Dollar Tree, Inc. (DLTR) Q1 2020 Earnings Report, Transcript and Summary

Good day, and welcome to Dollar Tree, Inc.'s First 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, 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 Mac Naughton; 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 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. 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. GAAP 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 $0.01 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 continuing 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 comped 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. It remains strong, and 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 included Easter, seasonal, food and household products. Highlights in Q1 for Dollar Tree Direct are our online business. We saw increases on our in-line 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 catalogs 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 Dollar Trees and 26 Family Dollar Stores. We relocated or expanded 11 stores, 6 Dollar 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 Dollar Tree stores with freezers and coolers to 5,766. During the quarter, we closed 25 stores, 9 Dollar Tree and 16 Family Dollar. 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% tariffs imposed under Section 301 for Chinese goods included on List 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 it 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 Dollar's 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. 7 of our 8 lines of businesses comped positive for the quarter. From a regional perspective, 6 of our 7 zones comped 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 2/3 by traffic and 1/3 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 is -- 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 of Dollar Tree and $2.85 billion of Family Dollar. 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 Family Dollar 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 in the lower-margin consumable category. These increases were offset by improved shrink and improved initial merchandise markdown. 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 plan to close during 2019. Excluding these costs, occupancy costs would have delevered 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 Dollar Tree 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, support of company initiatives and an increase in incentive compensation resulting from prior year adjustments due to lower performance of target. These increases were partially offset by a decrease in retirement plan expense. Operating and corporate expense increased approximately 5 basis points resulting from higher debit and credit fees, primarily due to increased card penetration. Store operating costs decreased approximately 5 basis points due to lower utility costs, specifically electricity, resulting primarily from the benefit of the LED lighting program in the stores. Selling, general and administrative expenses for the Family Dollar segment was 21.6% as a percentage of sales in the first quarter compared to 21.5% for the same period last year. The increase in SG&A as a percentage of sales was due to the net of the following: payroll expenses increased approximately 25 basis points, primarily due to an increased store hourly payroll -- increased average hourly rate and a support of the company's initiatives related to the costs per store renovations, re-banners 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% compared to 7.9% in the last -- in last year's first quarter. Operating income margin for the Dollar Tree segment declined 20 basis points to 13.2% when compared to the prior year's quarter. Operating income margin for the Family Dollar segment was 3.2% for the quarter. Nonoperating 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 $0.02 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 $0.52 of costs 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 4, 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 in our share repurchase authorization. We will provide updates on additional share repurchases, if any, following the quarter in which they may occur. Inventory for the Dollar Tree segment at quarter end increased 10.6% from the same time last year, while selling square footage increased 5.7%. Inventory per selling square foot increased 4.6%. We believe that current inventory levels are appropriate to support the scheduled new store openings, re-banners 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 increased 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 6 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 6, 2019 included $95 million in discrete costs related 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 6, we did not include charges for lease obligation and related expenses for any closed doors 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 $0.10 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 1 based on negotiations in April. The new contracts were unfavorable compared to our prior outlook and will add approximately $15 million or $0.05 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 6. We expect continued pressure on store payroll based on competitive markets, states 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. Net 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've 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 $0.64 to $0.73. 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've noted, our outlook now includes approximately $30 million or $0.10 per diluted share of costs related to Q2 store closures for lease obligations and related costs that 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 of approximately 1% of selling square footage growth. The company anticipates GAAP net income per diluted share for full year fiscal 2019 will range between $4.77 and $5.07. This 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 diluted share in store closure related costs and import freight costs of $15 million or $0.05 per diluted share related to increased import freight rates, as previously described in our updated outlook. I'll now 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 in 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'll 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 sales 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 4-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 we'll measure, analyze and adjust products, layout and other variables to ensure we are responding to customer feedback in our continued merchandising efforts. Because it's an iterative process, we now have a set time frame 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 a call-out to all of our family Dollar Tree members that are 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.

[Operator Instructions] We'll take our first question from Robby Ohmes with Bank of America Merrill Lynch.

My question is actually on the H2 format. And I guess maybe Gary and maybe Duncan should answer this, but just could you guys talk through -- 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?

So Robby, 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've 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 it 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 efforts to see how high it can go. But Duncan?

Yes. Thanks, Gary. Thank you, Robby, for your question. As Gary stated, we're pretty excited about the success we've had to date. It's very exciting to see 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've noticed that we did fix the adjacencies of these stores to make 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 6 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 more appropriately, we also added 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 the 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 have seen in our traditional format. So I'm 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 don't -- 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 4 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. They are -- we show them a section flow. So the work is relatively easy and 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 -- these are smaller stores, but the more Dollar Tree assortment you get into an H2 Family Dollar, does the EBIT margin of that store start to look more and more like a Dollar Tree store EBIT margin?

Robby, 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 the 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 we'll ever have EBITDA of a Dollar Tree store. Just given the amount of consumables we sell to our core customer for our Family Dollar banners versus discretionary business we've had in our Dollar Tree business, they will never -- they are 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.

[Operator Instructions] We'll go next to Brad Thomas with KeyBanc Capital Markets.

I also wanted to follow up on 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 1.5% tailwind to comps for Family Dollar? Or is there 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 7 out of 8 of our lines of businesses, positive comp in 6 of our 7 zones. So we're seeing a 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 then 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. And the key here is the base business is solid.

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

If we back out the $0.15 of incremental, one-time item from your guidance, the midpoint's going up $0.02, 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 out for the year, basically, if you take the fact that on a GAAP basis for the quarter, you would 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 at adjustment. And then beyond that, it's just the range always narrows as you go further down the end of the quarter, a quarter further into the year. We now have 3 quarters left, so we have roughly $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 -- it's the initiatives, the 2 new items that we've brought in. So I don't think there's anything to read into it other than that. From my perspective, we didn't -- 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 ASC 842 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 $0.15 hit from those items that you mentioned?

No, Michael, I think as a backdrop of our outlook in March, we wanted to give a little longer-term outlook, given the significant investment we were making in this year in particular around the initiatives to drive improved performance in our Family 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. Given another point in time, I think -- I don't think we've changed necessarily our viewpoint. We've said at that point in time that it was based upon the GAAP number. We haven't really updated anything at this point, so I think it's -- 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 -- it's Gary. From my perspective, as we go through this year, with the initiatives we've called out, we're closing almost 400 Family Dollar Stores, a 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 in 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 are 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 those 2 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 those 3, I would have been wrong because our team mitigated most of it -- all of it as we went through our buying trips. And that's the approach we're taking on this List 4. 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 is 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. We're going to use all those chapters in our playbook to get to the right answer on it. So -- 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.

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

So just a follow-up on Michael's question. With the current tariff exposure of 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 -- 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, 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 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 wouldn'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 costs in our 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 2-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?

Yes. This is Kevin. I'll give you some background on that. Obviously, we're very disappointed in our results, and we own that. And we have not executed at the level we've expected to. So -- and this is, I would tell you, this is not sitting in the corner of somebody's desk, this is front and center for everybody, the operations team, the loss prevention team, the logistics team, management. I think one of the things we have fought a little bit is our inventory levels. Again, our inventory levels have grown. If you saw for the first time this quarter, we're 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 banners with regards to 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 disappointing trend, but I think there is a lot of work going on to really address this on an overall basis.

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

I just wanted to get back to the profit dollars on the H2. It wasn't clear. Are EBITDA -- sorry, EBIT dollars up in those stores? Or are they flat? Or are they down, for the ones you've converted?

No, they're absolutely up.

They're up? Okay, great. And then looking -- I just want to poke a little bit more at this gross margin on Family Dollar. Where do you think we've gone? Obviously, they've come down a lot. Shrink's part of it. So number one is, is that shrink really just thieving? How should -- what's the #1 cause of that shrink? And number two, as we bounce Family Dollar gross margins, any thought where we can come back up to?

I think as we look at our gross margin 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 in consumable goods, a lot of work going on to really energize the discretionary business to help offset that, so that 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, excluding 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, the shortage of truck drivers was an impact this year. That will level out in the back half. The DCs, we've -- listen, we've paid up more just to get people to work in distribution centers, but our productivity over time will catch that up and surpass it. Shrink, we have everybody on a red alert. This is -- that's controllable. And where does it come from? Well, as any good retailer, you look inside and outside, but we're just going 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, 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. And the import piece, if -- what we've continued to work on, 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. We've still got runway there, and that's the upside opportunity at Family Dollar on the margin side.

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

A question on the Dollar Tree Plus!. Really 2 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?

Well, a couple of important points, Scot. I mean, you may see some $2 in there. I think the point I was 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 schoolteachers 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've 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 prepriced in some fashion. That will be very clear to them. And our folks are being trained to answer all those questions. It's -- 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.

Yes. The full price point certainly make sense. How much of the store's SKU base will be, let's call it, changed?

Well, I mentioned you're going to see, let's just say, 100-plus SKUs. And listen, in the same way we do at Dollar Tree today, you're going to see items come and go while you see it. It's not always going to be there. And so when you think about the SKU base, 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.

[Operator Instructions] We'll go next to Paul Trussell with Deutsche Bank.

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.

Yes. I mean, I think freight, we've been fairly transparent on it in the sense of, 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 just some -- from an overall perspective, inbound has started to regulate itself a little bit. It seems like domestic's still running a little high. And then, obviously, we gave you the news on the import. I think that's about $0.05, but it's back half related if you 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 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 level out as we get to the second half. I think as -- the other thing to remind everybody is 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. 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 bigger picture, as we think about the fact you are doing a lot of remodels, closing a number of Family Dollar Stores, just wanted to take a step back and get your current outlook on the opportunity 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.

Paul, this is Gary. So we had said a few years ago, 25,000 domestic U.S. and 1,000 in Canada. I think on the U.S. side, I'd still see that opportunity, is going to be both Dollar Tree and Family Dollar. And I think as we've learned about the business, the opportunity to build Family Dollars, 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 opportunity is sort of what we've called out. What we deliver is a great box shopping environment, items that people need, that as independent drugstores, 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 a 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've got 1,000 -- we're obviously talking about Snack Zones, but we're touching 1,000 Dollar Trees as well. But the opportunity to build more doors is there. It's 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 our renovation or being new in the last 4 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 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.

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

So either for Gary or Duncan. When you guys think about the Family Dollar's organization -- the organization's capacity, right, for change, and particularly on the real estate side, as 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, does that -- when you think about the bell curve on store performance, once you close the stores you're going to close this year, we're basically through now because of the H2'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 the Dollar Tree and Family Dollar people. But I will tell you that we are -- nowhere near our capacity here, we're -- 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 H2, we also are getting much more efficient on how to handle 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 maintenance of where the store performs.

And John, it's 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 they're headed for, and actually reach out for our landlords to get input and contributions from them to 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 particularly hit on the stores closing out a lease as we go through the out years 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.

Ladies and gentlemen, this does conclude our question-and-answer session. At this time, I'd like to turn it back to Mr. Randy Guiler 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.