Nov 24, 2015
Executives
Randy Guiler - VP, IR Bob Sasser - CEO Kevin Wampler - CFO Gary Philbin - President and COO, Family Dollar
Analysts
Matthew Boss - JPMorgan Stephen Grambling - Goldman Sachs Dan Binder - Jefferies Michael Lasser - UBS Scot Ciccarelli - RBC Capital Markets Paul Trussell - Deutsche Bank
Operator
Good day, everyone and welcome to the Dollar Tree Incorporated Third Quarter Earnings Conference Call. Today’s conference is being recorded.
For opening remarks and introductions, I will turn the conference over to Mr. Randy Guiler, Vice President, Investor Relations.
Please go ahead, sir.
Randy Guiler
Thank you, Debbie. Good morning and welcome to our conference call to discuss Dollar Tree’s performance for the third quarter of fiscal 2015.
Participating on today's call will be CEO, Bob Sasser; 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 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 and current report on Form 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 and you should not expect us to do so.
At the end of our prepared remarks, we will open the call to your questions. Please limit your questions to one and one follow-up if necessary.
Now, I will turn the call over to Bob Sasser, Dollar Tree’s Chief Executive Officer.
Bob Sasser
Thank you, Randy, and good morning, everyone. This morning we announced results for the third quarter of fiscal 2015.
Total sales increased to $4.95 billion and same-store sales increased 2.1% on a constant currency basis. Adjusted cash EPS increased 30.4% to $1.33 per share versus $1.02 per share in the prior year's third quarter.
Despite what continues to be viewed by many as a challenging retail environment, I’m very pleased with our third quarter performance and especially with our contingent progress in integrating our recent acquisition of Family Dollar. There have been no surprises that will change our outlook on the strategic rationale.
There is only increased excitement about the opportunities that lie ahead as a larger, stronger and more diversified organization. We’re only one full quarter into the integration and both our teams are aligned strategically and collaborating to deliver solid results.
Accomplishment in the third quarter include another solid quarter for the Dollar Tree banner. As expected Dollar Tree delivered a low single digit positive sales comp.
Same-store sales on a constant currency basis increased 2.1% and that was on top of a strong 5.9% increase in the third quarter last year. This was the most difficult quarterly comparison for the year.
On a two-year stacked basis, our same-store sales accelerated from the second quarter to the third quarter just as they had done from the first quarter to the second. Sales growth in Q3 was driven by increases in both traffic and average ticket.
We’re making meaningful progress on integrating the Family Dollar banner. Only one full quarter end, the stores are cleaner, the shelves were better stocked, we've cleaned up old inventory and the end caps are more compelling and relevant.
The feedback we’re receiving from store teams and customers has been positive. We’ve developed and announced plans to re-banner our deals locations.
Our full resources and energy are being focused on our two primary banners Dollar Tree and Family Dollar, and on November 2 we announced the successful completion of our required divesture of 330 Family Dollar stores. I’m extremely pleased with the consistent growth and strength of the Dollar Tree business.
This was the 31st consecutive quarter of positive same-store sales. Third quarter results continue to validate the relevance of the Dollar Tree brand as customers are shopping with us more often, we're attracting new customers every day and when the customers are in the store, they're buying more.
Dollar Tree continues to be part of the solution for millions of consumers as they strive to 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 merchants do a great job sourcing product that exceeds customer expectations for what $1 can buy at a cost that fits our margin requirements.
And our store teams are focused on providing a clean, full, fun and friendly shopping experience. Our merchandize values are better than ever.
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 fashioned stationary, teacher supplies, classroom essentials and lunch box values all priced at $1. In September, we celebrated Dollar Tree’s 29th anniversary with bonus buys and well items for our customers, key categories included cleaning supplies, home office essentials, snacks and a broad assortment of special values from our million dollar brands.
Our stores were filled with well-known national brands and high value private labels throughout the event. Seasonally our store teams transitioned efficiently from back to school to fall harvest and Halloween.
In September, Dollar Tree became Halloween headquarters with major statements in Halloween costumes, make up home décor, candy and party supplies. Customers responded enthusiastically and our sell through was improved over last year.
Dollar Tree stores are now set and prepared for Christmas and fourth quarter Holiday shopping season. For the third quarter, same-store sales increased as a result of growth in both our basic consumables and discretionary products.
The top performing categories in the quarter included snacks and beverage, candy and food, household supplies and beauty and eyewear. Geographically, Dollar Tree same-store sales growth was strongest in the Mid-West followed by the Mid-Atlantic, Southeast and Northeast.
All six geographic zones produced positive same-store sales for the quarter. Looking forward, the Dollar Tree segment is positioned for increased relevance to customer’s sustained growth and improved profitability.
We have multiple opportunities to continue growing and improving our business through opening more stores and increasing the productivity of all of our stores. In the third quarter, we opened a total of 118 new Dollar Tree stores and relocated or expanded 16 stores for a total of 134 projects.
Additionally, during the quarter, we re-bannered 143 Family Dollar Stores to Dollar Tree stores and we’re pleased with the results. We're now targeting a total of 200 conversions in this fiscal year.
Total Dollar Tree square footage increased 9.9% compared to the prior year and we ended the quarter with 5,841 Dollar Tree stores in North America. In addition to new stores, we continue to execute our strategy to improve the productivity of our existing stores.
Some of our drive the business initiatives include category expansions, customers realizing more value as we rationalize and expand assortments in our pet supplies, hardware, healthcare, beauty and eyewear as well as home and household products. Seasonal relevance, our storefronts change with the seasons.
At Dollar Tree, we want to own the seasons at the $1 price point. Merchandize energy and the thrill of the hunt throughout of the store at Dollar Tree, you always find an unexpected value.
And being first of the month ready, we place special emphasis on basic consumables, core items at the beginning of each month when many customers are shopping for basic needs. Additionally, we're continuing the expansion of our frozen and refrigerated category.
In the third quarter, we installed freezers and coolers in 135 additional stores for a total of 390 stores year-to-date. We currently offer frozen and refrigerated product in 4,148 stores and growing.
We continue to support planned growth with infrastructure and distribution capacity ahead of the need. Construction on our newest DC in Cherokee County, South Carolina is well underway.
This 1.5 million square foot automated facility will provide capacity and increased efficiency to support continued profitable store growth in the Southeast and Mid-Atlantic regions of the U.S. We plan to have the facility operational in Q3 of 2016.
Additionally to support continued growth in our California markets we are expanding our Stockton distribution center from 525,000 to 820,000 square feet, and increase of 55%. This project is scheduled to be completed by the end of our second quarter in 2016.
Again I'm extremely pleased with our company's accomplishments in the third quarter. Our Dollar Tree segment continues to deliver sector leading operating margins.
Our customer base is large and growing, and we are on schedule with our integration of Family Dollar. We have an incredible opportunity ahead of us, as a combined organization.
I view the strategic rationale as more compelling than ever. In the early days of integration, we found nothing that diminishes our vision and plans for value creation.
In fact I'm even more enthusiastic about the opportunity this merger presents for our customers, our suppliers, our associates and our shareholders. Our primary areas of focus for Family Dollar are on the customer, the shopping experience and the value equation.
In the third quarter we kicked off our red red-tag clearance event, while continuing the review of our merchandise assortments and category flow, refining real estate plans, reviewing and refining marketing plans, and defining the table stakes in our stores. With our red-tag clearance event we identified markdown and cleared out old slow-moving and non-productive inventory.
In doing so, we reclaimed our end caps to make way for fresh new and seasonal merchandise and to refresh our discretionary sections and apparel home and seasonal. All of these are important categories as we enter the holidays.
The red-tag event was well executed across stores, customers responded to the additional savings and we have cleared more than $135 million at retail in aged and non-productive inventory. Merchandise assortments are under review.
Our focus is on providing product and value that best meets our customer’s needs. We are paying special attention to opening price point, national brand pricing, private label products, enrolls, while rationalizing SKUs for increase productivity and a focus on basic in stock levels.
In real estate we are analyzing portfolio data to gain a better understanding of customer and demographic targets. This is assisting in the identification of additional stores that we have better Dollar Tree demographics for potential re-banner and identifying metrics for improving new store productivity and our return on investment.
We are extremely focused on opportunities to improve the customer experience. The table stakes requirements are being refined, quantified and rolled out for testing.
Table stakes includes store standards and conditions, the customer experience, merchandise relevance, and customer engagement to name a few of the key metrics. Many of these metrics are less about investment and more about disciplines and benchmarks.
Customers are already seeing cleaner aisles with less clutter. For table stakes initiatives that require investments we plan to manage with the same disciplined approach that we've used at family Dollar Tree for many years.
Identifying and paying special attention to the customer facing metrics with a focus on return on investment and productivity enhancement. We're making great progress on delivering announced synergies.
We have confidence in our ability to deliver at least $300 million in annual run rate synergies by the end of the third full year post closing. In fact, I'll be disappointed if we don't exceed this number.
As a reminder, the synergies will be driven through four primary avenues. Sourcing and procurement, our re-bannered program for optimizing store formats, distribution and logistics, and overhead and corporate SG&A.
As announced, we expect to spend approximately $300 million in one-time cost to achieve these synergies. We still have a lot of work ahead of us, but at this stage we're clearly on track to achieve our year one milestone of at least $75 million in run rate synergies.
Plans and processes to capture sourcing and procurement synergies are well underway. Our exact match initiative to provide the lowest cost on identical items across both banners is nearly complete with expected results no surprises.
The review of similar match items continues positive results are growing. We are achieving payment term parody with savings from harmonizing payment terms, auctions, RFPs and formal bid process are well underway on expense items.
Our savings continue to build towards expectations. During the third quarter we re-bannered an additional 143 family Dollar Stores to Dollar Tree bringing our total of converted stores to 147.
We are continuing to re-banner stores into November and fourth quarter and we are now targeting a total of 200 conversions for fiscal 2015. The preliminary results are meeting expectations and feedback from both store teams and customers has been positive.
We are well on our way towards finalizing the supply chain roadmap and initiating the multiple banner supple chain project. With the cross organizational functional team we're integrating our warehouse management systems.
And we’re making plans to rationalize the fleet of combined DCs, analyzing our space need by banner and determining our ability to ship both banners at all facilities. This is a very large project with a very significant opportunity for long-term synergies.
Our pilot facilities planned to be operational in third quarter of 2016. We continue to make progress on reducing cost through our shared services model.
We are combining back office functions to support both banners through our shared services organization. Over time, the shared services will include human resources, finance, information technology, supply chain and logistics, legal, strategy and internal audit.
Our goal is to provide consistent, efficient support of our business initiatives across the combined organization through a more cost effective approach. On October 13, 2015 we announced plans to re-banner all 222 deals locations in 2016.
For nearly a decade our committed team of Deals associates has done a great job of consistently providing customers with terrific values. With the acquisition of Family Dollar we are confidence that we can provide more focus and better serve our deals customers and markets through our primary banners, Dollar Tree and Family Dollar.
We will begin to conversion of deals in January with plans to complete the re-bannering of all Deal stores by the end of July 2016. Only a few months into the integration we have made great progress.
There are some quick and easy wins and some that we will take a more time and great deal of work. The timing of some will be depended on our IT integration.
Our strategy is not to touch everything at once but to prioritize our areas of focus to get it right the first time and build the overall banners for business for the long-term. It is a process it will take more than a few months but the return is worth it.
Now I'll turn the call over to Kevin to provide more detail on our financial metrics and our outlook for the remainder of 2015.
Kevin Wampler
Thanks, Bob and good morning. As a result of the recent acquisition year-over-year comparisons for the next several quarters will be very complex.
However, we had added tables to the press release which will we believe will helpful in understanding the ongoing business. Total sales for the third quarter grew 136% to $4.95 billion which includes our first full quarter of Family Dollar sales.
Dollar Tree segment sales increased 8.4% to $2.27 billion, all Family Dollar segment sales increased 6.1% to $2.67 billion. Same-store sales on a constant currency basis increased 2.1% versus a very strong 5.9% in the prior year's third quarter.
The increase was driven by both traffic and ticket increases. Adjusted for the impact of Canadian currency fluctuations the same-store sales grew 1.7%.
Please note that all of the recently acquired Family Dollar stores and newly re-bannered are considered new stores and are not included in our same-store sales calculation. We were pleased with Family Dollar sales during the quarter we saw low-to-mid single digit positive same-store sales each month during the quarter.
September was the strongest month driven by the timing of our red-tag clearance event. Geographically, sales strength was relatively balanced by region.
Gross profit for the combined organization increased by $674.7 million, or 93%, to $1.4 billion for the third quarter of 2015 compared to last year's quarter. The majority of the dollar increased was driven by Family Dollar gross profit of $627.8 million.
A few factors to note are: during the quarter $38.4 million was amortized to cost of goods sold related to the inventory setup and negatively impacted gross margin results. This amount was higher than originally projected based on inventory sell-through.
The total dollar amount to be amortized has not changed. We currently estimate an additional $11 million wil be amortized to cost of goods sold in Q4.
During the third quarter we took an additional $30 million in markdowns related -- markdown related expense in the Family Dollar banner for red-tag clearance event. We opt take advantage of the success and traffic of the clearance event to clear additional inventory that was deemed to non-go forward.
Gross profit margin for the Dollar Tree segment was 34% during the third quarter compared with 34.6% in the prior year's third quarter. The 60 basis point decline as a percent of sales was primarily driven by a decrease in mark-on related to the increased third-party product testing, increased freight, and higher distribution center labor costs.
Gross profit margin for the Family Dollar segment was 23.5% during the third quarter compared with 24.3% in the comparable period - comparable prior year period. Excluding the $38.4 million of inventory step up amortization in the $30 million of additional clearance mark-on gross profit margin was 24 point - 25.4% for the quarter.
The improvement of 110 basis points on a comparable basis was driven by improved the mark-on, lower markdowns, improvement in freight and distribution costs, partially offset by higher occupancy costs. Selling, general and administrative expenses in the quarter for the combined organization increased 132.7% to $1.18 billion from $505.6 million in last year's third quarter.
The majority of the $670.7 million increase related to $628.9 of Family Dollar expense. Q3 SG&A expense for the Dollar Tree segment as a percent of sales was 24.1% consistent with the prior year's quarter.
The current year includes $20.3 million of acquisition and integration related cost, while the prior year included $14.3 million of acquisition related costs. Excluded the - excluding these cost, adjusted SG&A improved to 23.3% for Q3 compared to 23.5% for the prior year's quarter.
This 20 basis point improvement was driven primarily by lower incentive comp and legal fees. SG&A expense for the Family Dollar segment as a percent of sales was 23.5% compared to 23% in the prior year’s quarter.
The current year includes $6.8 million of integration and divestiture costs. $19.8 million of depreciation for amortization of policies and fair market value adjustments, and $19.2 million of favorable lease right amortization.
The prior year's comparable period included $30.6 million of restructuring charges and $9.7 million of acquisition related costs. Excluding these costs, adjusted SG&A increased 40 basis points as a percent of sales to 21.8% from 21.4% in the prior year.
The increase was primarily driven by increased repair and maintenance expense for the quarter. Adjusted operating income, excluding acquisition and integrated related costs for Dollar Tree segment increased $11.1 million to $245.1 million.
As a percent of sales, adjusted operating income decreased 40 basis points to 10.8% compared to 11.2% of sales in the prior year's third quarter. Adjusted operating income for the Family Dollar segment increased $23.1 million to $96.1 million.
As a percent to sales, adjusted operating income increased 70 basis points to 3.6% compared to 2.9% of sales in the prior year's comparable period. Non-operating expenses for the third quarter totaled $99 million and were comprised primarily of net interest expense of $98.4 million in the quarter.
For the third quarter, the company had net income of $81.9 million or $0.35 per diluted share. Adjusted earnings per share is detailed in the press release tables was $0.49 per diluted share.
On an adjusted cash EPS basis, earnings perspective share for the quarter increased 30.4% to $1.33 per share compared to $1.02 per share in last year's third quarter. In our earnings release issued this morning, we provided a detailed reconciliation of net income to adjusted EBITDA, adjusted cash earnings and adjusted cash earnings perspective share.
Our tax – our effective tax rate for the third quarter was 34.3% compared to 36.5% in the prior year's quarter. The lower rate was primarily attributable to an increase in Work Opportunity Tax Credits or WOTC in relation to income for the third quarter and a decrease in state tax expense.
Combined cash and cash equivalents at quarter end totaled $1.1 billion compared to $407.6 million at the end of the third quarter of last year. Inventory for the Dollar Tree segment at quarter end was 12.1% greater than at the same time last year, while selling square footage increased 9.9%.
Inventory per selling square foot increased 2%. We believe that current inventory levels are appropriate to support scheduled new store openings in our sales initiatives for the fourth quarter.
For the Family Dollar segment, we are extremely pleased with our clearance event which eliminated aged and non-productive inventory and at the end of the quarter inventory decreased 0.2% compared with the prior year, where are continuing review merchandise assortments into our current inventory levels are appropriate for the fourth quarter. Capital expenditures were $169.5 million in the third quarter of 2015 versus 94.2 million in the third quarter last year.
For fiscal 2015 we are planning for capital - consolidated expenditures to range from $505 million to $525 million. Capital expenditures will be focused on new stores and remodels, including additional key development stores, re-banner select Family Dollar stores to Dollar Tree stores, the addition of frozen and refrigerated capability approximate 425 stores, IT system enhancements, a construction of our new Cherokee County South Carolina distribution center and the expansion of our stock in California distribution center.
Depreciation and amortization totaled 168.7 million for the third quarter versus $50.9 million in the third quarter last year. For fiscal 2015 we expect consolidated depreciation and amortization to range from $470 million to $490 million.
As discussed with Q2, this range includes increases over the traditional run rate of depreciation and amortization expense for Family Dollar for two items, first it includes $46 million of depreciation above the historical run rate for Family Dollar's as a result of harmonizing the depreciable lives accounting policies and the increase in the value of assets based on purchase price allocation. Secondly, it includes $45 million for the amortization of favorable lease rights for the purchase rights valuation of Family Dollar leases.
Our guidance takes into account our actual performance for the first three quarters of 2015, as well as our visibility and forecast for the remainder of the year. Our guidance includes the following assumptions.
I'd like to reiterate that our same-store sales calculation excludes recently acquired Family Dollar stores and excludes stores that were re-bannered from Family Dollar to Dollar Tree. These stores will be included in our same-store sales calculations where they have been owned by Dollar Tree or opened as a Dollar Tree for 15 months.
We will continue to experience some 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 and analysis, and our outlook for same-store sales.
In October 13 we announced our 2016 plans to re-banner all of our deal store locations. So that we can place all of our focus on our two primary banners, Dollar Tree and Family Dollar.
The conversion process will be similar to that we are using to convert Family Dollar stores to Dollar Tree's. We expect to have this initiative completed by the end of July 2016.
Our guidance includes $12.5 million of markdown reserves, accelerated depreciation and other re-bannering expense. This represents our best estimate at this time to complete the re-bannering of deal stores to Dollar Tree stores.
In November 2 just after our third quarter ended, we announced the successful completion of our require divestiture of 330 Family Dollar stores. These 330 stores represented approximate $45.5 million in annual operating income.
In terms of the sales have not been disclosed in the net effect of the divestiture on Dollar Tree's assets and liabilities has been reflected in the consolidated balance sheet. The divestiture will have two effects on our future income.
In addition to losing the operating income associated with these 330 stores, we also expect to incur $5 million to $10 million in transaction closing costs and setup costs related to transition services. Over a period expected to be no more than 24 months, we will be providing certain support and transitional services and expect to be reimbursed by the buyer for these direct operating costs and support services.
The expected financial effect of the divestitures, which includes the loss of the operating income from the 330 stores, along with the cost of the transition services agreement is included in our guidance. Our guidance also assumes a tax rate of 37.9% for the fourth quarter.
Weighted average diluted share counts are assumed to be 235.8 million shares for Q4 and 223.5 million shares for the full year. For the fourth quarter we are forecasting total sales to range from $5.32 billion to $5.42 billion.
For fiscal 2015, we are now estimating total sales to range from $15.45 billion to $15.55 billion. Both of these estimates are based on a low single digit same-store sales increase.
We have attached our press release a reconciliation of the forecasted Q4 range of net income to adjusted EBITDA and adjusted cash earnings per share. We are forecasting net income to range from $213.2 million to $242.2 million and adjusted cash earnings per diluted share of $2.32 to $2.51 for the fourth quarter.
I'll now turn the call back over to Bob.
Bob Sasser
Thank you, Kevin. The strategic rationale for the Family Dollar acquisition is more compelling than ever.
This is an extremely large and complex transaction involving more than 13,000 retail store locations 180,000 people and 23 distribution centers, which based on store count is the largest of any previous retail merger. While we are very early in integration process, I'm pleased with our progress.
We have great confidence in our ability and opportunity and the ability to achieve at least $300 million in annual run rate synergies by the end of year three. These synergies will be achieved through a combination of lowering costs in both direct and indirect sourcing, banner optimization, logistics and overhead.
We will employ a disciplined approach to driving key strategic initiatives to the combined organization through improve communication analysis, collaboration and incentives. We are confident that placing our initial emphasis in these areas can materially enhance operating performance of the Family Dollar brand to improvements in sales, margin, expense control and greater customer satisfaction.
I'll close the prepared remarks by saying that the Dollar Tree business model is powerful, flexible, and more relevant than ever, providing extreme value to customers, while recording record levels of earnings. Our model has been tested by time and validated by history.
For 31 consecutive quarters Dollar Tree has delivered positive same-store sales increases through good times and difficult times and all retail cycles consumers are looking for value, no matter the state of the economy. While on price point remains a dollar, our operating margin continues to lead the discount sector.
With the addition of Family Dollar, we are larger, stronger and more diversified business, better able to serve more customers, and more markets with exactly what they are looking for, great value, in every store every day. And we have many years of growth ahead of us.
Operator, we are now ready for your questions.
Operator
Thank you, sir. [Operator Instructions] We'll go first to Matthew Boss with JPMorgan.
Matthew Boss
Thanks. And congrats on the progress to date.
So the first question I just wanted to ask is more around Family Dollar. I guess first is the inventory clearance now complete.
Secondly, have the positive comps continued into the fourth quarter? And then Bob if you could just talk about the categories that you been able to touch so far and how you'd like us to judge you during the holiday and into early next year?
Bob Sasser
Well Matt, thank you for the questions. I will tell you that we had great success with our clearance and the initial plans on that have been pretty much completed.
We had great clean up on that as I said in the prepared remarks $135 million worth of inventory retail moved out. We still will have Christmas to come.
Obviously we're going to be better served in getting rid of that during the Christmas season. So that’s smaller dollars, but that still yet to come in the fourth quarter.
The second question was fourth quarter trends. You know I will tell you that I'm really jazzed about fourth quarter.
We are not going to report fourth quarter for a while. So I can’t start talking to you about the sales and specificity, but all in all, we are excited about our plans.
At Family Dollar again we've opened up all of those end caps and all that space for our seasonal merchandise. The seasonal merchandise looks really terrific and we're excited about our opportunities there.
And third question was categories?
Gary Philbin
So Matt, this is Gary. Let me just maybe add a little color.
As we stepped into driving the business, step one was to get the red-tag clearance event going. That did a couple of things for us.
It got rid of unproductive inventory. But I would say it also got ourselves set up for the holiday the right way, which is very important for us.
The category reviews are ongoing, but the priority going into the fourth quarter was just to make sure that our holiday merchandise and lot of our discretionary categories were in place. So during the fourth quarter you are not going to see wholesale changes in categories.
We are focused purely on getting the holiday merchandise out in front of the customer and I think we have our best opportunity this year to have a great sell on lots of seasonal relevant items. The merchandising reviews will be ongoing as we go into fiscal '16 and you'll see those changes as we roll them out.
But our focus now to the holidays is just purely sell all of the holiday merchandise related Thanksgiving and Christmas that we can.
Matthew Boss
Great. And then just one quick follow-up.
As we think for next year there's been a lot of talk out there about vendor negotiations and wages. Bob, I know you are not giving formal guidance until February.
But anything larger picture that you’ve uncovered that surprised you so far as you dug into Family Dollar and just any help around the best way to think about vendor funding and wages, I think would be really helpful?
Bob Sasser
Well you know, I will share with you this. One of our synergies was to work with our vendor partners to align the cost on the exact match items and also to begin work on the similar match items and we’re really well into that and I'm really excited about - we are achieving what we expected in that.
As far as working with our vendors going forward, our plan is to work with them to provide the best product to our customers to sell it. We want to drive product sales from our vendor partners.
The way we go to market, we prefer in many cases to take those incentives and apply it to the cost of the goods in such a way that we can share that value with the customer. We're going to make money by selling product, not by collecting funds.
Now having said that, we don't expect the funds to go away, we expect to work with our vendor partners to use them in such a way that we can drive more cartons, more cases of their product through our doors. So I'm excited about the transition.
I think you can get as a retailer and many retailers, I think get too focus on collecting the funds and not focused enough on the customer, not focused enough on driving value for the customer. And we are just exactly as we've done it at Dollar Tree, we're always focused on the customer, giving the best price that we possibly can, that includes getting our share of the funding where possible, but getting the lowest price possible, so that we can price a product appropriately and drive more case sales through the front doors.
And our vendor partners have the same goal by the way. So we are completely aligned on that strategy.
I think that plans are coming together very nicely.
Matthew Boss
Great. Best of luck.
Bob Sasser
Thank you.
Operator
We'll next to Stephen Grambling with Goldman Sachs.
Bob Sasser
Hey, Steve.
Stephen Grambling
Good morning. Thanks for taking the question.
So I guess changing the focus to the Dollar Tree business, as you look at the gross margin line, I think that Kevin mentioned the increased third-party product testing and increased freight cost. Can you elaborate on some of the drivers of both and how we should be thinking about these impacts going forward?
And then I guess maybe a bigger picture question, just to your longer-term expectations for the Dollar Tree segment margin? Thanks.
Bob Sasser
Yes, Steve, that's a fair question. I can tell you that the two things that Kevin mentioned, the things that we do in the normal course of business, we have doubled down on our testing, testing more times, especially on some of the categories that are more subject to compliance issues, and the idea is we don't want to fail.
We want to make sure that we are providing a safe product for our customers and we double down on our testing. I think that's a one time, not that we're going to – not going continue testing, but what you saw there was a little bit of a bubble based on a change in the way we are doing our testing.
That will smooth out over time. I have great confidence we'll be able to manage that for the long haul.
The second thing was, the big, largest impact was our DC productivity was lower in the third quarter and there is a couple of things there and they are all - you can point to them. We can identify them and we can fix them over time.
But we are here at peak inventory times at Dollar Tree. We are receiving all the products for - in the third quarter for our third quarter as well as our fourth quarter sales.
It's a peak inventory time. And at the same time we decided to re-banner couple hundred Family Dollar stores to Dollar Tree and we scrambled around to buy the products and insert that into the inventory equation receiving it in the appropriate DCs and maybe signing things a little differently moving things around.
As well as re-bannering our Deals stores, which over time we are not going to start that that until January, but just the planning and getting things positioned for that, reduced our overall productivity at a time when our buildings are an absolutely max peak capacity. As I mentioned a couple of times we are building a new distribution center of 1,500,000 square feet.
We always build ahead of the need, but just ahead of the need, in South Carolina to serve mid-Atlantic in Southeastern Dollar Tree stores, as well as expanding our Stockton distribution center over 50% for next year. So we're opening up more capacity, while we are doing a lot of things in addition to what we had originally planned in our distribution model.
The result was we had some distribution productivity lag, at the same time our outbound transportation which is something we’ve talked about before was also a little higher than it has been in the past. So all in all things are identifiable, opportunity to improve and we will improve on those, but that was really the main components of the drag on the gross profit number, at the third quarter.
Stephen Grambling
Great. And just a follow-up there, was just on the margin path going forward for Dollar Tree segment, which it sounds like from putting that altogether would be theoretically you'll see some of that even out and be up.
Is that fair?
Bob Sasser
Yes. I mean, we are - as I said we are putting this huge company together into a shared services model.
Over time we're going to be combining both banners under one supply chain, with all of our buildings supplying product for all banners with the ability to supply merchandise for all banners. The same time we are looking at rationalizing our buildings and also identifying where the capacity needs are going to be for the future.
All of that is going on right now. What that means to us over time, we will have lower supply chain costs.
We're looking for more productivity around our buildings. We're looking for reducing stem miles as we are able to service both Family Dollar stores and Dollar Tree stores out of the same building.
So there's a lot of opportunity to lower costs going forward, and to improve our service to our stores through the combined power of this combined supply chain.
Stephen Grambling
Great. Well, thanks for the answers.
And good luck for the holidays.
Bob Sasser
Let me add one more thing, I don't think I gave you an answer on the margin for Dollar Tree going forward. Merchandise margin for Dollar Tree going forward, I don't think - we are always in control of that.
It's more about the mix than it is the items, because we don't have to have anything. I'll say again, we change a lot of our product every year and our buyers go to market with the same goal that is to offer the best value for a dollar at a margin that fits our margin requirements.
So we are still in control of our operating – our merchandise margin at Dollar Tree. We have this one quarter where we've got some little noise in there frankly.
But like I said, that's identifiable, that’s fixable. We're going to improve that over time.
But the merchandise markup at Dollar Tree is still absolutely in our control and I don't see any pressures to change that. Frankly, our sourcing opportunities are improved with both the size of our pencil [ph] now, as well as the economic conditions around the world, especially China.
It's really a buyer's market out there. Thank you.
Stephen Grambling
Thanks for the color.
Operator
[Operator Instructions] We'll next to Dan Binder with Jefferies.
Dan Binder
Hi, good morning. It's Dan Binder.
I was just curious if you could give us a little bit of color on your thinking for Family Dollar store growth next year and just remind us what it look like net for this year, net of the closings and re-brands?
Bob Sasser
You know, we're looking at that right now, Dan. As always, we announced our store growth at the January - the March call after our fourth quarter.
And we're going to do that again. There is plenty of room to grow.
I will tell you that on the Dollar Tree side I've always said for years anyway, I've said 7,000 stores in the U.S. Dollar Tree stores and other thousand in Canada makes it 8000.
The Family Dollar talking to them they’ve said for some time 12,000 Family Dollar stores in the U.S. So there's a potential to 20,000 stores there.
We've got a little over 8000 now. So there are 13,000 now.
So there is plenty of room to grow. We are putting together our plans for 2016.
I will tell you that we are directionally pulling back on the number of stores, Family Dollar stores for next year. We're not ready to announce that number yet, because we're still working on budgets and all the things, the CapEx and all that goes with that.
And we would plan to continue to grow our Dollar Tree banner next year. But again, I'm not going to give you the numbers until the March call.
So that’s directionally we're thinking about it. And we'll share more with you when we've got more firm numbers on that.
Dan Binder
And then my follow-up question was with regards to the fourth quarter guidance that you provided. If we think about sort of the breakdown between the Family Dollar operating margin versus the Dollar Tree operating margin, I'm not sure if you could just maybe comment to the Dollar Tree operating margin, how do you think about that for Q4.
Is it similar sort of contraction in Q4, as we saw in Q3 or do you think it’s close to the flat or just directionally how think it plays out?
Bob Sasser
I think Dan, as we think about it, obviously because of the - what you got take into consideration is the deals information we gave today, which is a $12.5 million estimated cost. So that’s - a big piece of that is markdowns, which is going to affect the gross margin.
Excluding that, I think we potentially see maybe a little pressure from freight in DC cost in the quarter or expect SG&A cost to continue to leverage obviously in the quarter just ended on basically a 2% comp we leverage 20 basis points, which felt like a pretty good performance with everything going on. So I think in general, I think flattish operating margins for the Tree is a reasonable thought process.
I think on the Family Dollar side, I think it’s - as I think about it it's really around how does the holiday sell through grow and Gary talked about the holiday merchandise and the focus on that and that will determine I think how that plays out at the end of the – we're very excited about it and have high expectations and that will be a big piece. I think from Family Dollar on the SG&A side in general my expectation would be to show improvement from where we were in Q3.
In Q3 we were up 40 basis points year-over-year and I wouldn’t expect to that sort of key up 40 basis points, but if we can get somewhere closer to flat, we'd be in a better position I think.
Dan Binder
Okay. Thanks for the color.
Operator
We'll next to Michael Lasser with UBS.
Michael Lasser
Thanks a lot for taking my questions. On the SG&A for the Family Dollar business, how much of the increase that you saw in the quarter that you are implying for the fourth quarter is a cost of doing business and how much is more one time in nature.
I think the markets trying to understand what the true underlying operating income production of Family Dollar might be and then we can layer on what our expectations and synergies and other factors might be over the long-term. Right now it's difficult to comprehend it at this point.
Bob Sasser
Yes, well I think, obviously given the color that looking for the SG&A to be flat to maybe slightly up, we're obviously operating in real time. There's a lot of moving levers, no surprise there at the end of the day.
You know we're being prescriptive the way we look at things on an overall basis. We've talked about the need to potentially invest in the stores.
So you saw repairs and maintenance being up in Q3. Not totally surprising.
So some of that was normal course, some of that was catch-up. We don't necessarily break it totally down that way when we're looking at it.
So we're running the business in real time. We look to control the cost where we can.
We don't just spend money that we don't have to very prescriptive in the way we do it. I know that really doesn't answer the question, but I don't know that if I truly can answer your question, in the sense of how much of it is one time versus ongoing.
So I mean, that's really what we tried to do in the quarter in a sense of stripping out all the unusual things and getting back to a more baseline analysis of showing it up 40 basis points, with the - basically the main component being repairs and maintenance. So again it's a work in progress and we'll continue to go forward.
Michael Lasser
Let me ask you from a different perspective, as you look back last year on standalone basis, Family Dollar did about $0.5 billion in operating income. Is there anything that you're seeing in the business now to suggest that structurally the way you going to run the business is that operating income production will be lower as results of investments that you're going to need to be made or other changes moving forward.
And I want to by the spirit of the question, so now I also tie back can you talk about the interest expense outlook for the fourth quarter is that a sustainable run rate? Thank you.
Bob Sasser
Interest rate for the fourth quarter as in our guidance is projected at $98.4 million if you look at the table. I believe it’s last table in the scheduled to the press release that details out the expected interest expense.
So that number is what we would expect without any rate increases on an overall standpoint. As far as operating income, we've said generally speaking, our belief is that we can overtime, Family Dollar backed the historical operating margins which I think we're, if you look at the last 10 year period they were basically 7% to 8% for a vast majority of that timeframe.
There is no belief that we can do that, I think that’s really the way we are focused on an as first to a specific number of $500 million or whatever. It really more about, continue improvement so the way we think about the Dollar Tree business we're thinking about the Family Dollar business the same way to continue improvement, how do we, continue to make the merchandize more relevant, how do we run to stores better, how do we control our cost and how we bring it to the bottom line at the end of the day so there is no different there.
But there is nothing structurally or competitive wise that would preclude us from, overtime getting back to that 7% to 8% range.
Michael Lasser
Okay. Thanks for the color.
And have a good holiday.
Bob Sasser
Thank you.
Operator
Ladies and gentlemen we do have time for just a couple more questions. We'll go next to Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli
Hi, guys, first the clarification and then question. Kevin just to be clear that, the reconciliation for the quarter that you've disclosed the $0.49 that still includes the roughly $66 million of excess amortization you previously highlight in you’re 8-K is that right, so it’s more like a $0.67 EPS number?
Bob Sasser
Basically what we did Scott is what we have done here we taken our report income before income taxes and really adjusted for items that we had not previously given this Tree. So the Tree have been given detailed information via our second quarter call as well as an 8-K that subsequently filed in regards to really the three biggest items being inventory step-up amortization as well as the depreciation for the amortization of the policies as well as the favorable lease right amortization.
We had given you all the information so we assume that was, that would in our number because we have given it to you. What we've done here is basically reconcile the things you didn’t know.
So the inventory step-up was actually $38.4 million as oppose to the $26.9 million we had given you. So we have adjusted for that $11.5 million difference.
We took an additional $13 million of markdowns for our Red Tech clearance sales and we've adjusted for that. And then acquisition fees and integration and divestiture-related costs which this Tree couldn’t predict or we did not give any numbers on that.
That’s the way we thought about it as really trying to reconcile our number based upon information that has not been previously given.
Scot Ciccarelli
Got you. That’s very, very helpful for the color.
Thank you. Now I guess the question that you guys have been growing Dollar Tree square footage at 7% for many years, obviously you're very comfortable with that 7% growth cadence but now we're doing the re-banners we are depending Deal re-banners coupled with, what's call the Greenfield store growth.
Can you talk about your thoughts on the Dollar Tree store growth cannibalization and kind how that may play out?
Bob Sasser
We have looked at the cannibalization there is some degree of cannibalization this year from the 200 stores that we re-bannering. There will be some cannibalization next year from the additional re-banner stores as well as the re-bannering of the deal stores to Dollar Tree, and some of them to Family Dollar.
So there will be continued to be some cannibalization. They are always is when we had looked at these stores to re-banner as well as when we look at new stores that we look at the sales projections for the particular store.
We also look at the any cannibalization that’s going to occur in the market. So we look at surrounding stores and we define what we think the cannibalizations are going to be, we then look at the market returns when we opening up the new stores.
And we're going to continue to do that, we've done it with the rebanner stores from Family Dollar. We're doing it with the Deal stores go into Dollar Tree and we'll with new stores.
So cannibalization is just part of it but after you have opened up the first store, the second store, the cannibalization in the market. So, but I will tell you we've done a homework on it.
We're pleased with the results that we're getting also from the once we have already rebannered. The Deal stores that we're going to rebanner we build that on model of real estate model for Dollar Tree.
So that’s one of the reasons that most of those are turning into Dollar Trees that is because they will serve our interest better with higher returns as Dollar Trees they are go into Family Dollar. So cannibalization is part of it, we'll talk about it, we'll point it out, but it's really the growth in the market and growth in the business for the company that’s most important.
Scot Ciccarelli
Right, as we're going to go in the fourth quarter guidance, now and kind of the look for 2016 is that something you might be able to define for the Tree a little bit better?
Bob Sasser
That we've included in our guidance. And I think that’s the best way we can share with you is that, as we give guidance we've included all the things that we know including cannibalization, including anything that would come in there.
Scot Ciccarelli
Great, thanks a lot guys.
Bob Sasser
Thank you.
Operator
Ladies and gentlemen, we'll take our final question today from Paul Trussell with Deutsche Bank.
Paul Trussell
Hi, good morning. I wanted to ask about pricing, Family Dollar sales obviously were strong in the quarter.
And I believe you mentioned about $135 million of excess inventory that you're able to get out of that which I think is about 500 basis points of add on sales. How do we think about your pricing strategy going forward with in this box you mentioned looking at some private label insert, some open price points.
But in particular on the national branded goods where I know that there was, at least historically a bit of spread there between them and peers?
Bob Sasser
Well, Paul I want to say couple of words on specific Gary because he is living in and breath in this every day but obviously intend to be comparably priced on international brand products where you tend to offer a selection of private label name brand equivalent products that is a value to the customers, lower retails than the national brand but it is equivalent to quality. We think there is a big opportunity in our direct customers I think they will appreciate the value of being able to buy a name brand equivalent product that cost 30% less for example, or 20% less or less than the name brand.
So the combination of name brands compared to priced, name equivalent products at a nice discount to the name brand price as well as some special opportunity that all the things that we can do with our size to take advantage of opportunities exist through the year. Gary would you like to add anything on the this…
Gary Philbin
Paul let me may be start with your first comment on the $135 million. Keep in mind that was the retail value before we start to markdowns.
So we start with the cadence that was already discounted in stores some are between 10%, 15%, 20% off and then we started our markdown cadence, so 50, 75, 90. So, when you think about the units that we cleared out the actually retail sales that we were receiving from that pilot goods was fairly statistic over that time.
I think the good news on the clearance was when folks came in for that event they tend to buy something else from store at our regular retails. And so I think the energy and just getting our stores cleaned up a bit, getting our end-caps reclaimed by organizing and clearance even which is no smaller task to make it look like something all served as pretty well.
Maybe just to tag on to Bob's comments, there is an art and science to pricing. And the science piece is we do want to be grounded against our strategy on competition you will always have an eye on them.
But what we really focused on at Family Dollar is what was meant for to our customers. What is that they need for first two months, what's the best goods that they are looking to buy on a weekly and monthly basis.
And so our strategy is one that talks to what's on-promotion and what's on-shelf. The addition for Family Dollar of a private label firm needs to be polished up and really enhanced opening price point and some of the assortment gas we have is a great one.
Not to mention the addition of we have a great import program, but that can also drive additional value into the store. So we really see all those arrows in our paper as we get routed and what do we need to be competitive.
But really stay focused on what a Family Dollar customer needs to drive value and deliver basket on a weekly and monthly basis. So that's the approach we're taking as we go through our category reviews and looking into '16.
Paul Trussell
That's very helpful color. Thank you.
And just a follow up to close. Bob, maybe if you can just touch on the consumer overall.
I think that you’re better than expected revenue comes on the heels of some other discounters, perhaps beating some expectations. Is your sense that your core customer is a bit more confident now, has a little bit more money in their pocket or are all of your gains more market share driven?
Bob Sasser
You know, Paul, I think the customer especially our customer, our middle income, low middle income to lower income customers are still under pressure and they are concerned. They've seen lower gasoline prices and that's helpful.
But at the same time it's not enough to do that lower income customer. It's just on enough to make a change in your shopping habits.
And at the same time they've seen lower gasoline prices. They've seen higher food prices.
They've seen higher rent prices. They've seen higher healthcare costs.
They've seen higher taxes. So they are still concerned, they are still under pressure.
The concept of Dollar Tree and at Family Dollar of serving those people is serving as well. You know at Dollar Tree we've said that we are right for all times.
We have great products that people need everyday, consumer products and things you've got to buy to have, things you have to have every day and the price is only a dollar. Alongside things that may be discretionary that you'd like to have, but everything is a dollar.
So through good times and difficult times we've tended to do very well, usually better than the market at Dollar Tree. At Family Dollar with that low income customer the more we focus on what the lower income customer needs, offering the great value, improving our in-stock, giving the better shopping experience, exceeding their expectations when they go into our stores, the better serve we're going to be especially during difficult times, because that lower income customer really needs as at Family Dollar and at Dollar Tree in order to make ends meet throughout the month.
So that’s your question, I mean, I think they are grateful that gasoline prices are lower, but not much else is in their world, and they've got to come a long way really to get their head back above water many of them.
Paul Trussell
Fair enough. Thank you.
Good luck.
Bob Sasser
You know in closing, I just like to make one comment sort of in regard to that last question. I'll close with this, but as a combined organization, both banners, our focus is on growing our earnings power for years to come.
There is a lot of things that we're doing right now that are in regard to giving us position and for the future. Our decisions are always with our eyes on the horizon, but managing in real time, so what you're going to see from us is, our decisions are going to be made for the longer term and I'm not telling you it's going to take forever to bring value, I'm just saying our decisions are based on building this large entity combining two great banners for the long-term.
But we are dedicated to managing the business in real time and that means every month, every day, every quarter it means every expense line of the P&L, it means looking at our customer in the eye and trying to deliver the product that they need from us, identifying the position that we hold in the market using our size and our leverage to offer the greatest values for that customer. So we're going to do both.
And I think I'd like to tell you that Mike, my expectations as we're going to continue to improve quarter-over-quarter. You know this is the first full quarter that we've had the combined company.
I think we had one month in the last earnings release. But it’s a first full quarter that we've had and we shown improvement.
And some slight improvement mind you, but improvement. And I think I would tell you that I expect that to continue quarter-over-quarter, we'll show improvement.
We're going to share with you all the information’s that we know that is pertinent to where we are going with this thing. We're not going to surprise anybody with it.
But we're not going to give you information until we can absolutely get our arms around it and share with you how that looks going forward. So thank you for your time and before I turn it back to Randy, I just want to say, thank you for your support and hope everybody has a great Thanksgiving.
Randy Guiler
Our next quarterly earnings call is currently scheduled for Tuesday, March 1, 2016. Thank you and have a good day.
Operator
Ladies and gentlemen, thank you for your participation. This does conclude our conference.