Dollar Tree's (DLTR) CEO Bob Sasser on Q3 2016 Results - Earnings Call Transcript

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Dollar Tree, Inc. (NASDAQ:DLTR) Q3 2016 Earnings Conference Call November 22, 2016 9:00 AM ET

Executives

Randy Guiler - VP, IR

Bob Sasser - CEO

Kevin Wampler - CFO

Gary Philbin - President and COO

Analysts

Edward Kelly - Credit Suisse

Stephen Tanal - Goldman Sachs

Dan Wewer - Raymond James

Paul Trussell - Deutsche Bank

Michael Lasser - UBS

John Zolidis - Buckingham

Alvin Concepcion - Citi

Operator

Good day everyone, and welcome to the Dollar Tree Incorporated Third Quarter Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Randy Guiler, VP of Investor Relations. Please go ahead, sir.

Randy Guiler

Thank you, Diana. 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. Please limit your questions to one and one follow-up question if necessary.

Now I will turn the call over to Bob Sasser, Dollar Tree’s Chief Executive Officer.

Bob Sasser

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 three 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 includes 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% 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 in run-rate by the end of the first three 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's 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 Deals 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 two days of October and Halloween sales from third quarter into fourth quarter, we finished the third quarter strong. October was our highest comp month of the quarter.

Geographically, Dollar Tree’s 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 re-banner initiatives.

The Dollar Tree business continues 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 one dollar 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 stationary, teacher supplies, classroom essentials , and lunchbox values all priced at one dollar.

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 built 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, 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 re-bannered 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 6320 Dollar Tree stores across North America.

I continue to be pleased with our rebannering efforts. Since the acquisition, our store development teams have re-bannered 210 deals 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 re-bannered 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 conversions 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 the business initiatives include category expansions, customers are realizing more value as we rationalize and expand assortments in pet supplies, hardware, healthcare, beauty and eye care, as well as home and household products.

Creating a fun and enjoyable shopping experience was a focus on seasonal relevance. Our storefronts change with the seasons. In 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 find 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 product in 4710 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're employing 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're 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 priorities.

Gary Philbin

Thank you, Bob, and good morning everyone. After five full quarter, 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're working hard to improve these across our base of 8000 stores.

Our customers are seeing cleaner, better merchandise stores that have more compelling en-cap despite 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 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 month shifting money out of the core.

However we did see an acceleration of our two-year stacked comp of greater than 100 basis points from Q2 to Q3. And our Q3 basket improved slightly against the 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 re-bannered 42 Family Dollar stores to Dollar Tree and we ended the quarter with nearly 8000 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 our foundations on delivering value for our Family Dollar customer. These simple ways to say reflect from our ad into our store and these show our customers EDLP, pricing on everyday values, our sale items that reflect the most meaningful values on key items, dollar well, which drives a surprise and opening price point throughout the store, compare and save to shed out really our excellent values in 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 kick off. We already have over 1 million customers 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 to 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 products found throughout the Family Dollar across a high-energy front format that Pat's competing real Family Dollar shoppers against each other. So for Family Dollar is a great way to reach a demographic overlap that serves us well and really brings additional credibility to our smart ways to say.

Another fundamental part of our strategy for success is our focus on table stakes. At a high level this includes improved store standards and conditions, neat, clean fully recovered, merchandising relevance and energy, finding what I need a 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 en-caps with a compelling offer. 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 a test and learn discipline to measure our success and develop 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 our customers that counts on us and response and we deliver value, customer service and the Family Dollar shopping experience that we're 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?

Kevin Wampler

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 re-bannered 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 deals 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 re-bannered Family Dollar and deals 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 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 gross margin performance during the quarter included lower merchandise cost due to favorable freight cost of 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 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 $30 million in the 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 cost.

Selling, general and administered 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 payroll as a percent of net sales were offset by lower professional fees and lower depreciation expenses as a percent of sales.

Q3 SG&A expense for the Dollar Tree segment as a percent of sales was 23.2% and 90 basis point improvement compared to the prior year's quarter. Prior year's quarter included $11.8 million of acquisition-related costs, excluding the prior year's acquisition related cost 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 costs 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, although prior year's comparable period included $6.8 million of acquisition-related and divestiture costs.

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 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 quarter. Excluding the $11.8 million in acquisition related cost 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.

Non-operating expenses for the quarter totaled $112.2 million which is comprised primarily of net interest expense, as well as $26.6 million of acceleration of amortizable non-cash deferred financing costs and $2.6 million in fees associated with our debt refinancing.

Our 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 one-time 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 Tradename intangible assets, as well as the adoption of ASU number 2016-09 under which the incremental tax benefit recognized upon RSU restricted stock vesting in the quarter and 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 to 8.2%. Inventory per selling square foot increased 0.4%. We believe the 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're pleased with the progress we're 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 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 few development stores, our re-banner initiatives, the addition 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 the 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 valuation 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 few days of October our biggest Halloween sales is shifted into our fourth quarter. This shift is included in our sales guidance. Two are two additional sales days between Thanksgiving and Christmas in 2016.

We'll continue to experience a higher than normal degree of cannibalization to Dollar Tree comps as part of our re-banner efforts. This cannibalization expectation was planned and factored into both our re-banner strategy analysis and our outlook for same-store sales. We have budgeted lower freight and import trade costs than a year ago.

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 the 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're forecasting total sales to range from $5.59 billion to $5.69 billion and diluted earnings per share on a GAAP basis is in the range of $1.24 to $1.33 an increase from our 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're 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 $3.76, which includes the effect of $0.09 of refinancing cost in the third quarter. This compares to our previous EPS guidance range of $3.67 to $3.82, which did not include any refinancing cost. These estimates are based on low single-digit same-store sales increase and a 3.9% of square footage growth.

I’ll now turn the call back over to Bob.

Bob Sasser

Thank you, 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're making meaningful progress in developing what I consider to be the best model in small box value retail. Dollar Tree is now diversified combination of 6,000 store banner and 8,000 store banner each with its unique ability to effectively serve more customers across all types of markets.

With the combination of these two great brands we've powerful flexibility and how and where we choose to grow while expanding our opportunity to grow. Across 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. Overtime we 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 driving key strategic initiatives to the combined organization through improved communications, 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 is powerful, flexible and more relevant than ever, providing extreme value to 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.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go first today to Edward Kelly with Credit Suisse.

Edward Kelly

Hi, good morning, guys. I'd like to start with a 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. 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 been bouncing around either up or down modestly. Curious how you think you - 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?

Gary Philbin

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, it 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, I would hope, going into the holiday season.

So I’d start with saying the foundation that we're 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, and anything else we're going to do past that, we have to stick because we're consistent on delivering value in the store and we have a shocking experience that our customers find value when they come to 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 private 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 store that our customers are looking for, when we see our first-of-the-month of the 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 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're not all the way there, I would tell you that we've made progress, and it's still our focus as we go into '17.

Edward Kelly

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?

Kevin Wampler

We're right on schedule with what we said on the $300 million, we have 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 the exceed $3 million over the three years.

Edward Kelly

Okay. Thank you.

Kevin Wampler

$300 million.

Operator

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

Stephen Tanal

Good morning, guys. Thanks for taking my question. I guess just to follow-up on the synergy point, can you talk to the one-time costs that you expect to incur as you got there? Are we still thinking about 50% of $300 million as sort of in SG&A? And where are you at today relative to that kind of a number?

Bob Sasser

Yes, Stephen just to reset maybe where we laid that out, originally we said $300 million of one-time cost to achieve. We said half of it OpEx, half of it CapEx basically is how we're looking at it, at the beginning of the process.

I would tell you, as we -- as I look at it to where we're at to this point, we probably spent more CapEx and OpEx through this point because if you think about the number of stores, we've re-bannered as part of that, that's been a fairly large cost at the end of the day. We probably have spent more like I said, CapEx and OpEx.

But I still think the $300 million holds 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 could be a little bit of movement in that direction as we think about not only re-banners but the systems integration and various other projects. We've got one DC that we have co-bannered.

So a lot of things that we've done have required capital dollars to make those changes. So I think it may lean a little bit closer - a little heavier on the CapEx side than the OpEx at the end of the day.

Stephen Tanal

Got it, that's helpful. I guess just on Family Dollar and thinking about the guidance for the fourth quarter, what gives you the confidence in the inflection there?

Bob Sasser

Well, it's - I think our comparison to last year where we know that we went to this holiday season. I think better merchandise, our stores are cleaner, they're 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 quicker, better start. I think our assortments are 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 into 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 systems says and then what have we done to ourselves that 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 three pieces, we're 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.

Stephen Tanal

That's great to hear. Just lastly for me, as I think about leverage in our models, how should it really play out from here? When do you expect to make bigger pay downs? Where do you expect to get over time sort of thing?

Bob Sasser

Sorry, you broke up a little bit, could you repeat the question.

Stephen Tanal

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

Bob Sasser

Yes, I mean obviously we reached 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.

As I look at it today, I think we have the opportunity to be investment grade by fiscal year 2019 and again, we think that's important just from a flexibility standpoint as we go forward and have the flexibility to be able to do whatever we want to do from a financing and again also from investment grade we will bring down the cost of capital overall as well.

So I guess how we're thinking about it is we're going to continue to build the business and invest in the business and grow the business, but we're also working to continue to pay down the debt as well.

Stephen Tanal

Okay, great. Thanks a lot guys.

Operator

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

Dan Wewer

Thanks. Gary, when we've had a chance to visit a lot of Family Dollar stores, the in-store standards looked terrific compared to where 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?

Gary Philbin

Hi Dan, thank you. 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're aware of all the competitive checks out there and I would, 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 on ad versions, but with us, we also have the ability to do price drops along with our base price, conversions along with playing our private brands, along with showing Dollar valve. And that gives me the flexibility that says, I can go to market with some or all of those to show the 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 were on first of month and at the holiday. So that’s where I’m focused right now and it’s not lost on me where everyone is out and we are responding. We think in the right way across those markets.

Dan Wewer

Just two 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 would be less. Then also, any comments on the Utah distribution center supporting both brands? And what is going to be the rollout for the other distribution centers supporting both brands going forward?

Bob Sasser

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 hat, but that’s been any impact.

I think our four walls what we can control is such a bigger opportunity for us to have those items in stock for first so 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’ll roll through the price deflation as we go into next year and then we’ll be back apples-to-apples.

Gary Philbin

The St. George's test that we rolled out earlier in the year, by the way went very smoothly and it was accomplished faster than we expected to be accomplished and high margins of the people who work together on both sides, both banners to make that happen. We’re assessing the success of it and the savings that we’re gating from it right now.

I think we need a few more – little more time to understand the operating metrics there and where their opportunities are to say as well as some other ideas that we’ve got in logistics. I’ll tell you that, we haven’t – we haven’t settled in on the answer to your question, yes how many and when or what, but we’re 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 and our synergies are going to come from our supply chain and how we manage our distribution network across the country, so big opportunities 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.

Dan Wewer

Okay, great. Thank you.

Operator

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

Paul Trussell

Good morning. I 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.

Then for Family Dollar, I believe it was about a 2.2% EBIT margin rate, which is lower than the run rate from the past few quarters. Help us understand what took place in 3Q and what will change going forward. Thanks.

Bob Sasser

Sure, Paul. So as we look at it, we look at the Dollar Tree banner. Obviously a 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 the source unbelievable values at the $1 price point, and obviously, it’s been a little bit of a buyers 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 Dollar price point, and that something that we've been able to do.

Freight in itself is been a benefit. I would tell you a couple of things. One, Q4 is the – the quarter in which we see basically a flip where diesel will not see 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 April, but obviously, that landscape is changing as well as we go forward, so that we – keep that in mind, but so – but I would think for the fourth quarter we would expect to see our gross profit continue to expand on the Dollar Tree banner.

On the SG&A side of the equation, we saw some various moving pieces, as I spoke to in a sense of lower costs for professional fees, health insurance, store supplies and legal costs but we also had investments 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 important aspect of running good stores that our customers expect as we go forward in the conditions and merchandise and full fun and friendly, so we think that will continue. But, so I would say there is opportunity on the SG&A on an overall basis but I think probably gross profit is a little bit bigger potential.

If you look at Family Dollar, Family Dollar on a GAAP basis basically improved from a flat operating margins were 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 mark-on and improvement in freight and 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 marked down. But I think that is somewhat that is really a condition of last year. You remember right in Q2 last year, we took $60 million reserve for markdowns for the Red Tag clearance sales. We spent half of that in Q3, so we are able to take that reserve to offset some of those markdowns in Q3. So our Q3 markdowns last year probably little below what they would be on a normal run rate basis, so that was not unexpected at the end of the day.

On an SG&A basis, I think, one of things we have going on is we do have a geography change going on in the Family Dollar P&L between merchandise margin and advertising. So we are getting – we're taking – we’re not taking co-op dollar, we’re getting it net cost upfront in the products. So we're 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 as 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 a Family Dollar banner will continue to decrease as we’ve cycled through the comparisons of the harmonization of depreciation policies and the favorable lease rights. So somewhat of a long-winded answer but that’s kind of the puts and takes Paul that’s for you.

Paul Trussell

No, that's very helpful color, thank you. My follow-up just to Gary. Just regarding Family Dollar merchandise assortment, as you mentioned certainly there's a more compelling offering. If you can just help us better understand what categories 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. Also maybe just discuss just what are the -- what you are implementing from a consumables standpoint.

Gary Philbin

Paul, I would say what we worked hard on, I would help you to see walk into a Family Dollar now, 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 did not have a home and they tended to collect on end caps.

So our ability to put in front of the customer what she wants on weekly, monthly and during the holiday basis is by far the biggest difference that you are going to see at our 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 in our discretionary business.

We still have a strong apparel business on ladies that is seasonally relevant and driven by a cold weather, which looks like we’re finally going to get a good as we go into the Thanksgiving holiday. And just around the seasonal displays an impact, much like you see sometimes at Dollar Tree, the things our customers need and left few days going up to a holiday. Family Dollar shopper shops so much later in the season than 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 of Family Dollar had at the beginning of this process was just getting in stock and that’s how we continued to work on every day of the week to make sure that we haven't with support from our DSD suppliers as well as what we’re touching from the back door to our shelf.

Paul Trussell

Thank you. Good luck.

Operator

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

Michael Lasser

Good morning, thanks a lot for taking my question. Gary, you mentioned that November is starting off how you had hoped with markets interpreting that the business is comping positive. Would that still be the case if you adjust for Halloween shifting into the early part of this quarter?

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.

Gary Philbin

Well, I know you haven’t done all of the math on how – we just tagged we had a good first of month Michael for the first 10 day, so sort of forgetting where Halloween impacted us those first two days really a lot of our focus is what's happening to us from the first through the 10th of the month and that is where we saw 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’re going into the very meat of the holiday obviously this week and kick-off on Thursday going to the balance of the quarter into Christmas. And then we’ll keep our fingers crossed on whether most of which have just the right amount cold weather to sell all of our apparel that we need and not too much know that people can’t get to the 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 on risk in the older stores at Family Dollar that require either perhaps some deferred maintenance but maybe even more than that gaining their right assortment in the store with the right amount of square footage for each of the departments.

And that's where we see the past long-term drive that sustained cost at Family Dollar to – that’s the basics in retail but having the right assortment and part of that is how is it set up in each of our stores. So, let me take a look at the Family Dollar fleet. It works against us right now where we have a large fleet of order stores. The upside is once we get into them and renovate them, there's a long runway there for us to keep improvement across our store base.

Michael Lasser

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 than what you thought because of factors like deflation or price competition?

Gary Philbin

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 we take a look at the margin expansion of Family Dollar, a good piece of that is the 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're getting through net cost.

I think the synergy work over the long-term will give us flexibility. So, you know, while we said when $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 a Family Dollar to say where should we invest it now. We went into knowing that we had deferred maintenance and CapEx to put in the stores. We’re on – we've been following that model.

It's sequenced in a way that gives us a biggest feedback. We've invested in store labor, because we just quietly needed to give our customer a better shopping experience, but that was, that's proceeding as we’ve projected.

So I don't know that’s – 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 would – I feel that we're on track with the things, with the big levers that we start with the Family Dollar.

We have stayed focused on and stay true to. And at the end of the day staying focused on what our customer’s will give us credit for, and that's maybe the anchor that we went into this work. That's where we are today.

Michael Lasser

Thanks, again, and have a great holiday.

Operator

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

John Zolidis

Thanks for fitting me in. 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 HVA; 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 think you are with the breadth of the assortment in the stores? Do they need to increase, decrease? And how does that relate to the efforts to get in-stocks in place as you move forward? Thanks.

Bob Sasser

John, I think it's – I think what you're going to see – listen, its not going to be dramatic big bang or you see hundreds of skews dropout one week over the past week. I think our measured approach here is really been doing line reviews and really taking a look at the skews 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're going to take a look really 4 feet by 4 feet as, what's the reason to have the offering that's in front of the customer, and have the right assortment. I'm not caught up in skew count. That's a 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 to the store.

And so, I think while the two are related, I really think a little bit 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're in stock on shelf for our customer, and that's a work we're 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 the customer on the shelf. So the two are hand in glove but I sort of view them independently in terms of our work processes.

John Zolidis

Great. Thanks for that and Happy Thanksgiving to everyone.

Operator

And we will have time for one more question. We'll take it from Matthew Boss with JPMorgan. And Mr. Boss, please check your mute button, we're unable to hear you. Mr. Boss, your line is open. Please go ahead.

And with no response, we will move to our next, we will go to Alvin Concepcion with Citi.

Alvin Concepcion

Thanks for squeezing me in here. Just wanted to ask about the competitive promotional environment, what you saw in the third quarter into November, perhaps sequential or year-over-year. I think you said you were comfortable with your competitive response, so would you consider it pretty rational out there? Just general observations would be helpful.

Bob Sasser

Alvin it's Bob. Just a couple of notes on the competition from a Dollar Tree perspective as well as Family Dollar perspective, we've always seen 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 Dollar and the ever-changing mix.

So we don't always exactly the same items as some of the Big Box retailers or even the Family Dollar's small box sector. So from the Family Dollar - from the Dollar Tree side, 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 planogram. We sell a lot more of the same things that others sell. We've been watching that as Gary said, we shop religiously with competition, whoever they maybe 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 what they're offering and offer more value and more ways. One of the things at 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 maybe has been accomplished and one of the major accomplishments, I see is our smart ways to save marketing program.

The stores - the store is what we're selling to our customers more to it than just an item or product is the shopping experience and it's an stock, in store and that'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 say everyday low price as Gary says throughout the store sale items, frequent sale items, our Dollar well in our stores, it's not a Dollar Tree but we have a Dollar well 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 shopping compared with our private label and the newest one is our digital coupon that Gary said at a short period of time, we had over million customers signed 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 skews 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 add items.

So I look at the competition always and I'm very much as we are all students of retailing, that at the end of the day, all of our actions are focused on the customer and executing our plan to that customer, we're going to be competitive, we're going to be appropriately competitive, we're going to shop the market, but we look at 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're right on target with that and the building of the foundation that 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 retailers build, this Family Dollar business, so that survives - there is always going to be a price issue here, there is always going to be emphasis on one category or the other. What will stand the test of time is how we’re serving our customers are from the best product, at the best price, and a shopping experience that they expect.

Alvin Concepcion

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

Bob Sasser

We didn’t even mention Hurricane for a good reason, because I was - 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 that. 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 a Dollar Tree.

So our store teams and our logistics teams and everyone just did a fabulous job in really difficult times. That was a Category 4, 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 needs, it did not cripple us, our people did just 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.

Alvin Concepcion

Thank you and happy holiday.

Operator

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

Randy Guiler

Thank you, Diana. 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.

Operator

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

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