Good morning. My name is Kayla, and I will be your conference operator today. At this time, I would like to welcome everyone to the Dollar General Third Quarter 2016 Earnings Call. Today is Thursday, December 1, 2016. [Operator Instructions] 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 call over to Ms. Mary Winn Pilkington, Vice President of Investor Relations and Public Relations. Ms. Pilkington, you may begin your conference. .

Thank you, Kayla, 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 2016 diluted EPS guidance; fiscal 2016 and '17 store growth; initiative, capital allocation strategy and related expectations; our long-term financial growth model; 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 outlook, may, believe, anticipate, expect, will, would, plan, going forward, looking ahead, estimate or goal and similar expressions that concern our strategy, plans, intentions or beliefs about future matters.

Important factors that could cause actual results or events to differ materially from those projected by our forward-looking statements are included in our earnings release issued this morning, 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 may be otherwise required by law or as described under the heading Financial Outlook set forth in our earnings press release issued today. .

Now it's my pleasure to turn the call over to Todd. .

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 in 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 expectation, 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 continued in the quarter, we have reevaluated 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 to some of the highlights for the third quarter of 2016 as we compare it 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 the nonconsumable categories.

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 costs 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 expectation 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're 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 transaction 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 share 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 drive 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 improvements. .

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, value and convenience at a time when they need us most.

Our proactive pricing actions were implemented selectively across about 70% 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 transactions, 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 to 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 nonconsumables were impacted, requiring greater-than-anticipated markdowns to move through the inventory and keep our merchandise 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 environments. We remain committed to controlling the factors that we can control and seizing the opportunities we have identified to improve our performance. .

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

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 markdown, primarily for inventory clearance and promotions; a greater proportion of sales of lower-margin consumables; and increased inventory shrink, partially offset by higher initial inventory markups. .

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 costs.

In addition, we incurred charges and related expenses of $13 million or 25 basis points associated with the acquisition of the former Walmart Express store locations. These expenses were primarily related to lease termination costs 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, incentive compensation expenses and advertising costs.

For comparability, please keep in mind that 2015 third quarter SG&A results reflect expenses of $6.1 million or 12 basis points for severance-related benefit costs associated with the corporate restructuring of certain support functions.

In light of our same-store sales performance for the quarter, I am pleased with the way the team managed our SG&A expenses.

Year-to-date through 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 costs 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 statement. At quarter end, merchandise 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.

And the increase was mainly in our everyday planogram categories or what we think of as core items. .

Year-to-date through 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 dividend. From December 2011 through the third quarter of 2016, we repurchased $4.3 billion of 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 rating by managing to a leverage ratio approximately 3x adjusted debt to EBITDAR. .

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 model range of 10% to 15%.

This outlook includes the impact of the charge for the store relocation costs 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 Standard Act's new salary requirement, 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 an 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 reenactment of the federal Work Opportunity Tax Credit in Q4 2015. We anticipate providing further details on our 2017 initiatives 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. .

first, driving profitable sales growth; second, capturing growth opportunities; third, enhancing our position as a low-cost operator; and fourth, investing in our people as a competitive advantage. .

Our first priority is to 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 everyday low 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 staff participation and benefit levels and increased housing and health care 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 refining our advertising effectiveness to drive productive 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 and how they decide to engage with us.

Through applied predictive technology, we are conducting a test and learn to gain further insights into our ability to achieve a higher return on investment 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 4-wall 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 remodel 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 productivity, all while continuing 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 a unique position to leverage knowledge across our multiple formats, given that Dollar General has always been a leader in store format innovation. I view our store formats 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 tailor the 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 rural locations.

Across the formats, 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 Janesville, Wisconsin distribution center is nearing completion, with a goal to begin shipping from this facility in early 2017.

Our 15th distribution center in Jackson, Georgia is also under construction, with a goal to begin shipping from this facility in late 2017. .

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 2 of our zero-based budgeting process, the team is actively working on a pipeline of additional future savings, opportunities across the company leveraging process improvement, procurement and prioritization to remove costs that don't affect the customer experience. .

Our fourth operating priority is to invest in our people. We believe that our people are a 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 those store managers who have gone through the program. .

We have exciting opportunities ahead of us. Our test-and-learn program is a foundation of our continual improvement we believe are 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 a strong plan in place for the remainder of the holiday selling season with exciting gifts, decor, toys 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 2 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 our mature store base, while continuing to return cash to shareholders through consistent share repurchases and anticipated dividends. We remain very excited about our business over time. .

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. .

Thank you. [indiscernible] We'll take the first question please. .

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

Based on the initiatives that you deployed and what you saw in October, Todd, do you think you're at the point where you could 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?.

Yes, 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 initiatives start 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. .

And my follow-up question is, could you dimension the performance of those stores that you -- the 70% of the stores that you made those price investments? And are those outperforming the chain average? And are you seeing a lift to the entire store? So is the customer coming in and buying the discretionary goods as well to offset some of the gross margin pressure that you probably seen from those investments?.

Yes, that's another great question, because 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 the units transactions and sales starting to build momentum.

And actually, as we exited Q3 and entered 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 3, we spent 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. .

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

So in sort of looking at your revenue [indiscernible] as it relates to [indiscernible] categories... .

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

Can you hear me better now?.

Yes. .

Okay. In looking at your comp gains with respect to categories, it seems as if the categories, that consumables, where arguably the deflation is greatest, are actually outperforming some of the more discretionary categories like apparel and home, that is actually less deflation.

Can you help explain that apparent anomaly? And then I do have a follow-up. .

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 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 categories. And as we look at this pretty transitory.

And as those deflationary pressures hopefully start to ease mid next year, when we pop 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 that are out there for the consumer. So 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. .

Okay.

And Todd (sic) [John], if I may, you said that while most of your leases for 2017, you're committed to, did you give any consideration to possibly slowing down the 1,000 new stores that are now being earmarked for 2017, just in case things are not as transitory as what you hope they'll be? And in that regard, if, in fact, the environment continues to be difficult for longer than what you foresee, what incremental efforts with respect to zero-based budgeting could possibly be implemented to help reign in the cost structure?.

Good questions. To start with the question around real estate. The way we see it now, this is something we watch very closely, monitor the sales performance and the returns. And we continue, as we mentioned in our prepared remarks, we continue to see the stores open as expected at the 80% to 85% sales productivity.

We continue to see the returns above 20% above our target. We continue to see paybacks in less than 2 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 pressures on the comps are largely transitory in nature, we don't see a need to do that thus far part, but we'll closely manage that.

And in terms of the 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's done a phenomenal job managing costs, looking at everything through the lens of, does it touch the customer? Is it in line with our strategic priorities? Does not doing this put the business at risk? And so were -- we have, and we're 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, if you exclude the impact of the relocations of the acquired stores and the 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 toward 4% to 2.5% to 3%. So we're ahead of schedule.

We feel great about what we've done. But we'd be very balanced going forward in doing the right things for the business for the right long term. .

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

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?.

John, we're continue to monitoring the investment 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 about -- or 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 squarely 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. .

Well, let me follow up to that. If you think about -- it's really 2 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 or is not cost deflation? And then just theoretically, high level, do you think price investments work better? When we start to reflate, is it better to hold back pricing than when all the competition is raising price rather than cutting now when everybody has the potential right to take pricing down because their costs are falling?.

Well, 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 really start to react in a real positive manner on the sales side. Some of those items 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 have 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. .

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

I actually just wanted to clarify on the 17% of the store base, are your comps in those stores positive currently?.

Again, when you look at -- in aggregate, 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 nonconsumables. It started with more of the consumable areas, as you can imagine.

But as we 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 word of mouth getting out there plus our advertising, we're now starting to see transactions 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 a little bit better than we thought it would do this early on. .

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

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 a 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 give in 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. .

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

This is Alison Levens on for Stephen.

Can you provide more detail around gross margin in the quarter? Specifically, can you quantify the impact of price investment versus inventory clearance?.

Sure. So after driving 6 straight quarters of expansion in Q3, we did have contraction of 49 basis points in Q3. The key drivers there were markdown, mix and inventory shrink. Markdowns, being the most significant driver, as it was listed first.

And that was both in consumables and nonconsumables, first is we moved through inventory with clearance and 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 and 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 and EDLP and optimizing the spend for maximum results going forward.

And again, pleased with the momentum we saw coming out of the quarter and into this quarter. So those were the key drivers there. We feel like with the actions we've taken here, that's the best actions for the long term.

And I think with the learnings going forward, we'll be able to be more targeted with this and continue to see opportunity over the long term.

Managing the various levers, we continue to see opportunity to reduce shrink over time, supply chain efficiencies, strong category management and opportunities around increased foreign sourcing and private-label penetration as we look at the long term. .

Great. 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?.

Yes, 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 these SNAP benefits.

And those states that have had the reduction or elimination, they are approximately 100 basis points worse in 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 in and around those states because they need us right now based on what we see. .

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

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 2 to 4.

Just looking forward, do you think as these headwinds abate, that you'd see some acceleration in traffic to get you back up into that range? And what might be driving that?.

When you look at it though, we feel pretty good about a lot of the initiatives that we 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 moved into Q4 for us. And not to make any excuses, but there's 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 effects start to abate and we start to see that the consumer starts to come back in the store as well as those deflationary pressures starting to ease.

Over the long term, we believe that we can have comps in that 2 to 4 range over the long term. .

Okay. Maybe now for John, just 2 unrelated quick follow-ups. Number one, could you quantify the Halloween impact on Q3 comp? And then secondly, I was unclear on how you're managing the overtime rule 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?.

Yes, this is Todd. Let me -- I'll take the second one first and have John quantify that Halloween impact for you. Right now, with the 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 transpires.

So we are on hold, and the operating group has done a fabulous job in communicating that to our folks. And we're in a wait and see. So we, like you, will wait and see what happens. But at the end of the day, we always do what's right for our employees, right? And again, that's one of our 4 operating priorities is really taking care of our people.

So we'll do what's right by them 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 2 fewer selling days this quarter as the quarter ended on October 28 this year versus October 30 of last year, so about 20 basis points. .

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

You mentioned that you were very focused on doing what it took -- takes, rather, to drive traffic. And so my question is related to the long-term earnings growth target that you provided back earlier in the year of 10% to 15%, which I believe 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 some EBIT margin to get incremental people through the door?.

Yes. So bear in mind, the model is a long-term growth model, and that's really where our focus is on over the long term. And we said 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. And so we'll do what we need to in that regard.

But 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, the great returns we continue to see from the new stores, with 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 dividends and share repurchases.

Feel great about the model and the long-term prospects, but it's a long-term model. We'll do what we need to, invest where we need to along the way. .

Okay, great. And just -- not a second question, on a different topic. You mentioned that the traditional DG format is your highest-return format. You got about 1,000 opening for next year.

Can you give us a rough breakdown of openings by format?.

Yes. Again, overwhelmingly, 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'll be that 7,300-square-foot store. .

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

Appreciate the incremental color on the current headwinds deflation, SNAP. You said competition about the same as last quarter. Just wanted to see if you could give any further color around -- the low-end consumer health was one of the other things that you kind of more specifically called out last quarter.

Versus then, kind of what are you seeing now either by basket, geography, et cetera? That would be great. .

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're citing and continue to cite is the rising health care costs that they're facing. I don't believe any of our core customers realize what they were up against on those rising costs. And then rental costs 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 some things a little differently than they've done before.

For instance, they're 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 a 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 quarters, but what was interesting to us was that she was feeling worse off today, middle of the third quarter, than she was earlier in the year. .

Okay. All right. Todd, that's very helpful. And just a quick follow-up, just going back to your initiatives. Kind of like you said, it seems a pretty similar scope, at least, going forward.

But if we try to just reconcile kind of what may be working better or worse than you thought and even going back to Alan's question on kind of consumables, nonconsumables 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 nonconsumables or maybe some greater or less than that kind of 10% pricing that you had cited last quarter. .

Yes. As we look at the entire box, and we've got one of the most robust category management processes and teams in consumable 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 nonconsumable businesses will drive the basket. We see that no differently.

And actually, we've seen our nonconsumable business tail off along with our consumable business, as that customer pulled back and especially in the SNAP-affected states. In saying that, a lot of our initiatives for this year and next year are both in consumables and in nonconsumables.

Because we believe that you have to have a fine balance between the 2 to really round out 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 are starting to look for better-for-you, more healthy, a little bit more fresh products.

And the great thing about having the market stores, 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 test-and-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 in a low accelerated rate as we move into 2017 because, again, our consumer preferences are changing. .

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

As retail a retail veteran who's done this in dozens of countries, I just want to say you guys are doing it right. You're doing it carefully. Test and control and the willingness to refine it is rare among leadership, and so just hang in there. You guys are getting it right. Our question's actually related to HBA.

One of the things that the merchants were kind of excited about in the Investor Day was that was a place where a little more SKU, 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. .

Yes. The health and beauty initiative, 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 and 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 5 to 6 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 products that she needs.

And the great thing is, it's at 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, 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. .

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

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 these metrics to the 2013 road map? And what was the time line back then that it took to see the traffic return?.

Yes. A little bit different time and date, but I could 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 of a sale than we thought we were going to get by now and just moving into a 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'd love to be able to compare it, it is a little bit different.

But I can tell you that we're happy with what we've seen so far. .

Great. And then just on the gross margin front. As we think about some of the headwinds this quarter that hit you, as we think about you 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. .

Yes. So in terms of 2017, we're still in the budgeting process and weren't going to provide any updates on that at this stage. We will in the next call. But again, with gross margin, our focus is on the long term here and continue to see a lot of opportunities managing the various levers and look to balance gross margin on SG&A to offset things.

So 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 bottom line results. .

Your next question comes from the line of Brad Thomas with KeyBanc Market. .

You all done a lot of interesting work on customer segmentation 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. .

Yes. We, again, as I mentioned earlier, we go out and talk to the customers each and every quarter.

And again, I believe that the majority of what we communicated to everyone earlier in the year pretty well is still well intact as far as the consumer is concerned, except for the notion that she may be 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 -- what we affectionately call our BFF, which is our core best customers, continue to really resonate with our everyday low price. And through Q3, with all the traffic-driving 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 in key, and that is our best customers look to us to deliver everyday low price first, because she needs to count on us each and every day. But in -- but beyond that, we're still seeing a healthy customer base outside of our core.

Some of our reach customers, we're 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. .

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

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