Dollar Tree Inc

NASDAQ:DLTR

Earnings Call Transcript 2019-Q3

[Operator]

Good day and welcome to the Dollar Tree Inc.’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, Vice President, Investor Relations]

Thank you, Aaron. Good morning and welcome to our conference call to discuss Dollar Tree’s performance for the third fiscal quarter of 2019. 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 the most recent press release, most recent 8-K, 10-Q and annual report, which are on file with the SEC. We have no obligation to update our forward-looking statements and you should not expect us to do so.

At the end of our prepared remarks, we will open the call to your questions. Please limit your questions to one and one related follow-up, if necessary.

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

[Gary Philbin, President, Chief Executive Officer]

Thanks, Randy. Good morning everyone. The third quarter represents another period of solid sales performance for both brands Dollar Tree and Family Dollar. Our store optimization efforts and sales driving initiatives are working. The teams have completed more than 1,150 Family Dollar H2 renovations, nearly 200 Dollar Tree re-banners, and more than a 1,000 Dollar Tree Snack Zones, and launched our Dollar Tree Plus test already this year. These efforts have driven top line sales and transaction counts of both banners.

Fiscal 2019 has been a unique year as a result of several factors. We planned and accomplished the material acceleration of our Family Dollar store optimization initiatives and the consolidation of our two support centers to Chesapeake, Virginia. Additionally, the global helium shortage which has an outsized impact on our party business and the continued uncertainty regarding trade and the related tariffs have impacted our business.

I’m proud of our team’s efforts and the sales execution through this environment. We worked hard to maintain focus on our customers and our values in stores. Our results for the third quarter included sales increase of 3.7% to $5.75 billion, consolidated same store sales increase of 2.5% and our EPS of $1.08 was within our guidance range.

Other highlights for the quarter included completing 247 Family Dollar H2 renovations, completing 512 Dollar Tree Snack Zones bringing our total to 2,087 across the chain and repurchasing 11.6 million shares as part of our share buyback program. In mid October, we hosted our fourth annual nationwide hiring event focused on hiring more than 25,000 associates in communities all across the country.

This event provides individuals with the opportunity to join the Dollar Tree or Family Dollar’s teams. These new associates can earn the opportunity to be promoted through the field organization. As a growth company, we’re always looking for talent and bench strength that can develop into future leaders in our stores. Our application flow was strong for the successful hiring event.

Regarding Dollar Tree segment sales highlights for the third quarter, we delivered a 2.8% comp, representing the twelfth consecutive quarter of comps exceeding 2%. Dollar Tree had increases in both traffic and ticket with traffic slightly outpacing the ticket increase. Geographically, all the zones comped positively, and we're at or better than 2%. Strongest performing zones were in the Northeast, the upper Midwest, and Southwest.

Our cadence of comps in the quarter, all three months were better than 2% with August being the strongest month. Dollar Tree continues to deliver solid positive comps in the consumables category, and our seasonal business continued to perform very well. In fact, Halloween was on par with a very good seasonal sell-through we've been experiencing over the past couple of years.

Our variety business, which includes party at Dollar Tree comped positive each month during the quarter but was again impacted by the helium shortage. We estimate that our comp was negatively impacted from lost balloon sales by about 20 basis points. We expect this helium shortage headwind to continue, but to a lesser degree for the remainder of 2019. The Dollar Tree marketing team continues to do a terrific job of delivering ever-changing and new product ideas that drive customer excitement and repeat visits. Dollar Tree WOW is the excitement that our customers have come to expect.

Snack Zones have started 27, we have rolled out to great success and we continue to extend this initiative into more Dollar Tree stores. Last year, we added Hallmark cards to all stores across the chain, and it has proven to be a great partnership and customers certainly love the Hallmark brand, the offering, and the value. And this year, we’ve been rolling on a new program called Crafters Square. Crafters Square is now in more than 600 Dollar Tree stores and is a new and expanded selection of arts and craft supplies all priced at $1.

Feedback from stores and customers has been fantastic, and we’ll continue to expand this traffic driving initiative to more stores going forward. The sharing of projects within the crafting community on Pinterest, Instagram, and other platforms has made this one of the quickest launches to our customers on a small base of only 600 stores.

Let me give you an update on Dollar Tree Plus. , As we’ve discussed previously, we’re conducting a test of multi-price points at select Dollar Tree stores and multi-price assortment is in increment of $2, $3, $4 and $5 that’s been tested in a 115 stores. We just reached the six-month mark in the initial stores, as the majority of the test stores were added in June. And we’re closely monitoring performance including impact to traffic, sales, margin, and of course customer feedback. As always, with tests we follow an interim process where we test, learn, modify, and improve along the way.

Our focus regarding multi price point tests as we finish this year and move into 2020 will be on delivering on great values to our shoppers within targeted categories, shifting more towards discretionary and unique products that we believe delivers the WOW factor to consumers and is additive to the basket and margin profile. Utilizing our broad vendor base to source these great value products, and ensuring as always that we protect the Dollar Tree brand.

Our brand is more than the items we sell for a $1. The Dollar Tree brand represents a pricing value and the customers get tremendous value for what they spend at Dollar Tree. Our efforts to drive this test should include extending our reach by adding great value, exciting merchandise, and opportunities to expand margin. We are still early in this test and look forward to updating you as the test evolves.

Family Dollar team delivered another quarter of positive comps with a 2.3% increase. Importantly, comparable transaction count for the quarter was positive, continuing the trend that began to emerge in midsummer. The team’s performance demonstrates that efforts to improve the consistency of execution across the chain and efforts to drive H2 performance are working and are gaining traction.

For Family Dollar segment highlights for the third quarter, our consumables business performed very well delivering its 12 consecutive quarter of positive same store sales. Our cadence of comps through the quarter all three months were better than 1.5% with August being the strongest month. From our zone perspective, comps for six of our seven zones were positive with the strongest performance in the West, Southwest and Southeast zones.

Our Family Dollar customer service course for Q3 showed improvement from the prior year, categories of store cleanliness, product assortments, speed of checkout were among the notable improvements. We continue to believe we are taking the right steps to transform our customer experience to increase the frequency of the business. These steps include improving customer satisfaction, developing brand and price reputation, focusing on opening price points, incorporating better organized and focused Dollar impact sections and serving more of what our customers need including frozen foods.

And as we expected the average scores for H2 stores where we have invested in our fleet are higher across the board. We continue to be very pleased with the performance of our H2 store format at Family Dollar. All new and remodel stores are in this format which is driving greater royalty, repeat business and value perception in these locations. These renovating stores continue on the average to deliver a comp greater than 10% in their first year post-renovation. We’re committed to this format and plan to renovate at least 1,000 Family Dollar stores to the H2 format in fiscal 2020.

We began rolling out the H2 format in Q3 last year. We continue to like the sales that we’re seeing in the H2 stores, now cycling into the second year. Our efforts to drive performance across the store base continued to focus on initiatives around our private brands with compare and save, our smart coupons that offer our loyal customers the latest and best values. Hallmark cards will be coming to all Family Dollar stores in 2020 and of course our store manager training and retention efforts as always to drive performance and consistency store-by-store.

In our store support center, we are seeing the benefits of having our teams Dollar Tree and Family Dollar together in one location. We anticipate being together will greatly enhance our culture, our ability to recruit great talent and improve the collaboration within our organization as we train and develop and provide even more and better support for our stores.

Looking at real estate for both segments in the third quarter, we opened a total of 165 new stores and 114 Dollar Trees, two in Canada and 51 Family Dollar. We relocated or expanded 12 Dollar Tree and three Family Dollar stores. We renovated 247 Family Dollars as part of our H2 renovation initiatives and we re-bannered 39 Family Dollars to Dollar Tree stores for a total of 463 projects during the quarter.

We also added freezers and coolers into a 138 Dollar Tree stores, bringing our total to stores of freezers and coolers to just over 6,000. During the quarter, we closed 42 stores, 12 Dollar Tree and 30 Family Dollars, and we ended the quarter with 15,262 stores, 11,447 Dollar Trees, 7,815 Family Dollars.

Before I turn the call over to Kevin, I’d like to provide an brief update on tariffs just prior to our last earnings announcement August as USTR announced at tariffs on List 1, 2, and 3 prices were increased from 25% to 30% on October 1st, tariffs on List 4A price were increased from 10% to 15% on the September 1 and tariffs on 4B price were increased also 10% to 15% on December 30.

As noted in our August earnings announcement, our outlook provided at that time does not include any impact related to these changes. Our updated outlook includes approximately $19 million of cost to good sold with the expected impact from the USTR tariffs for List 1, 2 and 3 as well as Plus 4A and 4B tariffs were implemented in Q4. Nearly all the expected impact is related to the introduction of List 4A tariffs.

Now, I’ll turn the call over to Kevin.

[Kevin Wampler, Chief Financial Officer]

Thanks, Gary, and good morning. Consolidated net sales for the third quarter increased 3.7% to $5.75 billion comprised of $3.07 billion at Dollar Tree and $2.67 billion at Family Dollar. Enterprise same-store sales increased 2.5%. On a segment basis, same-store sales for Dollar Tree increased 2.8% compared and for Family Dollar increased 2.3%. Overall gross profit was $1.7 billion compared to $1.67 billion in the prior year quarter.

Gross margin was 29.6% of sales compared to 30.2% in Q3 of 2018. Gross profit margin for the Dollar Tree segment decreased 60 basis points to 34.2% when compared to the prior year's quarter. Factors impacting the segment’s gross margin performance for the quarter included merchandise costs, including freight, increased approximately 55 basis points primarily due to higher freight cost. And distribution costs increased approximately 10 basis points primarily due to higher payroll costs and depreciation.

Gross profit margin for the Family Dollar segment was 24.5% during the third quarter compared to 25.3% in the comparable prior year period. The year-over-year decline was due to the following. Merchandise costs including freight increased approximately 30 basis points, driven primarily by an increase in freight costs and higher sales of lower margin consumable merchandise partially offset by improved initial mark on.

Shrink increased approximately 15 basis points resulting from unfavorable physical inventory results in the quarter. Distribution costs increased approximately 15 basis points due to increase payroll cost at the DCs. Occupancy costs increased approximately 10 basis points due to an increase in real estate taxes and markdown expense increased by 5 basis points, resulting from higher clearance activity in the quarter.

Consolidated selling, general and administrative expenses as a percent of net sales in the quarter increased 30 basis points to 23.5% from 23.2% in the same quarter last year. For the third quarter, the SG&A rate for the Dollar Tree segment as a percentage of sales increased to 22.1% compared to 22% for the third quarter of 2018. The increase was due to store operating costs increased by approximately 15 basis points were going from increased debit, credit card fee penetration and an increase in loss of global success after an earlier lease termination in the quarter. Payroll costs decreased approximately 5 basis points primarily due to lower retirement plan expenses and lower insurance benefit expenses compared to the prior quarter partially offset by an increase in-store hour and payroll due to higher average hourly rates and additional hours to support store initiatives.

SG&A expenses for the Family Dollar segment were 22.5% of sales in the third quarter compared to 22.2% of sales in the same period last year. The increase in SG&A as a percentage of sales was due to the net of the following. Operating expenses increased approximately 25 basis points, resulting primarily from higher costs related to the disposal of fixed assets in connection with our store optimization initiatives.

Depreciation and amortization expense increased approximately 10 basis points as a result of capital investment requirement to support H2 initiative. Corporate and support expenses increased 10 basis points, primarily related to store support center consolidation costs and higher depreciation. This included approximately $4 million of expenses related to the Q3 2019 discrete costs associated with our store support center consolidation. For the quarter, the Company incurred approximately $9 million in total discrete costs, which was consistent with our guidance.

On a consolidated basis, operating income was $358.4 million compared with $387.8 million in the same period last year and operating income margin was 6.2% of sales compared to 7% of sales in last year’s third quarter. Non-operating expenses for the quarter totaled $41.5 million, which was comprised primarily of net interest expense.

Our effective tax rate for the quarter was 19.3% compared to 17.1% in the prior year third quarter. The prior year quarter benefited by $15.7 million based on the Company substantial completion of our analysis of the Tax Cuts and Jobs Act on a net deferred tax liability valuation. The current year tax rate reflects the benefit of statute expirations and the reconciliation of the tax provision to the tax insurance.

For the third quarter, the Company had net income of $255.8 million or $1.08 per diluted share. This compared to net income of $281.8 billion or $1.18 per diluted share in the prior year quarter. Combined cash and cash equivalents for quarter end totaled $433.7 million compared to $422.1 million at the end of fiscal 2018. Our outstanding debt as of November 2nd was approximately $4.3 billion.

During the third quarter we purchased, repurchased approximately 125,000 shares for $11.6 million. At quarter end, we had $800 million remaining in our share repurchase authorization. We’ll provide an update on additional share repurchases, if any following the quarter which they may occur.

Inventories for the Dollar Tree segment at quarter end increased 14.4% from the same time last year while selling square footage increased 7.5%. Inventory pursuance worth 6.4%, our inventory levels reflect the early receipt of imports to mitigate tariffs, we believe the current inventory levels are appropriate and support the scheduled new store openings and our sales initiatives for the remainder of the year.

Inventory for the Family Dollar segment at quarter end decreased 4.2% from the same period last year an increase 0.9% on a selling square foot basis. Based on store closure for Family Dollar segment has 5.1% less square footage outstanding.

Capital expenditures were $279.8 million in the third quarter versus $228.4 million in the third quarter of last year; and for fiscal 2019, we are planning for consolidated capital expenditures to be approximately $1 billion consistent with our initial outlook. Depreciation and amortization totaled $160 million for the third quarter and $150.5 million in the third quarter of last year. For fiscal 2019 we expect consolidated depreciation and amortization to be approximately $635 million.

We’ve updated our outlook for fiscal 2019 and have lowered our guidance for Q4 based on the following expected effects. With regards to tariffs in USTR announcement we estimate Section 301 tariffs will increase our cost of goods sold by approximately $19 million or $0.06 per diluted share in the fourth quarter if the tariffs are fully implemented. Almost all of the cost is due to List 4A as its timing did not allow for significant mitigation.

We expect additional pressure on merchandize margin based on lower margin consumables growing faster than originally forecasted. We expect distribution costs to be higher than originally forecasted primarily due to payroll cost pressures from higher turnover which may affect productivity. The expenses related to repairs and maintenance, utilities and depreciation are now expected to have a higher run rate than originally forecasted.

Additional assumptions of our outlook are the calendar considerations for the remainder of the year which seems like there will be six year selling days between Thanksgiving and Christmas which will natively impact Q4 sales. We expect continued pressure on store payroll based on competitive markets, states increasing minimum wages or employment levels from completing the Company's initiative plans including H2 renovations and Snack Zones.

We estimate year-over-year domestic freight cost as a percent of sales to be slightly lower than the fourth quarter. Import freight rates as we noted on last quarter’s call will increase based on our April rate negotiation and beginning in January 2020 as a result of low sulfur fuel requirements for ships.

Net interest expense will be approximately $41.9 million in Q4 and we cannot predict future currency fluctuations we've not adjusted our outlook for currency rate changes. As always our outlook assumes no additional shares purchases. Our outlook assumes a tax rate of 22.3% for the fourth quarter and 21.4% for fiscal 2019. Weighted average diluted share counts are assumed to be 237.7 million of shares for Q4 and 238.2 million shares for the full year.

For the fourth quarter, we are forecasting total sales to range from $6.33 billion to $6.44 billion and diluted earnings per share in the range of $1.70 to $1.80. Investments based on our low single-digit increase in same-store sales and year-over-year square footage growth at 1.1%. For fiscal 2019, we're now forecasting total sales to range between $23.62 billion and $23.74 billion based on a low single-digit same store sales increase at approximately 1.1% of selling square footage growth.

The Company anticipates GAAP net income per diluted share for the full fiscal 2019 will range between $4.66 to $4.76, which includes discrete cost of approximately $85 million or $0.28 per diluted share, approximately $15 million or $0.05 per diluted share of store closer related costs and approximately $19 million or $0.06 per diluted share related to tariffs.

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

[Gary Philbin, President, Chief Executive Officer]

Thanks Kevin. Like I mentioned at the beginning of the call, 2019 has been a year of distinct opportunities. We planned and executed the material acceleration of our Family Dollar store optimization initiatives. Snack Zones resets at more than 1,000 Dollar Tree stores and the consolidation of our two banners to our store support center in Southeast Virginia. We accomplished that against the backdrop of the helium shortage and uncertainty regarding trade and related tariffs, continued impact of freight costs and DC costs affected by the increasing starting wage rates.

I'm proud of the sales results that both Dollar Tree and Family Dollar that were accomplished in the quarter. This is done in the first three quarters of the year with more than 2,000 stores disrupted from our initiatives. We invested in our stores, our starting rates in specific markets and have our fleet of stores ready for the fourth quarter and the key holidays.

As stated in today's press release, we also announced that we will do at least another 1,000 H2 renovations in 2020. Our confidence in this model grows as we have more across our fleet of stores and various types of settings, demographics, and densities of population. We will announce our new, we'll have another store level capital plans for 2020 at the end of Q4.

The impact on our gross margin in specific areas is ours to control and do better. We are focused on making improvements across several categories as we finish the year and start 2020. These areas include improving our shrink results, enhancing the efficiencies within our supply chain to better manage freight costs. Driving sales on the discretionary side of our business to reduce mix headwinds to margin and tariff mitigation efforts.

With shrink our plans are focused on enhancing allocations and right size inventories to all of our stores, especially those with a high shrink history. Continued focus on training throughout our field leadership district in-store teams, having loss prevention tools within our stores. And last week we're pleased to bring on a seasoned experienced retail executive in a senior VP role to lead both our Dollar Tree and Family Dollar asset protection teams.

The asset protection teams from both banners will report to him effective immediately, and our visibility to market issues external and internal will be enhanced with the combined teams in priority, high shrink markets. Our opportunities across our supply chain and freight costs are focused on optimizing our less than truckload inbound costs, fitting our key freight lanes and seeming to reward our best carriers by building that deliver on cost and service and getting back to our historical backhaul levels.

On the discretionary side at Dollar Tree, we're working hard to overcome our helium shortage with more party centered items to service our customers. For Family Dollar, we like what H2 has done for the top-line and transactions are focusing specifically around the impact on driving more discretionary within our stores. This includes our WOW tables, our dollar impact sections and the queuing assortment at checkout.

We still have more run way for all these discretionary sales in these areas. We're building on important categories that are doing well, especially around mom with kids across a combination of all things needed for young kids, including infant apparel and baby needs. Enhancing our party footprint with the addition of hallmark branded cards and Family Dollar through the first half of 2020.

For tariff mitigation, we are planning to continue our efforts to mitigate ongoing and potential new levels of tariffs as we head into 2020. These efforts include the continued support of many vendors to lower costs, the redesign of product packaging, efforts to shift mix between higher and lower cost products, awarding volume from multiple vendors to our most competitive suppliers, moving products out of China to reflect lower landed cost of goods.

In our combined team's purchasing power throughout all of Asia, and as always finding new vendors domestically and in other countries to develop the new and exciting values that our customers have come to expect. During the planning stages for 2020, we'll provide details related to 2020 outlook on our fourth quarter earnings call.

I believe our store chains are well prepared for the holiday season. I would like to sincerely thank each of our associates as we head into the fourth quarter and holiday season. More than 415,000 stores across the U.S. and Canada, our network of 25 distribution centers, and of course our store support center in Virginia. Thank all of them for their commitment, dedication and efforts to deliver value and convenience to our shoppers each and every day.

Finally, we continue to focus and make meaningful progress to grow and improve our business for both brands. We are well positioned in the most attractive sector of retail to deliver continued growth and increased value for our shareholders. The combination of more than 15,000 Dollar Tree and Family Dollar stores provides us the opportunity to serve more customers and all types of markets. The combination of two great brands provides great flexibility and managing our future growth.

Operator, we're now ready to take questions.

[Operator]

Thank you, sir. [Operator Instructions] We'll go first to Scot Ciccarelli with RBC Capital Markets.

[Scot Ciccarelli, RBC Capital Markets]

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

[Gary Philbin, President, Chief Executive Officer]

Scot, this is Gary. We're pleased with H2 because when we went into this, we knew we were adding in more frozen food doors and some more food that obviously has an impact on margin. But we also went into it with the thought of let’s offset that with some of what we do on immediate consumption, the queuing lines, the WOW tables, and I just think some better adjacencies to run the store.

Early on, we saw some degradation in margin, but as we sit here now, H2 is neutral to the fleet. But we didn’t do this to be neutral, I really -- our goal here is to have margin expansion within H2. So, we’re on the right path, we’ve got traffic going in these stores and obviously you heard us call out the comp, our next workflow is to maintain all of that and add margin expansion to H2,. We like everything that the customers are telling us about it. We like the results on the top line in sales, and we got a good going on our margin mix now.

[Scot Ciccarelli, RBC Capital Markets]

And what kind -- on a go-forward basis, Gary, and that’s helpful, but what kind of margin improvement do you think is realistic if we're looking out over the next, I don't know four to eight quarters, because I mean we’ve seen several hundred basis points of gross margin degradation in that business, and I guess I just kind of keep coming back to the question, do we have a true reset here or is that something once we establish the better top line, we can kind of dig our way out?

[Gary Philbin, President, Chief Executive Officer]

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

The expansion that can rise across the whole fleet are some of the things I’ve' talked about. We got to focus on the discretionary, seasonal, apparel, electronics, all those are the categories that I think get teed up in the right way in H2. It doesn’t mean that the rest of the fleet can't benefit from some of the same elements and efforts across the fleet.

So, we’re putting together our 2020 plan with the specific initiatives around those discretionary categories to drive -- maybe get the same benefit that we've really seen on the consumable side. We’ve got more folks coming through the front door here, and that is as important as anything than we do, and now I got to get them over the others side of the store to buy more of the discretionary products, that’s doable. More to come when we announce our 2020 plan.

[Operator]

We go next to Michael Lasser with UBS.

[Michael Lasser, UBS]

Good morning. Thanks for taking my question. So, at what point do you think you’ll have a reasonable level of visibility into the business? The factors that you mentioned outside of tariffs that contributed to your 10% to 15% decline, the reduction in your 4Q guidance including mix, payroll pressure at DCs, and increased run rates for repairs and maintenance, utilities and depreciation should have been somewhat known and not really surprising. So is it, once you get past this, then as we get into the first part of next year, do you feel confident that you’ll have a level of visibility into the profitability of this business or is it going to take longer than that?

[Kevin Wampler, Chief Financial Officer]

Michael. It's Kevin. Yes, I think as we look at the items we called out, obviously the shift in mix as we’ve seen the -- basically the consumable business outpaced even what we had forecasted. And really that’s in both brands more so in the Family Dollar brand and the Dollar Tree brand, but it’s in both brands. So, the Dollar Tree brand, we’ve got some good things going with frozen food, refrigerated, and in our center aisle as well, so a lot of things going on there.

And again, a little bit of overall effect from the helium shortage and the halo effect to the party department in general. On the Family Dollar side, obviously, we haven't seen the discretionary business kick in as well as we'd like it to Gary, what he's just speaking to. A lot of opportunity there, getting customers in the door is key, obviously, and getting the foot traffic and having that opportunity to sell them that discretionary item is very, very important.

I think if we honestly look at other pieces of the business, obviously we called out DC costs. Really this is not an area we've called out in the past so much, it's really been more of a -- more bigger topic as of late as we've gone into the, we would call our seasonal peak here in the end of Q3 and beginning of Q4 as we look at basically getting all the merchandise through these buildings. And with unemployment where it's at, it's obviously required us to bring up basically starting wages and making sure we can engage with those associates and train them appropriately.

[Gary Philbin, President, Chief Executive Officer]

Michael. It's Gary. I would just add there is so keep in mind, this was a year that, with everything we've been talking about the beginning of the year. The store initiative, 2,000 stores at various times torn up, keep in mind at a DC level, we're also not just shifting re-banners back and forth, we are also shifting product back and forth especially with the impact of our dollar sections and some of our while items. So that a lot of going, we combined a store support center too. With all those balls in the air I give credit to our store teams and our store support teams to get that done.

Every time, we're talking about here gives us the consistency and visibility as we go forward in '20. We have done all this, really with major initiatives both in our store base and our store support center. So, listen the things that we're focused on are the right things to drive the business. And with all that going on, we drove sales throughout the year and with H2 stores building a momentum throughout the year. I'm really pleased with where we add up on the top line and initiatives around the margin piece, we got to get after on each of them.

[Michael Lasser, UBS]

Totally reasonable Gary, it just seems like investors want some timeframe when they can hold you accountable to an improvement in profitability and better visibility because there have been a lot of disappointments over the last few years, and having some sense of when then my turn will be helpful to the investment community? And as part of that, are you still committed to the 14% to 18% EPS growth off your original GAAP guidance that you provided earlier in the year for 2020? And why would that no longer be the case?

[Kevin Wampler, Chief Financial Officer]

Michael, as we said before, that was at a point in time, what we knew at that point in time, obviously, we're working through and finishing up our 2020 plans. Obviously, the biggest unknown as we sit here today for us and many other retailers is tariffs and where does that land at the end of the day. So honestly, we're committed to improving our business and improving on the many things we've talked about already this morning. But what are, we'll give obviously guidance when we get to our fourth quarter call. And hopefully we'll have some clarity around all those things.

[Operator]

We'll go next to Paul Trussell with Deutsche Bank.

[Paul Trussell, Deutsche Bank]

I know you give guidance on consolidated basis but to the extent possible, could you give maybe a little bit more detail regarding your expectations per banner, as we think about comps and gross margin and SG&A into fourth quarter? And then as a follow-up, just bigger picture for Dollar Tree, margins looks like they're going to be down this year, and just curious, if you can walk through what some of those, what you view as more temporary in nature, as we kind of turn the page into 2020? Is this a business that you believe can get back to expand the margins? Thank you.

[Kevin Wampler, Chief Financial Officer]

Paul, this is Kevin. I think as we look at it, again, we don't give guidance by banner. Obviously, when you look at it from, what I can give you a little feel for Q4. If you look at the guidance we gave today and you can back into a range of operating income based on all the data we've given you.

And I would tell you that it's basically a little right around 9% or just above. If you compare that to prior year excluding the items such as the markdowns for a good inventory and store impairment, I would tell you the pressure between basically gross profits and SG&A is fairly consistent. So, we're seeing pressure on both line items. So, that just gives you some directional ability to think about that.

I think as we look at this year and as we look at obviously the fourth quarter. Fourth quarter is a big quarter for Dollar Tree from a seasonal perspective so we get a pretty good boost in sales just from a seasonal set, which obviously is always provided us the ability to basically provide a good gross margin.

And I don't see that in the, but our seasonal set this year performed very well. We had a very good Halloween set. We had a very good performance with our Halloween seasonal and feel good about going into the fourth quarter with our Christmas set. So, I think that always bodes well. Obviously, we do have the 6 less selling days, but that doesn't mean we're not going to try to make sure we do everything we can to get every last sales dollar that we can at the end of the day.

[Gary Philbin, President, Chief Executive Officer]

Paul. It's Gary. Let me sort of answer your question, what's temporary and start with Dollar Tree. The things that have we've been chasing this year, start with shrink, it's about banner issue, but shrink is something I have an expectation we're going to do better on next year. We're coming off of a second year of not great performance and we can do better. I think the freight fees we started talking about it last year was certainly a bigger impact in the first half. We're going to see some of that modify in the second half, but we're still significantly up year-over-year.

And the distribution costs, I think, firstly, I don't know, if it's temporary or not. I know that impacts us when we have more folks coming into a DC and it's really not even once you had to pay folks again in the DC, it's almost productivity that you lose in the DC because you got new folks that you got to train and retain. Those are the things that I think were the one offs for both banners that I would expect us to make improvement on and the issues we’ve talked about.

The mix on product to me is bigger issue at Family Dollar than it is at Dollar Tree. We are happy with what H2 has done, but across 2019 we’ve worked hard on keeping sales going. And we just got to find some of the same elements that drive customer traffic into those sections as they do on the consumables.

For Dollar Tree, no I don’t know how to think about tariffs, but as always it’s going to be about incorporating the next WOW into the store. We like what Snack Zone has done, put a little pressure on mix that’s what we get Crafter's Square going. A year before that we’ve started on snack zone, but we put in the Hallmark. So, it's always what we push and pull with what to drive customers on both foot traffic and sales and margin. We’re going to do that again as we go into '20. So, this is going to be pieces that we talk about category-by-category.

[Operator]

We’ll go next to Peter Keith with Piper Jaffray.

[Peter Keith, Piper Jaffray]

Hi. Thanks. Good morning everyone. So I want to look at the tariff impact, certainly it’s been a very volatile situation with a lot of the unmet changes. It sounds like that the impact in Q4 is really just because of the timing with that 4A incremental didn’t have time to adjust. Are you still confident if you look at 2020 and if you think you'll be able to mitigate most of the List 3 and List 4 tariff pressures?

[Gary Philbin, President, Chief Executive Officer]

Peter, its Gary. List 1, 2, 3, I think the teams have done through a couple of cycles now of working with our vendors to, either we fill our cost or redesign packaging, so we can land it. And in some case we’re moving outside of China as you’ve heard us talk about and even on those class trips as we are buying already following Halloween next year we’ve moved additional product out of China. So, you’re not going to pick up that entire supply chain, but that’s what we do sometimes item-by-item, vendor-by-vendor as we see those opportunities.

As we go into 4A and 4B, it's more of our product and as always I want to go into 2020 I think with some compelling product and we’re going to do the smart things around what we have to do to the best we can to mitigate. But I've also told our merchant teams at the end of the day. I want to be able to see what it is we might be changing or the opportunity to move product away from a vendor to another country before we do it. So 4A, what we’ve seen is we’re going to announced and we don’t have much time to mitigate and that’s what we’re calling out with the Q4 impact.

Going forward, when we get a chance to get on regular cycle buy and meet with our vendors, yes we can mitigate more of it, I just don’t have full vision of that till we go on a big buying trip in January which will be our first time really to meet with all of our vendors and I’m assuming at that point 4B is in effect as WOW.

[Peter Keith, Piper Jaffray]

Okay. Thank you for that. And then just on the discussion of mix particularly with the H2 remodels. One thing I’m trying to get my head around is, it seemed that with the increase of $1 items that you’d be experiencing greater buying scale with similar items from Dollar Tree and Family Dollar. So it does seem to me at least from the outside that there would be some benefits to mix from $1 item. So, are we misreading that or is it just that the discretionary weaknesses, this overarching negative on the business?

[Gary Philbin, President, Chief Executive Officer]

No, you heard me talk a little bit about an H2 four-wall margin that's about neutral to the fleet. And so the overall mix change that we're experiencing is no different have H2. What's different is that we invested heavily with more of our lower margin frozen food and additional expansion of some key categories in center to store food as well. That's lower margin. That's been offset, you're exactly right, with the impact of the dollar sections with the queuing assortment, with dollar WOW tables with immediate consumption.

So, the fact that we're back to fleet neutral margin, I think shows the power some of the sessions we just put up another level to get margin accretion going in an H2 store. So, the way I look at with the team, we almost take a look at, here's the sections we've invested in, what our sales and margin on a frozen food category and is that being offset with some of those other sections. And that's pretty much what we're seeing right now.

[Operator]

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

[Joe Feldman, Telsey]

Just want to get a little more understanding of like the higher price point testing from what, how are people responding to that so far?

[Gary Philbin, President, Chief Executive Officer]

I would say as folks come in, I would say it's one-third folks have seen the product and buy it. One-third of our loyal customers have commented that they don't like the market price point in our stores, and one-third or somewhere in the middle. Here's my view from everything we interviewed our customers with. It's not so far, we've had a priority on more consumables, which I think were an item that we want to test get out there across categories.

The next phase of the test is more about what I would call the Dollar Tree WOW side of it. We went over on our buying trip this July to buy specific categories. So, I would call them more on our variety discretionary side things that people haven't seen, and we'll see how customers respond. But I think that's more to what our customers are going to enjoy seeing incredible values on and allow us under our Dollar Tree WOW umbrella to say that's a great item, I don't see anywhere else.

And I know that costs more when I do see it. And I think that's going to be what we push on into some of those showing up in stores now by the end of 2020. So when we get a chance to test and learn and put new products and especially when we can design them and import them or find discretionary items domestically, I just think that's going to be the next phase of the test that gives us another important data point.

Our customers that buy it tend to buy more than the average Dollar Tree transaction, but I go back to what's success, and success in this is really to increase the reach of Dollar Tree to another segment of customers, and another chance to increase margin as well and as always protect the brand to say, this is the WOW factor at Dollar Tree.

So, those are the things that are in the mix. I think we have some exciting product coming in and we stay close to watching that week-by-week.

[Joe Feldman, Telsey]

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

[Gary Philbin, President, Chief Executive Officer]

Well, we are seeing some modest year-over-year declines right now a little bit. And the things that we're doing, we're in control. But we need to bid on the process. Now somebody has to sign up for the lower bid and give us great service, both an in-bound and out-bound to get those rates. So I'd like to think that it's something that as we read this some of the same headlines. We are not in the same position as a truck driver shortage exactly at this time a year ago.

I think that bodes well for us. The opportunity when we get better service on the outbound allows us to do more backhauls. So we're going into 2020, pushing all the levers we know to do to get both lower freight and better service. And we'll understand better ones are important third-party suppliers and independent truckers continue to give us service as we expect to, as we finish out Q4 into 2020.

[Operator]

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

[John Heinbockel, Guggenheim Securities]

Gary, curious when you think about the real estate composition of the thousand remodels you're going to do with Family Dollar this year, this coming year. How will that be different than this past year? Is there a desired any cluster more and if you do cluster more can that lift the brand perception at non-remodeled stores, if you do that?

[Gary Philbin, President, Chief Executive Officer]

Well, when we do take a look where's the number of stores, we went into this knowing that we wanted to fix some of the older stores in the fleet. So based on the last year's talks, we went into with the best opportunity based on volume. We did need a certain size. And really what we're skating to is, by the time we face these next thousand, we ought to be close to 40% of our fleet or a little better, being less than 5 years old. And I think to your point that, does give our customer a different perception of what they've seen at Family Dollar.

So, it's not necessarily that everything has to be H2. We got some great stores out there that are not, but we are changing the face of what the customer sees with this store initiative along with what we close, along with what we re-bannered to Dollar Tree. So, the combination of all those things gets us closer to an inflection point, which is I think what you're talking about what there's a customer see, and when inside the store that consistency around store standards, conditions and stocks are important across all the factors of the different stores that we run.

So that's what we're aiming for. And as we get more and more stores with the same opportunity, we're still measuring it what's our biggest return on capital as we go and invest in these stores, but I think just by the nature of our fleet with where we are across the country we’re starting to get some critical mass into some key geographies.

[John Heinbockel, Guggenheim Securities]

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

[Gary Philbin, President, Chief Executive Officer]

So, we’ve already said we’re in the low 20s as a brand which is pretty darn good. I mean it’s not grocery stores because we're not a grocery store. But I think across the categories, what I would like to see is something closer to a 100 basis point improvement consecutively over a number of years, I think that’s the opportunity in front of us. And I think it speaks to one having great product and values in stores. And number two, our customer just needs it because she's stretching a budget and the commitment on what we compare and say to national brands.

I think fits in our wheel house. I think the magic to it as always is introducing customers, because they'll step up to private brands on something that first, is something that they try on because of the detergent and then they’ll go to HPA products and then they’ll go to food products. And the team has done a wonderful job on rebranding across the different categories and I think that’s opportunities still with runway to it.

[Operator]

We’ll go next to Karen Short with Barclays.

[Karen Short, Barclays]

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

[Kevin Wampler, Chief Financial Officer]

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

[Karen Short, Barclays]

And then I guess just in terms of Family Dollar 2.0, I guess, I’m wondering if you could give a little color on what the second year sales lift is? I know it's still early days, but any color there? And I guess maybe a little color on, why you think it's -- you’re having more challenges in terms of getting the discretionary spend in those stores?

[Gary Philbin, President, Chief Executive Officer]

I would say, when we think -- let me answer your second question first. It’s still a customer that comes in and I think as responding to what we’ve done. I mean you just buy consumables on a weekly basis, the discretionary is tied sometimes to the season, but more times when I have for our customer a little more jingle in our pocket across the discretionary category. So, it’s a piece of always we got to have the right values in front of our customer, across each of the category.

So, maybe a part of this Karen, I would even say as we went in just knowing 2,000 stores is going to be disrupted a 1,000 plus at Family Dollar, we ended this year saying this is not the year to not to have foot traffic coming in H2 has been giving that to us. We’ve been hitting the gas, so it’s not just been H2 that’s driving the comp, so all boats have been rising. And I think that is important with knowing we were going to have the down stroke on the store initiative going into it.

So, I think we’ve had some better compelling values in front of the customer on the consumable side, and not that we give all those thoughts that how we lay down the store, but I think got to get back to the basics of blocking and tackling on the discretionary side. What was your other piece of the question?

[Karen Short, Barclays]

Year two, H2 comp?

[Gary Philbin, President, Chief Executive Officer]

We'd like the comps, I'd like to -- as we get more stores into this, I mean, we just finished up a 1,100 and change of H2. That profile has stayed consistent with the addition of more stores across geographies, across densifications of population. So, we do like that. I think as we get into the second year here, it's their stores are still cycling some of their grand opening activities from last year, so more to come as we get more stores into that bucket.

[Karen Short, Barclays]

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

[Gary Philbin, President, Chief Executive Officer]

Sure.

[Karen Short, Barclays]

Is there any variation in terms of this various stores on urban versus suburban versus rural? I mean, you kind of gave that third, third, third comment in terms of the customer response, but is there any pattern on underneath those markets in particular?

[Gary Philbin, President, Chief Executive Officer]

For Dollar Tree?

[Karen Short, Barclays]

Yes.

[Gary Philbin, President, Chief Executive Officer]

Or Dollar Tree plus?

[Karen Short, Barclays]

Yes.

[Gary Philbin, President, Chief Executive Officer]

No, I wouldn't say, I can't tell you there's a nuance here that really says as much of a difference. I think it's more about the product, Karen, than anything else at this point.

[Operator]

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

[Matthew Boss, JP Morgan]

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

[Gary Philbin, President, Chief Executive Officer]

Well, listen, we've been building, rebuilding our execution and rebuilding our banner. So I think that speaks to satisfying this customer. I think that's what H2 calls out that when we get a shopping environment that's compelling, exciting, and has the items they want, they'll respond to it.

To answer your question on the customer, yes, I think unemployment at an all-time low. I think folks in general can find a job these days. I think the opportunity is still often times there, one doctor bill or one car repair bill away from not being in such good shape. And that's really our opportunity to make sure that we have the right items to help them navigate budget from beginning of the month to the end of the month.

So, I would say things are maybe slightly better because of jobs. But I never like to stray too far from a customer that is keenly focused on value, convenience, and that's the cross hairs of our Family Dollar ought to just win the customer with everything we've been talking about with H2 and the entire fleet.

[Matthew Boss, JP Morgan]

And then, Kevin, maybe just to follow-up on gross margin. At the Dollar Tree banner, so this is the second straight quarter of 55 basis points and merchandise cost headwind that of freight and 10 basis points of distribution pressure. How do these two items specifically shape up to the fourth quarter? And then do you still view 35% of the structural multiyear gross margin for the Dollar Tree concept?

[Kevin Wampler, Chief Financial Officer]

I think, as we look at it, as we said, we look at freight in fourth quarter, we said domestic, we feel like we're headed in a little bit better direction could be flat to slightly down year-over-year. So that's a good news item. Obviously, somewhat offset by the fact that our import freight is going up.

So I think overall, I think we would look for the freight effect maybe to be a little less as we go through Q4. I think as we look at just margin in general, obviously as we've talked about, helium is a component of this. It does affect. It does have a halo effect on whether it's one of our biggest departments, and one of our most profitable departments.

And we'll feel a little bit of assets, the team is working really hard to create the other exciting items within that department that will drive that business whether we have helium or not, which obviously we're working hard to make sure we have helium as well. So moving pieces there, I would expect though, that as we do the things we need to do to execute on improving our freights going forward, that you'll see it'll be less of an issue as we get into Q4 in the New Year.

[Operator]

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

[Randy Guiler, Vice President, Investor Relations]

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

[Operator]

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