Earnings Call Transcript - DLTR Q1 2024

Operator, Operator

Hello, and welcome to the Dollar Tree Q1 2024 Earnings Call. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Bob LaFleur, Senior Vice President, Investor Relations. Please go ahead, sir.

Robert LaFleur, Senior Vice President, Investor Relations

Good morning, and thank you for joining us today to discuss Dollar Tree's First Quarter fiscal 2024 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 Discussion and Analysis of Financial Condition and Results of Operations sections in our annual report on Form 10-K filed on March 20, 2024, 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 for the first quarter of fiscal 2024 are against the same period a year ago. Please note that a supplemental slide deck outlining selected operating metrics is available on the IR section of our website. Following our prepared remarks, Rick and Jeff will take your questions. Given the number of callers who would like to participate in today's session, we ask that you limit yourself to one question. I'd now like to turn the call over to Rick.

Richard Dreiling, CEO

Thanks, Bob. Good morning, and thank you for joining us today. I want to start by expressing my sincere appreciation to our Dollar Tree community after the catastrophic tornado in Marietta, Oklahoma. While our Dollar Tree distribution center there was damaged, I am grateful that no one was hurt. I am also very proud of the strength shown by our team members during this challenging time. Our distribution network is adaptable, and while we anticipate some additional operating expenses, we expect to keep disruptions in our stores minimal. The leadership at Dollar Tree is aware of the broader implications of this disaster for our associates, their families, and the Marietta community. To support our associates, we established a temporary site at a local hotel and provided essential supplies such as food, batteries, chargers, diapers, and toiletries. Our associates have access to over $200,000 in immediate response grants and mental health services. Thank you to everyone affected by the situation in Marietta for your hard work and resilience during this tough time. In challenging moments, the strength of our organization becomes clear. Whether it’s facing natural disasters or making crucial strategic decisions, we always prioritize our associates and the communities they serve. As announced earlier today, we are beginning a formal review of strategic alternatives for the Family Dollar business. We decided to explore these alternatives to assess how each brand may attract various owners and whether the growth of Dollar Tree and the transformation of Family Dollar would be better served through separate leadership teams. Separating the two could enhance the performance of both businesses and unlock their full potential. We have been on a journey to transform our organization and realize its inherent value. A significant step in this process was deciding to close 970 underperforming Family Dollar stores, which had suffered from years of underinvestment. The needed capital to remedy them would not yield an acceptable return. Streamlining our portfolio should help accelerate Family Dollar’s transformation and boost long-term returns. While we focus on transforming Family Dollar, we are also growing the Dollar Tree brand by expanding our multi-price offerings, increasing the pace of new store openings, and pursuing beneficial transactions, such as acquiring up to 170 stores from the $0.99 only bankruptcy. These acquisitions align well with the Dollar Tree brand and are expected to generate sales, profits, and returns higher than our portfolio average. We are excited to integrate these locations into the Dollar Tree brand and anticipate their openings later this year. Currently, each brand is at a different phase of its journey, with distinct requirements. We believe now is the appropriate time to thoroughly review strategic alternatives for Family Dollar to establish the right operational and ownership structure that supports its transformation while unlocking the value of the Dollar Tree brand. Ultimately, our goal is to make sure that both Dollar Tree and Family Dollar possess the appropriate strategic, operational, and financial structures to meet their customers' changing needs and maximize value. As I mentioned earlier, our associates and the communities they serve always remain a priority. For 65 years, Family Dollar has significantly contributed to communities across America, helping families stretch their resources. This success relies on the commitment of our dedicated Family Dollar associates. A key focus of this strategic review is ensuring Family Dollar is well-positioned for long-term success. That said, we are still in the early stages of this review and have not reached any conclusions about its eventual outcome, given the variety of possible results. As you can imagine, we have a lot of work ahead, and we don't plan to provide further updates until the Board has approved a specific course of action or determined if additional disclosures are necessary. I appreciate your understanding in this matter. Now, let’s discuss our first quarter results. First quarter adjusted diluted EPS of $1.43 was at the upper end of our expectations. These results reflect favorable freight costs and careful expense management during the quarter. I have often stated that the three essential elements in retail are growth in transactions, sales per square foot, and units, and I am pleased to report that all three metrics continue to trend positively. Here are some key financial highlights from the quarter. On a consolidated basis, net sales rose by 4.2% to $7.6 billion. Our enterprise comp was 1%, with a 2.1% increase in traffic partially offset by a 1.1% decline in average ticket. In both segments, comp growth was driven by increased traffic despite lower average tickets. The decline in average ticket reflected weaker discretionary demand, particularly in the Dollar Tree segment. Regarding performance by brand, Dollar Tree comps increased by 1.7% due to a 2.8% increase in customer traffic, which was partially countered by a 1.1% decrease in average ticket. Dollar Tree’s consumable comp was 7.4%, while discretionary comp was down by 3.2%. Although a 7.4% comp in consumables is commendable, it’s important to note that this follows a 6.9% consumables comp last year. Conversely, this marks the first discretionary comp decline at Dollar Tree since the first quarter of 2020 at the onset of the pandemic. Dollar Tree's first quarter comp did not meet expectations because this Easter season was particularly difficult for us. Easter serves as a major catalyst for discretionary demand; in fact, it accounts for about 1% of our annual sales, compared to only about 0.1% for the largest retailers. In other words, Easter is ten times more critical to Dollar Tree than to other retailers. This year, the combination of an early Easter and an extra week in the previous quarter created a shorter selling season. Additionally, unusually cold and wet weather affected how many families celebrated this traditionally spring-focused holiday. Recent consumer research indicated that gatherings for Easter were down 20% this year, with six million fewer households purchasing Easter products in 2024. This decline dampened consumer interest across our seasonal discretionary items, which heavily cater to these celebrations. Similar weakness was evident in non-Easter discretionary categories like garden supplies and outdoor toys. While we considered the calendar shift in our first quarter comp guidance, the unexpected weather was not accounted for. Overall, the weak Easter significantly influenced the monthly cadence of our first quarter comp, and it's important to highlight that this softness was specific to Dollar Tree and concentrated in the days leading up to Easter. Comps before and after were broadly in line with our quarterly expectations, and we believe Easter represented a 150 basis point drag on Dollar Tree's first quarter comp. Nonetheless, Dollar Tree gained significant consumable market share during the quarter, with our dollar growth outperforming the market by 660 basis points and unit growth exceeding the market by 520 basis points. In the last quarter, I announced the next phase of our multi-price strategy called "more choices." This program involves expanding our multi-price assortment by over 300 items at prices above $1.25 in approximately 3,000 Dollar Tree stores by year-end. Importantly, these multi-price items will be integrated throughout the store rather than confined to a single section. Before diving deeper into this program, let me clarify what multi-price represents. It does not mean increasing prices on existing items; it's about introducing new items at new price points that complement our core offerings. Multi-price provides customers with high-quality products at price points that provide great value in relevant categories. It is meant to enhance our core $1.25 strategy rather than replace it. We anticipate that at least 80% of the items in any Dollar Tree store will still be at that entry-level price point. Returning to the rollout, we converted around 10% of Dollar Tree stores to the new in-line multi-price configuration by the end of the quarter. So far, we are satisfied with the performance of these stores, which are exceeding our $1.25 only and Dollar Tree Plus locations. As we roll out our new concept to an additional 2,000 stores this year, we are taking proactive measures to minimize operational disruptions by utilizing dedicated third-party specialists for the conversions. I am enthusiastic about our multi-price journey. Post-conversion comps are meeting or surpassing expectations at most of the transitioned stores. However, we are still adapting to the multi-price structure as we move on from our fixed-price model. This represents a new approach for us, and it will take time to fully develop our core strengths. But our progress is promising, and the initial customer response to our new offerings has been positive. Now moving on to Family Dollar. The top-line performance in the first quarter met our expectations, with comps increasing by 0.1% as we compare to a 6.6% comp in the first quarter of last year. Customer traffic grew by 0.9%, though this was partially offset by a 0.8% drop in average ticket. Both traffic and ticket trends have improved sequentially as our merchandising initiatives and growth strategies make progress. Family Dollar’s consumable comp rose by 1.4%, while discretionary comp decreased by 4.7%. Although Family Dollar's discretionary comp remains negative, it’s noteworthy that the underlying trends have shown gradual improvement. The shift towards consumables at Family Dollar has indeed slowed, with a two-year stack discretionary comp improving by 1,000 basis points since the first quarter of last year. While our lower-income customers continue to grapple with inflation, high interest rates, and reduced government assistance, it seems that the worst of the SNAP challenges may be behind us. Lower SNAP benefits impacted Family Dollar’s first quarter comp by a meaningful 280 basis points, but this reflects a 200 basis point sequential improvement compared to the previous quarter. Similar to Dollar Tree, Family Dollar is also gaining market share in consumables, with our dollar growth outpacing the market by 180 basis points and unit growth exceeding the market by 80 basis points. Lastly, regarding Family Dollar, we closed 506 underperforming stores in the first quarter. The remaining 90 stores from the initial closure list were shut down in May. The stores that closed in the first quarter are not included in our comp results, although any revenues and expenses from the time they were operational are reflected in our first quarter financials. Before handing things over to Jeff, I want to reiterate that our operational performance across both segments remains strong. At Dollar Tree, we are successfully attracting new customers and capturing market share as our new multi-price offerings resonate with a wider consumer base. In Family Dollar, we are optimistic that the intentional actions we've taken to streamline the portfolio will yield positive outcomes for operations and returns. As a more focused organization, I am confident that Family Dollar's best days lie ahead, driven by the diverse growth initiatives we have underway. With that, I will turn the call over to Jeff.

Jeffrey Davis, CFO

Thank you, Rick, and good morning. I will start by discussing our first quarter results, after which I'll provide comments on our Q2 and fiscal 2024 outlook. Where applicable, I will focus on our adjusted results. A reconciliation of non-GAAP adjusted results is provided in our earnings release. Let's begin by looking at the business on a consolidated basis. Net sales increased by 4.2% to $7.6 billion. Adjusted operating income was $436 million, a 3% decrease from last year. Adjusted operating margin decreased by 45 basis points reflecting a 30 basis point increase in gross margin, offset by a 75 basis point increase in adjusted SG&A rate. Gross margin improvement came from lower freight costs, partially offset by unfavorable sales mix and elevated shrink. Adjusted SG&A increased primarily from temporary labor for Dollar Tree's multi-price rollout, higher depreciation and amortization and sales deleverage. Adjusted Q1 SG&A this year excludes $17.5 million of severance and other store closure costs and a $2.5 million reversal of a legal accrual. Q1 last year excluded a $30 million legal accrual. Our adjusted effective tax rate was 24.2% compared to 23.3%. Adjusted net income was $312 million, and adjusted diluted EPS was $1.43. Moving to our business segment results. Dollar Tree's net sales increased 5.9% to $4.2 billion. Operating income decreased 3% to $522 million. Operating margin decreased 110 basis points, driven by a 10 basis point increase in gross margin offset by a 120 basis point increase in SG&A rate. Gross margin improved primarily from lower freight costs. This was partially offset by unfavorable sales mix and elevated shrink. SG&A expenses increased primarily due to temporary labor for the multi-price conversions, higher depreciation and amortization and sales deleverage. Family Dollar's net sales increased by 2% to $3.5 billion. Adjusted operating income was $51 million, a 32% increase from last year, and adjusted operating margin increased 30 basis points. The increase was all attributable to gross margin as the adjusted SG&A rate was flat at 23.7%. Gross margin increased primarily from lower freight, partially offset by product cost increases and an unfavorable sales mix. Moving on to the balance sheet and free cash flow. Inventory decreased by 2% or $103 million. On a related note, in the quarter, we recorded a $70 million loss related to the book value of inventory destroyed at our Marietta distribution center and a $47 million loss related to property and equipment destruction. Given our expansive scale and breadth of operations, our insurance policies include significant property and inventory coverage above cost. Based on the catastrophic nature of this event, we expect these losses to be fully offset by insurance recoveries. As our recorded losses were fully offset by the insurance receivable, there was no net impact to the first quarter P&L. With cash and cash equivalents of $618 million and long-term debt of $3.4 billion, our balance sheet remains strong. Our bank-defined leverage at quarter end stood at approximately 2.3x, which continues to underpin our investment-grade credit worthiness. Regarding cash flow, we generated $696 million from operating activities compared to $752 million last year. Capital expenditures were $472 million in the quarter versus $350 million last year reflecting accelerated new store openings and ongoing investments in growth and other initiatives. Notwithstanding the higher CapEx spending, we generated $224 million in free cash flow in the quarter compared to $402 million last year. Consistent with our disciplined approach to capital allocation, after investing in the growth of our business, we returned $310 million to our shareholders by repurchasing 2.5 million shares at an average price of $122 per share. At quarter end, we had approximately $1 billion remaining under our existing share repurchase authorization. Now let me provide some perspective on our second quarter and full year expectations. Our current outlook reflects the following: we expect to incur additional operating expenses related to the loss of our Marietta DC. The EPS impact of incremental transportation and other costs is estimated to be approximately $0.10 in Q2 and approximately $0.20 to $0.30 on a full year basis. As more information on the costs associated with this disruption becomes available, we may revisit this outlook in subsequent quarters. The expected impact of freight, shrink, mix, and SNAP on our full year adjusted EPS outlook remains consistent with the expectations we outlined last quarter. Additionally, given the relatively low level of our freight volume that is subject to spot rates, we believe our exposure to recently observed volatility in the global shipping markets is limited and may be partially offset by favorable domestic carrier cost. With that as a background, for the second quarter, we expect net sales will be in the range of $7.3 billion to $7.6 billion based on a comparable net sales growth in the low single digits for the enterprise, 2% to 4% for Dollar Tree segment and approximately flat for the Family Dollar segment. Adjusting for the stores that were closed as part of the portfolio optimization, we expect second quarter net sales for the Family Dollar segment to decline by 1% to 3% on a year-over-year basis. We expect adjusted EPS will be in the range of $1 to $1.10, which reflects the incremental operating expense associated with the loss of the Marietta DC. For the full year, we still expect net sales to be in the range of $31 billion to $32 billion. Although at this point in time, we think we are more likely to be in the lower half of that range. We still expect comparable net sales growth in the low to mid-single digits for the enterprise, the mid-single digits for Dollar Tree segment and the low single digits for the Family Dollar segment. Adjusting for stores closed as part of the portfolio optimization, we expect full year net sales for Family Dollar to decline by 1% to 3% on a year-over-year basis. Adjusted EPS for the full year is now expected to be in the range of $6.50 to $7, again reflecting the incremental operating expenses associated with the loss of Marietta. Our outlook for Q2 in the fiscal year does not include any severance or additional incremental costs related to the portfolio review or related workforce reductions. It also excludes any future share repurchases. In the interest of time, I will direct you to our supplemental financial presentation, which is available on our IR website, for the remaining details that support our current guidance.

Richard Dreiling, CEO

Thanks, Jeff. We are pleased that we delivered first quarter adjusted EPS results towards the high end of our outlook range. At Dollar Tree, we overcame some Easter softness and remain focused on rapidly rolling out our next generation of multi-price stores. At Family Dollar, we are taking the difficult but necessary steps to position the business for long-term prosperity. Change is never easy, and I couldn't be prouder of our 200,000 associates across Dollar Tree and Family Dollar for their ongoing commitment to their communities and the customers that they serve. I am truly honored to lead and be part of one of the best teams in retail. Operator, with that, Jeff and I are ready to take your questions.

Operator, Operator

Our first question today is coming from the line of Edward Kelly from Wells Fargo.

Edward Kelly, Analyst

So I wanted to start with Dollar Tree. You've maintained the mid-single-digit comp guidance for the year. Q1 was obviously a little bit softer. Can you just help us what underpins the confidence around that? And then, Rick, as it relates to this concept, obviously, there's a lot going on with multiple price points, you're accelerating growth. Can you give us a little bit more perspective on how you see the future of this business? What do you think the earnings growth profile is here over a multiyear basis and the real opportunity?

Richard Dreiling, CEO

I will address the first part, and you can add the second. My confidence in Dollar Tree as we progress this year stems from the influence of multi-price points. We continue to see customers shifting toward that brand. I am encouraged by the traffic, and the multi-price stores are performing better than those without multi-price options as well as those that have limited multi-price offerings. We are satisfied with our progress in consumables and see potential for growth with the introduction of new items. Therefore, I am very optimistic about Dollar Tree. For context, the basket size for transactions that include a multi-price item is twice that of our regular baskets, and multi-price is also encouraging more visits to the stores. As I have mentioned before, transactions are a key driver for our future success.

Jeffrey Davis, CFO

Just to maybe add a couple more points on the multi-price before going into longer-term profitability. On the multi-price, we mentioned that we had roughly 10% of the stores that have been converted to the in-line conversion. That happened over the course of the first quarter those stores are still ramping up. We will still continue to roll that out for another 2,000 stores in the rest of the year; that ramp-up will give us some additional sort of tailwind, if you will. On top of that, our comps, I don't know if you've noticed, and you probably have by looking at some of the things that we've published before, but our comps actually get to be a little softer in comparison in the back half of the year versus the first half of the year with the second quarter being our most stringent sort of compare. The second part of your question, I believe, was regarding how we're thinking about the long-term profitability of the enterprise and the brand. And we continue to be very encouraged by what we're seeing across both banners. The multi-price offering is allowing us to drive sales and volumes to drive greater profitability. We continue to deliver from a standpoint of higher freight cost. We believe that there's opportunity across the Family Dollar brand to continue to drive greater gross margins as we continue to drive continued improvement in private label as well as the OTC and HBA. The combination of these things will allow us to drive greater gross profit dollars in the organization as we continue to drive greater discipline in our expenses along the way. So the outlook that we have for the year, we feel very confident in. There's the opportunity to manage through some of this. So at this point, we really don't have any additional outlook considerations to provide other than the fact that we continue to remain on the numbers that we've given you so far.

Operator, Operator

Our next question is coming from Michael Lasser from UBS.

Michael Lasser, Analyst

My question is a two-parter on the strategic process. If you are not able to sell Family Dollar, what is the plan B? And as a way to help us frame what the ongoing earnings power of the business could look like, can you give us a sense of how much the corporate overhead is allocated to Family Dollar and what the dis-synergies might be if you were to divest the Family Dollar business?

Richard Dreiling, CEO

Michael, thank you for the question. It's too soon in the process for me to say what's going to happen or exactly what all the alternatives are. So I'd like to stay away from that and come back to my original comment that I promised to keep you all updated. In terms of how the corporate overhead is basically, I think in terms of 50-50. I would also look at you and say that the business, the supply chain, merchandising and retail are all pretty much separate. There are some legal, HR, the basic functions are a little intertwined, but the most important pieces are not. Jeff, I don't know if you have anything you want to add to that?

Jeffrey Davis, CFO

I think that covers it.

Operator, Operator

Your next question today is coming from Matthew Boss from JPMorgan.

Matthew Boss, Analyst

So a couple of questions, one near-term, one multiyear. So at the Dollar Tree banner, near-term, just thinking about the 2% to 4% comp guidance for the second quarter, what trends have you seen post Easter? Maybe if you can comment on quarter-to-date just to provide some confidence around the 2% to 4% relative to the first quarter. And then multiyear, Rick, could you just elaborate on the acceleration strategy at Dollar Tree? Maybe speak to the acquisition? Is there any ceiling to consider in terms of annual unit growth and just how you're thinking about long-term saturation for that concept?

Richard Dreiling, CEO

Yes. A couple of great questions there. Do you want me to take the first question?

Unknown Executive, Unknown

Yes, I'll let the first one, I'll take the second one.

Jeffrey Davis, CFO

So Matt, the guidance we provided of 2% to 4% comparable sales for the Dollar Tree banner coming out of Q1 remains intact; this is why we issued it. Following the Easter period, as we noted in our prepared remarks, without the impact of an 8 to 10-day disruption, we essentially achieved a comparable sales rate that was indicative of low to mid-single-digit growth throughout the quarter. Therefore, I believe we are still aligned with that as we head into Q2.

Richard Dreiling, CEO

And in regards to the long-term future of the company, you look at $0.99; the acquisition there totally reflects Matt our commitment to the Dollar Tree franchise and the fact that we think that there are opportunities there to grow the business even more. The acquisition in California, to be very frank, is going to generate returns above our average in the overall chain. And we are very excited about these stores in terms of the real estate that we were able to acquire in the term we have on them. And as we've said on many occasions, a well-run Dollar Tree is an exceptionally powerful retail format. And we are committed, and I actually think I'm going to say this, multi-price is attracting a higher-income consumer into that box. And I think we have a lot of really good things moving together right now.

Operator, Operator

Next question is coming from John Heinbockel from Guggenheim Securities.

Unknown Analyst, Unknown

This is actually Anders Meyer on for John. So I just wanted to touch on the cooler resets. So overall, how have they been progressing? What has been the overall impact to comps? And upon completion, how do you size the sales opportunity with this product?

Richard Dreiling, CEO

Yes. I mean, the cooler work we're doing is basically on both franchises. I'm incredibly pleased with what's going on in the Family Dollar banner. We're pooling the number of cooler doors up to approximately 30, and it is driving incremental sales into the store overall. The consumer is moving more to refrigerated and frozen products. Now on the Dollar Tree side, we now have 5,700 stores that have multi-price frozen food in them. We've expanded the assortment in 1,900 stores and to be very frank, one of the big surprises for us is frozen and refrigerated in the Dollar Tree banner. The multi-price unlocks that category, and you have to think about it. You go into a Dollar Tree, you can buy a pizza for $4 or $5 that feeds a family of four. And that is a very powerful statement. So very pleased continuing to push it. It's where the consumer is going, and both banners are chasing it.

Operator, Operator

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

Simeon Gutman, Analyst

I want to ask about Family Dollar, but be respectful if you can't answer, I'll put a second question about Dollar Tree in as well. I wanted to ask if the EBIT that we see in the P&L, I think it's going to get a little bit better. You're going to run-rate a little bit better from what the leftover stores look like. Can you tell us if there's a big distribution call it, among the 7,000 remaining Family Dollar stores, a wide range of profit outcomes or if they're relatively concentrated? And then are you able to share what the average life of the leases are in that portfolio? And then have you talked about or can you share what the lease break costs could look like?

Jeffrey Davis, CFO

Let's see if I can take a few pieces of that.

Richard Dreiling, CEO

And then I'll take a couple.

Jeffrey Davis, CFO

Some of this information is not something we can disclose, but I can tell you that the remaining stores have a higher level of profitability distribution compared to before we closed the non-performing stores. We already mentioned that for the year, you should anticipate about $0.15 of additional profitability from those closed stores and $0.30 of earnings per share on an annualized basis. Typically, the leases we enter into last between 5 to 10 years on average. At any given time, around 10% to 12% of those leases are renewed annually. That’s about all I can share regarding lease obligations at this point.

Richard Dreiling, CEO

And the one thing I would say as you reflect on this announcement is the fact that we have not lost faith in Family Dollar and the progress it's making. The team has done a great job of implementing many initiatives that are designed to drive the long-term growth. What we're wrestling with and trying to figure out is we have two different brands at two different stages of where they're at in their development. And while we want to accelerate Dollar Tree, we want to position Family Dollar's transformation where it has the chance to grow. And by looking at them differently, that might provide more acceleration for both brands long-term.

Operator, Operator

Next question today is coming from Rupesh Parikh from Oppenheimer.

Rupesh Parikh, Analyst

Regarding your comments on multi-price point expansion, we've visited some of your newer locations featuring the new product. Have there been any unexpected changes in consumer behavior that you've observed in store? What type of feedback are you receiving from consumers regarding that expansion? Additionally, I would like to understand how the mix of consumables versus discretionary items is performing compared to your initial expectations in those locations.

Richard Dreiling, CEO

Yes. A couple of great questions. Our biggest challenge with multi-price right now is keeping it in stock. Consumers are responding positively and enjoying it. I truly believe it will be a significant component of our future. As we progress through the calendar year, you'll notice that we need to purchase multi-price products and seasonal items more than a year in advance for the holiday season, leading to increased multi-price availability on the discretionary side. For the first time, I am optimistic that we will have an affordable Christmas tree in our stores, likely accompanied by Christmas lights to complement our decorations. Regarding consumables, the variety in multi-price points is boosting our market share. Our commitment is to avoid raising prices or introducing similar items; instead, we're adding different SKUs to broaden the appeal of our assortment to consumers.

Jeffrey Davis, CFO

I had just one other point. With multi-price, as we're looking at those stores that have had this in-line conversion, the mix of discretionary and consumables is more in line with what we would have seen historically with a heavier balance on discretionary than consumables. So we like that balance in that the multi-price is not only driving consumables, but it's also lifting the discretionary basket also.

Operator, Operator

Your next question today is coming from Paul Lejuez from Citigroup.

Paul Lejuez, Analyst

Just a follow-up on that last comment. What changes do you observe in terms of traffic compared to ticket sales in the multi-price converted stores? That’s my first follow-up. Additionally, I’m interested in your insights on the promotional landscape. How does what you see in the first quarter align with your expectations, and what assumptions do you have for the remainder of the year based on what you’ve experienced so far in the promotional landscape?

Richard Dreiling, CEO

We are seeing a traffic increase in the multi-price stores of about 3%, and the average ticket is up by approximately 55 basis points. It's early in this process, but I would estimate that around 50% of the stores are exceeding our expectations, about 25% are meeting them, and the remaining 25% have opportunities for improvement.

Jeffrey Davis, CFO

And look, we're definitely seeing the customer right now buying a little bit more on promotion. And it's not that there is more promotional activity, but what the customer is actually buying is items on promotion.

Richard Dreiling, CEO

And I think what's important on the promotion thing is that Jeff is in my office every Monday asking me what's going on in the promotional landscape, and we have seen nothing irrational at this time. And I think that's really important. And what we are seeing is maybe incremental movements on CSD, soda pop, and 2-liter pop. And that is a very easy traffic driver. But I always remind everybody I talk to, we have to not confuse marking down stale inventory with promotional activity. And I think that's really, really important. So stable environment, I would say it's not irrational and maybe CSD.

Operator, Operator

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

Charles Grom, Analyst

So Rick, on the new multi-price rollout, can you talk about the transition once the third-party specialists have actually done the reset? In other words, what's the risk and you talked about the new discipline that store managers and employees are going to need to acquire post those specialists doing the initial reset? And then for Jeff, how much of the SG&A deleverage in the first quarter was from the resets? And I think you guys have outlined $23 million of expenses this year. Can you just talk about the phasing of that?

Richard Dreiling, CEO

Yes, Chuck, you brought up some excellent questions. I'll address the first one. This company has traditionally operated under a model where all products are at the same price point, regardless of location or customer choice regarding the product. Now, we are working on introducing multi-price SKUs into their respective categories instead of just placing them in a central location. It's important to establish a dedicated section that displays various prices so consumers are aware of the costs. When a customer decides against keeping a product, it needs to be returned to the correct spot on the shelf. This involves training our associates on how to handle and restock these items effectively, as well as instructing them on proper store maintenance. Although this is a comparable approach, it is new for us. We are implementing various strategies to manage it, such as placing shelf labels on the cases to assist associates in restocking. Additionally, we need to train warehouse staff to ensure they are selecting the correct items, as they are accustomed to dealing with singular priced items. With multi-price point products, accuracy in selection is crucial for maintaining accurate store inventory.

Jeffrey Davis, CFO

And then, Chuck, with respect to the SG&A, margin deleverage, if you will. This is really three components. You called out the temporary labor was absolutely the largest component. The second component was higher depreciation, and the third component was just sort of deleverage as a result of the lower comp. The one thing to recognize with the temp labor in the first stores that we opened up. There's a learning curve as to how to go about it, the number of crews that were actually allocated, and how to work with the store leadership teams. We continue to make progress on that in the subsequent stores that we're rolling out. So sort of the initial headwind that we had in the first quarter here, we would expect that to moderate over time. But as we had mentioned earlier, we definitely thought that the impact of using this third-party labor to do the in-line conversions was going to cost us approximately $0.23 of EPS for the year.

Operator, Operator

Our next question today is coming from Seth Sigman from Barclays.

Seth Sigman, Analyst

I want to talk about shrink. It hasn't come up a ton. It was a headwind this quarter, but I think that was expected. Just curious how that played out with some of the mitigation efforts, any signs of stabilization given that you didn't change the guidance for that? And then I guess a question on gross margin overall the improvement was a little bit more limited this quarter. I'm just curious, was that mix or something else? If you could just help us with that?

Richard Dreiling, CEO

Yes, I'll take the shrink question, if that's okay. I think the efforts we've put in place for the first time, I can honestly say the shrink trends that we have, while they still are not good, they're not getting away from us anymore. We're definitely tracking in the right direction. But I want to reinforce, shrink is still a problem, but it's not deteriorating like it was last year. We feel very good with the initiatives we've put in place. I also think it's fair to say that we were ahead on the shrink curve that we were calling it out and we were taking steps that people now are taking around us. Our self-checkout exposure is basically nothing, so we don't have to revisit that. We have started eliminating high-shrink SKUs. We started that about a year ago, and we've also placed things behind the check stand counters where we can control them. So I'm pleased we are not out of the woods, but at least I can tell you that it has stabilized.

Jeffrey Davis, CFO

Yes, to clarify, we expected a headwind of about $0.30 to $0.35 in the first half of the year, primarily due to mix. Currently, our performance aligns with that expectation, and we are seeing some slight improvement, though it's still early in the year. As mentioned by Rick, we have made significant investments, especially on the Family Dollar side, starting as a proof of concept and now expanding those self-help initiatives across the Dollar Tree brand as well. Regarding gross margin, the pressure at Dollar Tree primarily stemmed from the consumable mix, as we lacked the discretionary Easter items in our quarter's overall performance, which adversely affected gross margin. However, on the Family Dollar side, we have seen a solid improvement in gross margins of 40 basis points. Despite the impact of Easter, we are satisfied with the direction of our gross margins.

Operator, Operator

Our next question is coming from Krisztina Katai from Deutsche Bank.

Krisztina Katai, Analyst

So I wanted to ask you about the supply chain. You've been making a lot of investments there. You have rotacarts that are making store deliveries now as part of your fleet. Can you talk about what are some of the early benefits that you're seeing so far regarding in-stock availability, inventory turns? Is it helping reduce shrink and transportation damages? And just how best to think about the overall labor hour savings that you're able to take from the supply chain investments and then reallocate the store hours?

Richard Dreiling, CEO

Yes. Let me break it down into a couple of key points. The first distribution center we launched was in Matthews, North Carolina, specifically for Family Dollar. Previously, they were delivering to the store using pallets, but now we are utilizing rotacarts. We are experiencing improved delivery times on low volume shipments, which is what we expected. Additionally, there is a noticeable reduction in product damages, thanks to the handling methods we have implemented. Our associates are also more engaged and satisfied, as this change enhances their work experience. The next distribution center we just initiated is in Chesapeake for Dollar Tree. Here, we are again seeing a decrease in unload times, which enables us to get products onto shelves faster and address some out-of-stock situations. Overall, both in-store stock levels and distribution center service quality are improving.

Operator, Operator

Our next question is coming from Michael Montani from Evercore ISI.

Michael Montani, Analyst

I just wanted to ask kind of two-part thing. One was there's an improvement implied in the back half for EBIT margin of 100 basis points plus versus potentially flattish in the front half. So just wanted to see the top couple of drivers of that, that gives you the conviction for that. And then as a follow-up, you all did the incremental acquisition for the 99 Cent stores, as you mentioned. So is it feasible to see kind of $10 plus of EPS power just from core Dollar Tree now as you think out.

Richard Dreiling, CEO

So I'll let you handle the first part of the question. The second part of the question, it's too soon to know that. I'd like to stay away from that for now, if that's appropriate.

Jeffrey Davis, CFO

Michael, regarding the overall EPS phasing for the year, I appreciate your question. It can be divided into a few areas. From a revenue perspective, we discussed the acceleration of multi-pricing as we continue with the in-line conversions. We believe shrink and mix will be more neutral in the second half of the year compared to the first half. The $0.30 to $0.35 EPS headwind primarily impacted the first half. Concerning SNAP, while it remains in line with expectations, we anticipate potential tailwinds in the second half due to the October cola adjustment, although the extent is uncertain. Additionally, last year in the second half, we encountered a couple of setbacks, including an OTC recall that affected EPS by about $0.05 and an accrual adjustment related to general liability claims that contributed approximately $0.17. Furthermore, as mentioned, the portfolio optimization is expected to result in a $0.15 EPS improvement, primarily in the latter half of the year. Overall, we see an encouraging trend due to top-line revenue growth and easier comparisons related to shrink, SNAP, and previous setbacks that we view as one-time events.

Operator, Operator

Our final question today is coming from Priya Ohri-Gupta from Barclays.

Priya Ohri-Gupta, Analyst

I know it's a bit early in the process, but I was just hoping that perhaps you could talk to us a little bit about how you're thinking about sort of your credit rating with regard to possible considerations for Family Dollar? Would the expectation be to try to maintain your existing rating as you consider these various alternatives? Or would it be to at least maintain investment grade?

Richard Dreiling, CEO

Our investment-grade rating is a crucial aspect of our financial strategy. While it's premature to speculate on the structure or final results of the strategic review, we believe that the strength of our business, the robust cash flows it generates, and our approach to capital allocation align with maintaining an investment-grade status.

Operator, Operator

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

Richard Dreiling, CEO

Thank you all for taking your time to talk to us today and look forward to catching up down the road.

Operator, Operator

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