Dollar Tree, Inc. Q3 FY2023 Earnings Call

Hello, and welcome to the Dollar Tree Third Quarter 2023 Earnings Call and Webcast. 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 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 in the Investor Relations 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 in the Investor Relations section of our website. Following our prepared remarks, Rick and Jeff will take your questions. 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's 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 accumulated impact of inflation and reduced government benefits, we saw a notable pullback in spending, particularly in higher-margin discretionary categories. I will now review some of our third quarter highlights. For the third quarter, on a consolidated basis, we delivered a 5.4% increase in our net sales to $7.3 billion. This was driven by comp growth of 3.9%, with traffic up 4.7% and average ticket down a little less than 1%. Operating income came in at $301.7 million, which resulted in EPS of $0.97, including the negative $0.05 impact from the OTC recall. In the Dollar Tree segment, our comp was up 5.4%, with traffic increasing by 7% and average ticket decreasing by 1.5%. We are especially pleased with these results as they come on top of an 8.6% comp last year. Our consumables comp was up 11.1%, and discretionary was up 1.1%. We believe the consumables strength at Dollar Tree this quarter, as well as our strong multi-year discretionary comp, shows customers are embracing our compelling value proposition in this strained economic environment. According to Nielsen, Dollar Tree gained an impressive 30 basis points of consumables market share in the third quarter as our unit volume grew 6%, while market unit volume declined. In the Family Dollar segment, our comp was up 2%, with traffic increasing 1.4% and average ticket increasing 0.7%. Our consumable comp was especially strong at 6.2%, while discretionary was down significantly at 12.5%, particularly in categories like home decor, electronics and toys. In our view, these trends underscore how lower-income households are under increasing financial stress and directing their spending towards needs-based goods. While traffic and ticket were both positive for the quarter, results did soften substantially as we moved through the quarter, with average ticket turning negative in October as our customers pulled back and we realized the adverse impact of the OTC recall. Even with these external challenges, Family Dollar grew market share in consumables, with both unit and dollar growth exceeding the market by wide margins. Although our low prices enable us to operate from a position of strength in consumables, our lower-income customers at Family Dollar have been especially pressured by reductions in government SNAP benefits. Nationwide, third quarter SNAP benefits were down 23% on a year-over-year basis, which was much more than the 5% reduction in quarter 1 or the 16% reduction in quarter 2. Timing-wise, the month-by-month deceleration in our quarter 3 comps matched the progressive reductions in national SNAP payments throughout the quarter. In addition to pressure from lower SNAP payments, Family Dollar's comps were negatively affected by lower tax refunds this year. That said, I believe that the wide range of growth initiatives we have in place will help us maintain our momentum relative to the competition. As a value retailer, we're uniquely positioned to meet customers' needs in a challenging economic environment. We remain focused on the factors that we can control, and we'll continue to navigate as best we can around those that we don't. Now let me take a few minutes to update you on our transformation journey. Our merchandising, IT and supply chain initiatives are on time and on budget, and we are pleased with our progress to date. At Dollar Tree, we're ahead of schedule on our multi-price journey. Our Dollar Tree Plus assortment is now available in 4,500 stores, and we are on track to finish the year with more than 4,900. Our Dollar Tree frozen and refrigerated assortments are now in 6,500 stores, significantly ahead of our original year-end target of 5,500. Customers are clearly responding to our expanded multi-price assortment as our research shows that 17% of U.S. households have purchased a multi-price product from a Dollar Tree store at least once in the past 12 months. Importantly, these customers are adding multi-price products on top of their traditional baskets. For example, in quarter 3, the average multi-price basket included 2.3 multi-priced items and 11.6 traditional $1.25 items. At Family Dollar, we completed our planogram resets by November as scheduled, improving and expanding our product assortment while increasing our shelf profile and merchandising to 78 inches across the portfolio. We're on track to renovate more than 1,000 Family Dollar stores by year-end. We have now upgraded 1,600 Family Dollar stores to our H2.5 rural and extra-small box formats. In quarter 3, private brand penetration at Family Dollar reached 14%, a quarter ahead of schedule, and we are on pace to hit our 20% target by 2026. We are also on track to add over 70 new SKUs to our Family Wellness product line and more than 100 new private brand SKUs in total by the end of December. Within that same timeframe, we also expect to complete our conversion of 300 control brands to private brands. In real estate, we opened 197 new stores in quarter 3, and we are on track to meet our target of 600 to 650 new stores this year. In supply chain, we are preparing to implement our streamlined delivery process for stores serviced by our Matthews, North Carolina distribution center with roto carts and liftgate trailers starting next month. We have been testing our roto carts, and the feedback has been extremely positive. We remain on schedule for all of our distribution centers to be using roto carts by the end of 2027. Across our teams, the investments we've made in our people, including increased wages in key markets, simplified work at the store level, and increased communications throughout the company, are driving meaningful improvements in store turnover and associate satisfaction. Additionally, as we prepared for our busiest season of the year, I'm proud to report that our annual National Hiring Day in mid-October was a huge success. We hired nearly 14,000 part-time associates to work in our stores for the current holiday season, an all-time record for this event. While we still have a lot of work to do in this transformational journey, I am pleased with what we've accomplished to date. We are focused on our plans to accelerate sales and grow earnings, and I remain confident in our ability to execute this ambitious undertaking. That said, this journey also needs to be dynamic and adapt to changing market conditions and our learnings along the way. We believe being thoughtful about our store portfolio will help enhance our results. To maximize value creation, we need to periodically reevaluate our portfolio in terms of current market conditions, individual store performance and overall portfolio considerations. To this end, we have initiated a comprehensive review of our Family Dollar portfolio to address underperforming stores that are not aligned with our transformative vision for the company. This will involve, among other things, identifying stores as candidates for closure, rebannering, or relocation with the goal of ensuring that each asset under the Family Dollar banner is delivering its full value for our shareholders on a sustainable basis. I am a strong believer in the Family Dollar brand and what it means to our customers and associates in thousands of communities across the country. Going forward, we need to ensure that the Family Dollar portfolio is well positioned for success and meets the financial and operating objectives of our organization and the expectations of our valued customers and associates. We believe that this action will fortify our base, strengthen our brand and allow Family Dollar to achieve its full growth potential. Jeff will now review our financial results and outlook for the remainder of the year.

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, Dollar Tree's net sales increased by 6.6% to $4 billion. Operating income declined 3.4% to $482.7 million. And operating margin compressed approximately 125 basis points, driven by a 55 basis point decrease in gross margin and a 70 basis point increase in SG&A rate. Gross margin contracted primarily from higher product costs, distribution center costs and shrink. These were partially offset by lower freight and sales leverage and occupancy cost. SG&A expenses expanded principally from store labor investments, minimum wage increases and facility costs. These were partially offset by sales leverage. Family Dollar's net sales increased by 3.9% to $3.3 billion. Operating income declined $47.9 million to a loss of $66.3 million. Operating margin compressed 140 basis points on a 20 basis point increase in gross margin and a 160 basis point increase in SG&A rate. Gross margin increased primarily from lower freight, partially offset by higher shrink, markdowns related to the OTC recall and sales mix. SG&A expenses increased primarily from labor investments, minimum wage increases, facility costs, costs related to the OTC recall and depreciation. Moving on to the balance sheet and free cash flow. As a reminder, my comments reflect balance sheet comparisons between Q3 2023 and Q3 2022. Inventory decreased by 2.5%. As we work through our shipments of seasonal imports, we expect a meaningful improvement in our inventory position by year-end. Third quarter capital expenditures were $541.4 million versus $391.2 million, reflecting elevated investments in new store openings, renovations, supply chain and IT. Free cash flow improved $142.1 million versus the third quarter last year. This improvement comes despite a challenging macro environment and the accelerated investments to support our multiyear growth strategy. For the 9 months of 2023, free cash flow improved $299.1 million versus the same period last year, led largely by lower merchandise inventories, with a partial offset from lower net income adjusted for noncash items, increased CapEx and the timing of accounts payable. In the third quarter, we repurchased approximately 2.2 million shares for $252.3 million, including applicable excise tax. At quarter end, we had $1.35 billion remaining under our share repurchase authorization. Cash and cash equivalents totaled $444.6 million compared to $439 million. You'll recall last quarter, we announced our new commercial paper program as an additional source of liquidity to manage our working capital needs. At quarter end, we had $230 million outstanding under this program. During the third quarter, we also implemented a new supply chain finance program. Participation in this program is voluntary for our suppliers and provides them with additional flexibility to finance payments due from Dollar Tree. This process will be managed by a third-party financial institution. At quarter end, our leverage, as defined under our revolving credit agreement, was 2.53x. Now let me provide some perspective into our sales and EPS expectations for the fourth quarter and its impact on our full-year outlook. Our outlook takes into consideration the following factors and expectations: Consistent with our prior expectations and the patterns we have seen throughout the year, we expect shrink trends will remain unfavorable in the fourth quarter. Family Dollar comps are expected to remain soft, reflecting the unfavorable macro environment for low-income households, continued discretionary weakness and elevated promotional activity in the market. On the plus side, we expect continued strength at the Dollar Tree banner as consumers embrace our compelling value proposition and multi-price strategy in addition to incremental freight savings. With that background, we expect net sales for the fourth quarter will be in the range of $8.6 billion to $8.8 billion, based on a low single-digit increase in comp store sales for the enterprise, supported by a mid-single-digit increase at Dollar Tree and a minus 1% to plus 1% comp at Family Dollar. As a reminder, last year's Family Dollar comp accelerated meaningfully throughout the year, most notably in the back half as we began our price and labor investments and launched our transformation initiatives. Our Family Dollar comp results for Q3 and outlook for Q4 reflect these tougher comparisons. We estimate fourth quarter diluted EPS will be in the range of $2.58 to $2.78. For the fiscal year, which includes a 53rd week, we expect sales in the range of $30.5 billion to $30.7 billion, driven by a mid-single-digit increase in comp store sales at the enterprise level, supported by a mid-single-digit comp at Dollar Tree and a low single-digit comp at Family Dollar. With respect to EPS, we believe that higher sales at Dollar Tree, incremental savings and freight, and proactive expense controls will allow us to offset lower revenue expectations at Family Dollar. We are tightening our full-year GAAP EPS outlook to a range of $5.81 to $6.01, including the $0.12 legal reserve we took in the first quarter. We still expect selling square footage to grow by 3% to 3.5% for the year and new store growth to be back-end weighted. Other considerations in our 2023 outlook include the following: No incremental share repurchases. Depreciation and amortization should be in the range of $840 million to $845 million. Net interest expense should be approximately $30 million for the fourth quarter, or approximately $110 million for the full year. We are assuming an effective tax rate of approximately 24% for the fourth quarter and approximately 23.5% for the full year. We expect 218.4 million diluted shares for the fourth quarter and 220 million diluted shares for the full year. We expect capital expenditures will total approximately $2 billion, with approximately 40% allocated towards maintenance CapEx and the balance toward growth initiatives. Finally, our Q4 and full-year outlook does not include any potential impact from the optimization review of the Family Dollar portfolio that Rick outlined in his remarks. We expect the review process will take several months, and we will update you on our progress no later than our Q4 call in March.

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.

Our first question is coming from Michael Lasser from UBS.

It's a two-part question. First, given the current economic conditions, which seem to differ from what you anticipated when you provided your long-term guidance earlier this year, how does this affect your outlook on achieving $10 of earnings by 2026 if these conditions persist over the next few years? Second, there seems to be a consensus that you will earn approximately $6 this year, with an additional $1 of freight benefit expected next year, totaling $7 of earnings. What might prevent you from achieving that?

I'm going to let Jeff handle that.

I appreciate your question. Regarding the longer-term outlook in the current economic environment, we believe we are managing effectively. Dollar Tree and Family Dollar continue to gain market share and are performing well in consumables. Many of the actions we are developing and will implement as we progress through the fourth quarter into next year should help enhance our top line, particularly for customers seeking more value. We are still early in the transformation and believe that the initiatives we are pursuing will support our long-term outlook. A lot will unfold between now and 2026, and while we do not have a precise prediction, we remain committed to our outlook. For 2024, considering a no-growth scenario, we expect around $7 of EPS, taking into account this year’s forecasts and the impact of the 53rd week, which contributes about $0.30. We believe this serves as a solid starting point for our 2024 outlook. We are very confident in our ability to achieve additional improvements in freight and EPS. There could be further upside based on our current trends, and we expect that the actions we have initiated this year will yield positive results as we move forward.

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 one year are really starting to gain traction. And let's not lose sight of the fact why the 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 is 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.

I believe the starting point for FY '24, taking into account a scenario with no growth or additional investment, would be around $6.80 to $7 of EPS. This is based on our expectations for the end of this year, along with the added dollar from freight and various factors such as the 53rd week impact and some one-time items related to West Memphis, OTC, and general liability. We are optimistic about the potential for business growth from that point. While we are not providing guidance for 2024 at this stage, it's clear that the key components for determining a starting point are being correctly identified, along with assumptions regarding the continuity and success of our initiatives moving forward.

Regarding Family Dollar and the timing for seeing incremental margins, I'm reflecting on our current position. We're introducing more SKUs, mostly in OTC and HBA, which have higher margins, though they're somewhat discretionary. Additionally, private label has reached 14%, bringing significant incremental margin. All these factors will be in place as we head into 2024, which gives me confidence in Family Dollar's performance next year. While there is certainly pressure on consumers, I've always believed that lower-income consumers can adapt. We're providing a better value in Family Dollar than ever before. I'm very satisfied with the store's appearance, presentation, and consumer response. At the start of the third quarter, our comparable store sales were strong, although we noticed them decline throughout the quarter. We entered the quarter from a solid starting point.

Our next question is coming from Paul Lejuez from Citi.

Can you discuss your expectations for Family Dollar's comparable sales in the fourth quarter, particularly how you view the breakdown between customer traffic and average ticket size? Additionally, within ticket size, how do you see average unit retail compared to base ticket? I'm also interested in your inflation assumptions for the fourth quarter and for the fiscal year 2024.

Paul, we believe that the balance of the comparable sales has consistently been around 50-50 between ticket and traffic. Recently, we've noticed a decline in ticket sales as customers have faced challenges. We expect this trend to continue into the fourth quarter, which is reflected in our guidance of a decrease of 1% to an increase of 1%. We are not ready to delve into average unit retail and other specifics. However, we anticipate that traffic will likely be the primary driver of comparable sales, although it may be offset by some pressure on ticket sales.

And Paul, I'd like to add that we are intently focused on three key metrics: transactions, unit growth, and sales per square foot. These are the aspects we want to report on because I believe they drive comparable sales and ultimately, growth in the chain.

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

I wanted to ask a two-part question regarding Dollar Tree and its core business. You continue to introduce new price points. Could you provide an update on the evolution of this strategy over time and the timing for rolling out these price points? Additionally, it seems that this concept is becoming a strong competitor among traditional dollar stores. Where do you believe you are gaining market share? Is there any effect on Family Dollar considering current developments? Furthermore, how is the evolution of this concept shaping your views on growth in terms of the number of units and their potential locations?

Great question. Let's begin with the price points. Rick McNeely and his team have done an excellent job of introducing new price points. You have to remember that we need to purchase these items almost a year in advance to get them into the stores, and we are beginning to see them arrive. We performed a test around Halloween in several stores with multi-price candy, and we are really excited about the results. It's important to note that I want to clarify there won't be 100 different price points in the store. Our core price point remains $1.25. We are working on determining the right number of price points. I can tell you that when we moved past the $1.25 barrier a year ago, consumers became more receptive to what we are offering. When we introduced an additional price point, it was a different item that provided more value, not just a larger or slightly different version of a $1.25 item. This means we face some challenges in execution. We've already done the groundwork to ensure items are properly marked and priced when they reach the store. Currently, 40% of our SKUs are sourced internationally and will feature the price point directly on the product. Significant progress has been made, and we are seeing that with multi-pricing, our brand is becoming more relevant to a broader audience. Although it can be challenging, the consumable side and the team's response to changes have positively attracted a different customer segment. As for future store growth, we are currently evaluating the appropriate mix between Family Dollar and Dollar Tree. It seems Dollar Tree has quickly become very profitable and has broadened its demographic appeal. I believe a well-run Dollar Tree is a powerful retail format and one that many people are likely to shop. By getting a handle on price points and store standards, we may be able to explore areas we have traditionally avoided. Regarding the impact on Family Dollar, I would say these are two distinct customer segments. When our team came together, we recognized that the marketing strategies for both brands are entirely different. One is about the excitement of finding a good deal quickly, while Family Dollar focuses on traditional retailing, where customers expect certain items to be available every time they visit.

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.

Could you discuss your philosophical approach to resource allocation? On one hand, you want to focus more resources on stores with the highest potential, but on the other hand, you need to be cautious not to scale back too much. Is there an opportunity to convert all of those stores to Dollar Tree? Additionally, could you let us know when you anticipate reaching eight cooler doors at the $3 to $5 price point at Dollar Tree? Is that expected to be in one, two, or three years?

Let's focus on the straightforward matter. We should have the Dollar Tree cooler doors implemented within the next couple of years. We began with a review of all our initiatives, aiming to assess which stores perform well and which do not. I want to emphasize that I don't want anyone to jump ahead of me in this process, as I believe it's important and timely. There might be a few stores that could relocate, some may close, and others might rebrand, but I currently don’t have specific details on that. I take pride in being open about our plans, and I just want to communicate that we are evaluating the situation. I believe this approach is wise. I also want to clarify that my commitment to Family Dollar remains strong. This evaluation does not signify any intention to halt growth for Family Dollar; rather, it's about optimizing our assets to maximize productivity.

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, let's begin with the promotional landscape. At this point, I haven't observed anything unreasonable. Discretionary items are being promoted, which seems to be a response to concerns about inventory levels. Historically, Thanksgiving has been a strong period for grocery sales; when turkey prices are favorable, it typically leads to increased sales of surrounding grocery items. This year, we witnessed many well-priced grocery items from both big box and grocery channels, which is somewhat unexpected. Additionally, there has been significant activity in the sale of 12 packs of carbonated soft drinks, but overall, there hasn't been much else noticeable. And regarding the first question?

There was a question regarding the Family Dollar comps. The Family Dollar comps during the course of the quarter 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.

I want to emphasize that although we observed some softness in October, it's fortunate we had our initiatives in place. Despite the challenges, the situation could have been much worse, and I’m very pleased with how we managed 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 believe Dollar Tree has consistently appealed to a wide audience. Currently, we are observing a shift in customer spending at Dollar Tree. The customer demographic remains largely unchanged, with no significant decline among lower-income groups; however, we are definitely seeing growth driven by higher-income individuals earning $125,000 a year.

I reflect back on this, for Dollar Tree, we had a very strong performance in consumables, along with better than a 1% comparable sales increase in discretionary items, which is still showing significant growth year-over-year in that category. The lower-income customers appear to be spending more of their budget on consumables, which is beneficial as we're capturing units and market share in that area. Higher-income customers are supporting us in both discretionary and consumable categories as well. Thus, it's a combination of both customer segments contributing to strong performance across the Dollar Tree brand during Thanksgiving.

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?

In terms of our pricing strategy, I can confidently say that our pricing at Family Dollar has never been better. We evaluate our pricing on a comprehensive basis, focusing on key value items, which are those most sensitive to price changes. We conduct monthly checks across various channels, including big box, small box, drug, and grocery stores, and we feel very secure about our position, maintaining a price parity at 100%. We've been monitoring this for a year, and I believe consumers are beginning to recognize our efforts. In the third quarter, we saw significant growth in consumables for the Family Dollar brand, as this is where consumers are feeling financial pressure. Regarding deflation, I think it will enable consumers to purchase more discretionary items, and we will adapt as needed. This should also positively impact our margins.

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, Family Dollar and Dollar Tree, and into 2024? What are the biggest puts and takes to think about?

Yes, Chuck, I would prefer not to comment at this time since the process is ongoing and we have already initiated it. I will provide more information during the March call. However, I can say that it presents an opportunity for us that we plan to tackle directly.

Chuck, regarding your question about Q4 and gross margins, I'll start with Dollar Tree. We expect our margins to continue to improve in the fourth quarter, mainly due to increased freight and a stronger mix of discretionary items, which is typical for this season. Additionally, we've mentioned that we have about 90% of our inventories accounted for, with only 10% remaining. While we don’t anticipate any different outcomes from that remaining inventory compared to the past, its impact on the quarter is minimal since it represents a small fraction of our overall performance. Therefore, we expect further gross margin expansion for Dollar Tree in the fourth quarter. We also see similar opportunities for Family Dollar for many of the same reasons, including freight considerations, reduced impact from shrinkage this quarter, and distribution opportunities. So we anticipate gross margin expansion for Family Dollar in the fourth quarter as well.

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 stages, but I do feel we're making progress. We take a physical inventory once a year, so any improvements or adjustments we make will take time to show results. I can tell you that we've eliminated certain SKUs in some stores, placed items behind the checkout counter, and moved certain products to the front for better visibility to the cashier. Importantly, our sales have not been affected. Additionally, we've implemented an anti-sweep OTC panel with sliding doors that allows only one item to be taken at a time, helping to prevent theft. We believe we're going to make progress, but it's not going to be an overnight change, as we will need to go through the entire process. However, I do believe we are moving in the right direction without having to lock up the products.

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 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.