美元樹 (DLTR) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen.

And welcome to the Dollar Tree Stores second-quarter earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Bob Sasser, President and CEO of Dollar Tree Stores.

Mr. Sasser, you may begin.

Welcome, everyone, and thank you for joining us this morning.

With me today are Chelle Gagliano from Investor Relations and Kent Kleeberger, our Chief Financial Officer.

Today Kent will lead off with a review of our financial results for the quarter followed by guidance for the third quarter and for the year.

Then I will provide a little more information on the second quarter followed by progress updates on our 2005 initiatives.

Before I turn the call over to Kent, I will ask Chelle to speak to our Safe Harbor statement.

Thank you, Bob.

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, which are on file with the SEC.

We have no obligation to update our forward-looking statements, and you should not expect us to do so.

At the end of our planned remarks, we will open the call to your questions, which we ask that you limit to one question and one follow-up question if necessary.

With that said, I would like to turn the call over to Kent for his financial review.

Thanks, Chelle.

Good morning, everyone.

Sales for the second quarter of 2005 were $769 million which is a 9.2% increase over last year's second quarter.

These results were within our most recent guidance and reflect a 1.5% decline in comparable store sales.

The decrease in comparable store sales was attributable to a 2.6% decline in transactions that was partially offset by a 1.1% increase in transaction size.

We believe the decline in transactions can be partially attributed to higher energy costs, which continue to pressure our customers.

We believe our higher mix of discretionary product versus consumables is what separates our comp performance from others in the extreme value sector.

Bob will provide further insight into this comment later in the call.

Earnings per share.

Diluted earnings per share for the quarter were $0.25 in line with our most recent guidance.

For the second quarter, gross margin was 34% versus the 35.6% rate in last year's second quarter.

The decline in rate was led by occupancy costs, which increased 70 basis points for the quarter, due primarily to the comparable store sales decline.

Merchandise margin also declined due to higher transportation costs and increased sales penetration by lower margin categories such as candy and foodstuff.

Additionally, merchandise margin was further impacted by an increase in shrink rate as last year's second-quarter margin benefited from an approximate 50 basis-point rate reduction arising from favorable physical inventory adjustments.

We had accrued shrink to a much higher rate through much of the first half of the year and then adjusted toward the end of the quarter.

On a year-to-date basis, our current year shrink rate is 1.9% versus 1.82% for all of 2004, which is about flat.

SG&A expenses for the quarter were 27.9% expressed as a percent of sales versus 28.6% for the same period last year.

A basic tenet of Dollar Tree continues to be expense control and we are pleased with our efforts to date.

We experienced significant savings in health care and Workers' Compensation reflecting our efforts in plan redesign and lower claims experience over the last nine months.

While store payroll continues to be effectively managed during periods when sales are especially challenging, we did experience a slight uptick in rate; however, there were various other areas of home office expense which experienced a rate decline versus last year.

Now for comment on depreciation and CapEx.

While the bulk of depreciation expense is reflected in the SG&A line, you should know that the rate as a percent of sales was about flat when compared to last year.

This has not happened for some time so the results are pleasing.

For the year, we see depreciation expense in the range of 138 million to 140 million.

From a capital expenditure perspective, we see CapEx in the range of 130 to 140 million for 2005 versus 182 million in 2004.

In reviewing the balance sheet, cash and investments were 166 million versus 182 million at the end of second quarter one year ago, and that's after reflecting about 130 million in stock repurchases in the first six months of 2005.

The Company continued to view share repurchase as accretive to our shareholders as well as a good use of free cash flow, and we will continue to repurchase shares under our 300 million authorization as conditions warrant.

You may also recall, we are focused in 2005 on increasing inventory turns.

We are pleased to report that inventory was down roughly 11% per store at the end of the second quarter.

We still expect inventory per store to be down in the 7% to 8% range by the end of the year.

Regarding sales and earnings guidance for the third quarter of 2005, we are forecasting sales in the range of 775 million to 800 million, and diluted earnings per share in the range of $0.28 to $0.31.

As for the full year, we believe sales will be in the range of 3.33 billion to 3.38 billion, which will result in annual diluted earnings per share of the range of $1.57 to $1.66.

The sales and earnings estimates are slightly below previous guidance as we expect higher gas prices will continue to pressure our customer, as well as our freight and transportation costs.

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

Thanks, Kent.

And I am going to begin with a few comments on sales which were obviously our greatest opportunity for the quarter.

We remain focused with our highest priority on those initiatives that are aimed at driving sales, and we are seeing some positive indications.

For example, our initiatives to increase the average ticket are gaining traction.

The average ticket was up for the quarter, and we view this as an indication that our customers are responding positively to our merchandise offering.

When we get them into the stores, they are buying more.

And in our new stores, we are getting them open earlier in the year and the productivity of our 2005 class is up over last year.

On the flip side, there is no doubt that the economic environment remains challenging for our customers, and it is affecting their shopping habits.

Energy prices continue to rise.

We are paying more and record prices at the pump.

Our customers, especially those in the lowest income levels, have less disposable income.

They are making fewer shopping trips.

And while we saw 1.1% increase in the average ticket for the quarter, our traffic was down 2.6%.

In our efforts to attract more customers and promote more frequent shopping, we continue to emphasize our ever-increasing merchandise value with more wow items, improved in stock of basics and seasonal excitement.

For example, our stores are currently at the height of their back-to-school selling.

We are well stocked in basic school supplies and our new Teachers Corner line product which was developed with teachers and classrooms in mind has been particularly popular and is a Dollar Tree exclusive.

We continue to focus on offering unexpected value, that extra wow item that our customer just can't pass up, like backpacks and just for $1.

Branded close-outs and special buys provide our customers incredible value every day on things they need.

In our largest stores, we have expanded our offering of consumer goods, more of the things our customers need every day and buy more frequently, and with the price of fuel, they really should be shopping at Dollar Tree first.

Truly amazing what you can buy at Dollar Tree for just a Dollar.

As another unbelievable example we have been doing a land office business on our photo paper.

I know you all take digital pictures and you know how much that photo paper costs in the office supply stores.

It is incredible the value that we have on this hot commodity, and this fall we will not only have the paper to print your digital photos, but also ink for your printer and USB cables too and for just a buck apiece.

The values were never better at Dollar Tree.

This extreme value will serve us well as we move toward the back half of the year, and it is what we do best.

Before I give you an update on our key initiatives there's one more global issue that I want to address, and that is the value of the Chinese Yuan.

The potential impact of the unpegging of the Yuan has been in the news over the past several years and as you know in late July it was indeed allowed to float.

As a result, we have received a number of inquiries on this development.

The effect of the unpegging has resulted in about a 2% stronger Yuan which is in our case less than $0.01 an item.

This is most likely going to be offset by the Chinese makers' ability to buy raw materials better with their slightly stronger currency.

We are experience no immediate effect from this action and we see long-term impact as minimal and manageable for several reasons.

First, we finalize our import purchases at least six months in advance of need, which gives us ample time to react to global events.

And we are basically done now for this year.

Second, since we develop proprietary products, we design our product to fit within our margin requirements.

We remain in control of the cost of an item.

Third, it is a competitive market.

We are a flexible buyer, and we buy in volume.

Our sourcing is diversified with buyers not only in China but all over Asia.

We have long-standing relationships which we can leverage based on market conditions and competitive forces.

In a nutshell, we continue to be this control of our costs and we see no material effect for the balance of 2005.

Further, we believe that the currency will float in a very tight range and that we can manage the valuation changes in the long term.

Now for an update on our key 2005 initiatives.

You may remember that our goals this year centered around several key initiatives aimed at improving our business processes, leveraging assets, and positioning ourselves for the future.

The first of which is a re-engineering of our real estate process.

Our goal has been to open stores in a more timely fashion, to open better stores more productively, and to improve our new store ROIC.

I am pleased to say that we have seen some real improvement in this area.

As an example, last year we opened 40% of our new stores in the first half of the year.

This year over 60% of our estimated 225 stores opened in the first half of the year and we're well on our way to achieving our targeted annual growth.

We continue to hone in on the 12,500-square-foot store as the preferred size.

It provides our customers with a fun and exciting shopping experience.

It stands up very well against competition.

And it gives us the room to grow over a longer period of time without additional investment.

The productivity and ROIC of the 2005 stores is higher than the class of 2004, and we believe this will continue to improve.

Our metropolitan initiatives which include stores in Long Island is yielding promising results, while this initiative is still in its early stages, the news is good.

These markets are more expensive to operate and it takes longer to find the right space, but they have the potential of leading the Company in sales productivity.

In our construction and property management, we continue to look for opportunities to improve our processes, aided by new technology and diligent process analysis, we believe that we can drive costs from these functions and are encouraged by the opportunity which is still ahead of us.

Our second key initiative this year has been to improve store productivity, and this initiative involves several projects, including the expansion of our tender types.

Specifically adding debit card acceptance to our stores.

We began this rollout in May and to date we have added debit acceptance to an additional 1,000 stores.

We now accept debit cards at over 50% of our location.

We are pleased with the results in the short amount of time since installation and anticipate this initiative to have a positive effect on average ticket sales in the remainder of the year.

We are also using more advertising to drive store traffic especially in the second half of this year.

While we believe that advertising can help drive traffic, we want to spend our advertising dollars wisely.

Year-over-year, our advertising spend is up slightly, with the bulk of the campaign in the second half of the year, and our efforts are focused in markets that we believe will give us the biggest bang for our buck.

We will continue to emphasize grand openings, as well as new markets and use our advertising to support the all-important holiday season.

Our fall advertising program is a mix of print and electronic media, and it will reach roughly 20% of our stores.

Our next key initiative was to leverage our POS systems to improve the flow of inventory to our stores, and there are still opportunities ahead, but we have made fairly significant progress on this initiative.

As Kent point out we ended second quart with 11% less inventory per store than last year and almost 3% less total inventory even with store growth.

We are committed to improving our inventory flow, lowering our inventory investment, and increasing our inventory turns over time as our history improves.

We continue to roll out more SKUs on automated store replenishment and this is an integral part of our inventory flow objective as well as our objective to increase sales productivity.

With each additional SKU added to ASR we increase our visibility and efficiency.

At the end of the quarter we had 581 total SKUs on ASR well on our way to meeting our goal of 700 SKUs by the fall.

Before I turn the call over to your questions, I want to remind everyone that at present, it is prudent to remain conservative in our financial outlook for the balance of the year.

There is more work to be done, but I also want to share with you that while the current economic climate remains challenging, we continue to believe that our initiatives to increase traffic and average ticket will prevail in the longer view.

I remain confident in our management team and their demonstrated ability to control expenses and margins.

We've made great progress here, especially on some of the largest expenses, namely health care and Workers Comp.

It is evident that we are making progress on the real estate initiative.

We have opened more stores earlier in the year and our class of 2005 stores is opening up more productively than the class of 2004.

Now that we have our POS data and more visibility of store-level inventory by SKU, our inventory flow initiatives are beginning to pay off as evidenced by our lower inventory per store at the end of period six.

There is more work to be done here but we will continue to improve as history improves.

Our acceptance of debit cards is helping to increase our average ticket.

Our advertising initiatives give us more ability to reach new customers.

And our focus on value remains paramount.

We are now ready for your questions which we ask be limited to one question with one follow-up.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Mitch Kaiser with Piper Jaffray.

Good morning, guys.

Mitch, good morning.

I was wondering you talked about new store productivity.

Could you give us a sense for kind of the magnitude between '04 and '05?

I know that you've talked about opening the stores earlier, and that obviously helps our productivity calculations, but if you would just give us a sense of that.

I know that you have been excited about the metro stores on Long Island.

Well, as far as the new store productivity goes, I think the number that has been embedded in a lot of people's minds for the 2004 classes they were generating annualized volume of about 1.3.

So far -- and this was very preliminary but the '05 class seems to be generating somewhere around 1.5 to 1.6 million per store.

So what that means is that in theory, when we decided to focus on a smaller store size and still deliver the same volume, we are actually delivering even higher volume in that.

So we are quite pleased with that.

Okay.

And I think you said the -- this year, the class is going to be about 12, 5 to 12, 2.

What was last year's class?

New stores we ran around 13, 8 in size.

That is a gross square footage number.

Oh, okay.

And then I guess just in terms of the comp breakdown, if you were to think about what would your traffic expectations be for the third and fourth quarters?

I think your guidance probably implies flat to slightly negative comps.

It does in fact.

I am really taking a look at last year's results in the month-by-month basis in looking ahead.

I think our biggest challenge last year was the month of August that we are currently in.

August last year we were running at about a three plus comp, and I think part of that was we had the hurricane phenomenon that believe it or not generated some additional volume just prior to that.

I think the comps get easier as we go out through the balance of the quarter.

Obviously traffic remains a challenge.

It has a challenge for many other people in extreme value sector.

While I anticipate it getting a little bit better, I think that a lot of our initiatives that we have going for us will help build the average basket and help mitigate this traffic decline.

Okay.

Thank you.

Our next question comes from Meredith Adler with Lehman Brothers.

Hey, guys.

I was wondering if you could spell out a little more clearly -- you have obviously been working on managing all expenses including D&A.

I wasn't exactly sure given you have very strong square footage growth again, how you managed to get an actual Dollar decline in D&A.

What are the mechanisms you are using.

Well, I think part of it is that with the new stores with the smaller size, you are getting some lower investment in construction costs.

The other thing, too, is when we took -- examined our depreciable lies on the new distribution center I think we were probably a little bit aggressive in the past and we on the two new distribution centers that were completed in 2004, there were some pockets, some fairly significant pockets of assets that lies were extended anywhere from three to five years.

Okay.

Just a follow-up question.

You also are very focused on inventory management, and I was wondering whether you have put new procedures in place to keep track of what the inventory is in the back rooms.

How do you make sure that not just that you are controlling the amount of new inventory going into the stores because that will help you get a bigger improvement, but also what's sitting there and maybe not selling the way it should be.

What are your procedures?

Meredith, one of the things that we have done, as you know, over the past several years, is install our POS sales data collection by SKU by store.

Immediately following that we began doing SKU inventories at the store which we'd never had in the past.

We now know what we own in the store by SKU and it rolls out into category and department.

We also know what we are selling.

Once a year -- or whenever we do inventories, we know how much is in the back room by SKU.

That number always changes .

That basically is a moving target that changes every day.

But basically once a year, we capture what's in the back room versus what's on the sales floor.

Our initiatives going forward are to lower the inventory in the back rooms, supply the stores with more of the product they need closer to the time that they need it, and by knowing the sales and inventory they have on hand, we are able to do that.

We do have some pockets as we always had.

We went for years without any visibility as to -- on hand our sales by store, by category.

So we do have some pockets that we are working through, all good inventory, but we are encouraging our stores to be proactive and getting more of the products on the sales floor, building displays, merchandising techniques to sell through the products.

Okay.

Thank you.

You are welcome.

Our next question comes from David Cumberland with Robert Baird.

Thanks, good morning.

Good morning.

On the debit card acceptance, can you elaborate on the impact you're seeing in the stores where this has been rolled out?

Well, I think the average transaction size on debit is somewhere north $16.

And I think what's interesting to me, and, again, we just started rolling this out in May and in June so the results are preliminary, but in the 1,000 stores we roll it out in the second quarter, we established a transaction minimum.

And basically what's great about that is, first of all, we have about a 82% compliance rate.

In other words, that we don't have it programmed to reject the transaction if it is under the minimum, but we have an 82% compliance rate with our sales associates which I think is wonderful, but more importantly, the average transaction size in those thousand stores is higher than the stores that we rolled out in November 1, of last year, as well as the older stores that were acquired that already had debit and credit in place.

So I think it is a real win on the debit side the equation.

And separately, what is the recent trend for turnover among store managers and other store associates.

Did you see any change in trend in the first half of the year?

Store managers not really, and we've been making some great progress over the past several years.

It has been something that we have focused on, David, is our store manager turnover.

I am pretty pleased with that.

We were under 25% last year, and that includes promotions, retirements, and everything that goes with that.

In retail, that's pretty darn good.

As we go forward, we have had a little more turnover in our district manager ranks this year.

Frankly from none to just a little bit.

But some of that's promotions, retirements, and reflecting on just the normal business too.

But all in all, I think we've done an admirable job in hiring and training and retaining our store management, and I believe that's -- that's one of those soft assets that you really can't put a number to, but over time, as we run these larger stores for longer periods of time, that is really going to pay off for us.

Thank you.

Our next question comes from David Buchsbaum from Stanford Group.

Good morning.

Good morning.

Could you give us a sense of where you would expect inventory to be at the end of the third quarter and just clarify for me if the down 7 to 8% was an overall number or an in store number for year end?

The 7% to 8% was total inventory per store at the end of the year.

Okay.

And where should we be looking for that at that at the end of the third quarter?

Well, if we're 11 and we are going to get to 7 to 8%, then I would expect third quarter to come somewhere around, probably 6, 7, and the reason that is, Dave, because we are obviously building the inventory for the fourth quarter.

Sure.

And could you give us a best estimate on your free cash flow for the year at this point?

And what you think you might be able to do in terms of inventory turnover improvement looking into next year.

Well, I think as far as -- we look from a free cash and this is before the repurchase, okay, of which we have done 130 million year to date.

I still believe that our free cash is going to be somewhere in the vicinity of 180 million to 190 million, and I think your other question is, that -- what does it look like in terms of the ability to increase turn for '06.

I said maybe we can get another 30, 40 basis points to turn.

Okay.

Thank you.

Yes.

Our next question comes from Nancy Hoch with JP Morgan.

Thanks, good morning.

Good morning.

Bob I was hoping you could give us a little more color on advertising.

In the last conference call you gave a little bit detail just on the impact of traffic that the program was generating.

I was wondering if you have seen any changes from that last update in terms of markets with advertising versus without.

I think it is about the same.

We have narrowed and focused our markets more in the second half.

We have really zeroed in on the media type and also the markets where we think we can get the biggest bang for our buck.

It is about 20% our stores that we are going to be targeting.

We are running more advertising, more weeks of advertising in those markets this year.

And I think we've found the level that will move the needle.

These markets, though, are anywhere from, I'd say 2 to 6% left over the nine advertising markets and that's just in general.

Again, that is a moving target along with other business trends, and the ebb and flow of business in a particular market.

Okay.

Then just a follow-up.

Relative to your original plan in terms of total spend for advertising given that you have pulled back the scope a bit.

Is there some leverage that you can gain in the back half from a lower-than-expected spend, or are you just maintaining status quo by increasing the time period you are running the spots.

We were actually spent a little more advertising in the second half than last year, and more focused way marketwise and over a little bit -- few more weeks than we did last year.

So, it's -- it's -- I am not sure I -- the leverage that we hope for is on the upside of sales, driving more traffic into the stores.

Great, thank you.

Our next question comes from David Mann with Johnson Rice.

Hi, yes, thank you, good morning.

Could you talk a little bit more about the sustainability of expense leverage given your square footage growth and the, I guess, slightly negative comp turn?

I think we go back to the question I get quite often is at what level comp do we need to achieve in order to see some expense leverage on the occupancy line.

And I still believe it's probably is in the 1.5 range, positive comp that it.

But in the meantime as it relates to other types of expenses throughout the P&L, I still think there are some opportunities and pockets on the P&L side.

I always try to come down on professional fees.

Last year we basically went through SOX for the first time.

We spent an awful lot of money with our auditing firm as well as the consultants, and I am not sure we are quite at steady state in year two of SOX, but I am looking at that.

Legal fees I think we need to do a better job in terms of managing that.

We had some issues around the labor front last year that spilled over in this year.

There's a little bit of intellectual property as well, but I think we are doing a better job on that.

So that's just one area.

I think that the management team is focused.

We met recently and did a mid-year P&L review.

We came back with a huge list of opportunities to pursue so I look for further improvement in the expense area.

And from a timeline or in terms of how many innings in the game if some of that expense control.

I mean, is that something that you think can -- is just an '05 event or does it continue into '06.

It's ongoing -- it's ongoing into '06.

There's a lot of low-hanging fruit still, I believe.

One other question on the performance of your larger stores .

Can you just give some color in terms of the traffic trend at those stores and the overall comp number that they are generating?

I think it is a little bit early to provide that type of information, and at the end of the day, I really don't have it broken down as I do total company by transaction versus basket size.

I mean inherently because of the location of some of these larger stores, particularly those on Long Island, it's got to be -- the traffic has got to be head and shoulders above what our average store performance is and then also given the demographics I believe it is also basket as well.

Our next question comes from John Zolidis with Buckingham Research.

Hi, good morning.

How are you doing?

Pretty good.

A question on the new store productivity.

I ran a very quick calculation based on some of the numbers that you gave out earlier, and it looks like new stores last year were doing about $94 per square foot, and then using the number you gave out for the run rate for this year and the size of the stores, I get about $120 a foot, which is actually a 28% year-over-year increase.

That seems like a lot to me.

So I am wondering if that's accurate.

My model does show an acceleration in store productivity in the current quarter -- in second quarter over the past three quarters, but I wonder what do you think is driving that besides the earlier or more timely store openings, and do you still think 10,000 selling square foot is the right size or should it go a little smaller?

Thanks.

John, the numbers are the result of, first of all, last year was a disappointment frankly, and we have initiatives in place to improve that class of 2004.

This year is impacted by several factors.

First of all, the store size is a little smaller.

We are opening up as we said we would a little smaller average store and really targeting that 10,000 sell and 12.5 gross size store.

So it is a little smaller than last year.

There are -- we are learning how to run them a little better.

We are opening up in better locations as we said we would do, understanding the markets and providing the best location, the best anchors, the best position that we could find, and I think some of it is just the learning curve on that.

The other thing is these metropolitan stores when we really have -- as we have entered into some of these markets, they have exceeded our expectations frankly.

There is a lot of people, for example, on Long Island.

They are middle income.

They are our customers they're -- they buy, by the way one of the things that is great about -- that we found is they are buying our broad mix of product.

It is not just this or just that.

They buy the broad mix that we offer.

They seem to have accepted us and our product and our stores and everything that we do with open arms, so we are excited about the initiatives as we move into more of the metropolitan markets that we have.

We need a little confidence though because the rents are higher and stepping into that first market where we're paying those kinds of rents was a little unnerving I guess, but you start with a few and then you get confidence and I think you learn from that on where you do the best.

So it is all of the above.

It is better stores, it's a little smaller size, it's opening up with a bigger bang.

We've opened up with more promotion this year in our stores, we've opened them up early, and we have opened up in some darn good markets with some good locations.

Thanks for that answer.

One just housekeeping question.

Can you just give us the square footage added by expansions on a year-over-year basis?

Thank you.

Let me see if I've got that.

How about rather than fumble through my notes, John, I follow up with you later.

Our next question comes from Patrick McKeever with SunTrust Robinson.

Thanks, good morning, everyone.

Bob, you mentioned the Yuan and the float there not having an immediate effect on your cost of goods.

But are there other cost pressures that you are seeing outside of currency in your cost structure as it relates to purchasing products overseas or domestically even?

Well, yes, there is pressure, the biggest pressure that we have has more to do with things that have to do with fuel or energy or oil in general.

So things made of plastic.

We've had to deal with some of those rising costs domestically.

Frankly, some of our domestic purchases in plastics have moved off shore because now it makes more sense to do those offshore.

We have been able to mitigate the -- any increases there in the raw materials pretty well.

We do face always the change in product, which is kind of what we do anyway as you know.

We are always about this year's product line and improving on it or changing it for next year and always coming back with a little different product.

In that way, we design our own product.

We put into it the cost that we plan to put into it based on current conditions, and we always are in control of our margins from that viewpoint.

As long as it is something that we can see coming, we can generally react to it and manage through it.

It is the sudden upticks that give us, I guess, the most headaches.

Things like the sudden rise in fuel prices, diesel fuel, for example, right now.

So anything to do with transporting the product to our DCs to our stores is costing us, I guess, as everyone else dearly.

So cost pressures are there.

We are able to manage them.

As far as the unpegging of Dollar to the Chinese currency though, I really believe that that is going to end up being really a nonevent for us.

We know what it is now.

It wasn't that much.

There is leverage from the Chinese side on buying their raw materials better.

We see no price increases that are sticking from that.

As we go forward, and as it floats, we think the Chinese are going to be very consistent.

They are going to let it float only in a narrow range, and I think as long as we can manage -- we can see that, we can manage to it.

And I guess one of the things I am trying to decipher here is the -- you have talked before about how your gross margin rate is, over time, fairly consistent right around 36%, but it appears as if this year we are probably looking at a fairly significant decline in gross margin and the first two quarters of the year you saw a pretty sharp decline in gross margin.

So I understand that occupancy costs -- you haven't been able to leverage those at the store level with comps being negative.

But is is there something that has changed in your gross margin structure in recent quarters that would keep you from getting back to 36% over time.

I don't think there is anything going to keep us from getting back to 36%.

I will tell you this, there's more of -- as Kent spoke, you have got the 70 basis points gross margin decline due to occupancy.

Then you have also the issue of last year's shrink add-back.

This year we just did a better job budgeting and basically didn't have an add back this year.

That was a positive effect of last year's second quarter that we were up against.

And then the -- we did have a mix shift.

And the mix shift, Patrick is coming from the customers driving it.

Frankly, we've always -- we sell consumer products.

We sell seasonal products.

We sell special buys.

We sell our own brands.

We sell name brands.

And right now we are seeing that lower income customer especially more interested in the consumer products than in the other products.

They've got less disposable income.

They are buying the things they need first and then if there is a dollar left they are buying the other things but they are certainly buying more of the consumer products right now.

How that mitigates over time and how that plays out the rest of this year I think is going to a great degree depend on how that customer is able to manage their income with their fuel prices.

And fuel prices are at record highs and they may go up.

Heating oil is before us still.

So those in the northeast are going to be faced with larger heating oil bills for this.

It doesn't bode well for the disposable income of a customer, and I think what you are seeing -- I know what we are seeing now in the mix is that those customers are spending their first dollar on the things they need and their second dollar on anything else.

There's a couple of other points too to consider, Patrick.

Currently diesel fuel prices on average across the country and are about $2.57 a gallon.

When you roll back the calendar to last year at this time, I would be willing to bet it is probably under $2.

There is a little bit of pressure there in our cost structure on the transportation side.

On the other hand, when you consider buying costs which are a fixed component of our buying and occupancy, and we are not adding any appreciable headcount there, coupled with the fact that our distribution centers, we opened two last year, we are not opening any more at least in the near future and if anything we would expand so we're beginning to lever some of that cost as well.

So there's a lot of moving targets so it's really sort of hard to hone in and say what -- if it's going to slip from 36% historical norms or not.

But we think that 36% is still doable in the longer term.

[OPERATOR INSTRUCTIONS] Our next question comes from Rick Church with Shumway Capital.

My question was answered.

Thank you.

Thank you.

Our next question comes from Joan Storms with Wedbush Morgan.

Hi, good morning.

Hi, Joan.

Yes.

Just a couple of housekeeping items, and if you could -- can you give us store openings and closings by quarter for the back half?

I'll see what I can do on that.

For the third quarter, we are probably looking at store openings somewhere in the vicinity of about -- I'd say 75 to 80 new stores, 30 or so relocations.

It looks like we are going to close about 10.

And in the fourth quarter, whatever the balance is, the 225 which is nominal and that would be in period 10, also known as November.

Okay.

And then on the share count.

It was a little lower than I had been looking for.

Was that just reflective of the buyback that was done at the end of the first quarter?

Yes, we did 128 million in the first quarter.

We did a little bit toward the end of the second quarter we're out there a little bit starting the third quarter.

Okay.

And then tax rate was a little bit lower.

Should we continue to plan for about 38%?

Well, I think what's happened in the tax rate right now is that we've exceeded our expectations in terms of the amount of municipal interest income from investments.

That's a good thing, it's tax exempt, so that helps lower the rate.

We've also got some favorability in the work occupational tax credit, principally at the store level.

So we've reflected some of that favorability in the second quarter.

I would say that, looking ahead that I think if 37-8 rate is probably appropriate.

Our next question comes from Ed Grosch with Bank of America Securities.

Hi.

Good morning.

Apologize if you already talked about this, but I thought the health care savings is pretty remarkable and you've not seen that from many other retailers.

Can you talk about how that was achieved, and whether you may be shifting the contribution a little bit from employees.

Well, we have, Ed, every year we look at our health care benefits package at all of the benefits packages and we strive to offer the best benefits we can for the dollars that we can afford to spend.

Especially health care, we're very focused on providing the best types of health care coverage that we can.

This past year we had a planned redesign based on anticipated growth and costs as they have been growing, and costs of prescription drugs as well as other health care costs.

They're rising faster than anyone's business has been increasing so you have to take a look at that.

We redesigned our plan, we did change some things in there with the benefits, adding some, reducing some.

We changed our co-pays a bit.

We've done some things to encourage our people to use more generic drugs.

We've done some education on what it means, what a generic drug is and to ask for it and what that means.

And we've also made it worth their while if they use generic drugs then their co-pay is less on that than it is on the other drugs.

So we've done a lot of things with education.

We've asked and encouraged our people to take more control of their destiny and join arms with the Company in trying to manage this growing cost, and I think we've had some good results from that.

Teaching them how to read their EOBs and just it's okay to challenge.

Did you get the service or not and how much did they charge you for the service and just really taking control as if it was any other bill that they have.

So all of the above, and we'll continue to do that to manage this cost.

Its results have been really good and we're real proud of the answers there.

We also had good results on Worker's Comp as Kent said, and that too comes a lot from education, it comes a lot from more accurate reporting--earlier reporting that we teach our people to do.

We have seminars for our field people, we have seminars in our distribution centers and over time -- now that one has really been a struggle because you have to -- that is only affected over the long term and you have to get your experience level going in the right direction.

So for several years now we've been working on that one to get where we are and we are finally seeing some relief on that.

We're not letting up though, because those are two big ones.

Yes, very sensible changes on the health care.

When did those really take effect?

Was it this quarter?

First of the year.

First of the year.

Thanks very much.

I'm showing no further questions at this time.

Mr. Sasser, you may proceed.

Well, thank you everybody for participating in the call.

Our next conference call is scheduled for November 22, and I'll see you there.

I'll hear you there.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the program, you may all disconnect.

Everyone have a great day.