Dollar Tree, Inc. Q2 FY2021 Earnings Call

Good day, and welcome to the Dollar Tree, Inc. Second Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Randy Guiler, VP, Investor Relations. Please go ahead, sir.

Thank you, Shelby. Good morning, and welcome to our call to discuss Dollar Tree's performance for the second fiscal quarter of 2020. With me on today's call will be our President and CEO, Mike Witynski; and our CFO, Kevin Wampler. 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 8-K, 10-Q and annual report, which are 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 related follow-up question, if necessary. Now I will turn the call over to Mike Witynski, Dollar Tree's President and Chief Executive Officer.

Thank you, Randy. Good morning, everyone. I'm very pleased with the company's second quarter results announced this morning. Our store and distribution center teams have done a remarkable job of serving customers through an incredibly dynamic time in retail. Their continued efforts to ensure we are providing a clean, safe shopping experience, along with the great value and convenience our stores offer, contributed to our solid operating performance for the quarter. Our team delivered an earnings per share increase of 44.7% compared to the prior year's quarter. These results for the enterprise were comprised of a 7.2% same-store sales increase, a 180 basis points improvement in gross profit margin and a 130 basis point increase in operating profit margin. Same-store sales increased 11.6% at Family Dollar and 3.1% at Dollar Tree. It's a new day at Family Dollar. In early March, on our Q4 earnings call and following our December leadership realignment, I spoke about the challenge and opportunity to turn around the discretionary side of the business at Family Dollar. Our focus is on greater values and sharper price points with an enhanced focus on meeting the basic needs of our customers. It's all about sourcing more of the items customers want to buy. Our team's efforts are paying off as Family Dollar delivered a record 28.9% same-store sales increase in discretionary for the quarter. Our realigned and focused merchandising team is demonstrating how they can be nimble and opportunistic to drive sales, loyalty and repeat visits at Family Dollar. Examples of this included, following on the success we experienced at Dollar Tree, we have now completed the rollout of Hallmark-branded greeting cards to all Family Dollar stores. We are capitalizing on great brand name closeout opportunities, which is a relatively new approach at Family Dollar. We introduced what could be the top toy of the year, Baby Yoda, and sold tens of thousands in a matter of days. As the quarter progressed, we saw a shift from kitchenware and tabletop into more home decor and soft home as customers are investing in their homes and spending more time in their homes. Anything related to staying at home, such as lawn and garden and outdoor grilling, continues to perform very well. And on the apparel side, we have had strong sell-through of our spring and summer apparel with a focus on our at-home items like loungewear, sleepwear, slippers, athleisure, children's clothing as well as newborn and onesies. Family Dollar's 11.6% comp reflected the continuation of momentum that we saw in Q1 as customers are viewing Family Dollar as a convenient, safe, local option with great values on food, essentials, household products, cleaning supplies, home decor and much, much more. The strong performance in discretionary contributed to a 390 basis points improvement in gross margin, and operating income margin for Family Dollar in Q2 increased 470 basis points to 5.3%. Other Family Dollar sales highlights for the second quarter included the 11.6% same-store sales increase was on top of a 2.4% comp in Q2 a year ago. This was comprised of a 25.9% increase in average ticket, which was partially offset by an 11.3% decline in transaction count as customers continue to consolidate their shopping trips. The sales strength was broad-based geographically, with each zone delivering comp increases between 9.5% and 13.5%. Also, both rural and urban Family Dollar stores delivered double-digit comp increases, with rural slightly outpacing urban. Regarding the cadence of comps, each month's increase was greater than 8.5%, with May, which had the greatest benefits of stimulus, being the strongest month. And June was slightly stronger than July. While it is still early in Q3, Family Dollar is delivering very solid same-store sales despite less government assistance being available than during the prior quarter. The consumables side of the business delivered another positive quarterly comp at 6.3%. While as previously mentioned, the discretionary count was a record 28.9%. We saw more than 0.25 million new sign-ups in our smart coupon program during the quarter, bringing its total enrollment to 12.8 million customers. Our H2 stores continue to perform very well, delivering year 1 cap lifts greater than 10% when compared to non-renovated stores. For fiscal 2020, as previously stated, we plan to renovate 750 Family Dollar stores while new stores are also being opened in the H2 format. For the Dollar Tree segment, Dollar Tree bounced back with a 3.1% same-store sales increase for Q2 following a quarter where Easter seasonal performance was materially impacted by COVID-19. Gross margin, which was down 260 basis points year-over-year in Q1, was down 10 basis points for the second quarter. This sequential improvement was primarily due to the rebound on the discretionary side of the business following Easter. Geographically, comp sales were relatively balanced with increases by zone ranging from 1.2% to 4.25%. For the quarter, discretionary delivered a positive 9% comp, and consumables were down approximately 3%. The comp sales for every line of business at Dollar Tree improved from Q1 to Q2, with the exception of the food category. Factors impacting food include reduced availability of protein products from periodic plant shutdowns, slowed sales of impulse snacks as traffic has declined, and some vendors are focusing more on larger pack sizes based on demand and their production capacity. Categories performed well in the quarter include crafts, kitchenware, housework products, party celebrations, and beauty and eyewear. The Crafter's Square program is a tremendous hit with our customers and is driving repeat visits to our stores. Our timing with the rollout of more than 2,400 stores in Q1 could not have been better. The improved performance in the basic craft assortment is also contributing to a lift in our seasonal craft business as well. For the quarter, Dollar Tree's transaction count was down 15.9%, while average ticket increased 22.6% as consumers, in general, have been shopping less, but buying more. Q3 has gotten off to a good start at Dollar Tree as well. Regarding upcoming seasons, like back-to-school, Fall Harvest and Halloween, we are seeing more volatility than usual on the timing of back-to-school sales. But the good news is these are in line categories, and there is minimal markdown risk associated with these items. I view this as similar to the graduation category. The timing of the sales were disrupted, but, overall, the category performed very well for us. Consumers are adapting to the current environment and are still celebrating, albeit in smaller groups or celebrating in different ways. In March, the merchant team took action to make adjustments in Halloween buys and derisk the category, with much less focus on traditional trick-or-treating and large gatherings and more focus on decorations and costumes. We are seeing very nice trends regarding the early sales related to Fall Harvest and Halloween. Now regarding Dollar Tree Plus! Our focus on selling great value merchandise at price points of $5 and below, we are continuing to analyze, learn and make adjustments to the program. Earlier this year, we transitioned from the initial consumable-dominated assortment to a more wild-type discretionary product that Dollar Tree is known for. We recently added bins to our larger test stores to promote some hot, one-time item sales. Sales of these discretionary products remained strong with good sell-through as customers are responding favorably. We are excited about the many new, multi-price discretionary products that we already have on the store shelves for this fall selling season. We remain encouraged about the potential for Dollar Tree Plus!. Inventory levels in both our segments were impacted during the quarter as it relates to higher turned consumable categories. Current environment and related in-stock levels on domestic items are improving, but the continuation of high customer demand, especially on items such as paper towels and cleaning supplies, is still outpacing both vendor production capacity and the supply. In-stock levels on certain items are constrained, but we do expect to see continued improvement as we move through the quarter. Throughout the quarter, we rewarded our dedicated hourly store and distribution center associates with premium pay. This was in recognition of their extraordinary efforts to protect and serve our customers effectively with enhanced cleaning protocols and other safety measures. We believe these efforts contributed to our solid top line sales performance during the quarter. The value and convenience of our store offerings are desired in the current environment by customers who are looking to save money while shopping close to home. The COVID-19-related costs incurred for wage premiums for the frontline associates, our guaranteed sales bonuses for field management, and the supplies needed for keeping our customers, associates, and facilities safe totaled nearly $135 million for the quarter. Surveys indicate that customers want to shop where they feel comfortable and safe. We have invested in our associates and believe this is contributing to enhanced loyalty, attendance while reducing turnover in our stores. Over time, lower turnover can lead to improved shopper experience, more efficient store operations and reduced shrink. During the quarter, we were re-ranked Dollar Tree and Family Dollar first, in the aggregate of strongly trusted or somewhat trusted ratings of all retailers, enforcing safety measures for shoppers. Additionally, as many of you have seen in the news reports, more than 100 of our stores were impacted in certain communities during the recent periods of civil unrest. Overall, we incurred nearly $17 million in costs during the quarter related to store damages, repairs and lost inventory. The majority of the impacted stores have been reopened. Regarding our supply chain, we continue to support planned growth and infrastructure and distribution capacity ahead of the need. We recently began shipping from our newest distribution centers in Rosenberg, Texas and Ocala, Florida. These facilities will provide increased capacity and improved efficiencies to support continued profitable store growth in both Southeastern and Southwestern states. We completed more than 250 real estate projects in the quarter, including 131 new stores, 22 relocations, 76 Family Dollar H2 renovations, and 26 store closings. We ended the quarter with 15,479 stores. I am very proud of the work our leaders throughout the organization, including our store operations and field leadership teams, our merchandising group, our DC and supply chain teams, and our store support center team. I'll toss it over to Kevin now to provide more detail for the Q2 performance.

Thanks, Mike, and good morning. For the second quarter, consolidated net sales increased 9.4% to $6.28 billion, comprised of $3.18 billion at Dollar Tree and $3.1 billion at Family Dollar. Enterprise same-store sales increased 7.2%. And on a segment basis, comps for Family Dollar increased 11.6% and for Dollar Tree increased 3.1%. Overall, gross profit increased 16.2% to $1.92 billion. Gross margin improved 180 basis points to 30.5% compared to 28.7% in Q2 of 2019. Gross profit margin for the Dollar Tree segment decreased approximately 10 basis points to 33.7% when compared to the prior year's quarter. Factors impacting the segment's gross margin performance included distribution costs increased 70 basis points, primarily due to higher payroll costs and depreciation. This includes the start-up expenses of the two new distribution centers that Mike mentioned, as well as approximately $6.7 million or 20 basis points of COVID-related expenses, primarily premium pay bonuses and health screening costs. Shrink increased approximately 15 basis points based on inventory results and an increase in the accrual rate. These cost increases were partially offset by improved merchandise costs, including freight, which improved by approximately 65 basis points. Dollar Tree saw an improvement in merchandise mix, lower freight costs as a percentage of sales and improved markdowns, partially offset by an incremental $8.2 million of tariff costs. Occupancy costs decreased 15 basis points due to leverage on the comp sales increase in the quarter. Gross profit margin for the Family Dollar segment improved 390 basis points to 27.2% in the second quarter. The year-over-year improvement was due to the following. Merchandise costs, including freight, improved 190 basis points, primarily due to improved merchandise mix. Discretionary sales, driven by government assistance and improved assortment, comped up 28.9% for the quarter, increasing total discretionary sales to 26.2% of the business from 22.9% last year. And traditionally, the Family Dollar segment had improved markdowns and lower freight costs as a percentage of net sales, partially offset by $2.6 million of incremental tariffs. Occupancy costs decreased approximately 95 basis points as a result of leverage from the comp sales increase. Markdown expense improved approximately 85 basis points as we cycled the store optimization markdowns and higher clearance sales from the prior year's quarter and lower promotional activity in the current year, partially offset by $7 million of markdown costs for stores affected by civil unrest. Shrink decreased approximately 40 basis points based on improved inventory results in the current year and an increase in the accrual rate during the prior year. These benefits were partially offset by distribution costs, which increased approximately 25 basis points due to increased payroll costs at the DCs. These costs included approximately $4.7 million or 15 basis points of COVID-related expenses, primarily premium pay bonuses and health screening costs. The consolidated selling, general and administrative expenses increased 50 basis points to 24.5% of net sales compared to 24% in Q2 a year ago. For the second quarter, the SG&A rate for the Dollar Tree segment as a percentage of net sales increased to 24% compared to 22.4% in Q2 of 2019. Payroll costs increased approximately 175 basis points comprised of the following. Payroll expenses increased approximately $66 million or approximately 210 basis points for costs associated with COVID-19 premium pay and bonuses. This increase was partially offset by decreases in workers' compensation and benefit costs as well as leverage from the comp sales increase. Other selling, general and administrative expenses increased approximately 5 basis points. The company incurred COVID costs of $3.5 million or approximately 10 basis points for PPE and cleaning supply. Additionally, general liability claim expense increased based on development, partially offset by lower legal and travel costs. So our facility costs decreased approximately 10 basis points, primarily due to leverage of the stronger same-store sales and lower electric costs. The SG&A rate for the Family Dollar segment improved approximately 85 basis points to 21.9% compared to 22.7% for the second quarter of 2019. Operating expenses decreased by approximately 90 basis points, primarily due to higher costs in the previous year related to the disposal of fixed assets in connection with the store optimization plan and reduced advertising and travel as a percentage of net sales in the current year, as well as leverage from the comparable store sales increase. Store facility costs have improved approximately 25 basis points, primarily from leverage on comp sales and lower electric costs. And depreciation improved 5 basis points, primarily from leverage on the comp sales increase. These benefits were partially offset by payroll expenses, which increased approximately 40 basis points, driven by COVID-19 costs of $48.2 million or 155 basis points for premium payments and bonuses, as well as an increase in incentive compensation based on performance. These increases were partially offset by decreases in workers' compensation, benefit costs and temporary health and leverage from comp sales. Operating income increased 39.4% to $374.9 million compared with $268.9 million in the same period last year. And operating income margin improved 130 basis points to 6% compared to last year's second quarter. The current year quarter included $134.9 million in COVID-19-related expenses and $16.8 million in civil unrest costs. Nonoperating expenses totaled $35 million, comprised primarily of net interest expense. Our effective tax rate was 23.1% compared to 21.1% in the prior year's second quarter. The company had net income of $261.5 million or $1.10 per diluted share, which included $134.9 million or $0.44 per diluted share of incremental operating costs for COVID-19-related expenses and $16.8 million or $0.05 per diluted share for civil unrest costs. This compared to net earnings of $180.3 million or $0.76 per share in the prior year's quarter. Combined cash and cash equivalents at quarter end totaled $1.75 billion compared to $539.2 million at the end of fiscal 2019. The company paid down $250 million on its revolver during the quarter. Outstanding debt as of August 1, 2020, was approximately $4.1 billion, which includes $500 million drawn on our revolving line of credit. Inventory for Dollar Tree at quarter end declined 4.2% from the same time last year, while selling square footage increased 4.9%. Inventory per selling square foot decreased 8.7%. The team is actively managing the mix of inventory to build food and essential goods categories. Inventory for Family Dollar at quarter end decreased 7% for the same period last year, while selling square footage increased 0.6%. Inventory per selling square foot decreased 7.6%. Our Family Dollar inventory reflects higher-than-normal out of stocks in certain categories. Our merchants, supply chain and vendors continue to work to improve our position to meet increased product demands. Capital expenditures were $232.5 million in the second quarter versus $293.3 million in Q2 of last year. And for fiscal 2020, we continue to expect consolidated capital expenditures to be approximately $1 billion. Depreciation and amortization totaled $168.1 million for Q2 compared to $155.1 million in the second quarter last year. And for fiscal 2020, we expect consolidated depreciation and amortization to range from $675 million to $680 million. While we are not providing sales and EPS guidance, I do want to provide a few data points for your modeling. Net interest expense is expected to be approximately $38 million in Q3 and $152 million for fiscal 2020. The tax rate is expected to be 22.4% for the third quarter and 22.6% for fiscal 2020. And weighted average diluted share counts are soon to be 238.3 million shares for Q3 and 238.1 million shares for the full year. As demonstrated by the significant business trend changes between Q1 and Q2, the environment remains volatile. We have always valued the flexibility of our business model, and we continue to adapt as necessary during this uncertain period. We have a strong balance sheet and continue to grow the company by investing in new and renovated stores, our supply chain and technology to improve the customer experience. We remain confident in our business and our ability to drive long-term shareholder value. I'll now turn the call back over to Mike.

Thanks, Kevin. I could not be more proud of the overall team's performance for the second quarter. As I stated earlier, it is a new day at Family Dollar. Family Dollar delivered a 13.6% comp for the first half of the year, and operating margin has improved 350 basis points from the first half a year ago. We have seen nice momentum thus far in Q3. Dollar Tree had a good quarter with sequential improvement in both sales and margin, following a very challenging Q1. Aside from the food category, we saw comp improvement in every line of the business in the second quarter. I believe we are in the right spot at the right time. We have a business team consolidated into one store support center. Our leadership teams are aligned, focused and energized. Our support teams are receiving consistent direction and are acting with enhanced clarity, focus and speed. Our merchant teams are doing a tremendous job of adapting and reacting to evolving customer trends, and our store operators are focused on running great, clean, safe stores. At Dollar Tree and Family Dollar, we have a tremendous opportunity to drive sales, enhance gross margins and leverage our cost structure, each contributing to operating margin improvements over time. We are a growth company in the most attractive sector in retail, opening more stores, renovating stores, improving our efficiencies, generating significant free cash flow, focusing on our customers and running great businesses. I truly believe the best is still ahead of us. Before we go into Q&A, I would like to just share that our thoughts are with all of our families and communities and our associates that have been impacted by Hurricane Laura that is passing through the Louisiana and Texas area right now.

We'll take our first question from Matthew Boss with JPMorgan.

Mike, congrats on the new role. Maybe while early, any change in the key areas of focus as we think about Dollar Tree and the Family Dollar banners? And maybe specifically, how are you thinking about multi-price points at Dollar Tree? Where do we stand today? And what key metrics are you looking forward to potentially scale this initiative?

Matt, thank you for your interest. We are very excited about the opportunity with the multi-price point at Dollar Tree. As we move into more discretionary items that Dollar Tree is known for, we are seeing positive responses from our customers with the exciting products we are offering. We will continue to monitor several key metrics, including whether our customers are responding positively and if we are achieving greater productivity in our stores. We want to see an increase in sales per square foot and improve our margins. These are the three primary factors we will assess to determine the success of this initiative. On the Family Dollar side, we believe the 11.7% comp reinforces that our customers value the investments we are making in our H2. They are responding well. Under Rick's leadership, the merchant teams have focused on refining the H2 assortment over the past 18 months. We are constantly working on improvements, examining adjacent categories and SKU counts, and exploring ways to grow in the discretionary segment. As we roll out the H2, our merchants are dedicated to making continuous enhancements that will lead to increased sales per square foot and improved margins by strengthening our discretionary mix.

Great. And then, Kevin, at the Dollar Tree banner, what's the best way to think about the gross margin headwinds versus tailwinds in the back half of the year, maybe relative to the second quarter? And then as we think about the 35% to 36% banner gross margin long term, that I think you are very confident, with any constraints to getting to that level next year, that we should think about?

Thanks for the question, Matt. As we reflect on it, we saw some balance in Q2, with improvements in our overall margin. Our discretionary mix grew in Q2, which helped offset the situation from Q1. Looking towards the latter half of the year, I believe we are positioned for a strong discretionary period. As Mike mentioned earlier, we're observing good sales in Fall Harvest and Halloween, which is encouraging. We will also continue to strengthen our categories related to food and essentials. However, as we move into the second half, I believe our main challenge will be distribution costs, which increased by 70 basis points in Q2. This includes start-up costs for two new buildings, marking the first time in many years that we've opened two buildings simultaneously, which contributes to these costs. Additionally, shrink continues to be somewhat persistent, but I am optimistic that we can manage it. Overall, if we can drive additional sales and create more leverage, we feel confident about the natural product margin. The commodity side of our business remains strong, and our buyers have just completed their sourcing trip in July, which went well and will positively impact us going forward. This is my perspective on the second half in the Dollar Tree segment.

Matt, just to give a little color, too, on your question, getting to the 35% to 36%. We absolutely believe we can get to that range that we historically have. As Kevin said, we like the mix that can drive us there. And if you really look at our initial markdown from a product and mix perspective, we're in great shape. Our pressure is from the shrink and the DC costs. We know where it is, and we're going to get after those areas.

We'll take our next question from Michael Lasser with UBS.

On the Family Dollar side, first, why do you think the spread between Family Dollar and its largest competitor in terms of comps expanded this quarter versus where it had been in the last several quarters? And as part of that, your consumable business was very good that drove gross margin expansion. Are you going to give some of that back? And this is not a realistic gross margin to expect that we should be modeling moving forward?

Michael, thanks for the question. We're very proud of and like our 11.7% comp growth and especially a record 28.9% growth on the discretionary side. We're seeing that on the Family Dollar side, based on the information that we're getting from third parties and internally, that we captured 15% new customers during the quarter. Our discretionary market share gains were three times what the market was on the discretionary side of the business. And with our 250,000 new sign-ups on our smart coupons, we are getting new customers engaged. So we like our comp sales growth. And all the things that our merchants and the Rick McNeely and the team are focused on are the right things. They're responding. And that focus on sharper price points, basic items and having what customers need when they're in our store, we think, is working.

Okay. My follow-up question is about the comments you made regarding early trends in the third quarter. This is significant because many individuals are still unemployed and rely on the value you provide, but their unemployment insurance or enhanced benefits have diminished. You mentioned that Dollar Tree has started off well. Can we assume that this business has improved compared to last quarter, especially since you've resolved some of the out-of-stock issues in the consumable categories? Should we also consider that Family Dollar is experiencing similar trends to what you reported in July?

Yes, we are optimistic about the third quarter, which we believe is beginning similarly to how we finished the second quarter. We're seeing strong comparable store sales and a favorable mix across both segments of the business. As Kevin mentioned, early signs for fall and Halloween are promising, and we feel well-prepared for what's ahead. Given that customers are spending more time at home, they seem eager to decorate and invest in their living spaces more. This trend is reflected in our sales data.

We'll take our next question from John Heinbockel with Guggenheim.

And Mike, let me start with your thoughts on Dollar Tree, right, and the discretionary business over the next, I don't know, six to nine months, right? Because in '08, '09, you did see an acceleration on trading down as the recession took effect. What's your outlook when you think about Dollar Tree in the next couple of quarters? And are the merchants doing anything differently in anticipation of some trading down benefits?

Thank you for the question, John. I believe we are in a strong position as everyone is currently staying at home. Our Crafter's Square initiative, which we launched in the first quarter, is now available in 2,400 stores and over 3,000 stores overall. Customers are responding positively, and our merchants are consistently reordering to meet the demand in this category. On the consumables side, we see improvement in replenishment each week as vendors increase their capacity. We're optimistic about the sales mix moving forward, and I believe we will be well positioned in the latter half of the year. Looking ahead to next year, especially as customers may need us more with the reduction of unemployment benefits and the current unemployment rate, we feel we are in a strong position similar to what we experienced in 2008, 2009, and 2010.

All right. And then maybe secondly, you mentioned two distribution centers at Dollar Tree. Could you provide an update on the progress of co-mingling distribution between the two banners? I assume those two centers will focus exclusively on Dollar Tree, but are we getting closer to more co-mingling to reduce distribution costs, or is that still a while away?

Yes, that's a great question. As you've seen, our DC costs are outpacing where we want them to be. So part of that is we do have a longer-term strategy to leverage our network. Currently, we have one co-banner DC in our St. George, Utah. But keep in mind, in the last two, two and a half years, every DC that we've opened or we are opening is with systems and the capability of co-bannering just as we have these two. So we are starting out these two because that's where the growth historically has been on the Dollar Tree side, so we've been feeding that growth. But down in the Ocala business and the Texas, they are going to be capable of co-bannering. And in that long-term plan, we will be moving to that.

We'll take our next question from Scot Ciccarelli with RBC Capital Markets.

Can you provide some more color just regarding some of the supply shortages you highlighted, especially on the Dollar Tree side, and how you think that inventory flow will change as we get kind of further through the back half?

Yes, Scot, thanks. On the consumables side, we're focusing on paper and cleaning products. Specifically, paper towels are in demand as people enhance their cleaning protocols at home or elsewhere. This includes any cleaning chemicals with a kill claim and hand sanitizers, as there is still significant pressure to meet customer needs. However, we are observing improvement in bath tissue availability, and we're able to keep that tissue on the shelf for longer than just a few days. Throughout the second half of the year, we expect to see enhancements in our stock levels for these highly consumable items. Nevertheless, our vendors have communicated that there will be ongoing pressure from manufacturers during the latter half of the year.

Mike, do you have an estimate for the potential sales impact or challenges you encountered during the quarter due to these supply shortages?

Yes. No, we do not.

We'll take our next question from Robby Ohmes with Bank of America.

Mike, could you provide more insights on Dollar Tree and what you're observing there? One question relates to the impact of stimulus as we transition from the end of one quarter to the beginning of another. I understand that Dollar Tree attracts a wider income demographic compared to Family Dollar. Are you noticing any changes in customer behavior, particularly among lower-income customers in response to the stimulus? Additionally, can you help us understand the significant decline in transactions, which you've indicated is a 16% drop at Dollar Tree? How are you approaching the transaction comp for the latter half of the year, and what should we keep in mind regarding that?

Thank you for your question, Robby. In Dollar Tree, we believe that the sales growth in May was supported by stimulus benefits. However, the positive news is that even as those benefits diminished and customers sought value, convenience, and safety, they continued to shop at Dollar Tree and Family Dollar. We are optimistic about our comparable sales as we approach the end of this quarter and move into the third quarter. Customers are still shopping with purpose, resulting in larger basket sizes. We anticipate this trend will persist into the fall as people continue to prioritize social distancing and follow safety protocols.

And Mike, as other stores came back online, because you guys obviously were a necessity retailer that's been open, but any changes you've had to make from a marketing standpoint or any pressures you've seen on either Family Dollar or Dollar Tree related to some of these other stores coming back online?

Yes, we have not noticed any significant changes. As I mentioned, at Family Dollar, our discretionary category saw growth as customers shifted from competitors. The market expanded in the discretionary area, and Family Dollar experienced growth that was three times that of the market. Therefore, with the reopening of more stores and increased competition, we haven't observed any significant changes in our customer traffic or average transaction size.

We'll take our next question from Chuck Grom with Gordon Haskett.

Mike, congrats on the new position. My question is on Family Dollar. You talked about 15% new customer acquisition, I believe, in the quarter. Just wondering if you could just give us that metric for the first quarter. And then looking ahead, I'm curious what steps you're taking to retain those shoppers and cultivate those relationships over the next few quarters and even into next year.

Thanks, Chuck. I don't have that number for the first quarter, but we can find it, and Randy can follow up with you. To retain our customers, we aim to provide a great shopping experience. Currently, safety, cleanliness, and convenience are extremely important to our customers, and we are focusing on addressing those needs. On the consumables side, we want to ensure that we have the products they are looking for on the shelves. For discretionary items, our teams are working on offering competitive price points with great value on essential items. We believe that by doing these things, we can effectively retain our customers. Additionally, we are pleased with the increase of 250,000 people signing up for our smart coupons, as this will help us engage with those customers, track their purchases, and encourage them to buy more.

That's helpful. And then just bigger picture, like the Dollar Tree guys purchased Family Dollar four years ago, it's been a little bit of a struggle over the past few years. Just curious what you think needs to get done, not near term, but just bigger picture to fix the Family Dollar business to narrow the gap with Dollar General to improve margins. Just what do you think needs to get done?

I believe it's a new era for Family Dollar. The team, led by Rick McNeely and the merchants, is focused on the right areas, ensuring we have the appropriate products, which is reflected in our customer retention and impressive comp figures of 11.7% overall and 28.9% in our discretionary business. These are positive indicators. Additionally, our organizational structure has improved, as we are now all in one building under a single leader, with strong individuals in place to effectively drive our strategy. It's crucial to have the right focus and the right team to implement and achieve our goals. I feel more confident than ever that we have the right talent on both the merchandising and operations teams to carry out our plans. Furthermore, as the two companies come together, we are adopting the purchasing discipline that Dollar Tree exemplifies, which helps in managing costs and delivering value in our products—this has become ingrained in our culture. We've also made some personnel adjustments, including bringing in experienced leaders from Dollar Tree to oversee our discretionary business. This combination of a unified location, a solid strategy that resonates with our customers, and the right people in place will drive our execution.

We'll take our next question from Paul Trussell with Deutsche Bank.

I wanted to revisit the discussion on EBIT margins. This quarter has come with some increased expenses, particularly on the Dollar Tree side related to labor and other store issues. If you are expecting a comp in the 3-plus percent range moving forward, Kevin, how should we consider the ability to manage overall expenses in the third quarter and the second half? I'm also curious about how to approach the ongoing strategy of the business and its ability to impact the bottom line.

Thank you, Paul. To your point, we have made investments in our associates regarding safety and premium pay, and we believe this has positively impacted attendance and turnover, which helps improve store operations and customer loyalty, despite a challenging 15% decline in traffic for Dollar Tree. Without the COVID-related expenses, operating income and EBIT would have increased. As we move into Q3, we recently announced that premium pay would continue for the first four weeks of August at a cost of approximately $18 million, which is a reduction from previous amounts. Our 10-Q filed this morning confirmed that premium pay will extend for an additional four weeks, and for modeling purposes, you should anticipate it to be in place for the full 13 weeks of Q3. We will also continue to incur expenses related to PPE and cleaning supplies, which will pose challenges. Therefore, I do not expect Dollar Tree to experience a year-over-year improvement in operating income or EBIT in Q3 due to these factors. As a company, we believe it is essential to reward our frontline workers during this time, though these costs will not be permanent. Looking ahead to next year, we anticipate some reduction in these costs, although not completely, as certain cleaning protocols will likely remain. These ongoing costs will be a headwind for us. On the positive side, SG&A has been well managed, and we are making progress in restoring our gross profit to our target range of 35% to 36%. Overall, I am optimistic about our long-term outlook, even though we are currently facing these one-time expenses. Additionally, we expect to incur costs related to the hurricane that we cannot quantify at this stage, but we anticipate it will impact our Q3 results, with more details available when we report in November.

And just wanted to also ask about your cash priorities and thought process. You do have an elevated amount of cash on the balance sheet today versus usual levels this time of the year, although some of that is related to what's drawn on the revolver. Just help us think about how you are thinking about leverage, store openings and remodels and share repurchases, which I think has been about a year since you've been engaged in that.

Yes. So obviously, to your point, we did preemptively draw on the revolver in Q1 with the uncertainty of the pandemic. We've paid back $250 million of that $750 million draw. So at some point in time, we'll pay that $500 million back as well. The other thing we have due February 1, 2021, the $300 million legacy Family Dollar notes come due. So the plan would be to extinguish those notes at that point in time. That being said, we'll still have a nice cash position even with that. Obviously, we always want to support growth, and we continue to grow through new stores, renovations, supply chain technologies I spoke to. So those things will continue. We do have a share repurchase plan authorization out there. We have $800 million authorized and outstanding as we sit here. Obviously, we kind of put the brakes on that with the pandemic, but as things settle. Again, there's obviously some uncertainty as we go to the back half. Will there be a rebound in the pandemic as we get into the fall and the flu season that comes with winter? So we'll keep our eye on those type of things and make some decisions as we enter the new year.

We'll take our next question from Kelly Bania with BMO Capital.

I wanted to just go back a little bit to H2 remodels. It sounds like from a top line perspective, they continue to perform well. Wondering if you can expand a little bit more on the margin performance you're seeing there relative to the other stores. And is there any opportunity to kind of reaccelerate the remodels there? Or is there any logistical headwinds in accelerating that? Maybe you can just touch on that a little bit.

Thank you, Kelly. I'll pass it to Kevin for the margin details. In terms of accelerating our efforts, we are striving to accomplish as much as possible given the current travel and COVID restrictions in the state. We plan to undertake 750 remodels. However, as soon as the states and locations reopen and it is safe for our teams and third parties to carry out the remodels, we will definitely ramp up those efforts.

In discussing the margins, it's clear that the second half of the model contains various components. There are additional freezers and coolers, which generally carry lower margins, while more impulse and media consumption items tend to have slightly higher margins. Additionally, there is a focus on seasonal items. Mike previously mentioned that Rick and his team are actively working to enhance the overall model, especially regarding the space allocated to discretionary items. The objective is to offer a better and more relevant assortment within that space. Overall, we anticipate a significant increase in sales and, consequently, a boost in profit dollars. We aim to achieve a higher overall rate of profitability from those stores, and while we are already seeing positive results, we believe there is still more potential to tap into.

We'll take our last question from Karen Short with Barclays.

I have a couple of questions regarding the COVID costs. You mentioned the $18 million in ongoing costs, which we should assume will continue for the entire quarter. Does this also apply to the $4.5 million in manager bonuses? Should we expect that to remain for the quarter as well? Additionally, could you provide the breakdown between Dollar Tree and Family Dollar for those two components? I have one more follow-up question.

From an overall standpoint, the Dollar Tree segment incurred $76.6 million in Q2, while Family Dollar incurred $57.1 million, with the majority of those costs being related to payroll. This includes aspects of store operations as well as distribution centers, which we detailed earlier. Regarding the $4.5 million in manager bonuses, those were one-time additional amounts and are not expected to continue. However, the situation remains fluid and subject to change, but currently, we do not anticipate that they will recur.

But take the $18 million and allocate it the same way between the $76 million and the $57.1 million that we saw throughout the quarter.

Yes, I think that's reasonable because we have a larger hourly workforce in the Dollar Tree banner compared to the Family Dollar banner.

I'm still unclear about the takeaway regarding Family Dollar comps in the current quarter. You mentioned that they're still solid, but can we assume that they will continue at the level we observed throughout 2Q, or is it too soon to make that judgment? I would appreciate any clarification on this matter.

I think, Karen, as you consider this, we mentioned in our prepared remarks that the performance trend for Family Dollar showed that the lowest month in the quarter was about 8.5%. The best way to interpret this is that there has been minimal decline from that trend since July.

This concludes today's question-and-answer session. I would now like to turn the call back over to Randy Guiler for closing remarks.

Thank you, and thank you for joining us on today's call and especially for your continued interest in Dollar Tree and Family Dollar. Our next quarterly earnings conference call to discuss Q3 performance is tentatively scheduled for Tuesday, November 24, 2020. Thank you, and have a good day.

This concludes today's call. Thank you for your participation. You may now disconnect.