Dollar General's (DG) CEO Todd Vasos on Q3 2016 Results - Earnings Call Transcript

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Dollar General Corp. (NYSE:DG) Q3 2016 Earnings Conference Call December 2, 2016 10:00 AM ET

Executives

Mary Winn Pilkington - VP, IR & PR

Todd Vasos - CEO

John Garratt - CFO

Analysts

Michael Lasser - UBS

Alan Rifkin - BTIG

John Heinbockel - Guggenheim Securities

Karen Short - Barclays

Alison Levens - Goldman Sachs

Peter Keith - Piper Jaffray & Co.

John Zolidis - Buckingham Research

Vincent Sinisi - Morgan Stanley

Brandon Fletcher - Bernstein

Matthew Boss - JP Morgan

Bradley Thomas - KeyBanc Markets

Operator

Good morning. My name is Keyla and I will be your conference operator today. At this time, I would like to welcome everyone for the Dollar General Third Quarter 2016 Earnings Call. Today is Thursday, December 1, 2016. All lines have been placed on mute to prevent any background noise. This call is being recorded. Instructions for listening to the replay of the call are available on the Company's earnings press release issued this morning.

Now, I would like to turn the conference over to Ms. Mary Winn Pilkington, Vice President of Investor Relations and Public Relations. Ms. Pilkington, you may begin your conference.

Mary Winn Pilkington

Thank you, Keyla 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 non-historical matters, including but not limited to, our fiscal 2016 diluted EPS guidance, fiscal 2016 and 2017 store growth initiatives, capital allocation strategy, and related expectations, our long-term financial growth models and future economic trends or conditions. Forward-looking statements can be identified because they are not statements of historical facts, or used words such as outlook, may, believe, anticipate, expect, will, would, plan, going forward, looking ahead, estimate our goal, and similar expressions that concern our strategy, plans, intentions or beliefs about future matters.

Important factors that could cause actual results or events to differ materially from those projected by our forward-looking statements are included in our earnings release issued this morning, our 2015 10-K filed on March 22, 2016, and our most recent 10-Q filed today 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 or as described under the heading Financial Outlook set forth in our earnings press release issued today.

Now, it is my pleasure to turn the call over to Todd.

Todd Vasos

Thank you, Mary Winn, and thanks to everyone for joining our call. On today's call, I would first like to share our perspectives on the third quarter and review some of its highlights, then turn it over to John to take you through a more detailed review of the quarter and our outlook for fiscal year. I will then provide insights into our strategic action plans going forward.

Since we last spoke on our earnings call at the end of August, the retail environment has continued to be challenging, although we are pleased to see some of our traffic and sales driving actions beginning to take hold as we exited the third quarter. As I shared with you last quarter, we have taken a number of actions across merchandising and store operations to drive same-store sales all while being very disciplined in our SG&A spending. Although our sales and earnings fell short of our expectations, I believe we made progress on our initiatives in the quarter. Together, the team has spent a tremendous amount of time and resources on the analytics of our business and the targeted actions going forward.

As the deflation cycle continues in the quarter, we have re-evaluated how we're looking at the impact ultimately taking a more broad based view. Rather than limiting our view to commodity cost of milk and eggs, we expanded our analysis to the average unit retail price deflation. Applying this broader view of deflation to both our second and third quarters, we experienced a greater impact in the third quarter as compared to the second quarter. We estimate that the combined headwinds from the average unit retail price deflation and reduction in SNAP benefits negatively impacted our same-store sales for the third quarter by approximately 150 to 175 basis points and for our second quarter by approximately 100 to 115 basis points. We believe many of these issues are transitory in nature.

Now let's turn the some of the highlights for the third quarter of 2016 as we compare to the prior year quarter. Third quarter sales increased 5% to $5.3 billion; year-to-date through the third quarter, net sales were $16 billion, an increase of 5.9% over the comparable prior year period. Same-store sales declined 0.1% for the quarter as an increase in average transaction size was offset by softer customer traffic. Same-store sales growth was positive for consumables, offset by decline in non-consumable category. In terms of the sales cadence for the quarter, August and October were both positive with October being the strongest period of the quarter. Year-to-date, through the third quarter, same-store sales increased 0.9% over the comparable prior year period.

For the quarter, diluted EPS was $0.84, including approximately $0.05 for store relocation cost, and disaster related expenses. During the quarter, we returned $295 million to shareholders through the repurchase of 2.9 million shares of common stock and the payment of a quarterly dividend. We successfully converted 42 Walmart Express locations to the Dollar General banner. These locations are performing well ahead of our expectations and provide us with great insights to apply to our existing store formats and future opportunities. The store operation team continues to aggressively work towards improving our on-shelf availability. We are seeing progress as our third-party audits indicate that our stores have reduced their out-of-stocks on core items by 13% over prior year third quarter.

Our real estate model is the foundation of driving strong returns. We continue to see our new store productivity at around 80% to 85% of our comp base, all while driving returns over 20%. For 2016, we are on-track to open 900 new stores and relocate or remodel a combined 900 stores. The real estate and store operations team have done a tremendous job in executing our store growth plans. We continue to grow transactions and item units in syndicated share data for the quarter. In the most recent syndicated data, we experienced low single digit to mid-single digit growth in both units and dollar share for the 4, 12, 24 and 52 week periods. I'm especially encouraged that we experienced a notable [sheer] [ph] change trend improvement in the most recent 8-week data.

During the third quarter, we invested gross margin dollars in a number of strategies designed to draw traffic. Some of these initiatives performed better than others but I believe we learned important lessons that will guide us in being more effective with the spending going forward. Based on the recent work we've done to analyze the business and to test various initiatives, we believe that we have identified those actions and strategies that provide the best opportunity to drive traffic and ultimately profitable sales growth. We are moving fast to aggressively pursue the actions that we believe will drive our same-store sales performance improvement. During the quarter, we made pricing, labor and marketing investments in designated market areas where we saw opportunities to be proactive as we look to improve same-store sales and market share with the objective to provide our customers with affordability of value and convenience at a time when they need us most.

Our proactive pricing actions were implemented selectively across about 17% of our store base or on about -- and on about 450 items targeting high household penetration, fast turning categories. While these investments take time to deliver the full impact, we are seeing the expected improvements in transaction, units, and weekly same-store sales across the vast majority of stores where we have made these investments. We believe we are on the right track with these selective price investments which are noticeable to our consumers. As I mentioned, while some of the third quarter investments resulted in the desired performance, others did not. For instance, we invested in incremental promotional activities that drive traffic although results were mixed and did not meet our overall expectations. As such this is an area we look to be more effective in deploying gross profit dollars going forward.

Additionally, as we move through the quarter, it became apparent to our incremental actions would not be able to overcome the decline in traffic in our stores. Both, traffic driving consumables and basket building non-consumables were impacted requiring greater than anticipated markdowns to move through the inventory and keep our merchandize in the stores fresh. Based on our learnings, we have focused our efforts on the most efficient and impactful activities and we will continue to monitor these traffic driving initiatives and continue to optimize these investments to achieve the best returns. I have confidence in this retail management team that has successfully navigated other challenging sales environment. We remain committed to controlling the factors that we can control and season the opportunities we have identified to improve our performance.

With that, let me now turn the call over to John.

John Garratt

Thank you, Todd, and good morning, everyone. For the 2016 third quarter and year-to-date, I will share more insights on some of the important financial details and our outlook.

Gross profit for the 2016 third quarter was $1.6 billion or 29.8% of sales, a decrease of 49 basis points from last year's third quarter. As compared to the prior year third quarter, the most significant drivers were higher mark-downs, primarily for inventory clearance and promotion, a greater proportion of sales of lower margin consumables and increased inventory shrink, partially offset by higher initial inventory mark-ups.

SG&A expense in the quarter increased by 48 basis points over the comparable 2015 period to $1.2 billion or 22.5% of sales. The SG&A increase was due in part to increased retail labor and occupancy cost. In addition, we incurred charges related expenses of $13 million or 25 basis points associated with the acquisition of the former Walmart Express store location. These expenses were primarily related to lease termination cost for existing stores and costs related to the conversion of acquired stores to DG stores.

We also incurred an increase of $7.7 million or 14 basis points of disaster related expenses in the 2016 period, most of which were hurricane related. Partially offsetting these items were reductions in administrative payroll costs, instead of compensation expenses and advertising costs. For comparability, please keep in mind the 2015 third quarter SG&A results reflect expenses of $6.1 million or 12 basis points, while severance related benefit cost associated with the corporate restructuring of certain support functions.

In light of our same-store sales performance for the quarter, I'm pleased with the way the team managed our SG&A expenses. Year-to-date for the third quarter, we would have successfully leveraged SG&A expenses on our same-store sales performance of 0.9% had it not been for the store relocation cost and disaster related expenses mentioned earlier. Our effective tax rate for the quarter was 36.2%. As in the first half of the year, our effective tax rate was lower this quarter as compared to the 2015 quarter, primarily due to the recognition of the work opportunity tax credit in the quarter in which it is earned given changes by Congress in December 2015.

Moving now to our balance sheet and cash flow statements; at quarter end, merchandized inventories were $3.49 billion, up 5.6% on a per store basis. Key factors impacting this increase were our on-shelf availability initiative and the timing of receipts coupled with our sales performance with the actions we have in place designed to help get inventory growth in line with our sales growth. Even with this increase, we believe our inventory is in good shape and we are comfortable with the quality as the increase was mainly in our everyday planned [ph] categories or what we think of as core items.

Year-to-date for the third quarter, we generated cash from operations of $1.12 billion, an increase of 39% or $315 million, compared to the 2015 third quarter, primarily as a result of working capital improvements and higher net income. During the quarter, we repurchased 2.9 million shares of our common stock for $225 million and paid a quarterly dividend of $0.25 per common share outstanding totaling $70 million. Year-to-date to the end of the third quarter, we have returned cash to shareholders totaling $892 million through the combination of share repurchases and quarterly dividends. From December 2011 to the third quarter of 2016, we've repurchased $4.3 billion or 70.2 million shares of our common stock.

At the end of the third quarter, our remaining repurchase authorization was approximately $1.2 billion. We remain committed to a disciplined capital allocation strategy to create lasting value for our shareholders. Our first priority remains investing in new stores and the infrastructure to support our store base, while our second priority is to return cash to shareholders through anticipated dividends and share repurchases.

Underlying our capital allocation strategy, is our goal to maintain our investment grade ratings by managing to a leverage ratio of approximately three times adjusted debt-to-EBITDA. Looking ahead, we are realistic about the environment in which we are operating. We now expect that our fiscal 2016 diluted EPS growth will be at the low end of our long-term growth mile range of 10% to 15%. This outlook includes the impact of the charge for the store relocation cost and disaster related expenses in the third quarter, and the benefit from the 53rd week this year of approximately $0.09 per diluted share.

Because of the uncertainty surrounding the implementation of the Fair Labor Standards Act and new salary requirements, it does not include any incremental expense related to the potential implementation of that regulation. In the event that the new salary requirement under the Fair Labor Standards Act is implemented, we anticipate that this would be as incremental annualized expense of approximately $60 million to $70 million or $0.03 for the 2016 fourth quarter.

Please keep in mind that we had an incremental $0.04 per diluted share benefit from the preannouncement of the Federal Work opportunity tax credit in Q4 2015. We anticipate providing further details on our 2017 initiative when we release our fourth quarter and fiscal year 2016 results in March 2017.

With that, I'd like to turn the call back over to Todd.

Todd Vasos

Thank you, John. Well, while we are still on our planning process for fiscal 2017, we remain focused on our four operating priorities for growth. First, driving profitable sales growth. Second, capturing growth opportunities. Third, enhancing our position at the low cost operator. And fourth, investing in our people as a competitive advantage.

Our first priority is to drive profitable sales growth. Our goal is to attract and grow new consumers and trips, and capture share with existing customers, utilizing our customer segmentation work and our disciplined approach to category management. To enhance our value proposition, we are committed to providing our customers with every deal or [ph] prices that they know and trust from us. Clearly, our consumers budgets are pinched, the cumulative effect of macroeconomic factors such as the reduction of SNAP participation and benefit levels and increased housing and healthcare expenses appear to have taken a noticeable toll on their spending. Our goal is to be there for our customers when they need us the most.

We remain committed to refreshing our price investments across items and categories, as well as incremental markets. Our changes would be made as needed in a very rational manner as we move through the coming quarters with the goal to drive traffic and units and capture market share. To further enhance our value proposition, we are also focused on refiling our advertising effectiveness to drive product or sales growth with a continued focus on everyday low prices that resonate with our customers. For 2017, we plan to further integrate our traditional and digital media mix to work together to ensure we are reaching our target consumers where, when, how they decide to engage with us. Through applied predictive technology, we are conducting a test to learn to gain further insights into our ability to achieve a higher return on investments, on our advertising media mix.

A key area of focus for 2017 is to build on our 2016 progress to expand the merchandising initiatives that focus on our mature store base to drive our same-store sales. For a select group of these stores, we anticipate a more extensive four walled remodeling effort that we believe will provide compelling returns. The recent acquisition of the former Walmart Express stores gives us great insights as we develop the remodeled program for these stores. Merchandising initiatives across all departments have been deployed to provide consumers with more of the products and brands they want and need to save time and money every day across this group of stores.

Second, we will focus on initiatives to capture growth opportunities. In 2017, we plan to accelerate our square footage growth to about 7.5%. Our 2017 pipeline is essentially complete as we continue to plan for about 1,000 new store openings. The primary format will be our traditional DG Box which is about 7,300 square feet of selling space and provides us with strong new store economics and returns. This format consistently proves to be our highest return format against which we benchmark the performance of all other formats. We expect that these traditional stores will utilize our successful Dollar General 16 layout to expand high growth traffic building categories in a more customer-friendly format all while providing consumers with a faster checkout.

We are planning for the future as we segment our store opportunities that we believe can have a greater impact on sales and productivities, all while continue to drive compelling returns. We view this as more of an evolution of our existing, highly productive traditional store format rather than a wholesale change. We are in the unique position to leverage knowledge across our multiple format given that Dollar General has always been a leader in store format innovation. I view our store format along a continuum of selling square footage. On one end we apply lessons from the best-selling items in our 16,000 square foot Dollar General market stores, to our newly acquired 10,000 square foot box. Both of these formats give us great experience with fresh produce and meats.

From there we move along the continuum to the 9,000 square foot Dollar General Plus with about 30 or so cooler doors and more holding power on the shelf. Next, we've held assortment to our 7,300 square foot traditional box. With over 12,500 traditional stores, this box will always be core to our model. Finally, we have been pleased with the test results of our smaller box, that is less than 6,000 square feet for certain metro and relocations. Across the format, we constantly are editing the assortments and taking our best selling items from one format to the next to satisfy our customers changing needs while driving -- while continuing to drive productivity.

Key consumer trends going forward that are becoming more important to our core consumers include healthier, better for you options, and a greater fresh assortment. Our range of formats positions us well to seek opportunities to capture this growing customer sentiment. Given that we are still in the planning process, I look forward to sharing more with you over the coming months. To support our new store growth and productivity, we continue to make investments in our distribution center network. Our Jamesville, Wisconsin distribution center is nearing completion with a goal to begin shipping from this facility in early 2017. Our 15th distribution center in Jackson, Georgia is also under construction with a goal to begin shipping from this facility in late 2017.

Our third operating priority is to leverage and reinforce our positioning as a low cost operator. The team has embraced the spirit and process of zero-based budgeting that we implemented last year as part of the 2016 budget. We have had great success in leveraging our culture and heritage of cost management with our zero-based budgeting program across our cost structure. As we enter year two of our zero-based budgeting process, the team is actively working on a pipeline of additional future savings opportunities across the company, leveraging process improvements, procurements and prioritization to remove costs the don't effect the customer experience.

Our fourth operating priority is to invest in our people. We believe that our people are our competitive advantage. In the third quarter, we redesigned our store manager training program and while it's still early, we are seeing almost a 20% improvement in satisfaction scores from the store managers who have gone through the program. We have exciting opportunities ahead of us. Our tested learned program is a foundation of our continued improvement. We believe our positioning Dollar General to be even more relevant to help our customers save time and money now and in the future. We remain confident in our long-term growth prospects of the company and are moving quickly and deliberately to restore traffic to our stores.

Our stores are prepared for the holidays and we have strong plans in place for the remainder of the holiday selling season with exciting gifts the core choice and other holiday necessities, and multiple avenues to save in-store and online. Our customers can take advantage of our holiday offerings and stretch their holiday budget even further. Our long-term commitment to growth and shareholder value is unchanged. We have a business model that is proven and resilient. We have strong new store economics with returns above 20% and a payback under two years. Our team is energized to seize growth opportunities. Our business generates significant cash flow and we are in a position to invest in accelerated store growth as well as mature store base while continue to return cash to shareholders through consistent share repurchases and anticipated dividends. We remain very excited about our business overtime.

In closing, I want to recognize more than -- the more than 120,000 Dollar General employees who serve our customers every day. We are in the midst of our busiest season in retail, and our customers are depending on us for convenience and everyday low prices. I want to thank all of our employees for their contributions to our mission of serving others.

With that Mary Winn we would now like to open the lines for questions.

Mary Winn Pilkington

Thank you. Keyla, we'll look to take the first question, please.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from the line of Michael Lasser with UBS.

Michael Lasser

Good morning, thanks a lot. Good morning, Todd. Thanks for taking my question. Based on the initiatives that you deployed and what you saw in October, Todd, do you think you're at the point where you can start to see some more consistent gains in your traffic or is your expectation that traffic is just going to be lumpy from here for at least the near-term?

Todd Vasos

Mike, that's a great question, as we came out of October and then into November, we saw continued traction from those initiatives. It was great to see that our pricing initiative started to really take hold, as well as all the initiatives that we really launched in early '16 around our merchandising pieces, those continue to gain traction throughout the year and especially in the third quarter, and now into the fourth. But keep in mind that we are still seeing those headwinds from the SNAP participation rates being down, as well as deflation. So a little choppiness is probably the right way to look at it but we're very encouraged on how we see our initiatives taking hold and taking shape. And again, as we saw our comp sales improving throughout the quarter and especially in October, and now moving into November, we feel good about a lot of the initiatives that we put in place.

Michael Lasser

My follow-up question is, can you mention the performance of those stores that you -- the 70% of the stores that you made those price investments, are those outperforming the chain average? And are you seeing a lift to the entire stores, so is the customer coming in and buying the discretionary goods as well to offset some of the gross margin pressure that you've probably seen from those investments?

Todd Vasos

Yes, that's another great question. As we stated earlier on, it takes a little time for these price investments to take hold with the consumer but the great thing is as we move through Q3, we saw units, transactions and sales starting to build momentum and actually as we exited Q3 and enter Q4, we even saw a further acceleration of that whereas we have actually crossed over where we're now returning pretty nicely on our investment. So again, in the quarter -- quarter three, we spend a little bit to get it moving but now it's really starting to pick up. So we feel good about where it's headed.

Operator

Thank you. Your next question is from the line of Alan Rifkin with BTIG.

Alan Rifkin

Good morning, how are you?

Todd Vasos

Good.

Alan Rifkin

I'm just looking at your revenue as it relates to funds category…

Mary Winn Pilkington

Alan, it's Mary Winn. Alan, I'm sorry to interrupt but we're having a real hard time hearing you.

Alan Rifkin

Can you hear me better now?

Mary Winn Pilkington

Yes. Thanks.

Alan Rifkin

Okay, thank you for taking my question. And looking at your comp gains with respect to categories, it seems as if the categories like consumables where arguably the deflation is greater they are actually outperforming some of the more discretionary categories, like apparel and home; there is actually less deflation. Can you help explain that apparent anomaly? And then I do have a follow-up.

Todd Vasos

Yes, the real thing to look at there is that a lot of our initiatives coming into the year 2016 were around those traffic driving areas, so again, around perishables in the food areas and immediate consumption. So while we're facing great headwinds on deflation there, what we're starting to see is that those -- those initiatives are overtaking even some of those deflationary pressures but make no mistake, those headwinds are pretty strong and that's why we said we feel pretty good about where we're headed because those initiatives are really taking hold in those category and as we look at this pretty transitory and as those deflationary pressures hopefully start to ease mid-next year, when we prop out of the other side, we should be in very good shape because the initiatives that we deployed to include some of the traffic driving initiatives around our pricing that we've recently implemented are in a lot of those consumable high discretionary categories or that are out there for the consumer. So I think -- I think all in all, we made the right decisions and as we come out of this we should be in a much better shape.

Alan Rifkin

Okay, thank you. And Todd, if I may, I mean you said that while most of your leases or 2017 you’re committed to, did you give any considerations to possibly slowing down the 1,000 new stores that are now earmarked for 2017 just in case things not as transitory as what you hope they will be. And in that regard if in fact the environment continues to be difficult for longer then what do you foresee, what incremental efforts with respect to zero-based budgeting could possibly be implemented to help rein in the cost structure? Thank you.

John Garratt

Good questions. To start with the question around real estate, you know, the way we see it now, this is stuff we watch very closely, we monitor the sales performance and the returns, and we continue, you know, as we mentioned in our prepared remarks we continue to see the stores opened as expected at the 80% to 85% sales productivity. We continue to see the returns above 20% of our target. We continue to see paybacks of less than two years and given the low risk, low cost, high return opportunity we see here, we're proceeding but watching it very carefully and understand that this is something that we could dial back quickly if needed, but based on the great results we continue to see and the belief that the pressure is on the comps are largely transitory in nature, we don't need to do that thus far but we'll closely manage that.

And in terms of second question around zero-based budgeting, our ability to dial back that even more, we're very pleased with the performance that we've seen with zero-based budgeting when you consider in the difficult environment, we've been operating; the team has done a phenomenal job managing costs. Looking at everything through the lens, does it touch the customer, is it aligned with our strategic priorities, does not doing this puts the business at risk, and so we're going to, we have and are going to continue to go after all the cost we can continually but thoughtfully and making sure that over time we're also -- as we manage the business for the long-term investing in those initiatives that will drive long-term growth. But rest assured, the team is hard at work on zero-based budgeting, it's performing better than expected this year. When you consider it, you exclude the impact of the relocations of the acquired stores and disaster related costs, we would be leveraging our SG&A at 0.9% comp versus the stated target at the beginning of the year where we lowered it from 3.5% to -- and creeping up towards 4% to 2.5% to 3%. So we're ahead of schedule, we feel great about what we've done but we will be very balanced going forward and doing the right things for the business for the right long-term.

Operator

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

John Heinbockel

Good morning, Todd. So a couple of things on pricing, it sounded to me like, right now there is no plan to expand the scope of those price cuts. Is that right? Is the average cut still about 10% on those items? And then what kind of competitive response if any have you seen?

Todd Vasos

John, we're continuing to monitoring the investments that we did make in pricing. Remember, it's really only a quarter old right now and while we're very pleased and we're gaining traction, we're going to continue to monitor it to ensure that we've got the right items and is driving the proper returns that we expect to get from that. So I think it's fair to say that we'll continue to monitor that for a bit longer. And as you look at it, yes, we see that when you look at the competitive environment for Q2, it's been -- it's been about -- oh, I'm sorry, in Q3, it's been about the same as Q2. So overall, I would tell you that it's aggressive out there but not anymore than we've seen in Q2.

And I'm sure, when we monitor prices, everyone monitors prices, and we look at what everyone else is doing but I can tell you that what we're surely [ph] focused on is what we can control and driving traffic into our stores and being there for our consumer. So we're pretty pleased on what we've seen so far.

John Heinbockel

Well, let me follow-up to that. If you think about -- and there is really two things; one more sort of theoretical and one more real. If you look at the items where you've cut pricing on, are you getting a better response where there is -- where there is or is not cost deflation? And then just theoretically, from high level, do you think price investments work better? You know, when we started to reflate, is it better to hold back the pricing then when all the competition is raising price rather than cut now and everybody has the potential right to take pricing down because their costs are falling?

Todd Vasos

So when we look at the 450 or so items that we've taken price on, I can tell you that in face of deflation, we're still seeing the entire store -- it really starts to react in a real positive manner on the sales side. Some of those items are not -- are not reacting the way we thought, we'll roll some off, we'll roll some new ones on. And as you could imagine, some that has heavy deflationary pressures, the top line may not be as robust but again, it's not always about the sales piece right off hand; eventually it is but it's about driving traffic and units to the store and we've always said that we're going to do everything we have to do to drive traffic, John. And we continue to do that because we believe through any economic cycle, whether it be deflationary or inflation, that if you're there for the consumer when she needs you the most -- that when you come out the other side of those economic times, she's going to stick with you. We've proven that time and time again, and I believe this will be no different.

Operator

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

Karen Short

Hi, thanks for taking my question. I actually just wanted to clarify on the 17% on the store base; are your comps in those stores positive currently?

Todd Vasos

Again, when you look at in aggregate, you know, we look at it by geographic area and of course in aggregate; and again -- we're pretty happy with what we're seeing there. And the great thing about the comps in those stores, that it's lifting both consumables and non-consumables. It's started with more of the consumable areas as you can imagine but as we've started to build not only units going through the register because of the better prices. When we started to see traffic start to increase because we're at a mouth [ph] getting out there plus our advertising; we're now starting to see transaction start to move through and more sales. So we're pretty happy with where it is right now, it's still early but it's doing exactly what we thought it would do and actually on the sales side, maybe even a little bit better than we thought it would do this early on.

Karen Short

Okay, that's helpful. So I guess I'm just wondering it with all that success why you wouldn't consider rolling this out to a greater percent of the store base or potentially broadening it to greater number SKUs?

Todd Vasos

You know, we're very much a real disciplined company. And we want to make sure that we're doing exactly what's right for the profitability of the company at the end of the day. So we're -- this is the real test-and-learn for us, right. But it's a pretty big one, 17% of the store base today has these prices in it. So I think it's prudent to given a little bit more time to percolate, if you will, and to continue to grow. And as that happens, and we see it performing the way we think it's going to perform, then as we get into next year I think we'll continue to look at ways to expand that and to be there for our customer to continue to give her that everyday low price that she needs.

Operator

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

Alison Levens

Good morning. This is Alison for Stephen, thanks for taking our questions. Can you provide more detail around gross margin in the quarter; specifically can you quantify the impact of price investment versus inventory clearance?

John Garratt

Sure. So after driving six straight quarters of expansion, in Q3 we did have contraction of 49 basis points in Q3. The key drivers there were markdowns mix and inventory shrink; markdowns being the most significant driver and that was listed first. And that was both in consumables and non-consumables. First, as we move through inventory with clearance of markdowns to keep the inventory fresh. The good news here is that the quality of the inventory is in great shape. And then also with the tougher sales environment in Q3, we had additional promotional activity as we mentioned with the goal of driving the top line are pleased with the results we're seeing, and the learnings we've captured from that to be more targeted, more focused on targeted pricing in EDLP [ph] and optimizing the spend for maximum results going forward. And again, pleased with the momentum we saw coming out of the quarter and then to this quarter.

So those were the key drivers there. We feel like you know, with the actions we've taken here; it's the best actions in the long-term, and I think with the learnings going forward, we'll be able to be more targeted with it. And we continue to see opportunity over the long-term, managing the very flows. We continue to see opportunity to reduce shrink overtime, supply chain efficiencies, strong category management and opportunities around increased foreign sourcing and private label penetration as we look at the long-term.

Alison Levens

Great, thanks, very helpful. And then just as a follow-up, can you provide more detail regarding what changed with respect to the SNAP headwinds in 3Q versus 2Q?

Todd Vasos

Yes, you know, when we look at it -- it was about the same. When we look at our SNAP affected states, I'll give you a little color; really what's interesting here is a lot like Q2, Q3 was pretty close to about the same but if you look at it, it affects about 56% of our store base in the states that have reduced or eliminated the SNAP benefit and those states that have -- that have had the reduction or elimination, they are approximately a 100 basis points worse than comp. That gives you a real good idea of how impactful those SNAP benefits -- reductions have been. Again, we feel it's transitory, we'll move through that as we move through 2017 but right now that's why we've really taken a real hard look at reducing prices for those core consumers, especially given around those states because they need this right now based on what we see.

Operator

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

Peter Keith

Good morning, thanks for taking the question. When you look at the deflation and SNAP headwinds of 150 to 175 basis points, if we were to add that back in -- you'd still be below your long-term guide of two to four. Just looking forward, do you think as these headwinds abate [ph] that -- that you would see some acceleration in traffic to get you back up into that range and what might be driving that?

Todd Vasos

You know, when you look at it though, we feel pretty good about a lot of the initiatives that we've got in play. We feel good about early on the initiatives for 2017 as we start to really shape those up. We had a little bit of a Halloween drag in Q3 that was moved into Q4 for us. And not to make any excuses, but there is -- there is definitely some headwinds there but I think what we're really focused on here is a lot of the great things that we have moving that we believe are going to be real positive to our same-store sales as we move into 2017 and some of these transitory affects start to abate and we start to see that -- the consumer starts to come back in the store, as well as the deflationary pressure starting to ease. Over the long-term, we believe that we could have comps in that two to four range over the long-term.

Peter Keith

Okay. Thank you, Todd. And maybe now for John, just two unrelated quick follow-ups. Number one, could you quantify the Halloween impact on the Q3 comp? And then secondly, I was unclear on how you're managing the overtime real change announcement from last week with the injunction that was placed. Are you going forward with the changes or are you putting a pause on it to see how that transpires.

Todd Vasos

This is Todd, let me -- I'll take the second one first and have John quantify the Halloween impact for you. Right now with thing stay that is out there, we have communicated to our stores that we're in a holding pattern for right now to see exactly what happens in the courts and see exactly what transpire? So we are on hold, and operating group has done a fabulous job in communicating that our folks, and we're going to wait and see. So we like you will wait and see what happens. But at the other day we always do what's for our employees, right, and again that's one of our core operating parties, he is really taking care of our people. So we'll do what's right by then as we continue to move into '17.

In terms of the Halloween shift, the impact we believe it to be about 20 basis points impact on comps, and the Halloween shift had to do with two fewer selling days this quarter as the quarter ended on October 28 this year versus October 30 of last year by 20 basis points.

Operator

Thank you. Your next question comes from the line of John Zolidis with Buckingham Research.

John Zolidis

Hi, good morning. You mentioned that you're very focused on doing what it took -- takes rather too to drive traffic. And so my question is related to the long-term earnings growth target that you provided back earlier in this year of 10% to 15%. But I believe they assumed relatively flat or slightly up EBIT margins. So my question is, can you make this price investment to drive traffic and still hold EBIT flat or would you be willing to sacrifice on EBIT margin to get incremental people through the door? Thanks.

Todd Vasos

Yes, so bear in mind that the model is a long-term growth model, naturally where our focus is over the long-term and we've said that from time to time we will -- as needed, make investments to do what's right to drive traffic and to drive that long-term growth, so we'll do what we need to in that regard. But you know, as I step back and just look at the fundamentals of the business, I still feel great about this business as you look at the organic growth opportunity, great returns we continue to see from the new stores, the actions we're taking to reinvigorate the comp sales growth. And with all the levers we have in gross margin and SG&A, with the addition of zero-based budgeting and with the tremendous amount of cash this business throws off that we can reinvest in new stores, in the business while comparing -- providing a very compelling total shareholder return with the addition of dividend and share repurchases. It feels great about the model and the long-term prospects, but if the long-term model will do what we need to and best where we need to along the way.

John Zolidis

Okay, great. And just a second question on a different topic. You mentioned that the traditional DG format is your highest return format. You've got about a 1,000 openings for next year. Can you give us a rough breakdown of openings by format? Thanks.

Todd Vasos

Yes, again, overwhelmingly the -- the Dollar General traditional store, that 7,300 square foot store that we talk about will be the dominant -- by far the dominant player there. I believe we're going to have about 150 to 160 of the smaller format stores next year in key metro and rural areas to augment that but overall it will be that 7,300 square foot store.

Operator

Thank you. Your next question comes from the line of Vincent Sinisi with Morgan Stanley.

Vincent Sinisi

Hey guys, good morning, thanks very much for taking my question. I appreciate the incremental color on the current headwinds, deflation, SNAP, you said competition about the same as last quarter. We just wanted to see if you could give any further color around the low and consumer health was one of the other things that you kind of more specifically called out last quarter. You know, versus then kind of what you're seeing now either by basket geography etcetera, that would be great.

Todd Vasos

Yes, interestingly, we talk to our consumers each and every quarter through panel data, as well as we bring them in and talk to them in general. And I can tell you as late as mid-third quarter, they were telling us that their sentiment -- feeling is even more dire than it was in previous quarters in early 2016. And what they are siding and continue to say is the rise in healthcare costs that they are facing. I don't believe any of our core customers realized what they were up against on those rising cost. And then rental cost continue and they called that out second on paying rent because most of our -- again, core customers rent don't own and those rents are going up across the nation at a pretty high rate. And they have to continue to allocate their spending, so anywhere they are saving, they are doing something's little differently than they've done before.

For instance, they are investing in smartphone technology at a greater rate than we've ever seen, and those come with an expense, as we all know, a monthly expense. And so the little bit of money that she does may have -- from maybe lower gas prices and some other tailwinds, she is moving into a little bit of the technology world herself, very slowly, albeit but she is moving there. So we're hearing a lot of the same things we've heard over the last couple of quarters, but what was interesting to us was that she was feeling worse off today, middle of that third quarter than she was earlier in the year.

Vincent Sinisi

Okay, all right, that's helpful Todd, thank you. And then just a quick follow-up; just going back to your initiatives; kind of like you said, it seems like a pretty similar scope at least going forward. But if we try to just reconcile kind of what maybe working better or worse than you thought? And even going back to Alan's question on kind of consumables, non-consumables performance; as you're taking a broader view, do you think that there could be any change to -- kind of the focus of consumables versus non-consumables or you know maybe some greater or less than that kind of 10% pricing that you had cited last quarter?

Todd Vasos

You know, as we look at the entire box, and we've got one of the most robust category management processes and teams and considering the retailing today -- they do a great job in evaluating each and every year what should be inside of our stores and what those initiatives should be. And we've always said that the consumable initiatives and the consumable products will drive traffic and our non-consumable businesses will drive the basket, we see that no differently. And actually we've seen our -- we've seen our non-consumable business tail up along with our consumable business as the customer pull back and especially in these SNAP affected states. In saying that, a lot of our initiatives for this year and next year are both in consumables and in non-consumables because we believe that you have to have a fine balance between the two to really round up the shopping experience for the consumer. And so we're looking at it really no differently.

Now in consumables, there may be some differences in some of the products that we bring in because again, our consumers start to look for better-for-you, more healthy, little bit more fresh products. And the great thing about having the market stores -- a 150 or 160 market stores that we have, as well as our plus stores, we're able to infuse the best learnings and products into our traditional store from those formats. So there isn't any testing learn periods, we know what works, and we continue to bring those type of products to market in our 7,300 square foot store and you'll see even more of that, maybe even on the low accelerated rate as we move into 2017 because again, our consumer preferences are changing.

Operator

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

Brandon Fletcher

Hey guys, as a retail veteran who has done this in dozens of countries, I just want to say you guys are doing it right, you're doing it carefully, testing control and the willingness to refine it is rare among leadership and so just hang in there, you guys are getting it right. And our question is actually related to HBA, one of the things that the merchants were kind of excited about the Investor Day was -- that was a place where a little more skew, a little more brand, a little more focus could give you something your customers need; and also places where you have an enormous price advantage to your kind of convenient pharmacist. How are those initiatives going? Just wanted to get some color on that. Thanks.

Todd Vasos

Yes, the health and beauty initiatives, especially around health has been one of our really shining stars of 2016 so far. Those initiatives have been doing very well. Remember, they fall into our consumable world as it relates to how we report, how you see those numbers. And they've been doing well, but we still believe we have a lot of opportunity there and a lot of it really revolves around awareness. And while we've made great strides over the last five to six years on building loyalty in our HBA areas, we believe we still have a lot to go, not only in SKU proliferation there, probably more awareness and the ability for our consumers to know we have the projects that you need. And the great thing is, it's got a fabulous price, especially to our competition in the drug side and the grocery side of the equation. So as she learns and sees that those products are there and she sees the great price, and she – we've got her for life and I think it's about awareness for her and that's what we're going to work on into 2017.

Brandon Fletcher

Great, thanks.

Operator

Thank you. Your next question comes from the line of Matthew Boss with JP Morgan.

Matthew Boss

Thanks. So Todd, on learnings from this pricing initiative, I know we've had a number of questions around it but I guess you've done something like this in the past. How would you compare what you're seeing today from this metrics to the 2013 road map? And what was the timeline back then that it took to see the traffic return?

Todd Vasos

Yes, a little bit different time and date but I can tell you that it's a lot like 2013. I could tell you though that what we saw in '13 versus '16 is transactions actually start to get more traction this time around than even in 2013, which has probably translated into a little bit better over sales and we thought we're going to get by now and just moving into profitable ROI on that. So it's actually ramped up a little faster and I think a lot of that also has to do with -- we were a little bit more aggressive this time on how we communicated that to the consumer, as well as our operating group did a fabulous job executing signing packages, as well as our other in-store communication. So while I love to build it compare, this is a little different but I could tell you that we're happy with what we've seen so far.

Matthew Boss

Great. And then just on the gross margin front, as we think about some of the headwinds this quarter that hit yield. As we think about going forward, should we consider similar gross margin pressure through the front half of '17? Just any color on the puts and takes there would be helpful.

Todd Vasos

Yes, so in terms of 2017, we're still in the budgeting process and we aren't going to provide any update on -- at this stage we will in the next call. But again, with gross margin, our focus is on the long-term, here we continue to see a lot of opportunities managing the various levers and we look to balance gross margin on SG&A [ph]. And certainly in a challenging environment you do have the pressure of delivering that everyday low price but we have a lot of other levers that we will look to manage effectively as we have in the past to balance that out, to drive that growth while delivering results.

Matthew Boss

Great. Best of luck.

Todd Vasos

Thank you.

Operator

Thank you. Your next question comes from the line of Brad Thomas with KeyBanc Markets.

Bradley Thomas

Yes, good morning. Thank you for taking my question. You've done a lot of interesting work on customer segmentation, that you shared with us back in March. I was wondering as you reflect on the traffic trends that you've seen over the last couple of quarters if there are any interesting insights that you're able to share about the segmentations of your customer?

Todd Vasos

Again, we -- as I mentioned earlier, we go out and talk to the customer each and every quarter and again, I believe that the majority of what we communicated to everyone earlier in the year pretty well, it's still well intact as far as the consumer is concerned, except for the notion that she maybe a little worse off today economically than she was even earlier in the year, at least her sentiment is a little less positive. But in saying that, we're still seeing our -- but we are affectionately call our BFS which is our core of best customers, continue to really resonate with our everyday low price. And through Q3 with all the traffic driver initiatives we did, what really stuck and resonated the most was everyday low price, and that really goes to show you that the segmentation work that we do is right on and key, and that is our best customers look to deliver everyday low price first because you need to count on those each and every day.

But beyond that we're still seeing a healthy customer base outside of our core and some of our reach customers were still seeing trade-in and trade down type customers coming in; and we're still seeing a decent millennial type customer that really just started to emerge. And that's some of the reasons we're looking at even more better for you and healthier, as well as maybe some fresh options as we go forward because that consumer is really starting to emerge as a real player here at Dollar General.

Bradley Thomas

Great, very helpful Todd, thank you so much.

Mary Winn Pilkington

Operator, I think we've hit the top of the hour that's probably go into our call now. But I want to thank everybody for being on the call and if you have any questions, Matt and I are both around, so feel free to give me or Matt a call.

Operator

Okay, thank you, Ma'am. Ladies and gentlemen, that does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines now.

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