about mark downs with headwinds, somebody you haven't spoken to in the last couple quarters? And then maybe just multiyear any update on foreign sources, some of the initiatives from the gross margin side?

[Todd Vasos, CEO]

Yeah, right now as you look at the competitive landscape is, this channel and as well as just consumable retailing, it's always a very competitive out there. But I have to tell you that we are looking at this as we have in the last couple quarters is that we believe it's a well in check the competitive nature of what's out there.

We are competitively priced everyday low across the board and as we continued to become more and more competent and where that consumer is, we can see the pull back a little bit on that markdown and that's why you haven't heard too much about that and that continues to be a nice tail wind for us as well.

But as we continue to look forward, we always reserve the right though to make sure that, we stayed very competitive price. So we watched price very closely across all channels of trade.

[Matthew Boss, JPMorgan]

Great. Best of luck.

[Operator]

Next question is from Rupesh Parikh with Oppenheimer.

[Rupesh Parikh, Oppenheimer]

Good morning and thanks for taking my question. So first on the food inflation backdrop, I'll just curious in terms of what type of impact that had during the quarter and your expectations for, for the balance of the year?

[Todd Vasos, CEO]

Yeah, I'll just summarize that by saying we're not seeing a material impact one way or the other from food inflation right now.

[Rupesh Parikh, Oppenheimer]

Okay, great. And then as we look at the traffic declined during the quarter, do you attribute that primarily to weather or other factors at play?

[Todd Vasos, CEO]

So as you take a look at, again, the cadence of sales in the quarter, I think it's fair to say, traffic followed very closely that same cadence. So, predominantly it definitely was a weather phenomenon.

[Rupesh Parikh, Oppenheimer]

Okay, great. Thank you.

[Todd Vasos, CEO]

Sure.

[Operator]

Your next question is from Robby Ohmes with Bank of America.

[Marissa Sullivan, Bank of America]

Hi, good morning. This is actually Merissa Sullivan. I'm for Robby. I wanted to touch on that some of the produce tests that you're doing in some of your stores that beyond just the duty marketplace, how many stores does it right now? What are you seeing and what are your thoughts in terms of expanding produce to more of the store base?

[Todd Vasos, CEO]

Yeah, today we have over 200 stores outside of the market store, a piece for the produce, as we indicated we put a 45 more stores in this past first quarter. We feel good about where we are. We've got a lot of track record because of our market stores for many years on how to how to, how to treat produce within our stores, but we're still learning in our smaller store formats.

But we see it as a competitive advantage, especially in rural areas where there isn't a lot of competition and slash or food choices, especially healthy food choices for our core consumers. So we see it as a real opportunity and an advantage to deliver something to our core consumer that they're looking for.

And unfortunately today in many of the markets having to drive 15, 20 miles to get it. So we'll continue to learn and grow with that. I, I would tell you it's not going to be for every store somewhere down the line. But it could, could it be for thousands eventually? Yes, it could.

[Marissa Sullivan, Bank of America]

Got It. And just to follow up on your comments around some of your treasure hunt initiatives. I know you gave us the annual targets. How many stores do you have that initiative and right now, and can you give us any early commentary on what you're seeing in terms of lifts and penetration and the discretionary categories in those stores?

[Todd Vasos, CEO]

Yeah. It's in the very early stages as you can imagine. We have a handful up and running. Again, we've got a very aggressive plan to do 700 and by the end of the year we feel very good about executing against that.

It's probably a little early to talk about what we, what we're seeing. I can, I can tell you though that in the early results, they are on the positive side. But again, keep in mind a very early so, stay tuned, we'll give you more color as that becomes a more crystallized for us.

And we, we believe though it should be a, a real win for us in the longterm because what our consumers tell us, is in not consumable arena. They're looking for more of a treasure hunt experience than an everyday consumable shop for non consumables. SoI think that we're on the right track, but time will tell.

[Marissa Sullivan, Bank of America]

Great, thanks so much.

[Operator]

Your next question is from John Heinbockel with Guggenheim Securities.

[John Heinbockel, Guggenheim Securities]

Let me start with, you talked about the ROI of the store manager effort. So what metrics have you seen improve, say over the last few years since you've done that? And then one of the things that it does tend to improve, I think is shrink have you seen that correlate with shrink as well?

[Todd Vasos, CEO]

So we're very pleased. We were actually well exceeded the ROI in your one, well exceeded it. The culprits if you will they're the ones that you would think a, you will get benefit from there. We're getting benefit.

So that top line, I believe we're getting benefit there. We're definitely getting benefits from turnover. We're at, historic lows on our store manager turnover. And as John being a student of this business for a long time a good strong, stable store manager, then that translates and we're seeing this into less turnover in the assistant manager ranks and even less turnover in our hourly ranks, and we're seeing that for the very first time in so many years.

So we know it's directly attributable to our efforts there. You couple that with the training that we did last year and developing our people and encouraging them to move ahead with this company, it's all been a win.

So we feel very good about that investment. And we believe this has a multi-year link to it and we should see benefits as we move throughout ‘18 and even into early ‘19.

[John Heinbockel, Guggenheim Securities]

And then when, when you think about the discretionary business, right? So it had been negative for a while, turn positive in the second half of last year. You know negative in the first quarter, is it, is solely weather. And do you think a discretionary in total at all, all those three categories, they will be positive for 18?

[Todd Vasos, CEO]

Well, as you look at our non-consumable business. It's very important to us. Our teams work hard at ensuring that they have the right items at the right price for our consumers. You couple all of our efforts and category management there over the years. I would tell you as you look at Q1 we are pretty pleased with our non-consumables we're tracking, until we hit that, that weather time that we talked about.

So we're, we're pretty bullish as we move now into Q2. I can tell you that, again, we've talked about comps have accelerated and leading the way in comps right now are some of these seasonal and non-consumable categories.

And you would think that would be true because we're making up some of that ground. You never make up all of it, but you're making up some of that ground coming from the loss of Q1.

In the long term though we believe that that non-consumables is one of our biggest opportunities and that's the reason why our non consumable initiative of the 700 stores we're going to put in the ground this year with that is going to be so important as we continue to move forward. We believe that we may have the right formula here to really start to move, are non-consumable sales force.

[John Heinbockel, Guggenheim Securities]

Okay. Thank you.

[Operator]

Your next question is from Peter Keith with Piper Jaffray.

[Peter Keith, Piper Jaffray]

Morning. Thanks. Good morning guys. And Todd, you had noted on the, the plus formats. It's a pretty impressive complex 10% to 15%. There does seem to be a step up in the remodel activities that format, is that something that you think is a newer initiative that can carry forward for a couple of years at this called 400 DG plus format remodels?

[Todd Vasos, CEO]

Yeah. We have a very intricate real estate model which includes looking at all of our mature store bases and in touching those every 7 to 10 years on a remodel basis. So, the answer to your question, we believe the DGTP remodel has a lot of legs to it still left.

We again, don't believe every remodel will be underneath that. But again, could there be thousands of those somewhere down the road? Absolutely can be. And the same with the produce pieces I mentioned. I believe that you can see that in thousands of stores as we go into the future.

But we're very, very pleased with that DGPT format because it leverages our current box, but just makes it that much more productive. And those 10% to 15% comp lifts on a remodel or very, very impressive.

[Peter Keith, Piper Jaffray]

Okay. Thank you. And then lastly for me, I don't think it was ever quantified, but would you be able to give us what your estimation of the weather impact on Q1 is and then what amount of that you would expect to recapturing Q2?

[Todd Vasos, CEO]

We didn't quantify that, but I think it's instructive again, when you look at the cadence of the quarter in terms of how comps were, ahead of the full year guidance prior to April when the weather impact was and we're off to a great start for this quarter.

And as you look at the categories it was, the weather sensitive categories impact in the spring and summer and other weather sensitive categories. And if you look at the consumable side, which isn't as impacted by that, we had a very solid, strong comps in the consumables category.

So I think it's instructive to look at it that way as well as we've indicated from an expense standpoint, if not for the impact of the weather, we would have been even year-over-year in terms of operating margin, when you factor in the impact it had not only on the sales but weather related expenses.

[Peter Keith, Piper Jaffray]

Okay, great. Is there, there's a recap for dynamic and if not, is there some markdown risk to Q2?

[Todd Vasos, CEO]

No, at this point we feel very confident in our sell-through rates, especially as now we moved into the month of May, we've seen that acceleration. We don't see anything on the horizon that worries us at this point.

[Peter Keith, Piper Jaffray]

Okay. Terrific. Thanks a lot guys. Good luck.

[Operator]

Thank you. Ladies and gentlemen, that does conclude the portion of today's Q&A. We thank you for joining. You may now disconnect your lines.