Earnings Call Transcript - DLTR Q3 2020

Operator, Operator

Good day, and welcome to Dollar Tree, Inc.'s third quarter earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Randy Guiler, Vice President, Investor Relations. Please go ahead, sir.

Randy Guiler, Vice President, Investor Relations

Thank you, Aaron. Good morning, and welcome to our conference call to discuss Dollar Tree's performance for the third fiscal quarter of 2019. Joining us today are our President and CEO, Gary Philbin, and our CFO, Kevin Wampler. Before we start, I want to remind everyone that some of our remarks regarding future expectations, plans, and prospects for the company are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may differ significantly from those indicated by these forward-looking statements due to various important factors, which are included in our latest press release, recent 8-K, 10-Q, and annual report filed with the SEC. We are not obligated to update our forward-looking statements, and you should not expect us to do so. After our prepared remarks, we will open the call for your questions. Now I will turn the call over to Gary Philbin, Dollar Tree's President and Chief Executive Officer.

Gary Philbin, President and CEO

Thanks, Randy. Good morning, everyone. The third quarter represents another period of solid sales performance for both brands, Dollar Tree and Family Dollar. Our store optimization efforts and sales driving initiatives are working. The teams have completed more than 1,150 Family Dollar H2 renovations, nearly 200 Dollar Tree rebanners and more than 1,000 Dollar Tree Snack Zones and launched our Dollar Tree Plus! test already this year. These efforts have driven top line sales and transaction counts at both banners. Fiscal 2019 has been a unique year as a result of several factors. We planned and accomplished the material acceleration of our Family Dollar store optimization initiatives and the consolidation of our two support centers to Chesapeake, Virginia. Additionally, the global helium shortage, which has an outsized impact on our party business, and the continued uncertainty regarding trade and related tariffs have impacted our business. I'm proud of our team's efforts and the sales execution through this environment. We worked hard to maintain focus on our customers and our values in store. Our results for the third quarter included a sales increase of 3.7% to $5.75 billion. Consolidated same-store sales increased by 2.5%, and our EPS of $1.08 was within our guidance range. Other highlights for the quarter included completing 247 Family Dollar H2 renovations, completing 512 Dollar Tree Snack Zones, bringing our total to 2,087 across the chain, and repurchasing approximately 125,048 shares as part of our share buyback program. And in mid-October, we hosted our fourth annual nationwide hiring event focused on hiring more than 25,000 associates in communities all across the country. This event provides individuals with the opportunity to join the Dollar Tree or Family Dollar teams. These new associates can earn the opportunity to be promoted through the field organization. As a growth company, we're always looking for talent and better strength that can develop into future leaders in our stores. Our application flow was strong for the successful hiring event. Regarding Dollar Tree segment sales highlights for the third quarter, we delivered a 2.8% comp, representing the 12th consecutive quarter of comps exceeding 2%. Dollar Tree had increases in both traffic and ticket, with traffic slightly outpacing the ticket increase. Geographically, all zones comped positively and were at or better than 2%. Strongest performing zones were in the Northeast, the upper Midwest and Southwest. Our cadence of comps in the quarter, all three months, were better than 2%, with August being the strongest month. Dollar Tree continues to deliver solid positive comps in the consumables category. And our seasonal business continued to perform very well. In fact, Halloween was on par with a very good seasonal sell-through we've been experiencing over the past couple of years. Our variety business, which includes party at Dollar Tree, comped positively each month during the quarter, but was again impacted by the helium shortage. We estimate that our comp was negatively impacted from lost balloon sales by about 20 basis points. We expect this helium shortage headwind to continue, but to a lesser degree for the remainder of 2019. The Dollar Tree merchant team continued to do a terrific job of delivering ever-changing and new product ideas that drive customer excitement and repeat visits. Dollar Tree WOW is the excitement that our customers have come to expect. Snack Zones have started, and we have rolled out to great success, and we continue to extend this initiative into more Dollar Tree stores. Last year, we added Hallmark cards to all stores across the chain. It has proven to be a great partnership, and customers certainly love the Hallmark brand, the offering and the value. And this year, we've been rolling out a new program called Crafters Square. Crafters Square is now in more than 600 Dollar Tree stores and consists of our new and expanded selection of arts and crafts supplies, all priced at $1. Feedback from stores and customers has been fantastic, and we'll continue to expand this traffic-driving initiative to more stores going forward. The sharing of projects within the crafting community on Pinterest, Instagram and other platforms has made this one of the quickest launches to our customers on a small base of only 600 stores. Let me give you an update on Dollar Tree Plus! As we've discussed previously, we are conducting a test of multi-price points at select Dollar Tree stores. The multi-price assortment is an increment of $2, $3, $4 and $5, is being tested in 115 stores. We just reached the six-month mark in the initial stores, as the majority of the test stores were added in June. And we're closely monitoring performance, including impacts to traffic, sales, margin and, of course, customer feedback. As always with tests, we follow an iterative process where we test, learn, modify and improve along the way. Our focus regarding multi-price point tests as we finish this year and move into 2020 will be on delivering great values to our shoppers within targeted categories, shifting more towards discretionary and unique products that we believe deliver the WOW factor to consumers and is additive to the basket and margin profile. Utilizing our broad vendor base to source these great value products, ensuring, as always, that we protect the Dollar Tree brand. Our brand is more than the items we sell for $1. The Dollar Tree brand represents pricing value and that the customers get tremendous value for what they spend at Dollar Tree. Our efforts to drive this test should include extending our reach by adding great value, exciting merchandise and opportunities to expand margin. We are still early in this test and look forward to updating you as the test evolves. Family Dollar team delivered another quarter of positive comps with a 2.3% increase. Importantly, comparable transaction count for the quarter was positive, continuing the trend that began to emerge in midsummer. The team's performance demonstrates that efforts to improve the consistency of execution across the chain and efforts to drive H2 performance are working and gaining traction. Our Family Dollar segment highlights for the third quarter. Our consumables business performed very well, delivering its 12th consecutive quarter of positive same-store sales. Our cadence of comps throughout the quarter, all three months, were better than 1.5%, with August being the strongest month. From a zone perspective, comps for six of our seven zones were positive, with the strongest performance in the West, Southwest and Southeast zones. Our Family Dollar customer service scores for Q3 showed improvement from the prior year. Categories of store cleanliness, product assortment, speed of checkout were among the notable improvements. We continue to believe we are taking the right steps to transform our customer experience to increase the frequency of the business. These steps include improving customer satisfaction, developing brand and price reputation, focusing on opening price points, incorporating better organized and focused Dollar impact sections and serving more of what our customers need, including frozen foods. And as we expected, the average scores for H2 stores, where we have invested in our fleet, are higher across the board. We continue to be very pleased with the performance of our H2 store format of Family Dollar. All new and remodeled stores are in this format, which is driving greater loyalty, repeat visits and value perception in these locations. These renovated stores continue on average to deliver a comp greater than 10% in their first year post renovation. We are committed to this format and plan to renovate at least 1,000 Family Dollar stores to the H2 format in fiscal 2020. We began rolling out the H2 format in Q3 last year. We continue to like the sales that we are seeing in the H2 stores, now cycling into their second year. Our efforts to drive performance across the store base continue to focus on initiatives around our private brands with compare and save, our smart coupons that offer our loyal customers the latest and best values. Hallmark cards will be coming to all Family Dollar stores in 2020. And of course, our store manager training and retention efforts, as always, to drive performance and consistency store by store. In our store support center, we are seeing the benefits of having our teams, Dollar Tree and Family Dollar, together in one location. We anticipate being together will greatly enhance our culture, our ability to recruit great talent and improve the collaboration within our organization as we train and develop and provide even more and better support for our stores. Looking at real estate for both segments in the third quarter. We opened a total of 165 new stores, 114 Dollar Trees, two in Canada and 51 Family Dollars. We relocated or expanded 12 Dollar Tree and three Family Dollar stores. We renovated 247 Family Dollars as a part of our H2 renovation initiative, and we rebranded 39 Family Dollars to Dollar Tree stores for a total of 463 projects during the quarter. We also added freezers and coolers into 138 Dollar Tree stores, bringing our total to stores with freezers and coolers to just over 6,000. During the quarter, we closed 42 stores, 12 Dollar Trees and 30 Family Dollars, and we ended the quarter with 15,262 stores: 7,447 Dollar Trees, 7,815 Family Dollars. Before I turn the call over to Kevin, I'd like to provide a brief update on tariffs. Just prior to our last earnings announcement in August, the USTR announced that tariffs on List 1, 2 and 3 products will increase from 25% to 30% on October 1. Tariffs on List 4A products would increase from 10% to 15% on September 1, and tariffs on 4B products would increase also from 10% to 15% on December 15. As noted in our August earnings announcement, our outlook provided at that time did not include any impacts related to these changes. Our updated outlook includes approximately $19 million of cost of goods sold, with the expected impact from USTR tariffs for List 1, 2 and 3 as well as List 4A and 4B tariffs, if fully implemented, in Q4. Nearly all the expected impact is related to the introduction of List 4A tariffs.

Kevin Wampler, CFO

Thanks, Gary, and good morning. Consolidated net sales for the third quarter increased 3.7% to $5.75 billion, comprised of $3.07 billion at Dollar Tree and $2.67 billion at Family Dollar. Enterprise same-store sales increased 2.5%. On a segment basis, same-store sales for Dollar Tree increased 2.8% and for Family Dollar, increased 2.3%. Overall, gross profit was $1.7 billion compared to $1.67 billion in the prior year's quarter. Gross margin was 29.7% of sales compared to 30.2% in Q3 of 2018. Gross profit margin for the Dollar Tree segment decreased 60 basis points to 34.2% when compared to the prior year's 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 freight costs. And distribution costs increased approximately 10 basis points, primarily due to higher payroll costs and depreciation. Gross profit margin for the Family Dollar segment was 24.5% during the third quarter compared with 25.3% in the comparable prior year period. The year-over-year decline was due to the following: Merchandise costs, including freight, increased approximately 30 basis points, driven primarily by an increase in freight costs and higher sales of lower-margin consumable merchandise, partially offset by improved initial markup. Shrink increased approximately 15 basis points resulting from unfavorable physical inventory results in the quarter. Distribution costs increased approximately 15 basis points due to increased payroll costs at the distribution centers. Occupancy costs increased approximately 10 basis points due to an increase in real estate taxes, and markdown expense increased approximately 5 basis points, resulting from higher clearance activity in the quarter. Consolidated selling, general and administrative expenses as a percentage of net sales in the quarter increased 30 basis points to 23.5% from 23.2% in the same quarter last year. For the third quarter, the SG&A rate for the Dollar Tree segment as a percentage of sales increased to 22.1% compared to 22% for the third quarter of 2018. The increase was due to store operating costs increasing by approximately 15 basis points owing to increased debit and credit card fee penetration and an increase in loss on disposal of fixed assets from an earlier lease termination in the quarter. Payroll costs decreased approximately 5 basis points, primarily due to lower retirement plan expenses and lower insurance benefits compared to the prior year quarter, partially offset by an increase in store hourly payroll due to higher average hourly rates and additional hours to support store initiatives. SG&A expenses for the Family Dollar segment were 22.5% of sales in the third quarter compared to 22.2% of sales for the same period last year. The increase in SG&A as a percentage of sales was due to the following: Operating expenses increased approximately 25 basis points, resulting primarily from higher costs related to the disposal of fixed assets in connection with our store optimization initiative. Depreciation and amortization expense increased approximately 10 basis points as a result of the capital investment required to support the H2 initiative. Corporate and support expenses increased 10 basis points, primarily related to store support center consolidation costs and higher depreciation. This included approximately $4 million of expenses related to the Q3 2019 discrete costs associated with our store support center consolidation. For the quarter, the company incurred approximately $9 million in total discrete costs, which was consistent with our guidance. On a consolidated basis, operating income was $358.4 million compared with $387.8 million in the same period last year, and operating income margin of 6.2% of sales compared to 7% of sales in last year's third quarter. Nonoperating expenses for the quarter totaled $41.5 million, which was comprised primarily of net interest expense. Our effective tax rate for the quarter was 19.3% compared to 17.1% in the prior year's third quarter. The prior year quarter benefited by $15.7 million based on the company's substantial completion of our analysis of the Tax Cuts and Jobs Act on the net deferred tax liability valuation. The current year's tax rate reflects the benefit of statute expirations and the reconciliation of the tax provision to the tax returns. For the third quarter, the company had net income of $255.8 million or $1.08 per diluted share as compared to net income of $281.8 million or $1.18 per diluted share in the prior year quarter. Combined cash and cash equivalents at quarter end totaled $433.7 million compared to $422.1 million at the end of fiscal 2018. Our outstanding debt as of November 2 was approximately $4.3 billion. During the third quarter, we repurchased approximately 125,000 shares for $11.6 million. At quarter end, we had $800 million remaining on our share repurchase authorization. We'll provide updates on additional share repurchases, if any, following the quarter in which they may occur. Inventory for the Dollar Tree segment at quarter end increased 14.4% from the same time last year, while selling square footage increased 7.5%. Inventory per selling square foot increased 6.4%. 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 and our sales initiatives for the remainder of the year. Inventory for the Family Dollar segment at quarter end decreased 4.2% from the same period last year and increased 0.9% on a selling square foot basis. Based on store closures, the Family Dollar segment has 5.1% less square footage outstanding. Capital expenditures were $279.8 million in the third quarter versus $228.4 million in the third quarter of last year. And for fiscal 2019, we are planning for consolidated capital expenditures to be approximately $1 billion, consistent with our initial outlook. Depreciation and amortization totaled $160 million for the third quarter and $150.5 million in the third quarter last year. For fiscal 2019, we expect consolidated depreciation and amortization to be approximately $635 million. We've updated our outlook for fiscal 2019 and have lowered our guidance for Q4 based on the following expected effects. With regard to tariffs and the USTR announcement, we estimate that Section 301 tariffs will increase our cost of goods sold by approximately $19 million or $0.06 per diluted share in the fourth quarter if the tariffs are fully implemented. Almost all other costs are due to List 4A as its timing did not allow for significant mitigation. We expect additional pressure on merchandise margins based on lower-margin consumables growing faster than originally forecasted. We expect distribution costs to be higher than originally forecasted, primarily due to payroll cost pressures from higher turnover, which may affect productivity. Expenses related to repairs and maintenance, utilities and depreciation are now expected to have a higher run rate than originally forecast. Additional assumptions in our outlook are the calendar considerations for the remainder of the year, which is that there will be six fewer selling days between Thanksgiving and Christmas, which will negatively impact Q4 sales. We expect continued pressure on store payroll based on competitive markets, states increasing minimum wages, unemployment levels and completing the company's initiative plans, including H2 renovations and Snack Zones. We estimate year-over-year domestic freight cost as a percentage of sales to be slightly lower in the fourth quarter. Import freight rates, as we noted on last quarter's call, will increase based on our April rate negotiations and beginning in January 2020, as a result of low sulfur fuel requirements for ships. Net interest expense will be approximately $41.9 million in Q4. We cannot predict future currency fluctuations. We have not adjusted our outlook for currency rate changes. As always, our outlook assumes no additional share repurchases. Our outlook assumes a tax rate of 22.3% for the fourth quarter and 21.4% for fiscal 2019. Weighted average diluted share counts are assumed to be 237.7 million shares for Q4 and 238.2 million shares for the full year. For the fourth quarter, we are forecasting total sales to range from $6.33 billion to $6.44 billion in diluted earnings per share in the range of $1.70 to $1.80. These estimates are based on a low single-digit increase in same-store sales and year-over-year square footage growth of 1.1%. For fiscal 2019, we are now forecasting total sales to range between $23.62 billion and $23.74 billion based on a low single-digit same-store sales increase of approximately 1.1% selling square footage growth. Company anticipates GAAP net income per diluted share for the full fiscal 2019 will range between $4.66 and $4.76, which includes a discrete cost of approximately $85 million or $0.28 per diluted share, approximately $15 million or $0.05 per diluted share of store closure-related costs and approximately $19 million or $0.06 per diluted share related to tariffs.

Gary Philbin, President and CEO

Thanks, Kevin. Like I mentioned at the beginning of the call, 2019 has been a year of distinct opportunities. We planned and executed the material acceleration of our Family Dollar store optimization initiatives, Snack Zone resets at more than 1,000 Dollar Tree stores and the consolidation of our two banners to our store support center in Southeast Virginia. We accomplished this against the backdrop of the helium shortage, the uncertainty regarding trade and related tariffs, continued impact of freight costs and DC costs affected by the increasing starting wage rates. I'm proud of the sales results at both Dollar Tree and Family Dollar that were accomplished in the quarter. This was done in the first three quarters of the year with more than 2,000 stores disrupted from our initiatives. We invested in our stores, our starting rates in specific markets and have our fleet of stores ready for the fourth quarter and the key holidays. As stated in today's press release, we also announced that we will do at least another 1,000 H2 renovations in 2020. Our confidence in this model grows as we have more across our fleet of stores and various types of settings, demographics and densities of population. We will announce our new RILA and other store level capital plans for 2020 at the end of Q4. The impact on our gross margin in specific areas is ours to control and do better. We are focused on making improvements across several categories as we finish the year and start 2020. These areas include improving our shrink results, enhancing efficiencies within our supply chain to manage freight costs better, driving sales on the discretionary side of our business to reduce mix headwinds to margin, and tariff mitigation efforts. For shrink, our plans are focused on enhancing allocations and right-sizing inventories to all of our stores, especially those with a high shrink history; continued focus on training throughout our field leadership, districts and store teams; adding loss prevention tools within our stores; and last week, we're pleased to bring on a seasoned, experienced retail executive in a senior VP role to lead both our Dollar Tree and Family Dollar asset protection teams. The asset protection teams from both banners will report to him effective immediately, and our visibility to market issues, external and internal, will be enhanced with the combined teams in priority high shrink markets. Our opportunities across our supply chain and freight costs are focused on optimizing our less than truckload inbound costs, fitting our key freight lanes, continuing to reward our best carriers by offering them business that deliver on cost and service and getting back to our historical backhaul levels. On the discretionary side, at Dollar Tree, we are working hard to overcome our helium shortage with more party-centered items to service our customers. For Family Dollar, we like what H2 has done for the top line and transactions, focusing specifically around the impact on driving more discretionary within our stores. This includes our WOW tables, our dollar impact sections and the queuing assortment at checkout. We still have more runway for all of these discretionary sales in these areas. We're building on important categories that are doing well, especially around moms with kids across a combination of all things needed for young kids, including infant apparel and baby needs. Enhancing our party footprint with the addition of Hallmark-branded cards and Family Dollar through the first half of 2020. For tariff mitigation, we are planning to continue efforts to mitigate ongoing and potential new levels of tariffs as we head into 2020. These efforts include the continued support of many vendors to lower costs, the redesign of product or packaging, efforts to shift mix between higher and lower cost products, awarding volume from multiple vendors to our most competitive suppliers, moving product out of China to affect lower landed cost of goods and our combined teams' purchasing power throughout all of Asia. And as always, finding new vendors domestically and in other countries to develop the new and exciting values that our customers have come to expect. We are in the planning stages for 2020, and we'll provide details related to 2020 outlook on our fourth quarter earnings call. I believe our store teams are well prepared for the holiday season. I would like to sincerely thank each of our associates as we head into the fourth quarter and holiday season. More than 15,000 stores across the U.S. and Canada, our network of 25 distribution centers and, of course, our store support center in Virginia. Thank all of them for their commitment, dedication and efforts to deliver value and convenience to our shoppers each and every day. Finally, we continue to focus and make meaningful progress to grow and improve our business for both brands. We are well-positioned in the most attractive sector of retail to deliver continued growth and increased value for our shareholders. The combination of more than 15,000 Dollar Tree and Family Dollar stores provides us the opportunity to serve more customers in all types of markets. The combination of two great brands provides great flexibility in managing our future growth. Operator, we're now ready to take questions.

Operator, Operator

We'll go first to Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli, Analyst

Can you talk about the margin profile on the remodeled Family Dollar stores? And related to that, given the mix that you have in those remodeled stores, which is much more consumable based. Is there a reason to believe gross margins can improve on a go-forward basis? Or is that higher mix of consumables in these stores effectively reset the gross margin profile for Family Dollar?

Gary Philbin, President and CEO

Scot, this is Gary. We're pleased with the second half because we anticipated adding more frozen food doors and products that impact margins. However, we also aimed to counterbalance that with our immediate consumption strategies, like queuing lines and WOW tables. We believe there are better adjacencies to enhance store performance. Initially, we noticed some margin decline, but currently, the second half is neutral for the fleet, which was not our intention. Our primary goal is to achieve margin expansion in the second half. We're on the right track, with increased traffic in these stores. You've also heard us mention that comp. Our next focus is to maintain this momentum while adding margin expansion in the second half. We appreciate the positive feedback from customers, are pleased with the sales results, and now we need to improve the margin mix.

Scot Ciccarelli, Analyst

What kind of margin improvement do you think is realistic if we look ahead over the next 4 to 8 quarters? We've seen several hundred basis points of gross margin decline in that business, and I keep returning to the question: do we need a complete reset here, or once we establish better top-line results, can we work our way out of this?

Gary Philbin, President and CEO

Well, I've always said we need to get to an inflection point on the fleet. We were rebuilding the stores, basically one store at a time with H2. We did over 1,000 in the first three quarters this year. We're planning on doing 1,000 next year. I need the top line sales. I think that's what H2 has given us. The work on the margin, Q3 for Family Dollar, I think it was about an 80 points difference year-over-year comparison.

Kevin Wampler, CFO

Michael, it's Kevin. I think as we look at it, the items we called out, obviously, the shift in mix as we've seen the — basically, the consumable business outpaced even what we had forecasted. And really, that's in both brands, more so in the Family Dollar brand and the Dollar Tree brand, but it's in both brands. So the Dollar Tree brand, we've got some good things going with frozen food, refrigerated and in center aisle as well. So a lot of things going on there. And again, a little bit of overall effect from the helium shortage and the halo effect to the party department in general. On the Family Dollar side, obviously we haven't seen the discretionary business kick in as well as we'd like it to, Gary, what he was just speaking to. A lot of opportunity there, getting customers in the door is key, obviously, and getting the foot traffic and having that opportunity to sell them that discretionary item is very, very important.

Gary Philbin, President and CEO

Michael, Gary. I would just add this. Keep in mind, this was a year that was everything we talked about at the beginning of the year. The store initiatives, 2,000 stores at various times torn up. Keep in mind, at the DC level, we were also not just shifting rebanners back and forth, we are also shifting product back and forth, especially with the impact of our Dollar sections in some of our WOW items. So along the way, we combined a store support center, too. With all those balls in the air, I give credit to our store teams and our store support teams to get that done. Everything we're talking about here gives us the consistency, visibility as we go forward in '20. We have done all this, really, with major initiatives, both in our store base, in our store support center. So listen, the things that we're focused on are the right things to drive the business.

Kevin Wampler, CFO

Operator: We'll go next to Paul Trussell with Deutsche Bank. I know you give guidance on a consolidated basis. But to the extent possible, could you give maybe a little bit more detail regarding your expectations per banner, as we think about comps and gross margin and SG&A into fourth quarter? And then as a follow-up, just bigger picture for Dollar Tree. Margins look like they're going to be down this year. And just curious if you can walk through what some of those — what you view as more temporary in nature as we kind of turn the page into 2020? Is this a business that you believe can get back to expanding margins? Paul, this is Kevin. I think as we look at it, again, we don't give guidance by banner. Obviously, when you look at it from a — what I can give you a little feel for, for Q4, is, if you look at the guidance we gave today and you can back into a range of operating income based on all the data we've given you. And I would tell you that it's basically a little — right around 9% or just above. If you compare that to prior year, excluding the items such as the markdowns for aged goods, clearance of inventory and in-store impairment, I would tell you that the pressure between basically gross profit and SG&A is fairly consistent. So we're seeing pressure on both line items. So that just gives you some directional ability to think about that. I think as we look at this year and as we look at obviously the fourth quarter, fourth quarter is a big quarter for Dollar Tree from a seasonal perspective. So we get a pretty good boost in sales just from a seasonal set, which obviously has always provided us the ability to basically provide a good gross margin. And I don't see that in there. But our seasonal set this year performed very well. We had a very good Halloween set. We had a very good performance with our Halloween seasonal, and we feel good about going into the fourth quarter with our Christmas set. So I think that always bodes well.

Gary Philbin, President and CEO

Paul, this is Gary. Let me sort of answer your question. What's temporary and start with Dollar Tree. The things that we've been chasing this year start with shrink. It's a both banner issue. But shrink is something I have an expectation that we're going to do better on next year. We're coming off of a second year of not great performance, and we can do better. I think the freight piece, we started talking about it last year was certainly a bigger impact in the first half. We're going to see some of that modify in the second half, but we're still significantly up year-over-year. And the distribution costs, I think, listen, I don't know if it's temporary or not. The mix on product, to me, is a bigger issue at Family Dollar than it is at Dollar Tree. We are happy with what H2 has done. But across 2019, we've worked hard on keeping sales going. And we just got to find some of the same elements that drive customer traffic into those sections as they do on the consumables. For Dollar Tree, I don't know how to think about tariffs. But it's always just going to be about incorporating the next WOW into the stores. We'd like what Snack Zone has done for a little pressure on mix. That's why we got Crafters Square going. A year before that, we started out in Snack Zone, but we put in the Hallmark. So it's always what we push and pull to drive customers on both foot traffic and sales and margin. We're going to do that again as we go into '20. So those are going to be the pieces that we talk about category by category. Hope that's helpful.

Operator, Operator

We'll take our next question from Joseph Feldman with Telsey.

Joseph Feldman, Analyst

I just wanted to get a little more understanding of like the higher price point cash. And how are people responding to that so far?

Gary Philbin, President and CEO

I would say, as folks come in, I would say it's 1/3 folks have seen the product and buy it, 1/3 of our loyal customers have commented that they don't like the multi price go in our stores and 1/3 are somewhere in the middle. Here's my view from everything we've interviewed our customers with. It's not — so far, we've had a priority on more consumables, which I think were an item that we want to just get out there across categories. The next phase of the test is more about what I would call the Dollar Tree WOW side of it. We went over on our buying trip this July to buy specific categories. So I would call them more on our variety, discretionary side, things that people haven't seen. And we'll see how customers respond. But I think that's more to what our customers are going to enjoy seeing incredible values on and allow us into our Dollar Tree WOW umbrella to say, 'That's a great item I don't see anywhere else. And I know that costs more when I do see it.' And I think that's going to be what we push on into some of this showing up in stores now, but into 2020. So when we get a chance to test and learn and put new products in, especially when we can design them and import them or find discretionary items domestically, I just think that's going to be the next phase of the test that gives us another important data point. Our customers that buy it tend to buy more than the average Dollar Tree transaction, but I go back to what success, and success in this is really to increase the reach of Dollar Tree to another segment of customers, another chance to increase margin as well, and as always, protect the brand to say this is the WOW factor at Dollar Tree. So those are the things that are in the mix. I think we have some exciting product coming in, and we stay close to watching that week by week.

Joseph Feldman, Analyst

And then one follow-up. I know you outlined a couple of efforts on the freight side that you can do like optimize LTL and back to historical backhaul levels. Like how challenging a project is that to improve the freight side? Like, is that something that we can see happen pretty quickly into next year?

Gary Philbin, President and CEO

Well, we are seeing some modest year-over-year declines right now with it. And the things that we're doing, we're in control. But we need to bid out the process. Now somebody has to sign up for the lower bid and give us great service, both on inbound and outbound, to get those rates. So I'd like to think that it's something that as we read some of the same headlines, we are not in the same position as the truck driver shortage exactly at this time a year ago. I think that bodes well for us. The opportunity when we get better service on the outbound, allows us to do more backhauls. So we're going to go into 2020, pushing all the levers we know to do to get both lower freight and better service, and we'll understand better once our important third-party suppliers and independent truckers continue to give us service as we expect to as we finish out Q4 into 2020.

Operator, Operator

Ladies and gentlemen, due to time constraints, we have time for just a couple more questions. We'll go next to John Heinbockel with Guggenheim Securities.

John Heinbockel, Analyst

Gary, when considering the real estate composition of the 1,000 remodels planned for Family Dollar this coming year, how will it differ from the previous year? Is there an intention to cluster more stores? And if you do decide to cluster, could that enhance brand perception at the non-remodeled locations?

Gary Philbin, President and CEO

Well, we do take a look where is the number of stores. We went into this knowing that we want to fix some of the oldest stores in the fleet. So based on the last year talks, we went into with the best opportunity based on volume. We did need a certain size. And really, what we're skating to is, by the time we face these next 1,000, we ought to be close to 40% of our fleet or a little better, being less than 5 years old. And I think to your point, that does give our customer give a perception of what they've seen at Family Dollar. So it's not necessarily that everything has to be H2. We've got some great stores out there that are not, but we are changing the face of what the customer sees with this store initiative, along with what we closed, along with what we rebranded to Dollar Tree. So the combination of all those things gets us closer to an inflection point, which is I think what you're talking about, what does that customer see. And inside the store, the consistency around store standards, conditions and stocks are important across all the factors of the different stores that we run. So that's what we're aiming for. And as we get more and more stores with the same opportunity, we're still measuring it what's our biggest return on capital as we go and invest in these stores. But I think just by the nature of our fleet with where we are across the country, we're starting to get some critical mass into some key geographies.

John Heinbockel, Analyst

And then lastly, when you look at the private brand penetration opportunity, recognizing it's all consumable at FDO. But is that another 500 basis point penetration opportunities or much bigger than that? Where do you think that shakes out?

Gary Philbin, President and CEO

Well, we've already said, we're in the low 20s as a brand, which is pretty darn good. I mean, it's not grocery store-esque because we're not a grocery store. But I think across the categories, what I would like to see is something closer to 100 basis point improvement consecutively over a number of years. I think that's the opportunity in front of us. And I think it speaks to, one, having great product and values in store. And number two, our customer just needs it because she's stretching her budget and the commitment on what we compare and save to national brands, I think, fits in our wheelhouse. I think the magic to it, as always, is introducing customers because they'll step up to private brands on something that first is something that they try on because it's a detergent, and then they'll go to HPA products, and then we'll go to food products. And the team has done a wonderful job on rebranding across the different categories. And I think that's opportunity still with runway to it.

Operator, Operator

We'll go next to Karen Short with Barclays.

Karen Short, Analyst

Just one clarification question on tariffs and a bigger picture question. In terms of the $19 million, is it still fair to think of that split kind of 70% Dollar Tree and 30% Family Dollar in terms of the impact? I think that was the original split you gave back a couple of quarters ago.

Kevin Wampler, CFO

Karen, as you look at the $19 million, it's more skewed to Dollar Tree than the 70%. So the vast majority really relates to Dollar Tree. A small piece of it does relate to Family Dollar.

Karen Short, Analyst

Okay. Regarding Family Dollar 2.0, could you provide some insight into the sales increase in its second year? I understand it's still early, but any information would be helpful. Additionally, could you elaborate on the reasons behind the challenges in attracting discretionary spending in those stores?

Gary Philbin, President and CEO

When we consider the situation, let me address the second question first. We still have customers coming in, and they are responding positively to our actions. Customers typically purchase consumables on a weekly basis. Discretionary spending can be influenced by seasons, but it often depends on having a bit more money available to spend in those discretionary areas. It's crucial for us to present the right values to customers across all categories. Additionally, with the awareness that about 2,000 stores, including over 1,000 at Family Dollar, would experience disruptions this year, we made a deliberate decision to ensure we maintained foot traffic. In the second half of the year, we have been proactive in driving that attendance, and it's important to note that the factors influencing our comparable store sales extend beyond just the second half of the year.

Karen Short, Analyst

Okay. Can I just have one more question regarding Dollar Tree banner?

Gary Philbin, President and CEO

Sure.

Karen Short, Analyst

Is there any variation in terms of the various stores on urban versus suburban versus rural? I mean you kind of gave that 1/3, 1/3, 1/3 comment in terms of the customer response. But is there any pattern on any of those markets in particular?

Gary Philbin, President and CEO

For Dollar Tree, I can't say there's a significant difference. It seems to be more about the product than anything else at this point.

Operator, Operator

And ladies and gentlemen, we'll take our final question today from Matthew Boss with JPMorgan.

Matthew Boss, Analyst

So Gary, maybe larger picture, how would you assess the health of the low-income consumer today? Any changes to the competitive landscape that you've seen impacting any of your strategies? Or is it best to just think primarily that this is company-specific execution here?

Gary Philbin, President and CEO

We've been focused on improving our execution and our brand. This effort is aimed at satisfying our customers. When we provide a shopping experience that is appealing, exciting, and offers the products they desire, customers will engage with us. Regarding the current customer situation, unemployment is at a historic low, making it easier for individuals to find jobs. However, many people are just one unexpected expense away from financial strain. This presents us with the opportunity to offer the right products that help customers manage their budgets throughout the month. Overall, the job market has created a slightly better situation, but we must remain aware that our customers prioritize value and convenience. This focus aligns with our strategies at Family Dollar, which aim to attract customers with everything we’ve discussed for the upcoming period and across our stores.

Kevin Wampler, CFO

Matthew, maybe just a follow-up on gross margin. At the Dollar Tree banner, so this is the second straight quarter of 55 basis points merchandise costs headwind net of freight and 10 basis points of distribution pressure. How do these two items specifically shape up in the fourth quarter? And then do you still view 35% of the structural multiyear gross margin for the Dollar Tree concept? As we analyze the situation, we believe that freight in the fourth quarter, particularly domestic freight, is moving in a slightly more favorable direction, potentially being flat or slightly down compared to the previous year. This is a positive development. However, this improvement is somewhat balanced out by the increase in our import freight. Overall, we expect the impact of freight to be somewhat less as we progress through Q4. Regarding margins, helium plays a role in this area, influencing one of our largest and most profitable departments.

Operator, Operator

And this does conclude our Q&A session. At this time, I'd like to turn the call back to Randy Guiler for closing remarks.

Randy Guiler, Vice President, Investor Relations

Thank you, Aaron, and thank you for joining us for today's call. Our next quarterly earnings conference call to discuss Q4 and full year results is tentatively scheduled for Wednesday, March 4, 2020.

Operator, Operator

And ladies and gentlemen, this does conclude today's conference. We thank you for your participation. You may now disconnect.