Good day, and welcome to Dollar Tree's Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Randy Guiler, Vice President, Investor Relations. Please go ahead, sir.

Thank you, Brandon. Good morning, and welcome to our conference call to discuss Dollar Tree's performance for the third fiscal quarter of 2018. Participating on today's call will be our President and CEO, Gary Philbin; and our CFO, Kevin Wampler. Before we begin, I would like to remind everyone that various remarks that we will make about future expectations, plans and prospects for the company constitute forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors included in our most recent press release, 8-K, 10-Q and annual report, which are on file with the SEC. We have no obligation to update our forward-looking statements, and you should not expect us to do so. At the end of our prepared remarks, we will open the call to your questions. [Operator Instructions] Now I will turn the call over to Gary Philbin, Dollar Tree's President and Chief Executive Officer.

Thank you, Randy, and good morning, everyone. Today, we're going to discuss our third quarter performance as well as our plans to improve the consistency of execution across the Family Dollar store base and to optimize our real estate portfolio. This will include a meaningful acceleration in -- of in-store renovations and rebanners in 2019. This morning, we announced results for the third quarter. Sales increased 4.2% to $5.54 billion. Consolidated same-store sales increased 1%. By segment, comp sales for the Dollar Tree banner increased 2.3%. The Family Dollar banner comps were down 40 bps compared to last year's Q3 increase of 1.5. On a 2-year stack basis, comps accelerated slightly. Our enterprise gross margin rate declined 110 basis points to 30.2%. Operating income was $387.8 million or 7%, and diluted earnings per share increased 16.8% to $1.18 at the high end of our guidance range. We delivered earnings within the range of our expected -- of our expectations, despite continued cost pressures related to domestic freight and our investment in store wages. Dollar Tree delivered its 43rd consecutive quarter of same-store sales growth with increases in both customer transactions and average ticket. We're pleased with the performance of our newly renovated Family Dollar stores. Additionally, we have begun the important phase of consolidating our store support centers into our Chesapeake campus, which will improve our ability to support Family Dollar stores through enhanced collaboration, communication and teamwork. Dollar Tree continues to have the most unique, differentiated and defensible business model in U.S. value retail. Customers love our dollar fixed price point, as demonstrated by 43 consecutive quarters of positive comps. Despite periodic cost challenges, the company has continued to deliver a relatively consistent gross margin annually with sector-leading operating margin. Our 2.3 comp this quarter was on top of…

Thank you, Gary, and good morning. Total sales for the third quarter grew 4.2% to $5.54 billion. Dollar Tree segment total sales increased 6.3% to $2.85 billion. The Family Dollar segment total sales increased 2% to $2.69 billion. Enterprise same-store sales increased 1%. On a segment basis, same-store sales for the Dollar Tree banner increased 2.3% or 2.2% when adjusted for Canadian currency fluctuations, and the Family Dollar banner decreased by 40 basis points. Overall, our gross profit increased by $5.9 million or 0.4% to $1.67 billion for the third quarter 2018 compared to the prior year's quarter. As a percent of sales, gross profit margin declined 110 basis points to 30.2% versus 31.3% in the prior year's quarter. Gross profit margin for the Dollar Tree segment was 34.8% for the third quarter, a 30 basis point decline compared with the prior year's third quarter. The decline was primarily due to higher costs related to distribution center payroll and shrink. Increases in freight were offset by improved markdown and a positive margin effect from mix shift based on strong discretionary sales for the quarter. Gross profit margin for the Family Dollar segment was 25.3% during the third quarter, which compared to 27.5% in the comparable prior year period. The year-over-year decline was primarily due to merchandise costs, including freight, which increased 60 basis points, resulting from higher domestic freight costs. 11 basis points of that increase relates to hurricane-related costs incurred due to our Marianna, Florida DC being down due to the loss of power and store cleanup. Stores normally serviced by this DC were moved to other DCs in the network for approximately 3 weeks, increasing stem miles and costs. Markdowns increased 50 basis points related to promotional markdowns. Approximately 10 basis points of the increase was due to…

Thanks, Kevin. Following the completion of the acquisition of Family Dollar in July 2015, we've made significant progress on integration. We've exceeded our initial synergy targets, strengthened our balance sheet and, at the same time, laying the groundwork for our future growth. As part of the integration process, we focused first on building a single infrastructure by implementing initiatives to establish a single foundation to drive performance across the organization and support the growth of both Dollar Tree and Family Dollar brands. As part of this foundational work, we successfully implemented a shared services model across corporate support functions. We introduced common systems and processes across both brands. We improved logistic and supply chain efficiencies, including testing and refining the approach in systems for combined distribution centers. Our first combined distribution center is in St. George, Utah, where we began servicing both brands in 2016. The learnings from this area are paving away for the launch of our next generation of combined DCs and additional synergies. And we commenced the consolidation of corporate functions, including all support functions into our Chesapeake, Virginia headquarters location. We expect to complete the consolidation by fall 2019. With this foundation in place, Family Dollar's position, along with the Dollar Tree brand, should benefit from the combined scale of our broad footprint. But our integration work has not only been focused at the corporate level. During this time, we've implemented initiatives to improve operational performance across the footprint of Family Dollar stores. Examples of our work: building the leadership team by hiring executives with significant and relevant retail experience; changing restock policies to improve in-stocks; improving adjacencies and merchandising of key impact categories that are focused on consumables and increased refrigeration; introducing programs and training to enhance the sales culture, including, at store level, compensation…

[Operator Instructions] The first question will come from Michael Lasser with UBS.

Gary, can you provide more context around your comment that you mitigated 80% of the 25 -- 80% at Dollar Tree and 50% at Family Dollar of the 25% potential tariff? Does that mean that if the tariff goes through, you will see a 20% hit at Dollar Tree and a 50% hit from that at those 2 banners? Or is there more to go? And as part of that, how have you been able to mitigate it such that -- could there be an effect to your customer from either lowering product quality, product size or other factors?

Michael, thank you. Yes. And really, it's -- I called out the efforts of both merchandising teams. We're anticipating -- I mean, we should -- it doesn't, but we're anticipating it's going to go to 25%. So the number I'm referencing is -- we expect the 25%. So the mitigation is based on that going through. And you've heard us mention how we've done it before. I mean, it sounds like it's easy. It's not because we're touching a lot of SKUs. The one thing you mentioned, though, is lower quality. It's -- we don't reduce quality. It could be a count size change, but I would say it's probably been a bigger effort around where else can we buy things besides China, compare it to landed costs, a subtle thing, how do we make things to have better cube to come across so that we can land it on the U.S. side at a better landed cost. It's negotiation with our vendors who also know this is a very important time with the kind of volumes and [indiscernible] some of the factories to negotiate that. So it's never one thing. It's our efforts to negotiate very well on both sides, take a look at the items. What do we have to have? What don't we have to have? What can we change? What would you modify in how you pack it? But we're going to go into this -- but this will be a year where we also have to be nimble. Because while other folks get to raise retails, including our Family Dollar banner, as I've told folks before, our customers often don't have that extra dollar. So we've got to be just better buyers, and it's going to speak to both how we buy, the specs we buy to and which countries we go to.

And just to clarify, is there room to further mitigate the 20% at Dollar Tree and 50% at Family Dollar? I mean, just a follow-up. I think there's a prevailing view in the marketplace that even with the -- with the available [ dote today ], that Dollar Tree -- the enterprise's operating margin is going to continue to be under pressure for next year and down. I recognize it's early. But what would be the offset to all these factors that would allow you to keep your operating margin either flat or growing?

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

Next question will come from John Heinbockel with Guggenheim Securities.

So let me start with what's your broader thought on the Family Dollar store footprint, including the possible need for underperforming store closures? And then kind of tied to that, when you think about the 1,000 remodels next year, plus the openings, your thoughts on the field organization's ability to handle all of that change in 1 year's time.

Well, agreed. I mean, I think we boldly stepped out there and said, we're going to do -- really, across both banners, but I'll stay focused on Family Dollar, a lot of renovations, more than we've done. And the reason we like that and it's important is what we're seeing in the current renovation. So I would tell you the field's excited, everything we've done, John, to get our folks incented and aligned to run better stores. Now here's a chance to change the 4 walls of their stores. Now we've got to do one store at a time, maybe opportunity to drive more footsteps into these stores and improve top line. I would tell you, they're raising their hand, "Give me one of those." The execution piece, we've got to be on top of our game. It's a lot because of what you do to enhance the store and reset it and the SKUs that come in and out. So it's not a small task for the field team to execute, but we're up for it. This is our opportunity to make meaningful change at Family Dollar. It's how we've described it to our organization. They've seen the ones that are responding. I walked a recent store with both our RD and DM recently. Their eyes light up. The consistency, execution, we're going to be all over that next year. And I want to go through 2019 saying we did at least 1,000 of them, and we were pleased with all of them. And that's going to be the bar that we set going to 2019. Along with that is the rebanner. So just to call out, as we've taken a look at the store in reference to the broader question, we've taken a look at which stores are responding to the renovations and what is in urban versus rural. And the stores that are tweeners, you might say, well, that's where we're harvesting some of those to become Dollar Trees, so the opportunity to now understand that in a better way as we continue our iterations of renovations. And the stores that don't respond to that, now we can sort of see that. The things that we have worked on, on table stakes to get all stores to improve, those are good things to work on in retail. I think what we like about the renovations is that's what changes, really, the course of the future footsteps for that store and sort of breaks out for us. So that's our effort for 2019.

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

Well, listen, other people raise retails up or raise or lower them. And for us, you have to be close enough to this customer and have the same kind of value. The magic at Dollar Tree only works if they know that's worth more than $1 because it is somewhere in their shopping universe. Now Family Dollar, we don't have -- we always got flexibility. At Dollar Tree, our promise is to have great value in the store, not necessarily that item. At Family Dollar, there are some basics that I want to make sure we're in place with. Our team's still working hard on. We have our big post holiday trip. We will do better than where we are today. But at the end of it, we may have to invest some of that to stay in place with the right items as we go into 2019. I don't think you can just say, "Listen, if the tariff goes to 25%, it's a real thing." Other retailers are going to be faced with that, too, and we're going to respond to it, in our world, the right way to make sure our customers see the right values in both Family Dollar and Dollar Tree.

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

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

Exactly. I mean, I would say it's not going to be one change. But I would just say this, Peter, as we went through, really, over the last 18 months, you put these stores out there, you see what responds. It's easy to walk in a store. You like the layout, always comes down to the look and feel. But I would tell you, it's more around the assortment that the customer ultimately sees. So our latest iterations have focused on some of the things the customer needs most. I mean, you've heard us talk about consumables, very important for Family Dollar. It's a piece of the emphasis. I think the adjacencies that we've been talking about are paying off for us. Some of the price impact that we're making throughout the store is a piece of it. I think we'd just tell you what we've done that gives -- finds us a way to get that last dollar when she's waiting for our checkout is as important as anything we've done in the store. So is it one thing? No. Is it the combination of all those efforts that got us to that? Yes. And to me, Peter, the final judge for me -- and listen, we'll continue to refine. I mean, I can't put a thermometer on this and tell you we're all the way to the boiling point where we like it, but I think we're pretty darn close. And I would just tell you that it shows up in footsteps into the front door.

Okay. I did also want to dig into the opportunity for combined supply chain. And you've had the St. George, Utah test. It's going on for 2 years. So certainly can appreciate it's a complicated initiative, but also surprised that it's been a 2-year test. Could you give us a sense on what's taking so long at this point? And as you're looking forward, when can we begin to expect to see this broaden out to more of the DC network?

Well, it is complicated. Thank you for recognizing that. And it's -- we're past the test stage. I mean, we've built our latest DC in Warrensburg, Missouri now with the same systems that St. George allowed us to ship both banners. The difference and the issue really has been as we rebannered stores from Family Dollar to Dollar Tree, as stores were divested then rebannered from Family Dollar, all the capacity needs over the last 3 years have been on the Dollar Tree side. And so while Warrensburg has the capacity, at this point, we need the capacity for Dollar Tree, at some point, Family Dollar will show up there. And so I think where you're going to see it is the new DCs will get to that ability to ship first. And then while you have -- as we shift volume to and from in the network, then we'll have a better opportunity to go back into some of the locations probably on the Family Dollar DC side where they have capacity to shift to Dollar Tree stores. We don't -- we're working on that. I don't have a timeline to tell the Street that, that's when it's going to happen. It's still ahead of us, but we are planning for it.

The next question will come from Dan Wewer with Raymond James.

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

Yes, Dan. I think from a cost perspective, what we had said is it really ranges from probably $100,000 to $150,000, and the big variable is always going to be the number or amount of refrigerated and cooler units and freezer units that we may be putting into that store. So that's the biggest variable. And the typical renovation, it takes us only about 2 weeks. So it's a very coordinated effort, as you can imagine, to -- because there's some pretty significant changes in regards to moving layout, changing the storefront and as well as adding immediate consumption coolers to the front of the store. So it's well coordinated. I think we feel pretty good about the work we've done to get that down to a pretty nimble timeline. And then in regards to your question, the mid-single-digit comps, and obviously, Gary has commented it's higher. We haven't really specifically said how much higher, but it is definitely higher than the mid-single-digits.

During the 2 weeks to complete the renovation, and we have 1,000 of these taking place next year, could this put additional pressure on your inventory shrink accrual?

Well, I mean, I think part of this is, again, you do really have to look at inventory in these stores. And some categories might get a little smaller, so there can be some inventory movement. But I would tell you, just in general, we are not satisfied with where our shrink has been this year in either banner. It has not been a result that we're very proud of. It's something that we are working on, and again, it's just not something that you usually see out of us from an execution standpoint. So it's on the top of everybody's list out there, in the operations, loss prevention and the whole organization, from the standpoint of understanding that this is just as important as driving sales out there. So I don't want to say it's going to put pressure on it because my expectation is we have to do better next year.

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

There'll be thousands. I mean...

Starts with a 2?

Wait. I'd tell you -- I mean, it's -- Dan, it's really an issue of -- a thousand's a big number. We're -- and I'm -- I said a minimum because I'm obviously hoping for more because that's how I'm thinking about it. But I think, seriously, from the standpoint of just is this a 1 year project? No. We will see the results of this larger group of stores helping us, certainly, as we get into '19 and more and more of them are behind us. But I would see us doing a similar number in '20.

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

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

Well, it's one of the reasons we're doing the renovations, Chuck, is -- listen, as the stores go up in volume, they leverage their 4-wall fixed expenses. But I think you touched on the investments that are needed. I mean, we've talked about -- and I tried to call out some of the big ones that we've done. Technology will continue to migrate to best-in-breed between the 2 banners on some of the systems that we need. We'll continue to invest in our people, especially with unemployment being at a near all-time lows, just what we've done this year on what we call the year of the store manager, to drive success store by store with improving our store manager prioritization, how they direct, how they follow up with people. I mean, this is not either/or. We've got to do both. Over time, operating income, listen, we still have our sights set on where we started this journey. We will continue to improve it. I think what I want to emphasize today is we need to touch a meaningful amount of stores to get the consistency towards that trajectory that gets us there. And I've called out before the things that we've been doing, the blocking and tackling on our table stakes. All good retailers have to do that. But the equation that I want to change is to drive more renovations. And listen, we'll do the rebanners, too, because right off the bat, if it's the right market and the right neighborhood, adding a Dollar Tree assortment certainly changes the 4-wall cash immediately on that store, whether sales go up or not. But what we've seen is customers do figure out eventually that is a Dollar Tree, and we see multiyear comps coming from the rebanner segments that we've done. So when we find the right store to do that, we do that, too. So between those 2, you go out a few years, you start getting better comps from the suite of renovated stores that start to leverage their fixed expenses. You start to see rebanners that are opportunistic coming out of the Family Dollar fleet and falling into the Dollar Tree 4-wall cash model, and I think that's how we take a look over the next few years on building the business plan.

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

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

[Operator Instructions] The next question will come from Matthew Boss with JPMorgan.

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

Yes, Matt. As we speak to freight, I think we look at that as a continued headwind as we look at the fourth quarter. And again, diesel, while it's still up, I believe, in Q3, it was up roughly about 20% as a rate year-over-year with the recent pullback in oil prices that may dissipate a little bit in Q4. So that may come down a little bit. But freight in general, I think as the driver shortage and -- that's out there and the pressure we're seeing from that, we expect freight to continue to be up. And even really potentially through the first half of next year, there could be some pressure as well. But again, that's ongoing. From a markdown perspective, it's really pretty much a nonevent in the green banner because there just aren't that many markdowns. The Family Dollar business is obviously a little different from a markdown perspective. As we've noted in Q3, markdowns were up, partially to drive sales and, again, partially just to make sure we're moving through inventory appropriately. As we look at Q4, I would tell you, I would expect markdowns in the Family Dollar business to be up year-over-year. Again, I think the opportunity to be aggressive when appropriate and to keep our inventory as clean as we can is important. So I think that's there for us. And I think as we continue to push that business forward, that's something we need to continue to look at. In regards to 2019, obviously, we haven't given any guidance at this point, and we're finishing up, really, the planning and the budgeting as it relates to 2019. So there's not really much I can say at this point in time. But I would tell you it's always our expectation that we move the business forward and improve the business, and that's what's going to be our guiding principle as we go into 2019.

The next question will come from Greg Melich with MoffettNathanson.

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

The current tariff list, I think we've declared that we have about 9% of our sales are coming through that are tariff at this point from the tariff [indiscernible].

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

I say the tariff 301 list is what we're [ referencing ].

Perfect. Got it. And then a follow-up from before. You mentioned getting the $100 million reinvestment of the $250 million tax savings. How should we think about that in terms of -- is there any left? Or do we repeat part of that investment next year? Remind me of the timing of that. Was that all of an investment this year? Or was some of that $250 million going to be in the following years?

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

The final question will come from Robbie Ohmes with Bank of America.

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

Well, we'll go against a, I believe, one comp last fourth quarter. Here we are starting off the holiday season in earnest. To me, the kickoff is a little bit of Thanksgiving, but probably more for our customers, the first week of December. So all of our plans, all of our efforts, the alignment of getting the merchandise to the right stores, that's going to be the proof in the pudding over the next few weeks. So you certainly -- we call it, it's a big spike in our business as we march towards December 25. So listen, we're going to work hard on -- we're excited about the holiday season. I think we got our folks in the right place. We spent a lot of time in both of our field meetings way back in August to get them prepped on the excitement of the items that we have in our stores. We've gotten into not just stores but on display. I think both banners really going to this year have really done a job to improve the holiday assortment. And right now, we're sort of in the, you might say, trim a home and trim a tree segments. Trim a gift and gift-giving is still ahead of us. So those are clearly the biggest categories. For Family Dollar, it will be, I think, opportunity for us to really [ shout ] down toys with the void in the markets. We did lean into the toy business this year, and I think it's going to be an important part of us having a positive comp as we go through December.

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

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

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