In dollar-store operator Dollar Tree's (DLTR -1.23%) fiscal third-quarter 2018 results, released Thursday, its yearlong narrative remained unchanged: The Family Dollar segment continued to underperform the modest growth of Dollar Tree-branded stores. For the second time in as many quarters, management pulled back slightly on full fiscal-year guidance.
Below, we'll review the quarter's numbers from a bird's-eye view, walk through crucial details, and discuss management's perspective on the last three months. Please note that all comparative numbers that follow refer to the prior-year quarter (the third quarter of fiscal 2017).
Dollar Tree: The raw numbers
| Metric | Q3 2018 | Q3 2017 | Change (YOY) |
|---|---|---|---|
| Revenue | $5.54 billion | $5.32 billion | 4.1% |
| Net income | $281.8 million | $239.9 million | 17.5% |
| Diluted earnings per share | $1.18 | $1.01 | 16.8% |
Data source: Dollar Tree. YOY= Year-over-year.
What happened with Dollar Tree this quarter?
- The discount retailer's top-line improvement of 4% consisted of a 6.2% increase in Dollar Tree segment sales, to $2.85 billion, and a 2% rise in Family Dollar segment sales, to $2.69 billion.
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Total comparable-store sales improved by 1%, as a 2.3% comps increase in the Dollar Tree segment was offset by a 0.4% dip in Family Dollar comps.
- Family Dollar gross margin slipped by 2.2 percentage points to 25.3%, while Dollar Tree gross margin dipped by 0.3 percentage points to 34.8%. The two businesses combined for a decrease of roughly 1 percentage point in consolidated gross margin, to 30.2%. Management cited several factors behind the margin compression, including rising freight costs, inventory shrinkage, and markdowns. Lower merchandise costs partly offset these impacts.
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Consolidated selling, general, and administrative expenses held steady at 23.2% of total sales, versus 23.3% in the prior year. Thus, operating margin was primarily affected by the weaker gross margin, and fell by a single percentage point, to 7%.
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Last quarter, I discussed management's proactive debt reduction; over the last three months, Dollar Tree again reaped the benefits of lower leverage. Interest expense of $47.6 million declined by nearly one-third versus the prior year's interest tab of $69.7 million. We'll return to the company's debt structure below.
- Substantially all of Dollar Tree's net income improvement was derived from a decline in the company's tax rate due to last year's U.S. tax legislation. A dip in the effective tax rate to 17.1% against the prior year's 32.4% third-quarter rate reduced income tax expense by $57 million.
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The company continues its efforts to lift the Family Dollar brand's financial performance, which has consistently lagged the Dollar Tree label since its acquisition in 2015. Management initiated a Family Dollar store renovation last year, and executives said on Thursday that the company would hit 500 remodels by year's end. It aims to double the number of completed renovations to 1,000 by the end of fiscal 2019. This will cover roughly one-eighth of the brand's current 8,264 stores.
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Management also announced that it believes it has mitigated the potential fiscal 2019 impact of import tariffs by 80% in its Dollar Tree stores and by 50% in Family Dollar stores, primarily through vendor negotiation and supply-chain and shipping-logistics initiatives.
Image source: Getty Images.
What management had to say
In Dollar Tree's earnings conference call, CEO Gary Philbin discussed the company's capital allocation, and specifically its approach to leverage, which has helped the company's earnings and debt profile:
In connection with the [2015 Family Dollar] acquisition, we did not make share repurchases in order to allocate sufficient capital to reduce outstanding debt. Invest to support the growth of Dollar Tree and Family Dollar, invest in the initiatives to integrate Family Dollar, and to improve store performance across the portfolio. Since completing the acquisition, we've paid down approximately $3.5 billion in debt. In March, we achieved upgrades to investment grade from S&P Global and Moody's. We have continued to produce strong cash flow from operations.
As a result of our successful progress with integration and free cash flow in excess of investment needs, we expect to pay down our variable-rate outstanding debt. The company has an existing $1 billion board authorization to repurchase shares and will continue to evaluate share repurchases in 2019. We plan to provide more information related to our capital allocation strategy in 2019.
As my Fool.com colleague Dan Caplinger observed, the company's comments on its balance sheet progress (and news of potential share repurchases) changed the direction of shares during the morning session following the earnings release on Thursday. Dollar Tree stock finished the day up more than 6%, after an initial bout of profit-taking.
Looking forward
As it did in the second quarter, the company reduced its full-year guidance, although the revisions proved minor. Fiscal 2018 revenue is now pegged to land between $22.72 billion to $22.83 billion, against last quarter's estimated range of $22.75 billion to $22.97 billion.
Diluted earnings per share (EPS) have been lowered to an anticipated band of $4.86 to $4.95, a slight tightening of the former outlook of $4.85 to $5.05. While the company has given up a bit of ground in earnings expectations this quarter, it's managing to stay largely on course, providing shareholders with some hope for faster growth in fiscal 2019.
