Earnings Call Transcript - DLTR Q1 2023

Operator, Operator

Good morning, and welcome to our call to discuss results for Dollar Tree's First Quarter Fiscal 2023. With me on today's call are Chairman and CEO, Rick Dreiling, and CFO, Jeff Davis. Before we begin, I would like to remind everyone that various remarks that we will make about 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. These statements are subject to risks and uncertainties, and our actual results may differ materially from those indicated in these forward-looking statements. For information on the risks and uncertainties that could affect our actual results, please refer to the Risk Factors, Business and Management's Discussion and Analysis of Financial Condition and Results of Operations sections in our annual report on Form 10-K filed 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 we make from time to time with the Securities and Exchange Commission. We caution against reliance on these forward-looking statements made today and we disclaim any obligation to update or revise these statements, except as may be required by law. Also during this call, we will discuss non-GAAP financial measures. Reconciliations of these non-GAAP items to the most directly comparable GAAP financials are provided in today's earnings release and SEC filings. These non-GAAP measures are not intended to be a substitute for GAAP results. Unless otherwise stated, we will refer to financials on a GAAP basis. Unless otherwise stated, all first quarter comparisons for fiscal 2023 are against the same period a year ago. Please note that a supplemental slide deck that outlines a number of the company's key operating metrics is available on the IR portion of our website. Following our prepared remarks, Rick and Jeff will take your questions. I will now turn the call over to Rick.

Rick Dreiling, Chairman and CEO

Thank you, Randy. Good morning, everyone, and thank you for joining our call. As many of you are aware, Dollar Tree will be hosting its investor conference in 4 weeks on June 21 in Norfolk, Virginia, near our corporate headquarters. The conference will be webcast, and I hope to see many of you at this important event. Our investor conference has been overdue, and we understand the level of anticipation for many investors. I hope next month's gathering will provide each of you a better understanding of the transformation taking shape and the speed with which we are making these changes to increase both our productivity and profitability at Dollar Tree and Family Dollar. We have been hard at work building the team we need to drive the transformation of this business. The more we dig in, the more historically clear the opportunity becomes, and we are on our way to most fully realize upon it. Our stores are of comparable size to those of our closest peers, but they generate far less revenue per store. We understand why, and we know how to close the gap. There are no structural impediments to our progressing towards this goal. As we do, we will drive growth and gain market share. With the operating leverage embedded in the retail model, accelerating growth in revenue per store will translate into higher margins, and higher margins will increase our return on capital and fuel accelerated store growth. We've gone down this road before, and we know the way. We have a tremendous opportunity to improve both of our segments, and we are pursuing that with vigor. While our enterprise-wide transformation is still in the early stages, we are already seeing results. Our early initiatives have begun to deliver growth and market share gains. We are driving this transformation in the most dynamic retail environment I have seen in my career. While this volatility is real and will generate bumps along the way, it will not affect where this great adventure ends. In addition to the historic levels of inflation and labor market challenges, retailers have seen in just the past quarter, elevated levels of shrink and even further pressure on the consumers' willingness to spend on discretionary goods, shrink and the mix shift from discretionary goods have pressured margins throughout retail. We are no exception. Ultimately, shrink will either be resolved through defensive merchandising, store closures and/or through government action at the local level. Regarding the near-term unfavorable impact of consumables mix, we believe consumer shopping behavior will normalize over time and the margin profile will rebound. We are acutely attuned to each of these bumps. In the end, none will materially affect our delivering on the promise of this transformation unless we allow them to distract us from what we know we have to do, and we will not allow that to happen. We benchmark our top line sales performance primarily on 3 specific metrics. Sales per square foot growth, growth in transaction count and unit sales or volume growth. Based on these 3 metrics, I am pleased with our quarter 1 performance and the direction we are headed. Overall, the fundamentals of our business are strong. Most significantly, we continue to gain market share, and our traffic and unit volume growth are driving strong top line momentum. The market share gains are a clear validation of the actions that we have taken on pricing and wages and the ongoing improvements we have made in our merchandise assortment, service level and store standards. Now, despite our commercial success and building momentum, we are experiencing near-term margin pressures from the macro factors impacting sales mix and elevated shrink. But the most important message that I want to convey today is that we remain completely focused on delivering on our full potential and are executing on our transformation investments at full speed. I will now review the highlights for quarter 1. Following my remarks, Jeff will provide a detailed overview of our financial performance and our updated 2023 outlook. For the quarter, we delivered $7.32 billion in sales, an increase of 6.1%, with enterprise comp growth of 4.8% and operating income of $419.7 million, leading to EPS of $1.35 and adjusted EPS of $1.47, when adjusting for a $30 million accrual related to pending legal matters regarding our West Memphis distribution center. Our merchandising and execution remain strong, with comp increases of 3.4% at Dollar Tree and 6.6% at Family Dollar. The underlying sales strength was concentrated in consumables and driven by meaningful transaction growth across both segments. Results were even more impressive in the context of Dollar Tree's 11.2% comp increase from a year ago. After fully cycling the $1.25 price point in February, customer traffic remained very favorable at Dollar Tree as comparable traffic count increased by 5.5%. Notably, this was the fourth consecutive quarter of sequential improvement in comps at Family Dollar, with comp traffic up 4.3%. For nearly all of 2022 comp traffic count trends in both segments were negative, so quarter 1 was an important inflection point for the company, with traffic increasing both sequentially and year-over-year. The turnaround at Family Dollar is gaining meaningful traction. In addition to the improving traffic, Family Dollar's comp was driven by a 2.2% increase in average ticket. At Family Dollar, we increased our private brand penetration by approximately 80 basis points. Moving forward, we expect to continue growing private brands penetration as we further improve merchandise presentation, packaging and quality control standards. For example, we recently opened a new test kitchen here in Chesapeake and are excited about our growing pipeline of private brand products across consumables, health and beauty and other high-growth categories. We are also encouraged by the margin opportunities associated with expanding our private brands business. Last year, we took pricing actions at Family Dollar to bring us more in line with our most direct competition. These price investments strengthen our value offering at Family Dollar and followed our transition to the $1.25 price point at Dollar Tree, along with investments in wages and store standards. The steps we have taken on pricing across both segments are critical to improving our long-term financial and operating performance. As I mentioned earlier, the consumer continues to be under pressure. There are simply fewer dollars available to them, and those dollars are not going as far as they did a year or 2 ago. We are past the multiple rounds of government stimulus. SNAP dollars have been reduced and tax refunds are running lower. These impacts, combined with persistent inflation, have caused more families to prioritize needs over wants. Both Dollar Tree and Family Dollar are part of the solution for shoppers buying for need and close to need as they look to stretch their paychecks. Our stores are nearby, easy to shop, and provide tremendous value. While these factors are contributing to the mix shift and pressuring our gross margins, they are also driving more shoppers into our stores with increased frequency. We will continue to respond to the needs of the consumer across both consumables and discretionary categories by offering tremendous value and a great selection. While this mix shift towards consumables is clearly a margin headwind, it is worth noting that the promotional environment remains rational and is not driving any additional margin pressure. At Dollar Tree, we made great strides with our multi-price strategy, and we remain on track to add $3 and $5-plus items to another 1,800 stores this year. In quarter 1, we added Dollar Tree Plus assortments to more than 400 stores and anticipate accelerating the pace of this rollout over the balance of the year. Additionally, we have aggressively expanded our product assortment at Dollar Tree stores with $3, $4 and $5 frozen and refrigerated products, adding 3,500 stores last year alone on this initiative. During the first quarter, we added multi-price frozen and refrigerated doors in more than 400 Dollar Tree stores. Both our Dollar Tree Plus and our multi-price frozen assortments drive incremental sales, with the average ticket more than doubling in stores that we have added this expanded offering. At Family Dollar, we are on track to add 16,000 new cooler doors in 2023. This is helping drive Family Dollar to its highest market share in close to 4 years as measured by quarter 1 dollar volume. On a unit volume basis, Family Dollar's quarter 1 share of industry growth was the highest in more than 3 years. We continue to improve the in-store experience at Family Dollar and completed more than 250 store renovations in the quarter. On last quarter's call, I shared the strategic rationale for our increased SG&A spending in 2023. These investments should be pursued as rapidly as our management bandwidth will allow. The sooner each is implemented, the sooner we will enjoy the benefits and the greater the impact of our other investments. All of this is ultimately connected and interdependent. Many of our investments will be ongoing, including those on our associates and store conditions, and again, the results are starting to come in. We have already seen meaningful improvements in sales momentum and reduced associate turnover. In closing, we have a plan. I'm confident this plan will drive meaningful top line growth, increase productivity and improve profitability. We are vigorously executing on it. We will not allow bumps in the road to distract us or slow us down, and it's clear it's starting to work. Our investments in price, our stores, our merchandise and our associates have already begun delivering results. We will get to where we're going, but how we get there matters as well. I firmly believe that investments in our people and the communities we serve are the cornerstones of a successful retailer. We have taken a comprehensive approach to improve wages and benefits for our people and to increase associate engagement to make Dollar Tree and Family Dollar great places to work and grow. It is vital for the continued success of our organization to have a strong culture. While there is work to be done, we are pleased that our culture efforts are taking root and building the foundation for a thriving future. Finally, I am so very proud of the tremendous efforts of our 200,000-plus associates, each of whom has contributed to the great progress we are making and each of whom deserves our collective thanks. While Jeff will cover our outlook in more detail, I want to emphasize that we remain confident in the outlook for our business and our continued sales momentum. Our go-to-market strategies at Dollar Tree and Family Dollar are working and clearly resonating with consumers. I look forward to sharing more details on our long-term vision and our multiyear outlook next month at our investor conference. I will now turn the call over to Jeff.

Jeffrey Davis, CFO

Thank you, Rick, and good morning, everyone. As Rick mentioned, our top line performance was strong in both the Dollar Tree and Family Dollar segments. It was driven by meaningful growth in customer traffic, continued market share gains and an increase in underlying unit growth. Total sales increased 6.1% to $7.3 billion based on comp store sales growth of 4.8%. Traffic increased 5% on a consolidated basis, and average ticket was down slightly. Across the enterprise, our sales mix of consumables increased approximately 200 basis points as customer purchase behavior responded to deteriorating macro conditions. Our service levels were particularly strong in Q1. In-stock positions improved by 400 basis points in the Dollar Tree segment and by 200 basis points at Family Dollar. Our DC service levels also improved for both segments by nearly 1,600 basis points at Dollar Tree and approximately 500 basis points at Family Dollar. Operating income decreased by 43% to $419.1 million. Adjusted operating income decreased by 39% to $449.7 million. Recall that in Q1, we cycled the first full quarter of the $1.25 price point transition at Dollar Tree, which resulted in unfavorable margin comparisons given the outsized benefit we saw in Q1 last year. The variance between operating income and adjusted operating income came from a $30 million accrual related to previously disclosed legal proceedings associated with our Family Dollar distribution center in West Memphis, Arkansas. Gross profit decreased by 4.7% to $2.23 billion as gross margin contracted by 340 basis points. The biggest driver of the gross margin decline was merchandise cost. In Q1 last year, we benefited from the rollout of the $1.25 price point at Dollar Tree. In the current period, our sales mix shifted approximately 200 basis points towards lower-margin consumable merchandise. The impact of higher cost of goods and unfavorable sales mix were partially offset by lower freight costs and markdowns as we cycled the impact of our West Memphis DC closure last year. As Rick noted, elevated levels of shrink represent a persistent challenge. In Q1, shrink negatively impacted gross margin by 60 basis points and EPS by an incremental $0.14 per share compared to last year. On a business segment basis, Dollar Tree gross margin declined by approximately 530 basis points, primarily from lower merchandise margin based on the higher consumable mix and cycling the initial transition to the $1.25 price point, elevated shrink expense and increased distribution costs. We benefited modestly from lower spot rates for ocean freight relative to last year. But to date, this is only impacting a small portion of our shipments with a larger impact of savings from freight rate declines to come in the second half and into the years ahead. Family Dollar's gross margin decreased by approximately 100 basis points, with largely the same factors contributing to the decline as Dollar Tree. Specifically, gross margin was negatively impacted by mix, product cost increases, higher shrink and higher distribution costs, partially offset by lower markdowns and lower freight expenses. SG&A as a percentage of revenue increased 150 basis points to 24.8%. The biggest driver was wage investments for store and distribution center associates. We also experienced higher store facility costs as we continue to focus on improving store conditions as well as higher professional and marketing expenses. Corporate, support and other expenses were 1.7% of revenue, down approximately 10 basis points from last year. Net income was $299 million, and EPS was $1.35 in comparison to $2.37 a year ago. Adjusted net income was $325.1 million and adjusted EPS was $1.47. The $0.12 adjustment was related to the West Memphis legal accrual. Our effective tax rate was 24.1% versus 23.1% last year, reflecting lower stock-based compensation deductions and higher nondeductible expenses, partially offset by higher work opportunity tax credits. Adjusted for the impact of the West Memphis accrual, the Q1 implied tax rate for this year was 23.3% or 20 basis points higher than Q1 last year. Moving to the balance sheet and cash flow, my comments will reflect balance sheet comparisons at the end of Q1 2023 versus Q1 2022. Inventory increased 6.5% primarily from an increase in merchandise costs, DC unit volume growth, the continued rollout of our Dollar Tree multi-price inventory and new store growth. The quality of our inventory remains high and manageable. Q1 capital expenditures were $350.4 million versus $253.4 million. For fiscal 2023, we continue to expect capital expenditures to total approximately $2 billion, with approximately 40% dedicated to business continuity and the balance directed towards growth, optimization and productivity improvement. In Q1, we repurchased approximately 1 million shares for $151.1 million, of which $7.7 million did not settle until after quarter end. Cash and cash equivalents totaled $872.8 million compared to $1.2 billion. Our cash position increased $230 million in Q1 from the end of fiscal 2022, led by working capital improvements, partially offset by capital expenditures and share repurchases. Free cash flow improved to $402 million from $285 million last year. Moving to our sales and EPS outlook. The company expects consolidated net sales for the second quarter will range from $7 billion to $7.2 billion, based on a mid-single digit increase in comp store sales for the enterprise and for Dollar Tree and Family Dollar segments. Diluted EPS for the second quarter is expected to be in the range of $0.79 to $0.89. As a reminder, the bulk of our ocean freight savings for the year will fall in the second half, as previously mentioned. With respect to full year fiscal 2023 guidance, recall that fiscal 2023 has a 53rd week. Consolidated sales for the full fiscal year are now expected to range from $30 billion to $30.5 billion. The company expects to deliver a low to mid-single digit comparable store sales increase for the year, comprised of a low to mid-single digit increase in the Dollar Tree segment and a mid-single digit increase in the Family Dollar segment. Selling square footage is expected to grow by 3% to 3.5% for the year, with new store growth back-end weighted. While we modestly raised the midpoint of our top line guidance, we are incrementally more cautious on our margin outlook, given the growing industry-wide challenges of accelerating shrink, the unfavorable shift in sales mix and their impact on our near-term profitability. Since the beginning of the fiscal year, the impact of these 2 factors on our financial results has intensified. We expect that over time, our mix of discretionary will normalize, and that we will also improve our performance on shrink through defensive merchandising efforts, real estate optimization and perhaps higher prices to compensate for areas of systematically higher shrink. We expect the combined and continuing full year earnings impact of unfavorable consumables mix and higher shrink is expected to be approximately $0.55 per share in 2023. Our modeling considerations for 2023 outlook include the following. We expect consolidated depreciation and amortization to range from $845 million to $850 million. Net interest expense is expected to be approximately $28 million in Q2 and $110 million for the year. Our outlook assumes a tax rate of 24.1% to 24.3% for the second quarter and 23.9% to 24.1% for fiscal 2023. While our share repurchases are not included in our outlook, we had $1.7 billion remaining under our share repurchase authorization as of April 29. Weighted average diluted share counts are assumed to be 221.4 million shares for Q2 and 221.6 million shares for the full year. For the balance of 2023, we will work diligently to offset potential margin pressures that could come from elevated levels of discretionary inventory. We are taking actions to mitigate the potential impact of these cost pressures such as further optimizing our promotional spending and vendor allowances, identifying opportunities to further reduce inbound freight costs and managing repairs and maintenance costs. We continue to see a full year earnings benefit of $1 per share from lower ocean freight costs this year, which could be significantly weighted towards the back half of the year, and an additional $1 per share benefit in 2024 and beyond. As a result of the factors I just outlined, we are revising our diluted GAAP EPS outlook for fiscal 2023 to a range of $5.73 to $6.13, which includes the expected contribution from the 53rd week and the $0.12 legal reserve taken in Q1. I will now turn the call back over to Rick for closing remarks.

Rick Dreiling, Chairman and CEO

Thank you, Jeff. We are continuing to execute at a high level and acting with urgency around our business transformation, and I am pleased with our solid start to 2023. We are looking forward to our investor conference next month, where we expect to provide our investors and analysts with a multiyear outlook for the business, including a substantive and comprehensive overview of the key elements of our business. Our team has identified multiple levers to unlock value, and we have strong underlying business momentum that positions us favorably in the current retail and economic environment. We see a path to greater earnings power over the next 3 years and look forward to sharing our plans in more detail next month. I also want to take this opportunity to welcome our new Supply Chain Officer, Mike Kindy. I have worked with Mike in previous organizations, and he is a proven subject matter expert and thought leader in supply chain and logistics. I am very confident that Mike will demonstrate continued success at Dollar Tree based on his past record. I also want to thank John Flanagan for his contributions, which helped us get to where we are today. While John communicated to us at the outset his desire to serve only for a short period, over the past year, John has led our supply chain strategy and has overseen the early stages of the process to optimize our distribution network and he's had a tremendous impact. We are moving at a fast pace in our journey to fundamentally reposition our combined retailing operations for sustainable long-term growth. Our efforts are already paying off in the form of significant market share gains at both segments. Both formats have a clear runway for accelerated growth in productivity and profitability. Our leaders have complete ownership over the factors that will shape our outlook for the next 3 to 5 years. We have a winning team of more than 200,000 associates who are highly motivated and eager to succeed. I look forward to sharing more next month at our conference. And one last note. Before we go to Q&A, I want to share some IR news with you. Several months ago, Randy Guiler communicated with us his retirement plans. This advanced notification provided us with ample opportunity to seek Randy's replacement. I want to thank Randy for his 9 years of dedicated service leading the IR function at Dollar Tree. I am pleased to share that Bob LaFleur joined Dollar Tree on Monday of this week as our new SVP of Investor Relations. Randy will be with us at our upcoming investor conference and is continuing in his current role with the company through the month of June to help facilitate a smooth transition. Please join me in congratulating Randy on his impending retirement, and Bob on his new role at Dollar Tree. Operator, Jeff and I are now ready to take questions.

Operator, Operator

We will take our first question from John Heinbockel from Guggenheim.

John Heinbockel, Analyst

So Rick, it's more of a strategic question, right? If I think about your initiatives and then the consumer, do you think that consumable penetration, right, that mix not only will remain elevated, maybe the consumables mix goes higher over time. What's your thought on that? And then mitigating the impact of mix on margin. Private label will help, but maybe talk about where do you think that goes and the opportunity to do sort of ultimately a DG Fresh-like distribution initiative, right, to bring down COGS in that area.

Rick Dreiling, Chairman and CEO

Thank you, John. Great question. There's a lot of meat answering that question. The first thing I'd like to say is the strength that we are experiencing in consumables has nothing to do with weakness in our discretionary. The fact that we are responding to the needs of the consumer, which is the shift towards consumables, is a really significant step forward for us and that we're introducing consumable products, especially on the Dollar Tree side, that the consumer is responding to. Now when I talk about our discretionary, I think it's also important for everyone on this call to realize that our discretionary is a little bit different than what you'd see out in the marketplace. Our discretionary tends to be high-value items that you can compare to another operator, another retailer, and see a significant difference in the retail price point. So that's part of the reason I'm still very bullish on where we are with discretionary. Now as this shift continues, the advantage for us is twofold. Number one, private brands, and the amount of work that's being done on private brands. And what I'd like to say is not just on the consumable side. Our private brand effort includes HVAC or HBC and all of the higher-margin private label products. So that's another way for us to accelerate the margin on the consumable side. And let's not forget shrink, when you think about the pressure that we're experiencing, shrink tends to be cyclical. And what happens with shrink is we all work to mitigate it. If you can't, all costs that can't be taken out eventually get passed on to the consumer. So we're keeping an eye on it. And I would say, John, again, as we talk about margin, the shrink issue, we have 4 classes of shrink stores, with 4 being the highest. The shrink impact is pretty uniform through all 4 classes, which I've never seen that in my career, which is truly fascinating. So in regards to the fresh concept, right now, we are committed to frozen food and refrigerated, which is one of the highest growing categories with our particular consumer.

Simeon Gutman, Analyst

I wanted to ask about Dollar Tree Plus, I also wanted to ask about the $1.25 price point at Dollar Tree. Can you talk about, I guess, the trade-off here of maybe accelerating a move to higher price points given some of the higher cost pressures, given some of the margin headwinds? Just the trade-off, given how the consumer is behaving and then maybe speeding up Dollar Tree Plus rollout to more stores?

Rick Dreiling, Chairman and CEO

Yes, two good questions there. We are very excited about what we're seeing with Dollar Tree Plus, and our intent is to move that along as fast as we can. The same thing with the $3, $4, $5 frozen food. The change in the basket when those items go in is significant. The price point thing, Rick McNeely, our Chief Merchant, is actually experimenting with a couple more price points in certain stores, and there has been no consumer resistance. I think once we broke the dollar, any backlash on that is behind us. And what Rick is doing with incrementally priced SKUs is not a repetition of what we already have. So we're creating a bigger basket and a broader shopping experience.

Jeffrey Davis, CFO

If I could just add to that. One of the things that the merchant team is really focused on is always making sure that they're giving more value in relation to the market at every price. And while some of our prices in relation to where we were previously embracing the dollar at a higher price point, we continue to have that price separation and value separation against other competitors in the marketplace.

Edward Kelly, Analyst

So first on shrink. Just quickly, could you just walk us through the surprise there? I would think that shrink would be tied to, like, a year in inventory count, so I'm just curious as to what happened there. And then Rick, for you. Big picture, we all see the potential here and we hear you that nothing changes with all this. But the base that we're looking at as a starting point has been going down. And I'm sure you joined because you saw potential for significantly higher earnings than you're going to be at $6 this year. But I guess the question is the timing around the inflection. And you mentioned sort of 3 years, but like how quickly do you think we can begin to see that acceleration?

Jeffrey Davis, CFO

This is Jeff. I'll take the first part of the question regarding shrink. When we gave our guidance for the year, we had approximately less than 10% of our stores that had taken their inventories for the year. And while we did see some elevation in that shrink, that was embedded in our guidance for the year. As we moved through the course of the quarter, we saw a pretty rapid increase in the level of shrink that was being experienced by the stores. And as Rick has said, we were seeing that across all strength classes, which was really out of the normal for us. That's the reason why we needed to make the adjustment. So through this period of time, we only have a little less than 40% of our stores that have taken their inventories. We are anticipating that what we're seeing today could accelerate even further because we still have a number of our higher shrink class stores still left, and that's what's being reflected in the adjustment that we had for the year. But based upon what we know today, based upon some other leading indicators, we believe that the adjustment we made is most appropriate. This is not unlike what you're seeing in many other retailers across the industry. Some of this is societal, some of it is economic, some of it, of course, is particular to us. And we're taking all the appropriate steps that we can to control and mitigate this where we can.

Rick Dreiling, Chairman and CEO

Ed, regarding the second part of your question, I want to emphasize that we plan to address a lot of that at the Investor Day, which will provide more clarity on how things will unfold and the pace of those changes. Before that, I want to share a few thoughts. First, I am very optimistic about the opportunity we have. I believe the shift towards consumables and the impact of shrink are temporary challenges. We won't be facing them indefinitely, and they contribute positively to our plans. Additionally, everything is progressing now, including our move to a larger profile, adding nearly 1,000 new SKUs, developments in Dollar Tree Plus, expanded coolers, more frozen food options, and improvements in our store facilities. We're also reducing turnover, which is already evident from the wage investments we've made, benefiting many other areas. I want to convey that a lot is in motion, I am extremely confident and optimistic, and we will detail this further at the Investor Day.

Scot Ciccarelli, Analyst

A lot of your initiatives like expanding cooler doors and frozen foods have been focused on driving consumable sales, and that's obviously the driver to the transaction growth, as you've highlighted. But Rick, as the consumer behavior starts to stabilize, how do you shift consumers back to buying more discretionary goods? Because in theory, your consumable sales gain should be sustainable. And if we look at Dollar General as an example, like their consumable sales spiked during the great recession, but then consumables continue to become a bigger part of their sales pie every year up until the pandemic. So how do you actually change that trend once the consumer starts to normalize?

Rick Dreiling, Chairman and CEO

Another great question. I want to emphasize that we have often confused value with low cost. Our consumers are seeking value, which for them means that a product should not just be inexpensive but also durable. For instance, I recall a time when someone bought a rake from one of our stores, used it for just one day, and it broke. That was low cost, not value. To address this, we are improving our product procurement and expanding our selection. The team at Dollar Tree is taking their first trip to China in over three years, and we're very enthusiastic about it. This will allow them to meet face-to-face with manufacturers and vendors, enabling them to see and feel the products being brought into our stores. Additionally, the consumer will ultimately decide. If we provide the right products and selections and focus on promoting true value, the consumers will naturally be drawn to us.

Peter Keith, Analyst

So the transaction comps are pretty impressive and nice to see. I'm curious with the economic backdrop, what type of trade-in/track-down benefit you're seeing? Obviously, you're getting more customers in stores. Is this repeat behavior? Or are you starting to see new customers that you can track behavior on?

Rick Dreiling, Chairman and CEO

We're actually seeing new customers. Our core customer is coming more frequently. Now when they come, they don't spend any more, but they come more often. And what we're now seeing is the trade down in that $80,000 income range, and we're actually beginning to target that consumer, and that consumer is more wrapped up in the consumable business. And one of the things that Jeff highlighted, I hope that everybody caught was the improvement in our service level to the stores, which is significant. And that service level improvement is coming from giving the stores what they want when they order it, and they're drawing consumables at a much higher rate down. And then what happens, when that higher income consumer comes in, they're used to a certain in-stock level, and we're now able to do a better job of satisfying that, which is why we're seeing that trade down.

Jeffrey Davis, CFO

And Peter, to provide you with more details, both banners are averaging around 3 million new customers over the past year. These new customers are engaging with the entire store, shopping for both consumables and discretionary items. As Rick mentioned, it is crucial for us to create the right store environment to encourage these customers to return. This is why we are focused on continuously enhancing our store standards, delivery, and service.

Karen Short, Analyst

Look forward to seeing you in a few weeks. I just wanted to ask a couple of things. So on overall margin structure within the Dollar Tree banner, is it fair to say as we get through the year, you'll have more benefit from freight? So what we're looking at right now is not necessarily the run rate, but there is a mix shift and then that will be offset a little more impactfully in the second half of the year on freight. But then the second bigger thing I wanted to ask is I know you're doing a test on consolidating a distribution center and wondering if you could give some updates on that as it relates to what that could look like as a much bigger rollout as we go forward.

Rick Dreiling, Chairman and CEO

I'll take the second.

Jeffrey Davis, CFO

Yes. So on the first portion of the question with respect to margins at Dollar Tree, we had stated earlier that our expectation is we'd be able to manage that business over the course of the year to a 36% to 37% gross margin rate. And there's lots that goes into that, of course, not only product costs but shrink markdowns and some other elements. Today, as we look in our guidance, I would say that we would be at the lower end of that range, but we feel comfortable that we will be able to continue managing the business based on our product offering and how the customer behaviors have been in that 36%, 37% range, so at the lower end of that. There's just a number of elements we believe that we still have to work to from a product offering basis as we look at the introduction of new price points and able to capture a little more margin where previously we weren't able to do so at some of the lower price points.

Rick Dreiling, Chairman and CEO

Then in regards to the question concerning combined warehouses, we're opening on the process of building one in Florida. We had one in Utah, and we actually converted it to Family Dollar only. It's one of those propositions that sounds easy, makes sense but it tends to be a little more difficult to execute. And what John and Mike have done for us is we've done a total analysis of the system. And at the end of the day, this boils down to stem miles and how far away the distribution center is from the stores. And I have no opinion, I'm not sold that we need to do it, but I'm not sold that we don't need to do it. But we need to spend a little more time with it. And we're going to give you our thoughts on a broader base at the investor conference. And then we'll probably have an answer in the next 6 or 7 months where we would go ultimately on a combined warehouse.

Matthew Boss, Analyst

So Rick, at the Dollar Tree banner, could you speak to the economy that you're seeing between the traffic improvement, which obviously is a nice positive, relative to the average ticket decline that you're experiencing? And then just what are you seeing with recent trends to support the sequential comp acceleration that you embedded in your second quarter guidance at the Dollar Tree banner?

Rick Dreiling, Chairman and CEO

I don't want to provide mid-quarter guidance since we are only about three to three and a half weeks into the quarter. However, I am very pleased with the trends, and the transaction counts have remained consistent. I believe that foot traffic ultimately drives sales, and I'm happy with what we're observing in terms of transactions. The transaction growth we are experiencing is contributing to the comparable sales at Dollar Tree. Therefore, I remain very optimistic about both banners at this point.

Joseph Feldman, Analyst

I wanted to revisit the consumables mix. We all understand the current environment, but I'm curious about what was different in the quarter compared to your expectations. It appears the mix pressure accelerated. You mentioned earlier that the discretionary business seemed to be performing better from your perspective. Could you provide more details about the performance of discretionary?

Rick Dreiling, Chairman and CEO

Yes. Maybe we'll tag team that, if that's okay, and I'll start. If you go back to the last earnings call, we did call out that we were starting to see a shift in shrink and the drive towards consumables. Now there's absolutely no doubt over the last 12, 15 weeks that call out has accelerated. And I think the consumer is feeling the real pressure now of a lot of things that have taken place. We've had a change in SNAP benefits, tax returns are smaller than this time last year, all the stimulus is out of the system, and all of that is taking root. And the consumer now is more focused on needs and buying to those needs as close as they can versus wants, and that's the shift we've seen. Now we think that shift is going to continue for a while. We don't particularly believe it's going to get any worse. I can't remember the second part of the question.

Jeffrey Davis, CFO

Yes. The reason I bring up discretionary is really important. Our discretionary business is still good, and the fact is we've strengthened the consumables side. So we shouldn't be making the assumption that our low-cost pertinent discretionary items are no longer wanted or needed by the customer. It's that they're buying more consumables.

Operator, Operator

Now, I will hand over back to Randy Guiler. Please go ahead, sir.

Operator, Operator

Thank you for joining us today, and we hope to see you at our investor conference on June 21. Have a good day.

Operator, Operator

Thank you for joining today's call. You may now disconnect.