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Dollar Tree, Inc. (NASDAQ:DLTR)

Q2 2008 Earnings Call

August 27, 2008 9:00 am ET

Executives

Tim Reid – VP IR

Bob Sasser – President & CEO

Katy Mallas – VP, Controller

Analysts

Mitchell Kaiser - Piper Jaffray

Meredith Adler - Lehman Brothers

Karen Short - Friedman, Billings, Ramsey

Michael Baker - Deutsche Bank Securities

Charles Grom - JP Morgan

David Mann - Johnson Rice & Co.

Patrick Mckeever - MKM Partners

John Zolidis - Buckingham Research

Operator

Good day and welcome to the Dollar Tree, Inc. second quarter 2008 earnings release. (Operator Instructions) At this time I would like to turn the call over to Tim Reid, Vice President of Investor Relations; please go ahead sir.

Tim Reid

Good morning and welcome to the Dollar Tree conference call for the second quarter of fiscal 2008. My name is Time Reid. I am Vice President of Investor Relations.

Our call today will be led by Bob Sasser, our President and Chief Executive Officer, who will provide insights on our performance in the quarter and recent developments in our business. Katy Mallas, Vice President, Controller, will provide a more detailed review of our second quarter financial performance and provide our guidance for the third quarter and fiscal year 2008.

Before we begin I would like to remind everyone that various remarks that we will make about future expectations, plans and prospects for the company constitute forward-looking statements for the purposes of the Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors included in our most recent press release, our most recent current report on Form 8-K, Quarterly Report on Form 10-Q and Annual Report on Form 10-K, 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.

Now I'd like to turn the call over to Bob Sasser.

Bob Sasser

Thanks Tim and good morning everyone. Thank you for joining us. I hope you’ve had a chance to see our press release from this morning. We announced earnings for the first quarter of $0.42 per diluted share that represents a 27.3% increase over last year’s $0.33 per diluted share.

As previously announced total sales for the quarter were $1.093 billion, an increase of 12.5% over the second quarter of fiscal 2007. Comp store sales increased 6.5% for the quarter, that was on top of a 4.4% increase last year and a 4.2% increase the year before.

Our comparable store sales increase was the result of a 3.7% increase in traffic and a 2.7% increase in transaction size. For the first half of 2008 compared with last year, sales increased 10.2%, gross margin was up five basis points, SG&A was down 12 basis points, operating income increased by $16 million and 17 basis points as a rate of sales, and net income rose 15%, earnings per share increased 26.8% to $0.90 per share.

I believe that our success this quarter demonstrates the growing relevance of Dollar Tree to the consumer. I think you’ll hear me talk more about that as we go along. Customers know they can still find great value at Dollar Tree for just a dollar and the convenient and fun shopping experience. More and more our customers rely on us to deliver on this promise and new customers are finding us all the time.

Over the past few years we’ve grown our store size to accommodate the addition of our more needs-based consumer product to our mostly discretionary product mix. These products are lower margin but faster turning and drive footsteps into our stores on a more frequent basis.

Specifically we’ve added more health and beauty care products, household cleaning supplies, food and beverage and grocery to our discretionary mix of party supplies, seasonal décor, gifts, stationary, and higher margin variety merchandise.

This gives us more leverage to pull as we strive to stay relevant to the customers’ needs through both good times and tough times. Today consumers are under tremendous pressure from high food prices and high gasoline prices and from high energy prices especially. They have to make it up by saving somewhere and for millions of consumers Dollar Tree is becoming a destination as they look to find ways to manage their family budgets.

Going into this past quarter and observing increased pressure on the customer we made plans to ensure that our in stock position on basic products was better than ever. We added a mid-quarter Stretch Your Dollar promotion that featured more HBC, more household supplies, food and beverage and our customers responded enthusiastically.

I believe that the actions that we took beginning of second quarter were right on target. It was an appropriate response for the times and validated by our results which reflect increases in both traffic and average ticket for the quarter.

Sales were consistently strong throughout the quarter and across a broad range of product lines but the consumer products led the way. Sales of food and household consumables as well as health and beauty care basics increased more then 3.5% as a share of sales compared with the same period last year.

Additionally we’ve continued our expansion of frozen and refrigerated products to more stores. We remain on track with our goal to add freezers and coolers to 150 stores for the full year. During the second quarter we added freezers and coolers to 31 more Dollar Tree stores bringing our total to 115 additional stores in the first half.

At the end of the second quarter we had freezers and coolers in 1,089 stores compared to 873 stores at the same time last year.

The increase in in-store traffic and shopping frequency generated from our consumer basics also helped drive increased sales in our party and seasonal businesses throughout the quarter. Our merchants continue to provide an exciting assortment and our stores have made quick transitions from season to season throughout the quarter.

Mother’s Day gave us a good start to the quarter, our Build a Gift promotions and our Bath Shop promotions were both big hits. We transitioned quickly from Mother’s Day into Luau and Americana and Picnic themes for Memorial Day and into the summer and once again our annual Memorial Day steak sale was a success.

There’s always something new at Dollar Tree and always at a great value. This year we went after the Graduation business this summer with more gifts and document and picture frames and party supplies, the signage and in-store promotions highlighted this event. Our Graduation headquarters helped drive traffic and contributed to a strong sell-through of these items.

Turning to marketing and promotion, we actually reduced our advertising spend while we continued to improve the efficiency and effectiveness of our marketing. We ran a newspaper insert on May 18 in 28 markets covering about 1,200 stores that anniversary’s the same event last year and it’s about the same number of stores as last year.

Our primary themes for the summer were Stretch Your Dollar and Look What $20 Will Buy and our window banners and our in-store efforts really resonated with the customers as they looked for ways to balance their budgets.

And frankly there’s a buzz surrounding Dollar Tree. I know I’ve seen it and many newspapers and TV ads across, really news reports across the country, but the news media has taken note of our value, Dollar Tree has been featured in press and television throughout the country as a place to stretch your dollar in rough times and I think our customers are seeing this and I think we’re getting some positive influence from traffic from just the buzz that surrounds the value that we offer.

In additional to our merchandise initiatives the expansion of our payment type acceptance contributed positively to the second quarter results. First our debit card usage continues to increase and penetration increased 1% in the second quarter. Additionally we saw a lift from our VISA credit in the second quarter and we have not yet anniversaried this so we expect the penetration of VISA credit to continue increasing throughout 2008.

And last we currently accept food stamps in 1,461 qualified stores. This number will continue to grow as we rollout more freezers and frozen and refrigerated products to more stores.

Finally we feel the Federal economic stimulus package also provided some lift to the quarter, however the precise impact is very difficult for us to measure. While we know that sales have benefited we saw no discernable deviation in our sales cadence throughout the quarter that we can point to as a major impact from the program.

Sales were strong throughout the quarter and the quarter ended stronger then it began. Turning now to store growth, during the second quarter this year we opened 50 new stores, relocated and expanded another 19 stores and grew total square footage about 7%. This brings the total to 133 new stores opened in the first half of this year, 43 expansions and relocations which is similar to last year in terms of new stores.

We expect to open about 220 new Dollar Tree stores, 22 new Deal stores and expand and remodel about 90 stores this year. This is slightly less then the range that I gave you last quarter and is the result of slippage in our store opening schedule.

We ended the quarter with 3,517 stores with plenty of room to grow. Over the longer term we believe that we can operate 5,000 to 7,000 Dollar Tree stores across the country and our Deals multi-price concept has the potential of expanding that number.

And speaking of Deals, as most of you know, we’re developing our Deals stores as an additional format lifting the restriction of the one dollar price point in order to offer even more value and convenience while leveraging the strength and infrastructure of Dollar Tree.

We believe that Deals fills a unique void in the value retail segment and it will give us the ability to serve even more customers in more markets. As we’ve expanded the concept into new regions, the response from customers has been positive. We’ve opened 14 new Deals stores so far this year, that’s on top of 23 new Deals stores last year and our current store count is 144 stores.

The new Deals stores are the best test of the concept and in the second quarter they outperformed the original stores by nearly every sales metric. This quarter across all of Deals, we saw an increase in sales of product priced over $1 led by increases in health and beauty care, food, domestics, toys, electronics and pet supplies. We’re especially excited over the availability of new merchandise opportunities at the higher prices and especially excited about the lift that it can provide in average ticket.

We’ve also sharpened our messaging at Deals. We ran a newspaper ad on May 21 covering 80 stores promoting our Memorial Day steak sale at Deals. And in July we came back and ran another steak sale at Deals featuring three six ounce steaks for $5 and a 24 pack of bottled water for $3; both great values.

To support these events, all Deals stores featured more powerful graphic displays including outdoor banners and window posters, point-of-sale signs, and in-store handouts and the results were terrific. In the second quarter we’re seeing measurable improvements in comp store sales, store productivity, and four wall contribution from our Deals stores.

We still have a lot more work ahead, but we’re seeing a lot of improvements in our Deals. We are refining and improving our key operating metrics. We’re refining the assortment which really is the key issue; the assortment of product that we’re going to sell. We’re improving our replenishment discipline. We’re evaluating our pricing strategy and we’re expanding the supply chain for our Deals stores.

And we’re rolling out new stores in a measured and thoughtful way. In a moment I’ll turn the call over to Katy for a detailed review of our financial performance but before I do, I want to highlight a few metrics.

First of all our merchandise margins within product categories are as good as or better then last year and we are experiencing growth across our entire business, not just the consumer basics. Consumers however are under great pressure to balance their budgets and they have to save somewhere and we’re taking this opportunity to gain market share by giving them more of what they need.

We’re gaining new customers every day. Although the margins are slightly lower we are driving top line growth, increasing inventory turns, and leveraging costs throughout the P&L resulting in increased operating margin and earnings per share in the second quarter. And that’s with diesel fuel nearly $2 higher then the same period last year.

As in the past we will continue to consider these factors in the guidance that we provide. Now I will turn the call over to Katy who will give you more detail on these and other financial metrics during the second quarter and she’s also going to give you guidance for the remainder of the year.

Katy Mallas

Thanks Bob and good morning everyone. As Bob mentioned our earnings per share grew by 27.3% in the second quarter, driven by higher sales and a 10 basis point increase in operating margin. For the quarter gross margin was 33.2% which was 40 basis points below the 33.6% in last year’s second quarter.

It is the result of two main factors, first a planned shift in product mix toward more consumable products and second the impact of higher diesel fuel costs. These two factors were partially offset by improvements in shrink, lower markdowns and the benefits to [buying] distribution and occupancy costs associated with the increase in comparable store sales.

Moving down the P&L, SG&A expenses were 27.6% for the quarter expressed as a percent of sales. This is a 50 basis point decrease from 28.1% in the second quarter last year. We leveraged our expenses for payroll, benefits and incentive compensation and reduced our advertising spend.

These improvements offset higher utilities costs and increased fees for debit and credit card. Of course the top line benefits from increased usage of debit cards and VISA credit cards far outweigh the higher fees associated with the higher penetration of these forms of tender in the overall sales mix.

For the second quarter depreciation and amortization was $39.7 million. The overall rates as a percent of sales improved 35 basis points compared with the second quarter last year. We expect depreciation of $160 million to $165 million for the year which as a rate of sales will be a 20 to 30 basis point decrease from last year.

Our operating margin for the quarter was 5.6%, an increase of 10 basis points from 5.5% in the second quarter last year. Looking at the balance sheet and statement of cash flow, cash and investments at the end of the second quarter approximated $115 million, an increase of $31 million from the $84 million at the end of the first quarter.

During the third quarter as always, we expect to use cash for our normal inventory build for the holiday season. Capital expenditures were $32.7 million in the second quarter of 2008 versus $49.2 million in the second quarter last year. The majority of capital expenditures in the second quarter this year were for new stores, remodeled and relocated stores, and the addition of frozen and refrigerated equipment to 31 additional stores.

We now expect CapEx in the range of $145 million to $155 million for fiscal 2008. Our inventory grew by 4.3% on a per store basis in the second quarter compared with the prior year period. This is principally due to planned increases in inventory to meet the demands for basic products, to support back to school and Halloween promotions, and to support the build toward the Christmas selling season.

Inventory turns in the first half were up slightly over last year and we expect them to increase for the full year. Now for sales and earnings guidance, as we look to the remainder of 2008 the macro environment remains every bit as challenging and uncertain as it was going into the second quarter.

We still face an uncertain economy with many pressures on the consumer. We are factoring this uncertainty into our guidance. In addition the retail calendar is unfavorable for the latter part of the year as Thanksgiving is a week later then last year resulting in one fewer weekend in the traditional holiday shopping season and five fewer selling days between Thanksgiving and Christmas.

As a result of the economic pressures on the customer we expect to see a continued increase in demand for the faster turning, lower margin consumable products in our mix. Additionally we anticipate continued pressure on freight costs from the higher diesel fuel prices. While sales will continue to provide positive leverage on costs, higher freight costs and the shift in mix will likely continue to put pressure on our gross margin. This effect is planned to be offset slightly by continued improvements in our shrink results, and we have included this in our guidance.

From an SG&A standpoint energy prices and utility costs will most likely be higher for the remainder of the year. Otherwise we expect to hold the line on expenses in the second half. The tax rate is expected to be 36.2% in the third quarter and 37% for the full year.

With all of this in mind, for the third quarter of 2008 we are forecasting sales in the range of $1.075 billion to $1.105 billion and diluted earnings per share in the range of $0.40 to $0.43. This implies a low to low mid single-digit comparable store sales increase.

For the full year 2008, we estimate sales will be in the range of $4.61 billion to $4.68 billion based on a low to low mid single-digit increase in comparable store sales and 7% square footage growth. Diluted earnings per share are expected to be in the range of $2.33 to $2.43. This is an increase of $0.10 and $0.04 in diluted earnings per share above the low and high end of previous guidance for 2008.

Our guidance assumes a share count of approximately 91 million for the balance of the year. With that I would like to turn the call back over to Bob.

Bob Sasser

Thanks Katy, I want to leave you with just a few summary observations on the quarter and the half. We had a strong first half and we’re on track to accomplish our goals. Our investments and infrastructure continue to translate into better inventory management, more efficient stores, improved in stock position and better execution of our model.

In the second quarter we focused our merchandise mix more to the consumable categories in order to meet the needs of our customers and the results were terrific as sales for the quarter grew 12.5% and earnings per share were up 27%.

Through all of this fuel and energy prices remain high and in the second quarter of 2008 diesel averaged $4.60 per gallon; that’s nearly $2 higher then the same period last year. As expected this had a significant impact on both our freight costs and our gross margin and we expect this to continue throughout the end of the year. We’ve incorporated this into our guidance.

We continue to grow and open new Dollar Tree stores and our new Deal stores concept is progressing and exciting. We’re opening new Deals stores in new markets, we’re honing the merchandise mix and the customer acceptance is strong and is growing.

We continue to demonstrate the ability to self-fund the growth of our business while generating substantial free cash. During the first half of this year we increased cash and investments by more than $30 million and we’re in a great position entering the third quarter when we are building inventory for the holiday season.

We are dedicated to building value for our long-term shareholders and this means first of all running the business as effectively as possible and managing our capital in ways that enhances shareholder return. In these uncertain economic times building cash is consistent with this goal. I’ll remind you that we currently have $454 million remaining in our share repurchase authorization.

As has been our practice we will continue to review share repurchase opportunistically and we will update you on additional share repurchases at the end of the quarter in which they may occur.

As we look to the second half of the year we don’t know exactly how the customer will react to the continuing pressure from high energy prices and economic uncertainty. We do know that they will find no better place to stretch their dollars then at Dollar Tree. Our merchandise value and our increased mix of consumer basics make Dollar Tree more relevant now then ever and we believe that we’re positioned squarely in the bull’s eye of what customers are looking for.

We had a great first half and we’re off to a good start on the third quarter and we look forward to an exciting fall season.

We are now ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mitchell Kaiser - Piper Jaffray

Mitchell Kaiser - Piper Jaffray

Could you talk a little about the Stretch Your Dollar promotion that you did mid quarter and maybe an estimate on what that did to comps and maybe profitability and then are you looking to do something similar towards the back half of the year?

Bob Sasser

The Stretch Your Dollar promotion was something that we, as we looked forward and we got through Easter and we looked forward into second quarter and all the pressure on the customers that we saw and the high fuel prices and they were still rising, and we just saw it as an opportunity to first of all increase our sales, gain new customers, second of all be more relevant to their needs. We wanted when they spent their dollar to come into our store, because of high gas prices, we wanted to make sure that if they expected us to have it that we had it in stock so we stepped up our in stock position on our basics.

And we also took a real strong position in some key consumable categories like health and beauty care and household cleaning supplies, and some of our grocery and beverage and food items. And we went our and challenged the merchants to put together a great promotion in those consumable categories. We backed it up in the stores with signing and banners on the windows. One of the signs would show Look What $20 Buys and it would have 20 items in the consumable categories. We had another banner that showed Look What $20 Buys and it was somewhat less consumable products.

We pushed out extra product to support the promotions and as a result we really had a strong second quarter. We drove more sales in the consumer products, we drove more traffic. One point I’d like to make is our sales overall in the second quarter was pretty much up across the board. It’s just that we drove more sales in those consumer products because that’s what the customers needed. They were under pressure, they were looking for a place to go to stretch their dollars and I believe it was right on target. It was really a on-the-fly sort of decision to go after it but we have that ability now and I think that’s what we demonstrated here is that with our larger store, with a mix of things that people need and then the discretionary product we do have some leverage to pull.

And we pulled one on the consumer products in the second quarter and it really did increase our comp store sales and helped us leverage costs throughout the P&L for the quarter.

Mitchell Kaiser - Piper Jaffray

I think a number of retailers have said that the back to school started off pretty slow, and I know that inventories on a per store basis were up 4.3%, are you comfortable with that and I think you commented that Q3 was off to a good start. Could you just help us reconcile those two?

Bob Sasser

I’ll give you as much color as I can, obviously we don’t report by quarter but our third quarter has started off strong. We’re not a big back to school company, we don’t [inaudible] the apparel first of all so our business is more stable. We sell more the pens and pencils and the writing instruments and the teacher supplies, and that kind of thing.

As to our inventory we’re up a little bit over last year, 4.5% over last year, but just remember we just came off a 6.5% comp so we’re growing our sales faster then our inventory has risen. Our turns for the first half were higher than last year and we still expect the turns to be higher for the second half of the year. I believe we’re just well positioned, we’re exactly where we wanted to be with this and if sales continue to grow we have the ability to continue to chase and at the same time we’re going to end up a good inventory position at the year end. We’re happy about that.

Operator

Your next question comes from the line of Meredith Adler - Lehman Brothers

Meredith Adler - Lehman Brothers

We all know that fuel costs have come down recently, wondering how you are planning if you can to do something to sort of lock in energy prices or whatever you might be doing generally to manage energy because even though its coming down, fuel prices are still very high?

Bob Sasser

You’re right, and in our guidance we’ve included them in our guidance to remain high. As far as locking in, there’s no, we haven’t been able to lock in on any diesel fuel prices. We use third party carriers for our business and we have agreements with, as far as locking it in, in this time of rapidly rising diesel and oil prices we’re subject to it just like everyone else.

Our opportunity in managing in these times is on the consumer side and driving sales. If we can continue to drive the top line I believe we can, then we have an opportunity to leverage other costs. Can’t do anything about diesel fuel but we can certainly manage and get leverage on other costs on our P&L with more sales just as we’ve done in the second quarter.

The other thing that I’m encouraged by is our business is still very, very healthy on the non-consumable category. Its almost as if, if you took our business and just layered in more of the consumable products, increased sales in that way, that’s the effect that you saw on the gross margin. Two-thirds of the decline in gross margin was in mix because we’re selling more of those consumer products. That’s what customers need right now and we’ve evolved to the position that we have a store that we can offer both for them.

So our answer to higher fuel prices is to continue to manage it as best we can but then to leverage the other costs on our P&L as we drive sales.

Meredith Adler - Lehman Brothers

Last quarter you were kind enough to give us some sense of what your imported product costs were through the end of the year, Christmas is obviously the most important season, but do you have visibility beyond going into the seasonal items for the new fiscal year? Are you still seeing that you’re able to hold the line on import costs?

Bob Sasser

We have bought; obviously we’ve bought through fourth quarter and into first quarter now. We’ve made a trip after Easter to fill in some of those first quarter purchases and in July for the summer so we have bought, not completely, but we’ve made commitments into 2009’s year. We are encouraged, we still believe that and we’re proving it by the way, but more then just a belief that we’re able to manage our costs both domestically and on imports. First of all our buying power has increased and we have great relationships with our suppliers in this country as well as in Asia. To give you color I can’t tell you numbers, but I will tell you that we achieved our import margin targets for the purchases that we’ve extended into 2009 really better then what our targets were.

As far as managing the domestic side of it, we think of it the same way. We either change the product or we change the resource or we drop the item entirely and replace it with something else and that’s how we’re able to maintain our margins and categories that we do business with. Even on the consumable product categories, it’s all about the mix because within the categories our margins are up in those major categories.

Operator

Your next question comes from the line of Karen Short - Friedman, Billings, Ramsey

Karen Short - Friedman, Billings, Ramsey

Did you actually give what the VISA contribution was for the comp?

Katy Mallas

We didn’t but it was around 1%.

Karen Short - Friedman, Billings, Ramsey

So that cycles obviously in the fourth quarter. Not to be skeptical here but obviously this is a very skeptical and skittish market but you had a great comp in the quarter and I guess there would be some concern that the comp that you achieved in the third quarter is not necessarily sustainable going forward, so if you have that view given that you didn’t really achieve much of, didn’t get much leverage this quarter on a 6.5% comp, how should we think about the leverage opportunity going forward to the extent that that comp does decelerate? I know you talked about some opportunities, could you elaborate a little more?

Bob Sasser

The guidance that we gave you, we factored in the increases in fuel prices, we factored in the uncertain economic times as we looked at the sales and the sales guidance that we gave you so that really is the realistic view of where we think in these uncertain times that we’ve tried to provide you the best guidance going forward as we can. To just give you color, I believe first of all, we entered second quarter strong and we began third quarter strong. We are relevant to the times. Customers are looking for ways to stretch their dollar and to manage their budgets and they can’t do anything about the utility costs and their higher gas prices so they’re looking for ways where they can save bucks and more and more we’re gaining new customers at Dollar Tree.

So we are fully confident that we can manage through these uncertain times. We have great faith in the position that we are in as a company. We’ve positioned ourselves really right in the middle of the bull’s eye of customer sentiment right now. These larger stores that we’ve evolved to over the past six, seven years now have the component of discretionary product that customers always love from Dollar Tree and that’s the higher margins and now we’ve added this needs-based product that when times are tough we can really push that side of our business a little heavier. Old pioneer plan, old stick, old rudder and you try to keep the balance that way.

We’re very confident in our ability to manage through it. Diesel fuel is going to be high and we forecasted that and we’ve put that in our guidance. Energy prices are going to be high and that’s going to put pressure continued pressure on the customer. It has in the past and it will continue. We’ve tried to factor that into our top line guidance. So it’s uncertain times. I’m like you, I’m looking for certain answers in uncertain times and I can only tell you how we feel here about how we positioned ourselves and our ability to manage our margins. It’s not an accident as we go through these tough times where our margins are coming out. We’re running our business according to the current situation and serving our customers and we’ll come out the other side I think, I’d take our lot more, before then anyone else. That’s our feeling here. Our guidance is factoring all of that in and I hope that is helpful.

Katy Mallas

Really the pressure that we’re going to see truly is driven primarily by the fuel and the mix. If you take that out and look at where we’re guiding to for the back half of the year, G&A costs, we feel pretty good about where we are and with what we’ve got in the bank from the first two quarters we do expect to see health in G&A when you look at the year in total.

Operator

Your next question comes from the line of Michael Baker - Deutsche Bank Securities

Michael Baker - Deutsche Bank Securities

On the comps, you said third quarter is starting off strong so it doesn’t [inaudible] from that commentary any different then the second quarter, the guidance is a bit below that, is that just, you said your outlook is realistic is that some assumption and maybe things do slow a little bit in the coming months? How much of the calendar shift in the fourth quarter, the later Thanksgiving, plays into the full year sales and then full year margin outlook if there’s any deleverage from the sales on that?

Bob Sasser

Our second quarter was strong; you saw the numbers, third quarter started off strong. The guidance that we gave you considers the uncertain times that we’re in. Its just as uncertain now as it was back when we gave second quarter guidance at the end of first quarter. We’ve factored in the uncertainty of diesel fuel, we’ve considered the shift in the calendar and we’ve considered the impact that the macro pressures may put on the customer and we’ve given you our best shot at a guidance that does include all of those things.

We’re bullish on our business but we are negotiating the mine field as everyone else is out there right now and we will, I think the thought I’d like to leave you with on this though is we have a pretty good record of being able to negotiate that mind field and move with the customer sentiment.

Michael Baker - Deutsche Bank Securities

In the past I think when you’ve had a calendar shift on Easter you’ve been able to quantify that impact, is that Thanksgiving shift not big enough to worry about quantifying it?

Bob Sasser

We haven’t quantified the Christmas shift. It is the loss of one weekend is the main loss. There’s five less shopping days between Thanksgiving and Christmas. I don’t have a number in front of me. I will tell you this, that just as on Easter we quantified it and then we went to work on how to mitigate it and if you remember we guided, realistically we guided and then actually beat our Easter business pretty well, had a pretty good first quarter because of it. We have the same kind of plans in place for fourth quarter. It’s in our guidance.

Tim Reid

Remember any time that we give guidance like when we gave the Easter thing, it was the quarter before, it wasn’t two quarters ahead so what we’re doing is kind of giving you an advance heads up on what’s in our thinking for fourth quarter. When we get to that point, when we release our third quarter we’ll give you a little more quantification what we think that week might add up to.

Operator

Your next question comes from the line of Charles Grom - JP Morgan

Charles Grom - JP Morgan

On the second quarter gross profit margin, I know you’ll do this in the Q but can you get a little more granular for us on the mix headwinds as well as the diesel cost headwinds and then conversely what the benefits were from shrink markdown and buying and occupancy? On a two year basis gross profit margins were basically flat, in the first quarter they were up 50 basis points. I’m trying to see the trend in consumables that you’re seeing is going to be a permanent headwind, probably in the third and fourth quarter but beyond.

Katy Mallas

We don’t go into quite as much detail as what I think you’re asking for but directionally I would say that certainly the mix was a very big driver of our result in gross margin and yes, we are going to be pressured by that throughout year and I would say on similar levels to what we’ve seen then maybe a little more in the fourth quarter versus the third. On the fuel I think that what we’re seeing now is what we’re projecting based on what we’re seeing in terms of what the rates are expected to be. I’d say the second quarter cadence is going to be similar to what we’re going to see for the balance of the year.

In terms of shrink that trend has been a positive trend for us this year. We’ve talked about how we’ve wanted as a company to try to get that thing back below 2% and we have managed to achieve that this year and so we’ve included that in our guidance also for the balance of the year. The other costs as the comp runs higher, we certainly like that answer a lot more then when the comps are lower so we’ve built all those pieces and factored them into the model and so I would say in order of importance, its going to be mix and then its going to be fuel and then there’s some help from shrink and then there’s leverage in the other areas.

Operator

Your next question comes from the line of David Mann - Johnson Rice & Co.

David Mann - Johnson Rice & Co.

You commented that you spent less on advertising in the second quarter; can you give an idea of what you expect to do in the back half?

Bob Sasser

It’s going to be about flat to last year in the back half, it might be down just a little less as a percent of sales, but we’re basically going to anniversary the same promotions as we did last year.

David Mann - Johnson Rice & Co.

In terms of the Deals business I think your commentary over the last couple of quarters, it sounds like its performing very well versus your expectations and from what I remember you’ve put in some new management there, over the medium to longer term outlook there what needs to be seen for you to really start to ramp that up to say that you feel like you’ve got it where you want it and how close are you to doing that?

Bob Sasser

We’ve got to get our merchandise mix really more focused and targeted and that’s hard work and that’s the heavy lifting of this. There’s a lot of things that have to be done. That’s first and foremost. Other things that have to be done is the messaging in the store. When everything is a dollar the messaging is pretty singular and focused. When it’s not a dollar you have to work a little harder to get that value message out there so signing and pricing and not pricing and promoting and not promoting and all the things that go with running a multi price point versus a single price point. We still have a ways to go to really get that down.

And really the last thing is and its sort of along with the merchandise mix, but the Deals stores I’m contemplating them as being higher volume, maybe a slightly lower gross margin company, larger store but a higher top line and a higher operating margin as a result and I think that goes with the opportunity to enter into some of these higher cost but more densely populated areas with more stores and expands the number of stores and I think we can open and we haven’t gotten to that point yet. We’re still working on the mix.

We still haven’t gotten it to the point where the volume is where I’d like it to be and where it can be and where it should be and as a result our operating margin is still, although it’s getting better and we’re encouraged by it, I have to tell you it’s the biggest idea we’ve got. This is going to be a really good format for us as we look back over time we’re going to say this was really a good business to get into. But we still have some work to do on the merchandise, merchandising, the operating metrics of the store.

I will tell you we’re making headway though. It’s getting better all the time. There’s enthusiasm, there’s excitement over the Deals business. It’s a lot of hard work but the teams are really taking it on and embracing it even more as we’re seeing more improvement from this company.

Operator

Your next question is a follow-up from the line of Karen Short - Friedman, Billings, Ramsey

Karen Short - Friedman, Billings, Ramsey

Could you just give some color on what’s going on with the tax rate in the third quarter and fourth quarter you would assume its coming up a little bit seeing that the third quarter is going to be lower?

Katy Mallas

Generally if you look back at our tax rate, the third quarter generally will be the lowest quarter of the year. When we lay it out for the year we figure out what we believe the tax rate is going to be for the entire year and for the most part you can expect to see that in the first, second and fourth quarters. In the third quarter we file our tax return each year so to the extent you’ve got statutes rolling off that discrete event is going to take place in the third quarter. That’s why that rate ends up lower in the third quarter compared with the others.

Operator

Your next question comes from the line of Patrick Mckeever - MKM Partners

Patrick Mckeever - MKM Partners

On your sourcing costs especially as it relates to merchandise that you buy in Asia in particular with all the stuff we’re hearing about inflation in Asia and higher labor costs and raw material costs and so forth, and I know you’ve said in prior quarters, last quarter that you’d been able to really manage through, that you were seeing some pressure from vendors but you were able to manage through by shifting the mix and reducing package or changing packaging and those kinds of things, can you make a few general comments on that particular topic?

Bob Sasser

It’s really key, because things are and have been uncertain but I will tell you that we’re still, the answer is still the same. We’re able to manage our margins because we stay in control of the mix. We don’t have a standardized mix that we’re replenishing to so as costs or pressures to increase costs are there, we either change the product, especially in Asia because all the product that we bring out of China, almost all of it, we make to our order to our specs and its up to us on the value that we put into it.

But we either change the product, we change the resource or sometimes we drop the item. We drop a high percentage of items every year for two reasons even without the pressure on the costs. We believe that it’s healthy for our business to continually to change the product. It’s not the same old stuff the customer saw last season or last year. So we’re always looking to drop something, to add something that’s a little bit better. That also works with the margin because as costs tend to have pressure cause to go up, again we either change the product or we’ll drop it and we’ll replace it with something else.

We already know the retail. We’re different then anybody else out there. We already know the retail so all of our focus is on the cost and how do I get a price a cost that delivers the margin that fits our budgets. Our buyers again have, there’s been pressure in China and all the things that you read about, they’re all real and they’re all there but at the end of the day our buying trip in January, our margins we beat, we met and exceeded our planned margins on that trip. And our most recent buying trip that was finished in July, we were able to meet our target margins which are better than last year on that trip.

So we are in control of it and we are able to manage those cost pressures. By the way it feels like in China, and this is, I can’t quantify this for you but it just feels like things have settled down a little bit there too with the Chinese makers. A lot of uncertainty in China about currency valuation and inflation, they seem to have begun to get their hands and arms around that a little better too. So as a result it feels like the pressure is not as intense on it in China. That’s just anecdotal remark from our head merchants and but we strive every day, we know the retail. It’s all about really getting the right cost and our costs have fit within our margins so that’s how we do it. That’s how we’re going to continue to do it.

What you saw the mix change though in second quarter; I look at it as just a highly favorable thing because seven, eight years ago we didn’t have that ability. The stores were small and almost everything we had was high margin but it was just very discretionary. We’ve evolved from that to a mix of discretionary product, really higher volume then it ever has been. High margins but also a mix of product the people need, about 40% of our product and our sales, it would go 38% to 41% something like that on the consumer products, but somewhere in that range.

So we have buttons to push and when customers are under pressure to balance their budgets we’re pushing the [inaudible] budget puts pressure on our gross margin but it worked out in second quarter, we were able to leverage all those costs through the P&L and we ended up with a little higher operating margin. As long as the customer is under pressure we’re going to keep pushing on those. Things change though and we’ll make sure we stay relevant to what their needs are.

Operator

Your final question comes from the line of John Zolidis - Buckingham Research

John Zolidis - Buckingham Research

Can you quantify the occupancy leverage you achieved in the quarter?

Bob Sasser

We haven’t broken that out.

John Zolidis - Buckingham Research

Can you talk a little more about this planned shift into more consumables because it seems like in the last four quarters you’ve actually had gross margin improvement?

Bob Sasser

Yes we did, in first quarter we had gross margin improvement and of course the end of last year, but again its all about the larger store that we’ve evolved to over the past seven or eight years really has been in order to add more of the things that people need every day into the mix of things that people buy more frequently, the things that create traffic into our stores. So where we’ve fast forward to 2008 first quarter, second quarter 2008 we’re looking at the customer under tremendous pressure. We’re looking at them really buying only the things that they need. Anyone that you talk to their talking about they’re cutting back on going out to dinner and they’re cutting back on things that they can cut back but they have to have food and they have to have health and beauty care supplies and they have to have pens and pencils for the kids.

So we have a mix of product now that we can push and we’re right for the times. When times are tough and people want needs-based things we have that. That was second quarter and its likely going to be third quarter too the way we’re looking at it because it doesn’t look like the pressure is lifting off the consumer. But that’s how you see the gross margin, if you look at the operating margin line we’re getting there; we’re just getting there a couple of different ways. You can do it through higher margins and better times and you can, in less then better times, we have the mix, it might be lower margins but we can drive the top line to leverage the cost to still contain and improve our operating margin.

Operator

There are no additional questions at this time; I’d like to turn it over to Tim Reid for any additional or closing remarks.

Tim Reid

Thank you very much for participating in the call. Our next conference call is scheduled for Tuesday, November 25, 2008. That’s a slight difference from normal because you push it ahead one day because of Thanksgiving holiday.

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Source: Dollar Tree, Inc. F2Q08 (Qtr End 08/02/08) Earnings Call Transcript
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