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Dollar Tree Inc. (NASDAQ:DLTR)

Q3 2009 Earnings Call

November 24, 2009 9:00 am ET

Executives

Tim Reid - VP of IR

Bob Sasser - President and CEO

Kevin Wampler - CFO

Analysts

Charles Grom - JPMorgan

Meredith Adler - Barclays Capital

Adrianne Shapira - Goldman Sachs

John Zolidis - Buckingham Research

Mitch Kaiser - Piper Jaffray

David Mann - Johnson Rice

Joe Feldman - Telsey Advisory Group

Alan Rifkin - Bank of America

Mike Baker - Deutsche Bank

Scot Ciccarelli - RBC Capital Markets

Operator

Good day, and welcome to the Dollar Tree Incorporated third quarter 2009 Earnings Call. 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. Please go ahead.

Tim Reid

Good morning, and welcome to the Dollar Tree conference call for the third quarter of fiscal 2009. I am Tim Reid, 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 the business. Kevin Wampler, our Chief Financial Officer will provide a more detailed review of our third 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, quarterly report on Form 10-Q, and annual report on Form 10-K, 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, our President and CEO. Bob?

Bob Sasser

I appreciate your continued interest in Dollar Tree. This morning we announced earnings for the third quarter of $0.76 per diluted share. This represents a 61.7% increase over last year’s $0.47 per share.

Operating margin for the quarter was 8.6%, an increase of 240 basis points over the third quarter last year. Operating income was $107 million, an increase of $38 million or 55% over last year. Net income rose 58% to $68 million.

As previously announced, total sales for the quarter were $1.248 billion, that was an increase of 12.1% and our comp store sales increased 6.5% for the quarter. That's on top of a 6.2% increase last year. Year-to-date through third quarter and compared to last year's sales were $3.7 billion, an increase of 12.7%.

Gross margin through the third quarter was 34.8%, an increase of 110 basis points. SG&A was 26.8%, an improvement of 80 basis points.

Operating income through Q3 grew by $94 million to 8.0% of sales, an increase of 180 basis points. Net income rose 49.2% to $185 million and earnings per share year-to-date through third quarter have increased 49.6% to $2.05 per share.

I am pleased with our performance in the third quarter. It speaks to the value of our merchandise and the quality of our shopping experience. Through good times and tough times, customers know they can save money at Dollar Tree and they are responding in record numbers. Our traffic is up. Long time customers are shopping more frequently and new customers are finding us all the time and when they shop our stores, they are finding a balanced mix of both high-value basics that are needed everyday and surprising value on discretionary and seasonal product selections that add excitement to the shopping experience.

As evidenced in the third quarter, our top performing categories included health and beauty care basics, household cleaning supplies and party goods. Seasonal products has always been a very important part of our business, we like the margin which is generally higher and it adds an element of fun to our stores. Our seasonal assortments are more complete and more compelling than ever and the customer can count on getting a value. Even though it is a discretionary purchase, it’s still only $1.

During the third quarter, our merchants provided a superior assortment of seasonal product. Our store teams executed the transition smoothly from summer to back-to-school through Halloween and our customers responded. The sell-through on Halloween and fall seasonal merchandise was excellent. Our stores are now set for Thanksgiving and the holiday season.

Dollar Tree has proven to be relevant in all economic times, through good periods and bad, we continue to thrill our customers. This is no accident; it’s our merchandise value and our shopping experience that brings them back. Our strategy has been validated by results and it’s largely due to five key initiatives.

First, over the past several years, we have right-sized our stores and added new product. Our stores are now a mix of things customers need and things customers want. The 10,000 to 12,000 square foot store that we are opening in strip centers and in free-standing locations across the country is ideal for our model.

It’s small enough to be convenient yet large enough to accommodate more of the needs based products that customers are looking for as they seek ways to balance their budgets. These consumer basics are driving footsteps into our stores on a more frequent basis and the increased customer traffic is driving sales over high-value high-margin discretionary product.

Second, we have developed and implemented retail technology tailored to our unique business model and we are now leveraging these investments. Using point-of-sale data by item, by store, we are making smarter allocation, reflecting our inventory to meet increasing customer demand and proving our end stock of basic and optimizing the flow of seasonal product to our stores consistent with sales trends. Our inventory productivity continues to accelerate and we've consistently increased our inventory turns over the past four years.

Third, along with retail technology, we've built a solid and scalable logistics infrastructure to support a nationwide retail footprint and I have some news for you here. We currently operate a network of nine distribution centers, eight of which are company owned and one which is a leased manual operation in Utah.

We acquired the Utah, DC with the acquisition of [Green Bags] a few years ago and while it has service well as we have grown the store base in that region, it’s not the optimal location as we go forward. This lease will expire in April 2010 and we've given notice that we will not renew. Instead, we have recently completed the purchase of building in San Bernardino, California and we will transition to this location by April 2010 when we close the Utah facility.

The new facility is 418,000 square feet slightly larger than the Utah, DC and it will be fully automated. In addition to adding capacity to our network, it is strategically located to reduce costs and better serve our base of existing stores while supporting aggressive new store growth in the Southwest.

The total cost for the new facility, land, building, automation, and installation of equipment is expected to be $36 million and will be purchased using available cash. The move to San Bernardino will increase our network capacity to support $7.5 billion in sales. We can supply products efficiently to all 48 states and every new store that we open provides leverage to our system.

Our fourth key initiative has been our growth strategy. While many retailers have pulled back, especially recently, we continue to open new stores and increase market share. In the third quarter of this year, we opened 94 new stores and relocated and expanded another 33 stores, and we have grown square footage by 7.2% this year.

Through the first three quarters of 2009, we opened 233 new stores and expanded or relocated 74 stores. And we ended the quarter with 3,803 stores. Since the end of the third quarter, we have completed our 2009 opening plan. For the year, we opened 240 new stores and relocated and expanded 75 stores for a total of 315 projects this year. The 2009 [class] average is approximately 10,000 square feet, which is similar to the 2008 class and within our targeted size range.

Over the longer term, we believe that we can operate up to 7,000 Dollar Tree stores across the country and the Deal$ model will expand this number, which brings me to our fifth key initiative and that is developing new concepts to expand future growth, including Deal$ and Dollar Tree Direct.

We currently operate 156 Deal$ stores, offering merchandised focus predominantly, but not limited to $5 and less. We opened 19 Deal$ stores this year. We refined our assortments. We are seeing positive customer response across a broad range of categories. Top categories for the quarter at Deal$ included domestics, housewares, household supplies and health and beauty care. Customer acceptance in categories not offered at Dollar Tree is especially exciting. Some of our best selling Deal$ items are coming from these categories and we will continue to build these assortments.

Looking forward, as we’ve refined the Deal$ model, we will continue to rationalize our assortments to create merchandise excitement and give our customers more reasons to shop at Deal$. We’re improving our replenishment disciplines, expanding the supply chain and evaluating and testing our pricing policy. We continue to refine and improve key operating metrics that means continuing to upgrade our standards and run better, more compelling stores and we’ll roll out new stores in a measured and thoughtful way.

While on the subject of new growth engines, earlier this year, we launched Dollar Tree Direct, our enhanced e-commerce platform. Dollar Tree Direct is another way for us to offer Dollar Tree values to more customers, including case pack quantities to organizations, small businesses or individual customers planning large events.

During the third quarter, we expanded the selection available on Dollar Tree Direct. We launched our Christmas Corner, featuring more than 200 items for the holidays and drilling 2 million visitors in less than a month and we’ve reached out to customers through more than 15 million email blast during the quarter.

Customer acceptance of our new website has been good and we see a major opportunity to expand this business. Our website is compelling and I encourage you to check it out at www.dollartree.com.

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

Kevin Wampler

As Bob mentioned, our diluted earnings per share increased 61.7% in the third quarter to $0.76. The increase was resulting from our strong sale which was driven by increased traffic, a 130 basis point improvement in gross profit, and a 110 basis point reduction in total SG&A expense compared to the third quarter last year.

Starting with gross profit, our gross margin grew to 35.3% during the third quarter compared with 34.1% in the third quarter last year. Several factors contributed to this performance. Merchandise cost, including inbound freight decreased 90 basis points. This was driven by lower fuel costs and lower ocean freight rates relative to last year, improvements in operating efficiency and increased IMU on many product categories driven by continued improvements in our sourcing.

These improvements offset the negative pressure from the shift in our product mix. Basic consumable products continued to increase as a percentage of our mix in the third quarter, compared with the same period last year.

In addition, expenses for buying, distribution and occupancy decreased 30 basis points by leveraging the 6.5% comp sales increased. SG&A expense was 26.7% of sales for the quarter, which is a 110 basis point improvement from the third quarter last year. This was driven primarily by a 40 basis point reduction in store operating expense due to lower utility cost leveraging of the comp store sales increase, a 30 basis point reduction in depreciation and a 25 basis point reduction in payroll related expenses. In the third quarter, unlike previous quarters this year, the leverage from the increased sales was only partially offset by increased incentive compensation.

Debit and credit card fees increased slightly as a percent of sales, reflecting continued increases in penetration of these forms of tender. We accept debit cards, Visa Credit, Discover Credit and electronic benefits transfer in all of our stores. We also accept SNAP or food stamps in 70% of our stores.

In the third quarter, Debit card penetration increased 200 basis points. Credit card penetration increased 30 basis points. With our expanded mix of food items SNAP has become a more important component in our business.

Depreciation and amortization was $38.6 million for the third quarter, versus $38.3 million in the third quarter last year. We expect depreciation expense of $155 million to $158 million for the full year.

Operating income increased $38.3 million compared with the third quarter last year. Our operating margin for the quarter was 8.6%, a 240 basis point improvement compared to the third quarter of last year. Year-to-date to the third quarter, operating margin is 8%, an increase of 180 basis points from the same period last year. Dollar Tree's operating margin remains among the highest in the value retail sector.

The tax rate for the quarter was 35.7% consistent with the third quarter last year. The tax rate was lower than previous guidance due to favorable provision to return reconciliation adjustments. For the first three quarters, the tax rate was 36.2%, which was also the tax rate during the first three quarters of 2008.

Looking at the balance sheet and same at the cash flow, cash at quarter end totaled $342.1 million versus $78.6 million at the end of third quarter of 2008. Cash net of debt was $74.6 million at the end of the third quarter. During the quarter, we invested $69.3 million to repurchase 1.4 million shares of Dollar Tree stock. This brings the total repurchases to 3.5 million shares at a cost of $154.6 million through the first three quarters of the year.

As of the end of the third quarter, we have $299 million remaining in our authorization. As has been our practice, we will continue to review our 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 increased 1.2% over the same period last year, while selling square footage grew by 7.2%. Merchandise inventories per selling square foot decreased 5.5% and inventory turns increased once again in the third quarter. Inventory turns have been increasing for the past four years and we’d expect this trend to continue for fiscal 2009.

Capital expenditures were $45.8 million in the third quarter of 2009 versus $38.8 million in the third quarter last year. For the full year, we now expect capital expenditures in the range of $160 million to $165 million. Capital expenditures are focused on new stores, remodels, expansion of frozen and refrigerated capability to more stores and the cost related to our new distribution center in San Bernardino, California. The total capital expense associated with the project will approximately $36 million, with $30 million being incurred in 2009 and the remainder in the first quarter of 2010.

As we look forward to the fourth quarter, we must be mindful of a couple of issues. First, consumers remained under great pressure. For the first time in a quarter century, unemployment is at double digit levels. This places a vary series burden on families which may impact their holiday buying decision. We are factoring this uncertainty into our guidance.

Second, while we have benefitted from lower diesel prices in the first three quarters of 2009, we expect this to become a headwind in the fourth quarter. Our guidance assumes that diesel prices will likely be higher in the fourth quarter 2009 than in the same period last year.

With all of this in mind, for the fourth quarter of 2009, we are forecasting sales in the range of $1.49 billion to $1.53 billion and diluted earnings per share in the range of $1.30 to $1.39. This implies a low to mid single-digit comparable store sales increase.

It is an increase of $0.07 per share to the low and high-end of the previous guidance range for the fourth quarter and would represent a 13% to 21% increase compared to the fourth quarter 2008 earnings per diluted share of $1.15.

For the full fiscal year of 2009, we are forecasting sales in the range of $5.17 billion to $5.21 billion, based on a mid single-digit increase in comparable store sales, a 6.5% square footage growth. Diluted earnings per share expected to be in the range of $3.34 to $3.43. This would represent an increase of between 32% and 36% over our record EPS of $2.53 in fiscal 2008.

Our guidance assumes a tax rate of 37.8% in the fourth quarter and 36.8% for the full year, and a diluted share count of 90.1 million for the year. I will remind you however, 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

It's been a great year so far for Dollar Tree, building on a solid performance in 2008. Our investments in infrastructure continue to translate into better inventory management, more efficient stores, improved in-stock position and a crisper execution of our model.

We have the capital available to support our growth plans while generating substantial free cash and we continue to use our capital for the long-term benefit of our shareholders. With an eye on the future, we are investing for profitable growth. Expanding our store base, developing new retail concepts including Deal$ and Dollar Tree Direct, and enhancing our supply chain with a new company-owned in automated DC strategically positioned in the Southwest.

Most importantly, we are providing a better overall shopping experience for our customers. With our compelling mix of low price and high value consumer basics, we are relevant in tough economic times. When the economy improve, our assortment of fund compelling seasonally correct discretionary product can't be beat and it's still only $1.

Our stores are strategically located to serve Middle America and we are well positioned to benefit from a strengthening economy. I am very proud of our company's performance this year and I am excited about our future because I think we can continue to improve and do even better.

We have plenty of opportunities to grow our business and our vision of where want to go. We have the capital to support our growth and a talented and motivated workforce to make it happen. I'm especially proud of our Dollar Tree people, our management team, and what they have accomplished.

We are 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) We’ll take our first question from Charles Grom with JPMorgan.

Charles Grom - JPMorgan

On the 6.5% comp in the quarter, can you remind us how that trend is and if you could shed any color on November sales to date?

Bob Sasser

Charles, basically the sales were pretty consistent throughout the quarter. There was strong good performance across many of our categories as I said in the press release, the HBC basics and the household cleaning supplies and party were the top performing categories. Seasonal was very strong, we were pleased with our back-to-school business this year. We were pleased with our other holidays, like Halloween.

Basically, there were no meaningful geographic differences in the sales, but we didn’t have much weather this year. I think, in third quarter we had no meaningful hurricanes or anything like that to affect things. It was just a very consistent solid sale performance throughout the quarter. As far as November, we really don’t have any comments to make about that. We’ll talk to you in about another couple of months about that one.

Charles Grom - JPMorgan

Then my second question is for Kevin, on the gross profit lines. I appreciate the color on the [90 bips], but if we dig a little bit deeper, how much you got from IMU, How much was on freight and fuel and then how much you got from occupancy leverage?

Kevin Wampler

We said that buying, distribution and occupancy was 30 basis points, the leverage that we got and then in regards to the 90 bips, realistically, the majority of that was fuel related. Obviously as we've talked about this year, ocean freight rates, we’re seeing some nice benefits and one of the things you need to remember is in Q3, we bring a lot of containers and as we are getting ready for the holiday season, so we do see a nice benefit year-over-year from that. So majority of realistic of this now, we still are getting some benefit from diesel fuel at this point in time in Q3, basically, little bit there but not as much as we've saw in Q2 based on other rates compare year-over-year. So that's kind of how we sell out.

Operator

(Operator Instructions) We'll take our next question from Meredith Adler with Barclays Capital.

Meredith Adler - Barclays Capital

I'd like to have follow on Chuck's comments or questions about fuel, and maybe just talk a little bit on SG&A as well. Can you look at the things that are benefitting you now and say how many of them are going to last to 2010, and clearly you are going to have a tough comparison by the time you get to third quarter of next year in terms of diesel rates? Do you think they continue to come down? I'm trying to get a sense of how much of this is going to be ongoing?

Kevin Wampler

As far as diesel fuel rates go, I think your crystal ball is probably just as clear as mine I mean I don't pretend to be able to predict whether they are going to fall out at the end of the day. What we can speak to in regards to SG&A is a fact that and we look at a kind of from two perspectives and we spoke a little bit about this previously and that is the things we buy and then the processes that we have. So as it relates to the things we buy, we've been working to consolidate our buying power. We created a centralized purchasing function inside the company a while back and we’re working around that to create synergies that we can drive through the business.

Obviously process is now more important and when you think about our business being vary and we sell everything at a dollar, so every transaction is an item that we have to buy, we have to shift, we have to receive it, we have to get it to our store, and get it on the shelf. So, there is a lot of process around that and those are some of things we look at specifically.

We have talked about earlier this year. We talked about how we have worked on the flow of merchandize just through the system, bringing it in on a more level basis into the DCs, getting it out to the stores. Really smoothing out the valiant peaks so to speak which helps everybody from a planning perspective, a labor perspective being able to get it, manage it and get it on to the floor in a faster timeframe. Those are the kinds of things that we look at that are going to continue to be worked on by the company that we'll continue to benefit SG&A on their overall basis.

Meredith Adler - Barclays Capital

Some companies I thought you say that it’s an ongoing process that you never run out of opportunities. Do you feel that’s true, or do you feel that all the low-hanging fruit has gone?

Bob Sasser

Meredith, we still have a lot opportunity in SG&A and some of the things that Kevin broadly described to you or the answers that looking at not only the direct cost of what we buy and we're leveraging our buying power on that, but also looking at the processes and there are a number of initiatives that we have ongoing that have proven success. What I believe, we can continue to drive down our SG&A costs. As far the margins, as Kevin said, your guess on the diesel fuel is [as ours] but as far as the things that we control we feel very confident that we continue to deliver the required initial markup and the merchandise margin that we need to hit our margin budgets going forward. If you look at the past, we’ve always been able to manage our margin within a pretty tight range and we feel very confident about being able to do that as we go forward.

Operator

We’ll take our next question from [Joseph Purcell] with Morgan Stanley.

Unidentified Analyst

I was just wondering if you could help us quantify the success of your new and relocated stores in 2009. How much better is that class performing versus prior years and are relocated stores contributing more to the comp this year versus last year?

Bob Sasser

Our new store productivity is up for the class of 2009 and it’s up pretty good. So, we’re very proud of our new store class this year as it compares to last year’s sales per square foot. I believe our relos are also performing better than a year ago and I think some of this is again, as I spoke in the opening comments, it’s all about rightsizing the store, it’s all about getting the balance between the mix of basic things that you need everyday versus the discretionary things that you want everyday. So, that’s what we’ve been, that’s our initiatives that we’ve been doing and I think that’s what we’re seeing in our increased sales per square foot productivity in both our new stores this year as well as our relocated stores, and we think there’s still room to improve that year-over-year as we go forward.

Unidentified Analyst

Your square footage growth for the quarter was a little bit higher than your annual guidance. Is that just a timing issue or did you take opportunity in some other real estate locations?

Bob Sasser

That was just timing.

Operator

We’ll take our next question from Adrianne Shapira with Goldman Sachs.

Adrianne Shapira - Goldman Sachs

My question related to the guidance for the fourth quarter, obviously we are up against the much easier comparison, you had some weak weather last year and I'm just wondering if you could help us think about it. We appreciate the environment as you said double-digit unemployment, but it does suggest the deceleration from current trends. Is it just prudent conservatism, given the environment or have you see something changed since last quarter?

Bob Sasser

Adrianne, obviously as we talked about it, in many ways the economy is still in uncharted waters as we talked about it with double digit unemployment which we haven't seen in 25 years. So this is something totally new to me in many places. So that obviously takes a big part of it and we look at the burden that creates on the consumer. It doesn't mean we don't have a lot of confidence in our business, it doesn't mean we don't have a lot of confidence in the merchandise that we're going to have out there, but it seems like a prudent things to do, given everything we noted. Again, we don't know things like fuel, we've seen it ramp up here in the second and third quarter and we want to be cautious in regards to that. So I think those are some of the things we take into consideration as we look at it.

Adrianne Shapira - Goldman Sachs

Then just a follow-up on the consumables mix pressure, can you give us a sense of where that had been trending? It sounds like it continues to be a negative pressure for the margin. Have you now started to last some of the peak pressures from the year ago, and where would you expect that mix to settle out going forward?

Kevin Wampler

It’s up about the same as it was in Q2 actually, and it starting to decelerate a little bit comparatively year-over-year, and again we’re not forcing it one way or the other. We are trying to give the consumers what they need. We had basics for discretionary. Obviously, in the current economic times the basic needs have come into focus, and especially as Bob talked about the categories that we are good this quarter which included the HBC basics which has done a real solid job towards this year. So, as we look that I think that’s really how we look at it at the end of the day. So, I don’t know that it's not really accelerating anymore. I guess this is really what your question was. I think it has started to maybe temper down a little bit.

Bob Sasser

Adrianne, what we are seeing and what you're going to see in fourth quarter is our normal holiday shift. So, these sales of discretionary product always lift in fourth quarter. That was increased as a percent of our business in third quarter, but that was fairly consistent with what we have reported in the past. We are doing business, we are selling customers what they want to buy and when they are under pressure and they are looking for ways to balance the budget, we still make money on that consumer base. It’s just that we sell it faster, we make less on each item, but we sell a lot more of it. The shift in the mix I think that it’s very manageable. We kind of feel rhythm of what’s going on there, and remember we did raise our guidance as we go forward. We feel very confident in our business.

Operator

We'll take our next question from John Zolidis with Buckingham Research.

John Zolidis - Buckingham Research

Question, I guess looking at the first half of the year, there was one criticism I could level was that there wasn’t much SG&A leverage. Obviously that turned around in the third quarter and you had significantly better leverage. Can you talk about what changed from the first half to the third quarter? And on the depreciation, it came in below what we’re looking for and below what you’ve [bode] your guidance for depreciation for the year, looking into next year can we expect depreciation to start to grow again on year-over-year basis, especially with the addition of the extra distribution center?

Kevin Wampler

With regards to your first question John and regards to SG&A, I mean, I think one of the difference is what we called out is in regards to the payroll expense line item. You looked at the first of couple of quarters of the year, we didn’t get a lot of leverage there and a lot of it was because the decrease we were seeing in the basic payroll was more than offset by incentive compensation, based upon the favorable sales and earnings results. We basically started, as we talked about in this quarter, we actually saw some of that we were able to more than offset that are decrease in payroll expenses outside incentive compensation was higher and we were able to create 25 basis points of leverage. So, that’s something that was a pretty significant change I guess quarter-to-quarter.

We also saw a nice decrease driven out of store operating expenses and especially around utilities a little higher than we had been seeing. It was not the hottest summer around, it was a little bit milder, Instead of seeing consistent rate increases, we’ve seen some of those actually decrease a little bit, some of that was based on delivery charges which again is based upon fuel cost. So I think those are some of the things beyond appreciation that we've seen helping us.

With regards to depreciation for next year, I don't know that we are ready to say that it’s going to continue to go down or go up. I don't know that we haven't given guidance; we haven't given that information out there. What we can say obviously around the cost of the San Bernardino, DC is a fact that we are going to actually save dollars in the long run. That was part of the analysis of making that decision to close the Utah facility when the lease expires and open up the new location. I think that overall basis, we are going to be in a better position and I think that's what we need to keep in mind.

Operator

We'll take our next question from Mitch Kaiser with Piper Jaffray.

Mitch Kaiser - Piper Jaffray

I found it interesting that you didn't reference food as a big sales driver in the quarter for the first time in several quarters. Could you just talk a little bit about how the mix is shifting and how the customer response has been, especially given the strong traffic trends that you’ve continued?

Bob Sasser

Mitch, our food sales continue to be strong. We continue to rollout frozen and refrigerated product but that has become less of a percentage of the total we have. I think we rolled out a 160 some stores, frozen refrigerated this year, but we have more than 1100 I think store, so the impact on the total is less as we roll out frozen refrigerated. We have expanded our foot assortment over the past several years and while it’s doing very well and we are very proud of it, it was outpaced. It was simply outpaced by HBC basics and household cleaning supplies.

The growth in those two categories outpaced a really a solid performance in a large sales number on our food business. So that what you are seeing, we’re selling the broad assortment of things that people need everyday. Our customers are finding the cleaning supplies that we sell. It's only a dollar and that's worth, that clean just as well as the other stuff and they have some balance in their budget. They are buying more of that HBC of course with hand sanitizers and all of the things that are going on with the swine flu. We carry a lot of that type of products and that have driven a lot of the sales increases in that. I would just have to tell you though that one of the things that we looked at that we are very proud of all of our business but our party business was right up there in the top three as far as growth. It continues to be a rapidly growing and expanding business for Dollar Tree.

Mitch Kaiser - Piper Jaffray

It’s pretty safe to assume that the only -- the traffic has not driven simply by the food. So, it’s a broader assortment of…?

Bob Sasser

It really is. It's not just the food, it's the whole idea of selling more of the things that people need everyday and that includes their households supplies as well as the HBC in addition to the food and beverage and candy and all the things that you need to consume.

Operator

We'll take our next question from David Mann with Johnson Rice.

David Mann - Johnson Rice

Can you give us a sense on what the product cost is on merchandize that you sourced out of Asia for the spring? How that compares to last year?

Bob Sasser

I will tell you that pricing has been favorable throughout the year. The spring product that we have sourced for next year, the pricing was favorable. Our initial markup by the way in the third quarter was up. We continue to see really more of a return to normalcy and improvement in our cost out of Asia and not just in the cost of ocean freight, but also in the cost of products that we are buying. That has been a favorable trend. I think that’s going to continue and again it was really the unusual turn of events last year driven by those sudden spikes in oil prices that drove the prices up and even then we were able to manage through that. Because of, the way we run our business; because of, we feel that we’re in charge of our market, it’s all about how much value we put into the product or the dollar and how much margin we plan to make on the product. We are in control of that. We think that as prices go up and down, we’re able to manage through it and our history says that we’ve been able to do that.

David Mann - Johnson Rice

In terms of Halloween, can you just elaborate whether there was any unusual bump up from the timing of the holiday being on the weekend? Did you have any increased benefit in party or candy?

Bob Sasser

That was absolutely the best time to have Halloween. I have vote for less [footage] there every year. It really does give the best of our world for the parties and the adult parties and as well as the Halloween, the case [trick-or-treat]. So, that’s about as good as it gets from the timing aspect.

Operator

We’ll take our next question from Joe Feldman with Telsey Advisory Group.

Joe Feldman - Telsey Advisory Group

Question we wanted to ask you that was on Deal$, if you could just give a little more color on what do you think in there, I know in the prepared marks you outlined a few things you’re working on, maybe you could share how some of those programs are benefiting and what’s not working and then how you envision the chain a few years from now. Is it going to be double, triple and what you’re thinking?

Bob Sasser

We are very excited about the Deal$ model, because it gives us the ability that by lifting restriction of the price point we can offer more products to more customers. We can add categories consistently that we are not able to do at a Dollar Tree store which is going to give us the ability to serve more customers. To give just a little more color on the Deal$ in third quarter, our top categories included domestics and housewares and household supplies, HBC, our health and beauty care product was in the top five. We also had a very good performance that back-to-school, whether some back-to-school items including our teaching tree and supplies for the classroom we had a bagpack for $5; that was a [sell-off]. Overall, we are offering broader assortments with compelling values in our domestic area. We are able to sell sheet sets and we are actually selling king-size sheet sets for $10. So we are seeing a lot of growth in the domestics and the household area.

We are expand in this new categories including small appliances for the fall, automotive products, including antifreeze and motor oil, so it really does give us the ability to get into some categories that you just don't see consistently and can't see consistently at the price point of a dollar. Now have 156 Deal$ stores. We get a lot of room to grow, but we are still improving the model. I'm proud of lot of the progress that we've made on the average tickets. All Deal$ stores average ticket is over $9 and our new stores is approaching $10. So that's a big improvement from our Dollar Tree average tickets which runs around $7 or maybe little better, but when we have our average tickets that includes a multi-price point or higher than a dollar item, our average ticket jumps up to almost 14 and our new stores over $14, so we see that as the customer responding positively to the product offering.

Almost 50% of our transactions now include higher than the dollar price point item, another key indicator to us that the new more than a dollar product is resonating with our customers. So, we are excited about our Deal$ stores. We have got some new stores that are really exceeding expectations. We have got some new categories that are exceeding expectations. We are still working on communication of the price image in our stores. We have got our ways to go there, we'll get it, but there is still opportunity to improve the price image in the stores.

We are still working on improving the shopping experience in our stores, raising the standard, running better stores, and we are still really focused on identifying and communicating what our Deal$ stores stand for in the eyes of the customers. What's the top of mind? When you think of Deal$, what you think to our customers? So, we are excited about it. That gives you a little bit more color, where we're going to go in terms of the numbers. Next year, we haven't announced our growth plans, but I will tell you that Deal$ will be a part of that growth plan. As we go through, we are in this for the long haul. So, as we continue on, continue to open up more Dollar Tree stores across America, we are also going to be expanding our Deal$ concept.

Joe Feldman - Telsey Advisory Group

What are you seeing competitively? I know everything in your stores in dollars and you can’t really beat that price, but from Dollar General, Family Dollar, Wal-Mart, they are so much focus on the lower price and value this Holiday season, anything to note there?

Bob Sasser

If you are not value these days, then this is just really struggling. It looks like that the folks would value and their value component in their business are the ones that are doing the best. Dollar General, they’ve been around long time, they’ve really done a great job. I’ve always been an admirer of Dollar General, but it’s just a different model. We’re different than they are or they are different from us, whichever way you want to look at it. I am real proud of our Dollar Tree sales growth and our industry-leading margins and our inventory management and our consistent store expansion. I think we stack up very favorably against the other dollar stores and again we’re different and we’ve got more room to grow with the smallest of the three major players out there, we’ve got more stores to open and I like our position.

As far as the other guys and pricing, it’s competitive out there, but again I think that we do a nice job of offering value to the consumer and a terrific shopping experience and I think that’s what’s going to take us to the end zone. Wal-Mart, we pay very close attention to them, number one retailer in the world, they are awesome. They are also a major traffic driver and we like to be close to Wal-Mart because they bring customers under the shopping centers. So, if we need customers to come by our store, we can get [amend] the front door, we believe our values and our shopping experience will do the rest. So, we feel very confident about being able to compete in what is an increasingly competitive environment.

Operator

We’ll go next with Alan Rifkin with Bank of America

Alan Rifkin - Bank of America

Bob, does the decision to not renew the Utah facility but rather own a facility in California signal a greater commitment towards store expansion in that state specifically?

Bob Sasser

Yes. We’re very excited about the Southwest. I don’t think this marks any special milestone; we’ve been headed there for some time. We've got a lot of stores in the southwest, but our lease was up in Utah and when the lease was up, we took the opportunity to renew the lease or do you build the location or do you buy a location and when we started looking at the optimal location with our growth plans for the next three to five years out there. We saw that Salt Lake City was not the optimal location moving to San Bernardino gives us a better access to the port facility for example. Overtime, it gives us better stem mileage. We’ve reduced our cost and support our growth better by being in San Bernardino than we do in Salt Lake City, Utah but the timing was really just more at end of the Salt Lake City lease and there was a chance to either move or sign find up another five years.

We chose to move and also it’s the right time to buy, we got a deal I believe. We, as always are looking for opportunistic purchases and then selling California and San Bernardino, there were opportunities buildings that were already built that we could take and make along with our own automation, but that we got at a much lower price than if we build it ourselves. So that was really the answer to the timing.

Alan Rifkin - Bank of America

As we look at 2010, and hopefully it does marked an inflection point in terms of a rebound in the economy. Can you maybe just shed some color on how you are thinking about the proportion of non-consumables and your mix? Would it be reasonable for us to expect that if in fact the economy starts to improve even in the latter part of 2010 that we can't see the non-consumables portion of our mix start to increase?

Bob Sasser

Yeah. We think we are right for all times, we'll do better in an improving economy. We want to see a strong economic recovery and really it comes down to the value of our merchandise and the quality of our shopping experience, the same things that have brought us for the past 27 years to where we are. Customers are acutely focused on value today and that’s what we have. As they explore their choices for a value, we get new customers right now, we are more relevant than ever for customers given that the things that they need as well as the excitement of the things that they want. Our general merchandise is growing right now. In these tough economic times, it has grown quite as fast over the past two years as the consumer basics have grown.

Our real estate strategy puts us right squarely in the middle where Middle America lives and shops. We think that as the economy improves so will our consumers' ability to buy. They will be out. They will be more traffic in the shopping centers. They will come into our stores and when you come into our stores, it's amazing what you can buy and it's still only $1. It maybe discretionary, but it's still only $1 and that’s why we are able to grow it now and as the economy improves, I think that’s why we grow even faster.

Operator

We'll go next to Mike Baker with Deutsche Bank.

Mike Baker - Deutsche Bank

Two quick questions, one is on the average tickets, you talked about traffic drive in the comp. Was the ticket up, down or flat? Then my follow-up question would be on what you spoke about what the incentive comps. So, was it [big of a drag] in the third quarter? I assume we should assume going forward that that also won't be as big of a drag as you probably start to cycle up against some of the increases in the sense of comp? Is that a fair statement?

Bob Sasser

Your first question with regard to average ticket, it was basically flat, again, as we’ve said which has been pretty similar all year. Comps have been driven by traffic. With regards to fourth quarter incentive comp, I don’t know that I can say exactly. We don’t give specific guidance to that at this point in time. Anything that we know is implied within our guidance for the fourth quarter of this point in time. So, I don’t think I can make up an assumption one way or the other today as we sit here where that will fall out exactly, whether it will be plus or minus overall, but I think we’ll do everything, we’re keen to leverage it and if that happens, we’ll like it.

Operator

We’ll go next to Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli - RBC Capital Markets

Question about kind of merchandise pricing, I think Bob you mentioned that you got another round of good pricing for the spring already and obviously you guys are pretty sensitive giving your fixed selling price points. If we were to see a persistently deflationary environment from a strategic standpoint, are you inclined to pass the majority of that better pricing line to consumers, or are you in a position at this point where you might be able to keep a little bit more in the form of the higher gross margins?

Bob Sasser

We make the call relative to the timeframe and basically how we feel about the consumer’s propensity to spend and what I mean by that is we’re more likely than not in tough times to invest that back into the value of the product. Times are tough out there, the way we remained competitive is we give more value to the customer for a dollar than anyone else can and so when costs go down we’re likely to invest a lot of that, if not all of it depending on the times back into the offering better product for the same price versus just taking that in the form of margin.

I believe that we have taken some in the form of margin this year. I think that some of the things that we see in our initial markup. As I look forward into next year, I'm expecting things to remain fairly difficult out there and we are looking up right now. We are working real hard for the customers to offer the most value we can for a dollar.

Operator

We'll take our last question from Laura Champine with Cowen.

Unidentified Analyst

It’s actually [John Kurningson] in for Laura. It looks like cash on the balance sheet is at similar level from the earlier quarter this year. Can we think about share repurchase are being similar in Q4, just from modeling perspective?

Kevin Wampler

Obviously, our guidance assumes no repurchase, and I think in general when we look at the cash levels, obviously the first thing we’re always going to do is be able to fund our business and we continue to do that by funding the expansion of our stores through new stores and remodels, 315 project this year as well as in this case, purchasing a new DC in San Bernardino. So those are kind of things we always look at. Historically we've looked at the stock repurchase plan as an opportunity to returns to our shareholders and I think we'll continue to look at it as we go forward.

Unidentified Analyst

Then just one follow-up, Dollar General throughout has been pretty aggressive in long-term store expansion plan. Have you guys thought about the ultimate store base you can support? Has those plans changed at all?

Bob Sasser

No. We think that there is room for up to 7000 Dollar Tree store across country and that the Deal$ model will expand that number.

Operator

I will then turn the call back over to Mr. Reid for closing remarks.

Tim Reid

Thank you all for participating in the call today. Our next conference call is scheduled for Wednesday, February 24, 2010 when we will announce the results for our full-year 2009. Wish you all a happy Thanksgiving and thanks again for being part of the call.

Operator

This concludes today conference call. Thank you for your participation.

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Source: Dollar Tree Inc. Q3 2009 Earnings Call Transcript
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