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

Good morning, and thank you for joining us today to discuss Dollar Tree's third 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 about the company's expectations, plans and future prospects 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's Discussion and Analysis of Financial Conditions 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 results. Unless otherwise stated, we will refer to our financial results on a GAAP basis. Additionally, unless otherwise stated, all comparisons discussed today are for the third quarter of fiscal 2023 and 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. [Operator Instructions] And now, I'd like to turn the call over to Rick.

Thanks, Bob. I'd like to welcome everyone joining us on the call today. In brief, thanks to the dedication and hard work of our teams and continued execution towards our business transformation, third quarter results were well within our expected range. In a challenging retail environment where the accumulating pressures of inflation, reduced government benefits and depleted savings have negatively affected lower-income consumers, our top line performance outpaced most of our peers. We accomplished this by taking market share in both segments, which we believe reflects the initial impact of our investments and transformation initiatives. Despite Family Dollar softer comps and $0.05 per share of unexpected costs from the previously announced voluntary recall of OTC and other products, we delivered $0.97 of EPS. Our sales momentum continues to be mostly traffic driven as we attract new customers and gain both unit and dollar market share. In the last 12 months, we have added 4.3 million new customers at Dollar Tree and 2.3 million new customers at Family Dollar. Importantly, most of these first-time customers come back to shop with us multiple times after their first visit. In fact, our loyal customers are now the third largest retail customer base in the United States. As importantly, Dollar Tree is attracting customers from a broader range of income levels. Most of our new customers over the past year have household incomes over $125,000, and this income demographic was a significant contributor to Dollar Tree's quarter 3 comp growth. At Family Dollar, our price value perception remains strong after last year's price investments, which we cycled in July. That said, Family Dollar fell short of our quarter 3 comp expectations. Similar to what other retailers have reported, we experienced softening trends throughout the quarter, particularly in October. As lower-income consumers responded to the…

Thank you, Rick, and good morning, everyone. In the third quarter, our Dollar Tree and Family Dollar segments, both generated higher levels of customer traffic, unit volume and increased market share. Overall, we generated 5% more gross profit dollars in the third quarter than we did last year as consumers continue to respond positively to our growth initiatives. Consistent with prior-quarter trends, sales mix continued to shift towards consumables. This trend was more pronounced at Family Dollar, where our third quarter consumables mix reached an all-time high of 82%. Looking at the business on a consolidated basis, net sales increased 5.4% to $7.3 billion. Operating income declined 20.9% to $301.7 million. Operating margin compressed 140 basis points, which was a substantial trend improvement versus the first 2 quarters of the year. The contraction in Q3 operating margin was driven by a 15 basis point decrease in gross margin and a 125 basis point increase in SG&A rate. Gross margin contracted primarily from higher shrink, unfavorable product mix, increased distribution costs and markdowns from the OTC recall. This was partially offset by lower freight costs. While still elevated across both banners, shrink results were mostly in line with our expectations. We have now completed physical inventory checks across more than 90% of our stores, with a balance set for completion in January. SG&A expenses expanded primarily from ongoing labor investments in our stores, IT costs, depreciation and facility costs. Our effective tax rate was 21.8% versus 23.4%. Our tax rate was favorable versus expectations as higher work opportunity tax credits and lower net state taxes were partially offset by higher nondeductible expenses. Net income was $212 million, and diluted EPS was $0.97 versus $1.20. The net impact of the OTC recall was approximately $0.05 per share. At the business segment level,…

Thank you, Jeff. Similar to other retailers you've heard from this earnings season, we are seeing more macro pressures than we did earlier in the year, particularly among our lower-income consumers. Nonetheless, I'm encouraged by our market share momentum and am confident in our outlook for the balance of the year. Across our enterprise, we are making good progress on our transformation initiatives. As I've said before, we benchmark our operating performance on growing traffic, units and sales per square foot. All three of these metrics are heading in the right direction. With the steps we're taking to optimize our Family Dollar portfolio, we want to be better positioned to meet the financial and operating objectives of our organization and the expectations of our valued customers and associates. Relative to our competition, we want to operate from a position of strength at both banners. I look forward to updating you on our continued progress in the months ahead. And since we're in the midst of the important holiday season, I also want to take this opportunity to thank our more than 200,000 associates for their dedication in support of our continued growth as an organization. Operator, with that, Jeff and I are now ready to take questions.

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

It's a two-part question. Number one is, given the economic environment that you're facing, seems to be different than what you expected when you offered your long-term guidance earlier this year, how does that influence your thinking about your ability to achieve $10 of earnings by 2026 if the economic environment that is current to date remains the case for the next few years? And the second point is -- my second question is there's a perception that you're going to earn, call it, around $6 this year. You get $1 of freight benefit next year. And that would generate $7 of earnings. What would stand in the way of you not realizing that?

I'm going to let Jeff handle that.

I appreciate your question. The first part of your question regarding the longer-term outlook, the economic environment that we're in today, we believe that we're managing through. You see the Dollar Tree and Family Dollar continue to take market share, they're doing well across consumables. We believe that many of the actions that we're still sort of developing and will be put into action as we go through the fourth quarter into next year will help improve our top line, especially with a customer who is looking for additional value opportunities. This is -- we're early in the transformation. We believe that the actions we're taking that we feel strongly will continue to move us forward to our longer-term outlook. There's a lot that's going to happen between now and 2026, and there really isn't a real crystal ball there, but we remain resolute in our outlook. As it relates to 2024, I think that the way you're thinking about this from a standpoint on a sort of pro forma no growth, no incremental basis, yes, $7 of EPS when you take all the puts and takes between our forecast for this year. Remember, you've got to back up the 53rd week, which is about $0.30 in that. But we feel that that's a good starting point as you think about our 2024 outlook. We remain very confident in our ability to pick up the additional dollar in freight and EPS. There may be some additional upside to that, based upon what we're currently trending. And the actions that we're taking and the returns that we believe we will get from the initiatives that we've started this year will continue to develop as we move forward, that's a good starting point for you.

And Michael, let me add a little more thoughts on getting the 2026 number. We remain very bullish on that. And I think as we look into 2024, what's important is the number of initiatives that we've gotten done in just 1 year are really starting to gain traction. . And let's not lose sight of the fact why the fact that discretionary sales are softer than we all want our consumable sales are excellent, and we're responding to the needs of the consumer. And when we have the items they want, they're going to come into the store and see the incremental items, the incremental price points on the Dollar Tree side. They're going to see the new shelf profile, and they're going to see the fact that we're more relevant. And that's what gives me great confidence as we look into '24 and beyond.

Our next question today is coming from Simeon Gutman from Morgan Stanley.

It's a little follow-up to the prior question and then maybe a slight second part. If we take again the $1 in freight, should we think about next year, again, without talking about real guidance, the core business should grow plus we get freight? Or you're not endorsing that the core business necessarily grows as we get freight for sure? And then just the second part of it is on Family Dollar, can you remind us if the crux of generating higher margins to sales productivity, then what's going to be the step-change? And when should that occur?

Want to take the first part?

You take the freight, and I'll take the second one.

Very good. I think, and the way I was trying to respond to Michael's point from a standpoint of what's the starting point for FY '24 as he was kind of putting together the components, if you assume once again -- I think the view is looking at -- assuming a no growth, no incremental investment year, you would be starting off with a point that would be roughly $6.80 to $7 of EPS, assuming where we believe we'll end this year plus the additional dollar of freight and then once again, the other puts and takes around the 53rd week, which comes off as well as some of those discrete items we had this year as it relates to West Memphis, OTC and general liability. But we believe that we will have the opportunity to grow our business from there. We're not giving guidance for 2024 as of yet. But I think that people are focused on the right components that get you to a starting point and then what your assumptions are based upon how you think our initiatives will continue to take hold and grow from there.

And then in regards to Family Dollar and when we should start to see the incremental margin, I think as I reflect on where we're at right now, you think about the incremental SKUs, of which the bulk are OTC and HBA, which all carry higher margin rates, now they tend to be a little more discretionary. . You think about the fact that now private label -- we've already reached our 14%, which carries massive incremental margin. All of that stuff is going to be in place as we roll into 2024, which, again, gives me a lot of comfort on how Family Dollar is going to perform next year. There's no doubt there's pressure on that consumer. But I've always said the lower-income consumer has the ability to figure it out. And we are offering a better value proposition in Family Dollar than it has ever had. I'm very, very comfortable with the way the box looks, the way it's presented and how the consumer is responding. And I would add that when we entered quarter 3, the first period of the quarter, our comps were very good in Family Dollar, and we watched them [ erode ] through the period -- through the quarter. So again, we entered it from a very strong position.

Next question is coming from Paul Lejuez from Citi.

Can you talk about your Family Dollar comp assumption 4Q, just how you're thinking about how it breaks down from a traffic versus ticket perspective? And then within ticket, AUR versus [ BT ]? I'm curious if you can make any comments about your inflation assumptions for 4Q and FY '24?

Paul, I guess the way we think about it, we really -- the balance of the comp has really been between ticket and traffic. It's been pretty consistent in its makeup. It's been around 50-50. What we've seen here more recently is ticket has dropped off as that customer has been a little more challenged. We're continuing to see that going into the fourth quarter, thus our guidance of down 1% to plus 1%. We're not prepared to start getting into AUR and other further -- [ by-section ] of it. But as we think about traffic and ticket, it's going to -- we think we're going to have traffic probably driving more of the comp, offset by some ticket pressure.

And Paul, I'd like to add to that, that I -- we look -- we are intently focused on three key metrics: Transactions, traffic, whatever you want to call it, unit growth and sales per square footage -- square foot. And those are the things that we want to report on because I believe that drives comp sales and ultimately, growth in the chain.

Your next question is coming from Edward Kelly from Wells Fargo.

I wanted to ask you, I guess, a two-part question around Dollar Tree -- the core Dollar Tree business. You continue to roll out new price points. Maybe just an update on where you think the evolution of that is going over time? And how we should think about the timing of rollout of those price points? And then, that concept generally, it does like it's developing into a very formidable traditional dollar store competitor. I'm curious as to where you think you're gaining the share from? Is there any impact in Family Dollar, given what is happening there? And how is the evolution of the concept impacting the way you think about growth, both number of units and where those units may go?

Great question. Let's start with the price points. We have Rick McNeely and his team have done an outstanding job of introducing new price points. And you have to remember, Ed, we have to buy these things almost a year in advance in order to get them into the stores. And we're starting to see them arrive. We've actually done a test on Halloween and a number of stores with multi-price candy, and we're really, really excited with what happened with that. Now, it's really important that -- and I've said this frequently, I don't want anyone to think there's going to be 100 different price points in that store. We're going to -- our core price point is still $1.25. And what we're working on, what is the right amount and right number of price points. And what I can tell you is the consumer is -- it is -- when we broke the $1.25 a year ago, I have to tell you that, that barrier was broken, and now the consumer is very receptive to what's going on. And when we added an incremental price point, Rick and his team were not adding $1.25 item that's a little bit bigger or a little different at $2. We're adding a different item that has even more value. So there's no SKU overlap, which makes us a little more harder to get executed. Now we've already done the work. I know what it's going to take to get items into the store, get them marked, priced properly. 40% of our SKUs are coming from overseas, and they're going to add the price point right on the product. So a lot of great work has been done. And I think that's some of what we're seeing is the -- with the…

And Ed, just to add, in the prepared comments, we had mentioned the fact that a lot of the growth that's happening in Dollar Tree is actually coming from that higher-income customer, where we're attracting 4.3 million new customers on a year-over-year basis. A lot of these customers are in that income demographic of $125,000 or greater, and we're capturing that basket.

Next question today is coming from John Heinbockel from Guggenheim.

Two quick things or -- maybe the first one is not as quick. But on your [ FTL ] review, can you talk philosophically, right, how you're going to attack that? Because on the one hand, you'd want to dedicate more resources to the stores that have the most potential, but you also don't want to cut back too far from a descaling or deleverage perspective. So maybe talk about that, the opportunity to convert all of those to Dollar Tree. Does that exist? And then my small follow-up is just remind us when you think you'll get to eight cooler doors at $3 to $5 price point at Dollar Tree, is that 2 years out, a year out, 3 years out? When is that?

Well, let's go with the easy one. The Dollar Tree cooler doors, we should have done within the next couple of years. Now the [ FTL ] review, we started off with all of our initiatives and the idea being that we get everything in place and see what stores respond and what don't. And what I do want on this exercise, John, is not everyone to get ahead of me because I do think this is a very healthy thing to do and it's a timely thing to do. There will be some stores that will relocate, maybe some stores will close, maybe some stores will rebanner. But I do not have any of that information at this stage of the game. I've always prided myself on being transparent, and all I'm trying to do is tell the world we're taking a look at it. And I do think it's prudent. And I do think -- I don't want anyone to misconstrue that I'm not totally behind Family Dollar because I am. And I don't want anyone to think that, that doesn't mean we're not going to grow Family Dollar because I'm not saying that at all. It's simply a matter of reallocating assets to where we think we can be more productive.

Next question is coming from Matthew Boss from JPMorgan.

So a couple of questions from my side. Maybe first, Rick, on mid-single-digit comps at the Dollar Tree banner, what do you think is the best breakdown beyond this year to think about between traffic and ticket? At Family Dollar, Rick, what was the comp in October? Have you seen any change in November? And then, Jeff, could you just elaborate on what you've seen change in the promotional landscape?

Yes. I mean, let me -- let's start with the promotional landscape, and I'll take that, Jeff, if that's okay, and let you put the color around it. . I think the promotional landscape, I have not seen anything irrational at this stage of the game. I would look at you and tell you that we are seeing discretionary items being promoted, which I think is more a reflex against people worried about the inventory they have on hand. I will tell you, Thanksgiving being an all-time grocer, historically, you get the right price on turkey, then you make your money on all the grocery items around it. We saw a lot of incredibly well-priced grocery items this year coming out of the big box and the grocery channel, which is a little contrary. And there has been elevated activity on [ CSD ], basically 12 packs. But other than that, there hasn't been a lot out there. And then on the first question?

There was a question regarding the Family Dollar comps. The Family Dollar comps during the course of the quarter, they softened as we went through the quarter. We started off with a nice pace. October was the most challenged month of the quarter. And you'll see that, that was across all retail. We were essentially flat in that particular month. And our guidance for Q4 was reflecting the fact that, that has continued to soften for us, and that's the guidance of down 1% to plus 1% for the entire quarter.

And the one thing I'd add to that, Matt, while we think -- we saw things soften in October, I'm knocking on wood here thank God, we had our initiatives in place because while it softened, it could have been a lot worse. And I'm very pleased how we got ourselves through that quarter.

Next question is coming from Kate McShane from Goldman Sachs.

We wanted to ask specifically about Dollar Tree. We know you noted that you saw a broader range of income shopping at Dollar Tree and it contributed to your Q3 comp growth at the higher end. We wondered with regards to the lower end, just what you're seeing specific to the Dollar Tree banner?

I would say -- I mean, I would look at you and say, Dollar Tree has always had a broad appeal. And I think what we're seeing, what we're focused on is the fact that we're seeing a trade down in the Dollar Tree. I would say, the customer base is essentially the same. There's been no erosion in the lower-income strata, but the growth, undoubtedly, is coming from the higher income, $125,000 a year.

I reflect back on this, for Dollar Tree, had a very strong consumable performance but also better than a 1% comp in discretionary and still showing growth on a -- it's a sizable growth on a year-over-year basis in discretionary. The lower-end customer -- lower-income customer, we're probably seeing more of their dollar in consumables, which is good because we're continuing to capture units and share there. The higher-income customers supporting us in that discretionary as well as in consumable areas with respect to the multi-price also. So it's a combination of both those customers as Thanksgiving has a strong performance across the Dollar Tree banner.

Next question is coming from Krisztina Katai from Deutsche Bank.

So my question is on Family Dollar. Understandably, there was some weakness with the low-end consumer. But how are you planning to address the softer-than-planned top line at Family Dollar to get it back on track towards mid-single digits? That is a big part of the profitability inflection, so how do you think about your current pricing position relative to your peers? And then the second part of that, I know you're not guiding to next year, but philosophically, how best to think about the ability of the banner to drive positive units to offset any potential deflation next year in consumables?

Yes. In regards to the top line, in regards to our pricing position, so first thing I would say, our pricing in Family Dollars as good as it's ever been. And we measure our pricing on a full book basis and what we call key value items. And key value items are the most sensitive items out there. And we do these checks every month, and we do them across multiple channels, so big box as well as small box, as well as drug, as well as grocery. And we're very, very comfortable where we're at. We're right around -- right on the mark at 100% in both, which means we have price parity. And I believe -- and why we've been in this for a year now, I do believe the consumer is starting to respond to that. And remember, we had very powerful consumable growth in quarter 3 in the Family Dollar brand. It's the consumable side where that consumer is feeling that pressure. And I think you asked me a little bit about deflation. I would look at you and say, deflation will put us in a position where I think the consumer would be able to afford more discretionary items. So we'll take it as it comes. And of course, it should help us with our margin at the same time.

Just to add one final point. With respect to the work that Larry and his team is doing in private brands is something that's really important for us. The ability to drive greater value for that customer, give [ her ] other options, this is something that we're really just fully getting implemented here in the fourth quarter, going into '24. So we believe that as that customer is looking for greater value, they have more options within our private brands. It's an opportunity for us to improve our margins. And to the extent that there is sort of price deflation, there's opportunity that can actually provide even more value as we think about how we assort that particular product line.

Next question today is coming from Chuck Grom from Gordon Haskett.

On the Family Dollar store optimization, I'm just curious how, why the comp and profitability gap exists today across the fleet? And then I guess this question is more for Jeff. On the gross margin line for the fourth quarter, how should we think about that between each banner, [ FPO ] and the Tree and into 2024? What are the biggest puts and takes to think about?

Yes. Chuck, the first question, I would rather not comment at this stage of the game as the process is underway and we have started it. And I will disclose more of that as we get -- when we get into the March call. But let's say this, obviously, it's an opportunity for us that we intend to address head on.

And then, Chuck, I think your question is around Q4 and as we think about gross margins, let me take it Dollar Tree first. We would expect our margins to continue to expand in gross margins in the fourth quarter, largely driven by additional freight, the mix shift, a stronger mix of discretionary as you would normally have more seasonally. The other impact there is that as we had mentioned, we've taken approximately 90% of our inventories, we have the remaining 10%. While we don't expect that remaining 10% to have any different outcomes than we had in the past, the impact on the quarter is much less because you're only talking about a small portion of your inventories on a much larger portion of your overall performance. So our expectation is for further gross margin expansion for Dollar Tree in the fourth quarter. We also believe that, that opportunity is there for Family Dollar also for many of the same reasons as it relates to freight, less of an impact of shrink on the quarter as well as some opportunities that we have within distribution. So we'd expect margin expansion -- gross margin expansion in the fourth quarter also for Family Dollar.

Next question is coming from Scot Ciccarelli from Truist Securities.

This is actually Josh Young on for Scot. On the shrink issue, obviously, it's been a big margin headwind this year. As we think about '24, where do you guys think you are in terms of dealing with it? You've talked about some of the mitigation efforts there, but curious if you think we're still in the early innings or do you think you're starting to make some substantial progress on dealing with the problem?

Yes. I would say we're in the early innings, but I do feel we're making headway. The deal is that we take a physical inventory once a year. So if you make these improvements, these adjustments, you still have to wait in order to see them -- see the fruits of your labor. Now I can tell you, we've eliminated certain SKUs in certain stores. We've put items behind the check stand counter. We've moved certain items up front, so they have a line of sight to the cashier. And the important thing is we haven't affected our sales. And I might also say, we've put in, and I forgot to mention this, an anti-sweep OTC panel that's basically like sliding doors. And you move -- it doesn't lock the counter up, but you move that little door over and you could only pull one item out at a time, which prevents a thief from coming in and cleaning out the whole shelf. So we think we're going to make progress. And I don't think it's -- we're going to have to cycle through everything. So it's not like it's going to be an overnight change. but I do believe we're moving in the right direction without having to lock product up.

Our final question today is coming from Peter Keith from Piper Sandler.

I just want to circle back on the deflation theme because that seems to be something that's percolating out for 2024. Rick, you mentioned your customers have a little bit more money. But is it possible that deflation could be negative for the banners, thinking about maybe less fill-in trips and maybe more competition?

So on the Dollar Tree side, all it will do is enhance the margin because you basically have a fixed price point, so we end up getting the goods cheaper. So I can say that it could be a benefit. It might have fixed the top line a little, but it should be a benefit. To the Family Dollar side, I would look and say it might affect the top line. But again, I can make an argument, it should enhance the margin line.

It also gives the opportunity for that customer to take those dollars. And our customer today is limiting their purchases, maybe more in consumables, less in discretionary. The additional disposable income that they would have would allow them to pick up an additional discretionary that they didn't have before.

Yes. And again, I'd add, if we do have deflation, it allows us to invest more in the value of the product and actually give the consumer something a little bit additional.

We've 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.

Thank you all very much for taking the time, and look forward to talking to you soon.

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