Hello, and welcome to the Dollar Tree Q2 2023 Earnings Conference Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to your host, Bob LaFleur, Senior Vice President, Investor Relations. Please go ahead, sir.

Good morning, and thank you for joining us today to discuss Dollar Tree's second quarter results. With me today are Dollar Tree's Chairman and CEO, Rick Dreiling; and CFO, Jeff Davis. Before we begin, I would like to remind everyone that some of the remarks that we will make today are about the company's expectations, plans and future prospects and are considered forward-looking statements under the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties, which could cause actual results to differ materially from those contemplated by our forward-looking statements. For information on the risks and uncertainties that could affect our actual results, please see the risk factors, business and Management Discussion and Analysis of Financial Condition and Results of Operations sections in our annual report on Form 10-K filed on March 10, 2023, our Form 10-Q for the most recently ended fiscal quarter, our most recent press release and Form 8-K and other filings with the SEC. We caution against reliance on any forward-looking statements made today, and we disclaim any obligation to update any forward-looking statements, except as required by law. Also, during this call, we will discuss certain non-GAAP financial measures. Reconciliations of these non-GAAP items to the most directly comparable GAAP financial measures are provided in today's earnings release available on the IR section of our website. These non-GAAP measures are not intended to be a substitute for GAAP measures. Unless otherwise stated, we will refer to our financial results on a GAAP basis. Additionally, unless otherwise stated, all comparisons discussed today for the second quarter of fiscal 2023 are against the same period a year ago. Please note that a supplemental slide deck outlining selected operating metrics is available on the IR section of our website. Following our prepared remarks, Rick and Jeff will take your questions. Given the number of callers who would like to participate in today's session, we ask that you limit yourself to 1 question. I'd now like to turn the call over to Rick.

Thanks, Bob. I'd like to welcome all of you that have joined our call this morning. I am sure that many of you had a chance to attend our investor conference in June. I hope the information we presented was valuable to you and that you left the event with a better understanding of the key growth strategies that we have in place to deliver $10 or more EPS by 2026. I am confident that the team has identified the right levers to unlock the true value of our business. We are making good progress and continue to act with urgency to accelerate the pace of improvement in our merchandising, store operations, supply chain and IT infrastructure. Our renewed merchandising efforts represent a major opportunity to unlock value. We outlined our multi-price journey at Dollar Tree, detailed our real estate and merchandising initiatives at Family Dollar and reviewed our plans to improve store standards across the enterprise. We have also launched efforts to drive sales productivity and increase operating efficiency like simplifying the truck unloading process and improving in-stock levels. You heard me say many times that retail is all about growing units, growing transactions and growing sales per square foot. When these retail fundamentals move in the right direction, everything else follows. I am pleased to report that all 3 are heading in the right direction for us. For the past 2 quarters, both segments posted positive unit growth in consumables, while the market has been negative. Second quarter traffic was up over 3% at Family Dollar and nearly 10% at Dollar Tree. The fourth consecutive quarter of growth at Family Dollar and the second for Dollar Tree. And finally, sales per square foot is up 4% at Family Dollar and 6% at Dollar Tree. When it comes to…

Thank you, Rick, and good morning, everyone. In the second quarter, we continued to generate strong top line results across both segments, driven by growth in customer traffic, unit volume and an accelerating market share. We continue to have a favorable view of the current operating environment. Our top line performance was not driven by any material increase in promotional intensity. While our sales mix continues to shift towards consumables, we generated more gross profit dollars in the second quarter than we did last year. We also remain resolute in our strategy to make the necessary investments in stores, IT, supply chain and our people. On a consolidated level, operating income declined 43.1% to $287.8 million and operating margin compressed by 360 basis points. This was driven by a 220 basis point decrease in gross margin and a 130 basis point increase in SG&A expenses. Gross margin contracted primarily from lower merchandise margin as we lap the margin benefit from last year's $1.25 rollout and from unfavorable sales mix, product cost inflation and elevated shrink. SG&A expenses expanded primarily from wage investments, incentive compensation, general liability claims, and repairs and maintenance costs from improving store conditions. These were partially offset by leverage from increased comp sales and lower stock compensation expense. Notably, the impact of general liability claims was $0.07 for the quarter. Our effective tax rate was 24% versus 24.2% last year as higher work opportunity tax credits were partially offset by higher nondeductible expenses. Net income was $200.4 million and diluted earnings per share was $0.91 versus $1.60 a year ago. At a business segment level, Dollar Tree's operating income declined 27.8% to $397.8 million and operating margin compressed 510 basis points. This was driven by a 400 basis point decline in gross margin and a 110 basis…

Thank you, Jeff. We remain very pleased with the progress of our transformation in these early stages and remain confident in the 3-year road map outlined in June. For those of you familiar with my operating philosophy, the immediate focus of any retail turnaround is growing sales. From that perspective, we are succeeding. We are providing a new experience to the next generation of customers across both our segments and seeing strong repeat purchase activity from these new shoppers. Our goal is to provide the consumer with convenience, value, variety and a great shopping experience. Our stores are already conveniently located. 87% of the population of the Continental United States lives within a 5-mile radius of one of our stores. As we grow our footprint, we will be closer and more convenient to an even greater number of customers. I remain confident that our long-term earnings potential can be realized within the time frame we have communicated. Our improving top line performance places us in a position of strength and the combined impact of our merchandising, real estate, supply chain, IT and people initiatives should put us in an even stronger position relative to the competition. Operator, Jeff and I are now ready to take questions.

[Operator Instructions] Our first question is coming from Mike Lasser from UBS.

So with the knock on the transformation at Dollar Tree has been that it's just going to take a lot more heavy lifting, a lot more investment than what was originally anticipated. And the fact that your sales are trending better than what was expected is a good sign, but it does not seem like the profitability is flowing through. So, a, do you have a good handle right now on all of the ins and outs of the different considerations with the profitability. And b, as you look towards the next 12 months, there's going to be a benefit from lower supply chain costs. Is that going to flow through? Or will you use that as a source of further savings to then reinvest that back in the business to drive the $10 of earnings several years out.

Yes, Mike, 3 really good questions. First off, is the lift heavier than we thought it was going to be. I would say no. When we all got in on this, we knew what we were facing. I do think what we're trying to do, because of what has to be done, we are moving much faster than I thought we would. And when you move fast, it takes a little more expense, it takes a little more effort, it takes a little more push. And so is the lift heavier? No, it's the same. But what we're trying to do is move as fast as we possibly can. In regards to the drop-through, I think we are learning to do a lot of things, flexing a lot of muscles that we have not used in the past. The Family Dollar side is all about the commitment you make to the vendor community. And Jeff called out the potential for increased rebates and allowances that's all driven by retail execution. And the Family Dollar people are doing a really terrific job on that. What has happened on the Dollar Tree side, the Dollar Tree people have responded to the change in patterns that the consumer is exhibiting in our store, buying more consumables. So I think and I always have subscribed to the fact that when top line starts moving, everything else catches up. I remain incredibly bullish on our margin targets and where we're going. And I do not see any trouble to getting to more realistic margin levels. In regards to the improvements in the supply chain, that will be a combination of both. As you know, we've got massive changes taking place on the supply chain side. Some of that will make it to the bottom line and some of it will invest. And Jeff, I don't know if you have anything you want to add?

Yes. There's a couple of additional items, Michael. We -- as it relates to the flow-through, and we tried to call us out -- it's really a situation where our sales mix is an area that, as you see across the retail landscape, people are moving more into consumables, and that we're not immune to that. The other area that we talked about was shrink and the ongoing progression there. Those are the 2 more significant items from a gross margin basis that are really impacting us and addressing the flow-through or restricting the flow through. The other thing that it's kind of muted in our comments, but this past quarter, we had about $0.07 related to an accrual adjustment that we needed to make for the progression of certain general liability claims that really dated back to 2019 and 2020 during the pandemic period. Once again, something that we needed to take care of, but it also restricted the flow through and the tremendous sales that we were driving over the course of the year. So I think that we're seeing right now, we've called out in the past and reason for our adjustment in the overall guidance that we gave last quarter, which was around sales and shrink. And then it was just further exacerbated, unfortunately, with this accrual adjustment we need to make.

Our next question today is coming from Edward Kelly from Wells Fargo.

I wanted to dig in on the core Dollar Tree gross margin this quarter. If we think about the 33.4%, it's obviously a step back versus where you were in Q1. I was hoping that you could talk a little bit more about the incremental pressures? And then how we think about the back half, you had previously talked about a 36%, 37% gross margin for the year. Obviously, that's coming down. So thoughts there. And then just as it relates to all of that, how does this inform the longer-term target of 35.5%, 37.5%. It looks like this year, you maybe even below the low end of that range. What does it take to get to the middle end of that range? Do you need the backdrop to normalize demand, obviously you got freight coming in, but I'm not sure shrink is bottomed. Just thoughts around all of that, I think would really be helpful.

Yes. Great question again. What's happening in Dollar Tree as we were responding to the needs of the consumer. You go back a year ago, we did not have nearly the number of consumable SKUs that we now have in the store. Saying all that, our discretionary business on the Dollar Tree side was slightly up. But what -- when I think about quarter 3, particularly or quarter 4, we're going to be in a much stronger position on the margin due because of the change in the mix, we think is going to happen. And that's because quarter 4 is a very seasonal quarter for us with Christmas and Halloween and all of that. So I remain bullish on it. I do believe, Ed, that we are responding to the customer and sales takes care of everything eventually, and the 2-year stack in Dollar Tree is just outstanding. So I remain very, very bullish on where we're going with the margin.

And Ed, the other thing I would add to that, hopefully, I hope don't sound like a broken record here, but -- unfortunately, the headwinds we're having in shrink are muting our margins right now. When you get a chance, you have an opportunity to take a look at the supplemental presentation that we have, you'll see that shrink is continuing to be -- restrict our margins by about 75 to 80 basis points on a year-over-year basis. We are taking the appropriate actions, we believe in the organization to start to address that. As you know, shrink is a sort of a trailing indication because stores are shrinking over the course of the year. And as you're adding new actions to reduce it, it takes time for those things to actually take hold. But between the sales mix and the shrink once again, this is one of the things that have been muting the margin. The other thing that while we are seeing less frequency of product cost increases and maybe the magnitude of those are not as significant. They are still in the marketplace. And Rick McNeely and his team are freeing our ways to work through those through a number of different merchandising actions. So we still have a little bit of headwind there on product cost pressures, which as we move forward, depending on consumer demands, we believe that those will start to -- should start to abate over time.

Your next question is coming from John Heinbockel from Guggenheim Securities.

Rick, my question is multipart, really revolved around the $3, $4, $5, right, frozen and cooler. So can you maybe talk about the experience you're seeing because that clearly has to be lifting consumable comps. Your thought on the rollout, not just to all stores, but then expanding doors, right, getting to more than 3 doors today. But on the rollout and then the impact that that's having on traffic, that is hitting discretionary, right? And then ultimately, do you think that, that should -- it should hurt gross but the increased ticket, right, should positively impact expense control over time. So maybe your thought on that as it impacts the Dollar Tree P&L?

Yes. Another effort that we're working really, really hard on. In regards to the number of cooler doors, we're going to go from 3, I believe, 10 or 12 is the plan. We'll have a door that is a $1.25, couple of doors will be $3, $4, $5, and we're actually looking as we look at the multi-price point to expand that even more. The interesting thing is when a frozen food item goes into the basket, the basket actually gets larger. So your point about driving traffic, driving transactions is spot on. The other interesting thing, when we went to $3, $4 and $5, that allowed us to offer a family serving versus at $1.25, where it's just a single serve. So again, much more appealing to the actual -- to the consumer. The other thing, John, the fact that we went to multiple price points allowed us to put ice back in the stores. And ice is always a big seller. When we were locked in on the dollar, we had to take it out and we went to a larger bag, 7 pounds, took it to $2. And again, we're back in the ice business. I also agree that what will happen is we will keep growing sales and allow us to leverage our SG&A down in the stores. And then I also want you to think about the fact as we roll roto carts out, that we'll be delivering to the Dollar Tree stores and those also. So all of that time that it takes to unload a truck will be invested in putting more multi-price point items out on the shelves.

Next question is coming from Paul Lejuez from Citi.

Curious if you could talk about the monthly trend for each segment. Also curious to hear about performance in urban versus suburban and rural locations. And anything that you would say in terms of the competitive landscape that you see changing out there from a pricing perspective?

Yes. Great question. As I look at the flow across both banners through the quarter, it was pretty consistent all the way through. We started off strong, and it remained strong through the balance of the quarter. There -- in terms of performance, I think it's pretty even, but I will make this observation. It appears that the trade down from a higher income customer it's coming more in the urban environment than in the rural environment. So that's -- it's an interesting spin, but it's pretty even all the way across. In regards to the competitive environment out there in regards to pricing, the way I see it, it's very rational right now. Nothing significant is going on. I would say the ad collateral is basically the same it's always been. Everybody's kind of -- I think everybody is on the same playing field right now.

Our next question is coming from Matthew Boss from JPMorgan.

Great. So maybe a 2-part question, Rick, at the Dollar Tree banner, could you elaborate on the traffic trends? It seems like that's the real positive progression here. Any change in momentum that you've seen in August? And maybe just speak to market share trends that you're seeing by category at Dollar Tree. And then, Jeff, on the expense front, I guess, is there a way to think about the progression of the foundational investments that you've been putting in place as we think maybe beyond this year? It seems like store standards and wages, maybe 2 of the more stickier initiatives. Or maybe just ask differently, what do you see as the comp that we need to leverage fixed costs maybe next year in the model?

I'll take the first part, Jeff. Matt, the traffic is steadily increasing in Dollar Tree. Our traffic was up 9% in quarter 2. Really, really pleased with that. Your other question is discretionary was still up in Dollar Tree. It was up 3.9%. The consumables though, were up over 11%, which is our way -- and remember, consumables drive that traffic. And we have, by unlocking that price point -- and as we continue to unlock the price point, it's going to open up more opportunities for us to bring in really powerful value items. So pleased with customer traffic. In fact, I'll throw this in. Customer traffic was up 3.4% on the Family Dollar side. So we are seeing movement now with the customer base.

And as it relates to the investments that we're making, they're really twofold. So you have expense mix investments as well as CapEx. As we think about the expense investments, I think you're spot on with respect to the wage and store standard elements. There's a few elements that also transcend into our supply chain as we need to increase and improve the standards in our DCs. We're right on track with respect to how we thought they would play out over the course of this year and then as we think about going into next year. From a CapEx perspective, you kind of layer on top of that, then the work that we're going to be doing with our roto cart rollout and what we need to do with trailers and lift gates in the actual to other parts as well as what we're going to be doing from an IT perspective in adding additional capabilities with systems. As you think about what's the level of comp that we're going to need to deliver. There's going to be a number of factors that you have to take into account and quite honestly, we are working through that right now as we look out. One is going to be what's going to be rate of inflation as it relates to our cost in the marketplace, especially in labor, which is one of our more significant areas. The other piece, of course, is going to be in sales mix. The comp, you need a little higher level of comp when your sales mix is more weighted towards consumables versus discretionary. We believe, over time, we're going to see this mix balance out and then be not as significant a shift on a year-over-year basis, which you're seeing right now. Once again, that's over the long term. We had talked a little bit about this in the Investor Day, where we think that both Family Dollar and Dollar Tree will kind of average out over the period of time. So I'm not going to give you a comp number that we need to meet in order to leverage expenses at this point in time because there's a number of factors that we need to give a little more thought to and quite honestly, depending on what the economy does.

[Operator Instructions] Our next question is coming from Simeon Gutman from Morgan Stanley.

Wanted to just clarify and then ask the follow-up, all in one. The higher expenses this quarter, parsing it out between inflationary pressures being a little bit higher? Or are you spending more than planned or than you thought? And then bigger picture, the $10 in 2026, a long way to get there gives you flexibility. I don't think you've said it's ratable in any way. It may not be linear. What happened with expenses show that you're not afraid to spend back into the business. So curious where you're tracking. I'm sure you have your own plan and where '24, I know it's an early look, may land in terms of that run rate of expenses?

Great question. And I'm glad that I got this question finally. One of the things that if you take a look at this quarter and the pace that we're on, we are right on our outlook that we had anticipated with respect to the level of spend in the transformation. And we are actually leveraging against our original forecast, given this strong sales performance. This is also taking into account once again, unfortunately, this accrual adjustment that we just needed to make. So as we move forward, we continue to be disciplined in our spend. We look, as Rick has said, in some situations, an opportunity to pull forward a few items if we believe that we're going to be able to get the returns that much sooner. But the rate at which we are investing is according to our original outlook that we were we said at the beginning of this year. There are some modest inflationary components, as you can imagine, predominantly in utilities, and it is, as a result of the heat down that we're seeing on a national basis. The other area we're seeing a little more inflation would be in fuel, particularly in diesel fuel. And we've seen that here most recently and is reflected in -- both of these items are reflected in our guidance for the back half of this year.

Our next question today is coming from Kelly Bania from BMO Capital Markets.

I just wanted to go back to the shrink and mix and just be clear about the magnitude that is maybe coming in different or the same versus your expectations. And also how those 2 factors are planned for the second half. And also just related to the shrink, what kind of margin investment at all do you see necessary to combat the shrink headwind? And is that in your long-term plan?

Great. Thank you, Kelly. There's a few things here. As we think about shrink and mix, it has definitely advanced a little further than what we had anticipated in our guidance that we had given last quarter. Having said that, we believe that there are other more favorable items that are helping to offset against that. One, in our sales momentum; Two, we are seeing additional freight opportunity as it relates from an ocean perspective. But as it relates to shrink and mix, we had mentioned earlier that we had about $0.55 in total expected as an adjustment to our comp -- to our earnings, and that was going to be spread pretty evenly between shrink and mix. Of that $0.55, about $0.15 of that was actually incurred in the first quarter. So that remains -- that gives you a $0.40 for the back for Q2 through Q4. In Q2, against our original forecast, shrink and mix advanced another $0.08 on us. All of this is included in our forecast and as we're thinking about the back half, to the extent that there is any further acceleration, how we're thinking about offsetting that through other margin opportunities as we think about once again from additional freight favorability and/or other options that we have through the P&L.

So -- and I'd like to add 1 thing, if I can, Jeff. We are now taking a very defensive approach to shrink. And it's taken us a quarter, but we have several new shrink formats that we'll introduce in the back half of the year. And it goes everything from moving certain SKUs to behind the check stand. It has to do with some cases being locked up. And even to the point where we have some stores that can't keep a certain SKU on the shelf just discontinuing the item. So we have a lot of things in the works that's going to roll forward. You had a question about the mix. Is that correct?

And what's in the back half assumption?

She's asking specifically what's in the back half assumption, which I have not provided.

Yes. Okay. Fair enough.

So let me -- what I gave was a pretty widespread answer. If you think about the balance of the year, in Q3, what we've said and really in the back half of the year, Q3 sales mix and shrink continues to be a headwind for us. We've taken approximately 70% to 75% of our stores and inventories. So we'll be through the balance of most of those stores by the end of the third quarter. So sales mix and shrink continues to be a little bit of a headwind for us. Freight as far as diesel fuel continues to be a little bit of a headwind for us. And then once again, I said from utilities and this heat down back on this to be a little bit of a headwind for us. Offsetting that is going to be certain tailwinds. We've got sales momentum that we are projecting. We know that we believe that we have opportunities in additional freight from an ocean freight perspective. And also, we are starting to lap many of the SG&A investments that we started last year. As you go further into the back half of the year, we have less impact of sales mix and shrink because once again, we've taken all of our inventory. Fourth quarter is a much stronger quarter for us from a seasonal perspective, and it's focused on discretionary. And then the tailwinds in the back half or in the fourth quarter. Once again, we have the 53rd week, which we'll make an adjustment for continued sales momentum in our projection, ocean freight. And then once again, we can further along in lapping those SG&A investments that we started in the back half of last year. So as we progress through the quarters, the fourth quarter, we believe, will be one of our strongest quarters because we have less headwinds from shrink and mix, as well as the sales momentum and continued oceanic freight opportunity.

Your next question is coming from Chuck Grom from Gordon Haskett.

My question is on Family Dollar. I was wondering if you could speak to the progress on rolling out the higher shelf freights across the chain? And then just one for Jeff. On that $0.07, which banner was that in? Or was that in the corporate line?

Yes. In regards to the 78-inch profile, we hope to have that complete towards the end of the year. I would say we're probably maybe 40% or 50% done. While we're doing the Family Dollar side, we're also going to do the Dollar Tree side. So we're making progress on it. And the H2.5 remodels, all of those have the new shelf profile in. And by the way, the shelf profile raise allows us to add more cooler doors and refrigerated.

Yes. And on the journal liability claims, it was across both banners, and the best way to think about it was pretty evenly split.

We reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

No, thank you all for your time and look forward to talking to you soon.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.