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Executives

Timothy J. Reid – Vice President of Investor Relations

Bob Sasser - President and Chief Executive Officer

Kevin Wampler – Chief Financial Officer

Analysts

Adrianne Shapira - Goldman Sachs

Mitchell Kaiser - Piper Jaffray

Charles Grom - JP Morgan

[Joseph Partel] - Morgan Stanley

Meredith Adler - Barclays Capital

Dan Wewer - Raymond James

Alan Rifkin - Banc of America

David Mann - Johnson Rice & Company

Patrick McKeever - MKM Partners LLC

Dollar Tree, Inc. (DLTR) Q2 2009 Earnings Call August 26, 2009 9:00 AM ET

Operator

Good day and welcome to the Dollar Tree, Inc. second quarter 2009 earnings release. As a reminder, today’s call is being recorded. At this time I would like to turn the call over to Mr. Tim Reid, Vice President of Investor Relations.

Timothy J. Reid

Thank you, Brandy. Good morning and welcome to the Dollar Tree conference call for the second quarter of fiscal 2009. My name is Tim Reid and I’m Vice President of Investor Relations.

Our call today will be led by Bob Sasser, our President and Chief Executive Officer, who will provide insights on our performance in the quarter and recent developments in our business. Kevin Wampler, our Chief Financial Officer, will then provide a more detailed review of our second quarter financial performance and provide our guidance for the remainder of 2009.

Before we begin I would like to remind everyone that various remarks that we will make about future 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. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors included in our most recent press release, our most recent current report on Form 8-K, our most recent quarterly report on Form 10-Q, and annual report on Form 10-K, all of which are on file with the SEC.

We have no obligation to update our forward-looking statements and you should not expect us to do so. At the end of our planned remarks we will open the call to your questions which we ask that you limit to one question and one follow up question if necessary.

Now I’d like to turn the call over to Bob Sasser.

Bob Sasser

Thanks, Tim. Good morning everyone and thank you for your interest in Dollar Tree. This morning we announced earnings for the second quarter of $0.63 per diluted share that represents a 50% increase over last year’s $0.42 per share.

Operating margin for the quarter was 7.3%, an increase of 170 basis points over the second quarter of last year. Operating income was $89 million, an increase of nearly $28 million or 45% over a strong second quarter performance last year.

Net income rose 51% to nearly $57 million. As previously announced, total sales for the quarter were $1 billion $223 million, an increase of 11.9% over the second quarter of fiscal 2008 and comp store sales increased 6.8% for the quarter. This is on top of a 6.5% increase last year and a 4.4% increase the year before.

For the first half of 2009 compared with last year, sales were $2.4 billion, an increase of 13%. Gross margin was 34.5%, an increase of 100 basis points. SG&A as a percentage of sales was 26.8%, an improvement of 60 basis points.

Operating income increased by $56 million to 7.7% of sales, an increase of 160 basis points. Net income rose 44% to $117 million in the first six months and earnings per share increased 43% to $1.29 per share. This is on top of a 27% gain in earnings per share in the first half last year.

I’m very pleased with our results for the second quarter and I’m especially pleased in light of the comparisons to what was a very strong second quarter last year. Our stores and our concept are more relevant than ever. Through good times and tough times, customers know they can save money at Dollar Tree and they are responding in record numbers.

Our long time customers are shopping us more frequently and new customers are finding us all the time. Our success is driven by the value of our merchandise and the quality of our shopping experience and the second quarter customers continue to rely on Dollar Tree’s expanded assortment of basic products.

Some of our top performing categories included health and beauty care basics, household basics, and food. But that’s not all. In addition to the growth in consumer basics, things people need every day, our discretionary business is also growing. Party supplies, books, floral, and lawn and garden supplies, delivered strong growth and our seasonal businesses continue to drive sales, energy, and merchandise excitement.

None of this happened by accident. We make a coordinated effort to wile the customer every time they visit our stores. We have an extremely hard working and diligent staff of merchants who travel the world to provide an exciting assortment of high value merchandise. Our store teams do their part to consistently provide customers with a clean, bright, and fun place to shop.

Seasonal transitions are well executed with fresh and timely displays of merchandise for every season. In the second quarter that translated into strong seasonal performance for Mother’s Day, Father’s Day, and graduation through summer and early back to school with excellent results. Sales were consistently strong throughout the quarter.

Our inventory productivity has been increasing. By leveraging our investments and logistics and technology, our store teams and our planning allocation and replenishment organization have been highly effective in flexing our inventory to meet increasing customer demand and improving our in stock of basics, developing smaller allocation of seasonal product consistent with sales trends, and consistently increasing our inventory turns over the past four years, a trend which continued with another increase in inventory turns in the second quarter.

In our ongoing effort to provide more of what customers want, we continue to expand our offering of frozen and refrigerated product to more stores. During the second quarter we added freezers and coolers to 39 more Dollar Tree stores. That brings our total to 1235 Dollar Trees compared with 1089 stores at the same time last year. We’re now on track to add freezers and coolers to an additional 160 stores by year end for the year. That’s 10 more than our original plan.

Some of you have asked for an update on payment types. We currently accept debit cards, Visa credit, Discover credit, and electronic benefits transfer or EBT in all of our stores and we accept food stamps or SNAP as it is now referred to in 65% of our stores. SNAP is an acronym for Supplemental Nutrition Assistance Program.

In the second quarter, debit card penetration increased to 130 basis points and credit card penetration increased by 50 basis points and I will point out that while these initiatives were completed in 2006 and 2007 respectively, their usage in our stores continues to increase.

With our expanded mix of food items, SNAP has become a more important component in our business. We accept food stamps or SNAP in about 2400 qualified stores. This compares with 1570 stores last year. This number will continue to grow as we roll out refrigeration and qualifying product to more stores.

Turning to store growth, Dollar Tree continues to expand and aggressively open new stores. During the second quarter this year we opened 60 new stores. We relocated and expanded another 16 stores and total square footage grew by 6.4%. We’re slightly ahead of our opening plans for the first half with 139 new stores and 41 expansions and relocations.

For the full year we now plan to open 220 new Dollar Trees, 20 Deals stores, and we will relocate and expand about 75 existing stores for a total of 315 store projects. As a reminder, this is a few more new stores than plan and a few less relocations. The result is slightly more square footage growth than our original guidance.

This year’s [flash] should average approximately 10,000 square feet which is similar to the 2008 class and within our targeted size range. We ended the quarter with 3,717 stores, a net increase of 200 stores compared with this point last year. Over the longer term we believe that we can operate 5,000 to 7,000 Dollar Tree stores across the country and the Deals model will expand this number.

While on the subject of growth, in addition to new Dollar Tree stores, we have 2 relatively new early stage growth engines to talk about. They are Deals and Dollar Tree Direct. Beginning with Deals, the excitement at Deals is building and we continue to refine this model. Deals is positioned to fill a unique void in the retail landscape. It’s a small box general merchandise variety store concept that offers customers a compelling assortment of merchandise at great prices in a convenient, bright, friendly, and fun shopping environment.

At Deals, not everything is $1 but everything is a value and we want customers to enjoy the experience of shopping at Deals just as they do at a Dollar Tree store. We currently have 150 Deals stores with merchandise focused predominantly but not limited to $5 and less. As we refine our assortments we’re seeing positive customer response across a broad range of categories.

The top categories for the quarter included domestics, health and beauty care, hardware, candy, and household supplies. Customer acceptance in these categories has been especially exciting. Many of the best items will never be seen in a Dollar Tree as they do not fit the $1 price point. For example, we’re having solid sell through on sheets and sheet sets. Our bath towel business at Deals is just terrific. In housewares we’re selling cookware sets and flatware sets. The prices aren’t $1 but the values are outstanding and customers are responding.

Throughout the rest of this year at Deals, the merchants are focused on rationalizing the assortment to fulfill the customers’ needs. We are focused on improving our replenishment disciplines, expanding the supply chain, and evaluating and testing our pricing strategy. Our stores are working to create impactful presentations of merchandise, strengthening our price message, and creating merchandise excitement.

As a team, we will continue to refine and improve key operating metrics that means continuing to upgrade our standards and run better, more compelling stores. We will continue to refine our real estate model and roll out new stores in a measured and thoughtful way. We opened 10 new Deals stores in the first half of the year and we plan to open about 10 more Deals stores in the second half. This is a few less than our original plan due entirely to timing of the chosen sites. We are extremely excited about the growth potential of the Deals concept and the opportunity that it gives us to serve even more customers across the country.

While on the subject of growth engines, last quarter we announced the launch of Dollar Tree Direct, our enhanced e-commerce platform. Dollar Tree Direct has a big idea whose time has come. It’s another way for us to offer incredible Dollar Tree values to more customers. Every online item is a value at only $1 and is sold in case pack quantities. Dollar Tree direct is especially important to organizations and small businesses or individual customers planning events – anyone who needs larger quantities and wants a great price should go to Dollar Tree Direct.

During the second quarter we expanded the selection available on Dollar Tree direct. We expanded the payment options available to online customers by adding Bill Me Later. We began to reach out to millions of customers via email blasts and we produced our first Deals Direct catalog and distributed it at all Deals stores. Customer acceptance has been positive. We’re just getting started. We’ll give you updates on the progress of Dollar Tree Direct including Deals Direct as we continue to grow and develop this initiative.

In the meantime, I encourage you to check out the new website at www.DollarTree.com. You’ll find that just like our brick and mortar stores, there’s always something new at Dollar Tree.com and everything is a great value.

Now I’ll turn the call over to Kevin Wampler who will give you more detail on these and other financial metrics during the second quarter and provide guidance for the remainder of the year. I will then provide summary comments and we will answer any questions that you may have.

Kevin Wampler

Thanks, Bob, and good morning. As Bob mentioned, our diluted earnings per share increased 50% in the second quarter to $0.63. The increase was driven by our strong sales, a 130 basis point improvement in gross profit, and a 40 basis point reduction in total SG&A expense compared to the second quarter last year.

Starting with gross profit, several factors contributed to this significantly improved performance. First, freight cost decreased as a percent of sales in the second quarter, a trend that we noted in the first quarter [of the well.] The company started to see the benefit of better ocean freight rates in Q2. Additionally, as most of you know, diesel fuel costs were a significant drag on our gross margin for most of last year. This is reversed I 2009 with a reduction in diesel prices and our ongoing improvements in operating efficiency.

Second, we achieved improved merchandise margins within nearly all product categories, driven by continued improvements in our sourcing. These improvements more than offset the negative pressure from our continued shift in product mix as food, health and beauty care basics, and household consumables increased as a percentage of our mix once again in the second quarter compared with the same period last year.

In addition, the comp sales increase of 6.8% provided leverage on expenses for buying, distribution, and occupancy. SG&A expenses were 27.2% of sales for the quarter, which is a 40 basis point improvement from the second quarter last year. This was driven primarily by leveraging of expenses for depreciation, payroll, and utilities, partially offset by increases in incentive compensation and professional expenses.

Depreciation and amortization was $39.1 million for the second quarter versus $39.8 million in the second quarter last year. This represents a decline of 40 basis points as a percent of sales. We continue to expect depreciation expense of $160 million to $165 million for the year.

Operating income increased $27.6 million compared with the second quarter last year. Our operating margin for the quarter was $7.3%, a 170 basis point improvement compared to the second quarter last year. This was the highest operating margin for a second quarter in six years. At that time depreciation was significantly lower. Our product mix was weighted much more towards discretionary merchandise, and we had freezer and refrigerator capability in fewer than 30 stores.

Dollar Tree’s operating margin remains among the highest in the value retail sector. The tax rate for the quarter was 35.3%. In the second quarter last year the tax rate was 37%. The lower tax rate this quarter reflects a reduction in the tax expense of $2.3 million resulting from an immaterial correction of deferred tax assets partially offset by reductions in tax exempt interest income and work opportunity tax credits as a percentage of income before income taxes.

As we look at the balance sheet, cash at quarter end totaled $358 million versus $115 million at the end of the second quarter of 2008. Cash net of debt was $91 million at the end of the second quarter.

During the quarter we invested $42.5 million to repurchase 1 million shares of Dollar Tree stock. This brings the total repurchases to 2.1 million shares at a cost of $85.3 million through the first half of the year. As of the end of the second quarter we had $368 million remaining in our authorization. As has been our practice, we will continue to view share repurchase opportunistically and we will update you on additional share repurchases if any at the end of the quarter in which they may occur.

Our inventory at quarter end was 3.5% higher than at the same time last year and selling square footage grew by 6.4%. Merchandise inventories per selling square foot therefore decreased 2.9% and inventory turns increased once again in the second quarter. Inventory turns have been increasing for the past 4 years and we’d expect this trend to continue for fiscal year 2009.

Capital expenditures were $33.9 million in the second quarter of 2009 versus $32.7 million in the second quarter last year. For the full year we continue to expect capital expenditures in the range of $135 million to $145 million with the focus on new stores, remodels, and the expansion of frozen and refrigerated capabilities to more stores.

Now I’ll turn to sales and EPS guidance for the third quarter and the rest of the year. As we look forward to the remainder of the year, we must be mindful of a couple of issues. We still face an extremely uncertain economy with great pressure on consumers. Overall there seems to be some stabilization. Unemployment is at a 27 year high, placing a very serious burden on families and impacting their buying decisions. We are factoring this uncertainty into our guidance.

We are seeing continued increases in demand for faster turning lower margin consumable products in our mix and we are managing our inventory accordingly. Additionally, we believe that diesel fuel prices will continue to be a benefit through the third quarter; however, our guidance model assumes that this begins to reverse somewhat in the fourth quarter. From an SG&A standpoint, professional fees will most likely be higher at least through the third quarter.

Our third quarter sales and EPS guidance then is we are forecasting sales in the range of $1.19 billion to $1.23 billion and diluted earnings per share in the range of $0.58 to $0.64 which would be an increase of 23% to 36% compared to the third quarter last year. This implies a low to mid-single digit comparable store sales increase.

We have raised our guidance for the full fiscal year 2009 as well. We are now forecasting sales in the range of $5.09 billion to $5.19 billion and diluted earnings per share are expected to be in the range of $3.10 to $3.25. This would represent an increase of between 23% and 28% over our record EPS of $2.53 in fiscal 2008.

Our guidance assumes a tax rate of 37.1% in the third quarter and 37% even for the full year. 6.5% square footage growth and a diluted share count of 90.4 million shares for the year. I will remind you, however, that the economy is extremely uncertain and therefore our performance could differ materially from our current outlook as conditions change.

With that, I’ll turn the call back over to Bob.

Bob Sasser

Thanks, Kevin. It’s certainly been a great first half at Dollar Tree. After growing our earnings per share by 21% in 2008, our momentum increased in the first half of 2009. Sales grew 13% and earnings per share were up 43%. Our gross margin improved by 100 basis points and our operating margin increased by 160 basis points to 7.7%.

Our investments in infrastructure continue to translate into better inventory management, more efficient stores, improved in stock condition, and a crisper execution of our model. Our new Deals concept is progressing and exciting. We’re opening new stores in new markets, building store teams, strengthening the merchandise organization, and creating merchandise excitement in our Deals stores. Customer enthusiasm continues to build.

We now have a world class website that I invite you to visit and a new and developing e-commerce business that gives us the opportunity to continue to expand our business, serve more customers, and grow our market share.

While many other retailers have pulled back, we are growing and opening new stores and we’re on track with our plan to increase our selling square footage by 6.5% this year. We have the capital available to support our growth plans while generating substantial free cash and we're committed to use our cash flow to build value for our long-term shareholders by running the business as effectively as possible and managing our capital in a way that enhances shareholder return.

In the first half of 2009 we invested $85 million for share repurchase and increased our cash with no change in long-term debt. Most importantly we're providing a better overall shopping experience for our customers. Our merchandise value and our increased mix of consumer basics make Dollar Tree more relevant now than ever and we're determined to continue to improve.

I'm very proud of our company's second quarter and first half performance and I’m excited about our future because I think we're in a position to do even better. We have room for a lot more Dollar Tree stores and the infrastructure and capital to make them a reality.

We are strategically located to serve Middle America. Our stores are bright, convenient and fun to shop and our values will remain relevant as long as people want to get the most for their dollar.

With our compelling mix of low price and high-value consumer basics we are relevant in tough economic times and when customers have a few extra dollars in their pockets, our assortment of fun, compelling, seasonally correct discretionary products can't be beat. And, after all, it's still only a dollar.

We're well positioned to benefit when the economy improves. The Deals format is young and fresh. It's improving operationally and proving its merit to the customers. Deals expands our potential for growth and more merchandise categories, expands our appeal to more customers and provides a platform for entry into more markets.

Dollar Tree Direct and Deals Direct are exciting and in early stages. We've just begun to harvest the potential of e-commerce retailing. It is an exciting time at Dollar Tree. We had a great first half. Our merchandise values are better than ever and we look forward to an exciting fall season. Wait until you see what's coming.

We're now ready for your questions. So that we can accommodate as many callers as time permits, we ask that you limit your questions to two.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Adrianne Shapira - Goldman Sachs.

Adrianne Shapira - Goldman Sachs

Just, Kevin, maybe help us think about third quarter guidance. It seems as if the low to mid-single digit comps would suggest a two-year deceleration and that's obviously not what we've been seeing. So is there anything that you see that prompts this change or is this just a healthy dose of conservatism?

Kevin Wampler

Well as I look at it we're projecting our earnings per share increase of 23% to 36% which feels pretty good in the grand scheme of things given where the economy is at and what's going on out there. Obviously we're going against 6.2% comp in the third quarter. So, again, it's a good, tough comparison. We had a great third quarter a year ago. We believe we've got some exciting products out there that will hopefully continue the momentum. But as we look at it we don't know exactly what's going to happen in the economy. We've seen oil prices start to rise a little bit. There's just enough uncertainty that, while we think our guidance is pretty good for the times, we have to take those things into consideration.

Adrianne Shapira - Goldman Sachs

And just maybe a follow-up on that, Bob, as you mentioned, I think the concern out there is if discretionary spend comes back that maybe the dollar stores perhaps lose some relevance. Obviously the results are not suggesting that. So maybe if you can kind of walk us through what is happening there on the qualitatively on the discretionary side in terms of make shift, the traffic trends, ticket trends to help us understand what's going on in the basket and why, if discretionary spend does come back, Dollar Tree should participate.

Bob Sasser

Well, Adrianne, I believe that as compared to any of our competitors we're the best positioned when it comes to discretionary spend. We've built the business for the first 10 years on mainly, mostly discretionary products. Our party business is still dynamic right now, even in tough economic times. It's right up there, one of our top performing departments and it's because it's such great value and it's only a dollar.

Our roots are in the toy business. We understand the toy business. We understand creating value for the dollar. And it's only a dollar. So when times are tough we're selling toys because it's only a dollar. And when times are better, people have a little more jingle in their pocket and they buy more of the things that they may not necessarily need. But it's just such a compelling value and it's only a dollar. So I believe we're positioned very well.

As to sort of the color on the quarter, all of our sales increased in the second quarter is driven by increased traffic. I view that as just a huge positive. We're getting more shops from our current customers, the people that have been with us for a long time. We're seeing new customers in our stores. We're attracting people that in the past would not have shopped us or had not shopped us. And they're trying us out and they're liking us. So our traffic is up substantially.

And when they're in the stores and they're buying HBC and they're buying household supplies and toilet paper and paper towels and all the things that you've got to have to live everyday and try to balance their budget, they're also buying. We're seeing great improvements, lifts in our party business. We're seeing our toy sales, some items in our toy business that are really vibrant. And, again, that discretionary product at Dollar Tree is still only a dollar and it really does survive the test of times.

We also think that our shopping experience sets us apart from others in the business. Most of it is driven just by the fact that everything is a dollar and that's thrilling to a customer. And it's intriguing to a customer. It's a little bit disarming. So good times, bad times, everybody loves a value. You love going somewhere where it's friendly and where it's fun and you never know what you're going to find. So it's a pleasant, surprising value that you find at Dollar Tree. And that thrilling shopping experience I think will transcend any economic times. I think that answered most of the color on the question.

Operator

And we'll take our next question from Mitch Kaiser - Piper Jaffray

Mitchell Kaiser - Piper Jaffray

I was hoping maybe you could talk a little bit about the store opportunity. I was at ICFC in May and it certainly seemed like your booth was vibrant. How should we think about the opportunity and then the rent dynamics with landlords? Is it a situation where you think you could accelerate store growth in the next year because it seems like you have ample cash to do that?

Bob Sasser

Mitch, you're right. Thank you for the question. We do have - we have the capital to do it. We have the opportunity, the business model. We have all the things in place to grow a little faster, open a few more stores. But we're always, as you know, been very choosy, picky over the stores, sites that we do choose to rent. And we do rent most of them. We don't build them ourselves. It's always, or most of the time it's second used space, some new projects.

But we are seeing opportunities at, number one, we are seeing opportunities at better retail space than we normally might have seen because some of that better space is coming into our sweet spot of what we're willing to pay. That's allowing us to get into some improved developments. It's also allowing us to get into some more densely populated areas that are typically higher costs. So we're taking advantage of what we're seeing in that type of space.

As far as numbers, we are, we stand prepared to do more. But some of the space that has become available is bigger than we need. Obviously it needs to go through some redevelopment. And it's being done. It's being redeveloped slowly. And over time I think we're going to find even more opportunities of space out there. But it is going to take us a little time and the landlords and the developers a little time to reparse that space and to redevelop it for our use.

So but you’re right. Our booth's one of the busiest. We're out there. We're growing. Mitch, we're growing and we're growing as quickly as we feel that we can grow profitably. And we're very selective on our sites and I think that's how you get the best sites.

One thing I'm very proud of is we are ahead of our historical store openings this year. We've gotten more stores opened earlier in the year and that's exciting. It looks like we are ahead of the curve on our store openings and I'm excited about what that's going to bring to us.

Mitchell Kaiser - Piper Jaffray

Is the philosophy then to look for better space or cheaper real estate? I mean, just how would you categorize that? I guess better space at cheaper real estate would be the optimal. But how should we think about that?

Bob Sasser

Well, we forecasted, or we guided at the beginning of the year what our square footage growth was and what our store count growth was going to be. And that's really what we're focused at. But we're always looking for more opportunities. And as there has been failures in other retailers out there, we have seen the opportunity at better space at lower prices, still not cheap prices, but lower than what it might have been. So we are taking advantage of some of that.

As far as a lot of the space, though, that's available, things like the Circuit City boxes, the Mervin's boxes, they're going through a process of being redeveloped into smaller spaces because we don't need sizes, spaces that large. We're looking for that 8 to 12, really that 10,000 square foot space with street presence and the best centers in the shopping hubs that we can find. So it's not cheap real estate. It's well-located real estate that we're after, real estate that we know where our customers, that broad middle class customer either lives or works.

We do look for spaces that are in shopping areas. We like the idea that there are other retailers around. We do some free standers, but not as many. We typically look to co-locate with other retailers. So the model, that's the model. And then the availability, we do see more availability and more landlords with availability to rent but it may take some time for that to turn into more space for Dollar Tree.

Operator

And we'll take our next question from Charles Grom - JP Morgan.

Charles Grom - JP Morgan

Kevin, I just wondered if we can just dig into the gross profit margin line a little bit. You talked about freight being a key contributor. And obviously that's driven but diesel costs. But the ocean - with the ocean rates coming in second quarter, just wondering if you can maybe dissect how much of the freight benefit was the lower diesel cost versus the ocean rates.

Kevin Wampler

As we looked at it - and the logistics team has done a nice job with working on the ocean rates. We really got that done in May and start seeing some of the benefits here in second quarter. And basically what we've got is basically the freight benefit is about half related to diesel, about half related to ocean freight.

And from a diesel perspective what we've got is a year ago in Q2 rates were basically $4.60 a gallon, whereas this year they're basically $2.82. So really a pretty significant difference from that as well. And I think what's just as important to us is the process and efficiency and improvement we've been working on. Again, the logistics team has really worked on working, as we talked about in the past, keeping up the trucks better, working on [stem] miles and using more backhauls to come back to the DCs with.

We are seeing gains from that. That is definitely proven to be a big win for us from a process standpoint. So those are the kind of things just beyond the prices that we really think are important because we don't control the prices. But we obviously can control the processes around it.

Charles Grom - JP Morgan

And just to clarify that, obviously diesel is going to be a benefit in the third quarter. But you would suspect that the ocean rates would continue to benefit beyond the third quarter, correct?

Kevin Wampler

That is correct.

Charles Grom - JP Morgan

And then just one for you, Bob, you talked a little bit to back to school and some of the categories. I was just wondering if you could give a little bit of color, elaborate on the back to school trends, how your business is doing in August across the various categories.

Bob Sasser

Well, I can't comment on August, but I can tell you our back to school, our early back to school started up well in both our Dollar Trees and our Deals stores. Our offering of school supplies and teachers corner really got off to a good start. In our Deals stores we started selling backpacks, you know, for $5 as soon as they hit the sales floor. So we're excited about a strong back to school season. It really goes through Labor Day. A lot of schools don't open until after Labor Day, especially this year with a later Labor Day kind of gives you a longer selling period, frankly for back to school.

As far as guidance, we don't do the interim updates, but we did raise our second half guidance, Chuck, and that should give you some confidence in how things are going and what we think about the business. Our current sales trends are implied in our new guidance.

Operator

We'll go next to [Joseph Partel] - Morgan Stanley.

[Joseph Partel] - Morgan Stanley

I was just wondering while your traffic gains are obviously impressive, it seems like your ticket hasn't increased in over three quarters despite an increase in usage of credit cards and debit cards. I'd also imagine that improved merchandise is starting to roll in due to some benefits of deflation. So I was just wondering, in your mind, what you think it would take to drive that ticket higher?

Bob Sasser

Well, we're always working on driving the ticket higher through the way we display our product, putting like product together, trying to get customers the idea of when they buy this, then why not pick up that. We have our people in stores suggestive selling, our cashiers have drive items. We use clips, strips and side panels and stacking [inaudible] and we really do a terrific job of what we call our five-star end counters which include all of those components trying to get related sales together.

I see the, if you'll bear with me a little bit, this traffic, we're seeing a lot of new customers. We're seeing a lot more frequent shopping from our existing customers. So that has an effect of leveling out the average ticket because they're coming more often, because they're coming and buying some of the things that you consume more frequently. So this is a real positive from the standpoint that I'm getting more chances to sell them by more frequent shops. And we're also seeing new customers come into the fold.

And new customers typically come in for trial. And they may try a few things first because they may not be sure. But they're so jazzed about it they've got to buy the stuff. And then, if they like it, then they may come back. And I think over time we'll see converting these new customers into more long-term customers. And also we'll see the effect of that and increased average tickets.

[Joseph Partel] - Morgan Stanley

And then also, just as far as your balance sheet, it looks like you're keeping $350 million on the balance sheet. So the first question is, is there a reason to keep that much there? And number two, should we think about share repurchases in the future as just the cash generated during the quarter if you want to keep cash at that level?

Kevin Wampler

Joe, as we look at share repurchase, we've always viewed it opportunistically. And you look back prior to last year, I think the company had repurchased almost $1 billion of stock over about a three-year period of time. Last year with the most uncertain challenging economy ever, the company made the decision to hold tight and build some cash. And I know there's a lot of companies out there that would much rather be in our position than the position they're in based upon some of those facts. So we feel good about that realistically.

We definitely feel it was the right decision at that point in time. And we have bought $85 million worth of stock back this year. We've got $368 million authorized yet. So it's still available to us. We always view it as a potential use of our free cash as we go forward. And I look at $358 million today. It doesn't feel like too much, necessarily. It's $91 million net of our debt. So all in all it doesn't feel like too much in the overall environment. It's maybe stabilizing a little bit, but there's still uncertainty out there. So that's kind of the way we view it at this point.

Operator

(Operator instructions). We'll go next to Meredith Adler - Barclays Capital.

Meredith Adler - Barclays Capital

Most of my questions have been asked, but I was wondering if you could talk a little bit about what's going on in terms of importing, the procurement side of things both in terms of costs and maybe diversification of where you're buying product.

Bob Sasser

Meredith, we still buy about 40% of our product from imports and most of that's coming from China. As far as changes in that, we do buy in other places in the world and, again, mostly Asia. But the phenomenon in China is not that you're moving out of China. It's that you're moving from Southern China factories to factories more in the interior and maybe even towards Northern China because that's where the labor is and that's where the factory movement is for the type of product that we're looking for.

Right now it's very favorable for us out of China. Prices are really good. We're seeing values that we're able to bring back some items into our mix that over the past year or two with some pricing on some of the items we've either had to change the item or drop the item or replace it. And some of that's coming back. Some of the product that we typically would have seen a size that you might have seen in our store, we're able to up size or up the count in reality giving more value to our customers for the dollar because that really is the art of what we do. It's all about what we - we know the retail. So it's always about how much value can we offer for the $1 price point at the margin that we're willing to accept. So we're always in control of our margins.

Right now what we're seeing is being able to invest a lot more into the product to get better product for our customers to drive even more value so when that product starts hitting the shelf we're going to be even better positioned. It's a very favorable time for us now in China.

Meredith Adler - Barclays Capital

And what's happening? Any changes in your relationship with domestic vendors? What is that environment looking like?

Bob Sasser

Well, I think we have great relationships with our domestic vendors. And, again, 40% is imports, so 60% is domestic. And, of course, with our expanded assortment of the basic consumer products that we now sell and a lot of name brands and maybe not name brands but our brands made here in this country, our domestic suppliers are extremely important to us, changes that - we're always trying to find ways to improve the flow of product into our DCs and our store.

Our philosophy has always been to take the product as close to the source as possible and then use our people and our methods and our infrastructure to deliver that product to our stores in the most efficient way. We've always looked for the best first cost. We don't ask for advertising funds, key market funds, co-op funds, allowances for this, allowances for that. We try to work with all the manufacturers and make it simple, taking all that stuff out, how can we work with you to make this product at the most efficient way so that we can get the best cost possible and pass that along to our customers in the form of value for the dollar price point. So I think our - just as we've grown our categories that we now offer to our customers, our domestic business and our relationships with our domestic suppliers has strengthened and I would like to continue to strengthen those relationships.

Operator

Your next question comes from Dan Wewer - Raymond James.

Dan Wewer - Raymond James

I wanted to ask about longer-term changes in merchandise mix. I recognize the strategy of growing your every day basic needs is really working well in this environment but over the years you've also said you don’t want to be like them, Family Dollar or Dollar General. You still want to be a store of more wants rather than needs. With that in mind at what point would you guestimate that your mix begins to level off?

Bob Sasser

You know Dan, we talk about it like flying an airplane, a little stick, a little rudder, depending on the times. What we have right now is a mix of both discretionary and non-discretionary products. When times are tough we sort of follow our customers and what they’re looking for. Right now with economic times tough and unemployment high and people trying to balance their budgets, customers buy more of the basic consumer products and we’re really going after that.

If they want to buy it, we want to sell it to them, and we’re supplying all that we can and that share has grown over the past couple years. Actually it’s grown over several years because you know 5 to 10 years ago we didn’t have hardly any of that product. So only with the introduction of our new larger store have we begun to expand into those categories. But right now it is a time where we’re really pushing hard and giving the customers that consumer basics because they want it. As times maybe change, as times get a little better…

By the way, I’ll tell you that while there are other stores buying those consumer basics right now, our other variety general merchandise discretionary categories are still growing. Matter of fact, some of them are growing double digits. So we have some vibrant general merchandise discretionary products in our stores right now and it’s selling because it’s only a buck and that does set us apart from other companies. When times improve, when the economic environment improves and people have more jingle in their pockets, more money to spend, discretionary dollars, we have a larger mix of that product and as that product sells faster, we have the visibility of it now with our POS systems and we have the ability with our replenishment systems and our allocation systems to get more of that product into the hands of the stores that are selling the most of it.

So again it’s a little bit, you’re flying the airplane, and it’s a little stick, it’s a little rudder, and you react to what the customers’ needs are today. As I look forward I do expect the environment to improve. We’re all hopeful of that. We’ll react accordingly and as our business changes, we’ve always been very good at staying relevant to what the customers’ needs are. Always testing a lot of product, always testing a lot of categories, and we’ll try things now that okay, I don’t know how to make money on this, but let’s test it in a small way and then we’ll figure out how to buy it and make money on it. We do a lot of those things. So you always see new things in Dollar Tree, just fine one and walk in, I bet you’ll find something that you didn’t know they were doing that. That’s how we stay relevant to our customers.

Dan Wewer - Raymond James

Just as a follow up, your inventory’s turning a little more than 25% faster than it did three years ago. Do you have a sense how much of that is coming from… is it the change in the mix toward consumables? Perhaps have you looked at just the turns on your discretionary categories to see how that’s evolving?

Bob Sasser

Our discretionary categories turn slower than our non-discretionary in general. There are items that are exceptions to the rule, but the things that people consume more frequently do turn faster. A lot of that we just introduced in the last several years so that has been helpful in turns.

To answer your question, we really know the turns of all our product by category now. Our POS systems and our unit systems and our retail merchandise systems. We have visibility to what we own, where we own it, how much is in the DC, how much is in the store, how much is in the pipeline. So we have control of all those things. Overall, turns are up. In general, overall categories in our business. Our fasting turning product is faster turning. It’s hard to say it’s faster turning than it was 5 to 10 years ago because we keep adding more of it, things like frozen and refrigerated.

We’re still in the process of rolling out, so it’s not really a good comparison. But I have to tell you, between the visibility and the systems that we’ve invested in and now the team of people that are using these systems and they’ve gone up the learning curve and they really understand the pulse of this business and they’re landing the product closer to the sale and the stores that can sell it better than we ever have and that’s really the key, what you’re seeing right now, on improving our turns.

You’ll go in our back rooms and sometimes you go in the day before the truck arrives and they’re just empty. That’s a good thing. In some of our stores we replenish a couple times a week and you see the same phenomenon. The truck’s in, it’s out on the sales floor, and then the back room is just only a few cases of what you need until you get to the next truck. So that’s our goal, not all stores exactly are that perfect, but that is our goal and I congratulate our buying and our allocations teams who use these systems that we put in over the past say 7 to 10 years.

Operator

Your next question comes from Alan Rifkin - Banc of America.

Alan Rifkin - Banc of America

Relative to your corporate comp of a 6.8% increase, can you maybe provide some color on the performance of the stores where you are only accepting food stamps, where you only have a refrigerator/freezer, and even those stores where both of those initiatives are now in the store?

Kevin Wampler

Alan, that’s a hard one for me just sitting right here to answer specifically. I can tell you anecdotally that in the total comp, the stores that we are introducing now, the 160 stores that we added this year or will have added this year for example, really don’t move to comp that much. If you look back though at the class of ’08, ’07, ’06, as we’ve rolled out the frozen and refrigerated, we’re very happy with what that has done with our business in comping year-over-year and also what it does at the ancillary sales of the other product that’s in the store because the key is that when we introduce the frozen refrigeration, sales go up, but traffic goes up, because people are buying it more frequently and they’re shopping more frequently, and when they’re in there, we do see a rise in the sales of all the other general merchandise businesses.

So our comps in our frozen stores for the second quarter were 6.5% and our non-frozen stores were about the same, it’s pretty close, a little higher in the non-frozen stores. So traffic was higher in the frozen stores than in the non-frozen stores. So in general that’s the color. That’s about all I can share with you that I know right now.

Alan Rifkin - Banc of America

One follow up if I may. Within the discretionary category, what has been the trend on a sequential basis with respect to merchandise margins, and would there be any reason for us to believe that this trend would not continue into Q4 when discretionary products become a larger proportion of your overall revenue base?

Kevin Wampler

Q4 is always traditionally one of our highest merchandise [scan] margin quarters because of the holidays and because of all the high margin seasonal product that we sell which we’ve already bought. We already know what that is but to answer your question, in general, our merchandise margins, we’ve always been able to manage them within a pretty tight range by department. What you’ve seen over the past couple years is the introduction of more of the consumer products so with the mixed shift has affected the overall margin over the past couple years but we are going into a high margin part of the year as not third quarter but fourth quarter is the highest scan margin with all the Christmas ornaments and all the gifts and the gift bags and wrapping and all the fun things we do and not all of that but a lot of that is the discretionary imported higher margin product that we carry.

Bob Sasser

We feel good about margin as we give you our guidance, it’s implicit in here, but we’ve always, you’ve heard me say before, we feel very good about the ability to manage our margin and that was… If you look back at last year, one of the toughest years in retail history, 2008, you think back about fuel prices that went up to $147 for a barrel of oil last y ear midyear. You heard Kevin talking about what that did to diesel prices. It went up to $5 a gallon. In 2008 Dollar Tree, where everything is a dollar, still had a record sales year, a record earnings year, and so we have always been very confident that we will be able to manage our margin even in the toughest of times. It’s frankly gotten a little better margin wise this year from a general merchandise standpoint.

Operator

Your next question comes from David Mann - Johnson Rice & Company.

David Mann - Johnson Rice & Company

Question on the timing of Halloween. Can you give a sense on a relative basis of this year’s holiday on Saturday, how you think that will play out?

Bob Sasser

We think it’s going to be great. I don’t think it’s going to be a huge windfall but Saturday is a good time to have Halloween so that gives us some good shopping days up until that time. We didn’t plan it to be tremendously larger because of that. We planned Halloween up this year because we think we’ve got a better assortment.

David Mann - Johnson Rice & Company

Secondly when you look at your mix of payment types and you take into account sort of the difference in average ticket by payment type and the mix of merchandise that’s bought, which of the payment types is most profitable for you and is there much variation between the types?

Bob Sasser

Cash is the most profitable. Unfortunately customers want to use those other ways, but the debit cards would be the least costly I would say between debit and credit.

David Mann - Johnson Rice & Company

That takes into account any sort of mix differences and any average ticket differences as well?

Bob Sasser

I think so. I really do believe so. The credit cards we’re getting some good results and it’s growing. Our customer though uses debit cards and I think the credit while it will continue to grow may not be as big of an impact at a Dollar Tree as it might be at a Best Buy.

David Mann - Johnson Rice & Company

Where would food stamps fall in that list?

Bob Sasser

Food stamps are really growing. They’re very small right now because it’s driven by the product that you sell. So we’ve begun taking food stamps as we’ve introduced this qualifying product into our stores but it’s growing and in some stores it is tremendously important to us. But overall it’s still a very small percentage of our sales but it’s important. It’s growing and I’ll tell you this. It’s important to our customers that we sell it so one of the things we’re really driving for is trying to provide the things that low income customer needs. The recipient of this SNAP opportunity, we sell things for a buck. They like buying from us. So we’ve accelerated our initiatives trying to work with the agencies to try to qualify in more stores as quickly as we can.

Operator

Your final question comes from Patrick McKeever - MKM Partners LLC.

Patrick McKeever - MKM Partners LLC

Just a related question on food stamps. What does the average ticket look like on food stamp transaction and has there been any change there as some of the economic stimulus funds have gone into that program? Incremental funds.

Bob Sasser

The average ticket is above average I’m told. But as far as the stimulus impact, it’s hard for us to tell because again we’re in the midst of rolling out more frozen and refrigerated stores and broadening our food selections in these stores so when you look at it, it’s really hard to tell if it’s the stimulus package although I believe it could be some of that. But it’s hard to discern the difference between stimulus package and just the rollout of the program at Dollar Tree.

Patrick McKeever - MKM Partners LLC

A second bigger picture question and that is, just wondering if you could size up the competitive environment and just given the forthcoming IPO from Dollar General. I know it wouldn’t change that much, doesn’t change fundamentals too much, but they are growing aggressively, just the continued growth in the space and then outside of the space, who do you think you’re taking market share from and where are the greatest opportunities for Dollar Tree?

Bob Sasser

Dollar General, they’ve been around a long time, its’ not new. The IPO is maybe new but the Dollar General stores have been there a long time. I’ve always admired them. They’ve always been a good store for years and years. They’ve always done a nice job. They had a few issues there for a couple years maybe and it went private and it looks like they’ve done just a terrific job in doing some things to reinvigorate their business. But as you know, our model is just different. We’re different in terms of the price point. They sell things for more than $1. Everything we sell is $1. We’re different in store size. Our store size is typically a little larger. We’re different in store locations. We’re where middle America shops and we actually might pay a little more for our real estate to get in the right spots.

We’re different in many ways so we really focus on what we can do and who we are and what we bring to the table and that is, we’re focused on bringing more value to customers at the dollar price point. We’re focused on running great stores because we believe that shopping experience is important to a Dollar Tree customer. We’re focused on profitable growth and we’re focused on just the things that we know that are important to our customers out there. We have 3700 and change stores. Again, just another point of differentiation, Dollar General has over 8700 stores I think, something like that.

So we’ve got a lot of room to grow out there and it’s compared to any of the other competitors. Our opportunity to open more Dollar Tree stores is really greater. We have fewer to start with. There’s more places where we can put Dollar Tree stores and with the addition of our Deals model, that opens up even more opportunities in new markets and some of the more expensive markets we think. We can run Deals stores and expand our opportunities for growth with that.

So I like where we’re positioned. I see our infrastructure built out across this country and we can go anywhere in the 48 states because we have distribution and logistics. We have people and we have training and we have the ability to run stores across all 48 states but we only have 3700 stores. So how many can we open? We’ve modeled it and we always say something like 5000 to 7000 store range. Who knows what it could be? Both our other key competitors have much more than that. Again, we’re focused on the profitable growth and again we think Deals can expand that.

So those are my thoughts about this space. We’re different. I like our growth opportunities the best. I love our business. I think we’re in the right place for the customers, really relevant for all times. The fun shopping experience in our business sets us apart and we really work hard to keep that. That’s not by accident. That’s something that we do because we want to do it and because we think that it’s important to our business so who else is out there, you know the same people that I see.

Who do we compete with? We compete with everybody because we’re general merchandise people. You’ve got the chain drugs out there and with seasonal and party and those kinds of things. You have the specialty stores like Michaels. We have food stores now. We have all the general merchandise people. The gas stations sell general merchandise now so where we’re taking it from, I can’t really tell you where, and I will tell you this, sometimes I believe we create a sale where none existed just because they saw it and it was a $1 price point and why not. So we’re excited about our future.

Operator

That’s all the time we have for questions. I’d like to turn it back over to our speakers for any additional or closing remarks.

Timothy J. Reid

Thank you very much Brandy. Thanks all of you who participated in the call. Our next conference call is scheduled for Tuesday, November 24, 2009. Mark your calendars. It’s Tuesday in deference to the Thanksgiving holiday on Thursday. So it will be Tuesday, November 24, 2009 when we do our third quarter. Thanks again and that’s it.

Operator

This concludes today’s conference call. We thank you for your participation.

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Source: Dollar Tree, Inc. Q2 2009 (Qtr End 8/1/09) Earnings Call Transcript
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