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Dollar Tree Stores, Inc. (NASDAQ:DLTR)

Q3 2007 Earnings Call

November 28, 2007, 9:00 a.m., ET

Executives

Bob Sasser – President, Chief Executive Officer

Kathleen E. Mallas – Vice President, Controller

Timothy J. Reid – Vice President, Investor Relations

Analysts

Michael Baker – Deutsche Bank

Jeff Sonnek – Friedman, Billings, Ramsey & Company

Adrienne Shapira – Goldman Sachs

Ivy – Lehman Brothers

Patrick McKeever – MKM Partners

Mitch Kaiser – Piper Jaffray

Dan Wewer – Raymond James

David Cumberland – Robert W. Baird & Company

Ralph Jean – Wachovia Securities

Operator

Please stand by. We’re about to begin. Good day, everyone, and welcome to the Dollar Tree Store, Inc., third quarter 2007 earnings release conference call. As a reminder, today’s call is being recorded. And at this time I’d like to turn the call over to Mr. Tim Reid, Vice President of Investor Relations. Please go ahead.

Timothy J. Reid

-- on our performance in the quarter and recent developments in our business. Kathleen Mallas, our Vice President and Controller, will provide a more detailed review of our third quarter financial performance. Bob will then provide our guidance for the fourth quarter and fiscal year 2007 and offer summary comments.

Before we begin I’d 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 harbour 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 8K, quarterly report on Form 10Q, and annual report on Form 10K, all of which are on file with the SEC. We have no obligation to update our forward-looking statements and you should not expect us to do so.

At the end of our planned remarks we will open the call to your questions, which we ask that you limit to one question and one follow up question, if necessary. With that said, I’d like to turn the call over to Bob. Bob?

Bob Sasser

Thanks, Tim, and good morning, everyone. This morning we announced earnings for the third quarter of $0.38 per diluted share. This represents a 19% increase over last year’s $0.32 per diluted share and it is at the high end of our guidance.

We have previously announced that total sales for the quarter were $997.8 million, which was an increase of 9.6% over the third quarter of fiscal 2006.

Top store sales increased 1.9% for the quarter and were the result of a 1.6% increase in store traffic and 0.3% increase in average ticket.

Year to date for the third quarter, sales were $2.9 billion, an increase of 11.1%, and diluted earnings per share were $1.09, an increase of 21.1%.

Before we turn to the detailed financial results I want to highlight a few operating efforts. First of all, gross margin improved by 70 basis points over the third quarter last year. As we said at the beginning of the year, the gross margin rate would increase as we began to cycle through the recent addition of more basic, fast returning, and lower margin consumable products. Our gross margin percent is up for the quarter and year to date.

Second, while the SG&A rate is higher in third quarter than last year, I want to point out that our expenses continue to be well managed and the third quarter last year the SG&A rate benefitted from a 50-basis point, benefitted by 50 basis points from payments perceived for early lease terminations. Absent that, the rate this year would have been flat to last year. Our team has continued to hold the line on expenses.

Third, I’m pleased to point to the continued improvement in our inventory management by leveraging our investments and logistics and technology, our store teams and our planning allocations and replenishment organization have been highly effective in reducing inventory per store while improving our in-stock of basics by developing smarter allocations of product consistent with sales trends and consistently increasing our inventory terms over the past two years. This trend has continued for the third quarter of 2007. Our total inventory investment at the end of the quarter was up about $7 million or about 1% with 209 more stores than last year. That’s around 5.3% less inventory per store. Terms are up and our in-stock position is better.

At Dollar Tree I always like to start with the merchandise initiatives and there were several key merchandise initiatives that drove our sales performance in the third quarter. First of all, we had a very good performance in our seasonal business throughout the third quarter beginning with back to school. Our unique Teachers’ Corner concept continues to differentiate Dollar Tree as a high-value source for many of the things teachers and students need in their classrooms. With Teachers’ Corner we’ve been able to broaden our reach and bring value to a new and larger segment of business, larger segment of customers.

Of course, the big holiday in third quarter was Halloween and, once again, our Halloween values and our sell through were strong. While our advertising expense was down in the quarter, we ran an advertising circular on September 30th in support of the Halloween season and we had some good results. This tab ran as a newspaper insert in 29 markets and covered about 1300 stores, and all of our stores received quantities of the featured merchandise along with the in-store signage and copies of the insert. Our stores quickly made a clean transition from fall and Halloween and we’re now well prepared for the Christmas season.

In addition to seasonal merchandise, our expanded assortment of high value basics continues to contribute to our sales growth. With the growth of our large store format over the past several years we have expanded our assortment of basic products and we’re becoming more of a destination for categories such as basic cleaning supplies, health and beauty care, candy, and snacks. We are more relevant today than ever because we offer a lot of value on things that people need every day and we offer it for just a little bit of money. That’s important to our customers, who are under pressure from high fuel and energy costs.

As we’ve increased our offering of basic every day products, we’ve continued our expansion of frozen and refrigerated products to more stores. Our plan at the beginning of this year was to add 250 new frozen and refrigerated stores this year, but we stepped up the pace and we’ve added freezers and coolers to about 300 stores so far this year. During the third quarter we added freezers and coolers to 58 Dollar Tree stores. However, I would point out that in the third quarter last year we added freezers and coolers to 172 stores, so we anniversaried a very aggressive roll out from this quarter last year and as a result got a smaller boost of sales from the initiative than we have in previous quarters. At the end of the third quarter we had freezers and coolers at 931 stores compared to 532 stores the same time last year. We plan to add freezers and coolers to another 10 stores by year end.

While we’re clearly feeling the same results of the same macroeconomic pressures that have affected retailers with the expansion of every day basics in our merchandise assortment over the past few years, we’re better positioned than ever to withstand these pressures. Our customers are now finding what they need every day and it’s giving them a reason to shop Dollar Tree more frequently.

In addition to these merchandise initiatives, the expansion of our payment type acceptance contributed positively to third quarter results. We currently accept food stamps in about 1,000 qualified stores. The penetration of debit card usage continued to grow in the third quarter providing a lift to average ticket, though less than in previous quarters. We rolled Visa credit card acceptance to all of our stores nation-wide on October 31st, just in time for the holiday season. We are pleased to offer the added convenience of Visa credit to our customers and expect that it will contribute to continued increases in average tickets and traffic in the fourth quarter and beyond.

Turning to store growth, during the third quarter we opened 79 new stores and expanded another 40. This year for the third quarter we’ve opened 213 new stores, plus 93 expansions and relocations. That represents 42 more new stores and 17 more relocations than last year through third quarter. While we’ve got more stores open earlier this year, which was one of our goals, this is approximately 21 fewer new stores than we planned for the third quarter and the delay cost us about $3 million in sales relative to our plan in the quarter. We’ve caught up our store openings in November and we expect to finish the year with 3,413 stores after adding 240 new stores and 102 expansions and relocations. For your reference, last year we opened 211 new stores and we expanded and relocated 85 stores. And our targeted size remains 10,000 to 12,000 square feet. In that regard, the stores opened so far this year have averaged around 11,000 square feet.

I have an update for you on Deals. As most of you know, we’re using these stores as a platform to develop an additional format, lifting the restriction of the $1.00 price point to offer even more value and convenience while leveraging the strengths and the infrastructure of Dollar Tree. The key elements of a Deals store are surprising value and convenience, and a fun and friendly shopping experience. Much of the merchandise in our Deals stores is priced at $1.00, but we’ve lifted the restriction and we’re in the process of building assortments that are focused on merchandise priced at $5.00 and below.

Customer acceptance of the concept has been good, as I’ve mentioned in the past. We’re especially excited about the availability of new merchandise opportunities at the higher prices and the lift that it gives us in average ticket. To give you some feel for the shopping basket, during the quarter about 25% of the transactions in a Deals store contained in items selling for more than $1.00. That’s up slightly over the previous quarters. Almost 20% of the sales in the Deals stores came from items over $1.00, consistent with second quarter results. And the average transaction when the customer bought an over-$1.00 item was about $16.00. In the range of but a bit less than the previous quarters and I believe that’s a reflection of normal cyclical factors.

When compared to our Dollar Tree stores, average transactions of about $7.50 in the third quarter, this lift in transaction size is very compelling. In addition, we’ve achieved a significant list in Deal’s gross margin compared with the third quarter last year.

As I’ve said previously, I believe that our best test of the concept is in the opening of new Deals stores and new markets. Through the third quarter this year we’ve opened 14 new and relocated three existing Deals stores. We’ve expanded the concept into new regions, including opening our first Deals stores in the northeast. And I’ll tell you that we have had outstanding results in the early days of the opening. In the third quarter, the new Deals stores outperformed the existing Deals stores by nearly every sales method. This is consistent with our expectations and it is very encouraging. We opened several more Deals stores in November and we expect to end the year with 20 to 25 new Deals stores.

Again, we’re very excited about the Deals concept. We recognize the growth opportunity that this concept represents. We believe that Deals fills a unique niche in the values retail segment. But I will remind you that it’s a new model and there’s still a lot of work to be done, especially in refining the concept and especially in refining the merchandise index. We’re going to continue to invest the time, effort, and patience necessary to make this unique retail concept as successful as we know it can be.

Now I’ll turn the call over the Katie Mallas, our Vice President/Controller, who will give you more detail on these and other financial metrics during the third quarter. I will then return and provide guidance for the remainder of the year and summary comments. Katie?

Kathleen E. Mallas

Thanks, Bob. Good morning, everyone. As Bob mentioned, our earnings per share for the quarter were $0.38, which was at the high end of the range of our initial quarterly guidance and represents a 19% increase over last year’s $0.32.

The improvement in diluted earnings per share for the quarter was driven primarily by a 1.9% comparable store sales increase and improvement in gross margin. In the next few minutes I will talk about the components of gross margin, as well as SG&A expense, balance sheet management, and cash flow metrics.

For the quarter, gross margin was 34.5%, 70 basis points above the 33.8% in last year’s third quarter. Several factors contributed to this performance improvement. First, we had improved mark up on merchandise delivered during the quarter. Second, our shrink rate for the quarter was lower than last year. Third, the negative impact from the planned shift toward more consumables continues to diminish.

In addition to these three factors, our freight cost was unchanged as the percent of sales despite the higher fuel prices relative to last year. These will increase $0.19 per gallon on average versus the third quarter of last year. We succeeded in offsetting these increases through improved operating efficiencies, including better trailer utilization and better routing, which reduced haul miles.

Moving down the PNL, SG&A expenses were 28.4% for the quarter expressed as a percent of sales, a 50 basis points increase from 27.9% in the third quarter last year. However, last year’s results included $4.1 million of payments received for early lease terminations which amounted to a 50 basis point reduction in the SG&A rate last year. Absent this benefit to last year’s results, the SG&A rate was essentially unchanged. Reductions in advertising and insurance offset slight increases in expenses for store supplies and debit card fees, which reflect the continued increase in debit card penetration in our overall sales mix.

For the third quarter, depreciation and amortization was $39.6 million. The overall rate as a percent of sales improved 30 basis points compared with the third quarter last year. We expect depreciation of the $158 million to $159 million for the year, which as a rate of sales, should be down about 30 to 35 basis points from last year.

Our operating margin for the quarter was 6%, a 10 basis point improvement over the third quarter last year. This is in line with our forecast last year that we would begin to see improvement in operating margin in the second half of 2007.

The tax rate for the quarter was 36.5% versus 35.8% for last year. The lower rate last year reflected the benefits from the Katrina related watsi (sic). For the first three quarters the tax rate was 36.9%, which is essentially the same as in the first three quarters of 2006.

Looking at the balance sheet and statement of cash flow, during the third quarter of 2007 we repurchased 4.1 million shares for $163 million. This includes 330,000 shares repurchased early in the quarter on the open market for $13 million, 2.4 million shares repurchased through a $100 million accelerated share buy-back announcement in August 2007, and 1.4 million shares repurchased on the open market for $50 million near the end of the third quarter following completion of the AFB. Year to date we have invested more than $378 million in share repurchases and bought back more than 9.4 million shares.

Reflecting this share repurchase activity, cash and investments approximated $30 million at the end of the third quarter versus $119 million at the same point last year. In addition, our long-term debt increased by $85 million to $335 million, all of which is in our revolving credit facility. We anticipate that we will pay off the $85 million during December.

In early October, the board of directors authorized the repurchase of an additional $500 million of the company’s stock. We now have approximately $548 million of authorization, including $48 million remaining from the $500 million share repurchase program authorized by our board in November of 2006. Our share repurchase program reflects our commitment to building value for our long-term share holders and our confidence in the company’s ability to continue to generate significant cash flow.

Capital expenditures were $63.9 million in the third quarter of 2007 versus $51.4 million in the third quarter last year. The majority of capital expenditures in the quarter were for new stores, remodelled and relocated stores, and the expansions of our Briar Creek distribution centre and our home office and data centre in Chesapeake. The Briar Creek expansion was completed on schedule in October. As a result of these initiatives and the addition of frozen and refrigerated product to approximately 310 stores, we expect capital expenditures in the range of $185 million to $190 million for fiscal 2007.

Moving on to inventory, we continue to focus on lowering our per-store inventory investments and increasing turns. Year to date our inventory turns have increased about 26 basis points through third quarter as inventory per store finished down 5.3% at the end of the quarter. You will also note that our payables-to-inventory ratio continues to improve from 29% at the end of the third quarter last year to 32.2% at the end of Q3 this year. This is a continuation of a trend that began in late 2005 and is attributable primarily to improved payment terms with our suppliers. Inventory investment is presently planned about $30 million higher as of the end of this year versus last year, which we believe will result in inventory-per-store being slightly higher than the end of last year, primarily reflecting merchandise flow for an earlier Easter season next year.

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

Bob Sasser

Thanks, Katie. I want to make some comments about guidance for the remainder of the year and then I’ll leave you with a few summary observations.

Regarding sales and earnings guidance for the fourth quarter of 2007, we’re forecasting sales in the range of $1.31 billion to $1.35 billion and diluted EPS in the range of $0.99 to $1.06. This implies a range of flat to low single-digit positive comparable store sales.

For the full fiscal year 2007 we estimate sales will be in the range of $4.25 billion to $4.29 billion based on a low to low-mid single-digit increase in comparable store sales. As a result of these sales estimates we’re forecasting diluted earnings per share in the range of $2.06 to $2.13.

As we’ve reminded you since the beginning of the year, 2006 was a 53 week year based on the retail calendar. As previously disclosed, 53rd week added about $70 million to sales, a little over $0.07 diluted earnings per share to last year’s fourth quarter and full-year results.

In addition, our guidance for 2007 includes the impact of the $370 million of share repurchase activity so far this year. Our EPS estimates also include the reduction of interest income associated with the use of those funds that have been consistently invested in tax-free municipal income securities. Thus, our weighted-average share count may be in the range of 93 million to 94 million shares for the quarter and then the 96 million to 98 million share range for the full year.

Before turning the call over to you for questions, I want to leave you with a few summary observations. In the face of record high fuel and energy prices, as we all know, I’m very pleased with the third quarter results and I could not be more proud of this management team. We had a strong third quarter consistent with our guidance and we remain on track to accomplish our long-range goals.

Sales increased 9.6% with a comp sales increase of 1.9%. Gross margin improved 70 basis points for the third quarter and it’s up year to date. With more stores and volume our logistics network continues to become more efficient. As an example, freight costs in Q3 were flat to last year as a percent of sales even though diesel fuel was $0.19 higher per gallon than last year.

Our investments in infrastructure continue to translate into better inventory management, more efficient stores, improved in-stock position, and a better overall shopping experience for our customers. As an example, inventory turns which have increase each quarter over the past two years increased again by 26 basis points for the third quarter.

Our new Deals concept is progressing and it is exciting. We’re opening new stores in new markets, customer acceptance is strong, and the gross margin is improving.

For our shareholders, earnings per share increased 19% for the quarter 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; 4 million shares in the third quarter alone. We’re confident in the company’s ability to continue generating its significant amount of free cash flow and we remain committed to use our cash to drive shareholder returns.

Once more, I’m proud of our performance in the third quarter and I’m confident about the future. I want to be clear, however, that we have a very realistic view of the current retail environment. As we enter the holiday season we know that our customers are somewhat under economic pressure. They’re challenged. Especially from high and uncertain energy prices. Consumer confidence has declined and this has affected many retailers. We are not immune to this environment, nor can we change it, but we can adapt and succeed in this environment by being part of the solution for millions of consumers across the country, delivering great value to our customers through exciting high-value seasonal product, by being in stock with basics that people need, and by providing a bright, friendly, fun, convenient shopping experience.

As we have evolved to the larger stores we now have what people need and what people want every day. Our stores are relevant to these times.

We’re now ready for your questions. Again, 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

Thank you. The question and answer session will be conducted electronically. (Operator Instructions) We’ll take our first question from Meredith Adler with Lehman Brothers. Please go ahead.

Ivy – Lehman Brothers

Hi. This is Ivy on for Meredith.

Bob Sasser

Morning, Ivy.

Ivy – Lehman Brothers

Hi, how are you? Great quarter.

Bob Sasser

Well, thank you.

Ivy – Lehman Brothers

Question for you. How much flexibility do you have to reduce expenses or to slow new store growth if the economy does slow?

Also, could you tell us what kind of comp do you need in order to cover your expense growth? That’d be helpful.

Bob Sasser

Well, Ivy, as far as, we have no, announced no plans for our growth, but I guess if you were going to slow growth you could do it pretty quickly. Just stop leasing more stores. It’s probably easier to slow it than it is to ramp it up. But that is not something we’ve talked about at this point.

Flexibility on, I’m sorry, the first. Expenses, you know, we manage our expenses, we manage it line by line, Ivy. Our organization has been very good to stay focused on the things that could, that are variable in our business. With our size and with our buying power we’ve actually managed to reduce our per-unit cost, whether it’s merchandise or whether it’s expenses, in many ways. Given a long view of the environment, you know, sometimes we can’t change things right now, but anything that we can see coming I think we can react to very well.

The one thing that’s most troubling, if you’re asking this question, is the high fuel prices and diesel prices. I don’t know, we’ve never been in this rare air before with the kinds of diesel prices that you’re seeing. We were able to offset $0.19 in the third quarter and other expenses increase in diesel fuel. Right now diesel fuel is running $0.50, $0.60, $0.70 a gallon higher, so I don’t know what that means. Is that going to go higher again still or is it going to come back down? So we’re observant of that and we are managing our business accordingly, but we really manage it line by line.

Ivy – Lehman Brothers

Okay. And the level of comp you need in order to cover your expenses?

Bob Sasser

Well, we’ve always said somewhere in the 2% to 4% range, but you know, 4% covers it really well. Four percent is what we’ve always said.

Ivy – Lehman Brothers

Thank you.

Bob Sasser

Thank you.

Operator

We’ll take our next question with Jeff Sonnek with FBR. Please go ahead.

Jeff Sonnek – Friedman, Billings, Ramsey & Company

Thanks, guys. Great quarter. The fourth quarter with the 53 week, you mentioned a couple things there. Could you walk through, you know, what did that do to the gross margin compare? About last year, we had an increase in incentive comp from that solid quarter as well. Just to help us from a kind of apples to apples perspective.

Bob Sasser

Well, the effect of the 53 week we’ve been reminding everyone all year, if you go back to every call, remember we’re comparing on 52 when there was a 53 week last year. So I wanted to make sure that I keep saying that. Basically the 53rd week was about, added about $70 million to sales on the top line. And it was about $0.07 on EPS that that was worth. Because basically with a 53 week you have a lot more sales and not much more expenses. Gross margin was maybe within 10 basis points from a 53 week comparison to a 52 week comparison.

Timothy J. Reid

It was more than 30.

Bob Sasser

Thirty. Thirty. Thirty basis points. Excuse me. As far as the, oh, you asked about, help me with the question.

Jeff Sonnek – Friedman, Billings, Ramsey & Company

Yeah, you touched on gross margin more than 30 basis point help from the week and then how about SG&A? I think there was some incentive comp.

Bob Sasser

Well, not much, but as far as incentive comp, we don’t expect that to be a big, it was a big number last year fourth quarter that was an increase. We don’t expect that kind of a change this year in fourth quarter. We basically feel very good about how we’ve accrued for that throughout the year.

Jeff Sonnek – Friedman, Billings, Ramsey & Company

Okay. And then I think advertising was up last year in the 4Q.

Bob Sasser

Advertising this year in the fourth quarter as a percent in sales is likely to be slightly down. We expect our merchandise margin to continue to be slightly positive. Markdowns are well managed and within line. Our strength is about the same as last year. That’s under control. The big bogey, Jeff, this year again is the fuel, the diesel fuel prices and the affect on the gross margin. So if you can tell me what that price is going to be I’ll give you the answer on the rest of it. That is one that we’re just going to have to wait and see how that turns out.

Jeff Sonnek – Friedman, Billings, Ramsey & Company

And then, just to follow up on all of this, you know, you’ve talked about strength being a benefit for a couple quarters. Can you just describe for us, where is that really coming from when you really get down to it? Is there more opportunity or are you guys really pretty efficient?

Bob Sasser

You know, we’re pretty efficient. Right now we’re, for fourth quarter strength’s going to be the same as it was for last year. We’re at the same rates. It had been earlier in the year at a higher rate and through our inventories this year we’ve been able to see where we can, we have brought that down. There is still more opportunity and our strength, it’s, I think we’re 2.05 now is where we are. I want to get that below 2 and I believe we can. And I think it’s coming. We’re well on the way to getting there. Frankly it’s coming from just focus and oversight and managing the basics of the business at the stores and doing all the things that we know how to do to manage our strength. I feel very good about how it’s being managed. The pressure is going to be downward on the strength. I don’t really see that growing.

Jeff Sonnek – Friedman, Billings, Ramsey & Company

Great. Thank you.

Bob Sasser

Thank you.

Operator

We’ll take our next question from Patrick McKeever with MKM Partners. Please go ahead.

Patrick McKeever – MKM Partners

Thanks. My question is on the, you recently distributed a holiday circular and I’m just wondering, I think it’s just four pages. Did you do that last year or is it new for this year?

And then just generally speaking, how is your holiday advertising campaign? What is your approach this year versus last year? Is it any different? I know you’ve been talking about shifting add dollars from TV and radio into print. Will that be the case for the fourth quarter as well?

Bob Sasser

That is the case, Patrick. And the ad, we’ve just dropped a four-page circular, I believe dropped over this past weekend. It was an anniversary of a circular from last year, but we added more stores and more markets this year. So we had an event last year, this year we’ve expanded the coverage of that event. As far as the fourth quarter, the focus on our advertising is in the print, just as you saw that circular. We’ve had some success in the past with aligning the store. I’ve always said the store is the ad and it’s the focus on what’s on your front end and your lobby, what’s on the end caps, what you’re showing, what you’re standing for. And then what we’ve don with these circulars is we’ve supported that with the print media that we’ve distributed in the tab as well as the store front signing.

And if nothing else, I think that half the benefit comes from having everyone of the stores focused on these key items, these great mostly seasonal key items that we’ve developed for the holidays. I believe that since we’ve started doing this, if you go in our stores you’ll find a lot more consistency on these key holidays with what is on the front table. This week the front table is Christmas cards. I think everybody in the country across over 3000 stores knows that the drive item this week is Christmas cards. So we’ve really put a keen focus with our advertising on our in-store selling effort focusing our stores on these key items. That’s where I think we’re getting a lot of the results from the advertising.

Patrick McKeever – MKM Partners

Yeah, no, the stores look great. And then just my second question is on the Visa roll out and the question is, are you baking in any benefit to sales in the fourth quarter from the Visa initiative or Visa roll out or not?

Bob Sasser

Yeah, well, we rolled it out October 31st, I think was the date. Yeah, we are expecting some benefit. I think we’ll probably find that there’s more benefit from rolling credit out for fourth quarter than any other time of the year. So we are baking in some benefit for Visa credit. We already had it in 700 to 800 stores, I believe, so this was just getting out across the rest of the chain. But there is going to be a benefit from this.

Patrick McKeever – MKM Partners

Okay. Great. Thank you very much.

Bob Sasser

Thank you, Patrick.

Operator

We’ll take our next question from Dan Wewer with Raymond James. Please go ahead.

Dan Wewer – Raymond James

Bob, I had a question on sourcing. With indications of inflation rate accelerating in China and given the importance of that country to your product mix, what challenges will this present in your gross margin rate, recognizing that over the short term you’re contracts protect you, but over the long term I would assume there’d be some pressure? So can you touch on your strategies?

Bob Sasser

Dan, we’ve done, our buying group has done just a terrific job in China. I just returned from a week with them on their last trip and there’s all kinds of talk in China about prices going up and there’s talk about raw materials and there’s talk about energy and labour and all the things that you know. At the end of the day, we’re buying large quantities. We’ve developed a relationship with people. And we are actually getting lower costs in many cases from our Chinese goods. So on same-same items, we’re actually finding that we’re able to leverage our pencil into lower costs, even in the face of the concerns about inflation.

And then too, remember that we’ve always built our assortment around the margin rate and the value that we want to offer the customer. We’re in complete control of that. So it’s not always exactly the same item year over year. It might be a different item. It might be a different factory. It might be positioned differently in the mix. And at the end of the day our merchandise margins, two things are happening right now and have been happening all year. Our merchandise margins have been going up on our Chinese goods and we’ve also imported a larger percent of our mix goods from imported goods this year than last year, probably about 5% more this year. So the share of those goods have grown and that’s one of the things that’s impacting positively our overall gross margin this year.

As far as domestic sourcing, there’s pressures on raw materials. There’s pressures. The only thing that I can tell you that I can point to that we’ve said, well, we just won’t sell this anymore is half gallon quarts size milk. You know, milk has gone through the ceiling. We’re now down to pints, I think, on our milk. And in some of our stores we sell actually the soy product and we’re looking for creative ways to manage that piece. It wasn’t a good piece of our business anyway, but that’s the only piece that I can really point to on our domestic sourcing where we’ve just said, well, okay, we’ll go to another product. Some of our dairy, we’ve had some great success, by the way, with converting some of our dairy space in our frozen refrigerated stores to more refrigerated beverage. You know, non-carbonated beverages have been just really high. So we’ve taken doors in some of our stores and put an assortment of non-carbonated beverages that have really been more productive than some of the dairy type products that we’ve had in there.

Dan Wewer – Raymond James

Okay. And Bob, as a follow up, on the product recalls of Chinese manufactured products, what this is requiring Dollar Tree to do to ensure minimum quality standards and does that add any extra expenses or expand the number of days in the supply chain?

Bob Sasser

You know, Dan, we’ve always tested for the past five years plus. I know the more used third-party testing as a way of making sure that we are meeting the requirements. Whatever the product category is required for safety or health, that’s what we test to and we’ve used it. We’ve always, well, five years or more we’ve used the third-party testing on that.

It’s increased my anxiety level, I will tell you. I don’t like hearing these things. I can’t tell you that there’s any more issues that pop up than we have had. They seem to be more prominent when they pop up. We’ve been very good citizens, though, always and been proactive. We will typically find something that if there’s a problem with it before anyone else does and report it to the CPSC ourselves. That’s, we don’t want things to get through, but sometimes things do happen and something might get into the system. We’ve had a couple of instances this year, but not any great number, but we continue to test. We’re diligent on that. We have meetings with our factories and we express our sincere, you know, we want to get the right standards and we want to make a product that fits that quality. And we’ve had pretty good results.

But it’s all over the news and it’s not comfortable and there is anxiety about it being really overdramatized in many cases, I think.

Dan Wewer – Raymond James

Right. Well, good luck to you.

Bob Sasser

Thank you.

Operator

We’ll take our next question from Mitch Kaiser with Piper Jaffray. Please go ahead.

Mitch Kaiser – Piper Jaffray

Thanks, guys. Good morning. I think on the last call Kent talked about the stock being a good value. I think it was about 42 at that point. Today the stock’s at 27, as we’re all painfully aware of. What level of debt would you be willing to take on to buy the stock at this point, especially given that you thought, at least Kent thought it was certainly a good value at 42? And then I have one follow up.

Bob Sasser

Well, our position, Mitch, has always recently been to use our free cash flow to buy back our stock. And we’ve done that fairly consistently this year. Obviously if we’re buying back at 40 we feel 27 is also a good time to be buying. But as far as taking on more debt, you know, right now I’m looking at the opportunity, I continue to see the opportunity and Dollar Tree stores and continuing to open new Dollar Tree stores is a better opportunity for us and a better way to serve our shareholders by continuing to increase our market share to drive our top line. And also to continue to improve our efficiencies and our business.

I’m very proud of our logistics network and every store that we open now makes it more efficient. But we did just expand our Briar Creek facility because our business in the northeast has grown faster than we had anticipated. All good news. So we went up there this year and we added a few more hundred thousand feet to our Briar Creek facility.

So investment in our business, investments in the future, we’re still about growing this company. We have opportunities with the Deals concept that are just becoming somewhat clearer, but that’s before us. We would prefer, I would prefer to tell you that I’m going to use our capital, our cash, our capital to fund our business first and foremost. Now, $27 stock we’re going to stay, we have an authorization from our board still of over $500 million availability, and we’ll continue to look at the opportunities to buy back our stock as we have earlier in the year. I have no immediate plans to borrow money to buy back the stock.

Mitch Kaiser – Piper Jaffray

Okay. And then you mentioned, you didn’t mention the multi-price point in the existing Dollar Tree store, so it’s my recollection that you were trying an additional 25 this fall. Maybe you could comment on how those were going this far. And any plans that you might have.

Bob Sasser

I’d love to comment. The reason I didn’t say any more is because the other 20, actually 27 is still fairly new. So we’re having a good time with them. We’ve seen a lot of excitement. Just as a reminder, we call it Oops. We know it’s not a dollar, but the value’s too good to pass up and we’ve put 20 to 25 feet into now 50-ish stores across the wide geography. What we’ve found is really three things. First of all, the extreme value seasonal items have a great attraction for our customers. We’ve had some great success with some toy trucks recently at $5 and holiday candles and cheerleader dolls. We’re selling, you know, that’s pretty good numbers in some of these stores on those items.

The second thing we’ve really gone after is to stock up and save bigger sizes on the consumable items, particularly brands. Sometimes not possible at a dollar, but it is at $5 maybe. And we’ve had some good results on bigger sizes, bigger savings, and stock up and save. And then the ability to sell some new product that would never have sold at a $1.We had some lined storage baskets that we sold at $5. There was fleece blankets at $3. And microfiber blankets at $5. So item by item we’ve had some pretty good success and it is really exciting. It’s too early to say what that means across the chain.

Again, there are some issues with the ability for the customer to accept it and our ability to roll that out over a larger geography without contaminating, if you will, the value statement that we have with our customer where everything’s $1. So I’m very careful about that. But let’s get through the fourth quarter. As I said on the last call, we just rolled these out. Let’s get through the fourth quarter and then we’ll know more and we can talk more about plans for future. Right now I have no more plans more than the 50, I think it’s 53 that we have now. Although I’m excited about it. It’s been fun.

Mitch Kaiser – Piper Jaffray

Okay. Good luck over the holidays. Thanks.

Bob Sasser

Thank you.

Operator

We’ll take our next question from William Keller with FTN Midwest. Please go ahead.

William Keller – FTN Midwest

Good morning. Thanks for taking my call. I believe for the last quarter you gave us some idea of what the comps pace was through the quarter sort of by month. I wonder if you could do that again.

And then any update on the CFO search would also be appreciated. Thank you.

Bob Sasser

Yeah. I can’t give you, we don’t disclose by month what the comps were. I will share this with you that they started off stronger than they ended. So there was a little bit of a, to get to the 1.9% it just coasted down really through the three months a little bit. That’s one, just to give you some colour.

As far as CFO search, we have search companies employed out across America. I actually have two: one on the east coast and one on the west coast. We’re looking for the best CFO person we can find. We’re excited about the names that I’m seeing and the opportunities to bring in highly qualified candidates. If you have any ideas, let me know. I’d certainly appreciate some insight on to people. I would welcome input on that. But I don’t expect a new CFO until after the holidays. People are busy, the people I’m trying to hire are employed, and they’re employed at good companies and they’re busy running a business right now. So it’s likely going to be after the holidays before we can get with these people and really get down to the brass tacks of hiring one.

In the meantime, my finance team, Katie and Roger and the rest, are pretty darn good. I think you’ll have to say this business is in great hands. Any more questions?

Operator

Yes. We’ll take our next question from Adrienne Shapira with Goldman Sachs. Please go ahead.

Adrienne Shapira – Goldman Sachs

Adrienne Shapira. Bob, just, you know, in light of the pressures that you highlighted announcing on the consumer, can you just talk about what the competitive landscape is out there? How aggressive have you noticed pricing in like items? Thanks.

Bob Sasser

You know, Adrienne, I don’t look at pricing in like items as being a part of our pressure. Frankly, we are, we’ve always had an opportunistic point of view. On branded items especially, things that you can compare directly, we buy them opportunistically. We bring them in, we sell them through, and by the time anybody else notices that usually those are gone. And then as far as the rest of our mix a lot of it is things that we build and create the value ourselves. They’re maybe just a little different than what you’ll find in some of the big stores. I have not seen pressures from, other than there are just a lot of people out there, but I can’t tell you that I’ve seen a pressure from a competitor that’s oh, my goodness, and they’re taking share away from us. I don’t mean that to be crass. We actually look at ourselves as the most competition. We continue to open more stores in these markets and every time I open one I have one that’s up against it. So we compete with ourselves.

But as far as going out in pricing, first of all, like items you have to really look hard to find exactly the same items in our store as is at a Wal-Mart or a Target or those other stores. And when you do it’s usually, if it’s a branded item it’s usually a close-out or an opportunistic buy.

Adrienne Shapira – Goldman Sachs

Okay. I appreciate that you work hard to differentiate the assortment, but I’m just wondering, perhaps maybe not like items, but in same type of categories. When your managers go out and perhaps price in the market. Could you just share with us perhaps where your pricing advantage has been and has that changed?

Bob Sasser

We really look at our differentiation as the key issue. That and our shopping experience. The idea of coming, people shop at Dollar Tree, Adrienne, because they like shopping with us in addition to the value. They never know what they’re going to find. It’s that surprising value and then everything’s $1. When they come into our store everything’s $1 and, oh, my goodness, it’s only $1. It’s disarming and the value is great. You’ll find things in a Dollar Tree store that you’re not going to find anywhere else.

If you go into our seasonal offering right now, take a look at our decorations wall. You’re not going to find that anywhere. Yes, you’ll find Christmas decorations, tree ornaments other places, but you’re not going to find these with these themes that our people have put together that coordinate to make these themes for these trees. You’re not going to find that anywhere else. The Christmas cards on the front table for a buck. I mean, I’ll stand that value against anybody’s.

When we look at Family Dollar, Dollar General, anybody else that’s out there in the business, they have an offering too, but we have been very successful in differentiating our products and also offering something, we worked very hard to offer that shopping experience. So when you come into our stores they’re clean, they’re bright, they’re fun, people are friendly. How much is this is still the question that I hear the most in our stores. Oh, it’s only, everything’s $1. Everything’s $1? That’s the idea of a Dollar Tree. And that doesn’t exactly lend itself. Everybody knows the price; it’s $1. Once they get in there they can’t believe the price. That’s really what makes us who we are.

Going out and putting together a list of cleaning supplies, basic consumer products and comparing them against, you really gotta work hard to find exactly the same item across the network of competitors.

Adrienne Shapira – Goldman Sachs

Okay, Bob. That’s helpful. But just maybe then, following up, when you look in the baskets and you highlight and seasonal were strong, but as you’re expanding basics, could you just take us through, when you were looking at the basket, the percentage in there that’s perhaps discretionary. How much is, how much has been seasonal? Where is that percentage? Where is it heading, especially, as you grow basics and perhaps as the consumer is perhaps tightening up a little bit more on the discretionary spending?

Bob Sasser

That’s really a good, that’s a really good question because one of the things that we’ve done over the past five years especially is we’ve evolved and built these bigger stores. We have put more of the consumer fast return and things that people need every day product in the stores. We used to, probably five, six, seven years ago I would tell you that about 30% of what we sold was needed and 70% was discretionary. That’s closer now to 40% to 50%. It might be 45% needed consumer products, 55% discretionary. And that too will change by store and by market. But we have grown that mix. I call it things you need. You know, the things that people need every day. We’ve grown that mix of product. That is part of why this year we’ve had the opportunity to increase our traffic. We sell things now that people buy more frequently. They make more trips. And by the way, when they’re in the store they buy more and it lifts the tide, so to speak, on our discretionary product, too. So I’m going to say 45% needed and 55% discretionary, which is up considerably from 30% a few years ago.

Operator

Thank you. Due to time constraints we only have time for two more questions. And we’ll take our next question with David Cumberland with Robert W. Baird. Please go ahead, Sir.

David Cumberland – Robert W. Baird & Company

Thanks. On the gross margin increase, was the improved mark-up mostly due to the higher percentage of imports that Bob mentioned and will Q4 see a similar increase on the import percentage versus Q4 ’06?

Kathleen E. Mallas

It’s really, you know, we saw some help in terms of the merchandise mark-up across almost all the departments. We do anticipate seeing a similar trend in terms of the merchandise margin itself in the fourth quarter as well. That should stay the same.

David Cumberland – Robert W. Baird & Company

Thanks. And as the credit penetration likely grows with Visa chain wide, would you expect to call out higher credit related fees as you have on the debit card fees?

Kathleen E. Mallas

Yes, we do believe we will see a similar trend. We’ve seen some up-tick in that this year as the debit penetration ramped up and the credit will continue to put some pressure on that expense.

David Cumberland – Robert W. Baird & Company

Thank you.

Operator

And we’ll take our next question with Ralph Jean with Wachovia Securities. Please go ahead.

Ralph Jean – Wachovia Securities

Great. Thank you. Just a couple quick questions. One, Bob, you’ve gone about the roll out of the coolers at a very managed and measured pace. Do you see that pace remaining stable as you go forward?

Bob Sasser

Is this Ralph Jean or Sean Jean?

---Laughter

Ralph, we have grown as we’ve been known to do at Dollar Tree. We take a measured approach on these big initiatives and we’ve been very consistent with that. We’re going to continue to grow and roll out at somewhat lesser levels as we go forward. I’d like to say 200 to 250 stores maybe next year, in that range, as opposed to the bigger numbers that we’ve done. But we’ve only in it, we’re in less than 1,000 stores at the end of this year with more than 3,000 stores operating. So we do have a little more runway on that initiative.

Ralph Jean – Wachovia Securities

Yeah. And then just what you’re seeing so far on the Visa implementation. I know it’s been about a month, if that. Is it coming along as you expected? Is it taking out faster or does it take a little while to ramp up? How is it progressing so far?

Bob Sasser

It’s too early to tell, Ralph. It’s only been a couple weeks. I mean, we have seen some increases in our average ticket from the Visa roll out. But it is just so early, it’s hard to – It’ll be there. I have confidence that it’s going to be there. Especially in the fourth quarter. You know, people tend to use credit cards more and ride that float a little bit in the fourth quarter. So I believe firmly that we’re going to be able to see it in the fourth quarter. But it’s just so early I can’t tell you a number.

Ralph Jean – Wachovia Securities

Sure. Thank you.

Bob Sasser

Thank you.

Operator

And we’ll take our last question with Mike Baker with Deutsche Bank. Please go ahead.

Michael Baker – Deutsche Bank

Great. Thanks. Slid in there. So I wanted to ask you about the new store productivity based on your sales guidance in the comps and how many stores you’re going to open, etcetera. We gotta make some estimates. But I get to around 55% to 60% is what we should assume for new store productivity in the fourth quarter. Is that right and, so it’s a little bit of a slowdown. Are stores opening later in the quarter or is it just in a tough economy, stores don’t ramp up as well, or am I just completely off base on my calculation?

Bob Sasser

I’m not sure what the 55% to 60% you’re talking about. I’ll tell you this: we got two goals on our real estate plan. One was to open more stores earlier. Mission accomplished; we did that. We also wanted to open stores more productively this year. So far to date, to date I can’t tell you that we’ve had any improvement in that. Now, I still have some stores. Part of it is the mix of stores that we’ve opened. When we open a more higher mix of suburban and rural stores, the productivity on the stores are a little less than the metro stores. Most recently we’ve opened up in some of these urban markets in the northeast that aren’t end much productivity numbers yet because we can’t annualize them yet.

So right now I’m running just a little bit behind plan. I believe that by the end of the year my store productivity this year is going to look a lot like it was last year, which means that we did not accomplish our goal on that. I think there’s still an opportunity in merchandise and grand opening and driving those stores on the first few weeks of opening them up better. I think that’s something we can work on for next year.

Michael Baker – Deutsche Bank

Okay. Thanks. That’s simple. And the true follow up is, within the store counts that you gave, does that include or exclude the Deals stores?

Bob Sasser

It includes. That includes the Deals stores.

Michael Baker – Deutsche Bank

Okay. That’s all. Thank you very much.

Bob Sasser

Thank you.

Operator

That concludes our question and answer session. I’d like to turn it back over to management for any additional or closing remarks.

Timothy J. Reid

All right. Well, thank you all for participating on the call at this time. I hope you all have a happy and prosperous holiday season. Our next conference call is scheduled for Wednesday, February 27th, 2008, when we will announce our full-year results. Thank you.

Operator

Once again, ladies and gentlemen, this will conclude today’s conference. We thank you for your participation. You may now disconnect.

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Source: Dollar Tree Stores Q3 2007 Earnings Call Transcript
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