Dollar Tree, Inc. (DLTR) Q3 2017 Earnings Report, Transcript and Summary

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

Thank you, Dana. Good morning, and welcome to our conference call to discuss Dollar Tree's performance for the third fiscal quarter of 2016. Participating on today's call will be our CEO, Bob Sasser; our CFO, Kevin Wampler; and Family Dollar's President and Chief Operating Officer, Gary Philbin. Before we begin, I would like to remind everyone that various remarks 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 current report on 8-K, quarterly report on Form 10-Q and annual report on Form 10-K, which are all on file with the SEC. We have no obligation to update our forward-looking statements. At the end of our prepared remarks, we will open the call for your questions. [Operator Instructions] Now I will turn the call over to Bob Sasser, Dollar Tree's Chief Executive Officer.

Thanks, Randy. Good morning, everyone. This morning, we announced Dollar Tree's results for the third quarter of fiscal 2016. This represents the first quarter that we've owned the Family Dollar business for a full 3 months in the prior year's comparable quarter. Our acquisition was completed on July 6, 2015. Total sales for the third quarter increased 1.1% to $5 billion. As a reminder, third quarter results last year included sales from 325 Family Dollar stores that were divested after the end of the quarter. Same-store sales on a constant currency basis increased 1.7%, driven by increases in both traffic and average ticket. Adjusted for the impact of Canadian currency fluctuations, the same-store sales increase was 1.8%. Operating income increased 53.1% to $342.4 million. Net income for the quarter increased 109.4% (sic) [ 109.5% ] to $171.6 million, and GAAP earnings per share was $0.72. Adjusting for $0.09 of expense incurred outside of guidance, that was associated with debt refinancing, adjusted EPS was $0.81 and near the top end of our guidance of $0.76 to $0.82 per diluted share. I'm very pleased with our company's overall performance for the third quarter. We delivered our 35th consecutive quarter of positive same-store sales. Both Dollar Tree and Family Dollar segments improved gross margin rate year-over-year. SG&A expenses across both banners were well managed. Operating margin improved 230 basis points to 6.85% for the quarter and adjusted earnings per share were at the top end of our range of guidance. The Dollar Tree banner continues to show strong consistent growth, and we continue to make meaningful progress in the integration of Family Dollar. We remain on track to achieve our expected synergies target of $300 million and run rate by the end of the first 3 years. This includes improvements in direct and indirect procurement, rebannering of select stores and the development of our shared services model including supply chain and logistics. There is still much more to be done, and I believe, we will, ultimately, surpass our target. Highlights for the Dollar Tree banner in the third quarter included a total sales increase of 8.6%. Same-store sales on a constant currency basis increased 1.7% and this was achieved through increases in both traffic and average ticket. Gross profit margin improved 70 basis points over last year. And operating margin was 11.6%, an improvement of 170 basis points over last year's 9.9%. Excluding acquisition-related costs in the prior year's quarter, operating margin improved 120 basis points. To share some of the color on the quarter, top-performing categories for the Dollar Tree banner include snacks and beverages, household products, seasonal toys and party supplies. Sales in our discretionary categories outpaced sales in our consumables for the quarter. While we continue to experience an estimated 80 basis points of incremental cannibalization resulting from the rebannering of 210 deal stores and 293 Family Dollar stores to Dollar Tree, we delivered positive same-store sales each month throughout the quarter. And despite the calendar shift this year, which moved the last 2 days of October and Halloween sales from third quarter and into fourth quarter, we finished the third quarter strong. October was our highest comp month of the quarter. Geographically, Dollar Tree same-store sales growth for the quarter was strongest in the upper Midwest, the Southwest, the Northeast and the West zones. All zones had positive comps with the exception of the Southeast, which was only slightly negative as it experienced a higher degree of incremental cannibalization from our rebanner initiative. The Dollar Tree business continued to be strong, consistent and growing. This represented our 35th consecutive quarter of positive same-store sales. Our third quarter results once again validate the relevance of the Dollar Tree brand. Customers are shopping our stores more often, and we continue to attract new customers every day and when these customers are in the store, they're buying more. Millions of consumers continue to look at Dollar Tree as part of the solution to help balance their household budgets. We serve a very loyal and growing customer base. Our commitment is to continue serving our existing customers better, while taking every opportunity to gain new customers in every store, every day. Our merchant teams continue to do a terrific job sourcing products that exceed customer expectations for what $1 can buy and at a cost that meets our margin requirements. Our store teams are focused on providing a clean, full, fun and friendly shopping experience and seasonal energy was high beginning in August with Back-to-School. In addition to dominant displays of Back-to-School basics, the customers responded favorably to brightly colored fashion stationery, teacher supplies, classroom residuals and lunchbox values, all priced at $1. In September, we celebrated Dollar Tree's 30th anniversary with Bonus Buys and WOW! items for our customers. Key categories including cleaning supplies, home office essentials, snacks and a broad assortment of special values from our million-dollar brands. Our stores were filled with well-known national brands and high-value private labels throughout the event. Seasonally, our store teams transitioned efficiently from Back-to-School to fall harvest and Halloween. In September, Dollar Tree became Halloween headquarters with major statements in Halloween costumes, makeup, home decor, candy and party supplies. Customers responded enthusiastically and our sell-through was improved over the prior year. We ended the quarter with our inventory clean, well-balanced, seasonally relevant and stores prepared for the Thanksgiving, Christmas and the fourth quarter holiday shopping season. Looking forward, the Dollar Tree segment is positioned for increased relevance to our customers with sustained growth and improved profitability. We have multiple opportunities to continue growing and improving our businesses through opening more stores and through increasing the productivity of all of our stores. In the third quarter, we opened a total of 101 new Dollar Tree stores. We relocated and expanded 15 Dollar Tree stores, and we rebannered 42 additional Family Dollar stores to Dollar Tree's for a total of 158 Dollar Tree projects during the quarter. Total Dollar Tree banner selling square footage increased 8% compared to the prior year, and we ended the quarter with a total of 6,320 Dollar Tree stores across North America. I continue to be pleased with our rebannering efforts. Since the acquisition, our store development teams have rebannered 210 deal stores to Dollar Tree and 293 Family Dollar stores to Dollar Tree in addition to opening 495 new Dollar Tree stores. We ended our third quarter this year with a total of 565 more Dollar Tree stores than the same time one year ago. These new and newly rebannered stores are performing very well in terms of sales and improved operating margin. While the right decision for the long term and the near term, we continue to bear incremental cannibalization on our comp stores of approximately 80 basis points. This headwind will dissipate each quarter through the end of 2017, as we cycle the convergence from the prior year. In addition to new stores, we continue to execute our strategy to improve the productivity of our existing stores. Our drive to business initiatives include category expansion. Customers are realizing more value as we rationalize and expand assortments in pet supplies, hardware, health care, beauty and eye care as well as home and household products. Creating a fun and enjoyable shopping experience with a focus on seasonal relevance. Our stores fronts change with the seasons. At Dollar Tree, we want to own the seasons at the dollar price point. Number three, creating merchandise energy and the thrill of the hunt throughout the store that Dollar Tree always finds an unexpected value. And number four, being first-of-the-month ready. We place special emphasis on basic consumable core items on weekends, and especially, at the beginning of each month, when many customers are shopping for basic needs. We are continuing the expansion of our frozen and refrigerated category. In the third quarter, we installed freezers and coolers in 154 additional Dollar Tree banner stores. We currently offer frozen and refrigerated products in 4,710 stores with plans to continue growing. With the addition of the Family Dollar banner, we have an incredible opportunity to increase and create shareholder value as a combined organization. I continue to be as enthusiastic as ever about our opportunity to grow our business and to serve more customers in more ways. We are deploying a disciplined approach to building the foundation for long-term improvements and the customer experience at Family Dollar. And we remain confident in our ability to capture synergies for the combined organization. With a focus on managing our business for the present, we are developing the foundation for a larger, stronger and more diversified business that will generate cash and build shareholder value for years to come. I will now turn the call over to Gary to discuss Family Dollar's performance and priority.

Thank you, Bob, and good morning, everyone. After 5 full quarters, we continue to make progress at Family Dollar. Our focus at Family Dollar is around the customer-facing initiatives that our customers continue to give us credit for. And we are working hard to improve these across our base of 8,000 stores. Our customers are seeing cleaner, better merchandised stores that have more compelling end cap with price they need for everyday basics and holiday needs. While we have more to do here, we are on the right track with our continued investment in the business basics of the Family Dollar banner. For Q3, the Family Dollar banner had low single-digit negative same-store sales. However, August was slightly positive. September was our weakest comp during the quarter. And remember last year, we had kicked off our Red Tag Clearance Event mid-month. October was also negative as we cycled the completion of our clearance event last year. And of course, the impact of Halloween in first of the month, shifting money end of the quarter. However, we did see an acceleration of our 2-year stack comp of greater than 100 basis points from Q2 to Q3. And our Q3 basket improved slightly against a negative transactions for the quarter, primarily from the clearance event last year. Our consumable business at Family Dollar outperformed our discretionary business. And geographically, our West and Mid-Atlantic regions were the strongest performing areas of the country for us. In real estate, we opened 52 new Family Dollar stores, we relocated or expanded 24 Family Dollar stores for a total of 76 projects, we rebannered 42 Family Dollar stores to Dollar Tree, and we ended the quarter with nearly 8,000 Family Dollar stores, 7964 to be exact. We will achieve by year-end our target of 200 new Family Dollar stores for the year. And together with Dollar Tree and Family Dollar banners, we now have a total of over 14,000 store locations -- 14,284 across the U.S. and Canada. At Family Dollar, our customer-facing programs continue to drive and show value throughout the store, as we build momentum with our smart ways to save marketing program. Our customers continue to respond to the value and savings across all of our foundations on delivering value for our Family Dollar customers. These simple ways to save reflect from our ad into our store and these show our customers EDLP; pricing on every day values; our sale items that reflect the most meaningful values on key items; Dollar well, which drives a surprise in opening price point throughout the store, compare and save to shout-out really our excellent values on our private brands; price drop, which is our great savings passed on to our customers above and beyond. And during the quarter, we completed our national rollout of smart coupons. Our customers have responded positively with above projection sign-ups from our Labor Day kickoff. We already have over 1 million customers who have signed up. For our customers, it completes a "no-hassle shopping" experience to find national and Family Dollar exclusive offers. Also, we added emphasis to our "smart ways of save" strategy with the kickoff on the CW Network of our partnership of a 30-minute game show called SAVE TO WIN. Our host of the show, Pat Neely, highlights the great product expense throughout the Family Dollar across a high-energy fund format that fits competing real Family Dollar shoppers against each other. So for Family Dollar, it's a great way to reach a demographic overlap that serves us well and really brings additional credibility to our smart ways to save. Another fundamental part of our strategy for success is our focus on table sticks. At a high level, this includes improved store standards and conditions; neat, clean, full, recovered; merchandising relevance and energy; finding what I need at Family Dollar and at a value I recognize; and customer engagement, what we call Family Dollar-friendly. Our customers count on us all month long, but the first 10 days of the month at Family Dollar are critical in their efforts to be in stock, recovered and end caps with the compelling offers. Our focus here revolves around our efforts to have improved direct-to-store delivery, support and service along with our operational teams improving our truck-to-shelf process. The convenience of our stores combined with our focus on improvements across our customer-facing initiatives is the foundation for our improved customer experience at Family Dollar. Our investment across our business is measured with the test and learn discipline to measure our success and to involve our next step initiatives just like at Dollar Tree. So while we have more to do, our team at Family Dollar is motivated and energized to be the best at delivering value to our customers that are unique in many ways and often underserved. Our stores serve a customer that counts on us and responds when we deliver value, customer service and a Family Dollar shopping experience that we are all proud of in the neighborhoods we serve. Now, let me turn the call over to Kevin to provide more detail on our third quarter performance and our updated outlook on Q4 and the full year. Kevin?

Thanks, Gary, and good morning. Total sales for the third quarter grew 1.1% to $5 billion. Dollar Tree segment total sales increased 8.6% to $2.47 billion, while Family Dollar segment total sales decreased 5.2% to $2.53 billion. Year-over-year sales comparisons for Family Dollar were impacted negatively by the loss of sales from 297 stores, which we rebannered as Dollar Tree stores, in addition to the 325 stores, which were divested as required by the FTC. Same-store sales on a constant currency basis increased 1.7% versus 2.1% in the prior year's third quarter. The increase was driven by both traffic and ticket. As expected, we experienced incremental cannibalization of 80 basis points from the 507 Family Dollar and deal stores that have been converted to Dollar Tree stores. Adjusted for the impact of Canadian currency fluctuations, same-store sales grew 1.8%. All acquired Family Dollar stores and newly rebannered Family Dollar and deal stores are considered new stores and were excluded from our same-store sales calculation in Q3. Gross profit for the combined organization increased 8.6% to $1.52 billion for the third quarter of 2016, compared to the prior year's quarter. As a percent of sales, gross profit margin improved 210 basis points to 30.4% versus 28.3% in the prior year's quarter. Gross profit margin for the Dollar Tree segment was 34.8% during the third quarter, and 80 basis point improvement compared to the prior year's third quarter. Factors impacting the segment's gross margin performance during the quarter included lower merchandise costs due to favorable freight costs and higher initial mark-on, partially offset by higher distribution and occupancy costs as a percent of net sales. On a GAAP basis, gross profit for the Family Dollar segment increased to 5.6% to $663.2 million. Gross profit margins for Family Dollar segment was 26.2% during the third quarter compared with 23.5% in the comparable prior-year period. Excluding the inventory step-up amortization of $38.4 million and markdowns of $13 million in the prior year -- prior year's quarter, gross profit margin was 26.2% for the quarter compared with an adjusted 25.4% in the prior year's quarter. The improvement is due to lower merchandise, freight and shrink costs, partially offset by higher markdown expense and increased occupancy costs. Selling, general and administrative expenses in the quarter for the combined organization decreased to 23.6% from 23.8% in the same quarter last year as a percent of net sales. Excluding $11.8 million or 25 basis points of acquisition-related expenses in 2015, the SG&A rate remained consistent at 23.6%. Increases in store hourly payrolls as a percent of net sales were offset by lower professional fees and lower depreciation expense, as a percent of sales. Q3 SG&A expense for the Dollar Tree segment as a percent of sales was 23.2%, a 90 basis point improvement compared to the prior year's quarter. The prior year's quarter included $11.8 million of acquisition-related costs. Excluding the prior year's acquisition-related costs, SG&A as a percent of sales improved 40 basis points to 23.2% of sales from 23.6% of sales. The improvement was driven by lower cost as a percent of sales for professional fees, health insurance, store supplies and legal costs, partially offset by higher store payroll expense. On a GAAP basis, SG&A expense for the Family Dollar segment was $606.8 million. SG&A expense for the Family Dollar segment as a percent of sales was 24% compared to 23.5% in the prior year's quarter. The current year includes $3.8 million for severance benefits, while the prior year's comparable period included $6.8 million of acquisition-related and divestiture cost. Excluding these costs, SG&A expense increased 50 basis points as a percent of sales to 23.8% from 23.3% in the prior year. The increase was driven primarily by higher store payroll, health insurance and advertising costs, partially offset by lower depreciation and amortization expense. Operating income for the combined organization increased to $342.4 million compared with $223.7 million in the same period last year. Operating income margin increased to 6.8% for the quarter from 4.5% in the last year's third quarter. Operating income margin for the Dollar Tree segment improved 170 basis points to 11.6% when compared to the prior year's quarter. Excluding the $11.8 million in acquisition-related costs from the prior year's quarter, operating income for the Dollar Tree segment improved 120 basis points to 11.6% compared to an adjusted 10.4% of sales in the prior year third quarter. On a GAAP basis, operating income for the Family Dollar segment increased $57.5 million, to 2.2% as a percent of net sales. Nonoperating expenses for the quarter totaled $112.2 million, which was comprised primarily of net interest expense as well as $26.6 million of acceleration of amortizable noncash deferred financing costs and $2.6 million of fees associated with our debt refinancing. Effective tax rate for the third quarter was 25.5% compared to 34.3% in the prior year's quarter. The decrease was primarily attributable to a onetime tax benefit in the third quarter of 2016 of $21.4 million or $0.09 per share related to a 1% decrease in North Carolina's state tax rate, which decreased the deferred tax liability related to the trade name intangible asset, as well as the adoption of ASU No. 2016-09, under which the incremental tax benefit recognized the Dollar's restricted stock vested as reported in the income tax expense. For the third quarter, the company had GAAP net income of $171.6 million or $0.72 per diluted share compared to the reported net income of $81.9 million or $0.35 per diluted share in the prior year's quarter. Looking at the balance sheet and statement of cash flow, combined cash and cash equivalents at quarter end totaled $733.8 million compared to $1.1 billion at the end of the third quarter of 2015. Our outstanding debt is approximately $7.1 billion, a decrease of $1.2 billion from the end of the third quarter of 2015. Inventory for the Dollar Tree segment at quarter-end was 8.5% greater than at the same time last year, while selling square footage increased 8.2%. Inventory per selling square foot increased 0.4%. We believe that current inventory levels are appropriate to support scheduled new store openings and our sales initiatives for the fourth quarter. Inventory for the Family Dollar segment at quarter-end decreased 2.1% from the same period last year and increased 0.7% on a selling square foot basis. We are pleased with the progress we are seeing at in-stock levels on key items. We are continuing to review merchandise assortments and believe our current inventory levels are appropriate for the fourth quarter. Capital expenditures were $95.6 million in the third quarter of 2016 versus $169.5 million in the third quarter of last year. For fiscal 2016, we are planning for consolidated capital expenditures to range from $620 million to $650 million. Capital expenditures will be focused on new stores and remodels including fee development stores, our rebanner initiatives, the edition of frozen and refrigerated capability to approximately 400 Dollar Tree stores, IT system enhancements and integration projects, and our distribution center projects. Depreciation and amortization totaled $157.6 million for the third quarter. This includes purchase accounting-related costs of $18.3 million for favorable lease rights amortization. Depreciation expense was $168.7 million in the third quarter of last year. For fiscal 2016, we expect consolidated depreciation and amortization to range from $630 million to $640 million. This includes $17.9 million for Q4 and $74 million for fiscal 2016 for the amortization of favorable lease rights for the purchase accounting evaluation of Family Dollar leases. Our updated outlook for fiscal 2016 includes the following assumptions:. Beginning in Q4, our acquired Family Dollar stores will be included in our reported same-store sales. In 2016, the last 2 days of October, our biggest Halloween sales day shifted into our fourth quarter. This shift is included in our sales guidance. Our 2 additional sales days between Thanksgiving and Christmas in 2016. We will continue to experience a higher-than-normal degree of cannibalization to Dollar Tree comps as part of our rebanner efforts. This cannibalization expectation was planned and factored into both our rebanner strategy analysis and our outlook for same-store sales. We have budgeted lower freight -- import freight costs than a year ago. And our interest expense will be approximately $79 million in Q4. Our Q4 and full year guidance includes an impact of $0.03 to $0.04 per share related to the FLSA change and overtime regulations, which takes effect December 1. We cannot predict future currency fluctuations. We have not adjusted our guidance for changes in currency rates. Our guidance also assumes a tax rate of 36.3% for the fourth quarter and 33% for fiscal 2016. Weighted average diluted share counts are assumed to be 237.1 million shares in Q4 and 236.7 million for the full year. For the fourth quarter, we are forecasting total sales to range from $5.59 billion to $5.69 billion and diluted earnings per share on a GAAP basis in the range of $1.24 to $1.33, an increase from prior implied guidance of $1.21 to $1.30. These estimates are based on low single-digit same-store sales increases in both our Dollar Tree and Family Dollar segments and year-over-year square footage growth of 3.9%. For fiscal 2016, we are now forecasting total sales in a range between $20.67 billion and $20.77 billion compared to the company's previously expected range of $20.69 billion and $20.87 billion. The company now anticipates net income per diluted share on a GAAP basis for full year 2016 will range between $3.67 and $3.77 -- $3.76, which includes the effect of $0.09 refinancing costs in the third quarter. This compares to our previous EPS guidance range of $3.67 to $3.82, which did not include any refinancing costs. These estimates are based on low single-digit same-store sales increase of 3.9% square footage growth. And I'll now turn the call back over to Bob.

Thanks, Kevin. Again, I'm very pleased with our overall performance for the third quarter, and I'm extremely proud of our combined Family Dollar and Dollar Tree teams. We are making meaningful progress in developing, what I consider to be, the best model in small-box value retail. Dollar Tree is now a diversified combination of a 6,000 store banner and an 8,000 store banner, each with its unique ability to effectively serve more customers across all types of markets. With the combination of these 2 great brands, we have powerful flexibility in how and where we choose to grow, while expanding our opportunity to grow. Across the combined banners, we will continue to focus on providing greater values to our customers, while delivering superior returns to our long-term shareholders. Retail is an ever-changing environment, over time we've demonstrated our management team's ability to be agile and nimble to effectively adapt to the changing environment. As discussed on prior calls, we have been preparing for and testing changes to our compensation structure in regard to the new FLSA regulations. We have communicated these changes to our teams to ensure our company's compliance when the new rule will become effective on December 1. As always, we will continue to employ a disciplined approach to drive in key strategic initiatives to the combined organization, through improve communication, analysis, collaboration and incentives. We are confident that placing our initial emphasis in these areas can materially enhance operating performance of the Family Dollar brand through improvements in sales, margins, expense control and greater customer satisfaction. The Dollar Tree business model continues to grow and improve. It's powerful, flexible and more relevant than ever, providing extreme value to the customers, while recording record levels of sales and earnings. Our model has been tested by time and validated by history. For 35 consecutive quarters, the Dollar Tree banner has delivered positive same-store sales increases. Through good times and difficult times and all retail cycles, consumers are looking for value, no matter what the state of the economy. While our price point remains $1, our operating margin continues to grow and lead the discount sector. In the third quarter, Dollar Tree banner sales increased 8.6%, same-store sales increased 1.7% and operating margin improved to 11.6%. Our field management and leadership teams are talented, experienced, energized and incredibly motivated. It's a great time to be Dollar Tree. Operator, we are now ready for the questions.

[Operator Instructions] And we will go first today to Edward Kelly with Crédit Suisse.

I would like to start with the question on Family Dollar. If we just take a step back and maybe a little bit more detail on the assessment of the progress to date, I mean, the asset clearly holds a lot of opportunity. There clearly seems to be a lot of low-hanging fruit, you've made changes, but the comps have kind of been bouncing around either up or down modestly. Curious sort of like, how you think you are -- how are you progressing, I guess, so far versus what you initially thought? And then what happens from here to get the momentum of the business turned more positively?

Edward, this is Gary. Good morning. I think you're absolutely right. The opportunity is just as big as we saw at the beginning. And as Bob said, we remain just as enthusiastic. A little bit of, when you take a look at the opportunity showed itself in the quarter and even though we were slightly negative for the quarter, August was positive. And then we went against the Red Tag Clearance Event both in September and October. So I wasn't able to overcome some of the traffic. I think the silver lining for me was that the basket lift that we got last year stuck with us this year. And then I would tell you November is starting off how I would hope, going into the holiday season. So I start with saying the foundation that we are building around value, the marketing program, the table stakes, those are the things that we knew we had to do going in just to build the foundation. Anything else we're going to do past that, it has to stick, because we're consistent on delivering value in the store, and we have a shopping experience that our customers find value when they come through the door of a Family Dollar. Long term, what's going to change? While we continue to have the opportunities in front of us that we can enhance by our brands, of course, and we can do more direct imports, but we still have a store base that has wonderful opportunity for us to take a look and figure out how we continue to renovate, put in new assortments, expand the elements in our stores that our customers are looking for. When we see our first-of-the-month business on SNAP for instance, some modest changes that drive business to our frozen food, resonate very well with our customers. So the work so far has been around the foundation that allows us to long-term deploy capital in a meaningful way into our existing store base along with new stores that will create different flow for our customers as she comes in and sees more seasonal merchandise, sees more elements that drive a higher sales per square foot productivity because of our assortment expansions. So that's the work ahead of us. I would tell you that up to this point, we've been very focused on just driving the foundational pieces of our business that we had to fix. And while we are not all the way there, I would tell you we've made progress and it's still our focus as we go into '17.

And just a quick follow-up. In terms of synergies, can you just tell us how much of the $300 million you've captured to date?

Ed, we believe we are right on schedule with what we said on the $300 million. We've never really quantified where we are on that. I'm very excited about the work that's been done there and what we've accomplished so far. And as I said, I expect that we're going to exceed the $3 million over the 3 years -- $300 million excuse me.

And we'll take our next question from Stephen Tanal with Goldman Sachs.

I guess, just to follow up on the synergy point. Can you talk about the onetime cost that you expected to incur as you got there? Are we still thinking about 15% of $300 million sort of in the SG&A and where are you at today, relative to that kind of a number?

So to -- Stephen, just to reset maybe where we laid that out. Originally, we said $300 million of onetime cost to achieve. We said half of it OpEx, half of it CapEx, basically, is how we were looking at it, at the beginning of the process. I would tell you as we -- as I look at it to where we are at to this point, we probably spent more CapEx than OpEx to this point. Because if you think about the number of the stores we rebannered as part of that, that's been a fairly large cost at the end of the day. But we probably have spent more, like I said CapEx than OpEx. But I still think the $300 million hold true. What I don't know exactly at this moment is will it maybe be 60% CapEx at the end of the day as opposed to 50%. I think there is -- could be a little bit of movement in that direction as we think about, not only rebanners, but the systems integration and various other projects. We have got one D.C. that we co-bannered, so a lot of things that we have done have required capital dollars to make those changes. So I think it may lean a little bit closer, little heavier on the CapEx side than the OpEx at the end of the day.

Got it. That's helpful. And I guess, just on Family Dollar, thinking about the guidance of the fourth quarter, what kind of gives you the confidence in the inflection there?

Well, it's a I think a comparison to last year where we know that we went to this holiday season, I think, better merchandised. Our stores are cleaner. They are better merchandised because we were exiting our Red Tag Clearance Event really into the second week of November last year was the final cleanup. We've just gotten off to a quicker, better start. I think our assortment is going to be compelling and our offers through -- from Thanksgiving through Christmas give us that confidence. And I think our customers are starting to recognize they can come in to a Family Dollar on a more consistent basis and find what they need. Our in-stocks, I would tell you, we triangulate on it from both what our system says and then what have we done to our sales to cause any missteps, and then finally, in-store, what are we doing to have better in-stock. And I would just tell you that those 3 pieces were in a better position now than a year ago. And I think that's where our customer sees when she comes into our store. So that's what gives me the confidence. And like I said, while it's early start to the holiday season, nothing tells me that we shouldn't have a positive comp on the quarter.

That's great to hear. And just lastly from me, as we think about leveraging our models, is there -- how should it really play out from here? When do you expect to make bigger paydowns? Where do you expect to get over time sort of thing?

Sorry, Steve, You broke up a little bit. Could you repeat the question?

Yes, sorry. I was asking about just leverage and how that should play out from here? What do you expect to make debt paydowns or how should we think about that leverage ratio over time?

Yes, I mean, obviously, as we've stated our long term our goal is to get back to investment grade. With the refinancing we did here in the third quarter, we did pay down additional $242 million of debt. And last year, after the holiday season, we made a pay down. We will be in a position to consider that again this year. The -- as I look at it today, I think we have the opportunity to be investment grade by fiscal year '19. And again, we think that's important just from a flexibility standpoint as we go forward and having the flexibility to be able to do whatever we want to do from a finance. And again, also from investment grade, it will bring down the cost of capital overall as well. So I guess that's what we are thinking about it. We're going to continue to build the business and invest in the business and grow the business. But we are also go -- working to continue to pay down the debt as well.

[Operator Instructions] We will go next to Dan Wewer with Raymond James.

Gary, when we had a chance to visit a lot of Family Dollar stores, the in-store banners look terrific compared to what they were a year ago. But we also see that pricing remains somewhat higher relative to Dollar General and Walmart. My question is, would you be willing to reinvest into more aggressive pricing at Family Dollar in an effort to regain market share at a faster rate?

Dan, thanks for the comments on the store conditions. It's something we're working hard on and proud of, when we make progress, more to come. But for pricing, I would tell you we are aware of all the competitive checks out there. And I would just tell you it varies as you probably see by geography across the U.S. There are certainly pockets that are more competitive than others. I would tell you, our response is really built around our foundation of how we go to market still. So from the standpoint of what do we do on -- like every retailer, what do we do an ad versions. But with us, we also have the ability to do price drops along with our base price conversions, along with playing up private brands, along with showing dollar well. And that gives me the flexibility that as I can go to market with some or all of those to show customer the value. So I'm aware of where the competitive checks are when we go face-to-face with all those folks. But I want to maintain the flexibility at this point of putting the right offer for our customer in front of we're on first of month and at the holidays. So that's where I'm focused right now, and it's not lost on me where everyone is at. And we are responding, we think, in the right way across those markets.

And just 2 real quick questions. One, can you discuss how deflation impacted same-store sales for the Family Dollar segment. I guess, the impact for Dollar Tree to be less. And then also, any comments on the Utah Distribution Center supporting both brands and what's going to be the rollout for the other distribution centers supporting both brands going forward?

Well, I'll comment on the deflation. I mean, obviously, we're not a grocery store. And I would say the biggest impact in a Family Dollar is, obviously, milk and eggs, bread to a lesser degree. You can see the impact in those categories, but I don't want to hang my head that, that's been any impact. I think our 4 walls what we can control is such a bigger opportunity for us to have those items in stock for first of the month and make sure our customers have it when they come into -- we have it when they come into the store. That's our opportunity. And we will roll through the price deflation as we go into next year and then we'll be back apples-to-apples.

The St. George's test that we rolled out earlier in the year -- by the way, went very smoothly. It was accomplished faster than we expected it to be accomplished and high marks to the people who worked together on both sides, both banners to make that happen. We are assessing the success of it and the savings that we're gleaning from it right now. I think we need a few more -- a little more time to understand the operating metrics there and where there are opportunities to save, as well as some other ideas that we've got in logistics. I'll tell you that we haven't settled in on the answer to your question yet, how many and when or what, but we are working very hard on deciding what that should be as we go forward as well as other opportunities that we have in the logistics network. I believe that in the long term, that some of the highest returns of synergies are going to come from our supply chain and how we manage our distribution network across the country. So big opportunity there. A lot of it's tied to IT integration, that's a big part of the gating factor of the speed that we want -- that we're going to be moving forward. But so far so good. We accomplished the combination very quickly, quicker than we thought, and we're now looking at the results.

And we'll take our next question from Paul Trussell with Deutsche Bank.

Wanted to discuss the puts and takes on EBIT margins in both banners for the Tree. Obviously, a very strong result in 3Q. If you can just help us understand which of those drivers can sustain into the fourth quarter? And then for Family Dollar, I believe it was about 2.2% EBIT margin rate, which is lower than kind of the run rate from the past few quarters, help us understand what took place in 3Q and what will change going forward?

Sure, Paul. The -- so as we look at it, we look at the Dollar Tree banner, obviously, very strong gross profit during the quarter with improvement of 80 basis points. And, again, lower freight costs, better mark-on. Obviously, our merchant team has been doing a great job continuing to source unbelievable values at the $1 price point. And obviously, it's been a little bit of a buyer's market to a certain extent on the discretionary side for the foreign purchases, so that's always helpful. But again, what we always do is we manage that. We have to make sure that we're credit, providing a value to the consumer at that dollar price point and that's something that we've been able to go. You know freight in itself has been a benefit. I would tell you a couple of things. One, Q4 is the quarter in which we see basically a flip where diesel will not be a benefit in the fourth quarter. Diesel will actually be a slight headwind in the fourth quarter compared to last year than where the pricing was. We have import benefits through our contract, which goes through the end of the April. But obviously, that landscape is changing as well as we go forward, so we have to keep that in mind. But so -- but I would tell you, I would think for the fourth quarter, we would expect to see our gross profit continue to expand in the Dollar Tree banner. On the SG&A side of the equation, we saw some various moving pieces as I spoke to in the sense of lower costs for professional fees, health insurance, store supplies and legal costs and -- but we also had investment store payroll. So we do believe it's important. We will continue to invest in store payroll as we go forward. We believe it's an important aspect of running good stores that our customers expect as we go forward and the conditions and merchandised and full, fun and friendly. So we think that will continue. But I'd say there is opportunity on the SG&A on an overall basis, but I think probably gross profit is a little bit bigger potential. When you look at Family Dollar, Family Dollar on a GAAP basis basically improved from a flat operating margin to a 2.2 operating margin for the quarter. I think you have a lot of different moving pieces. On an adjusted basis, you saw improvement in the gross profit line items. And really, again, we saw improvement in mark-on, improvement in freight, improvement in shrink. And I think those are areas we think we can continue to improve upon. And I would tell you that one of the call ups was higher markdown, but I think that the somewhat -- that is really a condition of last year. If you remember in Q2 last year, we took $60 million reserve from markdowns for the Red Tag Clearance Event which then happened in Q3. So our -- we are able to take that reserve to offset some of those markdowns in Q3. So our Q3 markdowns last year are probably a little below what they would be on a normal run-rate basis. So that's -- that was not unexpected at the end of the day. On an SG&A basis, I think one of the things we have going on is we do have a geography change going on in the Family Dollar P&L between merchandised margin and advertising. So we are getting -- we are taking -- we are not taking co-op dollars. We are getting at net costs upfront from the product. So we are seeing an increase in advertising, which was called out in my comments -- prepared comments and that will continue as we go forward. So -- but otherwise, we've also had store payroll investments as well in Family Dollar. So some puts and takes there as well. But on a go-forward basis, we do expect there, maybe, some investments there but I would expect that depreciation and amortization on the Family Dollar banner will continue to decrease as we've cycled through the comparisons of the harmonization of depreciation policies and the favorable lease rate. So somewhat of a long-winded answer, but that's kind of the puts and takes, Paul, as I see them.

No, that's very helpful color. My follow-up just to Gary, just regarding Family Dollar merchandise assortment. As you mentioned certainly, there is a more compelling offering. If you can just help us better understand what categories you're -- we should see when we walk in the store, the kind of greatest rate of change over the near term, whether that's on the seasonal side and your approach to the holidays and also maybe discuss just what are the -- what you're implementing from a consumable standpoint?

Paul, I would say what we worked hard on and which, I would hope, you'd see walking into a Family Dollar now is just the fact that end caps reflect more of what we have in our ad and the seasonal relevance and the holidays. And we have cleaned up, obviously, from a year ago. Really, the merchandise that did not have a home and they tended to collect on end caps. And so our ability to put in front of the customer what she wants on a weekly, monthly and during the holiday basis is by far the biggest difference that you're going to see at a Family Dollar. The tweaks that you see on assortments going up and down the aisles really reflect around what we think our customer is most interested in and that reflects around our basics and things like candy and our consumable business, including frozen food, which drives traffic; and in our discretionary business; we still have a strong apparel business on ladies that is seasonally relevant and driven by cold weather, which looks like we are finally going to get a bit of as we go into the Thanksgiving holiday. And just around the seasonal displays and impact, much like you see sometimes at Dollar Tree, the things our customers need in the last few days going up to a holiday, Family Dollar shopper shops so much later in the season that our ability to get ready for that and to have those displays on the floor or on the shelf are very important for us. All that being said, I would tell you the biggest lever Family Dollar had at the beginning of this process was just getting in stock. And that's what we continue to work on every day of the week to make sure that we have it with support from our DST suppliers as well as what we're touching from the back door to our shelf.

And we do have time for a couple more questions. We'll take our next from Michael Lasser at UBS.

Gary, you mentioned that November is starting off how you would hope, which market's interpreting that the business is coming positive. Would that still be the case, if you adjust for Halloween shifting into the early part of this quarter? And can you also, as part of that, discuss maybe what's not working as well as what you thought. The intent here is to understand where the biggest opportunities for improvement are to really put the business on a sustainable comp path higher?

Well, you haven't done all of the math on how we just had a good first of month, Michael, for the first 10 days, so sort of forgetting where Halloween impacted us those first 2 days. Really a lot of our focus is what's happening to us from the 1st through the 10th of the month and that is where we saw a nice impact on first of month. And we've been able to sustain that kind of activity through the additional weeks. Big week in front of us, obviously. But I would say it's -- we are going into the very meat of the holiday, obviously, this week and kickoff on Thursday, going to the balance of the quarter into Christmas. Then we'll keep our fingers crossed on weather. But that we'd have just the right amount of cold weather to sell all of our apparel that we need and not too much snow that people can't get to stores. That being said, what's the biggest opportunity, I would say, besides the basics I've mentioned on being in-stock and compelling values, is then renovation of some of our store base. Because we are still at risk on the older stores at Family Dollar that require either perhaps some deferred maintenance, but maybe even more than that gain the right assortment in the store with the right amount of square footage for each of the departments. And that's where we see the path long term to drive a sustained comp at Family Dollar to -- that's the basics in retail about having the right assortment and part of that is how is it set up in each of our stores. So when you take a look at the Family Dollar fleet, it works against us right now, where we have a large fleet of older stores. The upside is once we get into them and renovate them, there is a long runway there for us to keep improvement across our store base.

That's helpful. My follow-up question is, if you look back at your projections at the outset of your path to improve Family Dollar, are you having to invest more merchandise margin dollars and operating expense dollars than you originally expected? Either because of what you have learned about the business or because the operating environment is different when -- than what you thought because of factors like deflation or price competition?

That's a good question. I don't know I can say how I thought about from the beginning to now. I think what -- we've gotten the benefit of is the work on synergy has given us the ability to see that -- when you take a look at the margin expansion at Family Dollar, a good piece of that is a synergy work. Another good chunk of that is what we just do at Family Dollar in terms of auctioning and getting the best cost and as markets go up and down, making sure we are getting true net cost. I think the synergy work over the long term will give us flexibility. So when we said $300 million, I think we've all said we would be disappointed if that's all we ended up with. So the flexibility that, that gives us in Family Dollar is to say where should we invest it now. We went into knowing that we had deferred maintenance in CapEx to put into the stores. We are on a -- we've been following that model. It's a sequenced in a way that gives us the biggest feedback. We've invested in store labor because we just flatly needed to, to give our customer a better shopping experience, but that was -- that's proceeding as we projected. So I don't know that it's changed from what we thought. It, certainly, never quite goes maybe as fast as I would like to see it happen, but I'd -- I feel that we are on track with the things, with the big levers that we started with at Family Dollar. We have stayed focused on and stayed true to. And at the end of the day, staying focused on what our customers will give us credit for. And that's maybe the anchor that we went into this with and it's where we are today.

And we will take our final question today from John Zolidis with Buckingham.

Question on Family Dollar. You mentioned the in-stocks being the most important lever. If I think back to the management of the business under the prior regime, one of the things that was tried at various times was to change the SKU counts, increase the assortments in terms of total choice, particularly in HBA that was the category where they took assortment counts up, and then -- and so what I'm wondering, and this is partially based on visiting the stores and sometimes noting that the Family Dollar stores appear to have fewer items or choices than some comparable format retailers, where do you are think you are with the breadth of the assortment in the stores? Does it need to increase, decrease and how does that relate to the efforts to get in-stocks in place as you move forward?

John, I think it's -- I think what you're going to see -- listen, it's not going to be a dramatic big bang, where you see hundreds of SKUs dropout one week over the past week. I think our measured approach here has really been doing line reviews and really taking a look at the SKUs that are most meaningful for our Family Dollar customer, what's responding to us as we put against the backdrop of our smart ways to save. And we are going to take a look really 4 feet by 4 feet that says, what's the reason to have the offering that's in front of the customer and to have the right assortment. I'm not caught up in SKU count. It's certainly a piece of it as much as it is on how I'm going to drive productivity and profitability 4 feet by 4 feet through the store. And so, I -- while the 2 are related, I really think a little bit of it is, how do I get the right assortment at Family Dollar across these categories. You'll see some additional expansions in the future on some categories. But clearly, we had an opportunity to just get ourselves looking through the lens of value from our customer to have the right assortment at Family Dollar. The in-stock piece, while related, is the opportunity for us just to make sure that we are in-stock, on shelf for our customer. And that's the work we are working very hard on to make sure that we have, especially the first 10 days of the month, but have the items that are most meaningful for our customer on the shelf. So the 2 are as hand and glove, but I sort of view them independently in terms of our work process.

And we will have time for one more question. We will take it from Matthew Boss with JPMorgan. And with no response, we will move to our next. We'll go to Alvin Concepcion with Citi.

Just wanted to ask about the competitive promotional environment, what you found in third quarter into November, perhaps sequentially over year-over-year, I think you said you're comfortable with your competitive response. So would you consider it pretty rational out there and just general observations would be helpful.

Alvin, this is Bob. Just a couple of notes on the competition. From a Dollar Tree perspective as well as the Family Dollar perspective, we've always seen it as being highly competitive in our sector discount store sector. So it continues to be. We see a lot of activity out there, especially now with the big-box and the grocery stores, and especially, on the food side of the business. From the Dollar Tree side, we're pretty well insulated from that from the standpoint of, our goal is to offer the greatest value to the customer for $1 and the ever-changing mix. So we don't always excel exactly the same items as some of the big-box retailers or even the Family Dollar small-box sector. So from the Family -- from the Dollar Tree side, we are -- we watch what the competitors are doing as always, but we're really focused on the customer and offering the best value there. That's about half of our business. The other half of our business is Family Dollar and more traditional type of a business, more is planogrammed, we sell lot more of the same things that others sell. We've been watching that. As Gary said, we shop religiously for competition, whoever they may be across a broad geography and very thoroughly, and we take that information and react to it accordingly. Really keeping the focus on what's important to our customers. We want to do what's in the best interest of our customers with the offering. And offer more value in more ways. One of the things that Family Dollar, and I'm extremely excited about, that was touched on really maybe on the last question, was the things that we've done and how -- what may be -- has been accomplished. And one of the major accomplishments I see is our smart ways to save marketing program. It's -- you want -- the store is the ad, the store is what we are selling to our customer. There's more to it than just an item or a product. It's a shopping experience and it's an in-stock, in-store and it's the whole idea of your Family Dollar store and customer engagement in the stores. So we've made a lot of progress on our smart ways to save. Every day low price, as Gary says, throughout the store. Sale items, frequent sale items. Our Dollar WOW! in our stores, it's not a Dollar Tree. But we have a Dollar WOW! section in our Family Dollar stores. It has gained a lot of traction. Our price drop program continues to find traction and interest from the customers. Our shop and compare with our private label and the newest one is our digital coupon, that Gary said, in a short period of time we had over a million customers sign up for. So just that idea of engaging with our customers, the store matches the ad, the ad matches the store. When a customer comes in, there is an expectation of being in-stock, in business, finding what they need. May not be as many SKUs as the big-box guys. We don't have room for everything. But what we have is what our customers expect to have, and we have it in-stock every day as well as our ad items. So I look at the competition always, and I'm very much as we are all a student of retailing. But at the end of the day, all of our actions are focused on the customer and executing our plan to that customer. We are going to be competitive. We're going to be appropriately competitive. We're going to shop the market, but we're looking for more ways to engage the customer to offer even more value than our competitors offer. That takes a little time. But frankly, I think, we are right on target with that. And the building of the foundation that we will expand into the future -- for years into the future, I think that's one of the most important things that we can do as a retailer, just build this Family Dollar business, so that it survives any -- there is always going to be a price issue here, there. There is always going to be emphasis on one category or the other. What will stand the test time is how we are serving our customers, offering the best product at the best price and the shopping experience that they expect.

Thank you. And my follow-up is just a quick one for you. Did you see any impact from Hurricane Matthew or SNAP with your comps this quarter?

We didn't even mention the hurricane for a good reason. Because I was -- maybe I thought about it, but if I said anything about the hurricane, yes, there was an impact. But our people did such a fabulous job of getting through there. We had stores closed. We had stores without electricity. We lost service from our Savannah Distribution Center for days because we couldn't get workers to the D.C. in order to serve. We were servicing stores in that area out of our South Carolina Distribution Center for example and -- for Dollar Tree. So our store teams and our logistic teams and everyone just did a fabulous job in really difficult times. That was a category for right -- came all the way from Florida up to Virginia off the coast. It hit a lot of people and created a lot of issues. So out of that, we had some extra markdowns because we lost some electricity. We lost a few stores out of that. You see the results though and it's really -- it did not bring us to our knees. It did not cripple us. Our people just did a fabulous job on really scrambling to continue to serve the customer in the best way possible. So we didn't speak to it, because we came through it in rare fashion.

And at this time, I'll turn the call back to Randy Guiler for any additional or closing remarks.

Thank you, Dana. Thank you for joining us for today's call and for your continued interest in Dollar Tree. Our next quarterly Earnings Conference Call is tentatively scheduled for Wednesday, March 1, 2017. Have a great holiday.

Thank you. And that does conclude today's conference. Thank you for your participation. You may now disconnect.