Dollar Tree Inc

NASDAQ:DLTR

Earnings Call Transcript 2018-Q2

[Operator]

Good day, everyone. And welcome to the Dollar Tree Inc's Second Quarter Earnings Call. Today's call is being recorded. At this time, I would 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, Lisa. Good morning, and welcome to our conference call to discuss Dollar Tree's performance for the second fiscal quarter of 2018. Participating on today's call will be our President and CEO, Gary Philbin and our CFO, Kevin Wampler.

Before we begin, I would like to remind everyone that various remarks that 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 our 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 for your questions. Please limit your questions to one and one follow-up, if necessary.

Now, I'll turn the call over to Gary Philbin, Dollar Tree's President and Chief Executive Officer.

[Gary Philbin, President and Chief Executive Officer]

Thanks, Randy, and good morning everyone. This morning, we announced our results for our second quarter. Sales increased 4.6% to $5.53 billion. Our consolidated same-store sales increased 1.8%. By segment, our comp sales for Dollar Tree banner increased 3.7% and the Family Dollar banner's comps were flat compared to last year's Q2 increase of 1%. Our enterprise gross margin rate declined 70 basis points to 30.1%; operating income was $382.5 million or 6.9%; and diluted earnings per share increased 17.3% to $1.15, one penny below the high-end of our guidance range.

In mid-July, our Company hit a milestone by opening our 15,000th store. We celebrated the occasion with exciting offers and promotions at both Dollar Tree and Family Dollar stores, along with coordinated grand opening celebrations at select stores across the country. Also, in July, we opened up our 23rd U.S. distribution center located in Warrensburg, Missouri on time and on budget. The 1 million square foot facility is creating approximately 400 jobs in Western Missouri and will initially be serving Dollar Tree stores, but is equipped with the necessary systems to serve both Dollar Tree and Family Dollar banners in the future. The partnership and support we received from the state of Missouri, the City of Warrensburg and the surrounding communities was just outstanding.

The Dollar Tree sales initiatives have been hitting on all cylinders. Dollar Tree has now delivered 42 consecutive quarters of same-store sales growth. In fact, each of the last five quarters, the increases have been greater than 3.5%. The last time Dollar Tree hit a streak of at least five consecutive quarters over 3.5% was in 2012. Our merchandize excitement continues to be driven by great values for a dollar, the discovery of what’s new and our efforts around our major holidays and seasons. The Dollar Tree continues to grow at the business around these important times of the year.

For our Dollar Tree banner in the second quarter, top performing categories were snacks and beverage, candy, health and personal care, toys and household consumables. Sales performance was balanced across discretionary and consumables; comps were positive all three months; May same stores sales was the strongest month in the quarter. However, on a two year stack basis July had the best monthly performance as we had a very strong July in 2017. Geographically, Dollar Tree same store sales growth was strongest in the West, Southwest and Midwest, and all of our zones delivered positive comps greater than 2.5%.

For the Family Dollar banner in the second quarter, while we did not achieve our intended target on comps for the quarter, we continue to focus on the key initiatives that will drive to long-term success. The important elements that will change the sales trajectory for Family Dollar are; investment in customer experience, including better in-stocks and assortment; more private brand offerings along with better buying from our import capabilities; delivering value through our Smart Ways to Save; and specific customer offers that are targeted through our Smart Coupon program; and most of all, around our efforts to renovate the stores with better adjacencies and merchandize impact of our important categories.

Top performing categories in the quarter included beauty care, accessories, electronics and snacks and beverage. Our comp performance in the quarter was driven by consumables, approximately three quarters of our business at Family Dollar is consumable needs base products. And we’ve comped again positively for seven consecutive quarters. For cadence in the quarter comp sales were strongest in May; July was negative, but up against the toughest comparison in the prior year. Geographically, Family Dollar same store sales for the quarter was again strongest in our Northeast and West Zones.

Switching to Canada, highlights for Dollar Tree Canada; our team continues to deliver mid single-digit positive comps for the quarter with increases in both traffic and ticket; the sales growth was balanced as both discretionary and consumables comped better than 5% for the quarter; top performing categories in Canada included books, lawn and garden, candy and greeting cards. For Dollar Tree Direct, while small less than 1% of our sales, but continue to be an important part of our business; it provides us the tool to connect with our customers and hence, loyalty at Dollar Tree and drive brand awareness. In Q2, we saw double-digit increases in both sales and Web site traffic to dollartree.com.

Our efforts here to connect with our customer and organizations help them find easily the solutions they need for bulk purchases and the ability to buy first some of the early seasons' great values. We continue to engage our customers in all forms of social media with a growing base of fans and social interaction that includes greater videos highlighting the Dollar Tree product. Please check both of our Web site, dollartree.com and familydollar.com.

Now, looking at the real estate in the second quarter; we opened a total of 146 new stores, 82 Dollar Trees, 64 Family Dollars; we’ve relocated or expanded 13 stores, 10 Dollar Trees and three Family Dollars; and we renovated 109 Family Dollar stores as part of our renovation initiative. We also re-bannered 17 Family Dollar stores to Dollar Tree stores for a total 285 projects during the quarter. We also have freezers and coolers to 125 Dollar Tree stores during the second quarter, bringing our total of Dollar Tree stores with freezers and cooler to 5,436 now. During the quarter, we closed 26 stores, three Dollar Trees and 23 Family Dollars. And we ended the quarter with 15,073 stores split out with 6,812 Dollar Trees, 8,261 Family Dollars.

Before I turn the call over to Kevin, I just wanted to speak briefly about tariffs and potential for additional tariffs that are in the news. So far, the United States trade representative has implemented tariffs against 50 billion in Chinese goods and is considering implementing 10% or 25% tariffs against an additional $200 billion in Chinese goods. This potential impact could be mitigated by a variety of factors; the U.S. TR may reduce a list of impacted tariff lines before tariffs are implemented; and later may even grant specific product exclusions. We are and will be active in the process, we will not stand still like other shocks to the system, we will do what we have always done to mitigate impact. We can also attempt to negotiate price concessions, change product [sizes] [ph], specifications and evolve products mix. At Family Dollar, we can do all those things and we can also change our price. And as always, we have always taken a look at alternative sources of supply and product outside of China.

I’ll now turn the call over to Kevin to provide more detail on our second quarter performance and our outlook for Q3 and fiscal 2018. Kevin?

[Kevin Wampler, Chief Financial Officer]

Thanks, Gary and good morning. Total sales for the second quarter grew 4.6% to $5.53 billion within our guidance range of $5.47 billion to $5.57 billion. Dollar Tree segment total sales increased 7% to $2.77 billion and Family Dollar segment total sales increased 2.3% to $2.76 billion. Enterprise same store sales increased 1.8% on a constant currency basis or 1.9% when adjusted for Canadian currency fluctuations. On a segment basis, same store sales for the Dollar Tree banner increased 3.7% or 3.8% when adjusted for Canadian currency fluctuations, and the Family Dollar banner comp was flat compared to the prior year’s quarter.

Overall, gross profit increased 2.2% to $1.66 billion for the second quarter of 2018 compared to the prior year’s quarter. As a percent of sales, gross profit margin declined 70 basis points to 30.1% versus 30.8% in the prior year’s quarter. Gross profit margin for the Dollar Tree segment was 34.5% for the second quarter, a 10 basis point decline compared to the prior year second quarter. The decline was primarily due to 20 basis points of increased shrink costs, partially offset by improved merchandise cost net of fright as sales mix positively impacted margin, offsetting freight headwinds.

Gross profit margin for the Family Dollar segment was 25.7% during the second quarter compared with 27.2% in the comparable prior year period. 150 basis points decline was primarily due to merchandise costs, including freight, which increased 85 basis points resulting from higher domestic freight costs, partially offset by increased initial mark downs. Distribution costs increased 30 basis points due to higher merchandising and distribution center payroll -related costs. Shrink costs increased 15 basis points and occupancy costs increased 10 basis points, resulting from the deleveraging effect of flat comparable store sales.

Consolidated selling, general and administrative expenses as a percentage of net sales in the quarter increased 30 basis points to 23.2% from 22.9% in the same quarter last year. Excluding the $2.6 million receivable impairment from the prior year's quarter, SG&A as a percent of sales increased 40 basis points from an adjusted 22.8% in the prior year's quarter. The increase was driven by higher store payroll costs, partially offset by lower depreciation and lower store repairs and maintenance costs as a percentage of sales. Second quarter SG&A expense for the Dollar Tree segment as a percentage of sales increased to 23.7% compared to 23.4% in the prior year's quarter. The increase was primarily due to our store ROI payroll costs, which increased 40 basis points related to our planned Tax Cuts and Jobs Act savings reinvestment plan.

SG&A expense for the Family Dollar segment as a percentage of sales was 22.6% compared to 22.4% in the prior year's quarter. Excluding the $2.6 million receivable impairment from the prior year, Family Dollar SG&A as a percentage of sales increased 30 basis points from 22.3%. The increase was a result of 55 basis point increase in store ROI payroll expenses that was partially offset by lower repairs and maintenance costs and lower depreciation expense.

Operating income for the enterprise was $382.5 million compared with $419.5 million in the same period last year and operating income margin was 6.9% compared to 7.9% in last year's second quarter. Operating income margin for the Dollar Tree segment declined 40 basis points to 10.8% when compared to the prior quarter. Operating income for the Family Dollar segment was $84.8 million or 3.1% for the quarter. Non-operating expenses for the quarter totaled $44.8 million, which was comprised primarily of net interest expense.

Effective tax rate for the quarter was 18.9% compared to 32% in the prior year period. The lower rate is the result of the Tax Cuts and Jobs Act, which lowered the federal tax rate to 21% from 35% in the prior year, as well as an $8.1 million reduction in the reserve for uncertain tax positions, resulting from statute expirations. For the second quarter, the Company had net income of $273.9 million or $1.15 per diluted share compared to reported net income of $233.8 million or $0.98 per diluted share in the prior year's quarter.

And looking at the balance sheet, combined cash and cash equivalents at quarter end totaled $647.3 million compared to $1.1 billion at the end of fiscal 2017. Our outstanding debt as of August 4, 2018 was approximately $5 billion. Inventory for the Dollar Tree segment at quarter end increased to 8.5% from the same time last year, while selling square footage increased 4.6%. Inventory for selling square foot increased to 3.6%. We believe that current inventory levels are appropriate to support to scheduled new store openings and our sales initiatives for the third quarter. Inventory for the Family Dollar segment at quarter end increased 15.6% from the same period last year, and increased 12.9% on a selling square foot basis. At quarter end last year, inventory was down 5.2% in total and 6.3% on the selling square foot basis. The increased levels in the current year represent our continued work to support in-stock levels, as well as early receipts of certain holiday merchandize.

Capital expenditures were $213.4 million in the second quarter versus $161.4 million in the second quarter last year. For fiscal 2018, we’re planning for consolidated capital expenditures to range from $850 million to $865 million, a slight decrease from our prior 2018 outlook. Depreciation and amortization totaled $152.6 million for the second quarter. Depreciation and amortization expense was $151.4 million in the second quarter last year. For fiscal 2018, we continue to expect consolidated depreciation and amortization to range from $610 million to $620 million.

Our updated outlook for fiscal 2018 included the following assumptions. Calendar considerations for the year include the following, 2018 is a 52 week year, the 53 week in Q4 of 2017 added $406.6 million to sales and approximately $0.21 to earnings per share. Halloween shifts from Q4 into Q3, this shift favorably impacts Q3 from a revenue and earnings perspective that has no impact to same store sales. We expect continued pressure on the store payroll based on states increasing minimum ways. Wages, additionally as previously discussed, we continue to invest in store hours and average hourly rates as part of our $100 million investment into the business from our projected $250 million tax benefit. We expect higher domestic freight and diesel costs to continue. These costs continue to trend higher than our original guidance and we have reflected this in our outlook. We continue to work to mitigate these increases as we go forward.

The Company, along with other retailers, recently learned of an anti-dumping duty assessed by the U.S. Department of Commerce on certain Chinese driven products. We expect to incur $0.04 per share of expense in our fourth quarter to account for the anti-dumping duty assessment. Net interest expense will be approximately $47 million per quarter in Q3 and Q4. Our guidance does not include any share repurchases and we cannot predict future currency fluctuations, so we have not adjusted our guidance for changes in currency rates. Our guidance assumes a tax rate of 21.5% for the third quarter and 21.4% for fiscal 2018.

Weighted average diluted share counts are assumed to be $238.9 million shares for 4Q. For the third quarter, we are forecasting total sales to range $5.53 billion to $5.64 billion and diluted earnings per share in the range of $1.11 to $1.18. These estimates are based on a low single-digit same store sales increase and year-over-year square footage growth of 3.4%. For fiscal 2018, we are now forecasting total sales to range between $22.75 billion and $22.97 billion based on a low single-digit same-store sales increase and 3.4% square footage growth. The Company now anticipates net income per diluted share for the full fiscal year 2018 will range between $4.85 and $5.05 and includes the previously mentioned $0.04 per share of antidumping duty, compared to the Company's previously expected range of $4.80 to $5.10.

Now, I'll turn the call back over to Gary.

[Gary Philbin, President and Chief Executive Officer]

Thank you, Kevin. Over the past few weeks, I attended our annual field leadership meetings at both Family Dollar and Dollar Tree. It's our opportunity to connect with our field leaders face-to-face, teach and learn, recognize and reward individuals and the teams for superior performance and give service awards. We interact with our merchant leaders on sales driving initiatives, coach field leaders on people development and ensure that we're all lines heading into the important holiday season. We had very productive meetings and I'm pleased with the caliber of businessmen and women, they are leading our field organizations.

Our leaders are energetic, focused and motivated going to this important back half. For Dollar Tree, the banner is up against some great sales in the back half of last year, 5 comp in Q3 and 3.8 in Q4. And let me talk a little bit about the sales driving initiatives in place to successfully cycle these numbers. These include our snack zone. Last quarter, we provide additional details regarding this concept, which we've been testing in Dollar Tree stores for some time. By the end of Q2, we’ve had stacks up and running in more than 500 stores. Store and customer feedback has been terrific and the numbers support this, and we really like the leap for getting in this new category within the store, the concept targets on the go customers with immediate consumption items. Snack zone sales are consistently outperforming the sales lift targeted for them.

A mid single-digit percent of the store sales are coming from the snack zone items. We plan to have the second zone in at least 750 stores by the end of fiscal 2018. We're already in the development stage of snack zone 2.0, which can be rolled out to smaller Dollar Tree stores in 2019 and beyond. Also, this week, we are announcing a new exciting partnership that Dollar Tree as with Hallmark Company with our greeting cards. Over the past three months, we have rolled out Hallmark greeting cards to all of our Dollar Tree stores. The new greeting cards are expressions from hallmark priced at a dollar and the Hartline line of cards from Hallmark priced at dollars for two cards. All the cards are brand-new and designed exclusively for Dollar Tree. These cards are tailored to be relevant to our customer base and our surrounding stores, and celebrate every type of occasion.

I could not be more proud of how hallmark our merchant teams and store teams execute this transition flawlessly across 6,000 plus stores; it brings a lower-class brand into Dollar Tree; we're excited about this new partnership; and encourage you to see our Hallmark cards being promoted on our Web site, in-stores and social media now that's in every Dollar Tree store. Additionally, our merchant teams continue to locate and source terrific buys that bring the thrill of the heart to the consumer; visit our stores now and you'll see that we are stocking for business; we're lining down to summer and back-to-school offerings and already showing the new holidays ahead of us, Halloween, fall, harvest; we are entering the best time of the year for Dollar Tree to show what’s new for the season.

At Family Dollar, we left our field leadership meeting with an emphasis on our store execution and consistency of delivering a Family Dollar brand standard. Our combine efforts to focus on driving a better store experience, along with the tools our store managers and district leaders new to win was the focus of our year long efforts to drive better store level traffic and conversion in store. The merchandize energy look great and our teams are up for the challenge in the back half.

Our field leadership has focused on the elements that we'll win in the marketplace; our investment in our people, our labor to drive sales, understanding sales impact and merchandizing energy within their four walls, shrink control and store growth and renovations. I've talked about our initiatives around Family Dollar; the basics we are correctly focused on, a better customer experience, better in-stocks and store conditions; improved private brands along with the value compared to our national brand counterparts; import merchandize, it allows us to create value but also to bring the excitement to our store categories; focus on the value on completing it; our callout for Smart Ways to Save; we’ve seen our customer respond to our consumables as we’ve had seven consecutive positive comps in this important line of our business.

Dollar Well items throughout the store creates great price impact and speaks to our customer that many times need this assortment to make it to the end of the month with their budget; and renovations and the excitement around renovations speaks to the portfolio optimization when we take a look at our fleet of stores; we have 8,000 stores and we take a look at how we optimize across the fleet; we have our top volume stores that continue to produce a positive comp; we re-bannered stores, where our metric show that we will do better as a Dollar Tree than a Family Dollar; and then as always, we take a look at the middle group of stores and target the renovations where we can drive better performance, both top line and bottom line.

We’re pleased with what we’re seeing on the renovations; we have targeted 450 locations this year and we will do more; we’re going to extend that to 500 this year and we can’t do them through back half of our October, November and December; but we will do 500 this year and are working on setting a higher target for 2019 renovations; our customers are buying more and the feedback gives us great confidence to move forward more of these in the right stores; I believe the right combination of more renovations, along with the foundational elements of our strategy, would drive the traffic and basket that we’re looking for; and really to make meaningful changes to our fleet of 8,000 stores.

We continue to focus on making meaningful progress to grow and improve our business for both banners. I feel that we are well positioned to the most attractive sector of the retail to deliver to continued growth and increase value for our long-term 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. This combination of two great brands provides great flexibility in managing our future growth. Our teams are ready for an important holiday season and are focused to win in their stores and markets as we enter the back half.

Operator, we're now ready to take questions.

[Operator]

Thank you, sir [Operator Instructions]. Our first question comes from Scot Ciccarelli with RBC.

[Scot Ciccarelli, RBC]

Gary, you talked about the need to improve consistency at Family Dollar in terms of store appearance, organization, et cetera and that would certainly conform to what we've seen in our stores tours. Do you think you've had the full buy-in from your Family Dollar employee base for all the changes that you're trying to implement? And if not, how do you get that full buy-in from the associate base given the importance of their contribution to what should be improved financial performance?

[Gary Philbin, President and Chief Executive Officer]

Scot, I think you’re spot on. At the end of the day, we do those absolutely a store at a time and it really speaks to I think two things. I would tell you our leadership, zone, region, district and our store managers that we recognize the ones with superior performance at our field meeting, they are on board. I think the consistency that I'm speaking to is how do we give them the tools to win in their box. And I would tell you it comes down to a few things that have always been part of our elements to focus on, is getting people trained correctly. And that still remains the number one priority in what we've invested in with our tax investment today. Our store manager turnover, while stubborn, has come down a few points and that's against the backdrop of even a robust economy out there. And if we were to say there is one element that combines great store performance match it up with the store manager that has taken the saddle over a year and it's actually remarkable for both banners our performance improves, so we’re focused on that.

When we have store managers leave us before one year, we put our folks in that spot that tends to show up in stores and that lack of consistency. And so that's where we tend to see the cracks in the dam and so we work real hard, trying to understand why people leave us before a year, both at Dollar Tree and Family Dollar. But the path is really the same for both, hire the right folks, get them trained, work through their hurdles. But the other piece and you touched on what is renovations too, which then I think gives us a chance to jumpstart and change that by store and district and region very quickly. And that give us the chance to go in and spend time with a greater touch in their stores to gain the consistency and the element that drive traffic and business into those stores. So our focus on investing in our store managers is where we clearly have our eye set. It was the theme of our meeting this year and it's where we expect to see progress over the next year.

[Scot Ciccarelli, RBC]

And can you just remind us when you start to raise wages for the group?

[Gary Philbin, President and Chief Executive Officer]

Well, the investment if we teed up this year. So keep in mind, we're always monitoring where we are by market and that goes back to even last year. I think we went to this year with a thought we went down when I get behind the curve with unemployment now at 4% people have opportunities. So it's really occasion in specific markets that are tied to investments in our hourly workforce. And so we kicked that off this year in both banners and putting a little bit of science behind it with where are the markets that have the highest increases going on, or can we affect turnover in a better way, because we give a higher starting wage to the folks that got to run the stores.

[Operator]

Our next question comes from Vincent Sinisi with Morgan Stanley.

[Vincent Sinisi, Morgan Stanley]

Just on the renovations at Family Dollar. Obviously, it has and continues to be a big focus for that banner. I know you haven’t really quantified in the past. But can you maybe just directionally give us a little bit of sense from what you guys are seeing close to renovation? How those stores are performing? Are there may be fewer markdowns at some of those stores if you look from more of the margin that'd be helpful?

[Gary Philbin, President and Chief Executive Officer]

Because we’ve excited about the renovations and I maybe just want to go back to why I said in comments. I think we’ve taken a hard look across all of our 8,000 stores; and we got a group of stores chugging along, giving us a positive comp; it tend to be our highest volume stores by nature, our customers have been doing business in there and continue to; we’ve re-bannered some that are in between, but the stores in the middle that we can affect to drive comps in; we have an old fleet of stores and we’ve targeted some of the oldest in the fleet to go after that. But more than that, I think what we’re seeing with the renovations is increased traffic and basket; the merchandizing layout is different enough in the store to give the customers to come in and really take a look at some everyday needs, we expand frozen food for instance; but we’ve also enhanced what we’ve done on our seasons at Family Dollar, different than Dollar Tree; summer time becomes much more of a grilling holiday at Family Dollar than it could ever be at Dollar Tree.

We have our impulse items both in our [wow] [ph] tables and up in the frontend, and so we’re seeing really a remarkable pickup for that last dollar our customer might have on something that wasn’t on their shopping list. And so, we’ve had mid single-digit comps in this growing fleet of stores. But as I sit back and take a look at this portfolio of stores, we just got to do more of them to affect change and that’s really going to be our focus for the balance of the year. We’re going to squeeze in another 50 and I’ll do more if we can, we’ll be limited a bit by just the holiday. We don’t -- try not to do too much in our stores after October but we’ll get to 500 maybe more. And then we have the confidence now with what we’ve learned to tweak it a bit and go into 2019 with a bigger number on that group of stores and that’s going to be how we end up this year and the basis for kicking off 2019.

[Vincent Sinisi, Morgan Stanley]

And then maybe just as the follow up, I'll stay on the same basic subject. Do you guys think that when you’re making enhancements, I mean, core Dollar Tree is obviously the consistent machine. But when you’re making enhancements, either to that or particularly Family Dollar more, do you think in terms of what you’re doing from an advertising perspective, I guess, the heart of the question is, do customers realize as quickly as they can of the enhancements that you folks are making, or do you think maybe there's even more that you could do from that perspective as opposed to just maybe next time they happen to be passing the store? Thoughts around that would be great.

[Gary Philbin, President and Chief Executive Officer]

Good question and unless you do something, your consumers never realize what you've done. So for Dollar Tree, at the snack zones now, we get a band around at one of the stores, it's on the website. It's word-of-mouth. I would tell you I see people in the isle actually face timing their family members at home because they found something that, in particular, was there. So we've never -- advertising a Dollar Tree is maybe like unlike any other retailer. We want to show people that we have something new but get a banner out in front our folks find us. Family Dollar, fair question, I think it's store-by-store. And so depending on the store in a market, we obviously do everything on the store level side to show customers either that’s [pendants] [ph], banners, big grand openings. And then if the store is worthy in terms of what we think it can drive in sales [it probably get to][ph] zone add to do exactly what you described, tell people what's new, this is why you ought to come. So we gauge that based on the upside opportunity and what we see as a potential and the marketplace that the store is in.

[Operator]

We'll take our next question from Matthew Boss with JPMorgan.

[Matthew Boss, JPMorgan]

So I guess at family dollar we think higher levels, the flat comps for the quarter, same store sales turned back negative in July. I guess when you break down the component, is it traffic that’s the missing ingredient here? And do you foresee any need to take pricing actions to accelerate footsteps. I guess just how best to think about the potential game plan and any change that you’re considering?

[Gary Philbin, President and Chief Executive Officer]

Well, it is traffic that -- during the quarter we actually had a pretty nice basket increase that offset that but we will obviously -- we got to do both. And so the focus on driving traffic and it comes down to some of the things we've mentioned right, consistency of stores. But when you come back to how we take a look at the group of 8,000 stores across the portfolio Matt, the stores that do fine we want to make sure that are amped up on the right store investments that we've talked about on labor. For our customer -- for the stores in the middle, we want to make sure that we have targeted operational plans to make sure we get them up to brand standards as always. We can do things specifically to store level.

Your comment on where we are on pricing, I would tell you our pricing shows us in the targeted area as we want to be against our major competitors, it doesn't mean every once in a while you got to go and find the right thing for a Family Dollar customer around first of month and end of the month to drive that traffic. Those are the arrows in our quiver that we can use on a monthly basis. Over the long range, I want to affect more stores to have customers come in the door, because they know they have that renovated store the right way. So our top line stores to me, I think about as an investment and the things we've talked about, investment in store labor, investment in wages in the middle they'll get some of that. But clearly we get more renovation lift from some of those stores. And as always, we'll take a look at the portfolio optimization and figure out what stores as they come up for lease shouldn’t be part of their hurt anymore. But that will be the process that we think about driving traffic in the back half and impacting 2019.

[Matthew Boss, JPMorgan]

And then just one follow-up. What’s the embedded gross margin outlook in the full year guide? I guess maybe even just higher level, how best to think about the headwinds versus the tailwinds that you're facing in the back half, maybe at both banners?

[Kevin Wampler, Chief Financial Officer]

I think Matt as we think about it and we’ve been pretty transparent about the freight headwinds for since we gave initial guidance way back in early March, that will continue. I think as you look at it, it has a little bit heavier effect in Q4 than Q3 and that’s just really because of the way that goods flow. You basically bringing in a lot of inventory now that you sell in Q4, which is when we capitalize freight it goes with it basically, so you’ll have some of that. So we know that’s going to be there. Obviously, I do believe these will become a little bit less of a headwind as we go through the year assuming the price stays steady where it is today.

If you look at diesel a year ago for Q2 is about 2.50, it went to about 2.70 for Q3 and about 2.95 for Q4, so diesel does trend up as you go to the back half of the last year. So to compare while still be a headwind will not be as big of a headwind as we get to the fourth quarter assuming current rates stay somewhat steady. And its right around 3.25 right now is where the diesel rate is. So that’s the big one realistically that we’ve seen. Shrink again is been a headwind, again it dissipates a little bit as we go to the back half, but it will still be a headwind as well. Now the good thing is as we talked about on the Dollar Tree side, the mix has been very good. We've had a very balanced sell on consumables and discretionary. And when we see that, we tend to like that on our overall margin and we’re able to get those nice comp sales in our discretionary category, so a lot of puts and takes. On the comp basis as we saw this quarter, we don’t -- we’re not able to leverage our Family Dollar overall occupancy cost, we are able to leverage the Dollar Tree. So some puts and takes for each banner but again, they’ll continue to be some pressure as we go through the back half.

[Operator]

Our next question comes from Judah Frommer with Credit Suisse.

[Judah Frommer, Credit Suisse]

So first maybe given the differences in the Dollar Tree and the Family Dollar banner in terms of how they’re shopped in the core customers there. Can you help us out with what you’re seeing from, I would say, the middle and the low income consumer clearly very good traffic at mass merchants, and Dollar Tree probably benefited a bit from that. But any insights into maybe that lower end consumer would be great?

[Gary Philbin, President and Chief Executive Officer]

I would say Dollar Tree and because of the geography and where the stores sites are, you’ve heard other retailers call down, I think Dollar Tree feeds off that. Our customers are coming in I think with a little more to spend, basically middle class and above and the opportunity is there to spend a little bit more and we’re seeing that both in traffic and basket at Dollar Tree. And it just make sense when we take a look at the anchors we're next to and we hear them report and we compare that to how we’re doing it with the same anchors and a pretty good correlation there, so it feels pretty good to us. I think with the Family Dollar customer, we do serve a needs-based customer. It is different. I think always as we've talked about, we're there to try to provide a solution for a budget from beginning of the month to the end of the month, much more consumable driven, which is showing up in the consumable comp we have. I think the stubborn part for us there has been discretionary.

And in May, we were really encouraged; obviously spring, early summer got to late start, because of weather in Q1 that everyone has talked about; May we really saw a pop up and I think it was a couple of things; I think clearly, people were probably behind on warm weather purchases at that point; but I think it also spoke to at Family Dollar, because sales were delayed and every stores have their best assortment right there at the beginning of May; and the comps we saw at that point across discretionary, I think point to I think when all gets in the store and looks as good as we hope or close to it, our customer response. I think as we went through the summer as assortments breakdown or we went out something here or there on our assortments, especially on the discretionary that’s what we lose steam and I think that's all on us. But that's something we can fix, that’s something we can control.

But I think this lower income customer listen; we’re very sensitive to it; utility bills have been higher this summer, because of all the heat across the country and rents; if you take a look at any trend that I do, it still shows rents continue to go up three years going now, so that's money in their pocket; so we can do better to get those dollars and appeal to them to buy across our entire store that's our focus; but I want us always to be sensitive to making sure we have opening price point for this customer when they come in our store; when they have to spend extra 20 bucks on a utility bill; we ought to be there to find the solution to make that somehow -- the burden of them of stretching out their budget for the back half of the month.

[Judah Frommer, Credit Suisse]

And maybe just a quick follow-up, I know we’re not talking about synergies much anymore, but as you talk about shipping for both banners out of your new DC. Is there supply chain opportunity we can think about as we continue in the integration there? Or is it going to be coming on new DCs or maybe active than historical once?

[Kevin Wampler, Chief Financial Officer]

I think we've pretty much said from day one that supply chain was a little longer term project as we think about it from rightsizing, rationalizing, getting everything in the right place at the end of the day. And again as you can see the new building in Warrensburg, Missouri has been built such that today it's servicing Dollar Tree stores where it can be co-bannered and service both. Again, from a stem mile perspective is always going to be beneficial. I think there's things we continue to look at in supply chain, automation is one of those and how you use automation to bring your overall -- where we really look at is cost per case, how much is it costing us to move a case through the distribution network at the end of the day. So there is opportunities, things that we’re working on and looking at and really should have an opportunity to continue to move forward with some of those as we go forward. It'll be some capital investment to do some of these things, but I think the return on that would we believe will make it worthwhile.

[Gary Philbin, President and Chief Executive Officer]

And I would just add also capacity issues really been on the Dollar Tree side as we re-bannered stores, converted deal stores to Dollar Tree. We just needed the firepower on the Dollar Tree side, so that's the other reason that Warrensburg will serve as Dollar Tree initially.

[Operator]

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

[Joseph Feldman, Telsey Group]

I wanted to follow up on with you guys on something regarding the tariffs. I know these are -- we haven't seen them all implemented yet and there is another $200 billion talked about and the 10% or 25%. But $0.04 for ribbon alone seems like a lot to me. Could you give a little more color around that? And what it would look like potentially if at least the current list that's being proposed was implemented?

[Kevin Wampler, Chief Financial Officer]

Joseph, just to be clear, I think there is a difference here. What we talked about is the anti-dumping duty, which was a specific ruling by the Commerce Department against ribbon from China. They had a dumping duty of 380%, that's 380% and is rolled up on August the 3rd or 8th somewhere in that timeline, while orders for the holidays had already been written six months before and implied in on both on trucks. That's completely different than the tariff fees, which is being considered at 10% or 25%. So it's all mixed up that to the dumping duty at a one company issue on Chinese ribbon that's what the effect is on the $0.04 based on that 380%, different than the tariff 3.01 that's been considered at 10% and 25%. Make sense?

[Joseph Feldman, Telsey Group]

Yes, that's very helpful, thanks for clarifying that. And then a quick follow-up, I know, I fully understand the vast number of stores that you guys are operating with Family Dollar, and you are accelerating some of the Family Dollar renovations. But how do you accelerate it further like -- how you get to 10,000 stores in a year, 2,000 stores even in a year. it seems as that's one of the gating factors. Is it just a human capital issue or is it -- are there other things that you could streamline to speed that up?

[Gary Philbin, President and Chief Executive Officer]

I think you’re exactly right. I mean, the optimization of this group of stores, we can impact more stores in the 500 this year and everything suggest that we're going through a budget season, now what they're going to take us to do more and how many more is that. We’re not lacking capital we certainly want great return for any dollar we want be prudent managers of capital. But this is what we got to do to change the impact for the fleet of stores. And so if anything, we'll overcome all of it, we'll figure out the right stores, we'll figure out how many people we need to put against it. Obviously, it's not the only limiting thing you got to consider but you certainly have to plain it. But I think you're spot on, how do we do more that’s how we’re going to change what we -- how we affect our fleet of stores and really how we affect our customers at the end of the day to buy more and have more of them come into the store.

[Operator]

Our next question comes from Robert Ohmes with Bank of America Merrill Lynch.

[Robert Ohmes, Bank of America Merrill Lynch]

Actually my question is on the Family Dollar gross margin, and if you could give us more color on how to think about that for the rest of the year, down 150 for this quarter and you -- it looked like merchandise cost pressures in freight was the biggest driver of that. Should we be assuming that type of rate decline for the back half? And then also just looking out over the next couple years, could you remind us how you're thinking about the gross margin at Family Dollar? Thanks.

[Kevin Wampler, Chief Financial Officer]

Rob, as we look to the back half as I stated earlier, there will continue to be pressure and freight is the biggest pressure item less in Q3 than in Q4 and again that’s timing of inventory coming into the system and when it's sold. But the belief is that the effect will be somewhat less than it was in Q2 as we sit here today, so that’s how we’re thinking about it. But there will continue to be pressure and really the freight is the biggest impact. We were -- in Q2, we actually saw our mark up was up, we did have a fairly significant shift to consumables in the mix about 60 basis points more in consumable sales in a year ago. So overall, we feel pretty good about how we navigated through that. But again, our needs space customers are liking what they are seeing from a consumable standpoint.

And as far as long-term, obviously, as we've said this, the freight item this year is one of those shop to the system type items that we have to deal with and manage through and we'll do that. Obviously, the expectation is that we’re going to drive the gross profit up as we go forward, that's the way we view it. Obviously, there is a lot of things that have to happen and we can definitely do better and shrink. We're not happy with our shirk performance this year in either banner, so there is an opportunity there. I think from the standpoint of distribution costs. Again, as I mentioned on the earlier question there is opportunity there. So there is going to be opportunities, it's just putting that together. And at the end of the day, to Gary's point, driving renovations, driving sales, creating leverage online items would be helpful as well. So I think that's the general thought process.

[Gary Philbin, President and Chief Executive Officer]

Rob, I'd just add color. I know you asked about long term and we're going through a year here where the shrink bogeyman is in the room with us, we’re going to get that one look. Freight is a real thing this year but it's not going to be forever, and we’re going to find a way to mitigate it until it does get better with the external forces at work. So I feel the pain right now it's not going to be a forever thing. In our discretionary business at Family Dollar is going to be the way that -- one of the ways we expand margin. As we do with renovations that drives margin expansion in the stores but we still have to get better on that side of the business, it’s fair to be head for us and the levers that we’ve talked about on private brands and import are just as true now as when we started it out, and that’s what our teams are working on.

[Robert Ohmes, Bank of America Merrill Lynch]

And one just follow-up question. In the second quarter if you look at the largest U.S. retailers, like Wal-Mart, Target, Costco, some of them put up some of the best traffic comps in a long time. I would love to just get your perspective on where both of your banners fit into an environment like we saw in the second quarter where the traffic really just accelerated, for example, at Wal-Mart?

[Gary Philbin, President and Chief Executive Officer]

Well, I would say, we like healthy customer. I mean, we’re in the same arena, especially at Dollar Tree. And I think our two year stacks at Dollar Tree, we’re pretty proud of. So I think that speaks to everything that they’ve been talking about what they see and health of the customer. And I think even at Family Dollar as we’ve started off the quarter, we certainly had thought that if we were going to extend what we saw early on we’d be having a different conversation now. We serve a different customer at Family Dollar we serve a little bit of everyone. And I go back to a customer that is on a different budget than most of us can think about and we get great at every first month and we have items that she need then. And at the end of the month, do we have the items opening price point often times that allows her to get towards the end of the month.

It’s not the same rising tide for the customer at Family Dollar and we owe it to ourselves and really to our customers there to make sure what we put in front of them will resonate with them. It's showing up on the consumable side, we like our business there. I mean, we’re gaining greater pray you all there and we’re working real hard on the discretionary things that it -- one more purchase that we needed at Family Dollar store to make all the difference in the world. And then do that against the backdrop of consistency, merchandising energy in the store that’s push the headcount that on renovations for the balance of this year and next, and I think that’s the magic sauce we need at Family Dollar.

[Operator]

And we’ll take our final question from Dan Wewer with Raymond James.

[Dan Wewer, Raymond James]

Gary, I think probably on every conference call during the last couple of years and probably most of your Investor meetings see the question about pricing for Family Dollar has come up again earlier on this call. And the Company always communicates that pricing is better than it was a few years ago. We have smart ways to say better in caps, et cetera. But is there a philosophical reason why Family Dollar doesn’t adopt a pricing strategy of let's say being equal to maybe no more than 3% above Wal-Mart on national branded consumable items?

[Gary Philbin, President and Chief Executive Officer]

Well, philosophically Dan, I think we take a look at the major of competitors as we go against in the consumer market. I mean, obviously, when we’re close in the trade area of Wal-Mart, they become one of them they're not in every market we have. So we take a look and either weight on specific items or match, or something that isn’t important to our Family Dollar customer based on how we see sales flow through the store, we make judgments. Clearly, what comes through loud and clear from every research we've ever done and we continue to see is opening price point at Family Dollar. And sometimes it's a dollar item, but not all of the time. And those are the items that we really got to be right on with our customer. And so those are the elements that when we take a look at the baskets that our customer buys, and I still go back to consumables.

We have a large number of KBIs like everyone else and what we see in our consumables business is driving that comp now for second consecutive quarters. So I’m not going to put together the pieces of all our pricing strategy on this call today, but I think those are the elements that allow us to drive that comp on the consumable side. And I would add maybe one other piece for our customer. You've heard me talk about two at every conference. What we do at first the month and end of the month at Family Dollar are two different things and that's important to for our customer. How we merchandise, what's in that, how we affect them with the Smart Coupons, which continues to grow. And I think it's not something we've talked a lot about, but we're really surprised by how many customers have signed up; one, because our customers have just as many smartphones as the average in the U.S.; and number two, they see the items offered to them that make the most sense. And we've heard me give the examples before and at conferences.

So it’s not just what's on the shelf, it's that plus what's in the ad promoted, it’s our price drop, it's the dollar wow our customers sees that go through the store with. So I view it as a recipe we go to market with, never taking a look at one item, but making sure that our pricing strategy is spot on with how we want to affect our customer base.

[Operator]

And that concludes the question-and-answer session. I would like to turn the call back over to Mr. Randy Guiler for closing remarks.

[Randy Guiler, Vice President, Investor Relations]

Thank you for joining us for today's call. Our next quarterly earnings conference call to discuss Q3 results scheduled for Thursday, November 29, 2018. Thank you and have a good day.

[Operator]

And that concludes today’s presentation. Thank you for your participation and you may now disconnect.