Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

TRANSCRIPT SPONSOR
Wall Street Breakfast

Dollar Tree Stores Inc. (NASDAQ:DLTR)

Q2 2007 Earnings Call

August 29, 2007, 09:00 AM ET

Executives

Timothy J. Reid - VP, IR

Bob Sasser - President and CEO

Kent A. Kleeberger - CFO

Analysts

John Zolidis - Buckingham Research Group

Mitchell Kaiser - Piper Jaffray

Stacy Turnof - Merrill Lynch

Dan Wewer - Raymond James

David Burman - Burman Capital

Patrick McKeever - Avondale Partners

Jeffrey Sonnek - Friedman, Billings, Ramsey & Company

Joan Storms - Wedbush Morgan Securities

Paul Trussell - JP Morgan

David Cumberland - Robert W. Baird & Co

William Keller - FTN Midwest Securities

Adrianne Shapira - Goldman Sachs

Christine Augustine - Bear Stearns

Presentation

Operator

Good day and welcome to this Dollar Tree Stores Incorporated Second Quarter 2007 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. Please go ahead.

Timothy J. Reid - Vice President, Investor Relations

Thank you, Tom. Good morning and welcome to the Dollar Tree conference call for the second quarter of fiscal 2007. My name is Tim Reid. I am Vice President of Investor Relations. Our call today will be led by Bob Sasser, our President and Chief Executive Officer, who will provide some insights on our performance in the quarter and recent developments in our business. Kent Kleeberger, our Chief Financial Officer will provide a more detailed review of our second quarter financial performance and financial guidance for the third quarter and full fiscal year 2007.

Before we begin, I would like to remind everyone that various marks 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, 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.

And with that said, I would like to turn the call over to Bob Sasser, our CEO. Bob?

Bob Sasser - President and Chief Executive Officer

Thank you, Tim and good morning everyone. This morning we announced earnings for the second quarter of $0.33 per diluted share. This represents a 18% increase over last year's $0.28 per share and it is at the high end of our latest guidance. Total sales for the quarter were $971.2 million, which is an increase of 9.9% over the second quarter of fiscal 2006. Comp store sales increased 4.4% for the quarter and was a result of 3.3% increase in store traffic and 1.1% increase in our average ticket with the largest increases coming in the month of May and July. As a reminder these sales results were on top of the 4.2% comp store sales increase for the second quarter last year and this was the sixth consecutive quarter of comp store sales increase of 4% or better.

Several key merchandise initiatives grew by a performance. First of all, our seasonal excitement was strong throughout the quarter, beginning with the Mother’s Day Build a Basket promotion and continuing through the 4th of July red, white and blue celebration. Memorial Day was especially strong with our picnic promotion and our steak sale was a real hit with the customers. Can you steaks for a buck? Our customers did and I really love them. Throughout the quarter our cool summer savings promotion added excitement with an emphasis on beach toys and picnic supplies and beverages and snacks and sun glasses and many of the things that you need for the beach, all for just $1. Our store teams really get behind this promotion. They have a lot of fun and good natured competition aimed at leading their district in sales during this period.

Secondly, and in addition to our seasonal business, our assortment of high value basics continue to gain sales momentum. Our customers are finding a better selection in our stores of the things they need everyday and its giving them the reason to shop with us more often. These are categories like health and beauty care, housewares and household supplies, things that people need every day. And when they are in the store, we are not disappointing them. The use of our POS data to drive smart allocations and our auto replenishment and our improved store ordering is producing a efficient flow of basic products. Our in stock position has improved greatly resulting in higher sales.

Third, we expanded our marketing initiative during the quarter. In store promotion and especially the item of the week drove add on sales and in store excitement. Of special note, we reduced our electronic advertising and stepped up our printed coverage on our May pre-Memorial Day tabloid and had great results. Last, we continued our expansion of frozen and refrigerated product to more stores. To give you an update on our progress here during the quarter, we added freezers and coolers to 131 Dollar Tree Stores bringing the Company total to 873 stores that compares to 360 stores for the same time last year. The results have been excellent. We are attracting more customers more frequently with this product and the increased traffic is resulting in a higher average transaction and incremental sales. Our original plan was to add 250 new frozen and refrigerated stores this year. We have stepped up pace and we now expect to add freezers and coolers to 60 additional stores during the remainder of the year for a total of more than 300 stores added in fiscal 2007.

In addition to these four merchandise initiatives, the expansion of our payment ties specifically through standard acceptance and debit card acceptance contributed positively to second quarter results. As we expand our offering of frozen refrigerated products and key basic food items, we meet the qualifications to accept food stamps. We currently accept food stamps in about 825 stores, that number is growing and we will expand to nearly 900 stores by the end of the year. As you all know, we now accept debit cards in all of our stores and the penetration of debit card usage is growing. This provided a list to average ticket in the quarter as well as traffic.

Turning to our store growth. During the second quarter, we opened 59 new stores, a little less than what we had anticipated and we expanded another 26. This brings the total to 134 new stores opened in the first half of this year and 53 expansions and relocations. While we ended the quarter slightly behind plan on new store openings, we still expect to reach our goal this year of 250 new stores and 100 expansions and relocations.

Our carpeted size remains 10,000 to 12,000 square feet size. The stores opened so far this year have averaged about 11,000 square feet right in the middle. I have an update for you on Deal$. As most of you know we are using these stores as a platform to develop an additional format, lifting the restriction of the $1 price point to offer even more value and convenience while leveraging the strength and atmosphere of the Dollar Tree.

We believe Deal$ fills a unique niche in the value retail segment. The key elements of the Deal$ strategy are surprising value, convenience and a fun and friendly shopping experience. Most of the merchandise in our Deal$ Stores is priced at $1 but we have listed a restriction and this enables our Deal$ Store to compete complete the shopping trip with the customer by offering them things they want but they just can’t be sold for $1. It also gives our buyers the opportunity to take advantage of the numerous opportunities they find which are outstanding values but don’t fit to $1 price point.

Customer acceptance of the concept has been good. They have responded enthusiastically to the extra value that we can offer and we are especially excited over the lift that it gives in our average ticket. To give you some feel for the shopping baskets during the quarter. About 25% of the transactions in the Deal$ Stores contain an item selling for more than $1. That’s up slightly over the first quarter. Almost 20% of the sales in the Deal$ Stores came from items over $1. The average unit retail for the over $1 items was $3.25 and again that’s higher than the first quarter. And the average transaction was more than $16 in the Deal$ Stores, when the customer bought an item over $1, that’s consistent with the first quarter.

When compared to our Dollar Tree stores average transaction of about $7.60, this lift in transaction size is very compelling because you know most of these stores were acquired or converted and as I have said previously, I believe our best chance of the concept is in opening new stores in new markets where customers have no preconceived expectations.

So far this year, we have opened five new and relocated two existing Deal$ Stores. This pace is going to accelerate in the third quarter and we have planned to open an additional 17 to 20 Deal$ Stores in the second half. We are very excited about the Deal$ concepts and we have recognized the growth opportunities that this concept represents. To keep this new business opportunity in perspective though, we would like to say, it’s a new model and still has a lot of work to do in refining it.

In a moment, I will turn the call over to Kent for the details to review of our financial performance but before I do I want to highlight a few of the numbers. First of all, our gross margin improved 40 basis points over second quarter last year. We have been saying that we would begin to see gross margin improvement as we cycle through the recent addition of more basic and faster time and lower margins in consumable products. We are now beginning to see this and frankly, quarter two has settled. Second, and looking at SG&A, while the rate is higher than last year, our expenses continue to be well managed. If not for the increase in professional fees and charges associated with the settlement of certain employment related matter in California, our operating margin which was up four basis points over last year would have increased by 34 basis points. Our team continues to hold the line on payroll, payroll related expenses and key discretionary expenses.

Third, I am pleased to point to the contiguous improvement in our inventory management. By leveraging our investments in logistics and technology, store teams and our planning allocations and replenishment organization working together have been highly affective than improving our in-stock of basis and developing smarter allocations of seasonal product consistent with sales trends and reducing our inventory per store and inconsistent with increasing our inventory turns over the past two years. This trend has continued in the second quarter of 2007. With 178 more stores than last year, we ended second quarter with about $19 million less inventory than last year. That’s about 8% less inventory per store and our in-stock position is better.

Now, I will turn the call over Kent Kleeberger, our CFO, who will give more details on these and other financial metrics during the second quarter and guidance for the remainder of the year. Kent?

Kent A. Kleeberger - Chief Financial Officer

Thanks Bob. Good morning everyone.

As Bob mentioned, our earnings per share this quarter was $0.33, which was above the high-end of the range of our initial quarterly guidance and represents an 18% increase over the last year’s $0.28. The improvement in diluted earnings per share for the quarter was driven primarily by the comparable store sales increase and improvement gross margin.

For the next few minute, I will talk about the components of gross margin as well as SG&A expense, balance sheet management, and cash flow metrics followed by comments on guidance for both the third quarter and remainder of the year. For the third quarter… or second quarter rather, gross margin was 33.6%, 40 basis points above the 33.2% in last year second quarter. Several factors contribute to this performance improvement. First, we had improved mark-up on merchandised deliver this quarter. Next, the negative impact from the planned shift toward more consumables continues to diminish. The sales penetration of lower margin consumable merchandise increased approximately 1% in the second quarter this year versus an increase of about 2% for the second quarter last year.

Also, while the Deal$ stores continue to negatively impact our margin rates somewhat, the margin rate of the Deal$ stores continue to improve. Hence, the other components of gross margin, we benefited from the possible leverage on buying distribution and occupancy cost associated with the increase in comparable store sales.

Moving down the P&L, SG&A expenses were 28.1% for the quarter, expressed as a percent of sales of 40 basis points increase from 27.7% in the second quarter last year. The increase in the rates was driven primarily by an approximate $0.02 per diluted share charge to cover settlement of certain employment related litigation when combined with legal fees amounted to 30 basis points into expenses.

In addition, we had higher advertising expenses attributable to reaching more markets with greater frequency using printed media. Also, while we are staying compliant benefit with increased debit card expectance, we are seeing increased debit card fees arising from higher penetration debit card in the overall mix.

For the second quarter, depreciation and amortization was $39 million. The overall rate as a percent of sales improved 27 basis points compared with second quarter last year. We expect depreciation of about $158 million to $159 million of this year, which as a rate of sales should be down to about 30 basis points to 35 basis points for the year.

Operating margins. Our operating margins for the quarter was 5.5%, a 4 basis points improvement over second quarter, despite taking approximate of 30 basis points in the SG&A rate on the California employment relates matters. As per taxes, our tax rate was 37.1% versus 37.4% last year. The lower rate in the current year reflects benefits from increased work opportunity tax rate credits in the current year. And the fall off of certain state income tax reserves associated with the exploration of the respective statute of limitations.

Looking at the balance sheet and statement of cash flow, cash and investment approximated $188 million at the end of the fiscal second quarter 2007 versus $180 million at the same point last year. During the second quarter of 2007, we repurchased 1.58 million shares for $62 million. These purchases were made in the latter part of the quarter and due to the settlement timing the actual cash impact on the second quarter was $45 million use of funds with $17 millions of trade settling early in third quarter. Plus, we repurchased an additional 330,000 shares early in the third quarter for an additional $13 million. So, this year-to-date, we spent more than $228 million on share repurchase, including the $158 million under an accelerated buyback program initiated in March 2007. We have approximately $198 million remaining from the $500 million share repurchase program authorized by our Board of Directors last November.

One other further point of interest, our stock price performance improved significantly over last year prior to the recent market correction. And we have experienced a significant amount of option exercise activity, especially in June and early July providing additional cash flow and related tax benefits of about $80 million year-to-date.

Capital expenditures reporting $9.2 million in the second quarter 2007 versus $46.1 million in the second quarter last year. The majority of capital expenditures in the quarter were for our new stores, remodeled and relocated stores, along with expansions to our Briar Creek distribution center and our home office and data center at Chesapeake, Virginia. We expect capital expenditures in the range of $180 million to $185 million for fiscal 2007. Capital expenditures will be focused on the aforementioned priorities as well as the addition of frozen refrigerated capability to approximately 300 stores.

For inventory, we contained a focus on lowering our per store inventory investment and increased in turns. Year-to-date, our inventory turns have increased more than 40 basis points through the end of second quarter as per store inventory finished down 8.1% at the end of the quarter. You will also note that our payable to inventory ratio also continues to improve from 31.6% at the end of the second quarter last year to 35.4% at the end of second quarter this year. This is a continuation of a trend that began in late 2005 and is attributable primarily to improve payment terms with our suppliers. Inventory investment is presently planned about $20 million higher as at the end of this year versus last year, which we believe will result in inventories being down 2% to 3% per store.

Also current assets at the end of second quarter 2007 reflect about $31 million of pre paid rent. This is entirely due to a shift caused by the 53 week retail calendar in 2006 where in rent that is due on the first of next month now occurs in the last week of the quarter. This timing event will continue for the balance of fiscal 2007 and in the third quarter 2008.

Now for sales and earnings guidance. Regarding sales and earnings guidance for the third quarter of 2007, we are forecasting sales in the range of $1 billion to $1.02 billion and diluted earnings per share in the range of $ 0.35 to $0.38. This implies a range of positive low to low mid single digits comparable store sales results. For the full fiscal year of 2007, we estimate sales will be in the range of $4.28 billion to $4.35 billion, again, based on the low to low mid single digit increase in comparable store sales.

As a result of these sales estimates, we are now forecasting diluted EPS in the range of $2.04 to $2.14, reflecting an increase of about $0.04 and $0.02 in diluted EPS above the low and high-end of previous guidance for 2007. We continue to remind investors in consideration of their estimates for fourth quarter sales and earnings that 2006 was a 53 week year based on the retail calendar and as previously disclosed the 53rd week added about $70 million of sales and a little over $0.07 diluted EPS to last year’s results.

Our guidance for 2007 also includes the impact of the $228 million of share repurchase activity so far this year. Our EPS estimates also include reduction of interest income associated with the use of those funds that have been consistently invested in tax free municipal income securities. Thus there is virtually no income tax benefit because of the lower tax exempt interest income. Further any future option exercises will work somewhat against the impact of lower outstanding shares from our repurchase activity. Thus our weighted average share count maybe in the $98 million to $99 million range for the balance of the year.

With that, I would like to turn the call back over to Bob.

Bob Sasser - President and Chief Executive Officer

Thank you, Kent. I want to lead you with a few summary observations before we go to questions.

For the sixth quarter in a row, we have had a very strong top line performance and we remain on track to accomplish our long range goals. We continue to hone our new store size for optimum performance, which we believe to be in the 10,000 to 12,000 square foot range. Our investments in infrastructure are translating into better inventory management, more efficient stores, improved in-stock position and better overall shopping experience for our customers. And we continue to demonstrate the ability to self fund the growth of our business, while generating substantial free cash and rewarding our long-term shareholders by buying back stock.

During the first half of this year, again, we have spent over $228 million on share repurchases. We are confident in this Company's ability to continue generating a significant amount of free cash flow and we remain committed to use that cash to drive shareholder returns.

Looking to the third quarter, we know that our customers face a myriad of challenges, especially from high and uncertain energy prices. In this environment, we believe that Dollar Tree can be part of the solution for millions of consumers across the country, besides delivering great value to our customers, dealing in-stock and basics that people need and providing a bright, friendly, fun convenient shopping experience. We have made great progress this year and we look forward to an exciting fall season.

We are now ready for the questions so that we can accommodate as many callers as time permits, I would ask that you limit your questions to two per person.

Question and Answer

Operator

Thank you. The question-and-answer section will be conducted electronically. [Operator Instructions].

We will take our first question from John Zolidis with Buckingham Research.

John Zolidis - Buckingham Research Group

Hi, good morning.

Bob Sasser - President and Chief Executive Officer

Good morning John.

John Zolidis - Buckingham Research Group

A few questions for you. Second… first question, looking at the second half, do you still anticipate the improvement in gross margin that you have been talking about earlier in the year? I guess when we started this year, the guidance or suggestion was that gross margins will be under pressure in the first half. And in fact, they have risen and now we are looking to the second half, does that mean that they are going to accelerate? And then my second question is on the inventory, I thought… is there some possibility that maybe we are a little bit too light on the inventory particularly in the seasonal category? Is there a possibility that can pull back in the same-store sale performance heading into 3Q? Thank you.

Kent A. Kleeberger - Chief Financial Officer

As far as gross margin goes on the second half, John, I think, we always have been pointing people top see some slight improvement in the second half. Again, yes, I have to remind people that’s on a 52 week comparison versus a 53 week comparison because we did get some artificial leverage if you will in the buying an occupancy cost because of that 53rd week. But I think, to say that it’s going to accelerate, I think we probably get a little bit ahead of ourselves, though, John. I think we are comfortable. We are pleased with the increase in mark-up particularly in the first half. We would like to see that continue, but we are not going to get greedy and expect any acceleration in the near-term.

Bob Sasser - President and Chief Executive Officer

On the inventory, John, there is still room for us to continue to improve our turnover. We still are seeing opportunities to flow the product more smoothly, better to the stores, closer to the time that they need that. Having said that, I do believe that we missed some seasonal business in some of our stores throughout the first half of the year. Now, that’s mostly resolved still refining our allocations and our replenishment giving the right amount to the right stores. Those high volume stores, I think we may not have still fed them enough inventories yet. I see that as an opportunity for next season, and going into fall and holiday, I feel like we are just better than we have ever been, better positioned, inventory flow come in and is better. There is no disruption that I can see out there and our DCs are handling it really marvelously right now.

John Zolidis - Buckingham Research Group

Thank you.

Operator

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

Mitchell Kaiser - Piper Jaffray

Thanks guys. Good morning. I was just wonder if you could comment on the multi-price point initiative, you had in the 25 stores, kind of the results that you are seeing there, that you said that you are going to rollout an additional 25 in the existing Dollar Tree Stores kind of where you are in that process?

Kent A. Kleeberger - Chief Financial Officer

Mitch, just to refresh everybody’s memory, we talked about testing, a concept we call oops and the concept is… in 25 stores, we are testing 20 feet on the wall of product that was over $1, less than $5 and less, but more than $1. And the concept is oops, we know it’s not a dollar, but the value is so good, we couldn’t pass it up, so we are passing the savings along to you, right now won’t last long and we will roll that out into 25 stores.

One of the things I want to find out was our customer acceptance on that where our customers accept the fact that we had 25 feet products that wasn’t $1 even if we were selling them up front. The answer to that is I did accept that the customer acceptance we have a very little confusion, we had very little… very few comments really from our customers that they didn’t like it. What we found was if the value was good they bought it. And it didn’t bother them that there was product in the store that wasn’t $1.

As long as we priced it and signed it and really kept it segregated, they didn’t see any problem with that. So what we are doing is we are going forward with testing 25 more stores. We haven’t roll that out yet that will be sometime in the third quarter that we are rolling out the 25 additional stores. And in addition to testing customer acceptance broadly and testing the execution, ability to execute in the stores, we are also going to do advertising on these next 25 stores and see if we can drive some bigger sales through this test. So far it’s been… the answer to our question have been positive and there has been so far good acceptance by the customers and good sales on the items that show the great value. We will know more as we rollout the next 25 through the best part of the year and we do some advertising.

Mitchell Kaiser - Piper Jaffray

Okay. Would you be wiling to quantify any type of benefit you are getting on ticket and then if you like the… here the results the next 25, what might… how should we be thinking about what a plan to further extend the program might look like. Is it something that you would potentially do in big ways, so would you kind of scale that as we go forward or how should we think about that?

Kent A. Kleeberger - Chief Financial Officer

As far as quantify it is really too small and too early and too soon to say much about. I will tell you that the results have been good, again I was really looking to see what our customers… that we have think for more than $1 on the shelves and they didn’t. And frankly, they accepted it and them bought it as long as the item was a value.

So, the learning so far basically has been that let’s go forward and let’s test 25 more stores. But it’s really so early on that I can’t tell you where that’s going to go. We are going to test these stores in next… in the middle… right in the best part of the year, going into third, fourth quarter. And we are going to advertise it and we are going to see how much business that we can drive through the 25 stores.

Looking past that obviously one of the things I am looking for now as our ability to execute to this across a broader range and I think we are learning lot about that, being able to roll it out across the more stores. I think we can do that. The outlook going forward into next year is going to determine on how well we do in these next 25 stores. So, while I am excited about it, I really can’t tell you that it’s going to be a 000 stores or 200 stores or 5 stores or really where we are going to past the 25 because I really want to see what we can do in these market… these new markets. I will let you know more. We will know more next time.

Mitchell Kaiser - Piper Jaffray

Okay. But it something that you could scale pretty quickly if you wanted to then.

Bob Sasser - President and Chief Executive

I believe, it scaled very quickly and fill some impact, assuming it was good, fill some impact in next year.

Mitchell Kaiser - Piper Jaffray

Okay. Thanks guys. Good luck.

Operator

We will take our next question from Stacy Turnof of Merrill Lynch.

Stacy Turnof - Merrill Lynch

I had a comment on rent and working on your lease time. I don’t one of the big initiatives was for you to start to negotiate out much further and I was wondering where you were in that process?

Kent A. Kleeberger - Chief Financial Officer

Well, Stacy when we are in the real estate committee and most of the deals that get presented are roughly five year terms. And what we try to do is we try to nail down the terms to five years and then we tell our deal makers to go back to see what sort of economics we can get if we were to go either to a seven or 10 year term which either is a function of lower rent and/or lower camp charges or increased construction allowances. I would say this is an initiative when we started in the last half of last year. It’s probably a little too early to tell we are having some impact on that and I think it’s a friend of mine to the deal makers now.

Stacy Turnof - Merrill Lynch

And then my second question is any… could you maybe quantify how that gap is now in between deals and the core Dollar Tree Store and when do you actually feel like its going to start to be on par?

Bob Sasser - President and Chief Executive Officer

The… from a margin standpoint, the Deal$ stores continue to improve and come closer to the Dollar Tree but they are not there yet. The new deal stored and we have only opened the few so far… five new stores so far. But the new Deal$ Stores where we are opening with a… instead of a converting of an old concept into the new concept where we are opening as a new Deal$ Store and new concept, those are performing better than the ones that we converted. So, the margin is continuing to rise, its not there yet. I think its going to say a little more time. We are sort of finding our way too with the mix of products than these stores.

And as far as the sales, we have got… we have some stores that really are doing great and some that aren't doing as well. So, we still have to work-through some of those answers. And of course, we are trying to new products and new mix and new merchandise and new standards and things. So, there are so many moving parts on that right that I believe… I still say that our best test is as we go into third quarter and start opening up more of then these new Deal$ Stores, I believe we are going to see more clearly what this concept can do. I am looking forward to be as a model that we… as a higher volume model. I am looking forward to a model that we could use in higher costs, reasons of the country because we can with a higher volume of leverage fixed cost. And I am looking for the margin to approach or be something consistent with the Dollar Tree market.

Stacy Turnof - Merrill Lynch

Great. Thank you.

Kent A. Kleeberger - Chief Financial Officer

Which means it’s only been a short while since we have opened new stores or relocated. We did a handful I think to start to end of first quarter little bit second quarter. And I guess what I would say is we are very encouraged and very encouraged, especially about the new relocations that we did recently.

Stacy Turnof - Merrill Lynch

Thank you.

Operator

We will take our next question from Dan Wewer from Raymond James

Dan Wewer - Raymond James

Bob, the information of the ticket size at Deals$ was helpful. Can you tell us how that translates into sales per square foot? How those stores are performing now prior to you adding the right point to dollar?

Bob Sasser - President and Chief Executive Officer

Dan, we haven’t broken that out probably… frankly we don’t… we haven’t shared any of that kind of information. I am unable to able to give you some of the numbers I have shared with you that as a matter of color on the direction that the Deal$ Stores are going but we haven’t broken sales per square foot out.

Dan Wewer - Raymond James

On the new stores you had noted that the margins are performing better than the Deal$ Stores that you would converted. Can you remind me are new Deal$ Stores going to be smaller, more in the 11,000 square foot prototype that you use for Dollar Tree?

Bob Sasser - President and Chief Executive Officer

Well the new Deal$ Stores are pretty consistent with the size of Dollar Tree 11,000, 12,000 square feet. The new Deal$ Stores and the old Deal$ Stores, frankly we have got some of the old… the stores that we have acquired ranked from probably about 7000 square feet up to 17,000 square feet. So, the Deal$ Stores that we required, it was pretty broad range or sizes there. The new ones were open though… we are looking for the same 11,000, 12,000 square foot. We believe that could be… should be the right size for the Deal$ Stores.

Dan Wewer - Raymond James

Okay. Let me ask question this way, if you were to look at the new store profit model on the new Deal$ Stores, the way you talked about Dollar Tree in the past, the sales per square foot, operating margins, return on cash investment. Do you think that these new Deal$ Store would be generating even higher returns than Dollar Tree because of the expanded price point selection?

Bob Sasser - President and Chief Executive Officer

At some point. Yes, that’s what we are looking for as a model as it says… a model that has the ability to grow. That has the ability to serve markets that we maybe can get to with Dollar Tree. The contribution that we need from the Company… it’s just too early to say what that is. We acquired, we integrated and now we have begun to open some new stores. And it’s just really too early to start claiming victory either way. I am excited about the concept there. The concept… this model fist a need out there across the country. And we… I believe have the best chances of improving that model. But we still got a lot of work to do and I don’t have enough new stores yet to really tell where we are in that process.

Operator

We will take your next question form David Burman with Burman Capital.

David Burman - Burman Capital

Hi guys. I was wondering if you could share with us a little bit deeper about your thoughts on consumer impact of the… what you are reading about macro is having on your business. And then secondly, if you could just talk about the repurchase program. Than you very much.

Bob Sasser - President and Chief Executive Officer

Well the impact from the consumer on our business with the recent opportunities out there in the housing market I guess to your point to and all the problems of late. We really are seeing that impact on our customers. I believe and I have said this for some time now that the biggest potential impact on our customers has to do with fuel prices and energy prices and mostly in times of rapidly increasing fuel and energy prices. So, the problem that we see in the economy is the problems with home sales, the problems with foreclosures. We really haven’t seen… I can’t relate that to my customer as my business directly. I haven’t seen it yet.

David Burman - Burman Capital

Okay. Thank you. And the repurchase?

Kent A. Kleeberger - Chief Financial Officer

Well we have about $198 million remaining under the authorization of $500 million that was approved last November. I guess in hindsight we are going to burn that pretty quick but yes we have been opportunistic I would say, in relation especially in the recent market correction. But at the end of the day, we are not just that smart by guessing market timings so you will have to stay tuned for any future activity.

David Burman - Burman Capital

Why you being so aggressive, Ken?

Kent A. Kleeberger - Chief Financial Officer

Well, I just believe that stock is trading at a discount and we have a variety of financial models and how we evaluate the stock price and our vowels would suggest that any thing below $45, $47 range is attractive.

David Burman - Burman Capital

Okay. Well, thanks a lot.

Operator

We will take our next question from Patrick McKeever with Avondale Partners.

Patrick McKeever - Avondale Partners

Thanks very much. Good morning everyone. Thinking just over the next few years about where the gross margin rate could go, do you think it could go back to the historical level of around 36%? It was so consistent there a few years back. Is that where the greatest opportunity is in terms of driving margin back to your goal, which I think is around 10%. I mean there is certainly an SG&A opportunity, as well but maybe seems sales-stores moderate a little bit. It’s a greater opportunity on the gross margin line or--?

Kent A. Kleeberger - Chief Financial Officer

Well… yes, I think at the end of the day, we want to get back to 10% and while the current expense is nice, we are not going to get there as quick as you focus your improvement on the gross margin line. So obviously, the biggest portion that’s going to come in merchandised margin arena, primarily an improved mark-up but than there is other areas that we can impact. We continue to see leverage on our distribution and occupancy cost. We are not adding a substantial mode on distribution capacity in the near terms, so that’s one area.

We do feel pressure from the occupancy line because inherently there is building inflation factors on an annual basis to both right and camp charges. But I think part of what we are trying to do is to take a look at lease terms and drive better economics in order to drive some of the rent down that we can charge. That also helps out in the gross margin line, the related store depreciation if we can spread that over a longer period of time for five to seven say even up to 10 years that’s going to give some relief on the overall operating margins.

Patrick McKeever - Avondale Partners

And how about private label how does that factor into the potential gross margin opportunity out there. Where is private, has that been growing as a percent of sales recently and can it grow further?

Bob Sasser - President and Chief Executive Officer

Patrick, private label is something that we have early on for almost past several years begin to… continue to develop our own products available only at Dollar Tree and it doesn’t have Dollar Tree’s name on it, it says things like Max Gray socks. Those are in private label. That percent of growth has grown in the past year and it has grown as our ample of percent has grown back towards that 39% to 40% range that we used to have. So, going forward, there is more opportunity of private label that exist and some of our long lead time basics that exists in our seasonal business and branding of things like our April bath and showers. If you go in our stores now, you will see pretty big and expanding bath shop displays across the chain and those that’s all private label all product that our buyers have developed. So, I don’t know how to answer your question expect that’s a focus as we go forward for couple of reasons, one, to drive sales and value, because you can't find it anywhere else, only at Dollar Tree, and also to help improve our margin on merchandise mark-up as we go forward private label fits that strategy.

Patrick McKeever - Avondale Partners

Okay. That’s great, very helpful. Thank you, Bob.

Bob Sasser - President and Chief Executive Officer

Thank you.

Operator

We will go next to Jeff Sonnek with Friedman, Billings, Ramsey.

Jeffrey Sonnek - Friedman, Billings, Ramsey & Company

Thanks guys. Great quarter. Can you talk about… update us on some of these metro market task that you have out there? And do you have any of these Deal$ stores in those types of markets that you might be able to talk little bit more about.

Bob Sasser - President and Chief Executive Officer

Well, Jeff, just pretty short… sort of the Readers Digest version of the Metro markets are some of our highest performing sales per square foot stores, and we like the metro markets. We like where there is a lot of people. And as you point out the Deal$ strategy, we have in the third quarter several stores. We are venturing out of the Midwest and into the Northeast with several stores. So, stay tuned for that. We don’t have them opened yet, but some time in the third quarter; we will have a few Deal$ opened in some of these very dense highly populated markets in the Northeast. I think that’s a strategy. I believe the Deal$ can provide higher sales volumes which will give us better leverage on operating expenses in these metro markets. The sales are there for Dollar Tree, the cost of getting them a little higher thought, as you know.

Jeffrey Sonnek - Friedman, Billings, Ramsey & Company

And then can you give us an update on this frozen refrigerated program? I think historically you talked about a same-store sales lift in the 600 to 800 basis point range, when that gets rolled out, if that’s still consistent?

Kent A. Kleeberger - Chief Financial Officer

Jeff, the sales… it’s actually I would say that we… when we originally got involved in the program, we expected the 6% lift on the consumable side of the business and 1% to 2% on the non-consumable side of the business, which is a higher margin portion of our stores. I mean the good news is that at least in the initial year rollout, we are seeing increases higher than that. So, that’s probably one of the reasons why we accelerated the rollout last year, and why we are coming up with 300 as opposed to 250 this year. It’s giving us a nice lift. It’s giving us a lift in traffic. It’s giving us a lift in tickets. So, it’s been very good.

Jeffrey Sonnek - Friedman, Billings, Ramsey & Company

And then on the Deal$... are those Deal$ stores now in the comp base towards the end of the summer?

Kent A. Kleeberger - Chief Financial Officer

Yes, they are.

Jeffrey Sonnek - Friedman, Billings, Ramsey & Company

Great. Thank you, guys.

Operator

We will take our next question from Joan Storms with Wedbush Morgan.

Joan Storms - Wedbush Morgan Securities

Hi, good morning.

Bob Sasser - President and Chief Executive Officer

Good morning.

Joan Storms - Wedbush Morgan Securities

Couple of quick questions. I was wondering if you could comment a little bit more on the advertising about your shift going from less electronic and more print. And then also for housekeeping if you could give us some idea number of store openings and closures you expect for the third quarter?

Kent A. Kleeberger - Chief Financial Officer

Joan, the advertising was centered around our pre-Memorial Day ad and last year, we ran the same of that covered about 600 stores. This year, we expanded the event to cover over 1,100 stores this year actually had the tabloid inserted in the newspaper or mailed out. Now all the stores have the tab and they had the merchandize. So, it was a really chain wide event. We took money away from electronic. We put it more into print. We expanded the number of stores that we mailed or inserted the circular for and we had really good results, with a good trade.

Joan Storms - Wedbush Morgan Securities

And just adding onto that, are there any anticipation for second half, any changes in advertising that you might be doing. Would that be similar?

Bob Sasser - President and Chief Executive Officer

Well, there will be a little more that I can add, but I will share them with you after we run them. We don't tell people where we are going to run, but we are planning to do a little more advertising in the second half of last year and taking off on the good results that we had with the print and tying the merchandise and the items and the in-store selling with the advertising, the vehicle, the print vehicle and getting that out in front of our people, our customers. We have had good results, so you will see more of that as we go into the second half.

Kent A. Kleeberger - Chief Financial Officer

And John your question on, I guess, housekeeping in terms of our store cadence opening for third quarter. I would expect that if third quarter is going to be a big quarter, it will be over 100 new stores that will open along with relocation probably in the 42 to 45 range. So, it is a lot of stores. We will probably end up closing roughly about 8 to 10 stores I think.

Joan Storms - Wedbush Morgan Securities

Okay. Perfect. Thank you very much.

Kent A. Kleeberger - Chief Financial Officer

Yes.

Operator

We will take our next question from Charles Grom with JP Morgan.

Paul Trussell - JP Morgan

Hi, good morning. This is Paul Trussell for Charles Grom. Question on the Deal$ stores, Bob could you provide us a little bit more color around….

Kent A. Kleeberger - Chief Financial Officer

Hello. Hello.

Operator

It looks like his line has cutoff. We will go next David Cumberland.

Kent A. Kleeberger - Chief Financial Officer

David?

Operator

One moment.

Kent A. Kleeberger - Chief Financial Officer

Hello.

Operator

And your line is now open Mr. Cumberland.

David Cumberland - Robert W. Baird & Co

Can you hear me now?

Kent A. Kleeberger - Chief Financial Officer

I can hear you now, David.

David Cumberland - Robert W. Baird & Co

Great. First question did the initial Q2 EPS guidance or the prior ’07 guidance include the $0.02 of the legal cost?

Kent A. Kleeberger - Chief Financial Officer

No.

David Cumberland - Robert W. Baird & Co

And my other question, can you comment on if the retail calendar shift has an impact on your comps in the second quarter or on your comps outlook for Q3 or the second half?

Kent A. Kleeberger - Chief Financial Officer

That really, I think, you may be referring to the back-to-school shift and sales tax holidays and like. Obviously still keep in touch with people on the specialty apparel side and I think it has more of an impact to their business than it does to ours.

David Cumberland - Robert W. Baird & Co

Thank you.

Operator

We will take our next question from William Keller, FTN Midwest.

William Keller - FTN Midwest Securities

Good morning everyone.

Kent A. Kleeberger - Chief Financial Officer

Good morning.

William Keller - FTN Midwest Securities

Just describe a little bit if you are seeing anything on your toy sales or really any general merchandise coming from China, regarding some of the rather unfavorable press as of late? Thank you.

Bob Sasser - President and Chief Executive

There is a lot of press on lot of activity over that issue. I can’t tell you that I have seen any direct response by our customers in our stores. Our product being $1 type goods, very basic kinds of products and some are seasonal at this point. We have… we do take that very seriously, though, and we have had testing program for several years that everything that we bring out of China that have to meet a federal regulation or standard.

We have third party testing on that and we have actually stepped up our testing so that we are… we always require this product before it leaves China to have a pass testing result. We are now testing a couple of kinds in the process, early on and the manufacturing of the product and then just as a product is about finished being manufacturing. So we stepped up our diligence on it. We are very sensitive to it for our customers and… but I can’t tell you that I have seen any negative response from our customers on that.

William Keller - FTN Midwest Securities

Great. Thank you very much.

Operator

And we do have our question back now from Charles Grom with JP Morgan.

Kent A. Kleeberger - Chief Financial Officer

Hello.

Paul Trussell - JP Morgan

Good morning.

Kent A. Kleeberger - Chief Financial Officer

Lost you.

Paul Trussell - JP Morgan

Hi, this is Paul Trussell for Charles Grom. Hey, Bob could you just provide us a little bit of further commentary on the new Deal$ stores that you all are opening. I know that there are some changes from the stores that you acquired in regards of the exterior as well as the category applications.

Bob Sasser - President and Chief Executive

Paul, the new Deal$ stores are the vision of what we think that customer are looking forward. And one of the things that you will see in the new Deal$ stores as oppose the stores that we acquired is that we have shrunk footage… square footage that we allot to our frozen and refrigerated products and also to our grocery products.

The existing Deal$ stores have these coffin coolers. We have taken those out of the new stores and we are putting in the stand-up wall unit, like we use in Dollar Tree. We are able to make better use of the square footage in the store by doing this, and the categories that we have expanded include some of the ones that we are so, I believe we are good at Dollar Tree and that would be our seasonal business, our party business as well as some of the business that we have consumer products and health and beauty care and our cleaning supplies.

So, as you walk into a new Deal$ store, you would see a little different look on the front of the store. And as you walk into the stores, you are going to walk into a more general merchandise selection, more of the seasonal selection that we offer. And I think the overall appeal of the store from what we found from our customers is that they liked it and it was easier to shop and it was fun to shop. And at every corner almost, there was something new and something exciting, something that exceeded their expectations of what they can get. And sometimes it’s $1 sometimes it’s $5, but always exceeding the expectations of our customers. I mean we had from back-to-school; we had kids’ athletic shoes for $5 in our stores. And those are the kinds of surprising values that we can offer deals that we in the past have had access to the product, but we just have to pass it up because although it’s a great value for $5, I couldn’t still sell it for $1 and so our Dollar Tree buyers would have had to pass that up. We are taking advantage of that in Deals and it seems to be thrilling our customers.

Paul Trussell - JP Morgan

Thank you, very helpful. Second question, I know that you all mentioned that May and July were the better performing months. Could you just talk a little bit about the rationale for the weakness in June?

Bob Sasser - President and Chief Executive

Well, I didn’t say there was a weakness in June, but that’s the best few months of the quarter were beginning and the third month of the quarter. And that has more to do with the holidays that are available in May with Mother’s Day and Memorial Day. And then in July with the 4th of July and leading into back-to-school. June was not weak, it was just not… if you have three months one has to be a number one, one has to be number three.

Operator

And ladies and gentlemen we have time for one final question today. That come from Adrianne Shapira with Goldman Sachs.

Adrianne Shapira - Goldman Sachs

Thank you. Bob, you had just mentioned that you are not seeing the macro impact on your consumer, but some of your competition are being pressured. And I am just wondering as a result, they are seeing inventory build and they are having to move… mark down more aggressively to move things out. As a result are you seeing anymore competitive aggressiveness as due to these markdowns seems as if more people are drifting down to your price point?

Bob Sasser - President and Chief Executive

Adrianne maybe, I just don’t maybe see it, but I cannot for the life of me, I have look and I had asked and I have been out in the stores and we have done some research. And we just can’t see the impact of the macro economy right now on our consumer. And as I have looked around at the competition, I don’t know if you are referring to the other guys with dollar in their name or if you are referring to just a discount industry in general. But our price point, $1 is very honest, it’s a valued proposition with our customers. It’s simple, it’s straightforward and now that we have added more of the things that people shop more frequently. We are seeing increased traffic and if anything, right now we are seeing maybe people gravitate to us because of our value, because of our price point and now that we sell more of the things that you need. We could be the place to go to. The thing that concerns me, if you are asking the question is as always, I have always said that the biggest impact on Dollar Tree is the rapid rise and these are fuel costs or energy prices. And those are the things that we have in the past for short-term struggled with… because of its pressure that it puts on our consumer, many of which, probably 20% of which are living in that lowest economic level pay check to pay check.

Adrianne Shapira - Goldman Sachs

Thank you.

Operator

And we actually have time for one final question, and it is Christine Augustine with Bear Stearns.

Christine Augustine - Bear Stearns

Thank you. I was wondering, if you were seeing any sort of regional variation in sales in the second quarter? And then last quarter, you talked about tying incentive compensation for the field organization and the buying team to get your team focused on operating margin improvement. Did you see any results from that? Is it sort of too early? When could we maybe start to see some improvement there? Thank you.

Bob Sasser - President and Chief Executive

Well, we have got the incentive compensation for the deal as far as, across the whole field now, we took first part of the year doing that, as well as the buying team. Everyone has a component of gross margin as part of their incentive and their bonus plan now. As far as seeing the results, I really don’t think, I can tell you that it’s going to be one quarter over the next. It’s more of a movement toward, but I fully believe that by incenting people for the results that we desire that they will be able to achieve those results. So, I would expect improved gross margins based on incenting people to do that.

It’s just a right thing to do. We just had our field management meeting last week, we had over 500 people from all across the country here and that was one of the topics that we talked about. Our field is enthusiastic about it. They are understanding the components of gross margin better now than ever. We are able to give them more information now on gross margins, so they can track their success now better than ever and that’s going to pay back. I just don’t know that I can… I can’t tell you a number and a date that’s going to happen. It’s going to be more of an improvement over time.

Kent A. Kleeberger - Chief Financial Officer

As far as regional comps, while we typically don’t give that information. Now I think we have been pretty open to say that we have had some challenges out in California and that from Central California and Northern California. They are lagging shall we say balance the company, but the good news is we are starting to see some improvement out there.

Christine Augustine - Bear Stearns

Great. Thank you very much.

Operator

And Mr. Reid this does conclude the question and answer session. I will turn the call back over to you for any closing remarks.

Timothy J. Reid - Vice President, Investor Relations

All right Tom, thank you very much and thanks to all of you for participating on the call. Thanks especially for your long-term interest in the Dollar Tree story. Our next conference call is scheduled for November 28, 2007, when we will discuss third quarter results. Thank you again.

Operator

This does conclude today’s conference call. We appreciate your participation. You may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Dollar Tree Stores Inc. Q2 2007 Earnings Call Transcript
This Transcript
All Transcripts