Dollar General Corporation (DG) Q1 2018 Earnings Report, Transcript and Summary

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. [Operator Instructions] This call is being recorded. Instructions for listening to the replay of the call are available in the company's earnings press issued this morning. Now I would 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.

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 up the call for questions. Our earnings release issued today can be found on our website at dollargeneral.com under Investor Information, News and 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 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, objective, outlook, will, believe, anticipate, expect, forecast, estimate, guidance, plans, opportunity, continue, focused on, intend, looking ahead, goal, over time or look forward and similar expressions that concern our strategies, 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. [Operator Instructions] Now it's my pleasure to turn the call over to Todd.

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. During 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 4 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% reflects strong performance in the consumable category. We continue to gain market share in highly consumables over the 4-, 12-, 24- and 52-week periods ending May 5, 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 commitment has contributed to our share gains. While 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 nonconsumable categories, particularly among spring and summer products. Consumables, which represents 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 impact, midway through the first quarter, our comp sales were 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.

Thank you, Todd, and good morning, everyone. Now that Todd has taken you through a few highlights of the first quarter, let me take you through some of the 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 30.5% in the first quarter, an increase of 17 basis points. This increase was primarily attributable to higher initial markups on 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 than our other product categories; the sales of lower-margin 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 leased 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 2 factors. First, the previously announced expenses associated with the store manager investments and the ramp-up of the stores opened in the second half 2017; and second, the unseasonably cold and damp weather that negatively impacted sales and drove higher-than-expected utilities expenses. The operating margin rate for the quarter would have been flat if not for those investments in the weather. Moving down the income statement. Our 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 had 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%. This 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 planned investments in new stores, remodels and relocations, continued investments in our 2 distribution centers under construction and spending related to previously announced acceleration of some key initiatives. During the quarter, we repurchased 1.6 million shares of our common stock for $150 million and paid a quarterly dividend of $0.29 per common share outstanding at a total cost of $78 million. Through the end of the first quarter, we returned cash to shareholders totaling $228 million through the combination of these share repurchases and quarterly dividends. From the inception of our share repurchase program in December 2011 to 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 and quarterly dividends, while maintaining our current investment-grade ratings and managing to a leverage ratio of approximately 3x adjusted debt to EBITDA. Turning now to our guidance. As Todd highlighted, we are off to a solid start during the first 4 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 the sales. We're off to a good start in the second quarter, but bear in mind, the second quarter comp lap tends to get tougher relative to the first quarter. Also, as a reminder, in the second half 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 base. The anticipated positive impact of these stores helps offset the tougher comparisons we faced in the second half. This positive impact is contemplated in our full-year guidance. Second, looking at gross margin. We continue to see freight and fuel headwinds. But as a reminder, we begin to lap these pressures in the second half of the year. The team is executing strategies that we believe can help mitigate the impact of these headwinds over time. 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 a reminder, for modeling purposes, our long-term goal is to leverage SG&A on an annual basis in the range of 2.5% to 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 what is right for the longer-term health of the business. Finally, regarding EPS. I would remind you that in the third quarter of 2017, we saw a $0.05 estimated net negative impact to diluted EPS due to the hurricanes. 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 to Todd.

Thank you, John. Let me now walk through how we are executing against our operating priorities and initiatives for 2018, as well as update 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 top line initiatives for 2018 to revolve around merchandising and store operations. These initiatives are designed to enhance the value and convenient 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 practically focused on remodeling stores that have fewer than 12 cooler doors. These store remodels typically drive amongst 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 have 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 approximate 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. Moving on the success of Phase 1 launch of our health and beauty initiative in 2017, we are launching Phase 2 in 2018. As reminder, during Phase 1, 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 2, we want to build on the increased category awareness we created during Phase 1 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 identify innovative ways to drive new customers into our stores. We plan to execute Phase 2 in about 7,000 stores in 2018. Another initiative I want to mention within merchandising is our efforts in private brands. Our private brands 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 resets planned for 2018. Let me briefly highlight 2 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 are 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 brand 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 2 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 operation 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 growth. 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 margin. These includes further reductions in shrink, additional contribution from global sourcing, private brands and nonconsumable 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 are 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's 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 investment can deliver multiple years of benefit. 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 our exposure to these headwinds. Some of our ongoing initiatives include reducing our stem mile, improving 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 that 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 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 5 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 pro forma models; third, average returns of 20% to 22%; and fourth, 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 2 years or less. We have consistently hit our goals for these metrics. We are very pleased with our overall new store returns, and we remain committed to investing our capital effectively to drive strong financial returns. For 2018, we expect to open 900 new stores, remodel 1,000 of our mature stores and relocate approximately 100 stores. That's about 2,000 stores in total. Of the 1,000 planned 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 are 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 remodeled store delivers a 4% to 5% comp lift on average and the 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 still through 3 criteria: first, is it 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-stock 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 are 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 in attracting and retaining talent. 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 retract -- attract, excuse me, and retain the right talent, and we are prioritizing investments in our people. Finally, before I open the call for questions, I want to quickly touch upon our recent progress executing against 2 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 U.S. population currently within 5 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 a self-checkout. Not only does this app save our customers' time, but it also allows them to see a running total of their basket. 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 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 progresses. To complement these efforts, we are continuing to push forward on 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 engage with our digital tools tend to check out 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 nonconsumable initiative. In recent weeks, we began our test of 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, continue to develop exceptional value by pricing the majority of the offerings at $5 or less. While we're expanding our assortment in select categories, the amount of the space currently dedicated to nonconsumables within our stores remains the same. We plan to implement this set in approximately 700 store locations this year as we look to further complement our strong and growing consumable 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 developed a -- 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 in retail, and our business model is differentiated by our 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 Instructions] Your first question will come from Michael Lasser with UBS.

So has traffic flipped positive in the second quarter to date now? Traffic has been negative in the last 6, 7 quarters. So how much are you willing to accept it for you might have to step on some price investments or other initiatives in order to drive traffic positive there?

Michael, we feel real good about our start to our second quarter. Once that weather headwind that we saw abated, 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 great about where we are in our pricing competitiveness in -- against all classes of trade, in all the areas that we operate in. And couple 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 continued momentum in our top line, in our comp stores and in our traffic.

And then my follow-up, Todd, you mentioned that the contribution from your revenue productivity should help fund tougher comparisons to the back half of the year. So can you quantify what you're expecting to contribute from your new-store ramp to be and what it has been over the last few quarters? Just can you provide us better indications of how your more mature stores are performing and as it's inevitably slowed the store growth, it might give us a sense for what the algorithms look like?

Yes, 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 last of year, 741 stores. I believe that's about an 80% increase over the prior year. And when you have that many stores rolling into the comp base, it delivers a considerable tailwind, which helps offset, as you'll see higher comp laps 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, our new store -- our real estate contributions for both new stores, relos, remodels, net of cannibalization delivered about 150 to 200 basis points. Obviously, as you're opening new stores, it moves you towards the higher end of that range, but we continue to see comp benefit from our mature stores as well. So as we look at our 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.

Your next question is from Paul Trussell with Deutsche Bank.

One, on gross margins, I mean, it sounds like shrink remains a strong opportunity. Just wondering if it's enough to keep 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 guide.

Sure, a couple of questions there, I'll try and hit all those along the way. I'll start by saying that we're very pleased with the performance in Q1, delivering 17 basis points of margin expansion despite the [indiscernible]. And we also called out that if you look at overall operating margin, it would have been level if you exclude the impact of the weather. And we really look at it that way. We really look at it -- we look at the full year operating margin rate, which we said would be, even with last year and 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, SG&A, make the right trade-offs in the best interest of the long-term growth of the business. With that said, within gross margin specifically, we have a lot of levers within there. Shrink that you mentioned is one that we're very excited about. We delivered 6 consecutive quarters of sequential improvement with shrink. We've made investments in EAS units, as we talked about, which are performing very well, as well as other targeted investments in defensive merchandising. We had 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 2 under construction now, that reduces the stem miles, we're also driving improved efficiencies around load optimization and productivity improvement 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 gross margin. The team did a final job of category management. We see opportunity to increase our private label penetration, foreign sourcing penetration and grow our nonconsumables business. So as you look at all those, both within gross margin and the ongoing rigor around the SG&A, we feel good about the guidance that we provided for the full year.

Got it. And I appreciate the commentary on cadence early on the call. But just to kind of clarify your 2Q comments, you're off to a good start, but have tougher compares sequentially. I don't want to put words in your mouth, but 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, should be better than the first half? If you can just circle back in detail that.

Yes, so 2 things there. One, we just wanted to point out, if you look at the cadence of the first 4 months, we started off with the solid comps in February and March, as we said, running ahead of our full-year guide for comps. Then as we got into the end of March and into April, we saw comps dip negatively. And then we saw those return strongly positive with the great to 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 confident in the full-year guide. Just pointing out the lap in Q2 and the balance of the year, we just want to remind people of that. I think people were trying to figure out the cadence. I just want to remind them that while we're off to a great to start, the lap does get tougher. But as we get in the back of the year in particular, as we mentioned with all those new stores getting into the comp base, that gives us confidence that we can lap those nicely and deliver the full-year guidance.

The next question is from Vincent Sinisi with Morgan Stanley.

First question, I just wanted to ask about the labor expenses. I just want to kind of make sure that I heard you guys properly. So one of the consistent questions we've gotten from folks since last quarter was, geez, so the full-year outlook sounds good. I think you may 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 weather 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?

Yes, 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 we had detailed that out. When you look past that on labor, we're seeing the benefits from our labor investments last year, and our turnover rates are well in check. And our applicant flows are as strong as ever, and a matter fact, stronger 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.

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

That's a great question. As you take a look at -- I'll address the smaller-format store first. 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 perhaps more crossroads than they are cities or towns. We continue to open those and we continue to be very pleased with the results of those. On the DGX front, we've got 3 stores that are up and running. We're looking for 2 more sites for this year. So we should have 5 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 who what resonates and what doesn't with the consumer. But I have to tell you, of the 3 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 U.S. cities that we have out there.

Your next question is for Matthew Boss with JPMorgan.

Todd, any change in the larger-picture view that you have with the low-income consumer? I know you talked about the tailwinds versus the headwinds, and I think more recently you've talked about tailwinds exceeding headwinds. I guess, just maybe help us to think about where you see that today and going forward?

Yes. Matthew, as you know, we really are probably some of the best out of 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 continue to rise for our core consumer. We continue to watch fuel rates. But right now, that isn't too much of a headwind for her, but we continue to watch that. But rents and health care are the 2 big ones. Especially rents in rural areas, there's not an abundance of homes and housing there, and rents have escalated 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 confidence levels are up a little. So all that is really positive and gives us confidence in our full-year outlook on the top line.

Great. And then just a follow-up. I guess, how would you measure the competitive backdrop today versus years past? Help us to think about markdowns, which I know have been headwinds. It has been something you haven't spoken to in the last couple of quarters. And then, John, maybe just multi-year, any update on foreign sourcing and some of the initiatives to stabilize mix from the gross margin side?

Right now, as you look at the competitive landscape, as you know, this channel, as well as just consumable retailing, it's always 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 well in check, the competitive nature of what's out there. We are competitively priced, everyday low across the board. And as we continue to become more and more confident in where that consumer is, we continue to 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 tailwind for us as well. But as we continue to look forward, we always reserve the right, though, to make sure that we stay very competitive in price. So we watch price very closely across all channels of trade.

Your next question is from Rupesh Parikh with Oppenheimer.

So first on the food inflation backdrop. Just curious in terms of what type of impact you had during the quarter and your expectations for the balance of the year.

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

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

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.

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

So this is actually Marissa Sullivan on for Robbie. I wanted to touch on some of the produce tests that you're doing in some of your stores that's beyond just the DG marketplace. How many stores is it in right now? What are you seeing? And what are your thoughts in terms of expanding produce to more of the store base?

Yes, today, we have over 200 stores outside of the market store piece for the produce. As we indicated, we put 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 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/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 would tell you, it's not going to be for every store, somewhere down the line. But could it be for thousands eventually? Yes, it could.

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

Yes. 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 of them 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're seeing. I can tell you, though, that in the early results, they are on the positive side. But again, keep in mind, very early. So stay tuned. We'll give you more color as that becomes more crystallized for us. And we believe, though, it should be a real win for us in the long term because what our consumers tell us is, in nonconsumable arena, they're looking for more of a treasure hunt experience than an everyday consumable shop for nonconsumables. So I think that we're on the right track, but time will tell.

Your next question is from John Heinbockel with Guggenheim Securities.

Todd, 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 year since you've done that? One of the things that it does tend to improve, I think, is shrink. Have you seen that correlate with shrink as well?

So we're very pleased. We're actually well exceeded the ROI in year 1, well exceeded it. The culprits, if you will, the ones you would think you would get benefit from there, we're getting benefit. So that top line, I believe we're getting benefits there. We're definitely getting benefit from turnover. We're at historic lows on our store manager turnover. And as you know, John, being the 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 that 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 to see benefits as we move throughout '18 and even into early '19.

And then maybe just as a follow-up. When you think about the discretionary business, right, so it has been negative for a while, turned positive in the second half of last year, negative in the first quarter. Is it solely weather? And do you think discretionary? In total, those 3 categories, they will be positive for '18?

As you look at our nonconsumable 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 in category management there over the years, I would tell you, as you look at Q1, we are pretty pleased with where nonconsumables are tracking until we hit that weather time that we talked about. So we're pretty bullish as we move now into Q2. I can tell you that, again, we've talked about the comps have accelerated. And leading the way in comps right now are some of these seasonal and nonconsumable 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 nonconsumables is one of our biggest opportunities, and that's the reason why our nonconsumable initiative, the 700 stores, we're going to put in the ground this year with that, it's 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 our nonconsumable sales forward.

Your next question is from Peter Keith with Piper Jaffray.

Todd, you noted on the Plus formats, it's a pretty impressive comp lift, the 10% to 15%,. There does seem to be a step-up in the remodel activity, that format. Is that something that you think is a new initiative that can carry forward for a couple of years at this, call it, 400 DG Plus format remodels?

Yes. We, as you know, we have a very intricate real estate model, which includes looking at all of our mature store bases and 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 piece, as 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 DGTP 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 are very, very impressive.

Okay. 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 recapture in Q2?

Yes, 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 impacted, the spring and summer and other weather-sensitive categories. And if you look at the consumables side, which isn't as impacted by that, we had very solid strong comps in the consumables category. So I think it's instructive to look at it that way, as well as, 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.

Okay, great. And just is there a recapture dynamic? And if not, is there markdown risks to Q2?

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.

Thank you, ladies and gentlemen. That does concludes the portion of today's Q&A. We thank you for joining, and you may now disconnect your lines.