Good day ladies and gentlemen and welcome to Dollar Tree Incorporated’s First Quarter Earnings Release. As a reminder, today’s call is being recorded. For opening remarks and introductions, I will now turn the call over to Mr. Tim Reid, Vice President of Investor Relations. Please go ahead, sir.
Thank you, Debbie. Good morning and welcome to the Dollar Tree conference call for the first quarter of fiscal 2012. Our call today will be led by Bob Sasser, our President and Chief Executive Officer, who will provide insights on our performance in the quarter and recent developments in our business. Kevin Wampler, our Chief Financial Officer, will provide a more detailed review of the first quarter financial performance and provide our guidance for the remainder of 2012.
Before we begin, I would like to remind everyone that various remarks that we will make about future expectations, plans and prospects for the Company constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors included in our most recent press release, most recent current report on Form 8-K, quarterly report on Form 10-Q, and annual report on Form 10-K, all of which are on file with the SEC. We have no obligation to update our forward-looking statements and you should not expect us to do so.
At the end of our planned remarks, we will open the call to your questions which we ask that you limit to one question and one follow-up question, if necessary.
And now, I’d like to turn the call over to Bob Sasser, our President and CEO. Bob?
Thanks, Tim, and good morning everyone. This morning we announced first quarter 2012 earnings of $1 per diluted share. This represents a 22% increase over the first quarter of 2011 earnings of $0.82 per share. Comp store sales increased 5.6% in the quarter and total sales grew 11.5% to $1.72 billion. Operating income increased by $26.3 million, operating margin was 10.9%, an increase of 40 basis points compared with the 10.5% operating margin in the first quarter last year, and net income increased 15% to $116.1 million.
I want to begin by saying that I’m very pleased with these results. Both sales and earnings growth exceeded the top end of guidance. Comp store sales are growing consistently year-over-year. Our comp increase of 5.6% this year was on top of a 7.1% comp in the first quarter last year and a 6.5% comp the year before. Our operating margin of 10.9% was the highest first quarter operating margin we have ever produced.
Inventory turns increased again in first quarter. Most importantly, our shelves are full of the right product, our stockrooms are in great shape, and we ended the quarter in stock, in business, and well prepared for our customers as we entered second quarter. I’m particularly proud of the day-by-day execution of our strategy across the organization. The merchant teams continue to source and develop product that exceeds customer expectations of what one dollar can buy. The product selection and assortment day-in and day-out is of the highest value and more relevant to our customers’ needs than ever. New customers are finding Dollar Tree and Deals to be a shopping destination and our store teams are working very hard to keep these customers coming back by delivering on our promise of a store that is clean, bright, friendly, and full of merchandise energy.
Our goal is to provide our customers a store that offers a balanced assortment of high-value basics, things that customers need every day alongside seasonally relevant and fun discretionary product, all for just a dollar. Delivering on this promise requires a coordinated effort across the organization. Bridging the gap from source to store, our supply chain is solid, scalable and efficient, and the logistics team is focused on smoothing and improving the flow of product. Our information systems provide visibility to valuable data and we’re using this information to effectively manage costs, increase inventory turns, and improve the customer experience.
Seasonal transitions in first quarter were well executed. Fresh assortments arrived in a timely manner and our stores transitioned seamlessly almost overnight from one season to the next, while consistently maintaining high levels of in-stock on basic items that customers need every day. At Dollar Tree and Deals, we’re gaining new customers all the time and existing customers are shopping more frequently. As a result, comp store sales growth in the first quarter was driven largely by traffic. Of the 5.6% comp store sales increase, 5.4% came from increased transactions.
The top performing categories for the quarter included home products, food snacks and beverage, healthcare products, party supplies, household cleaning supplies, and seasonal merchandise. Sales increases in the first quarter came from growth in both basic and variety categories, which basic consumable categories generally growing at a faster pace. This has been a continuing trend consistent with the difficult economy that we’re experiencing. With customers concerned over rising and uncertain fuel prices and high unemployment, many are finding Dollar Tree to be a destination for high value consumer products as they look for ways to balance their budgets. At Dollar Tree, we remain focused on the needs of our customers, and our flexible assortment strategy enables our stores to be right for all times and relevant in all economic environments.
When customers are under pressure from the difficult economy, as they are now, they can look to Dollar Tree for extreme value on products they need every day. As long as this trend continues, we plan to meet our customers’ demand by providing these products consistently and at the highest value possible. It’s another reason to shop at Dollar Tree. When customers are in the store shopping for the basics, we plan to give them every reason to stock up on our terrific assortment of high value and higher margin variety merchandise. Even in a difficult economy, at Dollar Tree you can still splurge – everything is only one dollar.
Sales cadence in first quarter reflected the growth in both consumable product and the growth of seasonal and variety merchandise sales. In February, we got off to a great start with sales for Valentine’s Day. Customers were thrilled with our offerings of gift bags and tissue, candy and balloons, and at two for a dollar you can afford to buy Valentine’s Day cards for more than one special person. From Valentine’s Day, our stores quickly transitioned to Easter and a Dollar Days event that was very successful and helped to sustain sales momentum into March. The Dollar Days event included a solid present of housewares, home textiles, household plastics, and variety merchandise. As planned, sales momentum continued to build in March and peaked at Easter, which was two weeks earlier this year on April 8. Performance in the first quarter was relatively consistent across the country with the highest comps coming from the mid-Atlantic and the midwest, followed closely by New England and the southwest.
Our stores have broad appeal. Our growth strategy remains consistent and can be summarized into five points: more stores, more productive stores, new formats, new markets, and new channels. In reference to more stores, during the first quarter this year we opened 110 new stores, relocated and expanded another 44 stores, and grew total square footage 7.1% relative to this time last year. We ended the quarter with 4,451 stores and we’re on track with our plan for the full-year 2012, which includes 315 new stores and 75 relocations and expansions for a total of 390 projects across the U.S. and Canada.
In addition to opening new Dollar Tree and Deals stores, we have a tremendous opportunity to expand categories, to grow new retail formats, to expand geographic reach, and to open more productive stores, increasing store productivity overall. New store productivity has increased consistently for six years, driven by improved site selection, by right-sizing our stores to the market, by opening new stores earlier in the year, through improved staffing building the bench of qualified store management, and by emphasizing and expanding the most productive categories of merchandise. Last year, average new store productivity increased to its highest level in 10 years. While it’s still very early, I’m pleased with the productivity of this year’s new store class and I am happy to report that we are ahead of plan.
Our expansion of frozen and refrigerated product continues. We installed freezers and coolers in 127 stores in the first quarter and now offer frozen and refrigerated product in 2,345 stores. We are planning approximately 325 installations for the full year. This important category is extremely productive. It serves the current needs of our customers, drives traffic into our stores, and provides incremental sales across all categories.
Another key component of our growth strategy is the development of new retail formats and the expansion of our geographic reach. Our Deals format extends our ability to serve more customers with more categories and increases our unit growth potential. Deals delivers low prices on everyday essentials, party goods, seasonal and home product. At Deals, our goal is to surprise and delight our customers on every visit and we’re seeing evidence of success. Customers are responding favorably to the strategy, customer awareness of the Deals brand is growing, and the concept is building momentum. In the first quarter, as in the past several quarters, Deals traffic, average ticket and average unit retail all continued to increase compared with the previous year. Comp store sales in our Deals stores have been robust.
We’re encouraged with the growth potential of Deals and the opportunity that it provides to serve even more customers. We ended the quarter with a total of 186 Deals stores across 18 states and we’re on track with our growth plan for 2012.
In addition to growing new formats, we have opportunity for growth in new geographies. Our expansion into Canada continues. We initially entered the Canadian market through the acquisition of Dollar Giant stores in November of 2010. As you will remember from earlier comment, we intend to operate our Canadian stores on an identical platform to the merchandising and productivity systems that support our stores in the U.S. Our primary focus in 2011 was to install retail systems, integrate processes, merchandise assortments and store teams, and to lay the foundation for future profitable growth in the Canadian market.
To summarize our progress, to date we have aligned both the merchandise organization and the merchandise plans. We’re in the process of rationalizing and cleaning up the non-go-forward merchandise assortment in the stores and DCs, replacing Dollar Giant assortments with higher value Dollar Tree merchandise. We’re solidifying our logistics model in Canada, changing from a model that was heavily vendor-direct to store delivery to our U.S. model of supplying most of merchandise through the distribution centers, of which we have two in Canada. We have completed the installation and training of store-level POS and enterprise-level merchandising systems in all stores, gaining visibility to sales and inventory by store by SKU while we are building sales history. These are key factors in the management of an efficient supply chain.
Equally important, we’ve conducted SKU-level inventories in each store and we’re beginning to roll out auto-replenishment of basics and smart allocations of new and seasonal merchandise. As we look to the future, the necessary tools and information are coming into place. Just as we have done in the U.S., the result will be more efficient store operations, an increased level of in-stock of basic products, higher store productivity, increased inventory turns, and most importantly improved customer satisfaction.
We’re extremely excited about the opportunity for Dollar Tree Canada. I’m proud of what the team has accomplished so far and I know that we have a tremendous opportunity for profitable growth in Canada as we leverage our investments. This year, we intend to grow our Canadian store base approximately 25% under the Dollar Tree brand and we’re well on our way to achieving this goal. We opened eight new stores in the first quarter and ended the quarter with 107 stores in Canada. As we grow and improve, we believe the Canadian market can support up to 1,000 Dollar Tree stores. This is in addition to the 7,000 store potential for Dollar Tree in the United States plus additional growth in our Deals format.
Before I turn the call over to Kevin, I’d like to give you an update on Dollar Tree Direct, our online business. As most of you know, Dollar Tree Direct is an additional channel distribution, providing an opportunity to broaden our customer base, drive incremental sales, expand the brand, and attract more customers into our stores. Dollar Tree Direct now offers more than 2,500 items online. Traffic on the sites grew to 4 million visitors in the first quarter, a 19% increase over the first quarter last year, and if you haven’t already had the opportunity, I invite you to take a look at our sites at dollartree.com, dealstores.com, dollartreecanada.com, espanoldollartree.com, or check us out on Facebook, YouTube, Twitter or Pinterest.
Now I’d like to turn the call over to Kevin who will give you more detail on our financial metrics and provide guidance.
Thanks, Bob. As Bob mentioned, our diluted earnings per share increased 22% in the first quarter to $1 per share. The increase resulted from our strong sales, a 35% gross profit margin, and a 40 basis point reduction in total SG&A expense compared to the first quarter of last year.
Starting with gross profit, our gross profit margin was 35% during the first quarter, consistent with the 35% reported in the first quarter last year. We leveraged occupancy and distribution expenses, reflecting the 5.6% comp store sales growth. This improvement offset the impact of the continuing shifts in product mix as basic consumable products increased by 110 basis points as a percentage of sales in the first quarter. In addition, freight expense increased to a small degree relative to sales as the impacts of diesel prices that averaged $0.21 per gallon above the same period last year more than offset the savings on ocean freight. Also, shrink increased slightly as a percent of sales.
SG&A expenses were 24.1% of sales for the quarter, a 40 basis point improvement from the first quarter last year. This was driven primarily by expense leverage across several categories, most notably payroll reflecting improved productivity at the field management and store level. In addition, utility costs decreased due to favorable weather conditions and trash removal costs were lower. Depreciation expense declined by about 10 basis points and debit and credit card fees declined, reflecting the lower legislated rates which more than offset continued growth in usage of these types of tender. In the first quarter compared to the first quarter last year, debit card penetration increased 140 basis points and credit card penetration increased 10 basis points. These improvements were partially offset by higher expenses for stock compensation and health insurance benefits.
Operating income increased $26.3 million compared to the first quarter last year, and operating margin was 10.9%, an increase of 40 basis points compared to the 10.5% operating margin in the first quarter last year. The tax rate for the quarter was 38.4%. This compares with a 37.5% tax rate in the first quarter last year which included the benefits of the Hire Act and work opportunity tax credit programs, both of which expired at the end of last calendar year.
Looking at the balance sheet and statement of cash flow, cash investments at quarter end totaled $382.3 million, an increase of $94 million during the quarter. Cash and investments totaled 510.3 million at the end of the first fiscal quarter of 2011.
During the first quarter, we completed our $300 million accelerated share repurchase that was initiated in November 2011. We also repurchased an additional 49,000 shares of Dollar Tree stock for $4.5 million. As you may remember, in October of 2011 the Board of Directors authorized an additional $1.5 billion for share repurchase. As of quarter end, we have $1.2 billion remaining in our authorization. We will continue to view share repurchase opportunistically and we will update you on additional share repurchases, if any, at the end of the quarter in which they may occur. At the end of the first quarter, the diluted weighted average shares outstanding were 116.4 million.
Our consolidated inventory at quarter end was 13.5% greater than at the same time last year while selling square footage increased 7.1%. Consolidated inventory per selling square foot at cost increased by 5.9%, reflecting an increase in goods on the water at the end of the first quarter as we continued to execute our smoothing of inventory flow throughout our logistics network, as we have previously discussed, and to provide for planned new store growth in the second quarter. Additionally, our Dollar Tree Canada inventory increased as we transitioned these stores to a DC delivery model from a direct store delivery model beginning in the second quarter of last year. We believe that current inventory levels are appropriate for our current sales plan. Also, inventory turns increased in the first quarter and we expect continued improvement in our inventory turns for the full year.
Capital expenditures were $65.4 million in the first quarter of 2012 versus 58.3 million in the first quarter last year. For fiscal year 2012, we are planning consolidated capital expenditures to be in the range of 330 to $340 million. Capital expenditures will be focused on new stores and remodels, the addition of frozen and refrigerated capability to approximately 325 stores, IT system enhancements, and approximately $80 million towards a new distribution center in the northeast U.S. Total capital investment anticipated for this facility is approximately $95 million.
Depreciation and amortization in the first quarter totaled $41.8 million versus 39.3 million in the first quarter last year. We expect depreciation expense to be in the range of 170 to $180 million for the year.
Our guidance for 2012 includes a couple of assumptions. First, regarding freight, while we are pleased with the results of our May 1 ocean freight contract negotiations, diesel prices have risen since we issued our previous guidance. The net effect is that we believe freight costs overall will be somewhat higher than those incorporated in our previous guidance. Second, as we previously disclosed, due to the retail calendar, 2012 will include 53 weeks and the fourth quarter will consist of 14 weeks. This is expected to add 120 to $130 million of incremental sales and $0.13 to $0.15 of earnings per diluted share in the fourth quarter and the full year. Third, our guidance assumes a tax rate of 38.3% for both the second quarter and the full year. Weighted average diluted share counts are assumed to be 116.6 million shares for the second quarter and 116.7 million shares for the full year. While we still see share repurchase as a good use of cash, our guidance assumes no additional share repurchase.
With this in mind, for the second quarter of 2012 we are forecasting sales in the range of $1.66 billion to $1.70 billion, based on a low to mid-single digit comparable store sales increase and 7.1% square footage growth. Diluted earnings per share are expected to be in the range of $0.87 to $0.93, an increase of 13% to 20.8% over second quarter 2011 earnings per share of $0.77. As a reminder, the second quarter last year included a previously disclosed benefit to gross profit from a favorable inventory adjustment related to immaterial corrections to prior periods.
For the full fiscal year of 2012, we are now forecasting sales in the range of $7.33 billion to $7.46 billion based on a low to mid-single digit increase in comparable store sales and 7.1% square footage growth. Diluted earnings per share are expected to be in the range of $4.74 to $4.94, representing an increase of between 17.6% and 22.6% over our record earnings per share of $4.03 in fiscal 2011.
With that, I’ll turn the call back over to Bob.
Thanks, Kevin. We entered this year with goals to drive more customer traffic, to delight our customers with surprising values on merchandise they need and want, to improve our shopping experience, and to build market share. I’m pleased to report that we’re off to a good start towards accomplishing these goals. First quarter sales grew 11.5% to a record $1.72 billion. Driven by increased customer traffic, comp store sales increased 5.6% on top of a 7.1% comp last year. Our inventory is balanced and more productive than ever. Our turns increased again in the first quarter and we entered second quarter well prepared for new store growth and customer demand. Our operating margin increased by 40 basis points to 10.9%. That’s the all-time highest first quarter operating margin in our history. Net income grew 15% to $116.1 million and earnings per share increased by 22% to $1 per share.
In addition, we opened 110 new stores across the U.S. and Canada, and so far the productivity of the new store class has been performing ahead of last year. The Deals brand is gaining traction, both traffic and average ticket are growing. Dollar Tree Direct continues to broaden its reach and we’re working to build and expand our Canadian business.
As I look to the future, I see even more opportunity to grow our business through new Dollar Tree stores, more productive stores, and category expansion. We’re developing new formats and new channels with Deals and Dollar Tree Direct, and we’re expanding geographically as Canada provides an opportunity for substantial growth. All of this provides a roadmap for sustained profitable growth ahead.
We’re now ready for your questions. So that we can accommodate as many callers as time permits, we ask that you limit your questions to two.
Question and Answer Session
Ladies and gentlemen, the question and answer session is conducted electronically. If you would like to ask a question, please press the star key followed by the digit one on your touchtone phone. If you are using a speakerphone, please be sure to disengage your mute function so that your signal can reach our equipment. Again star, one for questions.
We’ll go first today to John Zolidis with Buckingham Research Group.
John Zolidis – Buckingham Research Group
Hi, good morning. Great results. I have a question on traffic versus ticket, or two questions, rather. So the first question is on the traffic, which was very impressive – up 5%. Can you talk about some of the factors that may have contributed to that and whether the earlier Easter actually clipped some of the traffic? And my second question is on the ticket, which was roughly flat during the quarter. You mentioned that the Deals stores were showing ticket increase, perhaps suggesting that’s doing slightly better than the core Dollar Tree stores. Can you talk about the difference that might be going on in Deals versus Dollar Tree? And then also with the cooler roll-out, does that contribute more to traffic gains or more to ticket gains? Thank you.
Well John, the cooler roll-out contributes more to—has been recently contributing more to traffic gains. It’s a faster turning product. It’s a product category that people buy more frequently. One of the reasons we like it so much is that it does give us—first of all, it fills a customer need. They’re responding very favorably to it, but it gets the customer to come to us more often, and more footsteps in the store gives us the ability to showcase our seasonal product and all the variety merchandise that we do so well in and is so important to our continued profitability. I mentioned that our consumer products are growing; our variety sales were also growing. The consumer products are growing generally by category at a faster pace than the variety, but they’re both growing very nicely.
So the traffic increase of 5.4%, I view as a terrific metric. We’re gaining more customers all the time. When they’re in the stores, they’re buying the assortment that we have to offer, and by the way I think they’re coming back more frequently. I know they are because of things like frozen and refrigerated foods, because of our health and beauty care items that we sell, because of our household products that we sell. So it was a very healthy first quarter.
It was a little, to your point—the flow was a little different because it always is when you have an earlier Easter. Easter was April 8 this year – two weeks earlier – so we had terrific February, we had a terrific March leading up into that Easter April 8. And then as we thought, we were up against Easter for two weeks the year before, and as we planned, the sales fell back after those two weeks after Easter this year. But all in all, we had a terrific first quarter – 5.6%, most of it being driven by traffic.
John Zolidis – Buckingham Research Group
We’ll take our next question from Matt Boss with JP Morgan.
Matt Boss – JP Morgan
Hey, good morning. Can you speak to initial markup in the first quarter and your expectations for the second half of the year?
Initial markup was up in the first quarter. You know, when you talk about initial markup, it’s all about the—just the initial markup by category, we have a really strong handle around that. The mix of products that we sell is really the thing that drives any variation in our gross profit, or most of the variation in our gross profit. So you know, we’ve just come back from a trip in April. Our buyers have been, as they always are in April, in China and in Asia sourcing for the next spring and the next Valentine’s Day, the next Easter product; and I can tell you that our future has never been brighter. The markup from that trip was—we hit our target markup. Our buyers are saying that they’re not seeing any signs of pricing pressure. Basically, pricing would be characterized on this past trip as stable or maybe even better, depending on the category. So our initial markup, we feel very confident about being able to manage that part of our business – always have had.
Matt Boss – JP Morgan
Great. And then your same stores sales accelerated on a two- and a three-year basis in the first quarter. As we look to the early start of 2Q, have you seen the favorable trends continue?
Well, it’s only two and a half weeks into Q2, and we certainly don’t announce weekly sales, but the color is that we started off Q2 very well. We had a really nice Mother’s Day holiday and there’s nothing that has begun in Q2 that would give me any pause over the guidance that we just gave. We’re off to a great start in Q2.
Matt Boss – JP Morgan
Great. And real quick on Canada – I learned that a Field’s dollar store operator in western Canada was closing a bunch of stores. Could this be an additional opportunity for you guys in the region?
You know, we look at all opportunities, but that’s probably a very small opportunity in that. We were aware of that, by the way.
Matt Boss – JP Morgan
Great, sounds good. Thanks.
We’ll take our next question from Adrianne Shapira with Goldman Sachs.
Adrianne Shapira – Goldman Sachs
Thank you. Kevin, you had mentioned—it sounded like diesel prices are up a little bit, and freight costs a little bit higher than your original expectations for the year. Help us think about what that means for margins as we think through the remainder of the year.
Yeah, so obviously we’ve taken into consideration where the pricing is today in our go-forward guidance is a little higher than what we had in our guidance when we gave it back in late February. As we’ve always said, diesel prices being--$0.10 of increase in diesel price will be about $0.08, so if diesel is up $0.10 for a full year, it equates to about $0.08 of earnings at the end of the day—or excuse me, $1 does. So $0.10 is just a piece of that – I’m sorry, I misspoke there - $1 increase in diesel is about $0.08 for the year, so it’s a tenth of that. So it’s very small in the overall scheme of things right now, but obviously the marketplace has been very choppy, to say the least, if you look at it in the sense of the way it’s been up and down. So our crystal ball isn’t any better than anybody else’s realistically to that, so we’ve tried to take the position of expecting it to stay in the area of where it’s at.
Adrianne Shapira – Goldman Sachs
Okay, that’s helpful. And then Bob, I’m just wondering—you know, you have such a good pulse on your consumer. I’m just wondering as you talk about the traffic and ticket, I guess this is now the second quarter in a row where most of the comp was driven by traffic as opposed to the first three quarters of last year you definitely saw ticket being a lever of those helping drive comps. How do you think about this in terms of what does this tell you about the consumer out there, in terms of how cautious they are with their spending? What, if anything, does that mean when you see traffic start to be the predominant driver of comps as you kind of think through the rest of the year?
Well Adrianne, I think it means that we’re getting new customers and they’re coming from all walks of life, all demographics. We’re getting new customers, so more traffic in our stores from new customers. Our mix of product that we have evolved to because of customer demand is more of the things that are purchased more often, so existing customers are shopping us also more frequently. The price is still a dollar, so when you talk about the average ticket, that sometimes has been a little stubborn. I view the traffic increase, though, as increase in market share. I view it as more customers finding us every day, and our goal in the stores now is when we get these new customers in, to really, really show them a shopping experience, and that starts with all the fun things that we do at the front of the store with our variety merchandise and our seasonal, and at the same time in-stock and in business on what they came to shop for. We are better in-stock today on basic, needed product than we’ve ever been. When they spend their dollar on their fuel, or $4 sometimes on their gasoline, and they come to our stores, we want to make sure that we give them what they need. So there’s really a concentrated effort on in-stock home basics, running great stores, fun stores, friendly stores, and we’re working on improving the average ticket all the time. I think some of the initiatives that we have in place driving impulse sales on our front end, drive items at our checkouts, the items of the week – all the things when you walk into the store we’re really challenging our customers to add one more item to their basket, and I see that as just an opportunity. If we get the customer traffic in the store, I believe we can then drive some of that average ticket up.
Ladies and gentlemen, just a reminder, in order to give everyone an opportunity, we ask that you limit yourself to two questions. We’ll go next today to Charles Grom from Deutsche Bank.
Charles Grom- Deutsche Bank
Thanks, good morning everybody. Kevin, it’s been a long time since your inventory outpaced your sales growth, and I was wondering if you could maybe quantify for us how much of that inventory increase was to goods on the water and was the Canadian stores. You did open up more stores in the quarter than we were modeling, and I’m wondering how many of those were towards the tail end that may have added a little bit more inventory while not getting the benefit from sales.
Sure. So in regards to the various points that we raised in the sense of goods on the water, we’ve talked a lot about smoothing of inventory flow through our network over the last couple years and the benefits it brings to the entire organization. It all starts with the buy and the scheduled shipment, so we have obviously continued to shift some things around. From an overall perspective, if we look at the things—goods on the water, which is a large portion of the increase, Canada was a little less than the goods on the water at the end of the day.
The other thing I would mention is that another factor potentially that really relates to this is our shift in mix of product. So you’ve got to remember, we’re reporting inventory at cost and so part of the increase relates to that shift in the mix as our business has continued to have more consumable business. That difference at retail is really a much smaller increase year-over-year, so that’s a point of it as well.
And then I think the other thing to remember is that this is just a point a time disclosure and we have many ebbs and flows in any given year when we have—we’re moving over 250 million cartons of goods around the world. So we look at that but we feel very good. New stores – you know, we did do more new stores. I think we did about 83 new stores last year in Q1; 110 this year, so we do have more new stores. We have plenty of stores opening in Q2 as well, so there is a function of that as well.
But I would tell you the largest piece is the goods on the water and our Dollar Tree Canada at the end.
Charles Grom – Deutsche Bank
Okay. I guess my follow-up would be if that’s the case, what would you expect inventory to look like 90 days from now at the end of the second quarter?
You know, I think it could look—my guess it will potentially come down a little bit, but I would tell you the Canadian process really didn’t really get started until Q2 last year, so that’s likely to continue to be an increase year-over-year for Q2. And again, the other is it’s ebbs and flows – you don’t know exactly when goods are going to get on the water. We have some shipping windows and some things like that, but there’s always ebbs and flows to that. But it’s possible it will come down a little bit.
Charles Grom - Deutsche Bank
All right, great. Thanks a lot.
We’ll go next to Joseph Parkhill with Morgan Stanley.
Joseph Parkhill – Morgan Stanley
Hi, good morning. I was wondering if you could just comment quickly from the balance sheet perspective – I noticed the term loan moved to short-term debt, and the lack of share repurchases this quarter. Is that a signal that you’re going to repay the debt and not renew it, or what’s your thoughts on that?
Well obviously our current credit facility expires in February of 2013, so the term loan is now less than a year to maturity so it automatically moves from long-term to current liability on the balance sheet. Obviously we will look to renew that at some point within the year and prior to expiration. We believe it makes sense to have a line of credit available, even though we’ve traditionally had cash on the balance sheet. So that will be a process that we will go through, and once that happens we’ll obviously announce that and get that out to everybody. But that will be a normal process we will go through.
Joseph Parkhill – Morgan Stanley
Okay. And then just on the CAPEX side as well over the last two years, you’ve had a little bit more elevated as you’ve built out more distribution centers. Is there kind of a run rate as to how frequently you’ll need new distribution centers in the future and how you think about CAPEX on an ongoing, longer term basis?
Well I think as we look at our distribution centers, some of these buildings we’re just now adding larger second shifts and third shifts to, so we continue to work more efficiency into the network. So that plays a role in being able to offset the need for an additional distribution center. Obviously we’ve been building a lot of stores in the northeast the last few years. They tend to be very high volume stores, so the northeast makes sense that we need to a get new distribution center in that area.
Part of it depends on growth, part of it depends upon—again, smoothing of inventory is another way that we can gain efficiencies within our network, and so we continue to look at that. I think, again, size plays a part in it, so when we look at a new distribution center, we always look at size versus stem miles because obviously when you have a bigger building, you can serve more stores, but are your stem miles going to be efficient for you in the long term? So there’s a lot of different factors that go into it, and then part of it is just regionalization. You know, sometimes we grow stronger in certain areas of the country that can create needs maybe prior than it would other areas. So all those things go into consideration.
You know, the typical building—we have buildings that probably service 300, 400 stores, and we have some buildings that service closer to 800 stores, so that kind of gives you an idea – you know, the 400 to 800 range is kind of a general range of stores being serviced by a building – gives you an idea based on growth what may be kind of the cadence at the end of the day, so that you could potentially need one every three to four years.
Joseph Parkhill – Morgan Stanley
Okay, thank you.
We’ll take our next question from Dan Wewer with Raymond James.
Dan Wewer – Raymond James
Hey, morning Bob. I had a question – how important are carbonated beverages for Dollar Tree in driving traffic? And the reason I’m asking, obviously, is with Family Dollar adding Pepsi products and we’re anticipating some pretty hot pricing for Pepsi products over the Memorial Day weekend from Family Dollar; and I believe with Dollar Tree that the size of your Coke bottles are a little bit smaller than they were in the past. I’m just kind of curious as to how that could impact Dollar Tree.
Well, carbonated beverages are very important to us at Dollar Tree – it’s a huge business. We sell a private brand or a control label. We sell a lot of it. We also sell the single-serve Coke and Pepsi products at the fronts of our store. We are very pleased with our Pepsi-Coke sales. We think we offer for a buck the best value in the market. Now, you may find somebody running promotions here and there and trying to drive some sales on that. For us, it’s more of an impulse. We get customers in the store. We have them in the refrigerated cases at the front of the store. It’s a buck, it’s a big bottle of Pepsi, and it’s a great value on Coke. And so I don’t know if I’ve answered your question well, but we really don’t see other people’s Memorial Day promotions as really threatening that business. It’s more of an impulse category for us. It’s a big one, but it’s not something that—it’s not a destination, let’s go to blank store and buy our 12-pack or 24-pack of Coke or Pepsi. That’s not how we use it. It’s basically at our price point an impulse buy, and we like both those guys and we do a lot of business with both of them.
Dan Wewer – Raymond James
Yeah. My other question – what is your view on long-term gross margin opportunities for Dollar Tree? I recognize that every year, your initial markups improve. It sounds like your ocean freight contract for the next 12 months is favorable, and then further you always tell us that you don’t want to become another small-box grocery store. But at the same time, this consumable mix continues to grow every year, just as it does for Dollar General and Family Dollar. So are you thinking that gross margin rate is not really an opportunity, instead where the opportunities on the gross profit dollars just driving higher volume, so more of a flat long-term margin rate outlook?
You know, Dan, we look at both of them, and if you look back at our history, I think it’s remarkable – I use the word remarkable – but we’ve always said that we were in control of our margins, and when pricing was favorable we would maybe take some into margin, but we’re just as likely to put more value into the product and drive more top line. Also over the past several years, we have been responding to consumer needs and selling more of the things they need and building bigger stores and all that. But if you look back at the last 10 years of our history, it really is a remarkably tight range that our gross profit has performed at. If you look back at the last 10 years—now first quarter, we were 35% gross profit this year. Last year, we were 35%. If you look back at the last 10 years, the high was 35.6 and the low was 33.4 in 2006, with the average being about 34.6, so we’re just a little higher—just short of the high range of our gross profit percent. But over 10 years, you think about the changes in diesel fuel prices and you think about the changes in cost of goods up and down, and the mix changes and the larger stores and the more consumable products that we’ve added, and we’ve still managed that gross profit number in just a very tight range. And if you look at our operating margin, we just posted the highest operating margin percent in the history of the Company at 10.9%.
So I believe strongly that we’re going to be able to manage our gross profit percent going forward. Could you jump out there and make one year higher? Probably; but our strategy really is more along the line of offering the most value to the customer for one dollar and to deliver the margin that we need for our shareholders. So in doing that, if you look at that 35% range, maybe a few higher, maybe a little lower, but that’s where we’re managing the value of the offering to the customer. That drives top line growth, and when we drive top line growth, we can leverage our SG&A and all the other fixed costs.
Dan Wewer – Raymond James
Right. Okay, I think I understand what you’re saying. Thank you.
We’ll take our next question from Scot Ciccarelli with RBC Capital Markets.
Scot Ciccarelli – RBC Capital Markets
Good morning, guys. What is the best way to kind of think about SG&A growth and SG&A per-store growth? I mean, is there a right way to think about it, because there is maybe a little bit more volatility to that line item than I guess I would have expected, given how consistent the sales trends have really been.
Well you know, Scot, as we kind of walked through the various positives and helps and hurts, I guess, for the quarter on our SG&A, I know sometimes—you know, we don’t look at it as SG&A dollars by square foot or anything like that. We’re basically looking at it as running our business, trying to be as efficient as possible, continuing to try to drive cost out of the business as appropriate. So those are the kind of things that we think about, and so you’re going to have some ebbs and flows based upon all those things at the end of the day. We look at it as are we continuing to leverage it as a percent of sales, are we continuing to be able to push down those costs and gain efficiencies within our business; and I think that’s what we always look at and drive towards.
Scot Ciccarelli – RBC Capital Markets
Okay, thanks. And then this is a little bit of a sidebar, but can you guys talk—I guess you guys are starting to experiment with selling prescription drugs in, I guess it’s the Deals chain. Can you talk about that at all?
Well, there’s not a lot to talk about, but we do have one store in Florida in the south Florida area, a Deals store, that we have partnered with a third party and we have a pharmacy. It’s been a very short period of time, and it’s one store. We may try it in another store, too, but it’s clearly in the test mode and it’s so early, I really don’t have anything to report other than, again, we’re always about trying new things and pushing the envelope on what we can offer to our customers and what they want. So this falls into that category, but right now it’s one store for just a very short period of time, and I really don’t have anything. I’d tell you, but I don’t have anything much to report.
We’ll take our next question from Peter Keith with Piper Jaffray.
Peter Keith – Piper Jaffray
Hey, good morning everyone. Nice quarter. I want to ask a follow-up question on IMU. In the past, you’ve highlighted that the lift you got from initial markup was often sufficient enough to offset the negative drag from mix, and then you’d of course finally get some benefit from occupancy leverage. Are you still in a position right now where that benefit from IMU is offsetting the mix drag on gross margin?
Well, I can only speak to it from the standpoint of pointing to the operating margin; and remember, our price is still a dollar. Other than our Deals stores, our price is still a dollar, so our markup on what we sell for a dollar by category is favorable. When you start selling more of the consumer products, the mix does put pressure on the gross margin, but then we get the leverage on the fixed costs. So it really is about driving the most value possible to the customer at the dollar price point and delivering that improved operating margin. 10.9% - again, I’ve said it three times, we’re proud of that. It’s the highest first quarter operating margin we’ve ever had, and by the way that’s the highest first quarter penetration of the consumer products that we’ve had. So you can do both – it’s not just markup and it’s not just top line. It’s really both together that provides the quality of earnings that we’re after.
Plus, in this time and age that we’re in, our customers want—we serve our customers, we’re going to sell them what they need, what they want. And I’ll just say this, too – as the economy improves—and this has been a trend for several years. This isn’t just a first quarter trend. But as the economy improves, we’re going to do very well also because we do have a terrific mix of variety merchandise at higher margins, and it will be the same thought process but it’s just a little bit different calculation as we drive more variety sales to the mix of consumer products.
So that’s the secret formula. It’s not really that secret, but initial markup is important, top line growth is important, and how we manage our costs and our fixed costs as well as our variable costs is how we get to the bottom line.
Peter Keith – Piper Jaffray
Okay, thank you. I guess talking about one of your sales drivers, you are clearly enthusiastic about the coolers and the freezers. I guess I’m curious on why you may not be accelerating that roll-out. As you stand here today, you only have those in about 50% of the stores, and it seems like the roll-out is only keeping pace with store growth. Why not kick that up a bunch, maybe even double it for the next couple of years?
Well you know, we do what we think is the proper amount of installations. We are in some locations restricted by our leases, and there are some locations—you can’t do it in some places. There are some locations that the demographics aren’t as favorable. Believe it or not, I mean, there are some places where we’ve installed and it hasn’t done as well as it has in other places, so we’ve learned where the best demographics are. There are store size implications – you know, as you get below that 9,000 or 8,000 square foot store especially, you begin to pinch the assortment and you really don’t have the room, either on the sales floor for it or in the backroom for it. So there are some natural limitations to that.
We are installing them in new stores that we open if they fit our model, if it fits the model of that new store with the demographics and the size and the volume and the delivery availability, so we are putting them into new stores. We think we are going at the proper rate.
We do like it – you’re exactly right, and the stores where we have frozen refrigerated, sales per square foot are higher. Those are usually our largest stores. The average store size in those stores are larger. Our average sales in those stores are higher, and our cash contribution margin—our cash contribution is higher in those stores. So we like everything about the frozen and refrigeration; it just has some natural limitations, and then there are some limitations as we roll it out based on store size. And the delivery – we’ve built this delivery model over time, too, so part and parcel to being able to do it from a restriction standpoint is, by the way, can you efficiently deliver the product to the store and make a few bucks doing it.
Ladies and gentlemen, we do have time for a couple more questions. With that, we’ll go next to Matt Nemer with Wells Fargo Securities.
Matt Nemer – Wells Fargo
Thanks, good morning. I noticed that home products beat out food snacks and beverage as the top performing category in the quarter. Is this switch something that should have been more apparent in the gross margin, or is there not really that much variance year-over-year? And then secondly, can you just talk to the slight increase in shrink that you mentioned in your prepared remarks? Thanks.
The mix, Matt – home products is one that we’ve really been staking our claim to over the past several years, and it continues to grow. Now, there is a mix – when you talk about home products from a margin standpoint, it’s a little bit of both. You’ve got home products in regard to household cleaning supplies and paper towels and bath tissue that are fast-turning and lower margin, and then you’ve got home products like some of the tabletop merchandise – the placemats, the dishcloths, and the flatware – and those type products that are higher margin variety products. So you’ve got a little bit of both in that home product category. It’s a huge category for us. It’s one that we think that we want to stake a claim to because it appeals to the broad middle America, and it’s one that we think we can do well at not only the dollar price point but also in our Deals stores. We think it’s an important category, so that’s really the story there. As it appeals to our customers, it’s important and it brings in footsteps with a part of the mix and it makes a lot of money with the other.
And Matt, in regards to shrink, we did mention that it was up slightly. It was just slightly, but over the last two years we have been at a level that was a record low level for us, so obviously it’s something that we’re keeping our eye on, and our field teams and our loss prevention teams are very focused on. But again, it’s early in the year. We’re only about a little over 30% reconciled our inventory for this year of our stores, so we have a good opportunity to continue to bring that back into line. But for Q1, it was up just slightly.
Matt Nemer – Wells Fargo
Thanks so much.
We’ll go next to Dan Binder with Jefferies.
Dan Binder – Jefferies
Hi, it’s Dan Binder. Good morning. I had a question regarding the events and what’s new in this coming quarter versus last year, whether it’s Dollar Day events or anything else that might be incremental year-over-year that you can give us color on.
You know, I can give you some color, Dan, on where we are right now. We’re past Mother’s Day and full-blown into graduation sales, with graduation balloons and parties and all that goes with that. If you look at Dollar Tree stores up front, you’re going to see a really terrific assortment of summer items for summer fun. You’ve got water blasters for a buck, 26-inch water blasters. We have a new item—we’ve done well with our solar stakes – for only a dollar, can you believe that? You buy solar stakes, and for the Memorial Day through the Fourth of July time period, we’ve got some that have the red, white and blue on them, so you can be patriotic and light up your sidewalk all at the same time. Of course, with this time of year, a lot of things around Memorial Day with glow sticks and barbecue items and paper goods and paper plates; and water – you know, we’ve got terrific values on our beverage. So it’s all about summer fun and pools and going to the beach and having fun right now at Dollar Tree, and if you haven’t been in our store lately, you should probably stop by.
In our Deals stores, in addition to all the summer fun, we are also selling fans, for example. You know, you can’t sell an electric fan at Dollar Tree for a buck, but you can in our Deals stores and we’re having terrific success with stand fans and other kinds of electric fans. As soon as the weather really turns hot, I expect that business to pop in our Deals stores. Right now, we’re again selling 24-packs of water and little cooler and beach bags, and all the things in Deals for going to the beach or having fun in the summertime, or picnics or that type of thing.
So that’s what’s going on right now. There is always something new at Dollar Tree. You know, we’ll come out of the summer, we’ll go into back-to-school as usual, and I’m not going to give you all our secrets right now but I can tell you back-to-school this year will be the best ever. It just will. We’re excited about that, and of course after back-to-school you’re right back into the fall and Halloween and getting into the holiday season again.
We’ll take our final question today from David Mann with Johnson Rice.
David Mann – Johnson Rice
Yes, thank you. In terms of Dollar Giant, can you talk a little bit about the sales trends there? I know you talked last year that you had some headwinds from the transition. And then also, can you talk about anything you’ve gleaned from the inventory and sales data in terms of how you think you’ll change the assortments in certain categories.
Yeah, as you can imagine, sales are under pressure. Now that we know what we’re selling and we know what our inventory is by SKU, by store, we’re going through and rationalizing these assortments. You’re trying to get rid of some of the existing products, so you’re selling down on that; and in the meantime, there’s little voids between getting rid of the old and getting in the new. You know, all stores don’t sell down at the same rate. We’re getting it in stock in the DCs, we’re delivering—changing the delivery model so that we can get it from source to DC to store more efficiently up there, and we’re excited about what’s going there. We’ve just started relays in six of our stores up there to really change the flow of the product to more like a—and change the name of the stores to Dollar Tree from Dollar Giant.
So what you’re seeing right now is just a lot of activity around building the store teams, about building the merchandise assortment, getting rid of some of the old, replacing it with higher value merchandise from our Dollar Tree assortment. Not that it wasn’t a great value before, but with our buying power we are able to provide even more value for a $1.25 in our Dollar Giant stores.
So you’ve got a headwind to sales right now. Margin is probably neutral—margin rate is probably neutral, and a headwind on SG&A because we’re investing in the business. We’re doing store relays, we’re investing in all the things to put the infrastructure in place so that we can provide the platform for future profitable growth.
Just a look at the cadence – we expect headwinds all first half in our Canada business. We expect it to get better in the second half. I can’t quantify it, but I can tell you that first half is planned to be a lot of activity, a lot of investment and time and effort in getting the stores and the merchandise assortments right, and then showing some improvement in the second half.
David Mann – Johnson Rice
Ladies and gentlemen, this does conclude our question and answer session. Mr. Reid, I’ll turn it back to you for closing remarks.
Thank you, Debbie. Thanks to all of you for participating in this call, particularly for your interest in Dollar Tree and of course thank you for your investment in Dollar Tree. Our next sales and earnings release and conference call are scheduled for Thursday, August 16, 2012. Thank you.
Ladies and gentlemen, thank you for your participation. This does conclude today’s conference. Have a wonderful rest of your day.
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