Dollar Tree Inc

NASDAQ:DLTR

Earnings Call Analysis

Company Confident Despite Margin Pressures

Despite experiencing continued margin pressures expected to persist throughout the year, the company is positive about its transformation progress and sales growth, especially with the gains in market share at both Dollar Tree and Family Dollar. These gains position the company well to generate higher levels of rebates and promotional allowances. The long-term goal remains to achieve $10 or more in EPS by 2026. The company has adapted its retail execution, leading to an increase in rebates and allowances, and is learning new strategies to bolster profitability, including addressing shrink and supply chain optimization. Adjustments, such as an accrual for previous general liability claims, have affected profitability, but the company's leadership remains bullish on achieving more realistic margin levels.

Supply Chain and IT Systems Improvements Enhance Operations

The company is effectively optimizing its supply chain, expecting to complete temperature control upgrades at 8 more DCs by year-end and fully out across the network by the end of 2024, which would increase efficiency by reducing expenses and enhancing product range flexibility. Progress on their Rotacart rollout continues, with beta testing underway and a planned full implementation in a North Carolina DC by year-end. On the technology front, upgrades to store and inventory management systems are ongoing, while new warehouse and transportation management systems development are underway, anticipating rollouts early next year. These enhancements have contributed to a noticeable uptick in operational reliability, which, if fully optimized, might add an additional 1.5 points to overall comparable store sales (comp sales).

Performance Insights and Challenges

Despite strong sales driven by customer traffic and unit volume growth, the company faced a decline in operating income by 43.1% and a compression of operating margin by 360 basis points due to decreases in gross margin and increases in SG&A expenses. Gross margin suffered mainly from lower merchandise margin, cost inflation, and elevated shrink. Investments in employee wages and initiatives to improve store conditions drove SG&A expenses higher. Notably, general liability claim impacts represented $0.07 of this quarter's figures. Earnings per share (EPS) have also decreased to $0.91 compared to $1.60 in the prior year. Importantly, they expect third quarter net sales to be between $7.3 billion to $7.5 billion with third quarter diluted EPS estimated at $0.94 to $1.04.

Financial Outlook and Share Repurchase

For 2023, the full year sales expectations have been raised to between $30.6 billion and $30.9 billion with an adjusted diluted GAAP earnings per share outlook narrowed to $5.78 to $6.08. The company reported an improved free cash flow and announced share repurchases amounting to $99.9 million in the second quarter, leaving $1.6 billion under their authorization. Furthermore, they've set up a commercial paper program aimed at increasing financial flexibility, marking a strategic move to potentially lower short-term borrowing costs.

Capital Allocation and Future Initiatives

Capital expenditures were up due to investments in new store openings, renovations, supply chain, and information systems, expected to total about $2 billion for fiscal 2023. From this, around 40% is for maintenance capital expenditure (CapEx), while the rest supports growth initiatives. Additionally, net interest expense is anticipated to be $25 million for the third quarter and $110 million for the full year, with an effective tax rate of 23% in the third quarter and 24% for the full year. Diluted shares are projected to be 220.6 million for the third quarter and 221 million for the full year.

Earnings Call Transcript 2023-Q2

[Operator]

Hello, and welcome to the Dollar Tree Q2 2023 Earnings Conference Call and Webcast. [Operator Instructions] A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It's now my pleasure to turn the call over to your host, Bob LaFleur, Senior Vice President, Investor Relations. Please go ahead, sir.

[Bob LaFleur, Senior Vice President, Investor Relations]

Good morning, and thank you for joining us today to discuss Dollar Tree's second quarter results.

With me today are Dollar Tree's Chairman and CEO, Rick Dreiling, and CFO, Jeff Davis.

Before we begin, I would like to remind everyone that some of the remarks that we will make today are about the company's expectations, plans and future prospects and are considered forward-looking statements under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties which could cause actual results to differ materially from those contemplated by our forward-looking statements.

For information on the risks and uncertainties that could affect our actual results, please see the Risk Factors, Business, and Management’s Discussion and Analysis of Financial Condition and Results of Operations sections in our annual report on Form 10-K, filed on March 10, 2023, our Form 10-Q for the most recently ended fiscal quarter, our most recent press release and Form 8-K and other filings with the SEC. We caution against reliance on any forward-looking statement made today, and we disclaim any obligation to update any forward-looking statements, except as required by law.

Also during this call, we will discuss certain non-GAAP financial measures. Reconciliations of these non-GAAP items to the most directly comparable GAAP financial measures are provided in today's earnings release available on the IR section of our website. These non-GAAP measures are not intended to be a substitute for GAAP measures. Unless otherwise stated, we will refer to our financial results on a GAAP basis.

Additionally, unless otherwise stated, all comparisons discussed today for the second quarter of fiscal 2023 are against the same period a year ago.

Please note that a supplemental slide deck outlining selected operating metrics is available on the IR section of our website.

Following our prepared remarks, Rick and Jeff will take your questions. Given the number of callers who would like to participate in today's session, we ask that you limit yourself to one question.

I'd now like to turn the call over to Rick.

[Rick Dreiling, Chairman and Chief Executive Officer]

Thanks, Bob. I'd like to welcome all of you that have joined our call this morning.

I am sure that many of you had a chance to attend our investor conference in June. I hope the information we presented was valuable to you and that you left the event with a better understanding of the key growth strategies that we have in place to deliver $10 or more EPS by 2026.

I am confident that the team has identified the right levers to unlock the true value of our business. We are making good progress and continue to act with urgency to accelerate the pace of improvement in our merchandising, store operations, supply chain and IT infrastructure.

Our renewed merchandising efforts represent a major opportunity to unlock value. We outlined our multi-price journey at Dollar Tree, detailed our real estate and merchandising initiatives at Family Dollar and reviewed our plans to improve store standards across the enterprise. We have also launched efforts to drive sales productivity and increase operating efficiency like simplifying the truck unloading process and improving in-stock levels.

You heard me say many times that retail is all about growing units, growing transactions and growing sales per square foot. When these retail fundamentals move in the right direction, everything else follows. I am pleased to report that all three are heading in the right direction for us.

For the past two quarters, both segments posted positive unit growth in consumables, while the market has been negative. Second quarter traffic was up over 3% at Family Dollar and nearly 10% at Dollar Tree; the fourth consecutive quarter of growth at Family Dollar and the second for Dollar Tree. And finally, sales per square foot is up 4% at Family Dollar and 6% at Dollar Tree.

When it comes to our momentum in these key retail fundamentals, our ongoing merchandising efforts and the investments in labor and stores are paying dividends and setting the stage for everything else to follow.

Now, let me review some of our second quarter highlights. A little later, Jeff will provide a more detailed review of our results and update you on our outlook for the balance of the year.

For the quarter, on a consolidated basis, we delivered an 8.2% increase in sales to $7.3 billion, with 6.9% enterprise comp growth and $287.8 million of operating income, which led to EPS of $0.91.

In our Dollar Tree segment, our 7.8% comp was driven by 9.6% more traffic with a modest offset from average ticket. Dollar Tree's momentum remains strong, with this quarter's comp coming in on top of a 7.5% comp last year.

Meanwhile, the Family Dollar segment continues to make good progress in its operational turnaround. The second quarter comp of 5.8% was nicely balanced between 3.4% more traffic and 2.3% average ticket growth, with the strong comp trends being supported by our improved price position and merchandising efforts.

While the challenging macro environment continues to pressure our sales mix in both segments, I am pleased with the gains in traffic, new customers and market share. Regarding the industry-wide shift in consumer purchasing behaviors to consumables, we believe this is reflective of the current macroeconomic environment and continuing rotation to a pre-pandemic balance after years of elevated spending across discretionary categories. We believe we are winning in consumables as more customers come to see Dollar Tree and Family Dollar as the compelling destinations for value.

At Dollar Tree, our multi-price strategy provides flexibility to respond to changing customer needs. At Family Dollar, our improved price image and wide range of merchandising initiatives are clearly resonating with consumers. In this environment, consumers from all income levels are increasingly seeking value. We are well positioned to capture incremental share of wallet when higher-income consumers respond to our strong price value proposition and when lower-income customers concentrate their spending on needs based consumables.

This is particularly true across food and other consumables where value-oriented retailers are taking unit and dollar share. As a result, food categories are disproportionately driving sales momentum across the value retail landscape. Dollar Tree and Family Dollar are no exception. Our food business is especially well positioned in the current environment and we are seeing extremely high volume growth across our frozen and center store food categories.

There is also growing evidence that consumers are seeking value through private brands. Expanding and improving our private brand assortment will be a significant growth vehicle for us going forward. To this end, the private brand expansion program at Family Dollar remains on track. This year, we launched over 125 private brand items, which we will further accelerate when our new family wellness and vitamin products hit store shelves in the fourth quarter. We are already seeing encouraging results across our private brands, with second quarter penetration expanding by 55 basis points, units sold growing by 4%, and private brand comps increasing over 15%.

New customers are the lifeblood of retail and are critical part of driving traffic and market share. In the past year, we have added nearly 5 million new customers across both segments, with 2.6 million of these customers having a household income over $125,000. Importantly, our research tells us that a very high percentage of these new customers come back visiting an average of five times in the year following their initial trip. In fact, we now rank in the top 10 retailers measured by annual new customer activations.

These positive traffic and new customer trends are leading to strong market share gains. For the second quarter in a row, both segments gained market share in consumables as our unit volume grew, while the market's unit volume shrank. According to Nielsen data, our second quarter consumable unit volume growth outpaced the market by over 1,100 basis points at Dollar Tree and 530 basis points at Family Dollar, with both segments extending their margin of outperformance from last quarter.

Shifting from our recent sales performance, I'd like to take a few minutes to update you on several key initiatives across our company. In merchandising, we have increased our Dollar Tree PLUS target to 4,900 stores by year-end, up from 4,300 stores that we articulated in June. At the end of the second quarter, our Dollar Tree PLUS assortment was available in over 3,600 locations and the $3, $4, $5 frozen and refrigerated assortment was available in nearly 5,600 stores.

At Family Dollar, we are on track to complete planogram resets at all of our stores by November, and we are pleased with the sales lift from these resets so far. In real estate, we remain on pace to hit our target of 600 to 650 new store openings this year, with roughly two-thirds of those coming in the back half of the year. We also continue to make progress with our Emerging Formats at Family Dollar. We completed 271 H2.5 renovations, bringing the total number of H2.5 locations to 830. We opened or converted 90 Family Dollar stores under our rural combo format. Overall, we are on track to complete at least 1,000 Family Dollar renovations by year-end.

In supply chain, Mike Kindy and his team are investing in temperature controls across our distribution center network. Adding full temperature control to our DCs improves the work environment for our associates and drives improved operating performance. It also drives efficiency by reducing cross-stocking expenses and increasing flexibility to store the full range of OTC HBA products. We recently expanded temperature controls at two additional DCs, which brings us to four in total. By year-end, we expect to upgrade eight additional DCs, with the balance rolled out by the end of 2024. While still in its early days, we continue to make good progress on our Rotacart rollout. Beta testing on Rotacart deliveries is currently underway and we are on track for our DC in Matthews, North Carolina to be Rotacart-enabled by the end of this year.

Moving on to IT, we're also making good progress on needed upgrades to our infrastructure, particularly our new store and inventory management systems. Meanwhile, our new warehouse and transportation management systems are progressing through their development stages with rollouts anticipated to begin early next year. With the continued focus on our people, we saw double-digit improvements during the second quarter in employee turnover and store vacancy levels across both segments as the investments we are making in store-level wages, benefits and elevated standards begin to yield clear intangible results.

As I mentioned at our investor conference, we had a significant number of stores that don't open on time or close early due to staffing shortages. I'm happy to report that we saw a measurable improvement in this area during the second quarter at both Dollar Tree and Family Dollar. If we eliminated all late openings and early closings, it could add 1.5 points to our overall comp.

In summary, when it comes to factors that we can control, we continue to execute at a high level. As our recent sales performance shows, consumers are clearly responding to our merchandising initiatives. At the same time, Mike Creedon and his team are acting with urgency to upgrade our store conditions and improve operational consistency across our store fleet. We are making the investments we need to make to accelerate our top-line performance, generate greater operating efficiencies and improve profitability. We've built a strong cultural foundation as an organization and we are focused on delivering better results for all our key constituents, including our more than 200,000 associates.

And speaking of our associates, we've just spent the last two weeks meeting with our field leadership at our headquarters here in Virginia, a team of more than 1,300 leaders, who represent more than 200,000 associates, and the energy coming out of those sessions was amazing. Our people are the key to a great customer experience and I am so grateful for the progress we have made in our turnaround efforts over such a short period of time.

I will now turn the call over to Jeff to review our financial results and outlook for the balance of the year.

[Jeff Davis, Chief Financial Officer]

Thank you, Rick, and good morning, everyone.

In the second quarter, we continued to generate strong top-line results across both segments, driven by growth in customer traffic, unit volume and an accelerating market share. We continue to have a favorable view of the current operating environment. Our top-line performance was not driven by any material increase in promotional intensity. While our sales mix continues to shift towards consumables, we generated more gross profit dollars in the second quarter than we did last year. We also remain resolute in our strategy to make the necessary investments in stores, IT, supply chain, and our people.

On a consolidated level, operating income declined 43.1% to $287.8 million and operating margin compressed by 360 basis points. This was driven by a 220 basis point decrease in gross margin and a 130 basis point increase in SG&A expenses. Gross margin contracted primarily from lower merchandise margin as we lapped the margin benefit from last year's $1.25 rollout and from unfavorable sales mix, product cost inflation, and elevated shrink. SG&A expenses expanded primarily from wage investments, incentive compensation, general liability claims, and repairs and maintenance costs from improving store conditions. These were partially offset by leverage from increased comp sales and lower stock-compensation expense. Notably, the impact of general liability claims was $0.07 for the quarter.

Our effective tax rate was 24% versus 24.2% last year, as higher work opportunity tax credits were partially offset by higher non-deductible expenses.

Net income was $200.4 million and diluted earnings per share was $0.91 versus $1.60 a year ago.

At a business segment level, Dollar Tree's operating income declined 27.8% to $397.8 million, and operating margin compressed 510 basis points. This was driven by a 400 basis point decline in gross margin and a 110 basis point increase in SG&A expenses. Gross margin contracted primarily from lower merchandise margin as we lapped the margin benefit from last year's $1.25 rollout and from unfavorable sales mix, product cost inflation, and elevated shrink. These were partially offset by comp sales leverage against occupancy cost. SG&A expenses expanded principally from wage investments, minimum wage increases, general liability claims, utility cost, and repair and maintenance costs for improving store conditions. These were partially offset by sales comp leverage.

Family Dollar's operating income declined 78.5% to $11.8 million and operating margin compressed 140 basis points. This was led by a 30 basis point decrease in gross margin and 110 basis point increase in SG&A expenses. Gross margin contracted primarily from elevated shrink with a partial offset from leveraging occupancy costs. SG&A expenses also increased principally from wage investments, minimum wage increases, utility costs, and repairs and maintenance costs from improving store conditions. These were partially offset by sales comp leverage.

Moving onto the balance sheet and cash flow. As a reminder, my comments reflect balance sheet comparisons between Q2 2023 and Q2 2022.

Inventory decreased by 1.7%. While inventory was below last year's level, is elevated due to early receipt of imports. With a rapid recovery across our supply chain, seasonal imports from Asia arrived well ahead of our scheduled third quarter receipts. Moving forward, we will continue to manage our inventory and related trade accounts payable to improve free cash flow generation.

Capital expenditures were $425.4 million in the second quarter versus $276.2 million last year, reflecting elevated investment levels in new store openings and renovations, supply chain and information systems. For fiscal 2023, we expect capital expenditures will total approximately $2 billion, with approximately 40% allocated towards maintenance CapEx and the balance towards growth initiatives.

Free cash flow improved $40.5 million versus the second quarter of last year. This represents the third consecutive quarterly improvement in free cash flow generation, even as we make significant investments to support the long-term growth of the business. For the first six months of 2023, free cash flow improved $157 million versus the same period last year, led largely by lower merchandise inventories with a partial offset from lower net income adjusted for non-cash items, increased CapEx, and the timing of accounts payable.

In the second quarter, we repurchased approximately 700,000 shares for $99.9 million, including applicable excise tax. At quarter-end, we had $1.6 billion remaining under our share repurchase authorization.

Cash and cash equivalents totaled $512.7 million compared to $688.9 million a year ago.

In July, we established a new commercial paper program to issue unsecured notes with maturities up to 397 days, with an aggregate face amount outstanding at any time of $1.5 billion. We expect to use the net proceeds for general corporate purposes. The notes will rank pari passu with all other unsecured and unsubordinated indebtedness. Our revolving credit facility will serve as a liquidity backstop for the repayment of outstanding notes under this program. This new program provides additional flexibility to manage our working capital needs, and at current rates, it provides short-term borrowing at lower rates than our credit facility. There are no notes issued and outstanding as of the end of the quarter.

Now let me provide some additional visibility into our sales and EPS expectations for the third quarter and the balance of 2023. At a high level, we are reiterating the center point of the full year outlook we gave last quarter and bringing in the high and low end to better reflect the balance of opportunities and risks we see in the current operating environment. Our outlook takes into consideration the following factors: continued shift in sales mix and unfavorable shrink trends over the balance of the year; our utility and repairs and maintenance costs related to the national head dome; higher diesel fuel prices; on the PLUS side, we expect improved sales performance and incremental ocean freight savings. That all said, we see nothing systemic or structural in the current environment that would have a lasting negative implications for the multi-year outlook that we shared in June.

So against that backdrop, we expect consolidated net sales for the third quarter will be in the range of $7.3 billion to $7.5 billion, based on a mid-single-digit increase in comp store sales for the enterprise in each of the segments. We estimate third quarter diluted earnings per share will be in the range of $0.94 to $1.04.

For the full fiscal year, which includes a 53rd week this year, we are raising our 2023 sales expectations to a range of $30.6 billion to $30.9 billion, driven by a mid-single-digit increase in comp store sales across both segments and the full enterprise. Based on better visibility into the margin headwinds I just detailed, we are narrowing our full year diluted GAAP earnings per share outlook to a range of $5.78 to $6.08, including the $0.12 legal reserve we took in the first quarter. We still expect selling square footage to grow between 3% and 3.5% for the year, and new store growth to be back-end weighted.

Other considerations and our 2023 outlook include the following: we have not included any assumptions for incremental share repurchases; depreciation and amortization should be in the range of $845 million to $850 million; net interest expense should be approximately $25 million for the third quarter and approximately $110 million for the full year; we are assuming an effective tax rate of approximately 23% for the third quarter and approximately 24% for the full year; we expect 220.6 million diluted shares for the third quarter and 221 million diluted shares for the full year.

Our outlook reflects continued margin pressures that we expect to persist through the back half of the year. Based on our continued market share gains at both Dollar Tree and Family Dollar, we are in a good position to generate higher levels of rebates and promotional allowances. We also continue to be disciplined in managing our cost structure, even as we make investments necessary to meet our stated long-term growth objective of $10 or more of EPS by 2026.

Now, I'll turn the call back over to Rick for closing remarks.

[Rick Dreiling, Chairman and Chief Executive Officer]

Thank you, Jeff.

We remain very pleased with the progress of our transformation in these early stages and remain confident in the three-year roadmap outlined in June. For those of you familiar with my operating philosophy, the immediate focus of any retail turnaround is growing sales. From that perspective, we are succeeding.

We are providing a new experience to the next-generation of customers across both our segments and seeing strong repeat purchase activity from these new shoppers. Our goal is to provide the consumer with convenience, value, variety and a great shopping experience. Our stores are already conveniently located; 87% of the population of the Continental United States lives within a five mile radius of one of our stores. As we grow our footprint, we'll be closer and more convenient to an even greater number of customers.

I remain confident that our long-term earnings potential can be realized within the timeframe we have communicated. Our improving top-line performance places us in a position of strength. And the combined impact of our merchandising, real estate, supply chain, IT and people initiatives should put us in an even stronger position relative to the competition.

Operator, Jeff and I are now ready to take questions.

[Operator]

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from Mike Lasser from UBS. Your line is now live.

[Michael Lasser]

Good morning. Thanks a lot for taking my question. So, Rick, the knock on the transformation at Dollar Tree has been that it's just going to take a lot more heavy lifting, a lot more investment than what was originally anticipated. And the fact that your sales are trending better than what was expected is a good sign, but it does not seem like the profitability is flowing through. So, a, do you have a good handle right now on all of the ins and outs of the different considerations with the profitability? And, b, as you look towards the next 12 months, there's going to be a benefit from lower supply chain costs. Is that going to flow through? Or will you use that as a source of further savings to then reinvest that back in the business to drive the $10 of earnings several years out? Thank you very much for taking my question.

[Rick Dreiling, Chairman and Chief Executive Officer]

Yes, Mike, three really good questions. First off, is the lift heavier than we thought it was going to be? I would say no. When we all got in on this, we knew what we were facing. I do think what we're trying to do, because of what has to be done, we are moving much faster than I thought we would. And when you move fast, it takes a little more expense, it takes a little more effort, it takes a little more push. And so, is the lift heavier? No, it's the same. But what we're trying to do is move as fast as we possibly can.

In regards to the drop-through, I think we are learning to do a lot of things, flexing a lot of muscles that we have not used in the past. The Family Dollar side is all about the commitment you make to the vendor community. And Jeff called out the potential for increased rebates and allowances, that's all driven by retail execution. And the Family Dollar people are doing a really terrific job on that.

What has happened on the Dollar Tree side, the Dollar Tree people have responded to the change in patterns that the consumer is exhibiting in our store, buying more consumables. So, I think and I always have subscribed to the fact that when top-line starts moving, everything else catches up. I remain incredibly bullish on our margin targets and where we're going, and I do not see any trouble to getting to more realistic margin levels.

In regards to the improvements in the supply chain, that will be a combination of both. As you know, we've got massive changes taking place on the supply chain side. Some of that will make it to the bottom-line and, some of it, we'll invest. And Jeff, I don't know if you have anything you want to add?

[Jeff Davis, Chief Financial Officer]

Yeah, just a couple of additional items, Michael. As it relates to the flow-through, and we tried to call this out, it's really a situation where our sales mix is an area that, as you see across the retail landscape, people are moving more into consumables, and that -- we're not immune to that. The other area that we talked about was shrink and the ongoing progression there. Those are the two more significant items from a gross margin basis that are really impacting us and addressing the flow-through or restricting the flow through.

The other thing that -- it's kind of muted in our comments, but this past quarter, we had about $0.07 related to an accrual adjustment that we needed to make for the progression of certain general liability claims that really dated back to 2019 and 2020 during the pandemic period. Once again, something that we needed to take care of, but it also restricted the flow-through and the tremendous sales that we were driving over the course of the year. So, I think that we're seeing right now, we've called out in the past and reason for our adjustment in the overall guidance that we gave last quarter, which was around sales and shrink, and then it was just further exacerbated, unfortunately, with this accrual adjustment we need to make.

[Operator]

Thank you. Next question today is coming from Edward Kelly from Wells Fargo. Your line is now live.

[Edward Kelly, Wells Fargo]

Hi. Good morning.

[Rick Dreiling, Chairman and Chief Executive Officer]

Good morning, Mr. Kelly.

[Edward Kelly, Wells Fargo]

How are you?

[Rick Dreiling, Chairman and Chief Executive Officer]

Good.

[Edward Kelly, Wells Fargo]

I wanted to dig in on the core Dollar Tree gross margin this quarter. If we think about the 33.4%, it's obviously a step back versus where you were in Q1. I was hoping that you could talk a little bit more about the incremental pressures, and then how we think about the back half. You had previously talked about a 36%, 37% gross margin for the year. Obviously, that's coming down. So thoughts there.

And then, just as it relates to all of that, how does this inform the longer-term target of 35.5% to 37.5%? It looks like this year, you maybe even below the low end of that range. What does it take to get to the middle end of that range? Do you need the backdrop to normalize demand [indiscernible], obviously you got freight coming in, but I'm not sure shrink is bottomed. Just thoughts around all of that, I think, would really be helpful. Thank you.

[Rick Dreiling, Chairman and Chief Executive Officer]

Yes. Great question again. Hey, what's happening in Dollar Tree is we're responding to the needs of the consumer. You go back a year ago, we did not have nearly the number of consumable SKUs that we now have in the store. Saying all that, our discretionary business on the Dollar Tree side was slightly up. But what -- when I think about quarter three, particularly our quarter four, we're going to be in a much stronger position on the margin due because of the change in the mix we think is going to happen. And that's because quarter four is a very seasonal quarter for us with Christmas and Halloween and all of that. So, I remain bullish on it. I do believe, Ed, that we are responding to the customer and sales takes care of everything eventually, and the two-year stack in Dollar Tree is just outstanding. So, I remain very, very bullish on where we're going with the margin.

[Jeff Davis, Chief Financial Officer]

And Ed, the other thing I would add to that, hopefully, I hope don't sound like a broken record here, but, unfortunately, the headwinds we're having in shrink are muting our margins right now. When you get a chance, you have an opportunity, take a look at the supplemental presentation that we have, you'll see that shrink is continuing to be -- restrict our margins by about 75 to 80 basis points on a year-over-year basis.

We are taking the appropriate actions, we believe, in the organization to start to address that. As you know, shrink is a sort of a trailing indication because stores are shrinking over the course of the year. And as you're adding new actions to reduce it, it takes time for those things to actually take hold. But between the sales mix and the shrink, once again, this is one of the things that have been muting the margin.

The other thing that while we are seeing less frequency of product cost increases and maybe the magnitude of those are not as significant, they are still in the marketplace. And Rick McNeely and his team are figuring out ways to work through those through a number of different merchandising actions. So, we still have a little bit of headwind there on product cost pressures, which as we move forward, depending on consumer demands, we believe that those will start to -- should start to abate over time.

[Edward Kelly, Wells Fargo]

Thanks, guys.

[Operator]

Thank you. Next question is coming from John Heinbockel from Guggenheim Securities. Your line is now live.

[John Heinbockel, Guggenheim Securities]

Hey, Rick. My question is multipart really revolve around the $3, $4, $5, right, frozen and cooler. So, you maybe talk about the experience you're seeing, because that clearly has to be lifting consumable comps. Your thought on the rollout, not just to all stores, but then expanding doors, right, getting to more than three doors today. Though on the rollout and then the impact that that's having on traffic, benefiting discretionary, right? And then ultimately, do you think that, that should -- it should hurt gross,, but the increased ticket, right, should positively impact expense control over time. So, maybe your thought on that as it impacts the Dollar Tree P&L?

[Rick Dreiling, Chairman and Chief Executive Officer]

Yes. Another effort that we're working really, really hard on. In regards to the number of cooler doors, we're going to go from three, I believe, 10 or 12 is the plan. We'll have a door that is $1.25, couple of doors will be $3, $4, $5, and we're actually looking as we look at the multi-price point to expand that even more.

The interesting thing is when a frozen food item goes into the basket, the basket actually gets larger. So, your point about driving traffic, driving transactions is spot on. The other interesting thing, when we went to $3, $4 and $5 that allowed us to offer a family serving versus at $1.25, where it's just a single serve. So, again, much more appealing to the actual -- to the consumer.

The other thing, John, the fact that we went to multiple price points allowed us to put ice back in the stores. And ice is always a big seller. When we were locked in on $1, we had to take it out and we went to a larger bag, 7 pounds, took it to $2, and again, we're back in the ice business.

I also agree that what will happen is we will keep growing sales and allow us to leverage our SG&A down in the stores. And then I also want you to think about the fact as we roll the Rotacarts out, that we'll be delivering to the Dollar Tree stores in those also. So, all of that time that it takes to unload a truck will be invested in putting more multi-price point items out on the shelves.

[John Heinbockel, Guggenheim Securities]

Okay. Thank you.

[Rick Dreiling, Chairman and Chief Executive Officer]

Thanks, John.

[Operator]

Thank you. Next question is coming from Paul Lejuez from Citi. Your line is now live.

[Rick Dreiling, Chairman and Chief Executive Officer]

Good morning, Paul.

[Paul Lejuez, Citi]

Good morning. Curious if you could talk about the monthly trend for each segment. Also curious to hear about your performance in urban versus suburban and rural locations. And anything that you would say in terms of the competitive landscape that you see changing out there from a pricing perspective? Thanks.

[Rick Dreiling, Chairman and Chief Executive Officer]

Yes. Great question. As I look at the flow across both banners through the quarter, it was pretty consistent all the way through. We started off strong and it remained strong through the balance of the quarter. In terms of performance, I think it's pretty even, but I will make this observation. It appears that the trade down from a higher income customer it's coming more in the urban environment than in the rural environment. So that's -- it's an interesting spin, but it's pretty even all the way across.

In regards to the competitive environment out there in regards to pricing, the way I see it, it's very rational right now. Nothing significant is going on. I would say the ad collateral is basically the same it's always been. Everybody's kind of -- I think everybody is on the same playing field right now.

[Operator]

Thank you. Next question is coming from Matthew Boss from JPMorgan. Your line is now live.

[Rick Dreiling, Chairman and Chief Executive Officer]

Good morning, Matt.

[Matthew Boss, JPMorgan]

Good morning, Rick. Great. Thanks. So maybe a two-part question. Rick, at the Dollar Tree banner, could you elaborate on the traffic trends? It seems like that's the real positive progression here. Any change in momentum that you've seen in August? And maybe just speak to market share trends that you're seeing by category at Dollar Tree?

And then, Jeff, on the expense front, I guess, is there a way to think about the progression of the foundational investments that you've been putting in place as we think maybe beyond this year? It seems like store standards and wages maybe two of the more stickier initiatives. Or maybe just to ask differently, what do you see as the comp that we need to leverage fixed costs maybe next year in the model?

[Rick Dreiling, Chairman and Chief Executive Officer]

So, I'll take the first part, Jeff. Matt, the traffic is steadily increasing in Dollar Tree. Our traffic was up 9% in quarter two. Really, really pleased with that.

Your other question is, discretionary was still up in Dollar Tree. It was up 3.9%. The consumables though were up over 11%, which is our way -- remember, consumables drive that traffic. And we have, by unlocking that price point and as we continue to unlock the price point, it's going to open up more opportunities for us to bring in really powerful value items. So, pleased with customer traffic. In fact, I'll throw this in, customer traffic was up 3.4% on the Family Dollar side. So, we are seeing movement now with the customer base.

[Jeff Davis, Chief Financial Officer]

And as it relates to the investments that we're making, they're really twofold. So, you had expense investments as well as CapEx. As we think about the expense investments, I think you're spot on with respect to the wage and store standard elements. There's a few elements that also transcend into our supply chain as we need to increase -- improve the standards in our DCs. We're right on track with respect to how we thought they would play out over the course of this year and then as we think about going into next year.

From a CapEx perspective, you kind of layer on top of that, then the work that we're going to be doing with our Rotacart rollout and what we need to do with trailers and lift gates and the actual [indiscernible] parts as well as what we're going to be doing from an IT perspective in adding additional capabilities with systems.

As you think about what's the level of comp that we're going to need to deliver, there's going to be a number of factors that you have to take into account and, quite honestly, we are working through that right now as we look out. One is going to be what's going to be rate of inflation as it relates to our cost in the marketplace, especially in labor, which is one of our more significant areas.

The other piece, of course, is going to be in sales mix. The comp, you need a little higher level of comp when your sales mix is more weighted towards consumables versus discretionary. We believe, over time, we're going to see this mix balance out and be not as significant a shift on a year-over-year basis, which you're seeing right now. Once again, that's over the long term. We had talked a little bit about this in the Investor Day, where we think that both Family Dollar and Dollar Tree will kind of average out over the period of time. So, I'm not going to give you a comp number that we need to meet in order to leverage expenses at this point in time, because there's a number of factors that we need to give a little more thought to and quite honestly, depending on what the economy does.

[Operator]

Thank you. [Operator Instructions] Our next question is coming from Simeon Gutman from Morgan Stanley. Your line is now live.

[Simeon Gutman, Morgan Stanley]

Good morning, guys.

[Rick Dreiling, Chairman and Chief Executive Officer]

Good morning.

[Simeon Gutman, Morgan Stanley]

Good morning. I wanted to just clarify and then ask the follow-up, all in one. The higher expenses this quarter, parsing it out between inflationary pressures being a little bit higher, or are you spending more than planned or than you thought?

And then bigger picture, the $10 in 2026, a long way to get there, gives you flexibility. I don't think you've said it's ratable in any way. It may not be linear. What happened with expenses show that you're not afraid to spend back into the business. So, curious where you're tracking. I'm sure you have your own plan. And where '24, I know it's an early look, may land in terms of that run rate of expenses?

[Jeff Davis, Chief Financial Officer]

Great question. And I'm glad that I got this question finally. One of the things that if you take a look at this quarter and the pace that we're on, we are right on our outlook that we had anticipated with respect to the level of spend in the transformation. And we are actually leveraging against our original forecast, given this strong sales performance. This is also taking into account once again, unfortunately, this accrual adjustment that we just needed to make.

So, as we move forward, we continue to be disciplined in our spend. We look, as Rick has said, in some situations, an opportunity to pull forward a few items if we believe that we're going to be able to get the returns that much sooner. But the rate at which we are investing is according to our original outlook that we were -- we said at the beginning of this year.

There are some modest inflationary components, as you can imagine, predominantly in utilities, and it is as a result of the heat dome that we're seeing on a national basis. The other area we're seeing a little more inflation would be in fuel, particularly in diesel fuel. And we've seen that here most recently and is reflected in -- both of these items are reflected in our guidance for the back half of this year.

[Operator]

Thank you. Our next question today is coming from Kelly Bania from BMO Capital Markets. Your line is now live.

[Rick Dreiling, Chairman and Chief Executive Officer]

Good morning, Kelly.

[Kelly Bania, BMO Capital Markets]

Good morning. Thanks for taking our questions. I just wanted to go back to the shrink and mix and just be clear about the magnitude that is maybe coming in different or the same versus your expectations, and also how those two factors are planned for the second half? And also just related to the shrink, what kind of margin investment at all do you see necessary to combat the shrink headwind? And is that in your long-term plan?

[Jeff Davis, Chief Financial Officer]

Great. Thank you, Kelly. There's a few things here. As we think about shrink and mix, it has definitely advanced a little further than what we had anticipated in our guidance that we had given last quarter. Having said that, we believe that there are other more favorable items that are helping to offset against that. One, in our sales momentum. Two, we are seeing additional freight opportunity as it relates from an ocean perspective.

But as it relates to shrink and mix, we had mentioned earlier that we had about $0.55 in total expected as an adjustment to our comp -- to our earnings, and that was going to be spread pretty evenly between shrink and mix. Of that $0.55, about $0.15 of that was actually incurred in the first quarter. So that remains -- that gives you $0.40 for the back -- for Q2 through Q4. In Q2, against our original forecast, shrink and mix advanced another $0.08 on us.

All of this is included in our forecast and as we're thinking about the back half, to the extent that there is any further acceleration, how we're thinking about offsetting that through other margin opportunities as we think about once again from additional freight favorability and/or other options that we have through the P&L.

[Rick Dreiling, Chairman and Chief Executive Officer]

And I'd like to add one thing, if I can, Jeff. We are now taking a very defensive approach to shrink. And it's taken us a quarter, but we have several new shrink formats that we'll introduce in the back half of the year. And it goes everything from moving certain SKUs to behind the check stand. It has to do with some cases being locked up. And even to the point where we have some stores that can't keep a certain SKU on the shelf just discontinuing the item. So, we have a lot of things in the works that's going to roll forward.

You had a question about the mix. Is that correct?

[Kelly Bania, BMO Capital Markets]

What's in the back half assumption?

[Jeff Davis, Chief Financial Officer]

She's asking specifically what's in the back half assumption, which I have not provided.

[Rick Dreiling, Chairman and Chief Executive Officer]

Yes. Okay. Fair enough.

[Jeff Davis, Chief Financial Officer]

So, let me -- what I gave was a pretty widespread answer. If you think about the balance of the year, in Q3, what we've said and -- really in the back half of the year, Q3, sales mix and shrink continues to be a headwind for us. We've taken approximately 70% to 75% of our stores and inventories. So, we'll be through the balance -- most of those stores by the end of the third quarter. So, sales mix and shrink continues to be a little bit of a headwind for us. Freight as far as diesel fuel continues to be a little bit of a headwind for us. And then once again, I said from utilities and this heat dome, that -- this could be a little bit of a headwind for us.

Offsetting that is going to be certain tailwinds. We've got sales momentum that we are projecting. We know that we believe that we have opportunities in additional freight from an ocean freight perspective. And also, we are starting to lap many of the SG&A investments that we started last year. As you go further into the back half of the year, we have less impact of sales mix and shrink, because once again, we've taken all of our inventory. Fourth quarter is a much stronger quarter for us from a seasonal perspective, and it's focus on discretionary. And then, the tailwinds in the back half or the fourth quarter, once again, we have the 53rd week, which we'll make an adjustment for continued sales momentum in our projection, ocean freight, and then once again, we can further along in lapping those SG&A investments that we started in the back half of last year.

So, as we progress through the quarters, the fourth quarter, we believe, will be one of our strongest quarters, because we have less headwinds from shrink and mix as well as the sales momentum and continued oceanic freight opportunity.

[Operator]

Thank you. Next question is coming from Chuck Grom from Gordon Haskett. Your line is now live.

[Rick Dreiling, Chairman and Chief Executive Officer]

Hey, good morning, Chuck.

[Chuck Grom, Gordon Haskett]

Good morning, Rick. How's it going, Jeff? My question is on Family Dollar. I was wondering if you could speak to the progress on rolling out the higher shelf heights across the chain?

And then just one for Jeff. On that $0.07, which banner was that in? Or was that in the corporate line?

[Rick Dreiling, Chairman and Chief Executive Officer]

Yes. In regards to the 78-inch profile, we hope to have that complete towards the end of the year. I would say we're probably maybe 40% or 50% done. While we're doing the Family Dollar side, we're also going to do the Dollar Tree side. So, we're making progress on it. And the H2.5 remodels, all of those have the new shelf profile in. And by the way, the shelf profile raise allows us to add more cooler doors and refrigerated.

[Jeff Davis, Chief Financial Officer]

Yes. And on the general liability claims, it was across both banners, and the best way to think about it was pretty evenly split.

[Operator]

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

[Rick Dreiling, Chairman and Chief Executive Officer]

No, thank you all for your time, and look forward to talking to you soon.

[Operator]

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