Earnings Call Transcript - DLTR Q2 2020

Operator, Operator

Good day and welcome to the Dollar Tree, Inc.'s second quarter earnings conference call. Today's conference is being recorded.

Randy Guiler, Vice President, Investor Relations

Thank you, Cathy. Good morning and welcome to our conference call to discuss Dollar Tree's performance for the second fiscal quarter of 2019. Participating on today's call will be our President and CEO, Gary Philbin; our Family Dollar President, Duncan Mac Naughton; and our CFO, Kevin Wampler. Before we begin, I would like to remind everyone that various remarks we will make about future expectations, plans and prospects for the company constitute forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors included in the most recent press release, most recent 8-K, 10-Q and annual report, which are on file with the SEC. We have no obligation to update our forward-looking statements and you should not expect us to do so. At the end of our prepared remarks, we will open the call to your questions.

Gary Philbin, President and CEO

Thanks, Randy. Good morning, everyone. As we reported today, the turnaround of the Family Dollar business continues to gain momentum. Family Dollar same-store sales increase of 2.4% was the third consecutive quarter of sequential acceleration and represented a 160 basis point improvement in the 2-year stacked comp. And despite sales headwinds created by the global helium shortage, Dollar Tree segment delivered a same-store sales increase of 2.4% while cycling a strong 3.7 increase from the prior year's quarter. Dollar Tree has now delivered 46 consecutive quarters of positive same-store sales and 8 consecutive quarters of 2-year stacked comps exceeding 6%. I'm proud of the team's accomplishments. During the quarter, we successfully consolidated our store support centers and, as planned, closed 296 Family Dollar stores as part of our store optimization efforts. Additionally, we completed 542 Family Dollar renovations into the H2 format. Our results for the second quarter included a sales increase of 3.9% to $5.74 billion. Consolidated same-store sales increased 2.4%. Our GAAP EPS of $0.76 exceeded our $0.64 to $0.73 per share guidance range. Other highlights for the quarter included completing 542 Family Dollar H2 renovations, completing $275 Dollar Tree Snack Zones, repurchasing 88.4 million of shares during the quarter as part of our share buyback program. At the end of July, we formally moved all business to the Chesapeake, Virginia campus. This represented the work over the past year to bring all functions, especially our merchant teams together. While we still have associates in the moving process, we now have one physical location to conduct our business. Regarding Dollar Tree's sales highlights for the second quarter, Dollar Tree had increases in both traffic and ticket with traffic slightly outpacing the ticket increase. Geographically, all regions comped positively. Cadence of comps through the quarter. All 3 months were better than 1.5% with June being the strongest month. Dollar Tree continued to deliver solid positive comps in the consumables category. Our discretionary business also comped positive but was impacted by the global helium shortage. We estimated that our comp was negatively impacted from lost balloon sales by approximately 40 basis points. We expect this helium shortage headwind to continue, but to a lesser degree in the back half of the year. The first half is more impacted with the timing of our biggest balloon holidays, Valentine's Day, Mother's and Father's Day as well as school graduations. For real estate, in the second quarter for both segments, we opened a total of 150 new stores, 107 Dollar Trees, 43 Family Dollars. We relocated or expanded 17 Dollar Tree and 2 Family Dollar stores. We renovated 542 Family Dollar stores as part of our H2 renovation initiative, and we rebannered 106 Family Dollars to Dollar Tree stores for a total of 817 projects during the quarter. We also added freezers and coolers into 210 Dollar Tree stores during the second quarter, bringing our total of Dollar Tree stores with freezers and coolers to 5,970. During the quarter, we closed 305 stores, 9 Dollar Trees in consistent with our previous announced efforts to optimize our real estate portfolio of 296 Family Dollar stores. We ended the quarter with 15,115 stores, split out 7,306 Dollar Tree stores and 7,809 Family Dollars. Last week, we opened our 24th U.S. distribution center located in Morrow County, Ohio, on time, on budget. The 1.2 million-square-foot facility is creating approximately 400 jobs in Central Ohio and will initially be serving Dollar Tree stores. It is equipped with the necessary system to serve both Dollar Tree and Family Dollar segments in the future. I would call out the partnership and support we received from the State of Ohio, Morrow County and the surrounding communities has been just outstanding. Before I turn the call over to Duncan to discuss the Family Dollar business, I'd like to provide you all an update on tariffs. We have been operating in unique times, to say the least, as it relates to tariffs. As I stated one quarter ago, our merchandising teams have done an outstanding job of mitigating the effects of the 25% tariffs imposed under Section 301 for Chinese goods included on Lists 1, 2 and 3. Prior to the recent USTR announcements on List 4 as well as the additional 5% tariff increase on all lists, we believe our team has successfully mitigated most of the adverse effects of the Section 301 tariffs. We've negotiated price concessions, canceled orders, modified specs, evolved product mix and diversified vendors. We are now taking actions to mitigate the recently announced tariff increases, and we will continue to assess the future impact of those tariffs. Our merchandising team is experienced, committed and talented. They have developed a tested and proven process for mitigating costs and have the metrics in place to track and measure success. The team will continue to focus on delivering great values to our customers while managing and protecting margins.

Duncan C. Mac Naughton, President, Family Dollar

Thank you, Gary, and good morning, everyone. Before discussing Family Dollar's performance, I'd like to share details regarding a significant organizational milestone that we recently achieved. Effective July 22, we have successfully consolidated our store support centers into Chesapeake, Virginia. This was a large complex task that required effective communication, collaboration and teamwork throughout the organization. I'm proud of our team's attitude, commitment and determination throughout this process. Many of our associates stepped up to relocate with the organization and are now settling in the Southeast Virginia area. I'd also like to salute and recognize those who could not or chose not to relocate, but they stayed on through July to facilitate a smooth transition. The benefits of having our brands together in one location are simply immeasurable. The Family Dollar team is already seeing the benefits from the stability of having a clear vision of the direction and future of our company. The Family Dollar team delivered another quarter, a sequential improvement in comps with a 2.4% increase. The team's performance demonstrates that our efforts to improve the consistency of execution across our stores and our efforts to optimize the real estate portfolio are working and gaining traction. We continue to believe that we're making the right steps to transform our customer experience to increase the frequency of their visits. Regarding Family Dollar sales highlights for the second quarter, an increase in average ticket drove the same-store sales increase in the quarter as year-over-year transaction count was essentially flat. Our consumable business performed very well, delivering its 11th consecutive quarter of positive same-store sales. Regarding the cadence of comps during the quarter, May was up against the strongest compare from a year ago and was slightly positive, and June and July were the strongest months of the quarter. Notably, year-over-year traffic turned positive. From a regional perspective, comps for all 7 zones were better than 1% with the strongest performance in the West, Southeast and Southwest. A few weeks ago, we conducted Family Dollar's Annual Leadership Conference. This conference brings together our field leadership team and business leaders to teach, learn, network and strategize as we prepare for the very important holiday season. The field leadership teams are energized and focused. They will take that energy back to their respective store teams. The theme of our 2019 meeting was the road to reinvention. We must evolve to be prepared for the future, and we're making smart and bold changes in our business at Family Dollar. As demonstrated by 3 consecutive quarters of improved comps, our customers are giving us credit for the improvements they're seeing in our stores, which include our H2 renovations, which continue to deliver low double-digit lift; and our grand reopening events are effectively getting the word out to the local communities. Key components for the H2 renovations are $1 STOP or $1 WOW sections throughout the whole store, more freezer and cooler doors with a broader selection of products, new signage, new decor with improved queuing lines at checkout, better lighting, and much more. Our category resets are working. We're seeing material comp lifts post reset. Examples of reset success include candy, household products, and food storage. I'm very proud of the work the teams have done on our private brand offerings with improved labels and packaging. These national brand equivalent value-priced products represent an opportunity to deliver great values to our customers while driving customer loyalty, store traffic, and profit dollars. At Family Dollar, we are on the road to reinvention. The team has delivered positive comps of 1.4%, 1.9%, and 2.4% over the past 3 quarters, and I am pleased with the additional trends for the third quarter. We have the headquarters move behind us. We have an eager, energized and aligned leadership team and a terrific plan entering the holiday season. I look forward to providing you more updates on our progress in the quarters ahead. I will now turn to Kevin to provide more detail on our second quarter performance and our updated outlook for 2019.

Kevin Wampler, CFO

Thanks, Duncan, and good morning. Total sales for the second quarter increased 3.9% to $5.74 billion comprised of $2.96 billion at Dollar Tree and $2.78 billion at Family Dollar. Enterprise same-store sales increased 2.4%. On a segment basis, same-store sales for both Dollar Tree and Family Dollar increased 2.4%. Overall, gross profit was $1.65 billion compared to $1.6 billion in the prior year's quarter. As a percent of sales, gross margin was 28.7% compared to 30.1% in Q2 of 2018. Gross profit margin for the Dollar Tree segment decreased 70 basis points to 33.8% when compared to the prior year quarter. Factors impacting the segment's gross margin performance for the quarter included merchandise costs, including freight, increased approximately 55 basis points primarily due to higher domestic outbound freight costs and an increase in the mix of lower-margin consumables sold; distribution costs increased approximately 10 basis points due to higher payroll costs; and occupancy costs increased approximately 5 basis points on the lower comp compared to the prior year. Gross profit margin for the Family Dollar segment was 23.3% during the second quarter compared with 25.7% in the comparable prior year period. The year-over-year decline was due to the following: markdown expense increased approximately 100 basis points resulting from store closure, rebanner and renovation markdowns, as anticipated, as part of our store optimization process; merchandise costs, including freight, increased approximately 95 basis points primarily due to the increased sales of lower-margin consumable merchandise and slightly higher freight costs; and shrink increased approximately 45 basis points resulting from unfavorable physical inventory results in the current quarter and from changes to the accrual rate. Consolidated selling, general and administrative expenses as a percent of net sales in the quarter increased 80 basis points to 24% from 23.2% in the same quarter last year. For the second quarter, the SG&A rate for the Dollar Tree segment as a percentage of sales improved to 22.5% compared to 22.6% for the second quarter of 2018. The improvement was due to the following: store operating costs were lower by approximately 15 basis points due to lower utility costs, specifically electricity resulting primarily from the benefit of the LED lighting program in the stores; payroll costs increased approximately 10 basis points primarily due to an increase in store hourly payroll due to a higher average hourly rate partially offset by lower retirement plan expenses. SG&A expenses for the Family Dollar segment were 22.7% as a percentage of sales in the second quarter compared to 21.6% for the same period last year. The increase in SG&A as a percentage of sales was due to the net of the following: operating and corporate expenses increased approximately 95 basis points resulting primarily from the loss of disposable and fixed assets due to the store closure write-offs; and stores' supplies expense to support the H2 initiative; payroll expenses increased approximately 35 basis points primarily due to average hourly rate increases and additional hours, including temporary health expense, to support H2 renovations; and depreciation and amortization expense decreased approximately 15 basis points as a result of certain assets becoming fully depreciated or amortized. Corporate and support expenses increased 30 basis points as a result of $10.8 million of store support center consolidation costs and higher depreciation. On a consolidated basis, operating income was $268.9 million compared with $382.5 million in the same period last year. Operating income margin was 4.7% of sales compared to 6.9% of sales in last year's second quarter. Nonoperating expenses for the quarter totaled $40.5 million, which was comprised primarily of net interest expense. Our effective tax rate for the quarter was 21.1% compared to 18.9% in the prior year's second quarter. The quarter and prior year's quarter benefited by $5.8 million and $8.1 million, respectively, for a reduction in the reserve for uncertain tax positions resulting from statute expirations. For the second quarter, the company had net income of $180.3 million or $0.76 per diluted share. This compared to net income of $273.9 million or $1.15 per diluted share in the prior year's quarter. Combined cash and cash equivalents at quarter end totaled $623.4 million compared to $422.1 million at the end of fiscal 2018. Our outstanding debt as of August 3, 2019, was $4.3 billion. During the second quarter, we invested $88.4 million in the repurchase of approximately 882,000 shares. At quarter end, we had $812 million remaining in our share repurchase authorization. We will provide updates on additional share repurchases, if any, following the quarter in which they occur. Inventory for the Dollar Tree segment at quarter end increased 15.1% from the same time last year while selling square footage increased 7.1%. Inventory per selling square foot increased 7.4%. Our inventory levels reflect the early receipt of imports to mitigate tariffs. We believe that current inventory levels are appropriate to support the scheduled new store openings, rebanners and our sales initiatives for the back half of the year. Inventory for the Family Dollar segment at quarter end decreased 2.3% from the same period last year and increased 3% on a selling square-foot basis. Capital expenditures were $293.3 million in the second quarter versus $213.4 million in the second quarter last year. For fiscal 2019, we're planning for consolidated capital expenditures to be approximately $1 billion, which is consistent with our initial 2019 outlook. Depreciation and amortization totaled $155.1 million for the second quarter and $152.5 million in the second quarter of last year. For fiscal 2019, we expect consolidated depreciation and amortization to range from $630 million to $640 million. Our updated outlook for fiscal 2019 includes the following assumptions: Calendar considerations for the remainder of the year include the following: there will be 6 fewer selling days between Thanksgiving and Christmas, which will negatively impact Q4 sales. With regard to tariffs and the recent USTR announcements, we estimate that without mitigation, List 4A and the additional 5% tariffs on Lists 1, 2 and 3 would cost the company approximately $26 million in additional tariffs. Our updated outlook does not include the recently announced tariff increases as we are currently working to mitigate these costs. Our company outlook on March 6, 2019, included $95 million in discrete costs related to our Family Dollar store optimization initiative and our store support center consolidation. With the increased visibility of our overall costs, we now expect to incur $85 million in discrete costs for the year, of which we've incurred $76 million in the first half of the year. Our Q3 outlook includes the remaining estimated $9 million in costs related to these initiatives. We expect continued pressure on store payroll based on competitive markets, states increasing minimum wage and completing the company's initiative plans. We expect year-over-year domestic freight costs as a percentage of sales to flatten out in the second half while import freight rates, as we noted in last quarter's call, will increase in the back half of the year. Net interest expense will be approximately $41.1 million in Q3 and approximately $162.7 million for fiscal 2019. We cannot predict future currency fluctuations, so we've not adjusted our outlook for currency rate changes. As always, our outlook assumes no additional share repurchases. Our outlook assumes a tax rate of 22.4% for the third quarter and 22.1% for fiscal 2019. Weighted average diluted share counts are assumed to be 237.5 million shares for Q3 and 237.6 million shares for the full year. For the third quarter, we are forecasting total sales to range from $5.66 billion to $5.77 billion and diluted earnings per share in the range of $1.07 to $1.16. These estimates are based on a low single-digit increase in same-store sales and include approximately $9 million of discrete costs. For fiscal 2019, we are now forecasting total sales to range between $23.57 billion and $23.79 billion based on a low single-digit same-store sales increase and approximately 1.3% square footage growth. The company anticipates GAAP net income per diluted share for full year fiscal 2019 will range between $4.90 and $5.11, which includes discrete costs of $85 million or $0.28 per share and approximately $15 million or $0.05 per diluted share in store-closure-related costs.

Gary Philbin, President and CEO

Thank you, Kevin. I will share a brief update on our early reads from the Dollar Tree Plus! test. We are in the very early stages of our multi-price point test at select Dollar Tree stores, and we'll continue to closely monitor the results, including impacts to traffic, sales, and margins. Some details related to the test are that we launched in mid-May, by the end of June, we had the test rolled out to approximately 115 stores. The test includes newly added products at price points of $2, $3, $4, and $5. The products being tested, which currently include about 200 SKUs, are clearly identified as Dollar Tree Plus! items providing customers more choices, more sizes, more savings. We are testing a cross-section of high-, moderate-, and low-volume stores as well as urban, suburban, and rural settings, so we can understand how customers respond in the varying markets. Early in the test, the product mix has leaned more towards consumables, and this will evolve as we move towards the holiday season with more discretionary items added to the test. We've received feedback on the values from our customers on the initial merchandise assortment, and this is critical as we know we want to protect the Dollar Tree brand. Our customers view Dollar Tree as the destination for terrific value for what you spend in $1. We are pleased with how our teams have started and implemented the test across varied geographies to our volumes and size. It's giving us valuable insights into how our customers view these values across a Dollar Tree store. Our teams are excited about the evolution of the merchandise assortment as we approach the holiday season. On our most recent import trip, we have bought specifically for Dollar Tree Plus! stores and I think excited about the additional assortment that will resonate with our customers as we go into our holidays. Finally, I wanted to share a few words regarding our field leadership meetings that I attended in the past few weeks for both Family Dollar and Dollar Tree. This was the opportunity to connect with field leaders face-to-face, teach and learn, recognize, reward all those individuals and teams for performance and service awards. We interact with buyers and sellers. The merchants and our field team work together to coach and mentor people development and ensure that we are all aligned heading into the important holiday season. We had very productive meetings, and I'm pleased with the focus on business acumen of our businessmen and women that are leading our field organizations. Our leaders are energetic, focused, and motivated going into this important back half.

Operator, Operator

We will take our first question from Simeon Gutman at Morgan Stanley.

Simeon Gutman, Analyst

I wanted to ask about some of the improvement in the Family Dollar comp. To what extent can you tie it to initiatives versus underperforming stores coming out of the comp base versus macro strength? And do you think that we've turned a corner here on a higher run rate? I mean it's been a few quarters now of improved sales.

Gary Philbin, President and CEO

We're really excited about the 2.4% comparable sales growth at Family Dollar. What's particularly encouraging is that all of our stores are performing well. We're seeing excellent results from our H2 stores, and the majority of our stores are also achieving strong comparable sales. As I mentioned earlier, we're observing positive customer traffic across the chain, indicating that our efforts to improve store conditions are resonating with shoppers. We currently have about 1,000 H2 stores, and we ended the quarter with 7,809 locations. The good news is we have years ahead of us to expand, as we're planning to add around 1,150 stores this year and work on transforming our chain. While our smaller store base can't drive the entire comparable sales growth, the overall performance of the chain is very supportive. We've also benefited somewhat from store closures, but their impact was not nearly as significant as the overall strength of the chain.

Simeon Gutman, Analyst

And then in the follow-up, I guess, on margin and the visibility, at what point does the margin improve and sort of follow this top line? And related to it, can you just share with us on the Dollar Tree side how much helium may have hurt the GM and maybe the EBIT for the Dollar Tree business this quarter?

Kevin Wampler, CFO

So as we look at the margin, as we look to the back half, obviously, the front half, in particular, was loaded with the discrete costs. As we've said, we have incurred about $76 million of what we now believe is $85 million of costs that we will incur. We look for the gross margin to become much more comparable to last year. It's obviously been down. I think the one thing that we have to always consider is we've been driving our business in the Family Dollar world with consumables. And even in Q2, the Dollar Tree business was driven by consumables based upon everything we have going on, touching all these stores that we're touching. So we're driving traffic. We're getting our core customer back into the store in Family Dollar, and they're liking what they're seeing. It's a little bit more consumable-driven. So our job that we still have ahead of us is to continue to improve our discretionary business, but we do look for the gross margin on the kind of dollar side to start to level out as we go through the back half.

Gary Philbin, President and CEO

And Simeon, this is Gary. Let me add my color to that. For both banners, I think it's important as we went into this year knowing all the stores that were going to be torn up for renovations. H2 at Family Dollar, Snack Zones at Dollar Tree. By the time we were going to get to Q2, we will touch 1,000-plus stores. And by design, not exactly reading the crystal ball as well as you would like, we went in aggressively, closeouts, our WOW product at the Dollar Tree side, a little bit more on the consumable side, on the merchandise plan at Family Dollar. So part of that was to make sure we could go through touchy stores, catch them, pull them back together and still drive a positive comp. As far as balloons, the impact there was the impact of 40 basis points. And that's really just on what we lost on balloon sales in the first half or in the second quarter year-over-year. And obviously, the first half, as I called out, is a little more impactful. What we didn't measure was balloon sales usually have a halo effect on everything else in the party department, which is obviously one of our highest-margin in a very large business, and it really drives customers to that store. So we know it's not going to be as impactful because the holidays aren't as big, and we'd like to think it's going to get moderately better as we go into 2020, but that was probably the best way to measure the balloon impact.

Matthew Boss, Analyst

Nice progress, guys. I guess first, at Family Dollar, how best to think about sequential same-store sales improvement opportunity in the back half of the year? Maybe what do you see as top drivers of the traffic inflection at your H2 remodels? And any color on early 3Q trends would be helpful.

Gary Philbin, President and CEO

Thank you for the question, Matt. Our engine is growing, and our traffic is becoming positive. We're seeing significant growth in consumables, and our goal is to translate that into discretionary sales to improve our margins throughout the year. We have a solid plan for the second half and a strong holiday strategy that we recently presented at our Annual Leadership Conference. Year-over-year, we expect to continue improving our comparable store sales as more H2 stores come online and mature. We're also noticing that existing stores are raising their standards, becoming cleaner, and customers are recognizing these improvements. Even stores that aren't H2 remodels are incorporating successful elements from those locations. We're working quickly to identify winning strategies in key categories, and the resets we made last year will start to pay off in the latter half of this year. Overall, I feel optimistic about our business plan with regard to comparable store sales moving forward.

Duncan C. Mac Naughton, President, Family Dollar

Matt, and Gary, I would just add. I mean that's part of the energy and why we added more H2s. A showdown to our openers have gotten us ahead of the game to this point to get the 1,000 done by the time we finish up August to your Labor Day weekend, and we had some more runway. So we're up for another 150 to get done mainly through September, a little bit probably into October to give us more H2s on the ground. But to give credit to the Family Dollar team, the consistency of what we're seeing in-store, the work we've done on key resets are I think are what we see as lifting all boats right now.

Kevin Wampler, CFO

Matt, it's Kevin. In my prepared remarks, I aimed to provide some detailed insights on this. Let's break it down step by step. In the press release, we mentioned $48 million in one-time costs for the quarter, along with $15 million in store closure costs. This totals $63 million, which translates to about 230 basis points. If we exclude the $10 million in store consolidation expenses, approximately $52 million is attributed to the Family Dollar segment, accounting for around 190 basis points. This consists of about 100 basis points from markdowns related to store closures, renovations, and rebranding efforts. On the SG&A side, this includes asset write-offs due to the closure of 296 stores during the quarter, along with supplies and temporary labor costs for renovations. This roughly amounts to 90 to 95 basis points. This is how we can categorize these figures in a broader sense. Looking ahead, we have significant opportunities for improvement. It's been a challenging year regarding shrinkage, but we see potential moving forward. As mentioned last quarter, we anticipate some stabilization in the second half on a comparative basis. We have several initiatives underway, including changes in leadership and structure, a renewed focus on training and execution of policies, defensive merchandising strategies, and improved analytics. Additionally, reducing our inventory levels will greatly assist us. I believe we have a substantial opportunity to enhance our gross margin as we enter next year.

Duncan C. Mac Naughton, President, Family Dollar

Matt, I want to add a few points. First, with the increase in traffic, we can effectively manage our operations. This is evident with the improvements we're seeing across the fleet. When customers come to the store, it becomes much easier to sell them appealing merchandise on the discretionary side. Secondly, I'm really excited that everyone is now in the same building, with merchant teams all on the same floor and vendors meeting with both banners simultaneously. This setup strengthens our position as a $25 billion company with a strong presence in the vendor community, allowing us to drive sales and become a top choice for our partners. Lastly, regarding imports and tariffs, the ability to design and create valuable merchandise that appeals to both Family Dollar and Dollar Tree will have a significant positive impact as we look ahead.

Chuck Grom, Analyst

Duncan, could you elaborate on the increase in traffic this quarter? Do you believe it's due to new customers or repeat visits from existing ones? And Kevin, as a follow-up to Matt's question regarding the gross margin for Family Dollar, could you clarify the one-time costs, including both discrete expenses and store closures, and their impact in basis points compared to regular operational factors like shrinkage and markdowns?

Duncan C. Mac Naughton, President, Family Dollar

Thank you, Chuck. Regarding Family Dollar traffic, we've observed low double-digit increases in our H2 stores, with around two-thirds of that growth attributed to increased traffic. This translates to more transactions and a notable number of repeat purchases. Additionally, we are attracting new customers from competitors in the market. Many returning customers are coming back more frequently, and through our grand reopening initiative, we are reaching out to previous Family Dollar customers to show them our updated offerings. This strategy seems to be effective as we’re seeing them return to our stores. Overall, we’re optimistic about this trend. Across the rest of the chain, customers are noticing improvements in our store standards and our strong growth in consumables, while we are also focusing on enhancing the discretionary side of our business. We've revamped our marketing campaign to increase our presence in the market, which is something I’m enthusiastic about since we had been lacking in that area previously. Thus, in the H2s, we see both new customers and a mix of returning ones, and the positive news is that the number of visits is on the rise.

Kevin Wampler, CFO

In response to your question about the Family Dollar margin, there are three main factors contributing to the year-over-year change for the quarter. Firstly, we saw a 100 basis points impact from markdowns related to our initiatives. Secondly, there was a 95 basis points effect from increased sales of lower-margin goods, along with slightly higher freight costs. Lastly, about 45 basis points were related to shrink. Those are the primary factors we've identified. Let me know if there's anything else you would like to know.

Chuck Grom, Analyst

No. That's helpful. I just wanted to get all the information. And then just on the Tree, just maybe unpack for us the difference between the first and the second quarter gross margin performance, and I guess how you're thinking about it in the back half of the year.

Kevin Wampler, CFO

In the first quarter, gross profit was fairly steady compared to this quarter. However, we experienced a greater impact from freight costs this quarter than in the first quarter. There were some timing factors involved, and we also increased our inventory during the quarter from an import perspective to counteract tariffs, which had some influence as well. Overall, the primary factor affecting us was freight costs, but we anticipate some relief in the latter half of the year as we have mentioned. Additionally, we observed improved sales from our consumable business in the second quarter, which resulted in a slightly lower average margin mix due to the sales mix. Looking ahead, I don’t believe we will encounter the same kind of pressure we faced in the second quarter.

Gary Philbin, President and CEO

Yes. And Chuck, I would just give you some color. I think really, the last two years, our seasons have gotten out of the gates very quickly and performed very well. All this inventory we brought in to beat the tariffs is there. That's the imports. It's higher margin. As we kick off, really, the fall/harvest season as we get past Labor Day, to me, we are set up to take advantage of what the Dollar Tree does best, and that's getting geared up on the discretionary side of the business. We've invested in consumables to make sure we had the kind of traffic and customer count we needed as we went through all of our Snack Zones. Snack Zones are delivering what we brought across the network. Now let's shift gears a little bit back to what the best time of the year is for Dollar Tree, and that's really September, October on through the Christmas holiday.

Judah Frommer, Analyst

First, to circle back to tariffs. It sounds like you've quantified the potential impact from the increase on Lists 1 through 3 and List 4A, but it's not embedded in the 2019 guide. Is the messaging that you do feel you can fully offset that? Or is the message that you're working to offset and you'll update us with the magnitude of offset at some point?

Gary Philbin, President and CEO

Thank you, Judah. To keep it brief, we're just six days past the last update. Here’s a recap of our year: the merchant teams successfully managed Lists 1, 2, and 3 as anticipated. When Lists 4A and 4B were first introduced, we had strategies in place and felt optimistic about our approach during our Asia trip. The recent changes are now our primary focus. Our initiatives are proving effective, and I believe the vendor community is responding positively. We've previously mentioned our efforts to adjust packing methods and increase container efficiencies to lower overall costs. Through our China plus 1 strategy, we've managed to capitalize modestly, moving around $100 million during our buying trips in China. I commend our merchants for their efforts; this requires negotiating with vendors individually to achieve those improvements. I wanted to convey the scale of our work ahead, and while we still have tasks to accomplish since the recent update, I am confident that we will manage these challenges effectively for the remainder of the year.

Judah Frommer, Analyst

Okay. Great. And, Kevin, you are kind enough with Q4 earnings to give us an early read on next year and the earnings growth related to that. I think you've been clear that you guys guide on a GAAP basis, but GAAP earnings have moved around quarter-to-quarter as discrete costs kind of come and go. Is there any directional update you can give us on how you're thinking about that earnings growth trajectory for next year?

Kevin Wampler, CFO

No, we haven't changed the guidance we provided in March on that topic. We're currently starting our budget planning for next year. In simple terms, I don't believe anything in our fundamentals has shifted. We do face uncertainties with tariffs and their potential impact, but there's no clear answer at this time. We will need to factor that into our considerations. However, regarding our base case, I don't foresee a change in our thinking.

Joseph Feldman, Analyst

I wanted to ask with regard to the new front end that you have at the Family Dollar side of the business, how many stores have that at this point? And like how fast can you get that to all the stores?

Duncan C. Mac Naughton, President, Family Dollar

Joe, thanks for the question. This is Duncan. We've implemented the new queuing line in all H2 stores and are including it in all our new stores as well. The main limitations at the store level are size and width. We offer multiple formats for the queuing line and we are installing it wherever possible because it significantly boosts store profitability, especially with the single-serve beverages. Additionally, the front end is quite lucrative, not only from snacks but also from the discretionary items we've introduced. Our team is currently testing a new front queuing line that aims to further enhance profitability and better meet our customers' needs. Right now, this initiative is primarily focused on H2, and we'll evaluate if it can be incorporated into other renovations, but our main focus is on the H2 number.

Gary Philbin, President and CEO

Well, we have one DC that is in Utah that distributes to both Family Dollar and Dollar Tree. We now have one, two, three, four additional DCs that have the internal workings and warehouse management systems that allow us to deliver to both. We've needed the capacity for the Dollar Tree banner because we have capacity in the Family Dollar network because of their closures and rebanners. Of course, that's putting pressure on the Dollar Tree banner. So ultimately, it comes down to the size of the building. Any new building that we've done, it comes out now with the ability to deliver either banner, which will be a place that we move to. That's a stem-mile opportunity for us in the out years. It's right now a function of capacity needed for the Dollar Tree banner to make sure we can service those stores. We pick up some stem mile every time we open up a Dollar Tree banner because we have more stores closer to that.

John Heinbockel, Analyst

So two quick things. I know there's not a lot of H2s with a lengthy history. But do you guys have a sense of how that format will mature and waterfall in years 2 and 3 comp-wise? Do you think it's above maybe what a new store would do? Like a normal new store, it settles into a more normal waterfall.

Duncan C. Mac Naughton, President, Family Dollar

John, it's Duncan. Thanks for the question. I think it would probably comp like a regular new store is what we're thinking about. We've got a handful of them that have kind of cycled themselves. So we're learning quickly, but it's behaving like a new store.

Gary Philbin, President and CEO

Thanks, John. I would say, at this point, it's purely additive to the basket. So it's telling us, I'm a Dollar Tree shopper. I come in. I like my regular items. And now here is something that surprised me is some of the feedback we hear. That goes into what was, "their regular basket." So I think we begin with some items that give us some good information on our customer view. But what I'm really perhaps most excited about is putting a bit more of the Dollar Tree whimsy and surprise of the WOW effect into some of the items. That will give us another variant of what customers are buying, especially as we get around holiday time. More to come. We bought specifically for these stores, and they'll be in addition to the assortment as we continue to evolve and get the best read we can.

Karen Short, Analyst

I just wanted to clarify a couple of things. You commented that you were pleased with 3Q trends at Family Dollar. So I guess I just want to clarify, is that to be interpreted that comps are above where you came in, in 2Q? And then I had another clarification on guidance.

Kevin Wampler, CFO

Duncan made that comment. I mean, obviously, I think we're only three weeks in. So it's not like we're going to get a whole lot of other information. But I mean we're pleased is where we would state it, that we're not going to make a statement whether it's higher or lower or what it might be, but we're very pleased at this point.

Kelly Bania, Analyst

Just wanted to ask about tariffs. It was helpful to have the quantification I guess of the $26 million over the next couple of months. I'm guessing in terms of List 4 that you're still working through that, which is why that wasn't quantified. But maybe you can just talk about the order of magnitude, how that would compare to what you're quantifying today, if you can at all. I guess a couple of other questions related to that. How much have you saved with respect to tariffs by bringing inventory early at multiple points throughout this year? And then is there at all an upper limit to what you think your team can offset here? Do you feel confident that even if you get into next year that this can further be mitigated?

Gary Philbin, President and CEO

We're managing based on the information we have. Initially, we targeted a 10% impact for the 4A situation, and our team began working on it immediately, knowing that 4B was on the horizon. We had more time to prepare for 4B. After the tariff increase for both List 4 and Lists 1, 2, and 3, we continued to follow our successful strategy. We are facing unique challenges, but our vendor community is eager to collaborate and address these issues. However, they are also worried about losing business, which has led some to explore other opportunities both inside and outside of China. There’s no single solution to navigate through this situation. I feel confident about the rest of this year because I can clearly see the challenges we face, and our teams are working diligently to tackle them. It's too early to make predictions for next year; I’m focused on immediate developments. We are actively addressing current issues, especially with the upcoming tariff increases on September 1, followed by another in October and finally in December. Those are the ones we are currently aware of.

Edward Kelly, Analyst

Just a few questions for you. First, I just wanted to ask you about store manager turnover at Family Dollar. I was just hoping you could give us an update on the progress that you're making there and the initiatives that you have in place to improve that.

Duncan C. Mac Naughton, President, Family Dollar

Edward, it's Duncan. Thanks for the question. I would say that store manager turnover has improved slightly. We're still at a level that I'm not happy with. But last year, we focused all our training at our field meeting on the year of the manager, which was all about training our people, giving them tools, about hiring the right person, training the right person, and retaining the right person. We gave them many tools and consistent playbooks across the chain to do that. They've all been trained on that. We highlighted it again this year and updated those toolkits. We've had national recruiting fairs, as you're probably aware of. We've made progress there. It does attract a fair amount of people.

Gary Philbin, President and CEO

I want to point out that Dollar Tree is likely to experience one of its best three years in terms of store manager turnover during my time here. The initiatives are well-targeted and focused. We are putting in significant effort to improve turnover for both banners, and it should be a strong year for store manager turnover. Well, on the timing side, I think as we evolve the assortment, we're going to learn more. I can't quite give you a timeline. I'm more interested in what can I learn from giving our customers an evolving assortment that will tell us more about what resonates with her when she's in a Dollar Tree. As far as tariffs, obviously, anybody importing today is affected no matter what the price point. It does go into the equation, but it does make you take a look at where you're buying it from. But to hit the mark, you have to really focus on what the customer wants, as always, in retail; and for our Dollar Tree stores, how does that play out. When we take a look at retail, that go up to $5. I think that's really what we focused on. What's our Dollar Tree customer going to look for in our world? That’s where our merchandising teams are very focused on.

Operator, Operator

That concludes today's question-and-answer session. Mr. Guiler, at this time, I will turn the conference back to you for any additional or closing remarks.

Randy Guiler, Vice President, Investor Relations

Thank you, Cathy, and thank you for joining us for today's call and for your continued interest in Dollar Tree. Our next quarterly earnings conference call to discuss Q3 results is tentatively scheduled for Tuesday, November 26, 2019. Thank you.

Operator, Operator

That concludes today's presentation. Thank you for your participation. You may now disconnect.