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Dollar Tree Q4 2022 Earnings Call Transcript


Listen to Conference Call

Participants

Corporate Executives

  • Randy Guiler
    Vice President, Investor Relations
  • Rick Dreiling
    Chairman and Chief Executive Officer
  • Jeff Davis
    Chief Financial Officer

Analysts

Presentation

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
Vice President, Investor Relations at Dollar Tree

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 may be 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
Chairman and Chief Executive Officer at Dollar Tree

Thank you, Randy, and good morning, everyone. I apologize that I'm a little hoarse. I'm coming off of COVID and the good news is I'm 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 19%, 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 one-, two-, and three-year stack basis. This improved performance and market share gain is not simply happening by itself. It 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're just getting started.

I had been in retailing for half a century and I've been fortunate to play a leadership role in multiple transformations. I'm 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're 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're moving as quickly as possible to capture the full potential of this business and I'm confident we will succeed.

We have tremendous opportunity to improve the Dollar Tree banner. At Family Dollar, it's clear that we're 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're 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 three to five years most of what has taken far longer in other situations. Our merchant, 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 in 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 earlier stages of the turnaround. The many simultaneous moving pieces, the interdependence of many of these pieces, and the 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, an estimated $2 for the two-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, reduced 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'm certain that we can't sell a product if it's in the backroom. Improving efficiencies and workflows positively impacts our associate experience.

The worker. As an organization, it 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 churn-over 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 we will begin flowing this multiple price product through three additional distribution centers, bringing our total to seven. Separately, we have been aggressively expanding our $3, $4, and $5 frozen and refrigerated product across the Dollar Tree store base going from zero to 3,500 stores in 2022. This consists of three cooler doors, one 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-price 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 the $1.25 transition now behind us, we believe it's time for Dollar Tree merchants to get more creative than ever before. They have CARB 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 Three, followed by a 5.8% in Quarter Four.

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 based 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. 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 eaches which improves inventory flow and profitability on slower-moving, higher-margin items, including the over-the-counter in 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 Dollar's improved sales trajectory in the sales ahead.

We continue to be pleased with our positioning from 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 suggests 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's seat at Dollar Tree since October, he is pedaling 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
Chief Financial Officer at Dollar Tree

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 from 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 seven quarters. The improvement was driven by higher initial mark-on, lower freight costs, 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 balance 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%, 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 $1.25 in 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, enhanced permanent cooling for our DCs, and store safety and asset protection-related products. Our growth optimization and productivity improvement projects will include approximately 650 new stores and 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 $1.00 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 costs relief of approximately a $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 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 one 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 would 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
Chairman and Chief Executive Officer at Dollar Tree

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's 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 are 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's supply chain team is doing a great deal of work to enhance efficiency and ensure the stores have the merchandise they need and can up-stock 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 product 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 in initiatives and investments as it means higher in 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 in the path to get there and we will do so in a more structured format and 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.


Questions and Answers

Operator

Thank you sir. [Operator Instructions] And our first question comes from Matthew Boss from J.P. Morgan. Please, go ahead.

Matthew Boss
Analyst at J.P. Morgan

Great. Thanks. Appreciate all the color and hope you're feeling better, Rick.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Thank you, Matt.

Matthew Boss
Analyst at J.P. Morgan

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 to -- 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
Chairman and Chief Executive Officer at Dollar Tree

Yeah. 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 counts 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're pleased, we're excited. And now that we've cycled it, we're getting a true measure on what's going on. Did I reach you, Matt, or...

Matthew Boss
Analyst at J.P. Morgan

Yeah. No, absolutely. And then maybe just to just 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 multi-year return and any change in the high-single-digit long-term operating margin opportunity at Family Dollar?

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

We'll 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
Vice President, Investor Relations at Dollar Tree

Sergei [Phonetic] next question, please.

Operator

And our next question comes from Scot Ciccarelli from Trust Securities. Please, go ahead.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Hey, there, Scot.

Scot Ciccarelli
Analyst at Trust Securities

Good morning, guys. 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 three to five 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
Chairman and Chief Executive Officer at Dollar Tree

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
Analyst at Trust Securities

Got it. And then the second question is just a lot of retail turnarounds in the past, there's 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?

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Another great question. It's -- the more time I spend here -- I'll make a couple of observations for you, Scot. It's becoming really clear to me the composition of the new team married with the older team. There's a tremendous amount of experience here. And we believe that experience is going to help us drive get -- to drive to get things done faster. Then you couple that with an organization, the Family Dollar and Dollar Tree organization, I have never seen the willingness to accept change like I'm seeing here. The 207,000 people in this company are dying to be high performers and they believe in what we're doing. And they're seeing R&D investments we made so far in price and wage, store investments we've made in terms of the quality of the facilities, the employees are seeing that -- they're seeing those changes. They're seeing them in sales and they're viewing it as all positive.

Scot Ciccarelli
Analyst at Trust Securities

Got it. Thank you very much.

Operator

Thank you. We'll now move to our next question from Krisztina Katai from Deutsche Bank. Please, go ahead.

Krisztina Katai
Analyst at Deutsche Bank Aktiengesellschaft

Hi. Good morning and thank you for taking the question. I wanted to just follow up on the market share Family Dollar. I mean, certainly, it has been challenged over the years, but it does seem that with price and store investments that is actually starting to change. So, a question on traffic, which remained negative on a year-over-year basis but also a multi-year. So, how important is it to inflect positive for the model to work here and how do you envision arriving there, like what are the most critical components of the strategy to actually unlock that?

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Yeah. I mean, I think as I reflect on what you're asking here, most important thing we can do is maintain consistent store standards and execute against our operating model. We have -- we know what to do. And I think if you look what's taking place, the consumer is responding to it and they're responding to it in terms of a bigger share of their wallet, they're responding in terms of market share. And all of the initiatives that we're putting in place, Krisztina, are all designed for that store experience. Even if you look at what we're doing with labor, we're not trying to take labor out of the store; we're trying to eliminate work so we could spend that on more customer-facing activities.

Krisztina Katai
Analyst at Deutsche Bank Aktiengesellschaft

That's great. And just a quick follow-up, again, regarding Family Dollar. But can you just touch on in-stock levels? How is that improving since the new team has been in place? And how far are we from optimal levels of in-stocks?

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Yeah. I would say one of the key initiatives in this building is the in-stock level at Family Dollar. Several things are happening. A lot of the manufacturers have retailers on allocation. So, if you order a 100 cases, you might get 65. And that is affecting everybody right now. The other issue we are -- we have discovered we've had for a long period of time is we use a perpetual inventory system. And if that system is not right, if it's not showing the on-hand quantities properly, the system will order product. So, we're going through a process now of truing that up. But I will reiterate one of the -- and people are tired of me talking about it around here, in-stock is one of our key initiatives.

Krisztina Katai
Analyst at Deutsche Bank Aktiengesellschaft

Great. Thank you so much and best of luck.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Thank you.

Operator

Thank you. And before we take the next question, I'd like to remind you, please limit your questions to one as we have a large audience today. Our next question comes from Anthony Chukumba from Loop Capital Markets. Please, go ahead.

Anthony Chukumba
Analyst at Loop Capital Markets

Thank you so much for taking my questions. Hey. Good to hear you're recovering from the bit. Hey. So, I just wanted to clarify, you talked about those wage investments. Can you just walk through that again, because I wasn't quite sure? I think you said $2 now, but I wasn't sure on the sequencing of that. So, I just wanted to better understand that. Thank you.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Yes, sir. We're doing that market-by-market. And what we're looking at it is not only the hourly wages, which is where the bulk of the investment is, we're also looking at coverage to ensure we have the proper amount of coverage. And then we're also looking at what I would call the field team, the store manager, and the district manager. We do know and it's proven that when we have the right wage structure, we increase our retention and our turnover has been -- it's been pretty astronomical and we're seeing that slowdown. We know we get better shrink. We know we get better store standards and we get better morale. And that all leads to better execution, which the customer sees on the shelf when they're in the store. So, it's a broad-based approach.

Anthony Chukumba
Analyst at Loop Capital Markets

Got it. Look forward to seeing you in June.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Thank you. sir.

Operator

Thank you. We'll now move to our next question from Michael Lasser from UBS. Please, go ahead.

Michael Lasser
Analyst at UBS Group

Good morning. Thanks a lot for taking my question. So, Rick, the message today and what it's been for the last few quarters is what -- we're going to burden the cost structure with a lot of investments to get this business to where it needs to be, and we're going to frame and quantify what the return on these investments is going to be at some later date. So, could you give at least a framework on what you expect the return on these investments to how they -- you expect them to flow in terms of timing and the nature of how the return on investment is going to look? If it's just sales leverage on fixed costs, it may take quite a bit of time for the enterprise to get back to the operating margin level that it's achieved historically. And as part of that for the $400 million that you're investing this year, how does that break down between those wage investments that are more structural in nature and the maintenance and repairs that are perceived to be more one-time in nature? Thank you very much.

Jeff Davis
Chief Financial Officer at Dollar Tree

Thank you, Michael. This is Jeff. Now, as we think about the returns -- and Rick had indicated earlier, there are a number of interdependencies that are related to these investments. So, as you can imagine, we are -- a lot of these investments are complementary to what we're doing. There are merchandising and our other store initiatives. There's interdependencies, are dependent upon -- has been able to execute against this, against all 16,000 stores, and it will take time through the course of 2023 to accomplish that. We have seen early on at the back half of 2022 some early returns in some tests that we've done, so we're confident that we will have an improvement in returns in future years. But between the interdependencies as well as quite honestly trying to execute this and what we are all seeing is at somewhat uncertain macroeconomic environment, the combination of these two things we believe that the impacts this year will be minimal. We're saying it as minimal because it is not any relevant level for us to actually speak any specifics to it at this point in time.

Operator

Thank you. We'll now move to our next question from John Heinbockel from Guggenheim Securities. Please, go ahead.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Hey, there, John.

John Heinbockel
Analyst at Guggenheim Securities

How are you? Well, I know [Speech Overlap]

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

I'm good, sir.

John Heinbockel
Analyst at Guggenheim Securities

Good. Excellent. Looking forward to seeing you again. Can you touch on, right, the consumable opportunity at Dollar Tree, right? I know historically, it's not been a huge consumable business because of the price point limitations. How do you think about that opportunity, right, in terms of getting MPP rolled out coolers everywhere, expanding that beyond, right, the three coolers? And then when you think about guarding against going too far, right, in terms of either mix or cannibalizing FDO, if that's an issue?

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Yeah. A great question. I think as I reflect on the consumables, the $3, $4, and $5 frozen food is a perfect example of there is an add -- there's an appetite for it in the stores. I do think it's a balance. But I will say this, consumables drive transactions. And what we have to figure out is how to get a consumable item and a non-consumable item in the basket together and grow the basket. And that's the challenge right now. So, as we look at consumables, John, it's going to be a very selective approach. Hey, this sounds silly, but we introduced bread into Dollar Tree over the last quarter. We put ice in Dollar Tree over the last quarter. And they're doing very, very well. And we've done it without upsetting the mix in the store. So, it's a methodical process. But I think what's important here is that it's nothing but opportunity if we can manage our way through it.

John Heinbockel
Analyst at Guggenheim Securities

Okay. Great. Thank you.

Operator

And our next question comes from Paul Lejuez from Citi. Please, go ahead.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Hey, Paul.

Brandon Cheatham
Analyst at Citi Investment Research

Hey, everyone. Hey, this is Brandon Cheatham on for Paul. Thanks for taking the question. I wanted to dig in on the freight costs. Just curious if you can expand on why wouldn't there -- that be a benefit real time? Spot rates are below where you contracted. Just sort of managing, you'd be able to go back to your business partners and negotiate something that looks a little bit more like the freight costs that are being experienced on the spot market? So, just curious if you can expand on some of the dynamics there and the timing of that benefit this year and next year. Thanks.

Jeff Davis
Chief Financial Officer at Dollar Tree

Yes. So, there's a couple of pieces to this. I -- first off, our teams are always going back to our supplier partners and looking for ways to reduce our costs where that is available and to the extent that spot rates where they are and given our volumes and serve our scale to the extent that we can do so, we'll take advantage of that. But part of the challenge also for us is that a large portion of our contracts, about 60% of all the contracted business that we have for any particular year right now, 60% of that is long-term charter or contracted rates. And that's the reason why those contracts and charters do not roll off until starting late 2024 or 2025.

The other element of this is that we capitalize our freight into our inventory cost. So, in any one particular year to the extent that our inventory is turning, let's say, four times, you've got that portion that is going to roll over to the next year as part of your capitalized cost. So, the combination of those things, so it's going to be the timing of contract, exploration and renegotiation. It's going to be to carry-over from one year to the next, are the two reasons why, for us, we have more of a back-ended loaded benefit of freight in 2023 that we'll be carrying over into 2024. But then also you have a further continuation of freight cost reductions as those other contracts roll off.

Brandon Cheatham
Analyst at Citi Investment Research

Thank you. That's very helpful. Best of luck.

Operator

And our next question comes from Kelly Bania from BMO Capital. Please, go ahead.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Hey, Kelly.

Kelly Bania
Analyst at BMO Capital Markets

Hi. Good morning. Thanks for taking our questions. Wondering if we can just talk a little bit more about the operating expense investment, in particular, the wages. How much of the $430 million is wages? And you called out the $2 dollar increase in your labor rates. Just curious if you can help us understand where that brings your average, your starting wage, how would that compare to peers once this is implemented. And does this bring you in line with peers or you get ahead of the rest of the industry?

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Yeah. I appreciate your question because I realize I didn't answer the $430 million question earlier, so I apologize. Of the $430 million, about two-thirds of that is related to wage and wage-related items. The delta, if you will, is around sectioning in store standards, what we're doing in store standards, where we're doing for IT, what we're doing in our supply chain. As it relates to our wage rates at $2, it definitely brings us more competitive in the marketplace as it closes the gap. We believe that, once again, this is not only closing the gap on hourly wages, but then it's also for us -- collectively bringing us more competitive as it relates to the field leadership teams. We haven't provided any sort of average hourly rate. But it is about a 20% increase over the course of the two years that that $2 would represent.

Kelly Bania
Analyst at BMO Capital Markets

Okay. That's very helpful. And just another one on freight. The comments you provided are very helpful. But you've outlined sort of $2 in freight really over the next couple of years. I guess, the question is, would that be a -- would that reflect a full recovery of the significant increase in freight costs that you've had over the last few years, or is that assuming only a partial recovery?

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

It would only be a partial recovery. There's a number of factors to this one. Freight rates have not gone back to 2019 levels in its entirety. Also, if you think about freight, there are really three components of freight and everyone seems to want to focus only on the transatlantic portion. But there's import and -- I'm sorry, inbound and outbound freight also, which is ultimately included in all of this. And those particular rates, you have not seen a significant reduction or return back to 2019 as driver costs, chassis cost, fuel, all those components continue to be at more elevated rates versus 2019. So, as we look at these freight cost reductions in its entirety, we do not -- we're not forecasting that this is going to recover that which we would have seen in comparison to 2019.

Operator

Thank you. We will now move to -- please, go ahead. We'll now move to our next question from Joe Feldman of Telsey Advisory Group. Please, go ahead.

Joe Feldman
Analyst at Telsey Advisory Group

Yeah. Hey, guys. Thanks for taking the questions. I had a question about the investments that you guys are making. You've outlined both the Dollar Tree side and the Family Dollar side. As you think of store improvement, presumably, it's more in the Family Dollar side. But I'm just curious how you balance the investments between the two and how you decide where to allocate to each brand and where you feel there's more need for store improvement? Is it -- because it sounded like Dollar Tree actually could you use some store improvement too, which I think I was little surprised by. But maybe you could address that issue.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Yeah. I'll take that, Jeff, and then you can jump in. The first thing I'm going to say is we believe in the long-term earnings power of both banners. And we think there's potential there and I look forward to sharing that with everybody on the Analyst Day. I think if we are honest with ourselves, which we are, the facilities in both banners need work in terms of the quality of the gondolas, floor care, ceiling care, lights, I can go down the list, that applies to both banners. I think when you look at the difference between the two banners and what shows up in one versus the other in terms of store standards is Dollar Tree has no planograms in it. So, it's incredibly easy just to put stuff on the shelf. And a lot of SIMs get covered up when you do that. Family Dollar, every square inch of that thing when we get done by the middle of the year will be planogrammed. And out of stocks, rusty shelves, and more problems show up when you have a planogram-based merchandising strategy. So, I would look at you and say, both stores have a tremendous amount of opportunity. Both banners have a lot of long-term earnings power. So, it's really not a balance; it's more about getting it done in both.

Joe Feldman
Analyst at Telsey Advisory Group

Got it. That's helpful. Thanks. And Rick, you had mentioned earlier that you're seeing a trade-down or trade-in from higher income consumers which I know we've all heard about and are seeing it as well. But how does the health of the consumer factor into your forecast this year? And how you see the consumer health playing out? That would great. Thanks.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Yeah. I mean, what we're seeing is the consumer making $80,000 a year is trading down. And that's -- timing is everything. We're doing better on so many fronts with a long way to go. They're having an experience they can relate to. But as far as planning for that, in our outlook, no, we don't do that.

Joe Feldman
Analyst at Telsey Advisory Group

Got it. Okay. Thank you, and good luck this quarter.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

Thank you.

Operator

Thank you. We'll now take our next question from Simeon Gutman from Morgan Stanley. Please, go ahead.

Simeon Gutman
Analyst at Morgan Stanley

Hey, everyone. Two-parter on Family Dollar. First, on the comp. We would have expected it to be more traffic than ticket given some of the price investments. It's the opposite. So, maybe related to that last question to diagnose how the customer is spending and maybe give us a peek on the basket composition. And then second, it's a little bit of a twist on what was asked before. There is a step change that should happen in Family Dollar with EBITDA margin. Your comps are inflecting. Obviously, the business isn't really generating a lot of profit. I know there's a lot of assumption in that. But curious what's the assumption that needs to happen for the profit? Do you have to keep comping at this rate or there is some profit -- or is there some profit unlock? Thank you.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

So, in terms of the composition of the basket, like every other consumable retailer, we're seeing the shift toward more consumables. I do think that comp-wise, we are seeing transactions improve, which I think was called out. But I think what we're seeing is a larger share of wallet. So, the basket is increasing.

Jeff Davis
Chief Financial Officer at Dollar Tree

So, there's two things, if I could maybe add to that. One, as it relates to the traffic, we saw a 40 basis-point improvement in our traffic going from Q3 to Q4. We believe that is reflective of, one, quality of merchandising, the opportunities we're presenting, but also from a pricing perspective, the work that we've done. It's been a multi-point reduction in -- against the market, if you will, in our pricing to gain parity, as Mike -- excuse me, as Rick had said, with respect to our competitive set as well as widening the gap between grocery and convenience. So, the combination of those two things is very encouraging for us as it relates to improve traffic as well as being able to drive still ticket at those lower prices on a year-over-year basis. And then as it relates to Family Dollar and its ability to generate greater levels of profitability, there is somewhat of a step function that's going on right now with these accelerated investments and it's more exacerbated against a Family Dollar P&L, because of its overall unit economics versus that of Dollar Tree, as you well recognize. We believe that as we continue to drive greater productivity from a top-line perspective, improve -- simplify our stores and its operating procedures such that we can further leverage off of the existing base that we're building up, we believe that we will be able to drive higher levels of profitability. The last piece is from a margin perspective, gross margin perspective, the things that Larry is doing, we're talking about from a private-label additions, that, that will also help us from a gross margin. So, top-line sales, gross margin improvement, and then leverage against some of these expenses that we are now incurring over the longer period of time.

Rick Dreiling
Chairman and Chief Executive Officer at Dollar Tree

If I could add one thing. I think the key takeaway on what has been said is there is no structural problems with either banner. It's all fixable and we know how to fix it.

Simeon Gutman
Analyst at Morgan Stanley

Thanks.

Operator

Thank you, ladies and gentlemen. We have reached our allotted time. I will turn it over to Randy Guiler for final comments.

Randy Guiler
Vice President, Investor Relations at Dollar Tree

Sergei, thank you very much. Thank you for joining us on today's call, and have a good day. Take care.

Operator

[Operator Closing Remarks]

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