Dollar Tree, Inc.

Ladies and gentlemen, please stand by. We're about to begin. Good day and welcome to Dollar Tree Inc.' 's first quarter earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Randy Geiler, Vice President, Investor Relations. Please go ahead, sir.

Thank you, Aaron. Good morning and welcome to our conference call to discuss Dollar Tree's performance for Q1 2019. Participating on today's call will be President and CEO Gary Philbin, Family Dollar President Duncan McNaughton, and our CFO Kevin Wampler. Before we begin, I would like to remind everyone that various remarks that we will make about future expectations, plans, and prospects for the company constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially, from those indicated by these forward-looking statements as a result of various important factors included in our most recent press release, most recent 8K, 10Q, and annual reports, 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 question if necessary. Now I will turn the call over to Gary Philbin, Dollar Tree's president and chief executive officer.

Thank you, Randy. Good morning, everyone. I'm proud of our team's efforts throughout the first quarter. As many of the initiatives we discussed in Q4 have been kicked off and are progressing nicely. Our Dollar Tree team delivered a solid increase in same-store sales while cycling its toughest quarterly compare from the prior year. And Family Dollar again demonstrated a sequential acceleration in comp sales, In fact, the Family Dollar segment delivered its strongest quarterly same-store sales increase since we began reporting comps for the banner. Results for the first quarter included a sales increase of 4.6% to $5.81 billion, consolidated same-store sales increase of 2.2%. The Dollar Tree segment delivered its 45th consecutive positive comp quarter with a 2.5 comp, and Family Dollar same-store sales delivered a positive 1.9% despite the shift of early SNAP sales into Q4 from February. Gap earnings per share were $1.12 on an adjusted basis, excluding the accelerated rent expense for Family Dollar stores scheduled to close in 2019 related to ASC 842, diluted EPS was $1.14, within a penny of the high end of our guidance range. Other key highlights for the quarter included completing 372 family dollar H2 model renovations, completing 324 Dollar Tree snack zones, reinitiating our share buyback program, purchasing $100 million worth of shares in the quarter, and continue to remain on track with our consolidation of store support centers, as many of our family dollar associates and new hires are now in the process of moving to the Chesapeake campus. As we outlined in the previous call, due to the costs associated with our store optimization initiatives and store support center consolidation project, year-over-year operating income is expected to be lower in the first half of fiscal 2019, but is expected to show improvement in the second half as the initiatives gain traction. The majority of our previously announced store closings are taking place in the second quarter, along with the completion of our store support center consolidation. For Dollar Tree, sales highlights in the first quarter. Dollar Tree saw nice increases in both traffic and ticket, with traffic slightly outpacing the ticket increase. Geographically, all regions comp positively. Cadence of comps through the quarter. April was the strongest comp month of the quarter, and March was negative. Both months were impacted by the timing shift of the Easter holiday. Dollar Tree continues to deliver solid positive comps in the consumables category, and our seasonal business performed very well. They remain strong in our Dollar Tree's Easter season, was one of our best sell-throughs ever. At Dollar Tree Canada, the team delivered mid-single-digit positive comps for the quarter, with increases in both ticket and traffic. The consumable comp outperformed discretionary. Top performing categories include Easter seasonal, food, and household products. Highlights in Q1 for Dollar Tree Direct, our online business, we saw increases on our inline comp sales, items available for sale, site visitors, and engagement. Our e-commerce team continues to do a great job of engaging with our customers through a number of avenues. Our online content is constantly evolving to reflect our changing assortment, and we are very active in promoting the Dollar Tree brand through blog posts, banner ads, and social media. The team also did a great job in producing and distributing our Kellogg's for the Easter holiday and the upcoming summer season. Looking at real estate for both banners in the first quarter, we opened a total of 91 new stores, $65 trees, and 26 family dollar stores. We relocated or expanded 11 stores, $6 tree and $5 family dollar. We renovated 372 family dollar stores as part of our H2 renovation initiative. And we re-bannered 45 former family dollar stores to dollar tree. for a total of 519 projects during the quarter. We also added freezers and coolers into 102 Dollar Tree stores during the first quarter, now bringing our total of Dollar Tree stores with freezers and coolers to 5,766. During the quarter, we closed 25 stores, 9 Dollar Tree and 16 Family Dollars, and we ended with 15,264 stores, $7,102 being Dollar Trees and $8,162 being Family Dollar. Before I turn the call over to Duncan to discuss the Family Dollar business, I'd like to provide you an update on tariffs. Our merchandising teams have done a terrific job of mitigating the effects of 25 percent tariffs imposed under Section 301 for Chinese goods included on Lists 1, 2, and 3. We are uncertain as to whether or when tariffs will be applied to the List 4 products currently being considered by the U.S. Trade Representative. If tariffs on List 4 products are implemented, we expect that will be impactful to our business and especially to consumers in general. Until we have more clarity, our outlook excludes the impact of tariffs on List 4 products. However, our outlook continues to include the impact of tariffs on List 1, 2, and 3 products. Our teams are doing a nice job managing the controllables and running our business. We continue to believe we are well-positioned with the initiatives for both Family Dollar and Dollar Tree banners to capture the significant opportunity ahead of us. Now I'll turn the call over to Duncan.

Thank you, Gary, and good morning, everyone. While we are pleased with the Family Dollars team's same-store sale increase of 1.9% for the quarter, we recognize there is much more work to be done. As we make progress on improving the consistency of execution across our store base and accelerate our efforts to optimize the real estate portfolio, we see great opportunity to improve Family Dollar's productivity and performance in 2019 and beyond. We are very bullish on our progress to date and believe this will help transform our customer experience. Regarding Family Dollar sales highlights for the first quarter, an increase in average ticket drove the same-store sales increase in the quarter partially offset by a decline in transaction count. Consumables performed very well, delivering its 10th consecutive quarter of positive same-store sales, and the discretionary business was slightly negative. Regarding the cadence of comps during the quarter, February was negative, impacted by the shift of early snap sales into Q4. March was slightly positive, and April was the strongest month of the quarter benefiting from the later Easter in 2019. Seven of our eight lines of businesses comp positive for the quarter. From a regional perspective, six of our seven zones comp positive, with the strongest performance in the Northeast, the West, and the Southeast zones. As evidenced by our improved sales performance, our acceleration of initiatives to optimize the Family Dollar real estate portfolio is delivering results. We are seeing meaningful improvement in operational performance across the footprint of renovated Family Dollar stores, resulting in increased traffic and low double-digit comp sales lifts. We are pleased with the results of our H2 renovation program, both with traffic and the diversity of our locations. Comps are being driven two-thirds by traffic and one-third by average ticket. Customer feedback has included the following. Customers indicate they're shopping more often and spending more for the improved assortment. Broader selection of $1 items, more frozen and refrigerated product, and cleaner stores. Our survey feedback indicates H2 shoppers have a better overall shopping experience. More than half of the H2 stores, shoppers indicate they'll come back and spend more. In May, we closed 140 stores and we'll close another 150 by the end of July. We're making progress on our previously announced plans. Given the results we're seeing from our store optimization initiative, we're confident it will allow us to drive substantial improvement in the quality and performance of the Family Dollar portfolio and create long-term value. We're also in the process of consolidating our store support center. This project will be completed over the next few months and provide us great opportunity as an organization. We will benefit from the stability it provides and from the enhanced communication, collaboration and teamwork to provide our store teams with greater support. I will now turn the call to Kevin to provide more detail on our first quarter performance and our updated outlook for 2019.

Thanks, Duncan, and good morning. Total sales for the first quarter increased 4.6% to $5.81 billion, comprised of $2.96 billion at Dollar Tree and $2.85 billion at FamaDollar. Enterprise same-store sales increased 2.2%. On a segment basis, same-store sales for the Dollar Tree segment increased 2.5% or 2.4% when adjusted for Canadian currency, and the FamaDollar comp increased 1.9%. Overall, gross profit increased 1.6% to $1.73 billion compared to $1.7 billion in the prior year's quarter. As a percentage of sales, gross margin decreased to 29.7% compared to 30.6% in Q1 of 2018. Gross profit margin for the Dollar Tree segment was flat at 34.5% when compared to the prior year's quarter. Factors impacting the segment's gross margin performance for the quarter included higher distribution, depreciation, and payroll costs, increased freight costs, primarily outbound freight, as well as a higher proportion of sales than the lower margin consumable category. These increases were offset by improved shrink and improved initial merchandise mark-on. Gross profit margin for the family dollar segment was 24.8% during the first quarter compared with 26.7% in the comparable prior year period. The year-over-year decline was due to the following. Merchandise costs, including freight, increased approximately 90 basis points, primarily due to increased sales of lower-margin consumable merchandise, higher domestic freight costs, and inventory markdowns for stores being closed and re-bannered in Q1. Shrink increased approximately 50 basis points resulting from unfavorable physical inventory results in the current year and an increase in the accrual rate. Distribution costs increased approximately 35 basis points, resulting primarily from higher merchandising and distribution payroll-related costs. Occupancy costs increased approximately 20 basis points, resulting from the $6.7 million of accelerated amortization of the right-of-use assets for Family Dollar stores we planned to close during 2019. Excluding these costs, occupancy costs would have deleveraged slightly as a percent of sales. Consolidated selling general and administrative expenses as a percentage of net sales in the quarter increased 40 basis points to 23.1% from 22.7% in the same quarter last year. For the first quarter, the SG&A rate for the voluntary segment as a percentage of sales increased to 21.3% compared to 21.1% for the first quarter of 2018. The increase was due to the following. Payroll costs increased approximately 20 basis points, primarily due to an increase in store hourly payroll, due to an increased average hourly rate, supportive company initiatives, and an increase in incentive compensation resulting from prior year adjustments due to lower performance than target. These increases were partially offset by a decrease in retirement plan expense. Operating and corporate expense increased approximately five basis points, resulting from higher debit and credit fees primarily due to increased card penetration. Store operating costs decreased approximately five basis points due to lower utility costs, specifically electricity, resulting primarily from the benefit of the LED lighting program in the stores. Selling general administrative expenses for the family dollar segment was 21.6 percent as a percentage of sales in the first quarter compared to 21.5 percent for the same period last year. The increase in SG&As, the percentage of sales, was due to the net of the following. Payroll expenses increased approximately 25 basis points, primarily due to an increased average hourly rate and a support of the company's initiatives related to the costs for store renovations, rebanners, and closures. Store operating costs increased approximately 10 basis points, due primarily to higher refrigeration repairs and maintenance costs in the current quarter, And depreciation and amortization expense decreased approximately 25 basis points as a result of certain assets becoming fully depreciated or amortized. Corporate and support expenses increased 20 basis points as a result of $7.6 million of store support center consolidation costs and higher legal fees. On a consolidated basis, operating income was $385.5 million compared with $437.6 million in the same period last year. and operating income margin was 6.6 percent compared to 7.9 percent in last year's first quarter. Operating income margin for the Dollar Tree segment declined 20 basis points to 13.2 percent when compared to the prior year's quarter. Operating income margin for the Family Dollar segment was 3.2 percent for the quarter. Non-operating expenses for the quarter totaled $41.6 million, which was comprised primarily of net interest expense. Our effective tax rate for the quarter was 22.1% compared to 22.6% in the prior year's first quarter. For the first quarter, on a GAAP basis, the company had net income of $267.9 million, or $1.12 per diluted share, compared to net income of $160.5 million, or $0.67 per diluted share in the prior year's quarter. This year's first quarter included $6.7 million or 2 cents per diluted share of accelerated rent expense related to the adoption of ASC 842 for lease accounting that was not included in our previous company outlook. Adjusted EPS was $1.14. The prior year's quarter included 52 cents of cost associated with debt refinancing. Today's press release includes a reconciliation of non-GAAP financial measures for details on these adjustments. Combined cash and cash equivalents at quarter end totaled $725.8 million, compared to $422.1 million at the end of fiscal 2018. Our outstanding debt as of May 4th, 2019, was approximately $4.3 billion. During the first quarter, we invested $100 million in the repurchase of approximately 960,000 shares of stock. At quarter end, we had $900 million remaining on our share repurchase authorization. We will provide updates on additional share purchases, if any, following the quarter in which they may occur. Inventory for the Dollar Tree segment at quarter end increased 10.6 percent from the same time last year, while selling square footage increased 5.7 percent. Inventory for selling square foot increased 4.6 percent. We believe that current inventory levels are appropriate to support the scheduled new store openings, rebanners, and our sales initiatives for the second quarter. Inventory for the family dollar segment at quarter end decreased 3.8% from the same period last year and decreased 3% on a selling square foot basis. Capital expenditures were $209.2 million in the first quarter versus $180.9 million in the first quarter of last year. For fiscal 2019, we're planning for consolidated capital expenditures to be approximately $1 billion, consistent with our initial 2019 outlook. Depreciation and amortization totaled $151.2 million for the first quarter. Depreciation and amortization expense was $151.5 million in the first quarter last year. For fiscal 2019, we expect consolidated depreciation and amortization to range from $635 million to $645 million. Our updated outlook for fiscal 2019 includes the following assumptions. Calendar considerations for the remainder of the year include that There will be six fewer selling days between Thanksgiving and Christmas, which will negatively impact Q4 sales. Our guidance includes the expectation that Section 301 tariffs will be 25% on List 1, 2, and 3 goods. However, our guidance does not include potential tariffs on List 4 goods. Our company outlook on March 6th of 2019 included $95 million in discrete costs related to to our Family Dollar Store Optimization Initiative and our Store Support Center consolidation. With the increased visibility of our cadence of projects, we now expect to incur approximately 90% of these costs in the first half of the year. In Q1, we incurred approximately $28 million for these initiatives. Our Q2 outlook includes an estimated $57 million in costs related to these initiatives. As noted with our company outlook on March 6th, we did not include charges for lease obligation and related expenses for any closed stores in 2019, as we could not estimate the P&L impact until after the adoption of ASC 842, the new lease accounting standard. We now expect to incur approximately $30 million or 10 cents per diluted share of costs in Q2 related to store closings for lease obligations and related costs. We entered into new import freight contracts effective May 1st based on negotiations in April. The new contracts were unfavorable compared to our prior outlook and will add approximately $15 million or 5 cents per diluted share of expense in the back half of the year. That was not included in our original company outlook for fiscal 2019 provided on March 6th. We expect continued pressure on store payroll based on competitive markets, state increasing minimum wages, and completing the company's initiatives plans. We expect year-over-year domestic freight costs as a percentage of sales to increase in the first half of the year and then flatten out in the second half. That interest expense will be approximately $40.5 million in Q2 and approximately $161.8 million for fiscal 2019. We cannot predict future currency fluctuations, so we have not adjusted our guidance for changes in currency rates. Our guidance assumes no additional share repurchases for the year. Our guidance assumes a tax rate of 22.6% for the second quarter and 22.4% for fiscal 2019. Weighted average diluted share counts are assumed to be 238.6 million shares for Q2 and 238.8 million shares for the full year. For the second quarter, we are forecasting total sales to range from $5.66 billion to $5.76 billion, and diluted earnings per share in the range of 64 cents to 73 cents. These estimates are based on a low single-digit increase in same-store sales and includes approximately $57 million of discrete costs. Additionally, as I noted, our outlook now includes approximately $30 million or 10 cents per diluted share of costs related to Q2 store closures For lease obligations and related costs, it was not included in the company's previous outlook. For fiscal 2019, we are now forecasting total sales to range between $23.51 billion and $23.83 billion, based on a low single-digit same-store sales increase and approximately 1% selling square footage growth. The company anticipates GAAP net income-prohibited share for full sales year fiscal 2019 will range between $4.77 and $5.07, which includes discrete costs of $95 million or $0.31 per share as previously disclosed. Additionally, our outlook now includes $30 million or $0.10 per dilute share in store closure-related costs and import freight costs of $15 million or $0.05 per dilute share related to increased import freight rates as previously described in our updated outlook. Now I'll turn the call back over to Gary.

Thanks, Kevin. Before turning the call to your questions, I'd like to share some information about our Dollar Tree Plus test. As announced last quarter, we are conducting a test by lifting the dollar price point restriction. Testing is not new to us, and we've got a long track record of using an analytical approach to challenge our own thinking. It's the kind of approach and process that led to the development of our H2 stores at Family Dollar and gave us the confidence to accelerate our store optimization program across the Family Dollar portfolio. We spent the past several months laying the groundwork for this test, carefully and thoughtfully designing a test that we believe will allow us to measure the impact of different price points, items, and categories on shopping behavior, store profitability, and our loyal customers' affinity for the Dollar Tree brand. We will be leveraging Family Dollar and Dollar Tree distribution center systems and combined merchandise to efficiently get the new products into Dollar Tree stores. without disrupting our normal operations. For the test, we have selected a set of stores located in urban, suburban, and rural markets, and we will be measuring the performance versus prior results, as well as against our control stores in similar markets. As part of the planning for the test, our Dollar Tree team has been working closely with the Family Dollar merchants to identify the right products to include. We'll be offering a range of items across a number of categories, We will be testing primarily at price points of $3, $4, and $5, and the products will be displayed in four-foot sections or end caps clearly branded as Dollar Tree Plus in order to minimize confusion with our dollar values that our customers have come to expect. We believe the wow factor of what we have created at Dollar Tree should carry over to this test and continue to build our brand. This is not raising items from our dollar price point to a higher retail. This is about adding new items and categories to add sales and margin. The test officially launched a few weeks ago with products hitting the shelves of the first batch of stores. We are in the process of rolling it out to more than 100 test stores and will measure, analyze, and adjust products, layout, and other variables to ensure we are responding to customer feedback in our continued merchandising efforts. because this is an iterative process. We do not have a set timeframe for the test. It's in the early days right now, but we will have more details to share on our progress in the future. Lastly, my thanks to all of our store teams that are engaged daily to deliver great service and value to our customers. And I call out to all of our Family Dollar team members. They're in the process of moving while we consolidate campuses or are staying on to train as necessary. I'm proud of everyone's efforts and achievements during this first quarter. Now we're ready to take your questions.

Thank you, sir. Ladies and gentlemen, if you'd like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. In the interest of time, we ask that you limit yourself to one question and one follow-up question. Again, that is star 1 for your questions at this time. We'll take our first question from Robbie Ohms with Bank of America, Merrill Lynch.

Oh, hi. Good morning, guys. My question is actually on the H2 format. And I guess, you know, maybe Gary, you know, maybe Duncan should answer this. But just could you guys talk through, you know, so you've put party, freezer, and cooler in there. You're getting a 10-point comp lift. How far could you go with the Dollar Tree assortment over time would be one question. Another question is can you tell us how bringing that assortment into the H2 format changes the store level operating dynamics? Does it change the payroll structure significantly? What does sort of the expected EBIT margin look like for a family dollar store that's in the H2 format? Thanks.

Robbie, I'll start and hand it over to Duncan. From the standpoint of what H2 has done, it's put in some key dollar sections throughout the store. And the opportunity there is just to leverage what we've done at Dollar Tree for years. And it gives our customer the opportunity to see these great values. Obviously, we've added more frozen food doors. That drives traffic, but as you pointed out, we've also expanded seasonal party. We have a queuing line that sort of gives our customer the last chance to find great values. Let me turn to Duncan on what we see as part of the opportunity to keep driving sales. We're pretty proud of a 10 comp in this fleet of stores, and we're going to continue to drive some additional sales efforts to see how high it can go. But, Duncan?

Yeah, thanks, Gary. Thank you, Robbie, for your question. As Gary stated, we're pretty excited about the success we've had to date. It's very exciting to the customers as well as our team members when you walk these stores. It's not uncommon to get hugs and thanks from both customers and store people because the people really enjoy the store environment. So we're very excited about it. Just one other thing I had noticed is that we did fix the adjacencies in these stores to make our our shopping experience much easier and thoughtful for our customer. And as we added the freezer and cooler doors with primarily food and dairy, we also added six doors of immediate consumption products which drive good gross margin for our business. Really in there is the soft drinks, the teas, the waters, the flavored energy drinks that are so popular amongst our customer. And where appropriate, we also add adult beverages which drives foot traffic for our primary customer. So we're very excited about that. We do have 21 sections across the store with Dollar Tree items in the store. And a number of things it does is it creates a halo of strong price impression for our customers. And we get feedback that says it looks like prices are lower. And we're getting great engagement from our customer in those sections. But the real magic there is that the categories are actually starting to rise. It's not just the dollar sections alone, but we get better penetration in some categories that we had seen in our traditional format. So we're very excited about that. We provide additional labor when we reset these stores just because of the workload. And then we want to make sure that we test how high is high with this. So we do invest additional labor, but then we wean the store back off and let it self-fund Within about four weeks, it can get on a self-funding basis. We train one specific person in the store to handle the Dollar Tree items, as they are different and they behave differently than our family dollar products. They're not planogrammed. We show them a section flow. So the work is relatively easy, and it also allows us to get in and get out of these categories pretty quickly without disappointing a customer. And so I would tell you that We're very bullish on what we're seeing today, both from the store teams, the labor and how it balances right back to the stores pretty quickly, and the customer interaction.

So if I dream the dream, is the more, you know, these are smaller stores, but the more Dollar Tree assortment you get into a H2 family dollar, does the EBIT margin of that store start to look more and more like a Dollar Tree store EBIT margin?

Robbie, this is Kevin. I think as we think about it, obviously we're working to drive top line first and foremost, right, because that helps leverage all of our fixed costs at the end of the day. We've got a limited number of stores we've completed this time, still a lot of work going on. The freezers and coolers, adult beverage, tend to drive a little bit lower margin at the end of the day, so we have to offset that with the party and the things like that. So it's a little bit too early given the small number of stores in general. But I think in general, obviously, we're looking for an EBITDA lift. I don't think that the model is built such that it will ever have the EBITDA of a Dollar Tree store. It's just given the amount of consumables we sell to our core customer for our family dollar banners versus a discretionary business we have in our Dollar Tree business. business, they're never going to quite equate at the end of the day. But the idea, obviously, is to drive sales and drive improvement in that overall EBITDA margin as we go forward.

Very helpful. Thanks so much, guys.

And again, ladies and gentlemen, in the interest of time, please limit yourself to one question with one follow-up question. We'll go next to Brad Thomas with KeyBank Capital Markets.

Hi, good morning. Thanks for taking my question. I also wanted to follow up on the the H2 performance really encouraging. I guess when you look at Family Dollar here for this quarter, could you talk a little bit about how much of the comp lift you're seeing was explicitly from some of the initiatives that you have in place versus maybe just the cadence of the overall consumer? And as you're looking out through the balance of the year, do you still believe these initiatives are going to be a one and a half percent tailwind to comps for Family Dollar? Or is there a reason to perhaps get a little bit more optimistic at this point?

Brad, thanks for your question. We're excited about what we're seeing really across the portfolio. I will tell you that this is just not H2 driven. This is really watching the entire performance of the company going up. And that was demonstrated by seven of our lines of businesses, positive comp, in six of our seven zones. So we're seeing nice balance across the chain. H2 obviously is a highlight amongst where we're investing those dollars when we get that nice lift, and we believe that is a sustainable lift as we start to continue to roll this across the United States and most of our store base over time. I will tell you that we've had great balance across our promotional sales, our baseline sales, and when we're preparing to close some of these stores, we're seeing some good clearance sales. So we're getting a real nice balanced approach. So we feel good about that. The key here is the base business is solid.

Great. Thank you very much.

We'll take our next question from Michael Lasser with UBS.

Good morning. Thanks a lot for taking my question. If we back out the 15 cents of incremental one-time items, from your guidance. The midpoint's going up two cents, but the high end of the range is coming down quite significantly. Why is that?

Well, I think if you look at the guidance, Michael, from where we started at for the year, basically, if you take the fact that on a gap basis for the quarter, you'd have to reduce the high end by $0.03 and you'd basically bring up the low end by I believe it was $0.08. And so you have that adjustment. And then beyond that, it's just the range always narrows as you go further down into the quarter. You're a quarter further into the year. You now have three quarters left. So we had roughly a $0.40 range when we first started the year. We're now down to a $0.30 range. But then otherwise, to your point, it's just the initiatives, the two new items that we brought in. So I don't think there's anything to read into other than that. You know, from my perspective, we didn't, you know, the only changes to the guidance were for the lease obligation costs that we brought in. Again, as we noted, we couldn't give you those at the beginning of the year, given the fact that we had to adopt and implement ASCA 42 before we could even calculate those costs. And then obviously the new item with the new contracts on our import freight.

And Kevin, should we still be expecting 14% to 18% EPS growth into next year? And what number should we be basing that growth off of? Should we be excluding the incremental 15 cent hit from those items that you mentioned?

Yeah, Michael, you know, I think, you know, as a backdrop with our outlook in March, you know, we wanted to give a little longer-term outlook given, you know, the significant investment we were making in this year in particular around the initiatives to drive improved performance in our Fama dollar stores. And we're obviously very focused on all of our store initiatives and the projects. And as Gary and Duncan have described, we're making really good progress and we like where we're going there. So that's very, very positive. You know, it was given at a point in time. I don't think we've changed necessarily our viewpoint. We said at that point in time that it was based upon the gap number. We haven't really updated anything at this point, so I don't think anything's changed, and we'll just continue to update you probably later in the year as we continue to work forward through this year and we have more data to work with.

And Michael, from my perspective, as we go through this year with the initiatives we've called out, we're closing almost 400 family dollar stores. The big investment in the H2s will go a long way, first half, second half, as we build momentum at family dollar. For Dollar Tree, I'm pretty proud of what the team's accomplished with this quarter and overcoming the 25% tariffs. And we see ourselves... Chugging along here with the season still responding the way we like to see them come through with great sell-throughs and our customers responding. And we're set up in a nice way for the summer season after having some good spring sales on Mother's Day and Easter. So, you know, those two things together, I think as we go through the back half of the year, we'll see the momentum in the second half.

And can I just clarify one thing? We recognize that you didn't include the final list. of tariffs in your guidance given all the uncertainty there. But can you help us understand the exposure? What percent of Dollar Tree's cost of goods come from China and would be at risk if the full list of tariffs go through?

Well, here's how I think about it, Michael. If I had sat down last September and tried to take you through our exposure on list three, I would have been wrong because our team mitigated most of it, all of it, you know, as we went through our buying trips. And that's the approach we're taking on this list for. Listen, I don't know when, how big, how much, what items are going to be excluded. We all know what hasn't been detailed out there. All I know is our team doing the same process, running the same play. How do we mitigate? And that's everything from what we buy, how we buy it, where we buy it, how we ship it. You know, we're going to use all those chapters in our playbook to get to the right answer on it. Listen, as it comes to pass or not, we'll keep the group updated. But we are not sitting back on this one. We're also figuring out how we mitigate it if it comes to pass.

Thank you, and best of luck.

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

Hey, thanks. Good morning, everyone. So just to follow up on Michael's question, with the current tariff exposure of Good List 3, you guys did a really nice job of mitigating that impact. If there was broader exposure to the rest of the Dollar Tree business, are there differences with some of the other categories that may receive new tariff exposure that would limit your mitigation, or is it sort of a similar approach that you would use for the whole store?

Well, I think the way I, obviously, it's, you know, we import both banners. Not all of it comes from China. The vast majority does, of course. And so the things that we even did back on our January trip, you know, we moved $100 million of seasonal buy out of China. We changed some of the specs that we were shipping items in just so we could pack more in a case, more cases on containers. So you could land it, you know, overcoming the tariff. We're looking at other countries. The process will be the same. I mean, our merchants now have a pretty good, I won't wish this on us, but this made our merchants go and take a look at everything we're doing in terms of speccing product, where we're buying it from, negotiating, getting cost in a product. And those are going to be the foundational elements as we go forward. into this next round.

Okay, that's helpful feedback. And maybe I want to pivot to the gross margins at Family Dollar, specifically digging into the shrink headwind. So the shrink headwind has just continued to intensify over the last year. I guess looking at it on a two-year stack basis, it's now an 80 basis point headwind. Could you give us your view and when we might begin to see shrink stabilize, and what are the steps you're taking in order to minimize that hit?

Yeah, this is Kevin. I'll give you some background on that. Obviously, you know, we're very disappointed in our results, and we own that, and, you know, we have not executed at the level we've expected to, so... And this is, I would tell you, this is not sitting on the corner of somebody's desk. This is front and center for everybody, you know, the operations team, the loss prevention team, the logistics team, management. You know, I think one of the things we have fought a little bit is our inventory levels. Again, our inventory levels have grown. You saw for the first time this quarter we were actually able to bring inventory levels down, and that's going to be a continued effort there. by Duncan and team as we look at that. We've made changes in the reporting structure and leadership in regards to over looking at the Family Dollar Banner as regards to our loss prevention team and how we're looking at that. We have put in place several new programs. We're putting in a new analytics software. So we're doing a lot of things, and again, as you know, what we're working on now probably takes a little bit of time to see the benefits of, but my expectation is we see the effect of the negativity dissipate somewhat as we get towards the back half. Now, we still have work to do. I think it's a It's a disappointing trend, but I think there is a lot of work going on to really address this on an overall basis. Okay. Thanks a lot, guys.

We'll take our next question from Scott Mushkin with Wolf Research.

Hey, guys. Thanks for taking my question. I just wanted to get back to the profit dollars on the H-2. It wasn't clear. Are EBIT dollars up in those stores, or are they flat, or are they down? I don't know once you've converted.

No, they're absolutely up.

They're up. Okay, great. And then looking, I just wanted to poke a little bit more at this gross margin on family dollar. Where do you think we go? I mean, obviously, they've come down a lot. Shrink's part of it. So number one is, is that shrink really just thieving? What's the number one cause of that shrink? And number two, as we bounce family dollar gross margins, any thought where we could come back up to?

I think as we look at our gross margin of family dollar, you kind of have to look at it in buckets is kind of the way I would think about it. So if we look at the overall, if we look at just the product margin, including freight, obviously freight was a big headwind last year. A little bit of a headwind this year in the first half. We expect that to flatten out in the back half. As we look at actual merchandise costs, a little bit of pressure, obviously, from selling more lower-margin consumable goods. A lot of work going on to really energize the discretionary business to help offset that. So that's As we see that discretionary business continue to improve, I think we have the ability to offset that as we go forward. I think obviously markdowns this year will be a very tough year of markdowns because obviously we have all the initiative markdowns going into the P&L. I think occupancy cost was actually a good point here in Q1, as I noted. including the $6.7 million related to the adoption of ASC 842. We actually would have shown a slight deleveraging of occupancy costs as a percentage of sales. So those things are positive. So I think we'll still see pressure as we go through this year in particular because of some of the one-time costs and some of the initiatives things going on. I think as we get sales, continue to see sales improve, that helps leverage some of these things. and gets us back on track to improving it back to where we would like to see it.

Scott, this is Gary. Let me just give you my color on it, because the way I think about it, the things around our logistics costs, you know, the shortage of truck drivers was an impact this year. That will level out in the back half. The DCs, listen, we've paid up more just to get people to work in distribution centers, but our productivity over time We'll catch that up and surpass it. Shrink, we have everybody on a red alert. That's controllable. And where does it come from? Well, as any good retailer, you look inside and outside, but we've just got to be smarter on responding to it more quickly. And Duncan and team are working a lot to get our folks trained. But the margin piece, here's still the opportunity that I think we, besides what we're doing at H2, You know, we still are working real hard on private brands. We have a pretty good base-level penetration, but it's going to grow more over time. In the import piece, what we've continued to work on, you know, with the Chinese tariffs, it's shining even a brighter light on the opportunities there, and not just the fact that we're buying some items in China. But when we get a chance to move something from a domestic – to FOB China, to finding the folks that actually make it all enhances the margin there. You've still got runway there. And that's the upside opportunity at Family Dollar on the margin side.

All right, guys. Hey, thanks for the thorough answer. Really appreciate it.

We'll take our next question from Scott Ciccarelli with RBC.

Good morning, guys. Question on the Dollar Tree Plus. Really two questions. First, philosophically, why are you not testing $2 but focusing on $3 and $5, just trying to understand that? And then number two, how much of the store or SKU base will be, let's call it, repriced as you run through that test? Thanks.

Well, a couple of important points, Scott. I mean, you may see some $2 in there. I think the point I'm trying to make is we're going to see full price points. You're not going to see $3.25. You're not going to see $4.65. I think our customer, we're going to make this very easy for her to figure out as we go through it. And I just want to emphasize, we're not raising retails on the dollar items that our folks have come to love and count on. And I've gotten more letters from school teachers that are threatening me in a nice way that I don't dare do that. But I think our opportunity here is to find some additional categories, items that can add to the sales. And that's really the intent of this. It's does our customer understand the wow factor that we worked so hard on all these years to make Dollar Tree a breakthrough brand in America? And can we take that wow factor and put it into the store and make our customers understand it and they understand the wow? as we lift the dollar price point. So I think it's going to be very clear to the customer what these items are. They'll see the items with a sticker on them or pre-priced in some fashion. That will be very clear to them. And our folks are being trained to answer all those questions. We want our customers, when they raise their hand and say, how much is this? It's not going to be because they're confused on the price. It's going to be because they still see these incredible values. So we're all over this in terms of getting good execution first during rollout. What do we learn as we do that? And then following up with customer feedback as we go through the process.

Yeah, the full price point certainly makes sense. And how much of the store SKU base will be, let's call it, changed?

Oh, I mentioned, you know, you're going to see, you know, let's just say 100 plus SKUs. And listen, the same way we do at Dollar Tree today, you're going to see items come and go. Buy it while you see it. It's not always going to be there. And so, you know, when you think about the SKU base, you know, we're going to start someplace and probably end up skating somewhere else. But that's about where we're going to start and just learn as we go.

All right. Very helpful. Thanks, guys.

Ladies and gentlemen, we have time for just a few more questions. Again, please limit yourself to one question and one follow-up. We'll go next to Paul Trussell with Deutsche Bank.

Hi, good morning. I appreciate all the color on updated outlook and margins, but I wanted to just follow up and just maybe get a little bit more detail on specific expectations for 2Q versus the second half on some of those key items like freight and shrink payroll. If you can just give us a little bit more detail on how we should think about the cadence.

Yeah, I mean, I think freight we've been fairly transparent on, I believe, from a domestic standpoint. We've said it's a headwind in the first half of the year. I believe it becomes basically flat in the second half. We've seen, from an overall perspective, inbound has started to regulate itself a little bit, it seems like. Domestic is still running a little high, and then obviously we gave you the news on the On the import, which is about $0.05, but it's back half related. Think about that. Payroll in general, again, store hourly payroll is going to continue to basically be up slightly as we go through the year, probably no different than what we saw in Q1. We continue to see, from an employment standpoint, an increase in average hourly rate in our stores. And, you know, I think that's part of it. So we have that. And then I think from a shrink perspective, as I said, I think it's likely to continue to be up in Q2. My view is we need to see that start to, you know, level out as we get to the second half. Now I think as the other thing to remind everybody is, you know, initially when we were talking about the costs related to the initiatives, at the beginning of the year, we said about 75% of those costs would be incurred in the first half of the year. We're now, today we said roughly 90% of those costs would be incurred in the first half. So based upon the fact that we can, we've seen the cadence and the efficiency we've gained there and how our projects are laying out for the year, we've been able to see that and obviously It gives us that foundational base of the $57 million of costs that we're going to see in Q2 related to all those initiatives. And those touch many, many lines. You know, it touches labor, it touches markdowns, it touches various other costs as well. So those are all kind of blended in there at the end of the day, Paul.

Got it. And then, you know, bigger picture, as we think about the fact you are doing a lot of remodels, closing a number of family dollar stores, just want to take a step back and get your current outlook on the opportunities still for new door growth in the dollar store industry. Maybe speak to new store productivity that you're seeing today and just where the white space is.

Hey, Paul. This is Gary. So, you know, we had said a few years ago 25,000 domestic U.S. and 1,000 Canada. I think on the U.S. side, I still see that opportunity. It's going to be both Dollar Tree and Family Dollar. And I think as we've, you know, learned about the business, the opportunity to build Family Dollars, you know, we were probably 60, 40, even closer to 70, 30 urban versus rural over time. I see that switching. I see our greenfield for family dollar being more rural than urban. I don't know if they'll switch to a percentage of 70-30, but probably closer to something like that over time. And I think the opportunities are what we've called out. What we deliver is a great box shopping environment, items that people need that as independent drug stores, grocery stores, or other retailers are failing, it gives us an opportunity to grow for really both banners. But at Family Dollar, that's an opportunity in rural America. I think Dollar Tree continues to be one of the great brands in America. It cuts through the clutter. We still see the same opportunity across the broad middle of we can go anywhere. But Family Dollar probably works best inside the Beltway and in the extreme rural. And for Dollar Tree, we still see plenty of opportunities. I think you make a good point. We're spending a lot of time and energy on the 1,000 renovations this year on H2. We got 1,000. We're hardly talking about snack zones, but we're touching 1,000 Dollar Trees as well. but the opportunity to build more doors is there, is going to switch more to that in the out years. When you take a look at the number of stores we'll have touched on H2 renovations this year, 1,000, the new stores behind us, by the time we get through end of next year, we're going to be closing in somewhere close to 40% of our family dollar fleet having been touched through a renovation or being new in the last four years or so. So it's going to be a change from what our customers have seen in the past. So we're bullish on what H2 can do for us, where it can operate, where we can grow it. And for a Dollar Tree, we continue to be, as always, selective on the right sites for a Dollar Tree. But it's still a growth story for both banners as we look forward.

Thank you. Best of luck.

We'll take our final question from John Heinbacher with Guggenheim Securities.

So either for Gary or Duncan, when you guys think about the family dollars organization, the organization's capacity, right, for change, and particularly on the real estate side, so you think about the 1,000 renovations, is that sort of the max? Can the platform handle more than that? And then the success of that, you know, does that, when you think about the bell curve on store performance, once you close the stores you're going to close this year, are we basically through now because of the H-2's promise another round of closings next year or beyond.

John, it's Duncan. Thanks for the question. I will tell you that the Dollar Tree Enterprise team, actually based here in Chesapeake, really runs and leads all the store development work across the country for both of the banners, and it's supported locally, obviously, with the folks that are in the field, a mixture of both Dollar Tree and Family Dollar people. But I will tell you that we are nowhere near our capacity here. As you know, we're also adding freezers and coolers across the chain. We're adding 1,000 licenses and beverages at Family Dollar. We're doing the 1,000 snack zones that Gary talked about. We'll add 200 stores, new stores at Family Dollar, 350 at Dollar Tree. I think as we get more stores on the ground in H-2, we also are getting much more efficient in how to handle with this, both with our teams as well as our suppliers, to make these things go faster. I will tell you, and looking forward, I know that we will typically close 70 to 80 stores a year just based on normal store closures and and maintenance of where the store performs.

John and Gary, just from the standpoint of the store closures, we took a look at what needed to close outside of lease term, and that's what we're doing in the second quarter this year. As always, we take a look at end of lease term for our fleet of stores to figure out how do we optimize, where are they headed for, and actually reaching out for our landlords to get input and contributions from them to you know, now help us reinvigorate some of their properties on H2 as we go forward. So we'll be doing more of that. But as we go forward, second quarter is going to be where we, you know, take the hit on the stores closing out lease. As we go through the out years, you know, either at 75 to 100, depending on the number of stores coming up on any quarter, is probably closer to where we'll end up.

Okay, thank you.

Ladies and gentlemen, this does conclude our question and answer session. At this time, I'd like to turn it back to Mr. Randy Geiler for any additional or closing remarks.

Thank you, Aaron. Thank you for joining us for today's call and especially your continued interest in Dollar Tree. Our next quarterly earnings conference call to discuss Q2 results is tentatively scheduled for Thursday, August 29, 2019. Have a good day.

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