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Dollar Tree Inc. (NASDAQ:DLTR)

Q2 2012 Earnings Call

August 16, 2012 9:00 am ET

Executives

Bob Sasser – President, Chief Executive Officer

Kevin Wampler – Chief Financial Officer

Tim Reid – Vice President, Investor Relations

Analysts

Matt Boss – JP Morgan

Meredith Adler – Barclays

Dan Wewer – Raymond James

Scot Ciccarelli – RBC Capital Markets

Peter Keith – Piper Jaffray

Dan Binder – Jefferies

Joseph Parkhill – Morgan Stanley

Anthony Chukumba – BB&T Capital Markets

David Mann – Johnson Rice

Adrianne Shapira – Goldman Sachs

Charles Grom – Deutsche Bank

Operator

Good day and welcome to the Dollar Tree Incorporated Second Quarter Earnings conference call. As a reminder, today’s conference is being recorded. At this time, I’d like to turn the call over to Mr. Tim Reid, Vice President, Investor Relations. Please go ahead, sir.

Tim Reid

Thank you, Jim. Good morning and welcome to the Dollar Tree conference call for the second 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 our second 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.

Also, you are reminded that during the second quarter of this year, the Company’s Board of Directors approved and the Company executed a two-for-one stock split in the form of a 100% stock dividend. All share and per-share data in today’s report have been retroactively adjusted to reflect the stock split.

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?

Bob Sasser

Thanks, Tim. Good morning everyone and thank you for joining us. This morning we announced our sales and earnings for the second quarter of 2012. Comparable store sales increased 4.5%. This increase was on top of a 4.7% comp in the second quarter last year and it was driven principally by increases in traffic. Total sales for the quarter grew 10.5% to $1.705 billion, exceeding the high end of our guidance. Earnings for the second quarter were $0.51 per diluted share. This represents a 30.8% increase over last year’s $0.39 per share. Operating margin for the quarter was 10.8%, an increase of 80 basis points over the second quarter last year and another record quarter. Just to note, this is our highest second quarter operating margin ever as a public company. Operating income was $184.4 million, an increase of $30.9 million or 20.1% over last year, and net income rose 25.6% to $119.2 million.

For the first half of 2012 compared with last year, sales were 3.43 billion, an increase of 11%, and comp store sales increased 5.1%. First half 2012 earnings per share were $1.01, an increase of 27.8% compared with $0.79 per share in the first half last year. Operating income increased by $57.2 million, operating margin was 10.9%, an increase of 70 basis points compared with the first half of 2011, and net income rose 20.1% to $235.3 million.

I’m pleased with our performance in the second quarter. Both top line sales and earnings exceeded the upper end of guidance. Most importantly, we provided value to our customers and brought a record level of second quarter earnings to the bottom line. I’m particularly pleased by the productivity of our new stores. Our location planning is improving. The value of our merchandise has never been better, and customers are responding enthusiastically.

In our current economy with customer struggling to balance their family budgets in the face of persistently high unemployment and now unpredictable fuel prices, many people are finding Dollar Tree to be a destination for high value consumer products. We plan to meet our customers’ demand by providing these frequently purchased products consistently and at the highest value possible. It’s another reason to shop at Dollar Tree, and 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 high margin variety merchandise. Even in a difficult economy, at Dollar Tree you still splurge – everything is still a dollar.

Sales increases in the second quarter came from growth in both basic and variety categories with basic consumable categories growing at a slightly faster pace. Our top performing categories included housewares and home products, food and beverages, healthcare supplies, and toys. I’m extremely pleased with the continued increase in inventory productivity. Inventory turns increased once again in the second quarter, as they have consistently for the past seven years.

Our growth strategy remains consistent. It is to open more stores, to open more productive stores, and to develop and expand new formats, new markets and new channels. In regard to more stores, during the second quarter this year we opened 77 new stores and relocated and expanded another 21 stores. Through the first half, we have added 187 new stores and expanded or relocated 65 stores. Selling square footage increased 7.1% relative to the same time last year. We ended the quarter with 4,523 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 order to achieve consistent and profitable growth, our practice has been to add infrastructure and distribution capacity to support our growth ahead of the need. In that regard, in July we broke ground on DC10, a new distribution in Windsor, Connecticut. The new distribution center will be 1 million square feet. It will be automated and highly efficient, providing capacity and cost-effective service to our stores as we continue to expand in the northeast.

Along with opening new stores, we are focused with operating more productive stores. Efforts have been concentrated on improved site selection, on right-sizing our stores, expanding our assortments, improved staffing, building the bench of qualified store management, and on opening new stores earlier in the year. Average new store productivity has increased in each of the past six years, and the trend has continued through the second quarter of 2012.

Our expansion of frozen and refrigerated product continues. We installed freezers and coolers in 60 additional stores in the second quarter and now offer frozen and refrigerated product at 2,403 stores. We intend to roll this product out to 138 additional stores by year-end for a total of approximately 325 installations for the full year. This important category serves the current needs of our customers and it drives traffic into our stores more frequently, which promotes incremental sales across all categories. Our overall comp sales increase has been the result of growth in both needs-based consumer products and in higher margin discretionary variety merchandise.

The elements of our strategy to increase store productivity can be seen throughout our stores. Seasonal presentations are more powerful, we’re emphasizing more effective customer engagement, and we’re working to drive more related sales through cross-merchandising. In addition, we’re expanding our assortments in many categories, including candy, stationery, health and beauty care, and home and household products, which was our fastest growing category in the second quarter.

Another key component of our growth strategy is the development of new retail formats and 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. By lifting the restriction of the $1 price point at Deals, we’re able to serve more customers with more products at value prices every day.

Customers are responding favorably to the strategy. Customer awareness of the Deals brand is growing and the concept is building momentum. In the second quarter, Deals had strong sales across a wide variety of merchandise categories. To give you an idea, in May we broke our Summer Fun promotion, featuring the most relevant products for the summer season. This included snacks, beverage, picnic supplies, as well as lawn and garden and patio products. Deals outdoor products were very popular, led by lawn and garden, patio solar lights, decorations and lawn ornaments. As temperatures soared sometimes into the triple digits, Deals’ selection of summer hats, shoes, beach bags, beach towels, and summer toys sold particularly well, and our selection of electric fans were a great value and a big hit.

Overall in the second quarter, as in the past several quarters, traffic, average ticket and average unit retail all continued to increase at our Deals stores. Comp store sales in our Deals stores have led the Company in recent quarters. We’re excited about the growth potential of Deals and particularly the opportunity that it provides to grow profitably in the higher cost of operation urban markets. We ended the quarter with a total of 190 Deals stores.

Our Canadian integration and expansion continues. As a reminder, we initially entered the Canadian market through the acquisition of Dollar Giant stores in November of 2010. Our primary focus in the first year in 2011 was to install and train Dollar Tree retail systems, to integrate processes, to align merchandise assortments and store teams, and to lay the foundation for future profitable growth in the Canadian market. This year, we’re working to make use of the new systems, build history, and to leverage the investment. Our focus is on developing efficiency in store operations, improving the flow of product to the stores, and the continued building and training of our store teams. We’re working very hard to increase the service level and in-stock positions of basic products while improving the shopping experience through a more powerful seasonal presence and a higher level of merchandise energy.

Our goal over time is to be the largest retailer in Canada at the single price point of $1.25, just as we’ve done in the U.S. at the $1 price. We began the year with a plan to grow our Canadian store base approximately 25% under the Dollar Tree brand, and we will likely exceed this plan by 10 or 12 stores. We opened 10 stores in the second quarter, 18 stores year-to-date, and we ended the quarter with 117 Canadian stores.

We have a lot of room to grow at Dollar Tree. 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.

Dollar Tree Direct, our online business, continues to expand and develop. DTD is 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 exceeded 4 million visitors in the second quarter, a 14% increase over the second quarter last year. Of special note, we now have more than half a million friends on Facebook and more than 1 million customers logged on via their smartphones. We’re gaining customers every quarter and I’m pleased with the progress.

Now I’d like to turn the call over to Kevin, who will give you more detail on our financial metrics and provide guidance.

Kevin Wampler

Thanks Bob. As Bob mentioned, our diluted earnings per share increased 30.8% in the second quarter to $0.51. The increase resulted from our strong sales and expense controls which drove an 80 basis point improvement in operating profit margin compared to the second quarter last year. Our gross profit margin was 35.2% during the second quarter, consistent with the 35.2% reported in the second quarter last year. Several factors contributed to this performance.

We leveraged occupancy and distribution expenses, reflecting the 4.5% comp store sales growth. Second, IMU on many categories increased in the second quarter, reflecting continued improvements in sourcing and the flexibility of our merchandise model. Third, we achieved small reductions in shrink and markdowns compared with the second quarter of 2011. These factors were offset principally by two items: our product mix continued to shift in the second quarter but to a lesser degree than we have seen in several years. Basic consumable products increased by 45 basis points as a percentage of sales in the second quarter. Also we have previously disclosed, in the second quarter last year we recorded a favorable inventory adjustment related to immaterial corrections to prior periods, which benefited gross profit last year.

SG&A expenses were 24.4% of sales for the quarter, an 80 basis point improvement from the second quarter last year. Payroll related expenses declined by 60 basis points, driven by leverage on payroll and lower expenses for stock compensation, incentive compensation, and workers’ compensation. Health insurance benefit expenses increased relative to the second quarter last year. Operating expenses declined by about 20 basis points due to lower costs for utilities, repairs and maintenance, as well as leverage on sales.

Operating income increased $31 million compared to the second quarter last year. Our operating margin for the quarter was 10.8%, an 80 basis point improvement compared to the second quarter last year.

The tax rate for the quarter was 35% compared to 37.7% in the second quarter last year. The lower rate is primarily a result of statute expirations in the settlement of a state tax audit. The lower tax rate represented about a $0.025 per share benefit to second quarter earnings per share.

Looking at the balance sheet and statement of cash flow, our cash and investments at quarter end totaled $379.8 million versus $545.4 million at the end of the second quarter 2011. Cash net of debt was $115.5 million at the end of the second quarter.

During the second quarter, we repurchased 1.6 million shares of Dollar Tree stock for $80.9 million. At quarter end, we had $1.1 billion remaining in our share repurchase authorization. The diluted weighted average shares outstanding for the second quarter was 232.6 million.

We continue to view share repurchase as good use of capital. Over the past four quarters, we have invested $634.6 million for share repurchase. We will update you on additional share repurchases, if any, at the end of the quarter in which they may occur.

Also during the second quarter, we entered into a new $750 million unsecured credit agreement. The previous $550 million credit agreement was terminated concurrent with entering into the new agreement. The Company has drawn $250 million under the new revolving credit line. This amount is reflected as long-term debt on the balance sheet.

Our consolidated inventory at quarter-end was 9.6% greater than it was at the same time last year. Selling square footage increased 7.1%. Consolidated inventory per selling square foot increased by 2.3%. The increase reflects an increase in goods on the water and in the distribution centers at the end of the second quarter as we continue to execute our smoothing of inventory flow throughout our logistics network. Inventory turns increased in the second quarter and we expect this trend to continue for the full year 2012, as it has for the past seven years.

Capital expenditures were $74.7 million in the second quarter of 2012 versus $63 million in the second quarter last year. For the full year, we are planning consolidated capital expenditures to be in the range of 320 to $330 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 $70 million towards a new distribution center in Windsor, Connecticut. The total capital investment anticipated for this facility is approximately $100 million.

Depreciation and amortization was $43 million compared to $39.6 million in the second quarter last year. We expect depreciation expense of 170 to $180 million for the year.

Our guidance for the second half of 2012 includes several assumptions: first, Halloween shifts two days deeper into the fourth quarter this year from the first Monday of the quarter last year to the first Wednesday this year. We believe that this will shift approximately $5 million of sales from the third quarter into the fourth quarter compared to last year. Second, 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 million to $130 million in incremental sales and $0.07 to $0.08 of earnings per diluted share to the fourth quarter and the full year.

Our guidance assumes a tax rate of 38.2% for the third quarter and 37.6% for the full year. Weighted average diluted share counts are assumed to be 231.7 million shares for the third quarter and 232.2 million shares for the full year. As always, our guidance assumes no additional share repurchase.

With this in mind, for the third quarter of 2012 we are forecasting sales in the range of $1.71 billion to $1.75 billion based on a low to mid-single digit comparable store sales increase and 7.2% square footage growth. Diluted earnings per share are expected to be in the range of $0.47 to $0.51, an increase of 9.3% to 18.6%.

For the full fiscal year of 2012, we are raising our guidance. We are now forecasting sales in the range of $7.36 billion to $7.45 billion based on a low to mid-single digit increase in comparable store sales and 7.2% square footage growth. Diluted earnings per share is expected to be in the range of $2.45 to $2.54, representing an increase of between 21.9% and 26.4%, over our record earnings per share of $2.01 in fiscal 2011; and it does take into account the 53rd week that will be included in the fourth quarter of 2012.

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

Bob Sasser

Thanks Kevin. As I said in May at our last call, we entered this year with goals to drive more customer traffic, to thrill our customers with surprising values on merchandise they need and want, to improve our shopping experience, and to build market share. We continue to make progress toward accomplishing all of these goals. First half sales grew 11% to a record $3.43 billion. Comp store sales increased 5.1% on top of a 5.9% comp last year, driven by increased customer traffic. Our inventory is balanced and more productive than ever. Our turns increased again in the first half, and we entered third quarter well prepared for new store growth and customer demand.

Our operating margin increased by 70 basis points to 10.9%, the all-time highest first half operating margin in our history. Net income grew 20.1% to $235.3 million, and earnings per share increased by 27.8% to $1.01 per share. In addition, we opened 187 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.

Looking forward, I believe that we’re positioned to do even better in the future. The focus is on our customer and our stores and our product. They are strategically located to serve middle America, they are bright, convenient and fun to shop. Our business model is powerful and flexible – we can adapt to a changing environment. This has been tested by time and validated over the Company’s 26-year history. Our balanced mix of high-value consumer basics and our unique assortment of fun and compelling discretionary product positions us to be relevant to customers in all economic circumstances. Dollar Tree has a solid and scalable infrastructure that we’re expanding and leveraging for better inventory management, increasingly efficient supply chain logistics, more productive store and crisper execution overall. The Deals brand is gaining traction. Both traffic and average ticket are growing. Dollar Tree Direct continues to broaden its reach, and we are working diligently to build and expand our Canadian business.

We have plenty of opportunities to grow our business, a vision of where we want to go, and the infrastructure and capital to make it happen. We continue to generate substantial free cash and we use our capital for the long-term benefit of shareholders.

It’s real exciting to be at Dollar Tree. We had a great first half. Our merchandise values are better than ever, and our future has never been brighter. As we enter the third quarter, our shelves are full of the right product, our stockrooms are in great shape, and our values have never been higher.

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

Question and Answer Session

Operator

[Operator instructions]

And we’ll take our first question from Matt Boss with JP Morgan.

Matt Boss – JP Morgan

Hey, good morning. So your SG&A flow-through in the quarter was the best we’ve seen since 4Q of ’08. Can you speak to some of the investment spending around your Canadian operations and how we should think about expense control in the second half of the year, potential opportunities to look forward to?

Kevin Wampler

Yeah, Matt. I would tell you in general as we look at the second quarter, you’re right – I think our SG&A grew about 6.8%, and I would tell you that where we saw the biggest benefits, as we called out, was through the payroll line items. As you well know, our biggest SG&A line item is our store payroll and our field payroll for those teams, and they did a very, very good job in the quarter of being efficient, and we leveraged those costs very, very well. So as you think about it, I’ve spoken a lot over the last couple of years about the idea of flowing inventory in a much more efficient manner through our system, and obviously this is one of the aspects of it in effecting labor. So this year, we’ll basically have about 300 million cases of product flow through our distribution centers which ultimately get to our stores. The average store would get about 70,000 cases. Obviously we have many stores that do well above average sales; they’re handling a lot more cases.

So a lot of work has been done, as we’ve spoken, in regards to how we’re flowing these goods, so the logistics folks—you know, it starts with the buy and how it then flows through the distribution centers and then to the stores, and we do believe that we’re making gains there. At the same time, we do believe there is more to be gained in the long run as we continue to go down that path.

As far as Canadian SG&A, obviously we did a lot of work last year with infrastructure, and so we haven’t seen the same leverage there and we don’t necessarily expect to see the same leverage in the near term as we continue to build out our teams. The other thing we have going on up there is relaying these stores that are in the Ontario province, relaying them and re-bannering them as Dollar Tree stores, so there is extra labor that goes into that. So we have not—at this point, we have not seen that. Obviously longer term we do believe that there will be benefits from the infrastructure from the changes that we’re making, as well as productivity in the stores.

Matt Boss – JP Morgan

Great. And second, can you talk to the monthly cadence of comps in the quarter – any surprises in the quarter from a category perspective, and then any thoughts on traffic trends thus far in August?

Bob Sasser

Well the quarter was fairly consistent. It started off May was a little better than June, and July sort of rebounded back from May a little bit, so there was that sort of a cadence in the quarter. But throughout the quarter, it was consistent with our expectations. Matt, we don’t talk about upcoming quarters, so I can’t give you any remarks on that; but cadence throughout second quarter was as I expected and really no surprises there.

Matt Boss – JP Morgan

Okay, great. Thanks.

Operator

Moving on, we’ll take our next question from Meredith Adler from Barclays.

Meredith Adler – Barclays

Hey, thanks very much. I would like to kind of follow up on the question about sales. You said it was in line with expectations. Do you think that the weather had any impact at all on your sales? Could you look at geographic data and say that in places where the weather was normally hot or not so hot, sales were good; and then there was any kind of a slowdown in places like the midwest or the northeast where it was particularly hot?

Bob Sasser

Meredith, I really can’t say that there’s any correlation there to weather, really. We saw no real impact by the weather. If you look at the regions and the areas of the country, our best comp growth was in the mid-Atlantic and in the midwest, but it was really overall across the country a fairly tight range. You always have as you look closer with a microscope, you always have a little market here and a little market there that either overachieves or underachieves, and we saw some of that; but that’s the usual.

Overall, it was fairly consistent with expectations, with our expectations this quarter, whether you look at it geographically or by period of time. It was really hot; I don’t know that that had any—you know, I can’t tell you that I can see in the numbers where that had any effect. In our Deals stores, we sold a lot of fans. We sold a lot of water. We sold a lot of things that you need when it’s really hot, so it may have even helped us in some places.

Meredith Adler – Barclays

Great. And then you made a comment in your first prepared remarks – I’m not sure I can quote you exactly, but something about how important basics are to the consumers and that you want to have them there for them when they want them. I didn’t know whether that implied some change in sort of philosophy about replenishment of more categories, I won’t say plan-o-gramming but maybe more consistency in the offering.

Bob Sasser

Meredith, I’ll tell you what I was speaking to. We get a lot of questions about the penetration of consumer products to our overall mix, and of course consumer products are really important to our traffic because customers buy them more frequently. Everybody needs them, they shop more frequently for them, so it helps increase our traffic, but there’s always a balance. They’re a little lower margin. Higher turns, little bit lower margin, so there’s always a balance between that and what we call our variety merchandise, which is the fun and the seasonal and all the things that the surprising values that you find at Dollar Tree. Discretionary product, higher margin-type product. So we’re always talking about the balance, and if you look at the past several quarters, there’s been an increase in the consumer products as a percent of our total driven by the down economy, the dire straits that a lot of people are in with high unemployment, with uncertainty on fuel prices, with any uncertainty that there is out there.

So that was really all I was speaking to. We’re not really changing our distribution strategy, just speaking to the fact that we still see continued penetration from the consumer products driven by the customers’ need, and our intent is to continue to serve our customers. Sometimes I’m asked questions about, well, how far do you think that is? Well, we’re really following our customers’ lead, and we’re going to continue to do that.

If you look at second quarter, it was really a very good balance. I think the penetration of consumer products increased about 45 basis points, which gave us a little bit, about a 22 basis point headwind on gross profit during the quarter, and we still ended up with gross profit flat to last year. So we’re really pleased with the performance in that regard. That’s what I was speaking to that was the mix.

Operator

Moving on, we’ll take our next question from Dan Wewer from Raymond James.

Dan Wewer – Raymond James

Hey, good morning Bob.

Bob Sasser

Good morning.

Dan Wewer – Raymond James

So over the last five or seven years, there’s always been questions about inflationary pressures in China and whether or not Dollar Tree would be able to maintain its gross margin rate, given your adherence to a single price point strategy, and obviously the Company’s performance has been stellar but now we’re looking at a little bit of a different environment where the inflationary pressures in China may be abating. Do you think that there is an opportunity for Dollar Tree’s initial markups, which have been improving, to perhaps increase at an accelerating rate because of this change?

Bob Sasser

You know, as I’ve said in the past, it’s all about the mix. If you look at our gross profit—I’ll one-up you, here. Go look at the last 10 years, and our gross profit has been in a really tight range. The high was a 36.4; the low in the past 10 years was 34.2, and Q2 of this year was 35.2. So we always manage within a very tight range, and a lot of that—all of that, much of that is due to our flexible strategy. We’ve always said we’re in charge, we’re in control of our gross margin, and I will tell you that we still are. As prices go up, we change the product, not the retail price. We strive to get the best cost, the best value for the customer at a dollar and at a price that fits our gross margin. And as prices can—maybe pressure is a little bit down, we tend to invest more in the product. We get better product for the same dollar price because we’re still striving to get the customer the most value for one dollar and at a cost that fits our budget.

So that’s our strategy. It has been, it’s worked for us, that’s why we’re still in that tight range there over the past 10 years, and I expect we’ll continue to be there. There may be categories or items or times where we on judgment decide to invest more or less in the product, but I wouldn’t expect you to see that in the numbers.

Dan Wewer – Raymond James

And just as a follow-up question, the last few quarters Deals’ same store sales have bee exceeding Dollar Tree. You’ve told in the past that profitability for Deals is still not at the same level, but given the higher sales productivity, could you update us as to—you know, in some qualitative terms how much of a gap exists in either operating margin or return on capital, and with the better sales trends at Deals, are you now incentivized to grow that brand at a faster rate than you have been?

Bob Sasser

Yeah, that’s a fair question. You know, we don’t break it out and I can’t give you any solid metrics there. I can tell you just speaking about it anecdotally, I’m very pleased with the progress we’ve made in Deals. Our customers are accepting it more and more and recognizing the value that Deals provides. It lags in profitability as a percent, but our top line is growing and I think there’s still a huge opportunity to drive the top line to higher levels, at the same time managing our expenses a little better. We’re still in the try—you know, test and learn kind of mode, and we still will build a store and it will be really great, but then we’ll change it and we’ll turn it upside down sometimes and redo it.

So there’s still things we’re looking at. We know that we can get more productive, more efficient on our sales floor. We know we can drive efficiencies in the way we deliver our product, the way we display our product. We know that we can drive efficiencies and drive better cost advantage on the items that we’re buying as we get larger, as the Deals chain grows and the volume grows and our leverage on the buy gets better.

So I’m very excited about Deals. We intend to keep growing Deals. Mainly we’re using right now in the higher cost of operation urban market because we do believe we can drive more top line sales in our Deals store. So good question. I can’t give you the—I can’t break out the numbers because we don’t. I will just share with you the great enthusiasm that we have for Deals here, that I particularly have for Deals. Deals is going to be a big part of our business as we go through time here at Dollar Tree, and I’m very excited about it.

Dan Wewer – Raymond James

Okay, thank you.

Bob Sasser

Thank you.

Operator

Moving on, we’ll take our next question from Scot Ciccarelli from RBC Capital Markets.

Scot Ciccarelli – RBC Capital Markets

Bob, I know you were talking about some of the cadence and the mix, et cetera, already; but I guess we’ve seen a pretty steady shift towards consumables over the last many, many quarters here. Are you surprised, given some of the mixed signals we’ve seen in the retail economy, the mix didn’t shift even more towards consumables, in fact it went the other way a little bit?

Bob Sasser

Well frankly, we’ve been really working hard to make the mix go the other way, not by lowering our sales of the consumer products but by taking advantage of the traffic that its creating. As you know, our traffic this year really is largely—our increases are largely the result of increases in traffic, so we’re trying. We have a lot of initiatives in place to use that traffic to drive sales of the variety merchandise. So when you come into Dollar Tree or Deals to buy your cleaning supplies or your snacks or your HBC, your toothbrushes, toothpaste, whatever, we’re really working hard to challenge our customers with the new and exciting. The seasonal offering that we have—I tell our people, like the leaves on the trees changing from season to season, and the ever-changing mix of colors and excitement at the front of our stores. We’re talking really a lot about the front of our stores as a way to sell more on impulse and related sales and drive items, and the item of the month and all of those things up at the front of our stores, especially are the variety merchandise. Higher margin, it’s a surprising value, it’s part of the fun shopping experience that we create at Dollar Tree, so it’s really a big deal to us.

So when you say, am I surprised by it? Well, I’m really—I’m happy. Now we’re going to do more on both, by the way. We want to drive all of our business, but the strategy is to use the consumer basics for traffic and the variety merchandise for shopping experience and fun and margin. That’s what you saw in the second quarter – the consumer basics increased penetration still by 45 basis points, but that’s a smaller increase than we’ve seen in some recent quarters.

Scot Ciccarelli – RBC Capital Markets

All right, that’s very helpful. I know you also talked about the weather a bit. Just given some of Wal-Mart’s comments this morning with paycheck cycle, et cetera, can you provide us any other color, maybe what you’re seeing from your average consumer?

Bob Sasser

Well you know, I haven’t had a chance to see their comments in detail – I’ll take a look after the call. But we do see, as we have for the last several years, an increase in consumer spending around the paycheck cycle, around the first of the month. It’s something that has become part of our strategy around here, to be in stock and in business and really be ready for our customers around the paycheck cycle. I’m not sure what Wal-Mart said, but that continues. That is a trend that we see continuing here.

Scot Ciccarelli – RBC Capital Markets

Okay, great. Thanks guys.

Operator

Moving on, we’ll take our next question from Peter Keith from Piper Jaffray.

Peter Keith – Piper Jaffray

Hey, good morning. Thank you. I was wondering if you guys could actually quantify the impact that you saw with the debit and credit card penetration within your sales mix.

Kevin Wampler

Yeah. As it relates to debit and credit penetration, you know, it is continuing to increase year-over-year. I want to say it’s up about a point and a half to this point. It’s approaching 37, 38% of the overall tender mix, and it’s still broken out that debit is about two-thirds of that overall debit-credit mix. So that’s kind of what we’re seeing, and it continues to grow. And the interesting thing is where we’re seeing the growth, it is in the debit. If we look at our credit card business as a percentage, really pretty much flat.

Peter Keith – Piper Jaffray

Okay, thanks Kevin. To follow up on that, then, if you’re at 37, 38, it’s been increasing steadily over the last couple of years. I guess what would be maybe a long-term target you think you could reach? And then as a follow-on to that, the traffic gains have been tremendous for your guys but the ticket has been a bit muted. I guess I’m surprised with the increased penetration that the ticket strength hasn’t been stronger.

Kevin Wampler

Well, I think from a long-term goal perspective, I don’t know that we have a goal. I think the consumer is going to set that at the end of the day, and obviously the payment industry, people continue to move in that direction. You know, the writing of checks has become old-school and now the next wave is paying with your smartphone somewhere down the road, and there’s a lot of different people, different areas of retail working on that. So I don’t know that we believe that there’s a number that it should be. It’s going to go wherever the consumer goes, but I would expect it to continue to increase slightly year-over-year as we go forward.

As far as it relates then to the ticket, again, obviously traffic is up. We’re generating a lot of traffic. Maybe the average ticket isn’t going up significantly, but it has gone up a little bit last year and it’s been up just slightly this year. And again, as to what Bob had spoken about, there’s a lot of focus from our group internally to look at impulse items in the front end of our stores and how do you get that person to put one more item in their basket, because obviously our comp is all driven off units. There is no price inflation built into our comp, so it’s all about getting people to pick up one more item and putting it in the basket.

But at this point in time, we’re obviously going to take advantage of the traffic, and if that’s what they need under the current economic circumstances, if they’re just going to come more frequently and spend a similar dollar amount, that’s okay too.

Peter Keith – Piper Jaffray

Okay, that’s helpful feedback, and good luck this coming quarter.

Kevin Wampler

Thank you.

Operator

Moving on, we’ll take our next question from Dan Binder from Jefferies and Company.

Dan Binder – Jefferies

Hi, good morning. I just had a question around the consumable mix. As you pointed out, the shift was a little less severe. I guess as I tour your stores, and it’s been fairly consistent in terms of observations, at times there is some out of stock. So I’m curious if there’s an opportunity there, or if there were any issues in the quarter where you thought you maybe missed an opportunity. Again, not severe issues, but just sort of randomly see that now and again given the volumes you’re doing.

Bob Sasser

Dan, there hasn’t been any disruption in our supply chain that would indicate that. We’re always focused on providing a better level of in-stock and at the same time increasing our turns. We don’t want to get too much, you know; we don’t want to fill up our stockrooms. But there has really been nothing that would indicate that that’s been a problem. It could be it’s a local problem with the store that you were in. I’d be happy to follow up – give me a call and tell me the store number, we’ll take a look at it. But we’re always looking for improvements in that, and especially with the economy difficult and gasoline prices on the rise again. We’re really doubling down on our efforts to make sure we are in stock on those basics. When our customers get to the store, I sure want them to be able to buy what they need and what they expect, and what they’ve spent their money on coming to the store for.

Dan Binder – Jefferies

And then my follow-up question was around the expanded categories you mentioned in your formal remarks. It sounds like you’re trying to capitalize on the growth areas in the store. I’m just curious – when should we start to see that in the stores, and maybe if you could elaborate a little bit on how much you’re growing the SKUs in those respective categories that you mentioned.

Bob Sasser

Yeah, it’s a pretty broad strategy, Dan. I think you’ve seen some of it in the stores already. If you looked in our HBC departments in the last several months, you’ll see expanded patent medicines, you’re going to see expanded SKUs throughout our HBC area, throughout our home area. We’re working real hard on our stationery business. Right now, we’ve got back to school going on, so you’ve got a lot of expanded SKUs in that area, and we see stationery as an opportunity to grow tremendously as we go forward the rest of this year and into next year.

So I can’t really quantify it. There’s a lot of new SKUs, there’s a lot of new products and a lot of them are focused in those highly consumable categories.

Dan Binder – Jefferies

Thanks.

Operator

Moving on, we’ll take our next question from Joseph Parkhill from Morgan Stanley.

Joseph Parkhill – Morgan Stanley

Hi, good morning. I was just wondering if you could talk about what you’re seeing in the competitive environment as far as maybe California, when you see a Dollar General, Family Dollar moving in, if that’s not impacting your stores because it’s a different customer, or if you see any impact there. And then maybe as far as back to school goes, how aggressive more full-priced players are being, if it’s similar to last year, or any comments around that would be helpful.

Bob Sasser

Joe, good questions, but we’re seeing no impact on the west coast from Dollar General’s entry there. I think they’re entering with their market, but look – we’re always watching them. We watch all the competition. We’ve stayed more focus on what we’re doing than what they’re doing, though. If you look at the stores where they’ve opened up in California, there is no visible negative impact from their opening that we can see.

We have had them around for a long time, though. You’ve got to understand – they are a lot older than we are, and their model is just different. It’s different when everything is not a dollar; it’s just a different model, it’s a different customer, a different store layout and different pricing. So we really stay focused on our position in the marketplace. About half of our stores are within three miles of a Dollar General anyway. About a quarter of our stores are within one mile of a Dollar General. They are a much larger company than we are, so we see them all over the country. California is no different. Actually in California, we have a lot more stores than they do in California. It’s one of our more populous states in regard to stores, but we’ve seen no impact from them.

We have great respect for them; we’re just a different model. When everything is a dollar, it’s just different than they are, so we don’t see the impact there.

You know, as far as looking at, again, the landscape of competition, we’re really just staying focused on what we do best, and that’s providing the most value for the dollar, giving the customer what they want, things they need, things they want, reacting to the current opportunities. We don’t—you know, we’re not stuck on any one item or any one assortment. We don’t set plan-o-grams and that gives us the ability to react quickly when there’s an opportunity to take advantage of a category or an item, and we try to do that as cost effectively as we possibly can. So that’s how we sort of defend our turf.

Joseph Parkhill – Morgan Stanley

That’s helpful, thank you. And then just lastly, are you seeing any increase in looks at closeouts, given the current retail environment? Is that helping your business at all, or everything’s pretty similar to normal trends?

Bob Sasser

Yeah, it’s about the same. We always look for them and we’re always trying to grow it, but the whole business grows so as a percent to sales it stays about the same. We’re not seeing any more closeouts than we normally see. We stand ready to take advantage of all the good ones. We probably turn down more than we buy because we are—there are closeouts and then there’s closeouts, so we try to take advantage. And at the right price, all closeouts sort of turn to gold, but I can’t tell you there’s any increase in that given the economy.

Operator

At this time we have time for a couple more questions. Moving on, we’ll take our next question from Anthony Chukumba from BB&T Capital Markets.

Anthony Chukumba – BB&T Capital Markets

Good morning. I had a couple questions related to Canada. You mentioned in Ontario, I believe, rebranding some of the Dollar Giant stores to Dollar Tree. I thought that was intriguing. I mean, is that going to be the strategy going forward to operate both Dollar Giant and Dollar Tree stores in Canada, and when would you be actually opening just new Dollar Tree stores in Canada?

Bob Sasser

No. Our plan is to re-brand all of them to Dollar Tree stores over time. We’re in the process now of opening new stores, filling the pipeline with new store opportunities, and at the same time we have a plan for over time remerchandising, relaying, re-staffing all of our Dollar Giant stores and re-branding them at that time to Dollar Tree. So it’s going to take us a while and we’re starting in the east and we’ll sort of end in the west; but the plan is to re-brand them all to Dollar Trees over time.

Anthony Chukumba – BB&T Capital Markets

Okay, that’s helpful. And then you mentioned that you’re going to exceed your guidance in terms of store openings. I believe you said rather than 25% growth, it’s going to be sort of 10 to 12 stores above that. I was just wondering, what’s sort of driving that? Is it sort of you’re just having better real estate opportunities, or you just feel a need to open more because the stores are just doing so well there? I was just wondering if you could provide a little more color there. Thanks.

Bob Sasser

It’s opportunity. We’re opening more because we’re finding the opportunity to open more, and we’re excited about our opportunities in Canada so we’re taking advantage of that as we can find the right deals.

Anthony Chukumba – BB&T Capital Markets

Okay, that’s helpful. Thank you.

Operator

Moving on, we’ll take our next question from David Mann, Johnson Rice.

David Mann – Johnson Rice

Yes, thank you. Good morning. Bob, you normally talk about performance around the key holidays in a given quarter. Can you just elaborate about that?

Bob Sasser

Well, we haven’t had a real key holiday in this quarter – that’s sort of the obvious, I guess, and in the past when I did talk about current quarter, you know, we’re only a couple weeks into it and it was always about a key holiday. So I really can’t talk about—I can’t talk about this current quarter. I’ll be happy to answer questions about the first half.

David Mann – Johnson Rice

No, what I meant is whether it be the Mother’s Day, July 4th

Bob Sasser

Oh. Oh, I’m sorry.

David Mann – Johnson Rice

In the second quarter.

Bob Sasser

No, I’m sorry. I thought you were talking about the current quarter. I can’t do that. Yeah, I think the cadence around our sales—again, a lot of times it’s driven by those key holidays. Mother’s Day is one of our key holidays, and so as a result in May we had a really—I would say that May was better than June. Father’s Day is not such a key holiday, as it turns out, even though we try to make it so. But June is a little less of a key holiday than May, but then you’ve got—along with Dad, you’ve got grads, and I think that’s probably the bigger opportunity for us in June, and we had good results this year. And I think as we go forward, we’re going to really aim at that June time period to expand upon the graduation opportunities that we have. And then as you cruise out of June and into July, you’ve got the July 4th and clearance and all that goes with that.

So it is as we expected – Mother’s Day was good, graduation was good. Again, the cadence was pretty consistent with our expectations .

David Mann – Johnson Rice

And in terms of the earlier question on IMU, can you just remind us or let us know how the IMU is looking from the last trip you did to overseas, and also in terms of inflation, are you starting to see increasing food inflation in the food side of your business, given commodity costs?

Bob Sasser

Sure, I’ll give you the flavor on that. Our merchants recently returned from Asia where they were placing orders for our need through the summer of next year, the summer of 2013. And as I said earlier and as you’ve heard me say frequently, we have a flexible model. We don’t set plan-o-grams, we’re not stuck on any one item. Our merchants go to market, whether it’s in the U.S. or in China or wherever else in the world with really two goals – one, to give the most value to our customers for the dollar, and number two at the margin that we need for our financials. They can always change an item, they can drop an item, they can add an item; but at the end of the day, we’re always in control of our margin for that reason, and this trip was no different in that regard.

I would tell you just to characterize the pricing, overall the input—the down low from the merchants upon return was that it was a terrific trip, one of the best environments that they’ve seen in quite some time. The non-food commodity prices were down, and in some cases significantly down over a year ago. Cotton prices, for instance, were much more favorable. The currency seems to be stable. A year ago, there was a lot of anxiety and talk in the market on the part of Chinese vendors over more appreciation versus the U.S. dollar. Not so much talk this year, so that’s all settled down. A lot of this is driven, of course, by the slower Chinese domestic growth in conjunction with slower worldwide demand, especially in Europe. You hear a lot of talk in China about the slowdown in Europe that’s put downward pressure on prices, and when you’re Dollar Tree and you’re open to buy and you’re growing and you have cash, then that’s a real advantage as we go to China.

Our assortments from the trip are compelling, fresh, a lot of new product purchases on this trip. The value is the best ever, and I just can’t wait to see it on the shelf. So not much talk about inflation, I guess, on this trip.

David Mann – Johnson Rice

Very good, thank you.

Operator

And once again, we have time for a couple of questions. Moving on, we’ll take our next question from Adrianne Shapira from Goldman Sachs.

Adrianne Shapira – Goldman Sachs

Bob, I think in your prepared remarks, you described your operating margin, that you delivered an all-time high operating margin in the first half. So my question is twofold – first, you’ve done a great job setting new peaks, and I’m just wondering philosophically how you think about, as a dollar store, is there a true peak as an operating margin? And then second, as you’re continuing to drive future margin expansion, as your comments earlier about gross margin being relatively consistent, are the levers just increasingly top line driven? Thanks.

Bob Sasser

No, they’re not, Adrianne, but—good morning. Thank you for the question, Adrianne. They’re not just top line driven. I think as Kevin explained, I think, in some detail about the way we think about the flow of our product in our stores, the ability to operate more efficiently, the ability to take cost out of the supply chain, the ability to leverage that into more efficient store work group and lower our—if you look at our payroll in the second quarter, huge improvements in payroll and our stores are still operating just very well. We don’t think we are doing things that negatively impact our customers. As a matter o fact, that’s our goal. As we continue to make improvements, we’re always looking at the things that don’t touch the customer experience or that the customer doesn’t really care about. So we believe that there is a lot more room for improvement and efficiency in our operating margin, on a lot of lines on our operating margin, and of course there’s still a lot of room for growth in the top line. We talk about our new stores being more productive, and if you look back over the past 10 years, it’s the highest so far this year. These stores are opening up more productive than they have in 10 years, so I’m really pleased with that. I’m pleased with the year-over-year comps that we’re putting up. Top line is still a big opportunity for us to continue to grow, but we’re certainly not at the end of the line. I mean, we see opportunity every day.

Adrianne Shapira – Goldman Sachs

Great. Bob, is there a long-term view in terms of what the right EBIT margin should be?

Kevin Wampler

You know, Adrianne, I don’t know if there’s a long-term view. I would tell you this – obviously continual improvement is always our goal. Obviously this year our guidance would tell you that we would get over a 12% operating margin, and obviously once we’ve crossed 12 the next goal is 13 and so forth. I mean, I think it’s just—the way we think about it is continuing to drive results, continuing to drive improvement throughout the business, and we do not see a cap in the near term future. We do believe that there is plenty of room to continue to improve upon it.

Adrianne Shapira – Goldman Sachs

Great. And then just last question, Bob – you know, I think we heard a lot of questions asking, trying to dig into the sales; and it sounds like you were pleased with sales and it sounds like monthly intra-quarter pretty consistent; but if we step back, it does look like we saw on a two-year basis a deceleration. So maybe just help us think about is that even a relevant metric, or was there anything that surprised you on the top line?

Bob Sasser

You know, Adrianne, it’s a fair question, but as I look at this second quarter, I see a terrific performance – consistent, strong, growing, highly profitable. We had solid growth on our top line – 10.5%. It tells me our stores are seen as more relevant than ever. Our customer is responding favorably. As an example, our new store productivity – I keep telling everybody’s it’s up right now, the highest in over 10 years. The comp increase of 4.5% is consistent and in line with our guidance. It’s actually well above the midpoint and toward the top end of our guidance. Last year, comps in the same quarter were 4.7%; this year, 4.5. We continue to comp year-over-year, and our four-year comp’s 22%-plus, and now we’re comping on a much larger comp base than before so I see 4.5 We’ve got leverage on our occupancy. We’ve got leverage on expenses. Our gross profit percent was 35.2, flat to last year, which means we overcame some of the hurdles of the more consumer products that we’re selling. So gross profit was terrific. Our business is well managed. SG&A as a percent of sales decreased 80 basis points.

So just a lot of good news in this quarter. Inventory is up, productivity is up, our turns are up for year-over-year for seven years, you know, consistent, strong and growing. That’s what we always talk about here. So yes, you’ve got to look at the comps, but 4.5 is a good comp. It’s a consistent comp, and on this 4.5% comp we’ve got a lot of leverage and we dropped just a whole lot to the bottom line, and the EPS increased over 30% - 30.8%.

So that’s how I look at second quarter, and we still view Dollar Tree as having a lot of room to grow. We have a growth strategy that includes more Dollar Tree stores. We have Deals, which is gaining traction – another way to grow, a different model. We’ve got Dollar Tree Canada – new geographies, huge opportunities for growth in Canada. We’ve got to take some time, as we have in all acquisitions, to get them up to the productivity standards that we want, but we’re doing that. We’re making the investments. I’m just really jazzed about where we’re going with our Canadian stores and the opportunity for the future.

So that along with our direct business – you know, we’ve got just a ton of opportunities as I look forward.

Operator

And moving on, we’ll take our final question from Charles Grom with Deutsche Bank.

Charles Grom – Deutsche Bank

Good morning. Just a question on your guidance – Kevin, it looks like you took in the top end of your sales range just a touch. Can you just elaborate on why?

Kevin Wampler

You know, as much as I think, Chuck, it’s a little bit of a shift in new stores and how—you know, the timing of when they’re opening up. That’s always a continual shifting matter. A little bit of looking at, again, Canada and how they’re opening up and productivity there, and so it’s really at the end of the day, it’s kind of a rounding difference when it comes right down to it, is kind of how it all fell out.

Charles Grom – Deutsche Bank

Okay. And then when we look at the third quarter guidance, if I model in a 3 to 4% comp in order to get the $0.49 at the midpoint, it implies a flow-through of about 13%, which is a little bit lower than what you guys have done the past few quarters. Can you hold my hand on exactly how you get there in terms of the complexion of the operating margin line, both gross and SG&A?

Kevin Wampler

Yeah, I think kind of at that midpoint, I think the way we’ve kind of put it together is you might see just a little bit of pressure on gross profit year-over-year, but you’d see some improvement on the SG&A, maybe not quite to the same extent that we have had recently; but again, obviously, it’s guidance and we’ll work very hard to try to do better than that at the end.

Operator

And at this time, that will conclude our question and answer session. I’d like to turn it back over to Tim Reid for any additional or closing remarks.

Tim Reid

Thanks Jim. Well, just thank you all for your participation on the call this morning and for your interest in our company, and particularly for your investment in Dollar Tree. Our next sales and earnings release and conference call are scheduled for Thursday, November 15, 2012. Thank you again.

Operator

Thank you. That will conclude today’s conference. We thank you for your participation.

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