Dollar Tree, Inc. (NASDAQ:DLTR) Q4 2022 Earnings Call Transcript

Dollar Tree, Inc. (NASDAQ:DLTR) Q4 2022 Earnings Call Transcript March 1, 2023

Operator: Good morning and welcome to the Dollar Tree Fourth Quarter Earnings Call. This meeting is being recorded. At this time, I would like to hand the call over to Randy Guiler. Please go ahead, sir.

Randy Guiler: Thank you, operator. Good morning and welcome to our call to discuss Dollar Tree’s fourth quarter and fiscal 2022 results. 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 our 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 see the risk factors, business and management’s discussion and analysis of financial condition and results of operations sections in our 10-K filed March 15, 2022, our 10-Q for the most recently ended fiscal quarter, today’s press release and 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 maybe required by law. Following our prepared remarks, Rick and Jeff will take your questions. Given the large number of those that would like to participate, I ask that you limit your questions to one. I will now turn the call over to Rick.

Rick Dreiling: Thank you, Randy and good morning everyone. I apologize that I am a little hoarse. I am coming off of COVID and the good news is I am fine. I will review the highlights for quarter four fiscal 2022 and will provide an update on current priorities. Then Jeff will detail our financial performance and expectations for 2023. For the quarter, we delivered $7.72 billion in sales, an increase of 9%, with enterprise comp growth of 7.4%, operating income of $618.1 million, leading to a quarter four EPS of $2.04. Our sales performance for the fourth quarter was a continuation of momentum from quarter three. Same-store sales growth of 8.7% at Dollar Tree and 5.8% at Family Dollar represented comp accelerations on a 1, 2 and 3-year stack basis.

This improved performance and market share gain is not simply happening by itself, is the result of lots of hard work and good work by our store and merchant teams as well as the early fruits of our price, labor and store investments. And I truly believe we are just getting started. I have been in retailing for half a century. And I have been fortunate to play a leadership role in multiple transformations. I am incredibly excited by and energized to be part of the path ahead for Dollar Tree. We have an exceptional team assembled and I cannot overstate the amount of positive transformational change occurring in this business. We are committed to enhancing store productivity as we focus on developing our people, tools and technology to fuel accelerated growth.

And that we do this while simplifying operations, improving the supply chain and innovating our merchandising strategies to better support our associates and to better serve our shoppers. Given the team’s relevant prior experiences, we know exactly what to do to drive improved productivity and profitability. We are moving as quickly as possible to capture the full potential of this business and I am confident we will succeed. We have tremendous opportunity to improve the Dollar Tree banner. At Family Dollar, it’s clear that we are at least a decade behind and this is reflected in our prior performance levels and financial results. As we narrow the gap operationally, it will be realized in material improvements to our financial performance. As we get settled in, we are finding more and more opportunities to meaningfully improve both banners.

Compared to just a few short months ago, the list of improvement opportunities has grown. Our guiding objective is to maximize returns to our shareholders. Doing so calls for implementing these initiatives with responsible urgency. There is no point in dallying. It has over the months become increasingly clear that our team’s great experience gives us the opportunity to complete in just 3 to 5 years, most of what has taken far longer in other situations. Our merchants, stores and other teams are driving lots of initiatives, many of them with minimal investment. I will highlight some of these later. While these are already gaining traction, they will have the greatest impact, if supported by additional complementary investments. The stronger our associate team, the better the store conditions, the more competitive our pricing, the more we will get out of them.

There is a synergy across these initiatives and the complementary investments we are making with each enhancing the others. For this reason, we are accelerating and pulling forward our schedule of major high-returning investments. The cost of these investments is reflected in our 2023 outlook, as an incremental $430 million increase in SG&A and the outlook assumes only a minimal return from these investments. The company is confident that these investments once implemented will yield attractive returns in 2024 and beyond. While we are confident these operating expense investments will yield strong returns, we are also aware of the dynamic nature of the earliest stages of a turnaround, the many simultaneous moving pieces, the interdependence of many of these pieces and in current unusual dynamics in the economy.

These considerations make forecasting the quarterly cadence of the benefits from these investments, particularly challenging. For this reason, for this first year of our transformation, we will consider these benefits only as they, in fact, materialize. This year’s investments, which include the full year impact of investments made during fiscal 2022 are in several key areas in the following order of magnitude, labor and wages, including hourly wage rates and investments in field personnel, stores, through repairs and maintenance and improving store conditions, corporate, including technology and other initiatives. Under this new leadership team, we are increasing average hourly wages and estimated $2 for the 2-year period of 2022 and 2023.

We feel that looking on a market by market basis and benchmarking to comparable retail wages, this investment will put us in a more competitive position. We also made additional investments in store hours and coverage, investments in our field labor and managers and other areas to help us execute much better. We expect these labor and wage investments will drive improved execution in our stores, higher sales, lower turnover attraction of and retention of talent, reduce shrink and greater productivity and efficiency. Our associates and field personnel are critical to our transformation journey and we are excited about the investments in our talent. We are looking to invigorate the culture of this business, give our local operators and associates, the tools they need to execute and importantly provide them the opportunities they deserve to grow within our company.

On store standards, recall last quarter, I spoke about an intense focus on store standards, our commitments to clean them up, straighten them up and fill them up. When we do this, our shoppers respond with a bigger basket and more importantly, with repeat visits. Our new COO, Mike Creedon, joined the team in October. Mike possesses a relentless focus on the three pillars of successful store operations, the work, the worker and the workplace. The work, we must run efficient and productive stores. As a high transaction volume business, it’s critical we have processes in place to get product onto our shelves quickly. I am certain that we can’t sell a product if it’s in the backroom. Approving efficiencies and workflows positively impacts our associate experience.

The worker, as an organization must be a cornerstone that we support and enable our associates to be successful. This commitment will enhance our ability to recruit, hire, train and retain associates and contribute to their retail career development. We believe this focus, combined with our wage investments are contributing to the reduction in turnover that we are starting to see. The workplace and as we have indicated in the past, we must improve our store and DC conditions and we are in the process of doing so. Frankly, stores and DCs were not being maintained up to our new leadership standards. We are actively transitioning from what we consider to be reactive to proactive maintenance approach. In addition to the work, the worker and the workplace, Mike’s team are in the process of identifying certified GOLD stores for each region.

GOLD stands for a Grand Opening Look Daily. These stores will serve as a clear, concise example for our district and store leadership teams across all regions so they have a distinct vision and understanding of what our most successful and well-run stores look like. On the question of our corporate investments, I will address these later in the call. Our merchandising teams led by Rick McNeely and Larry Gatta are working hard. The Dollar Tree merchant team successfully managed through the transition to the $1.25 primary price point. As we cycled the majority of these stores throughout the fourth quarter, we saw a 410 basis point sequential improvement in traffic compared to quarter three. Now that we have anniversaried the remainder of our stores in February, traffic is positive and we are confident it will be a contributor to positive comps at Dollar Tree throughout the year.

In 2022, we added $3 and $5 plus merchandise into more than 1,800 Dollar Tree stores. We plan to add this multiple price point product in another 1,800 or more stores in 2023. And when we begin flowing this multiple price product through 3 additional distribution centers, bringing our total to 7. Separately, we have been aggressively expanding our $3, $4, $5 frozen and refrigerated product across the Dollar Tree store base going from 0 to 3,500 stores in 2022. This consists of 3 cooler doors, 1 at each price point with an attractive selection of proteins, pizza, ice cream and more, which the customers are responding positively to. What we are seeing with Dollar Tree plus and multiple price frozen is that when the customer purchased at least one of these items, the basket size is more than double the basket with no multi-priced items.

We are experiencing a more consistent and predictable slide chain. Stores were set well in advance for Valentine’s Day and we had terrific sell-through. The stores are now well prepared for the Easter season. And with $1.25 transition now behind us, we believe it’s time for Dollar Tree merchants to get more creative than ever before. They have carved launch to raise the bar on delighting customers and driving sales and all options are up for discussion. We believe doing what is easy has no reward. In addition to the opportunities at the Dollar Tree banner, we have a tremendous long-term opportunity to improve the operating performance at Family Dollar. We have a number of sales and margin-driving initiatives that are already underway, albeit in the early stages.

But as you have seen, these have contributed to the 4.1% comp in quarter 3, followed by a 5.8% in quarter 4. Among our actions are the following: we have begun raising the shelf height to a 70-inch profile throughout the stores to enable us to broaden the product offering for our shoppers. This profit-enhancing initiative allows us to grow our SKU base by 1,000 items, including OTC and HPA, without increasing our store-related costs. We are continuing to expand the number of cooler doors with plans to add 16,000 doors in 2023 to accommodate more frozen and refrigerated items. Our goal is to have 30 doors per store. Our shoppers rely on Family Dollar in their communities to provide these consumable base products to feed their families. We are replacing our control brands with private brands, and we will be introducing hundreds of national brand equivalent products in the back half of this year.

Photo by Franki Chamaki on Unsplash

These will include new labels and redefined labels, many of which are being developed in our new test kitchen here in Chesapeake, Virginia. To better meet both store and shopper needs, we are improving our ability to ship in ECS, which improves inventory flow and profitability on slower moving, higher margin items including the over-the-counter and health and beauty products. This enables us to be more nimble and provides greater flexibility. Additionally, we are working on improving Family Dollar productivity by enhancing end-cap displays, eliminating flex space and refining store adjacencies to better optimize the box. These are just a few examples that Larry’s teams are focused on that we believe will contribute to Family Dollars improved sales trajectory in the sales ahead.

We continue to be pleased with our positioning from a price perspective. We are at parity with key competitors and have widened the gap to grocery and drug. Shoppers have responded to the sharp pricing actions we took in late quarter two and third-party data suggest that Family Dollar is seeing an increasing amount of new customers in our stores. I will now turn the mic over to Jeff Davis, while Jeff has just been in his CFO seat at Dollar Tree since October. He is peddling fast and making great progress in a number of key strategic initiatives including leading the development of our long-term financial plan. Jeff will now provide more color on quarter four and what’s ahead of us.

Jeff Davis: Thank you, Rick, and good morning, everyone. Unless otherwise stated, all fourth quarter comparisons are against the same period a year ago. In addition to my comments today, a supplemental slide deck that outlines several of our key operating metrics is available on our Investor Relations website. Operating income increased 6.8% to $618.1 million or 8% of total revenue a 20 basis point decline in operating margin. This was compared to a 70 basis point improvement in gross profit margin, which was more than offset by SG&A. Gross profit increased 11.6% to $2.39 billion. The Dollar Tree segment gross margin improved 110 basis points, primarily from higher initial mark-on, lower freight cost and sales leverage, partially offset by product mix, product cost inflation and higher costs for markdowns, shrink and distribution.

Family Dollar’s gross margin increased 20 basis points. This quarter represented Family Dollar’s first improvement in gross margin in the last 7 quarters. The improvement was driven by higher initial mark-on, lower freight cost and leverage on occupancy, partially offset by mix, markdowns, shrink and higher distribution costs. SG&A as a percentage of revenue increased 80 basis points to 22.9%. The increase is due to a $23.9 million non-cash store impairment charge along with elevated repairs and maintenance as part of our commitment to improve store and DC standards. Investments in store and distribution center hourly wages and inflationary costs across several expense categories. Corporate support and other expenses were consistent at 1.4% of revenue.

Net income was $452.2 million, and EPS was $2.04 in comparison to $2.01 a year ago. Moving to the balance sheet, my comments will reflect balanced comparisons at the end of Q4 2022 versus Q4 2021. Combined cash and cash equivalents totaled $643 million compared to $985 million. Inventory increased 24.8% and primarily from unit growth associated with early receipts of spring 2023 merchandise, Family Dollar combo expansion and new store unit growth and cost growth from product inflation, including freight, the expansion of the $1.25 and multi-price plus inventory. Units per store are at a similar level to pre-pandemic period. Our inventory is fresh, and we have limited dated inventory well within manageable levels. Capital expenditures were $328 million, in the fourth quarter versus $271.6 million.

For fiscal 2023, we expect capital expenditures to total approximately $2 billion. Of this $2 billion, we would characterize 39% is dedicated to business continuity with the remaining 61% for what we consider to be growth optimization and productivity improvement. The business continuity includes projects to run and operate our stores and DCs as well as enhanced safety and compliance programs. More specifically, this would include freezers and coolers, HVAC replacements and facility improvements for stores. DC conveyor projects and building improvements for our distribution facilities, enhance permanent cooling for our DCs and store safety and asset protection related projects. Our growth optimization and productivity improvement projects will include approximately 650 new stores, an estimated 1,000 store renovations, numerous distribution center projects and technology projects to enhance our efficiencies and support our growth.

Our 2023 sales and EPS expectations incorporate a number of factors. First, this is a 53-week year. We expect this will benefit the fourth quarter by approximately $500 million in sales and $0.29 in diluted EPS. Second, we are cycling the outsized margin benefit for Dollar Tree’s initial transition to the $1.25 price point where last year, it produced a 39% margin rate in the first half of 2022 as we evolved our assortments to the new price point. Also for both segments, we expect to see continued cost pressure from inflation and margin pressure from merchandise mix as consumables are expected to outpace discretionary sales. Third, our outlook includes a benefit of approximately $1 per share from reduced freight expenses with nearly all of that benefit realized in the second half.

Approximately half of our fiscal 2023 import container volume will remain at existing long-term contracts or charters at elevated rates. We anticipate meaningfully lower rates for renegotiated contracts and spot volumes, which we expect to impact the remaining half of our container volume for the year. These factors limit the impact of lower freight rates on operating profits within the year. The Dollar Tree segment will realize approximately 80% of these freight savings, which will support a gross margin rate in the range of 36% to 37% in fiscal 2023. If current market conditions persist, we expect an additional freight cost relief of approximately $1 in fiscal 2024 and 2025 with the majority realized in fiscal 2024. Four, our outlook includes approximately $430 million or $1.45 per share in operating expenses across labor and wages, store repairs and maintenance and corporate as we accelerate our investments to transform this company.

These investments are roughly split evenly between the two banners and include investments in corporate. Given the amount of transformational activity, initiative interdependencies and the volatility of economic environment, it is difficult to precisely estimate the timing and related magnitude of investment returns. Our 2023 outlook assumes only a minimal benefit from these investments. Company is confident that these investments, once implemented, will yield attractive returns in 2024 and beyond. There is strong evidence in the back half of 2022 that management’s actions and investments are already yielding results at Family Dollar and Dollar Tree as evidenced by our recent trends. While our outlook assumes minimal profit contribution from Family Dollar this year, we believe there is tremendous opportunity to improve Family Dollar sales productivity and margins and we are confident this opportunity will realize and produce meaningful profits in the years ahead.

Finally, we will continue to focus on people, store conditions, tools and technology to drive growth and long-term operating performance improvements. We expect SG&A expense dollars, which includes general inflation, new store expenses and accelerated investments as well as the 53rd week to grow in the low teens. Based on the confluence of these factors, we anticipate year-over-year gross and operating margins will decline in the first half of 2023, followed by growth in the second half. We estimate 2023 EPS will be comprised of approximately 40% in the first half and approximately 60% in the second half which includes 1 extra week in Q4. Consolidated net sales for the full year fiscal 2023 are expected to range from $29.9 billion to $30.5 billion.

We expect a low to mid-single-digit comp store sales increase for the year, comprised of a low 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 from 3% to 3.5%. Our new store openings this year will be more back end weighted compared to 2022. Diluted EPS is expected to range between $6.30 and $6.80. For Q1, we forecast consolidated net sales will range from $2.7 billion to $7.4 billion based on a mid-single-digit increase in same-store sales for the enterprise. Diluted earnings per share for Q1 are estimated to be in the range of $1.46 to $1.56. While share repurchases are not included in the outlook, we had $1.85 billion remaining under our share repurchase authorization as of January 28.

Other modeling considerations for the 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 $27 million in Q1 and $97 million for the year. Our outlook assumes a tax rate of 24.25% to 24.5% for the first quarter and for the fiscal 2023 period. Weighted average diluted share counts are assumed to be 222.4 million shares for Q1 and 222.6 million shares for the full year. I’ll now turn the call back to Rick.

Rick Dreiling: Thank you, Jeff. As an organization, we are moving fast. Our operating initiatives are in flight and are gaining steam and the current economic climate is driving more higher income consumers into value retail. We believe we are in the right spot to deliver quality, value and convenience that shoppers need today. The momentum is continuing as both segments are off to a nice start early in quarter one. Before we move to Q&A, I want to briefly discuss two additional contributors to our future success. Information technology and supply chain. In order to unlock the value creation opportunity ahead of us, we must have the right tools and technology in place to support our accelerated growth. Bobby Aflatooni Technology Group has a clear vision and they are prioritizing projects that will have the greatest impact on our enhanced performance.

Some of the increased speed fueling these projects, our capital expenditures and some are operating expenses. All of the projected spend for this year is captured and included in our outlook. And John Flanigan supply chain team is doing a great deal of work to enhance efficiency and ensure the stores have the merchandise they need and can upstock it easily. We have identified an approach for eliminating the inefficiency of our current manual case-by-case handling process. This should enable us to more efficiently and reliably get products from our DCs onto our trucks and then into our stores. John has committed to having at least one DC up and running on the new process by the end of the year, which much more to come in 2024 and beyond. This will be a big step forward for our organization and especially for our store associates.

Also, I would like to pat our DC teams on the back. In the past year, all 25 of our DCs have been good distribution practices certified by an independent third-party auditor, and we are already in the process to begin recertifying for 2023. The company is very proud of this achievement and believe it demonstrates our company’s commitment to our associates to run good clean buildings. 2022 represented a year of substantial change for the Dollar Tree organization. Of the 16 officers listed on Dollar Tree’s website, only two were with our company 15 months ago. That is clearly a great deal of change in a very short period of time. I would like to share my sincere gratitude to our 207,000 associates that have not only embraced change but have welcomed our new leaders and me to the organization.

One day, we will be able to reflect on 2022 as the inflection point that got our company back on track. To capture the remarkable long-term value creation journey ahead of us. The team knows that I’m all in, in my commitment to support our store and field associates as they develop and grow in their retail careers by running full, clean and friendly stores to serve our shoppers each and every day. The long-term opportunity ahead of us is bigger than I imagined before I joined the Dollar Tree team. I want to be very clear. This transformation is not about saving dollars to deliver success. It’s about spending dollars in the right places to unlock the future value of the business. This transformation is a process, which includes stabilizing the organization as we run and operate our business and make investments to modernize and transform the company to create long-term value for our stakeholders.

As Jeff outlined, we pulled forward into 2023, certain investments that could otherwise have been extended for several years. And consequently, we expect fiscal 2023 to be a step back in earnings from the prior year. We’re excited about this acceleration of initiatives and investments as it means higher and earlier returns in the years ahead. This is an important year to put us on a path for an acceleration in growth and earnings as we move forward. We believe that this approach will maximize returns for our shareholders. Our leaders are eager to share more details on our vision and the path to get there, and we will do so in a more structured format in our Investor Day here in Southeast Virginia, currently being planned for June. We intend for this to be the first of several events over the years ahead as we outline our transformation and its progress along the way.

Before I turn it over to questions, I would like to take a moment on behalf of the employees, Board, shareholders to extend our thanks to Mike Witynski for his years of service and contributions. Mike, we’re all grateful to you and wish you the best. Operator, Jeff and I are now ready to take questions.

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Q&A Session

Operator: Thank you, sir. First question comes from Matthew Boss from JPMorgan. Please go ahead.

Matthew Boss: Great. Thank. Appreciate all the color, and I hope you’re feeling better, Rick.

Rick Dreiling: Thank you, Matt.

Matthew Boss: So maybe to kick off at Dollar Tree, can you elaborate on the sequential improvement in comps that you’re seeing in stores that have now lapped the break the dollar, maybe larger picture, how best to think about opportunities for that concept going forward, relative to before the decision to break the buck? And then just separately, can you touch on success of the $3 and $5 item introduction?

Rick Dreiling: Yes. The answer, Matt, is let’s do the last one first, the $3 to $5. We’re very pleased. And the key takeaway on that is not only selling the product but the store’s ability to manage it the multiple price points and not create confusion for the customer, which is why we’ve taken the approach that everything is now on the table. So very pleased with that, the improvement, as I look at the improvement, it’s not only the sales, but more importantly, the transaction count and what’s going on in the basket. And we know that the basket is substantially larger when we get the multiple price points in it. So very €“ we are pleased. We’re excited. And now that we’ve cycled it, we’re getting a true measure on what’s going on.

Matthew Boss: Yes. No, no, no, absolutely. And then maybe just to switch gears over to Family Dollar. So with mid single digit comps now for the second straight quarter, could you just elaborate on the market share gains that you’re seeing with the acceleration of the investments. I guess what I’m trying to get to is, is there any visibility that you can share for multiyear return? And any change in the high single-digit long-term operating margin opportunity at Family Dollar?

Rick Dreiling: We will spend a lot more time talking about that sort of thing at the Investor Day. And while I do not want to be specific, Family Dollar is starting to gain share. And it’s also gaining a larger share of the wallet.

Randy Guiler: Sergey, next question please.

Operator: And our next question comes from Scot Ciccarelli from Truist Securities. Please go ahead.

Rick Dreiling: How are you doing, Scot?

Scot Ciccarelli: How are you? Good to hear you. I guess a little bit of a follow-up on that second question, which is, I think we all kind of understand the need to accelerate investment in the business. But Rick, you made a comment earlier in your remarks about you plan to achieve in 3 to 5 years, what usually takes a lot longer. So I guess the question is, should we view kind of €˜23 as a reset or starting point for growth in €˜24 and beyond? Or just given that list of growing projects you mentioned, could we see investment spending continue to pressure earnings growth in €˜24 and €˜25?

Rick Dreiling: Excellent question. I would look at €˜23 as kind of getting us level set €“ and I think the investments we will utilize in €˜24 and €˜25 will be more basic. You’re always investing in the business, but it won’t be anything of the magnitude that we’re tackling now.

Scot Ciccarelli: Got it. And then the second question is just in a lot of retail turnarounds in the past, there is a natural limit to how much change a new management team can induce in a short period of time. Do you think that could be a challenge as you’ve kind of settled in at the Dollar Tree, Family Dollar operation at this point, Rick?