Dollar General Corporation (DG) Q1 2017 Earnings Report, Transcript and Summary

Good morning. My name is Hope, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dollar General First Quarter 2017 Earnings Call. Today is Thursday, June 1, 2017. [Operator Instructions] This call is being recorded, and instructions for listening to the replay of the call are available in the company's earnings press release issued this morning. Now I would like to turn the conference over to Ms. Mary Winn Pilkington, Senior Vice President of Investor Relations and Public Relations. Ms. Pilkington, you may begin your conference.

Thank you, Hope, and good morning, everyone. On the call today are Todd Vasos, our CEO; and John Garratt, our CFO. After our prepared remarks, we'll 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 nonhistorical matters including, but not limited to, our fiscal 2017 financial guidance and store growth plans; investments and initiatives; capital allocation strategy and related expectations; future economic trends or conditions; and the pending acquisition of store locations. Forward-looking statements can be identified because they are not statements of historical fact or use words such as outlook, will, believe, anticipate, expect, forecast, estimate, plan, opportunity, continue, pending, focus on, looking ahead or goal and similar expressions that concern our strategy, plans, intentions or beliefs about future matters. No assurances can be given that the pending real estate transaction will be closed or will be closed within the expected time frame or that the sites will be converted to the Dollar General banner within the time frame anticipated. Any failure to close the transaction or a delay in such closing or in the conversion of the store sites to the Dollar General banner would impact the financial estimates and store count outlined in our earnings release and discussed on today's call. 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 2016 Form 10-K filed on March 24, 2017, 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 may be otherwise required by law. Now it is my pleasure to turn the call over to Todd.

Thank you, Mary Winn, and welcome to everyone joining our call. I am pleased with the way the team managed through the ongoing tough environment across retail during the first quarter: successfully controlling what we can control. Even as we lapped our most challenging sales and earning results from last year, our earnings per share reflected solid management of the business. In the first quarter, we made progress on the implementation of our key initiatives for the year as we seek to capture growth opportunities over both the long and short term. As we shared with you last quarter, our SG&A investments in 2017 are primarily focused on an increased compensation structure and additional training for our store managers as they play a critical role in our customer experience and the profitability of each store. The team is working to refine and execute our long-term strategy framework that we believe will help to differentiate us from the competition over time. Let us recap some of the financial results for the first quarter of 2017 as compared to the 2016 quarter. First quarter net sales increased 6.5% to $5.6 billion. Same-store sales grew 0.7% for the quarter. Our same-store sales improved as we moved past the combined effect of the delay in the income tax refunds and the timing shift of a later Easter holiday, both factors we mentioned on our last call. Same-store sales growth was driven by consumables and apparel, offset by declines in seasonal and home categories. Operating profit was $474 million. For the quarter, diluted earnings per share was $1.02, including approximately $0.01 charge for the early retirement of debt. We continue to increase our overall market share in highly consumables, growing mid-single digits based on the most recent syndicated data over 4-, 12-, 24- and 52-week periods ending May 6, 2017. We continue to believe many of the headwinds we faced in 2016 and are continuing to face are transitory in nature, such as the impact of average unit retail price deflation as well as customer behavior that we believe to be associated with changes to the federal SNAP benefits program. Average unit retail price deflation from the combination of lower commodity cost and promotional activity, along with the reduction of SNAP benefits, continued to weigh on our same-store sales performance in the quarter. As we look ahead, we anticipate lapping some of these effects in the second half of the year. As John will discuss later in the call, we are confirming our 2017 diluted EPS guidance of $4.25 to $4.50. Our objective remains to provide our customers with affordability, value and convenience at a time when they need us most. The team is focused on moving the business forward. During the quarter, we entered into an agreement to purchase 322 store sites located across 36 states from a small-box, multi-price point retailer. The transaction, which was approved by the Federal Trade Commission in April of 2017, is expected to close this month with conversions to the Dollar General banner completed by the end of November. Most of these stores are located in metro areas where we had anticipated future growth for Dollar General, and this pending transaction will allow us to expand in some of these markets at an accelerated pace. After John reviews additional financial highlights for the quarter and our full year guidance, I will update you on our operating priorities and anticipated integration plans for the store sites that we expect to purchase in June. Now let me turn the call over to John.

Thank you, Todd, and good morning, everyone. As Todd has taken you through the highlights of our first quarter, I'll share more details on the rest of the financial results starting with gross profit. Gross profit for the first quarter was $1.7 billion or 30.3% of sales, a decrease of 34 basis points from last year's first quarter. The most significant drivers were 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 the mix within consumables. These factors were partially offset by higher initial markups on inventory purchases. SG&A expense increased by 34 basis points over the 2016 quarter to $1.2 billion or 21.8% of sales in the first quarter. The majority of the SG&A increase was due to retail labor, primarily our investment in store manager pay and occupancy costs, each of which increased at a rate greater than the increase in net sales. Partially offsetting these items were reduction in advertising costs, including improvements in our advertising efficiencies and lower waste management costs related to our recycling efforts. Even as we made strategic SG&A investments in our business, we exhibited good underlying expense control discipline. Moving down the income statement. Our effective tax rate for the quarter was 37.2% as compared to 35.4% in the first quarter last year. Our effective income tax rate was higher this quarter due primarily to the recognition of a tax benefit of approximately $9 million or $0.03 per diluted share in the 2016 first quarter associated with stock-based compensation that did not reoccur in this quarter. Now to our balance sheet and cash flow. At quarter end, merchandise inventories were $3.3 billion, an increase of 0.5% on a per store basis from the 2016 first quarter. We believe our inventory is in good shape, and we are comfortable with its quality. We generated cash from operations of $510 million in the quarter, an increase of 26% or $107 million compared to the first quarter of 2016. While just over half of this increase is due to the timing of income tax payments shifting from the first quarter to the second quarter as compared to 2016, we continue to have strong underlying performance in our cash from operations. We remain committed to returning cash to our shareholders through our share repurchase and dividend program while maintaining a disciplined approach to capital allocation and our investment-grade rating. During the quarter, we repurchased 1.3 million shares of our common stock for $89 million and paid a quarterly dividend of $0.26 per common share outstanding, totaling $71 million. Since December 2011 through the end of the first quarter of 2017, we repurchased $4.7 billion or 75.6 million shares of our common stock. As of the end of the first quarter, the remaining share repurchase authorization was approximately $845 million. Looking ahead, I thought it would be helpful to share with you some key highlights of our anticipated store site purchase that Todd mentioned earlier. The transaction is forecast to be modestly accretive to net sales and earnings in fiscal 2017. We expect to incur charges and related expenses associated with the conversion of acquired store locations to the Dollar General banner, which we anticipate will be completed by November 2017. These expenses will be primarily related to lease termination costs for a small number of overlapping store locations as well as additional costs related to the pending store locations. We currently anticipate the charge will be approximately $0.02 per share in the 2017 second quarter. Based on our expectations regarding the timing of both the closing of the transaction and the conversion of the sites to the Dollar General banner, we estimate that the acquired sites will add about 100 basis points to our fiscal 2017 net sales growth. Please keep in mind, the transaction is subject to customary closing conditions. Let's now turn to guidance, which includes the anticipated impact of the pending transaction that I just discussed. Net sales are forecasted to increase by approximately 5% to 7% as compared with our prior guidance range of 4% to 6%. Our forecast for growth in same-store sales is consistent with our prior guidance range of slightly positive to up 2%. We continue to forecast GAAP diluted earnings per share for fiscal 2017 to be in the range of $4.25 to $4.50, including modest net accretion from the pending store site acquisition I discussed a moment ago. Capital spending is forecasted to be in the range of $715 million to $765 million, an increase of $65 million from our previous outlook. This increase is related primarily to the conversion of the pending acquisition sites. Taking into account the pending acquisition sites for 2017, we now plan to open about 1,290 new stores and to reduce our total fiscal 2017 remodels, relocations by about 140 sites to a total of 760 stores to allow for organizational capacity to execute the incremental new store growth anticipated to result from this transaction. In total, the team expects to execute about 2,050 real estate projects in 2017. Our share repurchase guidance for fiscal 2017 remains unchanged at approximately $450 million. As you model the balance of 2017, please keep in mind the following: While the sales environment for retail continues to be choppy, we are working aggressively to improve our customer traffic, and we believe that we will see positive traffic in the second quarter. We anticipate the mix shift of sales to consumables and the negative mix within consumables that we experienced in the first quarter to continue and modestly accelerate in the 2017 second quarter. We believe that our customer will require sustained improvement in her economic outlook before she is willing to increase her spending on discretionary nonconsumable items. As you look at the quarterly cadence, both our margin and EPS comparisons to the prior year comparable periods begin to ease in the 2017 third quarter. In closing, we will continue to focus on the things that are within our control, including managing our working capital and always striving to be a low-cost operator. We will also be financially disciplined in our capital allocation. Now I'd like to turn the call back to Todd.

Thank you. As John mentioned, we remain focused on capturing long-term opportunities ahead. In March, I went into some detail on the work that we did to advance our business through a comprehensive strategic review. We are refining and executing on the plans that resulted from our strategic review of the business, focusing on the actions that we anticipate will have the greatest potential to drive shareholder value over the longer term. We are well into the process of staffing the strategy group, along with the dedicated business leaders and teams that will execute on the initiatives. These plans are a very exciting part of evolving our business, and we believe they will help us remain well positioned to capture market share in a changing retail landscape. We continue to believe we operate in one of the most attractive sectors in retail. Our ongoing operating priorities remain: first, driving profitable sales growth; second, capturing growth opportunities; third, enhancing our position as a low-cost operator; and fourth, investing in our people as a competitive advantage. Our first priority is to continue to drive profitable sales growth. In spite of the challenging retail environment, we look to attract and grow new customers and trips and capture share with existing customers. This includes expanding the merchandising initiatives in our existing stores to drive traffic into those stores and improve same-store sales. Merchandising initiatives across all 4 product categories are being executed in a select group of stores to provide consumers with more of the products and brands they want and need to save time and money every day. The vast majority of these initiatives for fiscal 2017 are either completed or expected to be completed by the end of the second quarter. For those that we have completed, the initiatives are performing at/or above our expectations. One of the most exciting merchandising changes that we have made is in health and beauty, where we have a significant opportunity to increase our share of wallet with our customers through trial and conversion. In beauty, we have redesigned the cosmetic area in the vast majority of our stores to showcase the breadth of on-trend products that we offer at compelling price points. While this reset has recently been executed across nearly 12,000 sites, we are seeing improvement in our same-store sales. More planogram changes and visual excitement will be coming to our health categories as well as we look to increase our offering of value-added differentiated products with a focus on health and wellness, nutrition and personal care. Across merchandising categories, we believe that our planogram changes should continue to build momentum as we move through the year. The remodeling of about 300 traditional stores based on lessons learned from the conversion of acquired sites last year is on track as well. The remodels include increasing the cooler set to 34 doors, an increase of about 160% on average from the existing cooler footprint for these locations. This allows for a greater perishable assortment, which helps drive trips and basket size. Additionally, across about 1/3 of the -- of these locations, we are testing assortment of fresh produce. While it is still very early, initial remodels are yielding strong same-store sales improvements. We are strategically investing in a portion of the existing store base that has been opened for 5 years or more that we often refer to as our mature store base. We are particularly focused on stores that have fewer than 10 cooler doors, which in relative terms are expected to drive the highest returns. By the end of 2017, we anticipate that across our store base, we will have an average of 17 cooler doors, up from 10 in 2012. Year-to-date, more than 11,500 cooler doors have been installed across the chain for these locations. We are seeing an improvement in transactions. On the customer side, we are seeing continued opportunity to improve engagement and build loyalty through further integration of our traditional and digital media mix. Our plan is to reach our consumers where, when and how they decide to engage with us. We are also leveraging in-store operational initiatives such as improving our customer experience and our in-stock position. The store operations team has an ongoing intensive effort to improve our in-stocks through training and technology as product availability is an important driver of our customer satisfaction. We have ongoing opportunities for gross margin expansion through improvements in shrink, global sourcing, private brands, distribution and transportation efficiencies and nonconsumable sales. As always, we will continue to work to ensure that our value proposition resonates with our customers. We are committed to providing them with everyday low prices that they know and trust from us. Our goal is to ensure we are highly relevant for our customers through our ongoing price investment in everyday low price and targeted promotional activity. We have consistently shared with you one of the keys to our business is growing transactions and units. Our pricing surveys continue to indicate that Dollar General is very well positioned against all classes of trade and across all geographic regions. We are committed to being priced right for our customers to drive traffic to our stores. Our focus on initiatives to capture growth opportunities is our second priority. We have a proven, high-return, low-risk model that our real estate -- which is our real estate growth. We believe that we can extend this model to the opportunistic purchases of the 322 sites. These sites are highly complementary to our long-term new store growth plans with about 85% located in metro areas. The majority of these sites are in strategic trade areas that we would have anticipated for new store site selection over time. This transaction would allow us to reach certain of these areas faster and potentially more economically with organic growth. We will look to build out these sites. The range of different DG store formats is a strength that we can leverage based on the marketplace, along with the opportunity to test new ideas. Our existing plans for 2017 new store growth remains on track with the goal to make the pending sites as accretive as possible to our new store locations. The 1,000 new stores anticipated when we announced 2016 year-end earnings are in the pipeline for fiscal 2017. As John discussed, we expect the transaction to bring our new store count for 2017 to 1,290. We believe we continue to have first-mover advantage to secure best sites while driving compelling new store average returns of approximately 20%. New store productivity and returns are metrics we constantly monitor to ensure our new store growth is best use of our capital. I continue to be very pleased with our new store returns. The metrics we use to evaluate our real estate portfolio of new stores include: one, new store productivity as a percent of our comp store sales; second, actual sales performance compared to our pro forma model; third, returns of about 18% to 20%; fourth, cannibalization of our new stores on our comp store base; and finally, a payback period of less than 2 years. Regardless of the metric, over time, we have seen very consistent performance from our new stores. Given the softness across retail, I am pleased with how our new stores are performing. We are committed to ensuring we are deploying our capital effectively to drive strong financial returns for the long term. Third, we will leverage and reinforce our positioning 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 3 criteria: first, is it customer facing; second, does it align with our strategic priorities; and finally, third, how does it impact our risk profile. In our stores, we are focused on simplifying our operations by reducing inventory, product movement within the stores and operating complexity, so our store managers and their teams can reinvest time savings to provide better customer service and a clean in-stock shopping experience for our customers. At the store support center, work elimination and process improvement are ongoing efforts to take cost out of the business. Our underlying principles are to keep the business simple, but move quickly to capture 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 that they are a competitive advantage. As we entered 2017, we made significant investments in compensation and training for our store managers. Our data-driven approach to store manager compensation segments our stores based on the labor market data and store-level complexity. Across our existing store managers, internal promotions and external hires, we are targeting our investments to drive results. Overall, while it's still very early, the strategy for putting the investments to work in the marketplace is off to a good start. For existing store managers, we have seen an improvement of more than 400 basis points for voluntary turnover since making the compensation investment. While internal promotions continue to be a great source of store managers who know our culture and processes, we have been able to attract experienced retail individuals from sectors of retail that assimilate well to our model and culture. The stores with these new external hires are seeing improved results in associate turnover and positive impacts to same-store sales. Our organization's capacity to focus on talent selection, store manager development through great onboarding and training and open communication are critical to this investment paying off over time. As I have traveled to our store locations with our field leadership, the feedback and interaction with our store managers on our investment has been extremely positive. The customer experience and the profitability of our stores should benefit over time from this investment given how important the leadership of store manager is to these metrics. Our early progress is encouraging. This year, we are on track to create more than 10,000 new jobs as a result of our planned new store openings and 2 new state-of-the-art distribution centers. These new jobs help provide our employees with great career growth. We expect to invest more than 1.5 million training hours in employees in 2017 to promote education and development as we look to use our robust and best-in-class training programs to support our commitment to invest in our people and our employees as a competitive advantage. As our -- as for our customer, we continue to be cautiously optimistic about economic conditions but acknowledge that for our core customer, it is always challenging given the pressures on her income and spending. Regardless of the economic outlook for our customers, we will do everything we can to provide them with the value and convenience they expect from Dollar General. We are committed to the long-term growth and to the creation of shareholder value. Our business generates significant cash flow, and we are in a position to invest in store growth while continuing to return cash to shareholders through our cash -- through our share repurchase program and anticipated dividends. To the more than 122,000 employees of Dollar General, I want to thank you for your efforts to put our customers at the center of all we do. With that, Mary Winn, we would like to now open the line for questions.

[Operator Instructions] Your first question comes from the line of Vincent Sinisi with Morgan Stanley.

Just wanted to ask about the traffic. I know you said that you're expecting it to turn positive in 2Q. But just wanted to see if you could give us maybe a little bit more color on kind of the thoughts behind it and some of those headwinds like you had mentioned being more transitory in nature, particularly as you're kind of lapping SNAP and more so if you're seeing any changes on the promotional environment, in particular to some of your traffic-driving items that have been deflationary, that would be great.

Sure. First of all, we're very, very confident in what we see coming out of our initiatives for 2017. The early results of the initiatives that we put in place in Q1 that have also -- being put in place so far in Q2 have been very positive. Health and beauty, we called out in the prepared remarks, I'm very encouraged in seeing that. And I'm very encouraged as well in the big traffic-driving areas of our coolers and our perishable-type items. We've added more than 11,000 cooler doors so far, and we've got a lot more yet to do as we work through this quarter and even into Q3 on many of those initiatives. So we're very, very confident in what we see so far that it should help us continue to drive traffic as we move to the back half of the year. As far as what we're seeing in some of those transitory-type items, we're seeing deflation start to moderate. As we move through Q1, deflationary pressures from a cost input standpoint, we did see some moderation. We're not seeing a lot of inflation, but we're not seeing a lot of further deflation either. So it gives us confidence as we move through Q2 -- and keep in mind, Q3 -- we saw a pretty big deflationary time. But as we get past Q3, those should really start to roll off at least based on what we see today. And as we look at our SNAP piece that really we start to cycle here in the next month or so, we're already seeing some effects of that cycling since the waiver is sort of waived-in, if you will, by state. And right now, we've actually seen where we had been running about 100 basis point difference in our comp sales performance in those SNAP-affected states versus our other states that we operate in. That has now been cut in half. We're now seeing about 50 basis points of difference. So we're already starting to see that moderation, and I believe we'll continue to see that as we move through Q2. And then lastly, your question on the promotional environment. Promotionally, we're really seeing about the same that we saw coming out of Q4. Q1 has been about the same. We're really not seeing a big difference. There's some pockets here and there of activity. But overall, we feel very confident about our promotional activity. But as you know, we're more squarely focused on our everyday low prices here. And there, we really feel good about where we are. Our everyday low prices are in the best shape that I think I've seen it in the close to 9 years that I've been here across all geographic areas, so we feel very good about that as well as we move through and into the second part of the year.

Super helpful. And just a fast follow-up. We, on the phone -- I'm sure, get asked this all the time. When we get asked -- you guys had set out some kind of longer-term financial growth metrics. I guess, it was earlier last year. We know obviously the macro changes this year, investing in store manager comp and all that stuff. Do you still, though, feel good in a more kind of normalized operating environment of the metrics that you did lay out last year?

Yes. We still feel good about the fundamentals of the business and the long-term growth potential. It's still our goal to be a 10% grower in the long term. As we look at the business, we still see a tremendous amount of organic growth opportunity, great store-level economics, still getting the 20% return on new store openings, and very excited about the additional acquired stores this year that gets us into places we wanted to go, continue to generate a tremendous amount of cash. We mentioned 26% cash growth even when you strip out some timing with taxes, it was still double-digit cash flow growth this quarter. So we continue to see a tremendous runway for growth. We're excited about the initiatives we have in place. We feel we're in a good position from a pricing standpoint. We believe that our combination of value, convenience really resonates with our customer and allows us to continue to grow share. And we continue to have a lot of levers within gross margin and SG&A that the team does a phenomenal job managing and has a great track record of making the right trade-offs, but with an eye on the long term and investing where we need to as we have this year.

Your next question comes from the line of Michael Lasser with UBS.

Can you give us a little more flavor for how trends unfolded over the course of the quarter? With the drag from the tax refunds, our sense is you're probably negative. And then by the end of the quarter, you were obviously nicely positive given where the full quarter ended up. Was that solely due to the tax refund drag going away and then the SNAP drag becoming less of an issue? Or were you able to definitively tie some performance results to the initiatives that you had put in place?

Yes. That's a great question. We saw the quarter unfolding this way: As we said in our prepared remarks, once we got past that delay in the income tax piece -- and remember, also, Easter shifted from March to April this year. Once we got past that combined Easter shift and the tax refund delay, we did see a nice uptick as we got into April. Even beyond the Easter shift, we saw that occur. And I think it is a combination of many things. But I again, feel very confident in our initiatives. We could really tie directly a lot of what we saw coming into April because that's when some of our initiatives really started to take hold, we could really tie directly some of our performance into that. While we're not happy or satisfied with 70 basis points of comp, we know that we could grow that a lot more over time here. I think in this environment, I think we laid a comp on the table that was very competitive but with an eye on growing that a lot more as we move to the back half of the year.

And then, Todd, my follow-up question is on the merchandise mix that's being sold. Do you think you're seeing an economic drag, maybe a post-cyclical drag on some of those discretionary categories where consumers might be trading to other retailers as a result of a stable or benign economic period and the potential for those to get better in a more challenging environment? Or is there some influence you can have over the discretionary categories such that those areas can improve independent of the macro?

As you look at our discretionary categories, prior to Q2 of last year, we had some very nice growth over -- about 6 to 8 quarters. We believe it's transitory in nature right now. We believe for a lot of reasons, the customer has been pulling back, been holding back a little bit. Matter of fact, we don't believe she's been trading out at all. What we see from our customer data is some of our stronger comps and stronger sales are coming from not only our very strong customers, but that next level-up, which would have a tendency and propensity to trade out over time, but actually have been our strongest in Q1, our strongest sales driver category of consumer. So I don't believe she's been trading out. I just believe that she's in an economic cycle right now where there's a little bit of uncertainty and a little bit of a holdback on these discretionary items. And I believe and feel very confident in what the team has built here on the category management side to take advantage as soon as she starts to loosen the purse strings up a little bit on that nonconsumable side of the business. But to really look at it the proper way, we had a very strong Easter. Matter of fact, Easter was as strong as we've seen in the last couple, 3 years. So it gives us a lot of solace that our nonconsumable businesses as well as many of our consumable businesses that we have are trending in the right direction.

Your next question comes from the line of Peter Keith with Piper Jaffray.

Just to follow up on that last answer regarding the challenging environment. I guess, Todd, what do you think you need to see with the economy at this point in order for your customer to loosen up the purse strings?

Yes. What I think we need to see is a little bit more confidence in what we're -- what the consumer is seeing today from job growth and wage growth, will it be sustainable? I think that's the big ticket right now that we're waiting to happen, I think that they're waiting to see happen. Our core customer, as you know, doesn't have large bank accounts to fall back on. And so [ during ] times like these where she's starting to feel a little bit more comfortable because she's back to work and seeing a little bit of wage growth, she wants to make sure it's sustainable. The huge downturn that we all experienced in 2008, 2009, hit our consumer extremely hard, probably the hardest of any group that was out there. And I think that's still very fresh in her mind. So she's making sure that what she's seeing now is sustainable and can grow over time. And I believe once that happens, we'll start to see that purse string loosen.

Okay. Maybe on a similar note then, you talked about the discretionary business being a little bit weak starting with Q2 last year. I would think discretionary within your mix would be the area that's most at risk to losing share to e-comm, certainly more so than consumables. Do you have a perspective on your positioning with e-comm today and if there is potential encroachment?

Yes. We see e-commerce about where we had seen it coming out of Q4. Our core customer is a fast follower. There is no doubt. Only about 70% of them today have cell phones -- excuse me, smartphones. And I believe that over time, she will probably start to gravitate a little bit more toward online purchasing. But today, all of our work shows that she is still lagging there compared to the rest of the customers in the economy that's out there. In saying that, we're working very diligently here as well. Part of our strategic review, as we mentioned, was digital. And we're working hard to ensure that as our core customer starts to gravitate more and more to digital that we're going to be able to take her along the journey with us, and she'll look to us for her future digital needs like many others do, other retailers, both online as well as brick-and-mortar retailers today. So I don't see that today, though, that our core customer is spending a lot more of her disposable income online than she did before. We just don't see that.

Your next question comes from the line of Matthew Boss with JPMorgan.

So on category drivers, I guess, how much do you believe tax refunds drove the mix shift towards consumables in the first quarter? And I guess, to go back to some of the comments you had earlier, what's driving the mix shift acceleration into the second quarter? And within the consumables, I think there was some talk about more micro-category -- an intra-category shift between food and nonfood. Just if you can parse through some of the 1Q versus what's continuing into 2Q and what you're seeing in that category.

Yes, sure. As we look at the tax refunds, and I think others have said the same thing, once you don't have that same refund at the same time, you never seem to get back all those sales that seem to not be there, right? Now we got our fair share, I think, of what came, but it just wasn't to the extent I believe that it would have been if it came on time. Now in saying that, the majority of those sales normally -- because it's tax refund in nature, usually does come in our discretionary categories. So it did slow our discretionary a little bit more than what we had anticipated in Q1. What we're seeing, though, as we move into Q2, is the continuation of what we saw really in Q1, and that's the consumer really holding onto her money, spending where her need is the most. And that's been on the consumable side of the businesses. And then even within that, we're seeing some mix shift inside of the categories. We're driving the mix to some less profitable areas as well within categories. So that continues to be there. The great thing is we have a great category management team that's able to watch and see what's happening and then be able to react to that. So that as we continue to move through Q2 then into the back half of the year, make adjustments. And those adjustments -- and we're used to doing this. We do it very well, make those adjustments to work that margin depending on the way the consumer is shopping. This isn't anything new. We've been doing this for many, many years, and we know how to do it pretty well.

Great. And then just a follow. Can you touch on the productivity and return metrics that you're seeing from some of your more recent classes of new stores? I guess, just more so, any perspective on what you're seeing from the latest classes versus historically some of the metrics that you had seen in the past?

Yes. We continue to see consistent results. We walked you through the key metrics that we look at in terms of new store productivity, with that goal of as a percent of our comp store base being in that 80% to 85% range. We remain within there. We continue to see our actual sales performance compared to pro forma very close, it ebbs and flows from time to time, but hitting those pro formas pretty consistently over time. We continue to see -- track returns. We target 18% to 20%. We continue to see our returns tracking towards the high end of that range. We've not seen cannibalization move on it. It has been pretty consistent and what we expected. And we continue to see a payback period of less than 2 years. So really, we continue to see the same great results that we expect, consistent performance. And with that in mind, we're very bullish about the future of this. But obviously, we diligently track these, monitor them very closely. We're a nimble company that can make adjustments if needed down the road. But right now, what we're seeing, we like.

Your next question comes from the line of Charles Grom with Gordon Haskett.

This is actually John Parke on for Chuck. So I guess, first, I mean, what is the annualized lift that you guys expect to see to both sales and earnings from these stores that you're acquiring?

In terms of lift, what we said there was we expected to drive 1 point of total sales growth. So as we had said in our guidance, we upped it from 4% to 6% to 5% to 7%. And then it doesn't show up in our comp base until next year, so there'll be no impact to the sales comp.

Okay. But there's no kind of guidance on what that does on an annual basis?

So on an annual basis from a dollar amount, it's a little over $0.5 billion.

Got you. Okay. And then just switching gears a little bit. It seemed like new store productivity kind of spiked up a bit here in the quarter. I mean, are you guys doing anything different around your new store openings to kind of speak to that? Or...

I think it just speaks to we have a tremendous real estate team that continues to hone that model. They do a phenomenal job of finding the best sites, and they continue to hone that algorithm, find the best sites, continue to optimize that box. I mean, we see ourselves as the innovator in different formats. And what we're finding is the right format that fits occasion and seeing good success in the smaller box, for instance, which opens up areas that weren't open to us in the past. So I think it's just a testament to the rigor and the capability of the team here.

Your next question comes from the line of Karen Short with Barclays.

Just a question to clarify. Is traffic -- did traffic end on a positive note in the quarter? And is it positive into the second quarter? I just wanted to clarify that, and then I had another question.

Sure. Traffic did spike up, obviously, in April. Combination of the Easter shift as well as our initiatives, I believe, drove that to positive. And we're not really talking too much about Q2 right now, but we saw some positive momentum coming into Q2, but it's still very early. So we don't want to comment on where we believe that's going to end up. But again, we're very, very confident in our initiatives to drive the top line. And we're looking forward in future quarters to see that traffic move to positive.

Okay. And then you commented, I guess, that stores testing produce are seeing strong same-store sales. I'm just wondering if you could get a little more granular on what kind of comp lift you're seeing from this, and then maybe you could give a little color on how shrink is looking at those stores in particular.

Yes. When you look at the stores that we put produce in, again, just keep in mind, it's a very few stores, but we have seen nice comp lifts in these stores. Now these same stores have been remodeled as well, so we're watching the comp across all categories within those stores. Produce is helping that comp. But even without that, those stores are comping very, very well. And it's really attributable to the amount of cooler doors we're putting in on the refrigerated and frozen side of that equation has been well received by the consumers. And we're starting to really see traffic start to pick up in those stores as word of mouth continues to get out that we've got a broader selection of things they need to include "better for you type" products within those coolers. So we're pretty excited about what we see there, but there's still a lot more yet to figure out on these new stores as it relates to produce. As you know, we've been in the produce business only a short period of time in these stores, but we've got a lot of experience with them in our market stores. And we've taken the learnings from those and applying them there. And then as far as the shrink in these stores, a little too early to tell yet. As you know, shrink has a pretty long tail to it. And since we've just been remodeling these stores recently, a real shrink indication probably won't be evident until probably latter part of this year in those stores to see exactly how they're starting to trend.

Your next question comes from the line of Stephen Tanal with Goldman Sachs.

So I guess, wanted to spend a sec just to understand kind of the analyses that you guys run around traffic to understand whether it's sort of exogenous or macro or competition. Specifically, I think I get it on the trade-up piece, but I wonder about replacement. How do you sort of analyze the idea that, well, maybe some low-end consumers are shopping at discount grocers or something like that more and maybe that's why we're seeing less trips, how do you get your head around that to get comfortable with what's going on there?

Yes. The great thing about Dollar General is we do a tremendous amount of work with our customer. Each and every quarter, we reach out and touch our consumer to understand exactly what she's feeling, what she's seeing and what she's doing. We do it on a personal level, then we do it on a macro level as well. And what we see and what we've been seeing for the past 3 quarters, including Q1, has been a continued consolidation of her shopping patterns. Shopping less and shopping fewer retailers as she shops, so -- on both sides of that equation. So she is making decisions on where she shops. And as she does that, she's also making decisions that I'm going to shop a little less as well, meaning less frequently. So we watch that very carefully. While we have seen the same phenomenon in our business as others have seen based on all the work that we see, we actually have seen the rate of that consolidation quicken in other channels of trade versus ours, while we still -- while we have still seen a decrease in the amount of time that -- or amount of shops that she does in a month period, we're not seeing the contraction as deep as other classes of trade. But it still concerns us that she's contracting across the board. So that means that while she is shopping, we have to have the right items at the right time at the price to attract her, and that's what we're working on to make sure that happens.

Got it. That's helpful. I was wondering as well if you would quantify or comment on the uplift from the remodels to sort of the like-for-like box?

Yes. We continue to see great performance from the remodels. What we've said in the past is in terms of a sales lift, we get about 4% to 5%. We continue to get that. And on some of the remodels where we're putting more coolers in, we're seeing a considerably higher lift on that. And we've been very pleased with what we've seen as we add coolers to the stores.

Yes. When you take a look at our Dollar General traditional Plus stores that we're putting together, these ones that we're remodeling, we're seeing 3x the comp sales lift in those stores than we've seen from a traditional remodel. Remember, we've always said a traditional remodel runs between 4% and 5%. We're seeing 3x that lift from these. So we're very encouraged early on, on what we're seeing.

Your next question comes from the line of Brandon Fletcher with Bernstein.

Our only concern is what we like best about you guys is how defensible you are geographically. We love the more rural locations, especially because that's hard to replicate and with new distribution centers letting you run efficiencies further out. We think those stores are protected for a long run. Help us understand why you guys like the metro stores as much, especially if we imagine -- let's say, produce goes in there and I don't know what your strategy is for produce and I know it's evolving. But we just get nervous that if you have more metro stores and they're doing the same thing that a Lidl and an Aldi will do that competition gets really intense. So if we could have any color on your strategy around that, that would be very useful.

Yes, absolutely. Those are great questions and it's things that we look at internally here all the time. One thing I think is important to keep in mind is not all metro locations are created equal. There are certain metro areas that actually feel and look more like our rural locations, let me explain, both from a customer standpoint as far as the demographic is concerned as well as from lack of competition. There is a lot of metro areas out there that we're looking at that we're actually opening as well as part of the 292 stores that we're going to be opening from our recent acquisitions, many of them are in these areas that have little competition in them as well because not every metro area has a great amount of competition. So we're very selective, and we've been watching this very carefully over time and feel confident that there's thousands of opportunities out there in metro that meet the criteria we need to be successful. So stay tuned, continue to watch. But we're watching it very carefully, and we're very happy with what we see early on.

Your next question comes from the line of John Heinbockel with Guggenheim Securities.

Todd, so the first thing on the acquired stores. So the productivity is obviously very good because they're metro stores. How large is the gap in profitability, right, with maybe your overall base or your metro stores? Do you think you need to invest in price and labor in those stores because maybe that has not happened? And then what does this do to your expansion profile after 2017? Does it come down because you front loaded it somewhat here?

As we look at it, John, these stores that we're acquiring -- again, top line as you indicated is pretty good. What I think they've been suffering from is really a lack of scale as it related to the profitability and watching it drop to the bottom as well as a lot of the know-how that we have on how to run stores from a shrink perspective. So we believe that the opportunity gap is very large on the profitability side. As we look at price, what we modeled in as we looked to purchase these is to get them more aligned with where Dollar General pricing is. So yes, the prices will come down in those areas, but they should because, again, we're all about making sure we drive traffic in units in there. And we believe that the $0.5 billion in sales that these stores are throwing off can also increase very profitably. So we think we've got opportunities both on top line as well as letting it fall right to the bottom line.

And then just unrelated, I actually thought the discretionary performance in the fourth quarter was pretty good, right? One of your better ones in the last year, 1, 1.5 years in light of the macro environment, right? So maybe touch on that a little bit. And in particular, I was surprised apparel was as good as it was.

Yes. As you said, John, while we're never happy with where we ended up there, we always think there's more, the team has done a great job in nonconsumables. And as you continue to look forward, I believe we've got the right product at the right price for what the consumer is looking for in nonconsumables. In saying that, apparel did do pretty well. As we move through Q1, I believe the lineup that we have for spring and summer is one of the best that we've seen. But also the transition out of Q4, which is more of our winter and fall-type goods, we were able to take advantage of that as well on the top line. With a little bit of a cooler, wetter start to the quarter 1 helped propel a little bit more of that and elongated out a little bit more of the winter goods as well. So we saw apparel benefit on both sides of that equation. And then lastly, I mentioned earlier, our seasonal business continues to do very well. And Easter was again one of our best in a couple, 3 years, and not only on consumable candy but also on our nonconsumable sides of seasonal. So we feel we're well positioned, but we're not going to rest until we see comps accelerate a lot more from where they are today in nonconsumables.

Your final question comes from the line of Paul Trussell with Deutsche Bank.

I just wanted to get a little bit of handholding around the guidance, and I know you don't provide quarterly detail. But as we think about your first quarter metrics from a comp and margin standpoint, how should we think about the puts and takes and the opportunity for improvement in 2Q versus the second half, in particular on SG&A and gross margins. If you can give just a little bit more detail around how you're thinking about, again, merchandise mix, markdowns, need for further price investments. And then we haven't really touched so much on the expense front around ZBB and what you were able to execute in the first quarter. So some details on that front would be great.

Okay. Well, starting with the overall guidance, that remained unchanged with GAAP EPS guidance remaining at $4.25 to $4.50. That is inclusive of the acquired stores. The thing we mentioned there was that, that will be modestly accretive for the year as we have expense in the front-end of that, about $0.02 in Q2, and then the back-ended loaded nature of the openings, we won't get a full year benefit. That will be toward the end of the year. The other thing we did mention is we continue to see the headwinds we saw in Q1, and the team did a phenomenal job working through that, but we continue to see those headwinds coming into Q2. And the other one we mentioned was mix. But as Todd said, we're comfortable with our ability through category management to improve that. And as we get through Q2, we'll have all our initiatives in place getting into the back half of the year as well as the thing we noted was in Q3 that's where you see the comps both from a top line and a bottom line ease. So we feel good as we get into back half of the year with those initiatives in place. With headwinds starting to subside and the comps easing, we feel good as we get into the back half of the year. But we stuck with the same guidance. There's still a lot of year left. Q1 came in about where we expected, so we thought we would keep the guidance where it's at for now, but very excited about the acquisition opportunity here and seeing over time that's going to be accretive to us.

All right. Hope, so I think that will wrap up our call. I know we left a few people in the queue, and I do apologize about that. But please feel free to give me a call, and we look forward to updating you as we move forward. Thank you.

Thank you. This does conclude the Dollar General First Quarter 2017 Earnings Call. You may disconnect.