Dollar Tree Inc

NASDAQ:DLTR

Earnings Call Transcript 2018-Q3

[Operator]

Good day and welcome to Dollar Tree's Third Quarter Earnings Conference Call. Today's conference 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, VP, IR]

Thank you, Brandon. Good morning and welcome to our conference call to discuss Dollar Tree's performance for the third 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, 8-K, 10-Q and Annual Report, which are on file with the SEC. We have no obligation to update our forward-looking statements, and you should not expect us to do so. At the end of our prepared remarks, we will open the call to your questions. 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 CEO]

Thank you, Randy, and good morning everyone. Today, we are going to discuss our third quarter performance as well as our plans to improve the consistency of execution across the Family Dollar store base and to optimize our real estate portfolio. This will include a meaningful acceleration of in store renovations and re-banners in 2019.

This morning we announced results for the third quarter. Sales increased 4.2% to 5.54 billion. Consolidated same store sales increased 1%. By segment, comp sales for the Dollar Tree banner increased 2.3%, the Family Dollar banner comps were down 40 bps compared to last year's Q3 increased of 1.5 on a two-year stack basis comps accelerated slightly. Our enterprise gross margin rate declined 110 basis points to 30.2. Operating income was 387.8 million or 7% and diluted earnings per share increased 16.8% to a $1.18 at the high-end of our guidance range.

We delivered earnings within the range of our expectations despite continued cost pressures related to domestic freight and our investment in store wages. Dollar Tree delivered its 43rd consecutive quarter of same-store sales growth with increases in both customer transactions and average ticket. We are pleased with the performance of our newly renovated Family Dollar stores. Additionally, we have begun the important phase of consolidating our store support centers into our Chesapeake campus, which will improve our ability to support Family Dollar stores through enhanced collaboration, communication and teamwork.

Dollar Tree continues to have a most unique, differentiated and defensible business model in U.S. value retail. Customers love our dollar fixed price point as demonstrated by 43 consecutive quarters of positive comps. Despite periodic cost challenges the Company has continued to deliver a relatively consistent gross margin annually with sector leading operating margin. Our 2.3 comp this quarter was on top of a 5.0 comp in last year's third quarter, and the comp growth was driven by balanced increases in both transaction count and average tickets.

In our Dollar Tree banner for the third quarter, top performing categories were snacks and beverage, candy, stationary, greeting cards and our Halloween seasonal assortment. We are extremely pleased with the recent addition of the Hallmark brand to our product assortment at Dollar Tree, customers are thrilled with the values and the offering, and I'll touch more on that in a moment.

Sales performance was driven by strength in discretionary categories. Comps were positive and exceeded 1.5% in all three months. October same-store sales were the strongest months in the quarter, and we saw a terrific sell-through on our Halloween seasonal merchandise. Geographically, Dollar Tree same-store sales growth was strongest in the West, Southwest, Southeast, and all of our operating zones delivered positive comps.

On last quarter's call, I briefly touch on our beginning of our new partnership with Hallmark. We introduce the new Hallmark greeting card program in June. Every Dollar Tree store in the fleet was re-fixtured and merchandised with a fantastic new assortment. The rollout across the chain was completed one week ahead of schedule and our customer acceptance and feedback has been terrific and was validated by a double-digit comp in our third quarter.

We are able to enhance the assortment by market and store. We have cards tailored for African-American shoppers or Hispanic shoppers, religious, inspirational card occasions. We have fantastic every day and seasonal assortments with our Heartline brand and our best products of two for a dollar and our Expressions brand for a dollar per card, all are branded with the Signature Hallmark brand and recognizable crown logo. We are enthusiastic about this new partnership with Hallmark and it adds to our very important party category.

Also during the quarter, we added new snack zones into an additional 300 stores. We now have snack zones up and running in more than 800 stores. Store and customer feedback has been terrific and our numbers support this as we like the lift not just from the category, but within the store. The concept targets on the go customers with immediate consumption items and our snack zone sales are consistently outperforming the budgets assigned to them. These are just two examples of how Dollar Tree continues to reinvent our assortment to drive excitement in our stores.

For the Family Dollar banner in the third quarter, since acquiring our Family Dollar brand, our team has made progress towards addressing needed investments, but there's more to be done. While comps for the quarter across the banner as a whole did not meet our targets our renovated stores continue to perform ahead of our expectations. In fact, in the third quarter, we are seeing that the performance of our newly renovated stores, are the best performing of our renovation waves over the past six quarters. These strong results give us the confidence that we're poised to see the benefits of our investments in the brand, and we continue to focus on the key initiatives that will drive to long-term success.

The foundational elements that we have shared from the beginning are investment in customer experience, being better in stocks and assortment, more private brand offerings along with better buying from our import capability, delivering value to our customers through our smart ways to save, specific customer offers through our smart coupon program, and now most importantly around our efforts to renovate the stores with better adjacencies and impact of our important categories. I will provide more detail on these efforts later in this call.

Top performing categories during the quarter includes snacks and beverage, refrigerated, frozen products, candy, beauty care and laundry care. We delivered our eighth consecutive quarter of positive comps in the Family Dollar consumables business. Sales cadence comps were slightly negative in August and September, and slightly positive in October. In the prior year all three months were greater than 1% positive comp. Geographically, Family Dollar same store sales growth for quarter was once again strongest in our West, Mountain West and mid-Atlantic zones.

Switching to Dollar Tree Canada the team again delivered mid single-digit positive comps for the quarter, with increases in both ticket and traffic. The sales growth was balanced as both discretionary and consumables comped at or better than 4% for the quarter. Top performing categories include harvest, apparel, greeting cards. Importantly, the team Canada achieved this operating income for the quarter.

The digital division of Dollar Tree, Dollar Tree Direct had another productive and profitable quarter in Q3. We experienced comp sales growth in our e-commerce sales where we are increasingly profitable. As we continue to over time leverage the existing infrastructure to drive to the bottom line. Online, we launched a robust marketing campaign to promote Hallmark cards in the stores. The campaign include a landing page deck, a dedicated Hallmark video and craft ideas featuring our cards.

Now looking at real estate in the third quarter we opened a total of a 127 new stores, 87 Dollar Trees and 40 Family Dollars. We relocated or expanded 14 stores - 10 Dollar Trees and 4 Family Dollars. We renovated 164 Family Dollar stores as part of our renovation initiative. We re-bannered 30 former Family Dollar stores to Dollar Tree stores for a total of 335 projects during the quarter. We have completed 488 Family Dollar renovations in fiscal 2018 exceeding our original target of 450 for the year. We also added freezers and coolers into a 143 Dollar Tree stores during the third quarter, bringing our total of Dollar Tree stores with freezers and coolers to 5579.

During the quarter, we closed 18 stores, 6 Dollars Trees and 12 Family Dollars, and we ended the quarter with 15,187 stores, broken-out 6,923 Dollar Trees and 8,264 Family Dollars. For the full year, we expect to have 325 new Dollar Tree stores and approximately 230 Family Dollar stores. This is below our original plan of 350 Dollar Trees and 300 Family Dollars. The shortfall is due to timing on the Dollar Tree side, and our accelerated focus to renovations on the Family Dollar side. We have mentioned previously our effort to switch to do more renovations at Family Dollar, and by our fiscal year end that number will be at 500.

Before I turn the call over to Kevin, I like to provide an update on the Section 301 tariffs and the potential for additional tariffs. Today, we currently source our product for more than two dozen countries, which does afford us a degree of flexibility. And I'm extremely proud of the work our merchandising teams, which have been very active working with our supplier base to minimize our impact from tariffs. Because of our team's effort, the expected impact on tariffs to fiscal 2018 will be minimal, as we've always said with visibility and due cost with some amount of time, we're typically able to navigate and manage the business for ways to offset these costs.

Our options include negotiating price concessions from vendors, changing product sizes, specifications and evolving our product mix. In Family Dollar, we can raise retails but only as a last resort, assuming a 10% Section 301 tariffs or freight will increase due to 25% next year. Dollar Tree has already mitigated the potential impact of the 2019 tariffs by 80% and Family Dollar by 50%. We have made significant process and will provide additional updates on our fourth quarter call.

Now, I'll turn the call over to Kevin to provide more detail in our third quarter performance and for our outlook for the remainder of fiscal 2018. Kevin?

[Kevin Wampler, CFO]

Thank you, Gary, and good morning. Total sales for the third quarter grew 4.2% to $5.54 billion. Dollar Tree segment total sales increased 6.3% to $2.85 billion within the Dollar segment total sales increased 2% to 2.69 billion. Enterprise same-store sales increased 1%, on a segment basis same-store for the Dollar Tree banner increased 2.3% or 2.2% when adjusted for Canadian currency fluctuations and the Family Dollar banner decreased by 40 basis points.

Overall our gross profit increased by $5.9 million or 0.4% to $1.67 billion for the third quarter of 2018 compared to the prior year's quarter. As a percent of sales, gross profit margin declined 110 basis points to 30.2% versus 31.3% in the prior year's quarter. Gross profit margin for the Dollar Tree segment was 34.8% for the third quarter a 30 basis point decline compared with the prior year's third quarter. The decline was primarily due to the higher costs related to the distribution center payroll and shrink. Increases in freight were offset by improved mark on and a positive margin effect from mix shift based on strong discretionary sales for the quarter.

Gross profit margin for the Family Dollar segment was 25.3% during the third quarter, which compared to 27.5% in the comparable prior year period. The year-over-year decline was primarily due to merchandise costs including freight, which increased 60 basis points resulting from higher domestic freight cost. 11 basis points of that increase related to hurricane-related costs incurred due to our Marianna Florida DC being down due to the loss of power and storm clean up. Stores normally serviced by those DC were moved to other DCs in the network for approximately three weeks increasing stem miles and cost.

Markdown increased 50 basis points related to promotional markdowns, approximately 10 basis points of the increase was due to damaged inventory in our Marianna DC in multiple Florida-based stores. Shrink cost increased 40 basis points due to unfavorable inventory results and changes in the accrual rate. Distribution cost increased 40 basis points due to higher distribution center payroll-related costs and a change to allocate certain benefit costs related to the DC to be consistent across banners. This represented 25 basis points of the increase. Occupancy cost increased 30 basis points resulting from the deleveraging effect of the decline in the same-store sales.

Consolidated selling, general and administrative expenses as a percentage of net sales in the quarter improved 10 basis points to 23.2% from 23.3% in the same quarter last year, the increase was driven by lower corporate and operating expenses and lower depreciation as a percentage of sales partially offset by higher payroll costs. In addition, the third quarter includes $2.3 million of expense related to the store support center consolidation announced September 18, 2018.

Third quarter SG&A expense for the Dollar Tree segment as a percentage of sales improved to 23.2% compared to 23.3% in the prior year's quarter. The improvement was primarily due to leverage from the increase in same-store sales and lower incentive compensation costs, partially offset by 20 basis point increase in store hourly payroll expense resulting from the planned tax reinvestment. SG&A expense for the Family Dollar segment as a percentage of sales was 23.2% compared to 23.4% in the prior year's quarter. The 20 point basis point improvement was a result of operating and corporate expenses decreasing approximately 40 basis points resulting from lower advertising expense, legal fees and a gain on sale of fixed assets.

Depreciation and amortization expense decreased approximately 20 basis points as a result of certain assets that were revalued upon the 2015 acquisition becoming fully depreciated or amortized. Payroll expense increased approximately 35 basis points, primarily due to increased store hourly payroll as a result of the planned reinvestment of income tax savings and higher healthcare claims, partially offset by lower incentive compensation expenses.

Operating income for the enterprise was $387.8 million compared with $425.2 million in the same period last year and operating income margin was 7% compared to 8% in last year's third quarter. Operating income margin for the Dollar Tree segment declined 20 basis points to 11.6% when compared to the prior year quarter. Operating income for Family Dollar segment was $55.9 million or 2.1% for the quarter. Non-operating expenses for the quarter totaled $47.8 million, which was comprised primarily of net interest expense.

Our effective tax rate for the quarter was 17.1% compared to 32.4% 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. Additionally, the Company recorded a tax benefit of 15.7 million based on the substantial completion of its analysis on the net deferred tax liability valuation. For the third quarter, the Company had net income of $281.1 million or $1.18 per diluted share compared to reported net income of $239.9 million or $1.01 per diluted share in the prior year's quarter.

Looking at the balance sheet, combined cash and cash equivalents at quarter end totaled $708.3 million compared to $1.1 billion at the end of fiscal 2017. Our outstanding debt as of November 3, 2018 was approximately $5 billion. Inventory for the Dollar Tree segment at quarter end increased to 12% from the same time last year, while selling square footage increased 4.7%. Inventory for selling square foot increased to 6.9%. The increase reflects the acceleration of receipts of certain import goods to minimize the impact of increased tariffs.

We believe that current inventory levels are appropriate to support our sales initiatives for the fourth quarter. Inventory for the Family Dollar segment at quarter end increased 7.1% from the same period last year, and increased 5.4% on a selling square foot basis. The increased levels in the current year primarily represent our continued work to support in-stock levels at a modest increase in the average unit retail.

Capital expenditures were $228.4 million in the third quarter versus $177.7 million in the third quarter last year. For fiscal 2018, we expect consolidated capital expenditures to be approximately $825 million. Depreciation and amortization totaled $150.5 million for the third quarter. Depreciation and amortization expense was $149.4 million in the third quarter last year. For fiscal 2018, we expect consolidated depreciation and amortization to be approximately $610 million.

Our updated outlook for fiscal 2018 includes the following assumptions. Calendar considerations include the following 2018 is a 52 week year, 2017 was a 53 week year and the 53rd week in Q4 of 2017 added $406.6 million to sales and approximately $0.21 to earnings per share. We reduced our sales outlook in Q4 due to opening 30 less Dollar Tree stores and 70 less Family Dollar stores as originally planned as noted earlier by Gary.

Our updated guidance now includes approximately 6 million for expected cost in Q4 related to our store support center consolidation. We expect continued pressure on the store payroll based on competitive markets and states increasing minimum wage. Additionally, as previously discussed, we continue to invest in store hours and average hourly wage rates as part of our $100 million investment into our business from our projected $250 million tax benefit.

We expect higher domestic freight and diesel costs to continue. That interest expense will be approximately 47 million in Q4. Our guidance does not include expenses and charges in connection with the effects in store optimization including store renovations, store closures, and other assets. We cannot predict future currency fluctuations. We have not adjusted our guidance for changes in currency rates. Our guidance assumes the tax rate of 21.75% for the fourth quarter and 20.2% for fiscal 2018.

Weighted average diluted share count assumed to be 239.3 million shares for Q4 and 238.9 million shares for the full year. For the fourth quarter, we are forecasting total sales to range from $6.1 billion to $6.21 billion and diluted earnings per share in the range of $1.86 to $1.95. These estimates are based on a low single-digit same store sales increase and year-over-year square footage growth of 3.2%.

For fiscal 2018, we are now forecasting total sales to range between $22.72 billion and $22.83 billion, based on a low single-digit same store sales increase and 3.2% square footage growth. The Company now anticipates net income per diluted share for full year fiscal 2018 will range between $4.86 to $4.95 compared to the Company's previously expected range of $4.85 to $5.05.

I'll now turn the call back over to Gary.

[Gary Philbin, President and CEO]

Thanks, Kevin. Following the completion of the acquisition of Family Dollar in July 2015, we have made significant progress on the integration. We have exceeded our initial synergy targets, strengthened our balance sheet, and at the same time laying the groundwork for our future growth. As part of the integration process, we focused first on building a single infrastructure by implementing initiatives to establish a single foundation to drive performance across the organization and support the growth of both Dollar Tree and Family Dollar brands. As part of this foundational work, we successfully implemented a shared services model across corporate support functions.

We introduced a common systems and processes across both brands. We improved logistic and supply chain efficiencies, including testing and refining the approach in systems for combined distribution centers. Our first combined distribution center is in St. George, Utah, where we began servicing both brands in 2016, our learnings from this center are paving the way for the launch of our next generation combined DCs and additional synergies. And we commenced the consolidation of corporate functions, including all support functions into our Chesapeake, Virginia headquarters location. We expect to complete the consolidation by fall 2019.

With this foundation in place, Family Dollar's position along with the Dollar Tree brand to benefit from the combined scale of our broad footprint. Our integration work has not only been focused on the corporate level. During this time, we've implemented initiatives to improve operational performance across the footprint of Family Dollar stores. Examples of our work building the leadership team by hiring executives with significant and relevant retail experience, changing restock policies to improve in stocks.

Improving adjacencies and merchandising of key impact categories of the focus on consumables and increased refrigeration, introducing programs and training to enhance the sales culture, including store level compensation programs to better incentivize and align performance, launching smart ways to save our customer facing marketing program, investing in mobile technology and introducing smart coupons to better reach core customers and increase store loyalty.

Commencing a program to improve and rebrand private label products and increase the variety and quantity of private label products in store. Completing a store format test to optimize layout and develop a new prototype design. As we've discussed in prior calls. We've analytically looked at our process to optimize Family Dollar real estate portfolio through renovating stores, re-bannering stores to Dollar Tree brand, or closing stores. Since completing the Family Dollar transaction, we have opened 830 new Family Dollar stores renovated 865 Family Dollars, re-bannered 354 stores from Family Dollar to Dollar Tree and closed 195 Family Dollars stores.

Our renovation program really began 18 months ago and since then, we continue to take the learnings from each generation of renovations and applied them to the next. You've heard us say our renovations, are comping the mid-to-high single digits that's true when you look at the entire footprint of renovated Family Dollar's, however if you look at the more recent renovations we're seeing higher comps which gives us the confidence were executing well.

We therefore going to begin accelerating our store optimization program in 2019, as of now, we expect to renovate a minimum of 1000 Family Dollar stores in fiscal 2019. Next year we plan to open 350 new Dollar Tree stores and 200 new Family Dollar stores, as well as re-bannering additional 200 Family Dollar stores to Dollar Tree. Additionally in '19, we will be expanding snacks zones to additional Dollar Tree stores and we expect to be in a position to provide you with additional information on the store related projects in 2019.

So in summary, through the hard work we've done in the past 3.5 years, we've put in place the foundational elements that we need to be successful over the long-term, and with the acceleration of our program to optimize our fleet of stores under the Family Dollar brand, we are going to improve the customer experience across our portfolio and accelerate our growth. We've done a lot of testing and we know what works in both urban and rural markets, and based on that, we think, we have a tremendous opportunity ahead of us and across the country. In short, we are more excited about our future than ever.

Let me give a brief update on our capital allocation plans in connection with the acquisitions, we did not make share repurchases in order to allocate sufficient capital to reduce outstanding debt. Invest to support the growth of Dollar Tree and Family Dollar, invest in the initiatives to integrate Family Dollar and to improve store performance across the portfolio. Since completing the acquisition, we have paid down approximately 3.5 billion dollars in debt.

In March, we achieved upgrades to investment grade from S&P Global and Moody's and we have continued to produce strong cash flow from operations. As a result of our successful progress with integration and free cash flow in excess of investment needs, we expect to pay down a variable rate outstanding debt. The Company has an existing 1 billion board authorization to repurchase shares and will continue to evaluate share repurchases in 2019, we plan to provide more information related to our capital allocation strategy in 2019.

In summary, we continue to focus and make meaningful progress to grow and improve our business for both brands. We are well-positioned in a most attractive sector of retail to deliver 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.

Before I turn the call over to Q&A, I would just like to make a shout out to our store and field teams because after the hurricanes and recent fires. Many of our store associates and customers were personally affected by these storms, I want to personally and publicly share our thanks to the thousands of associates who work tirelessly to have their stores open and serve their customers and preparation for and then in recovery from the significant weather and fire events. We saw a great team work passion and dedication throughout the organization. My personal thanks for all the efforts made in our stores, our Marianna distribution center, support centers and our many vendor partners that enabled us to get the impacted stores back up and running in hours and days through and after these events.

Operator, we are now ready to take questions.

[Operator]

[Operator Instructions] The first question will come from Michael Lasser with UBS. Please go ahead, with your question.

[Michael Lasser, UBS]

Gary, can you provide more context around your comment that mitigated 80% at Dollar Tree and 50% at Family Dollar of the 25% potential tariff? Does that mean that if the tariff flows through you will see a 20% hit at Dollar Tree and a 50% hit from that at those two banners? Or is there more to go? And as part of that, how have you been able to mitigate it such that -- could there will be affect to your customer from either lowering product quality, product size, or other factors?

[Gary Philbin, President and CEO]

Yes, and really it's, I'd call out the efforts of both merchandising teams. We are anticipating, I mean I wish it doesn't, but we are anticipating it's going to go to 25%. So, the number I'm referencing is that we expect the 25%. So the mitigation is based on that going through. And you have heard us mentioned how we have done it before. I mean it sounds like it's easy, it's not because we are touching a lot of SKUs.

The one thing you mention though is lower quality. We don’t reduce quality. It could be account size change, but I would say it's probably been a bigger effort around where else can we buy things besides China compared to landed cost, a subtle thing, how do we make things to have better cubed to come across so that we can land it on the U.S. side at a better landed cost. If negotiation with our vendors who also know, this is a very important time with the kind of volumes that we can [indiscernible] some of the factories to negotiate that.

So it's never one thing, it's our efforts to negotiate very well on both sides, take a look at the items what do we have to have, what don't we have to have out, what can we change, what would you modify and how you pack it, but we're going to go into this, but this will be a year where we also have to be nimble because while other folks get to raise retails, including our Family Dollar banner as I've told folks before, our customers often don't have that extra dollar. So, we've got to be just better buyers and it's going to speak to both how we buy the specs we buy to and which countries we go to.

[Michael Lasser, UBS]

And just to clarify. Is there room to further mitigate the 20% at Dollar Tree and 50% at Family Dollar? And then just a follow-up, I think there's a prevailing view in the marketplace that given what the available for those days -- that Dollar Tree -- the enterprises operating margin continue to be under pressure for next year and down, I recognize it's early. So what would be the offset to all this factors that would allow your operating margin either flat or growing…?

[Gary Philbin, President and CEO]

Well, to the first part on the imports, we are still working hard. Listen, this -- we've started in earnest in August, September, and we've made one trip, we still got things to buy in the back half of the year that's really the balance of what we have to mitigate. So, we're off to I think a real good start at both banners, more work to be done. And the pressure that comes, this is going to be a year where we're going have to understand what the customer between the tariffs, we've gone through a year of really nothing in my retail history, on seeing the lack of truck drivers that impacted freight, but I want to go into next year thinking that we have the right assortment in place for our customers first, and drive business and from there, there we get the chance to leverage some of our fixed cost and other things that we've always done to drive-up income. But as I look into 2019, this is going to be all about let's stay real close to our customer and what do we buy that they respond to you in both banners.

[Operator]

Thank you. The next question will come from John Heinbockel with Guggenheim Securities. Please go ahead with your question.

[John Heinbockel, Guggenheim Securities]

Gary, let me start with, what's your broader thought on the Family Dollar store footprint, including the possible need for underperforming store closures? And then kind of tied to that when you think about the thousands of remodels next year plus the openings, your thoughts on the field organization's ability to handle all of that change in one year's time?

[Gary Philbin, President and CEO]

Well, agreed. I mean I think we boldly stepped out there and said, we're going to do really across both banners, but I'll stay focused on Family Dollar, a lot of renovations, more than we've done and the reasons we like that and it's important is what we're seeing in the current renovation. So, I would tell you the fields are excited. Everything, we've done John to get our folks incented and aligned to run better stores. Now here's a chance to change the four walls of their stores and we got to do it one store at a time, but the opportunity to drive more footsteps into the stores and improve top line I would tell you they're raising their hand, give me one of those.

The execution piece, we've got to be on top of our game. It's a lot because of what you do to enhance the store and reset it and the SKUs that come in and out. So, it's not a small task for the field team to execute, but we are up for it. This is our opportunity to make meaningful change at Family Dollar. It's how we have described it to our organization, they have seen the one’s that’s responding; I walked a recent store with both our RD and DM recently. Their eyes light up. The consistency in execution we are going to be all over that next year.

And I want to go through 2019 saying we did at least a thousand of them, and we were pleased with all of them. And that’s going to be the bar that we set going into 2019, along with that is the re-banner. So just to call out as we have taken a look at the store and referenced to the broader question, we have taken a look at which stores are responding to the renovations and what is an urban versus rural, and the stores that are twinners, you might say well that’s where we’re harvesting some of those to become Dollar Trees.

So the opportunity to now understand that in a better way and as we continue our iterations of renovations and the stores that don't respond to that that we can sort of see that. The things that we had worked on on table stakes to get all stores to improve. Those are good things to work on retail. I think what we like about the renovations is that's what changes really the course of the future footsteps for that store and sort of breaks down for us. So that's our effort for 2019.

[John Heinbockel, Guggenheim Securities]

And then just secondly on the tariff topic, is the mitigation at Family Dollar the 50% versus 80% spread. Is that more a function of FDO does have pricing flexibility, right, where Dollar Tree doesn’t? And if we did not get the 25%, let's assume we do, but if we did not get it, does that on the incremental 15, I assume your gut feel would be to reinvest that benefit into the business not keep it?

[Gary Philbin, President and CEO]

Well, listen, other people raise retails up or raise or lower them and for us, you have to be close enough to discuss, we don’t have the same kind of value. The magic that Dollar Tree only works if they know that's worth more than a dollar because it is somewhere in their shopping universe, and in Family Dollar, we don't have, we always got flexibility. At Dollar Tree our promise is to have great value in the store not necessarily that item. At Family Dollar there are some basics that I want to make sure we are in place with, our teams still working hard on.

We have a big post-holiday trip. We will do better than where we are today. But at the end of it we may have to invest some of that to stay in place with the right items as we go into 2019. I don't think you can just say -- listen as the tariff goes to 25% it’s a real thing, other retailers are going to be faced with that too and we are going to respond to it in our world the right way to make sure our customers see the right values in both Family Dollar and Dollar Tree.

[Operator]

The next question will come from Peter Keith with Piper Jaffray. Please go ahead.

[Peter Keith, Piper Jaffray]

I wanted to just dig a little more into the renovation initiative around Family Dollar. So, Gary, last quarter you had said that, you are getting a mid-single digit comp lift. This quarter you said the store is performing better. Could you give us a sense on what some of the changes were driven that the better performance so we can hope to see that continue into 2019?

[Gary Philbin, President and CEO]

Well, exactly I mean I would say, it is not going to be one change, but I would just say this Peter as we went through really over the last 18 months. You put these stores out there you see what responds, it's easy to walk into the store, you like to layout, it always comes down to the look and feel, but I would tell you it's more around the assortment that the customer ultimately sees. So our latest iterations have focused on some of things the customer needs most I mean you heard us talk about consumables very important for Family Dollar, as a piece of the emphasis I think that the adjacencies that we've been talking about are paying-off for us.

Some of the price impact that we've been making throughout the store is a piece of it. I think, I would just tell you, you know what we've done that is that it finds us a way to get that last dollar when she is waiting for our check ounces as important as anything we've done in the store. So you know is it one thing, no, is it the combination of all of those effort that got us to that yes, and to me Peter the final judge for me and listen we'll continue to refine the I can't put a thermometer on this and tell you were all the way to the boarding point where we like it but I think we're pretty darn close. And I would just tell you that it shows-up in footsteps into the front door.

[Peter Keith, Piper Jaffray]

Okay, thanks for that. I did also want to dig into the opportunity for combined supply chain, and you have the St. George, Utah test, it's going on for two years. So certainly can appreciate, it's a complicated initiative, but also surprised that it's been a two year test. Could you give us a sense on what's taken so long at this point? And as you are looking forward, when can we begin to expect to see this broaden out to more of the DC network?

[Gary Philbin, President and CEO]

While it is complicated thank you for recognizing that, and it's -- we're past the test stage. I mean we've build our latest DCs in Warrensburg, Missouri. Now with the same systems that St. George allowed us to ship both banners. The difference and the issue really has been as we re-bannered stores from Family Dollar to Dollar Tree as stores were divested than re-bannered from Family Dollar, all of the capacity needs over the last three years have been on the Dollar Tree side.

And so while Warrensburg has the capacity at this point, we need the capacity for Dollar Tree at some point, Family Dollar will show-up there. And so I think where you're going to see it is the new DCs will get to that ability to ship first. And then we have as we shift volume to and from in the network then we'll have a better opportunity to go back into some of the locations probably on the Family Dollar DC side, where they have a capacity to ship to Dollar Tree stores. We don't -- working on that, I don't have a timeline to tell the street that, that when it's going to happen it's still ahead of us, but we are planning for.

[Operator]

Thank you. The next question will come from Dan Wewer with Raymond James. Please go ahead.

[Dan Wewer, Raymond James]

Kevin, I wanted to ask you about the cost of the renovations and also the time to complete a renovation? And just to confirm, if the sales lift now exceeding that mid single digit rate that you had alluded to in the past?

[Kevin Wampler, CFO]

I think from a cost perspective what we've said is, it really ranges from probably 100,000 to 150,000 and the big variable is always going to be the number or amount of refrigerated and cooler units and freezer units that we may be putting into that store, so that’s the biggest variable. And the typical renovation, it takes us only about two weeks. So it's a very coordinated effort as you can imagine to because there are some pretty significant changes in regards to moving layout, changing the storefront and as well as adding immediate consumption coolers to the front of the stores, so it's well coordinated.

I think we feel pretty good about the work we've done to get that down to a pretty nimble timeline. And then in regards to your question mid single digit cost and obviously Gary's comment is it higher, we haven’t really specifically said how much higher but it is definitely higher than mid single digits.

[Dan Wewer, Raymond James]

During the two weeks to complete the renovation, we have a 1,000 of this taking place next year. Could this put additional pressure on your inventory strength accrual?

[Kevin Wampler, CFO]

Well, I think part of this is again you do really have to look at inventory in the stores and in some categories might get a little smaller, so there can be some inventory movement. But I would tell you just in general, we are not satisfied with where our shrink has been this year in either banner. It has not been a result that we are very proud of, it's something that we are working on.

And again, it's just not something that’s you usually see out of us from an execution standpoint. So it's on the top of everybody's list out there and the operations plus prevention and the whole organization from the standpoint of understanding that this is just as important as driving sales out there. So I don't want to say it's going to put pressure on it because my expectation is we would have to do better next year.

[Dan Wewer, Raymond James]

And then, this is a quick follow-up question. If you had unlimited resources, both people and capital, how many Family Dollar renovations would you like to ultimately complete?

[Kevin Wampler, CFO]

There will be thousands.

[Dan Wewer, Raymond James]

Starts with the two or four…

[Kevin Wampler, CFO]

No, it's really, I mean Dan, it's really an issue of -- listen thousand is a big number and I have said, minimum because I'm obviously hoping for more because that's how I'm thinking about it. But I think seriously from the standpoint of just is this a one year project, no. We will see the results of this larger group of stores helping us certainly as we get into '19 and more and more of them are behind us. But I would see us doing a similar number in '20.

[Operator]

The next question will come from Chuck Grom with Gordon Haskett. Please go ahead.

[Chuck Grom, Gordon Haskett]

Just beyond the remodels. Gary, when you think about investments that need to be made whether it would be labor, training, technology. What else do you think it needs to get done to right size the banner? And how do you think about the operating margin profile of the Family Dollar segment over the next couple of years with that in mind?

[Gary Philbin, President and CEO]

That's one of the reason were doing the renovations Chuck, is as stores open volume they leverage there for a while fix expenses, but I think you touched on the investments that are needed. I mean we've talked about and try to call out some of the big ones that we've done. Technology will continue to migrate to best in breed between the two banners on some of the systems that we need. We will continue to invest in our people especially within employment being at near or all time lows and just what we've done this year and what we call the year of the store manager to drive success store-by-store with improving our store manager prioritization how they direct, how they follow-up with people, I meant this is not either or we've got to do both.

Overtime, operating income, just now we still have our sight set and where we started this journey, we will continue to improve it. I think what I wanted to emphasize today is, we need to touch a meaningful amount of stores to get the consistency towards that trajectory that gets us there. And I caught-up before the things that we've been doing, the blocking and tackling on our table stakes all good retailers have to do that, but the equation that I want to change is to drive more renovations, unless when we do the re-banners too because you know right off the bat, if it's a right market and the right neighborhood adding a Dollar Tree assortment certainly changes a four wall cash immediately on that store with the sales dropping off.

But what we've seen is, customers do figure out eventually that is a Dollar Tree and we see multiyear comps coming from the re-banner segments that we've done. So when we find the right store do that, we do that too so between those two you go on few years you start getting better comps from this fleet of renovated stores that start to leverage your fixed expenses, you start to see re-banners that are opportunistic coming out of the Family Dollar fleet and falling into the Dollar Tree four wall cash model and I think that's how we take a look over the next few years on building the business plan.

[Chuck Grom, Gordon Haskett]

And then my follow-up question would be just on comps variability across the Family Dollar banner. I'm just wondering, how wide is the performance across your stores? And is there a thought to close more stores in the coming years and some of the stores that I guess are potentially underperforming the chain?

[Gary Philbin, President and CEO]

I think that's the work we've really been doing on the store optimization on taking a look at okay to your point, we got stores that are we got good store we have great stores at Family Dollar, you got some that aren't where you want, so how do you fix them. As we've done the renovations we now have with the newly assortment and everything that we just talked about, well there's an answer. Some don't seem to respond the same way while maybe those should be re-banners some are just operational improvement we need to get as always the right team, the right effort from our operations and those that can't respond that might be too old, might be too small, we're dealing with our -- a big and order fleet of stores you know, at some point you got to see when we close them at least they they're being opportunistic.

[Operator]

[Operator Instructions] The next question will come from Matthew Boss with JP Morgan. Please go ahead.

[Matthew Boss, JP Morgan]

On the margin front, how are you thinking about freight and markdowns at both banners in the fourth quarter? And larger picture as we look to next year, do you see the opportunity to drive positive consolidated operating margin, as you put together all the headwinds and tailwinds as you see today on the horizon?

[Kevin Wampler, CFO]

Matt, as we speak to freight, I think we look at that as a continued headwind as we look at the fourth quarter. And again, diesel, well it's still up, believe in Q3 it was up roughly about 20% as a rate year-over-year with the recent pull back in oil prices that may dissipate a little bit in Q4 so that may come down a little bit, but freight in general I think is the driver shortage that's out there and the pressure, we are seeing from that we expect freight to continue to be up and even really potentially through the first half of next year, there could be some pressure as well, but again that’s ongoing.

From a markdown perspective, it's really pretty much a non event in the green banner because they are just not that many markdowns. The Family Dollar business is obviously a little different from a markdown perspective. As we noted in Q3, markdowns were up partially to drive sales and partially to make sure we are moving through inventory appropriately. As we look at Q4 I would tell you I would expect markdowns in the Family Dollar business to be up year-over-year again, I think the opportunity to be aggressive when appropriate and to keep our inventory as clean as it can is very important. So I think that’s there for us. And I think as we continue to push that business forward that’s something we need to continue to look at.

In regards to 2019 obviously we haven’t given any guidance at this point, and now we are finishing up really the planning and budgeting as it relates to 2019 so there is not really much I can say at this point and in time, but I would tell you what is our expectation that we move the business forward and improve the business and that's what's going to be our guiding principle as we go into 2019.

[Operator]

The next question will come from Greg Melich with Moffettnathanson. Please go ahead.

[Greg Melich, Moffettnathanson]

I wanted just to follow-up on tariffs little bit, thanks for explaining how you are really working to mitigate it. Remind me, how much of your COGS if you disclosed or not already are on the current list? I think we had around 25% of COGS coming from China, but I don't think that was the current list.

[Gary Philbin, President and CEO]

The current tariff list I think we have declared that we have about 9% of our sales are coming through that are tariff at this point.

[Greg Melich, Moffettnathanson]

And so if that extended that might be different, but that is what you're referencing was mitigating 50% or 80% of what's currently on the list.

[Gary Philbin, President and CEO]

That’s right, the tariff 301 list is what's, we're referring.

[Greg Melich, Moffettnathanson]

And then a follow-up from before, you mentioned getting the 100 million reinvestments of the 250 million tax savings. How should we think about that in terms of -- is there any left or do we re-repeat part of that investment next year? Provide me with the timing of that? Was that all of an investment this year or was some that 250 going to be in the following years?

[Kevin Wampler, CFO]

So, the 250 that's the 2018 benefit with us, reinvesting 100 million into labor and both in rate and hours, and that's not only stores that's also within our DC environment as well. So that will continue through Q4. I think as we look into 2019, my very early rate would tell you that there's likely to still be some general pressure on wages, just from competitive marketplaces, as well as some states continuing to increase their state mandated minimum wages, but I think that the 100 million really was related only through 2018.

[Operator]

Thank you. The final question will come from Robbie Ohmes with Bank of America. Please go ahead.

[Marisa Sullivan, Bank of America]

This is Marisa Sullivan on for Robbie. I just wanted to see if you can comment a little bit on traffic trends at the Family Dollar banner and how they've trended in the third quarter and then quarter-to-date and whether we should be expecting a positive comp inflection at Family Dollar in the fourth quarter and what would be the drivers?

[Gary Philbin, President and CEO]

Well, we will go against I believe a one comp last fourth quarter. Here, we are striving off the holiday season in earnest to me the kick-off is a little bit of Thanksgiving, but probably more for our customers the first week of December. So all of our plans, all of our efforts, the alignment of getting the merchandise to the right stores, that's going be the proof in the pudding over the next few weeks, so we certainly we call it it's a big spike in our business as we march towards the December 25th.

So, listen, we were going to work hard on we're excited about the holiday season, I think we got our folks in the right place. We spent a lot of time in both of our field meetings way back in August to get them propped on the excitement of the items that we have in our stores. We've gotten into not just stores but on display, I think both banners really going into this year have really done a job to improve the holiday assortment.

And right now, we're sort of in the, you might say, trimmer home and trimmer tree segments, trimmer gift and gift giving is still ahead of us. So those are clearly the biggest categories. For Family Dollar, it will be I think opportunity for us to really share down toys with the void in the markets. We did lean into the toy business this year, and I think it's going to be an important part of us having a positive comp as we go through December.

[Operator]

Thank you for the question. I'll now turn the conference back over to Mr. Randy Guiler for closing remarks.

[Randy Guiler, VP, IR]

Thank you, Brandon, and thank you for joining us on today's call and especially for your continued interest in Dollar Tree and Family Dollar. Our next quarterly earnings conference call is to discuss fourth quarter and fiscal 2018 results. That call is tentatively scheduled for Wednesday, March 6, 2019. Thank you and have a good day.

[Operator]

Thank you, ladies and gentlemen. That concludes today’s event. You may now disconnect your lines.