美元樹 (DLTR) 2006 Q2 法說會逐字稿

Good day, everyone, and welcome to this Dollar Tree Stores Inc. second-quarter 2006 earnings release.

As a reminder, today's call is being recorded, and now at this time I would like to turn the conference over to Mr. Tim Reid, Vice President of Investor Relations.

Please go ahead, sir.

Thank you.

Good morning and welcome to the Dollar Tree conference call for the second quarter of fiscal 2006.

My name is Tim Reid.

I'm Vice President of Investor Relations.

Our call today will be led by Bob Sasser, our President and Chief Executive Officer, who will provide some insights on our performance in the second quarter and update you on our strategies.

Kent Kleeberger, our Chief Financial Officer, will provide a more detailed review of our financial performance and financial guidance for the remainder of the year.

Following our prepared remarks, Bob and Kent will address your questions.

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, 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 up the call to your questions which we ask that you limit to one question and one follow-up question if necessary.

And with that said, I would like to turn the call over to Bob Sasser.

Bob?

Thanks, Tim.

Good morning, everyone, and thank you for joining the call.

This morning we announced that earnings for the second quarter were $0.28 per diluted share.

That is a 12% increase over second quarter last year.

As previously announced, total sales for the quarter were $884 million, an increase of 14.9%, and comp store sales increased 4.2% for the quarter.

Both sales and earnings were above the high end of our most recent guidance.

Year-to-date for the second quarter sales are 1.74 billion, an increase of 14.6%, and comp store sales increased 4.2%.

Year-to-date our diluted earnings per share are $0.59, an increase of 15.7%.

Our second-quarter performance was driven by several factors.

First of all, it is all about our merchandise and the merchandise excitement in our stores, and we had a lot of excitement and seasonal relevance throughout the quarter.

We've had better in-stock position on our basics, more of the merchandise that people need everyday.

We had an expansion of our frozen and refrigerated product to more stores during the quarter.

We increased our acceptance of more types of tender mainly debit, EBT and food stamps.

We continue to reduce inventory levels with better product flow and increased store deficiency resulting from that, and much of all of this result is the result of leveraging our investments in technology and logistics and the hard work of our associates using these tools to make it all happen.

We remain focused on driving the top line by offering our customers a full, fun, friendly store and an exciting shopping experience.

Our seasonal business again is a key part of that strategy.

We had solid performance each month throughout the second quarter, beginning with Mother's Day and continuing on through Father's Day, graduation and the Fourth of July promotions.

And overall our theme of the summer-selling season -- 100 Days of Summer Fun -- has been a great success.

Our Splash Item of the Week features have been a real hit with the customers, and we are drawing them in to see what is new each week.

Splash Items of the Week have included water blasters and huge 54 inch inflatable pool toys and recently men's, ladies and kids tank tops all at just $1.

In addition to the seasonal excitement, our second quarter benefited from increased sales of basic products.

Those of you who have followed Dollar Tree for awhile know that over the past several years we have grown our store size, and we have added a wider selection of consumer basics to our mix, merchandise that people purchased more frequently for their everyday needs.

We continue to improve our replenishment methods, and we are providing a better in-stock position on these basic products.

This increase in consumer basics and improved in-stock position has been a key to our increased customer traffic and an increase in our average ticket.

Now I would just like to note that with the price pressure of high gas prices customers really cannot afford to waste a trip these days.

Our stores are conveniently located.

They are easy to shop.

Our values are high.

Everything is still just $1, and now with a high degree of in-stock and consumer basics, we are right for the times, and I believe that we're seeing it in our customer's response in the form of increased traffic and a higher average ticket.

Along those lines, we continued to offer more frozen and refrigerated product.

We have added freezers and coolers to over 100 stores during the second quarter, bringing the total to 360 stores with freezers and coolers.

This compares to 100 stores at the end of the second quarter last year.

And we are going to end this year with frozen and refrigerated products in over 500 stores.

We're happy with the resulting increasing customer traffic.

As I have said over the past several months, this planned increase in the mix of basic products carries a slightly lower margin and, along with higher freight costs, have put pressure on our margins in the short-term.

I want to point out to you that this slight shift in product mix is a trade-off and one that we're willing to make to satisfy the customer and in the end generate increases in traffic, revenue and earnings per share.

In addition, our initiatives to expand our payment types have been positive to sales.

During the second quarter, we completed our rollout of debit card acceptance.

We now accept debit cards at virtually all locations.

Last year at this time less than 1800 of our stores accepted debit cards.

We have also entered into an agreement with Discover Card whereby Discover credit cards are now accepted at all of our stores.

We accept electronic benefits transfer cards in virtually all stores, and we currently except food stamps in qualified stores.

That number is growing and should expand to about 500 stores that will be accepting food stamps by year-end.

We continue to leverage our investment and logistics and technology to support these initiatives.

Our investment in POS applications has given us the ability to expand and improve our in-stock of basics while providing smarter allocation of seasonal products consistent with sales trends at each store.

Our auto replacement of basics provides products to the stores based on sales and inventory position, and most importantly, it allows our store associates to fill the shelves and help customers versus spending their time writing orders.

We have been able to improve product flow particularly around key holidays, leading to a cleaner more efficient store with less inventory in the backroom.

All of this translates into increased customer satisfaction and improved sales.

We continue to improve our inventory turns.

We ended the second quarter with a 4% reduction in inventory per store, and our turns increased 20 basis points.

Speaking of new stores, during the second quarter, we opened 47 new stores.

We expanded another 18 stores.

That makes 242 net new stores added this year, including the Deal$ acquisition, and 48 expansions and relocations.

And we are on schedule to achieve our 2006 growth plan.

A quick update on the Deal$ acquisition.

It is a work-in-progress.

We are on schedule with the integration as our front-end and back office systems have all been installed, and our people have been trained in these stores.

The Deal$ stores are now in Dollar Tree replenishment and are being supplied through Dollar Tree distribution.

We have completed the initial painting and fixturing and remerchandising of all the Deal$ stores, and over the next 60 days, we will install new decor packages and most importantly begin rolling out the new merchandise initiatives to these stores, including lifting the restriction of the $1 price point.

We are very excited about the progress that has been made in a short amount of time, but a lot of the real change is still to occur.

We will keep you up to speed as we progress.

Now we will turn the call over to Kent Kleeberger, our CFO, who will give you more detail on the second quarter and guidance for the remainder of the year.

Thanks, Bob.

Good morning, everyone.

Sales (technical difficulty)-- 2006 were 883.6 million, representing a 14.9% increase over last year and reflect the 4.2% increase in comparable store sales.

The increase in comparable store sales was attributable to an increase in both transaction size and traffic, which is the second consecutive quarterly increase in traffic after more than a year of declines.

Also our comparable store sales performance was fairly consistent from month to month during the quarter.

I would like to point out that our comparable store sales results were once again achieved despite rising gasoline prices, which we believe were up nearly $0.70 a gallon of regular gasoline on average over the second quarter of last year.

The negative impact of higher gasoline prices on transactions during the quarter is difficult to quantify.

However, we believe many of the initiatives which started last year -- the expansion of tender types, automated store replenishment, and frozen and refrigerated product -- will continue to mitigate the impact of higher gasoline prices and potentially less trips via higher average dollar sale.

Diluted earnings per share for the quarter was $0.28, which is above the high end of the range of our most recent guidance and represents the 12% increase over last year's $0.25.

It is important to note that in the second quarter last year diluted earnings per share benefited by nearly $0.03 from onetime favorable items, including about a 3.7 million favorable variance in health care due to plan redesign and nearly $1 million favorability in markdowns.

In addition, the second quarter of this year included onetime costs related to the integration of Deal$ amounting to merely $0.01 a share.

For the next few minutes, I will provide some color on our operating results, as well as speak to certain balance sheet items followed by third quarter and annual guidance.

As for margin, gross margin was 33.2%, 80 basis points below the 34% in last year's second quarter.

The decline in rate was primarily due to an increase in sales penetration by consumables, along with increased transportation costs arising from higher diesel fuel prices and higher shipment volume to our stores.

The addition of Deal$ stores, which demonstrated a lower merchandise margin due to their current product mix, also negatively impacted our margin rate.

The impact of Deal$ is expected to lessen in the second half as we begin the flow of fresh merchandise procured by our buying team through these stores in the third quarter.

Clearly gross margin represents our biggest opportunity for improvement as we cycle our planned shift to more consumable products.

I'm confident that, as we begin to focus more on the gross income line, we will create opportunities for improvement just as we are currently succeeding in addressing new store productivity, inventory management, increasing average ticket and driving topline.

SG&A expenses were 27.8% expressed as a percent of sales, down 10 basis points versus 27.9% for the second quarter last year.

As previously stated, last year's rate benefited by a 3.7 million or a 50 basis point onetime reduction in medical benefits expense.

This year, in addition to higher medical benefit expenses, we had increases in expenses for performance incentives and other benefit costs.

These increases were offset by operating expense control and the positive leverage associated with the increase in comparable store sales.

Depreciation for the second quarter was 37.8 million.

The overall rate as a percent of sales improved by 30 basis points compared with second quarter last year.

We expect depreciation of 152 to 155 million for the year, which as a rate of sale should be down about 20 to 30 basis points.

Looking at our balance sheet, you will note that cash and investments approximated 180 million at July 29, 2006 versus 166 million at the end of the second quarter last year, and this is after buying back 3.4 million of our outstanding shares during the second quarter for nearly $89 million.

Year-to-date through the first half we have purchased 5.3 million shares for approximately 136 million.

The Company continues to view share repurchase as accretive, as well as a good use of free cash flow.

We ended the quarter with approximately 36 million remaining available for repurchase under our 300 million authorization.

We continue to focus on increasing inventory turns.

As Bob mentioned, our inventory turns increased 20 basis points in the quarter as per store inventory was down 3.6% at the end of the quarter.

If we were to back out merchandise in transit, our per store inventory would be down 8%.

You will also note that our payables to inventory ratio continued to improve from 19.1% at the end of Q2 last year to 31.6% at the end of Q2 this year.

Most of this improvement is attributable to improved payment terms with our suppliers.

About 2.6% of the year-over-year change was due to a higher level of imports in transit.

We continue to do a good job of managing our inventory and improving turns in the second quarter, but as we expand frozen and refrigerated product to additional stores and begin to test multi-price points in some of our acquired Deal$ stores, inventory is planned up about 2% per store by the end of 2006.

However, we believe lower background inventories and improved product flow can help us reach to a slightly lower to flat inventory store per store comparison by year-end, thus improving annual inventory turns 25 to 35 basis points.

As for capital expenditures, we expended 46.1 million in the second quarter 2006 versus 40.6 million in the second quarter last year.

The majority of capital expenditures in the quarter were for our new stores and remodels.

We expect capital expenditures of about 155 to 160 million for fiscal year 2006, and that is up about 16 to 20 million from last year.

As for sales and earnings guidance, sales and earnings guidance for the third quarter of 2006, we're forecasting sales in the range of 895 to 915 million and diluted earnings per share in the range of $0.30 to $0.32.

This implies a range of positive low single digit comparable store sales results.

For the full-year 2006, we estimate sales will be in the range of 3.895 billion to 3.955 billion based on the 12 to 14% square footage growth and low single digit positive comparable store sales.

We expect diluted earnings per share in the range of $1.74 to $1.82.

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

Thanks, Kent.

Before turning the call over to you for questions, I want to leave you with just a few summary observations.

We had a very strong second quarter above our range of guidance, and we remain on track to accomplish our long-range goals.

We continue to own our new store size for optimum performance, which we believe to be in the 11,000 to 12,000 square foot range.

Our investments in infrastructure continue to translate into better inventory management, more efficient stores, improved in-stock positions and a better overall shopping experience for our customers.

This will serve us well into the future, and our balance sheet remains strong.

On that note, we spent nearly 90 million on share repurchase this quarter and almost 140 million in the first six months, approximately 54 million for the Deal$ acquisition, and we still ended the first half with more cash than last year.

Looking to the third quarter, with energy prices a constant concern, our focus must remain on delivering great value to our customers through trend relevant and seasonally relevant product, being in stock in basics and providing a bright, friendly, fun, convenient shopping experience.

We have made great progress so far this year.

Our stores are prepared for the fall and our value remains high.

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.

(OPERATOR INSTRUCTIONS).

Stacy Turnof, Merrill Lynch.

Could you give us a couple of comments on how your seasonal business has been going and anything on back-to-school?

We have had, as I said, the second quarter is not the biggest season, but we had a lot of small seasons, and they were all terrific.

Our Mother's Day and on to graduation and Father's Day, we had a nice response to some of the promotions that we did with building a basket where we were showing our customers what you could make with an item from here and an item from there all at a $1 each and the value that you could derive from building gift baskets -- gift baskets here in the season.

Our 100 Days of Summer Fun has been a real hit, and we have actually had customers, again as I said, coming back week after week to see what that feature item is for the next week.

So we are very happy with our sell-through on our summer seasonal product, all the cool toys, all the beach toys and the like.

Back-to-school started off just fine.

You know it is not over yet, but we are very happy.

As you go into our stores today, depending on where you are, I think down south where school has already started, you'll find that we had a pretty good sell-through there, and while there is still product on sale, because there's always a need for a little more of that, you can see the transition going on into fall.

In those stores, some of the stores where schools has not started until Labor Day, you still see a more focus on back-to-school upfront.

But we're happy so far with our sell-through on our seasonal product.

That is great.

And one follow-up, which is could you tell us what the average transaction is for the coolers versus non-coolers?

We have not given that statistic out.

Jeff Sonnek, FBR.

Just piggybacking on her question, were there any different promotions that were new year-over-year in the quarter?

You know, I don't think there's anything new, Jeff.

I believe that -- again, I believe we have done them better.

You have heard me say this before, but the value of our product was really good this year.

I cannot keep saying enough what the benefit of our merchandise technology is doing for us, enabling us to put more of the product that is selling into the stores that are selling it, and that is really helping our sell-through, satisfying more customers and driving more sales.

Then can you comment on, Kent, you have given some data points in the past on the kind of credit/debit penetration tickets, that type of thing?

Yes, I think in terms of total sales, I don't have it through the last month of the quarter.

This is through the first five months of the year.

Our debit penetration is now up to 17% of sales and around 7% of transactions.

So it is moving north.

The average transaction size is obviously higher than the balance of the Company.

More importantly, we're seeing some meaningful year-on-year gains in average transaction size just in debit only.

Charles Grom, JPMorgan Chase.

I'm kind of surprised that the SG&A did not leverage a little bit more on the 4.2 comp.

Can you quantify the subcomponents of the rise in SG&A, particularly the employee benefits expense control, the overall leverage and then D&A?

I mean last year in second quarter we did a planned redesign of our medical benefits which raised the deductibles, raised the copays, eliminated some unusual coverages such as morbid obesity.

Our health care costs in the second quarter are up 45%.

So that is a big number.

The other piece is that in last year in the second quarter let's just say that our outlook on not only the second quarter but the balance of the year was not overly impressive, and as a result of that, we lowered our incentive compensation profit-sharing accruals, and knock on wood, fortunately so far this year we are exceeding our expectations in terms of our estimates from a budget perspective.

So we have a higher rate of incentive compensation and related benefits.

In addition to that, our stores as they continue to generate significant increases in comparable store sales -- well, significant for us is 4% -- we obviously are seeing a higher sales bonus to our field.

So those are probably the big hitters that on a year-to-year comparison in terms of rate we have had to overcome, so I'm actually feeling pretty good despite all that, especially the benefit cost obstacles to overcome that we improved the rate by 10 basis points.

Okay.

That is fair.

So then looking ahead also to the gross profit margin line in the third and fourth quarter, your compares year-over-year get a little bit more challenging.

What is your field?

What should we expect there?

Should we continue to see the 50 to 80 basis points of erosion, or do you think we will see some improvement in that line?

Well, it is interesting because I think when we began to see a meaningful shift in consumables, it started in the third quarter of last year, if memory serves me correctly.

We had a 1.5% increase in penetration in the consumables business.

So we should begin to anniversary some of that, but I will tell you that our current trends, which is reflective of second-quarter results, is about double that rate.

So let's just say that the impact to gross income for the planned shift in consumables will still impact us but not as dramatic.

John Zolidis, Buckingham Research.

I could not hear the operator.

Sorry about that.

Looking here, it looks like you have now made or exceeded your guidance for the last five consecutive quarters, and that certainly contrasts with the several years leading up to that period.

Can you just talk kind of big picture what has changed to enable you to have a much better visibility on your earnings?

Well, John, I would tell you that I think it helps that with all the initiatives that we have planned and are exceeding in are basically impacting the topline in comparable store sales.

So that in-and-of itself makes us look a little bit smarter.

I think that the other piece about it is that with our real estate, which when I arrived we were having some issues hitting our targets on a quarterly basis.

So I think we're much more in tune on that, and we're doing a much better job in terms of execution.

So I think that when I got here and even before then, the Company was challenged in terms of declining operating margins, and part of the reason was because there were significant investments made at Bob and Macon's direction in terms of building infrastructure with new DCs and point-of-sale technology and new merchandising systems.

And so now we are really beginning to lever all of those investments, and those things are really paying off.

I just think our overall precision in the production process has improved dramatically.

Okay.

That is great.

Probably the only thing you can really complain about in the quarter is the gross margin.

It was a little bit better than I had actually modeled.

But let me make sure I understood you right.

For the back half, the 50 to 80 basis points decline year-over-year we saw in the first half is probably not going to be repeated to the same degree?

Is that what you said?

Yes, I think second quarter does not have any major events like Easter or back-to-school or Christmas.

So that is when I believe on an ongoing basis our gross margins have the biggest exposure, if you will, on a year-on-year comparison.

As we get into third and fourth quarter, obviously we get some higher volumes, which helps the margin rate.

And the other thing is that, as I pointed out with Charles Grom, is that it was really third quarter of last year is when we began to see a meaningful shift in penetration consumables.

So we will begin to anniversary some of that, so we will not be as hampered on the rate.

Patrick McKeever, Avondale Partners.

Another question I guess on gross margin.

I was just wondering if the increased -- the substantial increase it seems anyway in the penetration rate for debit cards, how does that affect the mix of sales?

I guess what I'm asking is, is the debit transaction, does it have a higher consumable component than the cash transaction?

Patrick, we really have not done any market basket analysis on the debit.

The only thing that we are pleased about is the fact it does have a higher average transaction value than most other vendors excluding credit.

So I really cannot give you any clarity on that.

The other thing I will tell you, though, that is embedded in the transaction, we also accept food stamps in many of the stores where we have frozen refrigerated product, and we also offer bread stuffs in order to qualify.

For now that is a fairly new initiative.

So when I look at those sales, that is really an increase in comparable store sales, if you will, and that actually has a decent average transaction size as well.

It is higher than the balance of the Company.

Okay.

And then my second question is just on -- I mean this question has come up before, of course.

But your product costs, are you seeing any pressure there from just rising commodity prices and that sort of thing?

Are you seeing any cost increases from the vendors that you buy merchandise from?

I know you're seeing some pressure on transportation costs, but I'm just wondering about your pure merchandise cost.

Patrick, the pure merchandise costs we continue to manage those very well.

Our merchandise team developed so much of the product themselves that we have always been able to build the product, to deliver the value, as well as the gross margin markup that we need on the products.

We are really not pressured so much.

The gross margin decline really is a factor in addition to diesel prices, which are much higher than last year and transportation costs.

It is a factor of the mix change for the consumer products.

I have just got to say again it is sort of a sign of the times.

We're out there serving middle America.

We're serving those customers, and they are under pressure with higher utility bills, as well as higher gasoline prices.

They want to make and need to have a place to go to make their shopping visit efficient.

We're serving those customers' needs in addition to all the great seasonal things that we are actually doing better on, but we are also selling them more of the things that they need everyday, which happen to have a lower markup but they turn faster.

And they are driving transactions.

They are driving average ticket.

And, as I said earlier, that is -- the lower margin is a price we're willing to pay to increase our market share, and I believe we are increasing our market share we're taking from other places.

We are building our average ticket.

You have seen that rise over the last several quarters, and we are building our traffic in our stores.

We have been able to say that for a few quarters in a row.

So all-in-all these larger stores and with the technology and with the mix that we put in them, they really are becoming more of a right for the times shopping location, and that is why I say what I say about the mix.

It is not the cost of goods same goods going up that is putting pressure, it is the mix change.

We're willing to make that change.

Joan Storms, Wedbush Morgan.

Bob, I was wondering could you talk a little bit about on the Deal$ acquisition about the implementation of multiple price points and how many stores do they have to have that now?

And just that whole process, how do you expect that to work?

Yes, we're right in the midst of really bringing the rubber to the road on that transaction.

We spent since late March, early April I guess just integrating and getting our systems in and getting training done, and we have done a lot of painting up and refixturing and remerchandising and sort of getting all the pieces in the right places.

Currently we're in the process of putting in the new decor package, the new signing package, and as of sometime in the next I'm going to say 30 days, we're going to have 50 or so more stores -- these are all around about kind of numbers -- with all the new merchandising strategies, as well as lifting the restriction of the price point.

And in the next 60 days, we will have finished the whole rollout on the stores that we are changing.

We are keeping some number of stores at the $1 price point.

A couple of things.

I want to see what we can do just by changing the merchandise mix in these stores and what impact that may have, and then the rest of this is a small number, in the teens, I guess.

And then in the rest of the stores, we are putting in new merchandising initiatives that include higher than the $1 price point.

So I cannot tell you any performance of that yet, but we are on the verge of that.

By the next call, I will be able to tell you how we are doing.

We are so excited about it because the initial response from customers to the decor packages that we are currently putting in and then just the cleanup, fix-up has been very strong.

So we are very happy with where we are.

It is sort of in progress.

It is right on the verge of coming to bear here I guess with the multi-price point, and I will be able to tell you more about that in the next quarter call.

That is great.

That is helpful.

I'm just curious, you have got 500 stores at year-end for the -- what is the consumable, the increased consumables to the coolers?

Where do you see that going?

You had sort of said in the past that you did not expect to roll it out to the whole chain.

But do you have an estimate sort of where you think is a percent of the chain coming into (multiple speakers) eventually have with that?

We're doing this in a very planned way.

There is no surprise on the impact to our business.

We're looking at probably another 250 stores next year.

But that could be -- that could grow.

It depends on a lot of things.

It depends on the availability of the direct markets to put the product in.

We also deal with restrictions that we have to work through and store size and just the whole -- we are building the supply chain to deliver this type product to these stores ahead of the need.

So you really do have -- it requires a little different delivery model.

It requires a little different acquisition model, and we want to do this in a rollout, really as a planned rollout and approach versus just, okay, it is great, let's go put it everywhere.

So another 250 or so stores next year is what I'm forecasting today.

David Cumberland, Robert Baird.

On the expense control that helped you in the second quarter, what are some examples of what you have done, and could your efforts there benefit the second-half earnings as well?

Well, I will give you a couple.

Our worker's compensation we have continued to drive meaningful savings there or better yet offset the increases.

So despite the number of new stores, including the Deal$ acquisition, which is roughly about a 14% or so square footage increase, our worker's compensation expense is up less than 5% year-on-year.

So that is one thing.

In the advertising line, I think we're getting a lot smarter in terms of how we are spending our advertising dollars.

We have backed down from TV, and we have done it in a more concentrated effort and made our dollars stretch further using radio and newspaper inserts.

So those are just a couple examples.

And as my follow-up, what are your advertising plans for the second half?

How would those compare to the second half of last year?

David, just a thumbnail of that is there is a little more advertising in the second half.

The percent to sales is about the same for the year.

But the second half we're going to touch probably 700 or so markets with our stores.

More markets and more stores.

About 700 stores compared to last year's approximately 500 stores that we touched in the second half, and we are going to have a little more frequency.

Meredith Adler, Lehman Brothers.

A couple of questions.

You have about 1800 stores that have had the dibit/credit card for more than a year now.

Can you talk about what happens to sales?

You saw obviously a good lift as you add it.

Do you see that continuing to benefit the second year?

Yes.

You may recall, we really started the debit rollout in the second quarter of last year around May 15, and we did about 1000 stores, and I think our execution was completed in the August timeframe.

As we begin to measure those results, we elected to put in another 500 stores as part of the debit rollout sometime in late third quarter, early fourth quarter for holiday.

So we still have some momentum from those stores.

My experience has been that when you roll out a new form of tender, you really hit the maximum penetration without any types of bells and whistles 18 to 24 months after you begin to roll it out.

And you have data that says two year you are actually showing sales gains?

Yes.

My other question is about new stores.

I think you have been tweaking what is the appropriate prototype, how big it should be.

Are you still comfortable with 12,500 square feet, or I think I had heard maybe that you were thinking about a little bit smaller?

11 to 12 is where we are.

We might take a 12.5.

It is all in that square footage size.

That is big enough to get all the product in.

It is more efficient.

It is the most efficient size for us.

We are still very opportunistic in our real estate approach, so we have a model that we can do a little larger as well as a little smaller.

But that 11 to 12,000 sweet spot is where we have sort of honed in on.

I think that if I look at this year's class, it looks like we're projecting the store size to be about 11,250 square feet -- that is gross -- versus the '05 class, which was around 12.4 I believe.

So it has gotten smaller.

It is not necessarily that we go out and dictate the size as much as with the combination of size and square footage productivity.

Christine Augustine, Bear Stearns.

Could you provide some commentary on what you have seen in the past when there has been a federal minimum wage increase?

I realized it has been 10 years, but I'm just wondering since there is legislation and we have seen some states like California, for example, go ahead and raise well above and they just look like they are going to pass another increase.

So what happens to your income statement?

And the second question is, just can you discuss regional trends that you're seeing?

Well, the minimum wage impact is something we look at all the time.

We are slightly -- we are a little above minimum wage overall.

So it depends on what the increase would be.

But from what we see and what we know, an increase in the federal minimum wage on our P&L today would not have a huge impact on us for the near-term.

Kent, do you have anything to add?

Yes, I think a substantial portion of our work force is employed above the minimum wage.

Our folks took a rough look at this, and it is less than $1 million on an annual basis.

So it is not a significant factor.

And the other question, Kent, if you will, can you share some regionality as far as trends?

Well, I think that our biggest concern in terms of competing wage, which is not just -- (multiple speakers)

Sales I think is what I'm asking?

Is that what you are asking?

It was sales.

Hello?

Yes, just wondering what your sales trends looked like in the second quarter on a regional basis, if you saw any variation?

We typically don't get into a lot of detail on that in terms of sales by region.

We basically track about 20 or 22 regions as opposed to other retailers who may divide it up into four parts of the country.

So we don't get into a lot of detail.

(OPERATOR INSTRUCTIONS).

Michael Baker, Deutsche Bank.

Very good quarter.

Congratulations to you.

My question is on the margin outlook.

On my math, at least if I do the midpoint of your sales and the midpoint of your earnings guidance for the third quarter and then for the year, it looked like margins are still expected to be down, even though it sounds like you're cycling some things that should help.

So I guess my question is, first, is my math right, or am I missing something?

And then my second, my follow-up would be, I wonder if there is any impact from the extra week I think that you guys have in the fourth quarter that we should be considering?

Yes, two things.

As far as third quarter, margins will continue to be down, particularly at the gross income line.

Again, the consumable mix penetration, while it was 1.5% in the third quarter last year.

We're currently running just under 3%.

So it may not be as pronounced as it was in the second quarter, but it nonetheless will have a negative impact.

The other piece is that we have not spoken to transportation costs in detail, but in going back and looking at my notes, I think diesel fuel prices on average per gallon in the second quarter was up $0.62 over last year.

So we believe every $0.10 a gallon is worth about $1 million on an annual basis.

So you can do the math.

So we had about 1.5 million obstacle to overcome in the second quarter.

The good news is -- the good news/bad news is last year with the hurricanes we saw a spike in diesel fuel prices, so the comparisons get a little bit easier in the third quarter.

But we will still -- we're projecting to be about $0.20 to $0.25 higher in cost of diesel fuel per gallon in the third quarter.

So those are probably the two biggest concerns in terms of a year-on-year comparison for the gross income rate.

Okay.

So I guess then my follow-up would be, at what point -- and I guess on what comps, do you guys see operating margins getting better?

Well, I think what we have to look at, Michael, is we looking really have to look into 2007 and where we can begin to lap some of these initiatives that we have particularly in frozen and refrigerated and consumables.

Right now when we compare all the major part of these initiatives where you have frozen refrigerated, you have consumables, you have the Deal$ stores, we really need to lap ourselves, and that really would suggest getting in those seven.

I would just look like to add a little to that, Michael.

You know, our operating margins are maybe the highest in the sector anyway.

So we have made a transition here from small stores to larger stores.

We have improved our retail technology.

We have invested in logistics to be more efficient to improve our costs.

And, as we go forward, we are focused on this customer that we are serving with a broader mix of product.

A broader middle America is the customer that we've targeted, and we have added in some of these consumer products.

Along with that, we have increased our traffic.

We have increased our average ticket.

We have increased our -- recently our comp store sales.

We have taken marketshare across -- there is a lot of good things happening out there with this change in mix.

It is very much a planned approach.

We have been planning it.

We actually exceeded our plan for the second quarter.

We did a little better than what we thought we were going to do in that regard.

But this is going -- you are going to see some lesser margins into the third quarter.

It won't be as much as in the second-quarter decline, but you're going to see it decline some in the third quarter.

And as we go into 2007 and as we then more level-set the mix and we can focus on the pieces of our business that we can drive and drive some of these higher margins categories that we are so good at, then our merchandise margins and our gross margins will begin to inflect at that point.

But this is a strategy that we have set out on some time ago, and you're seeing the impact of it in a positive way across all lines of the P&L.

But this gross margin line is under pressure.

It has been.

We have said it has been and it is going to continue to be until we can sort of get through the inflection and start working on these pieces.

At that time, I am confident that we can then begin to drive more of our seasonal business, drive more of our higher margin toy business, more of our party business in those high margin businesses, really taking advantage of this increased traffic to do more business overall and especially in those higher margin businesses.

So that is the strategy that we have set out upon that we have shared along the way.

We are on track, and we are very encouraged by what we are seeing by expanding our product offering.

David Mann, Johnson Rice.

My question is on the pack-away inventory or some of the older inventory that you might have left to clear.

I guess I have noticed some Christmas goods that have gotten back into the stores.

I just wanted to understand, is that some of the older goods that you're trying to clear out, or are you starting to set for Christmas?

David, we are starting to set for Christmas.

Now you may see in some stores some of the older goods that have come back on.

I just made a swath of trips over the last couple of weeks across the Southeast from Atlanta to Charleston and up the coast, and I have got to tell you I have seen cleaner stockrooms in this Company than I have seen in the last seven years.

Our inventory in our stockrooms, there was some stores that I was in had none.

Basically waiting for the truck to come in, which is the model that I particularly like.

Very very much improved.

There are some last Christmas pack-aways that we did carryover wrapping paper and the like.

We have also shipped new Christmas, early Christmas.

We have a Christmas in July promotion going up there.

It is not a lot, but some of the crafters like to start early.

We've got a Build a Wreath promotion going out there, on out there right now, that is being set.

It depends on where you are in your back-to-school cycle.

But basically you can buy the wreath form and all the ornaments and the ribbon and all the things to build a wreath, and everything is just a $1.

So, at the end of the day, you get a nice wreath that you can build for $10 or $12.

We have got some of our wrapping paper out there.

We have got some Christmas order balls and Christmas home decor.

Not a lot of quantities, but we did ship in some fresh new products into all stores that would enable them to really bring out if they had any of this leftover Christmas, the stores that do have it, to start bringing that out and mixing it in and turning into something that looks new and feels new.

So yes, you will see some out there, but it is a planned promotion, frankly.

I will tell you if it works next quarter.

Mr. Reid, at this time I will turn the call back to you for any closing comments.

Okay, Tracy.

Thank you very much.

Thanks to all for participating in this call today.

Our next conference call is scheduled for Tuesday, November 21.

Now remember Tuesday for the next quarter, November 21, 2006 when we report third quarter.

Thank you so much.

Thank you.

That does conclude today's conference.

Thank you all for joining.