Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 


 

FORM 10-Q

 


 

(Mark One)

x Quarterly report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

 

For the quarterly period ended May 1, 2004

 

OR

 

¨ Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

 

Commission File Number: 0-25464

 


 

DOLLAR TREE STORES, INC.

(Exact name of registrant as specified in its charter)

 


 

Virginia   54-1387365

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

500 Volvo Parkway

Chesapeake, Virginia 23320

(Address of principal executive offices)

 

Telephone Number (757) 321-5000

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

As of June 4, 2004, there were 113,540,155 shares of the Registrant’s Common Stock outstanding.

 



Table of Contents

DOLLAR TREE STORES, INC.

AND SUBSIDIARIES

 

INDEX

 

 

         Page

PART I-FINANCIAL INFORMATION

Item 1.

  Financial Statements:     
    Condensed Consolidated Balance Sheets as of May 1, 2004 and January 31, 2004    3
    Condensed Consolidated Income Statements for the Quarters ended May 1, 2004 and May 3, 2003    4
    Condensed Consolidated Statements of Cash Flows for the Quarters ended May 1, 2004 and May 3, 2003    5
    Notes to Condensed Consolidated Financial Statements    6

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    9

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk    13

Item 4.

  Controls and Procedures    14
PART II-OTHER INFORMATION

Item 1.

  Legal Proceedings    15

Item 2.

  Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities    16

Item 6.

  Exhibits and Reports on Form 8-K    16
    Signatures    18

 

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DOLLAR TREE STORES, INC.

AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

(In thousands, except share data)


   May 1, 2004

    January 31, 2004

 

ASSETS

                

Current assets:

                

Cash and cash equivalents

   $ 146,690     $ 168,685  

Short-term investments

     97,500       —    

Merchandise inventories

     565,219       525,643  

Deferred tax asset

     13,242       11,716  

Prepaid expenses and other current assets

     15,852       16,525  
    


 


Total current assets

     838,503       722,569  

Property, plant and equipment, net

     636,887       613,214  

Intangibles, net

     123,596       123,738  

Other assets, net

     21,646       20,785  
    


 


TOTAL ASSETS

   $ 1,620,632     $ 1,480,306  
    


 


LIABILITIES AND SHAREHOLDERS’ EQUITY

                

Current liabilities:

                

Current portion of long-term debt

   $ 19,000     $ 25,000  

Current installments of obligations under capital leases

     6,020       5,324  

Accounts payable

     139,059       114,972  

Other current liabilities

     79,388       82,771  

Income taxes payable

     30,085       37,035  
    


 


Total current liabilities

     273,552       265,102  

Long-term debt, excluding current portion

     250,000       142,568  

Obligations under capital leases, excluding current installments

     10,609       12,259  

Deferred tax liability

     34,016       29,717  

Other liabilities

     17,666       16,138  
    


 


Total liabilities

     585,843       465,784  
    


 


Shareholders’ equity:

                

Common stock, par value $0.01. 300,000,000 shares authorized, 113,624,880 and 114,083,768 shares issued and outstanding at May 1, 2004 and January 31, 2004, respectively

     1,136       1,141  

Additional paid-in capital

     193,767       208,870  

Accumulated other comprehensive loss

     (757 )     (970 )

Unearned compensation

     (50 )     (62 )

Retained earnings

     840,693       805,543  
    


 


Total shareholders’ equity

     1,034,789       1,014,522  

Commitments and contingencies

     —         —    
    


 


TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 1,620,632     $ 1,480,306  
    


 


 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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DOLLAR TREE STORES, INC.

AND SUBSIDIARIES

CONDENSED CONSOLIDATED INCOME STATEMENTS

 

     Quarter Ended

 

(In thousands, except per share data)


   May 1, 2004

    May 3, 2003

 

Net sales

   $ 710,330     $ 615,568  

Cost of sales

     459,189       397,780  
    


 


Gross profit

     251,141       217,788  
    


 


Selling, general and administrative expenses

     192,482       163,297  
    


 


Operating income

     58,659       54,491  
    


 


Interest income

     857       810  

Interest expense

     (2,935 )     (2,058 )

Changes in fair value of non-hedging interest rate swaps

     610       83  
    


 


Income before income taxes

     57,191       53,326  

Provision for income taxes

     22,041       20,531  
    


 


Net income

   $ 35,150     $ 32,795  
    


 


Net income per share:

                

Basic

   $ 0.31     $ 0.29  
    


 


Diluted

   $ 0.31     $ 0.29  
    


 


 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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DOLLAR TREE STORES, INC.

AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Quarter Ended

 

(In thousands)


   May 1, 2004

    May 3, 2003

 

Cash flows from operating activities:

                

Net income

   $ 35,150     $ 32,795  

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

                

Depreciation and amortization

     28,533       23,169  

Loss on disposal of property and equipment

     744       1,004  

Change in fair value of non-hedging interest rate swaps

     (610 )     (83 )

Provision for deferred income taxes

     2,640       4,057  

Tax benefit of stock option exercises

     904       249  

Other non-cash adjustments to net income

     258       96  

Changes in assets and liabilities increasing (decreasing) cash and cash equivalents:

                

Merchandise inventories

     (39,576 )     (58,465 )

Prepaid expenses and other current assets

     672       2,795  

Other assets

     233       (408 )

Accounts payable and other current liabilities

     20,705       (52,255 )

Income taxes payable

     (6,950 )     (9,499 )

Other liabilities

     2,479       2,246  
    


 


Net cash provided by (used in) operating activities

     45,182       (54,299 )
    


 


Cash flows from investing activities:

                

Capital expenditures

     (52,544 )     (63,336 )

Purchase of short-term investments

     (97,500 )     (28,360 )

Proceeds from maturities of short-term investments

     —         4,700  

Acquisition of favorable lease rights

     (251 )     —    

Proceeds from the sale of property and equipment

     —         29  
    


 


Net cash used in investing activities

     (150,295 )     (86,967 )
    


 


Cash flows from financing activities:

                

Proceeds from long-term debt, net of facility fees of $1,094

     248,906       —    

Repayment of long-term debt

     (148,568 )     (6,000 )

Principal payments under capital lease obligations

     (1,140 )     (1,657 )

Payments for share repurchases

     (20,908 )     —    

Proceeds from stock issued pursuant to stock-based compensation plans

     4,828       1,494  
    


 


Net cash provided by (used in) financing activities

     83,118       (6,163 )
    


 


Net decrease in cash and cash equivalents

     (21,995 )     (147,429 )

Cash and cash equivalents at beginning of period

     168,685       237,302  
    


 


Cash and cash equivalents at end of period

   $ 146,690     $ 89,873  
    


 


Supplemental disclosure of cash flow information:

                

Cash paid for:

                

Interest, net of amount capitalized

   $ 1,482     $ 1,980  

Income taxes

   $ 25,371     $ 25,742  

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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DOLLAR TREE STORES, INC.

AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements of Dollar Tree Stores, Inc. and its wholly-owned subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and are presented in accordance with the requirements of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the year ended January 31, 2004 contained in the Company’s Annual Report on Form 10-K filed April 13, 2004. The results of operations for the quarter ended May 1, 2004 are not necessarily indicative of the results to be expected for the entire fiscal year ending January 29, 2005.

 

In the Company’s opinion, the unaudited condensed consolidated financial statements included herein contain all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of its financial position as of May 1, 2004 and the results of its operations and cash flows for the periods presented. The January 31, 2004 balance sheet information was derived from the audited consolidated financial statements as of that date.

 

2. REVOLVING CREDIT FACILITY

 

In March 2004, the Company entered into a five-year Revolving Credit Facility (the Facility). The Facility provides for a $450.0 million revolving line of credit, including up to $50.0 million in available letters of credit, bearing interest at LIBOR, plus 0.475%. The Facility bears an annual facilities fee, calculated as a percentage, as defined, of the amount available under the line of credit and an annual administrative fee payable quarterly. The Facility, among other things, requires the maintenance of certain specified financial ratios, restricts the payment of certain distributions and prohibits the incurrence of certain new indebtedness.

 

The Company used availability under the Facility to repay $142.6 million of variable-rate debt and to purchase short-term, government-sponsored municipal bonds. The Company’s existing $150.0 million revolving credit facility (Old Facility) was terminated concurrent with entering into the Facility. The net debt issuance costs related to the Old Facility and the variable-rate debt, included in “other assets, net” on the January 31, 2004 accompanying condensed consolidated balance sheet totaling $0.7 million, were charged to interest expense in the accompanying condensed consolidated income statement for the quarter ended May 1, 2004. As a result of the repayment of the variable-rate debt, the $25.0 million, $10.0 million and $5.0 million interest rate swaps previously designated to the variable-rate debt were redesignated to new borrowings under the Facility. This redesignation does not affect the accounting methods used for the individual interest rate swaps. As of May 1, 2004, there was $250.0 million outstanding under this Facility.

 

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3. NET INCOME PER SHARE

 

The following table sets forth the calculation of basic and diluted net income per share:

 

     Quarter Ended

(In thousands, except per share data)


   May 1, 2004

   May 3, 2003

Basic net income per share:

             

Net income

   $ 35,150    $ 32,795
    

  

Weighted average number of shares outstanding

     113,814      114,258
    

  

Basic net income per share

   $ 0.31    $ 0.29
    

  

Diluted net income per share:

             

Net income

   $ 35,150    $ 32,795
    

  

Weighted average number of shares outstanding

     113,814      114,258

Dilutive effect of stock options and warrants (as determined by applying the treasury stock method)

     853      273
    

  

Weighted average number of shares and dilutive potential shares outstanding

     114,667      114,531
    

  

Diluted net income per share

   $ 0.31    $ 0.29
    

  

 

At May 1, 2004 and May 3, 2003, 1,555,255 and 5,514,622 stock options, respectively, are not included in the calculation of the weighted average number of common shares and dilutive potential common shares outstanding because their effect would be anti-dilutive.

 

4. STOCK-BASED COMPENSATION

 

The Company currently applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations in accounting for its fixed stock option plans. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. SFAS No. 123, “Accounting for Stock-Based Compensation,” established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure only requirements of SFAS No. 123.

 

If the accounting provisions of SFAS No. 123 had been adopted, the Company’s net income and net income per share would have been reduced to the pro forma amounts indicated in the following table:

 

     Quarter Ended

 

(In thousands, except per share data)


   May 1, 2004

    May 3, 2003

 

Net income as reported

   $ 35,150     $ 32,795  

Deduct: Total stock-based employee compensation determined under fair value based method, net of related tax effects

     (2,646 )     (3,187 )
    


 


Net income for SFAS No. 123

   $ 32,504     $ 29,608  
    


 


Net income per share:

                

Basic, as reported

   $ 0.31     $ 0.29  
    


 


Basic, pro forma for SFAS No. 123

   $ 0.29     $ 0.26  
    


 


Diluted, as reported

   $ 0.31     $ 0.29  
    


 


Diluted, pro forma for SFAS No. 123

   $ 0.28     $ 0.26  
    


 


 

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These pro forma amounts for SFAS No. 123 may not be representative of future disclosures because compensation cost is reflected over the options’ vesting periods and because additional options may be granted in future periods.

 

On May 10, 2004, the Board of Directors granted options to employees under the Company’s Equity Incentive Plan to purchase 1,550,750 shares of the Company’s common stock at an exercise price of $25.26 per share. The exercise price represents the fair market value of the Company’s stock at the date of grant.

 

5. SHAREHOLDERS’ EQUITY

 

Comprehensive Income

 

The Company’s comprehensive income reflects the effect of recording derivative financial instruments pursuant to SFAS No. 133. The following table provides a reconciliation of net income to total comprehensive income:

 

     Quarter Ended

 

(In thousands)


   May 1, 2004

    May 3, 2003

 

Net income

   $ 35,150     $ 32,795  
    


 


Fair value adjustment-derivative cash flow hedging instrument

     340       (101 )

Income tax benefit (expense)

     (131 )     39  
    


 


Fair value adjustment, net of tax

     209       (62 )
    


 


Amortization of SFAS No. 133 cumulative effect

     6       6  

Income tax expense

     (2 )     (2 )
    


 


Amortization of SFAS No. 133 cumulative effect, net of tax

     4       4  
    


 


Total comprehensive income

   $ 35,363     $ 32,737  
    


 


 

The cumulative effect recorded in “accumulated other comprehensive loss” is being amortized to expense over the remaining lives of the related interest rate swaps.

 

Share Repurchase Program

 

In November 2002, the Company’s Board of Directors authorized the repurchase of up to $200.0 million of the Company’s common stock. Stock repurchases may be made either in the open market or through privately negotiated transactions. During the quarter ended May 1, 2004, the Company repurchased 699,700 shares for approximately $20.9 million, under this plan. As of May 1, 2004 and June 4, 2004, cumulative stock repurchases under this plan, totaled 1,965,100 and 2,130,100 shares for approximately $59.0 million and $63.2 million, respectively.

 

6. Litigation Matters

 

The Company has been named in two suits filed in California State Court related to employment matters for its California store employees. The Company is currently unable to estimate the potential liability under these suits. There can be no assurances that the liability will not be material to its results of operations, accrued liabilities and cash.

 

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

INTRODUCTORY NOTE: Unless otherwise stated, references to “we,” “our” and “us” generally refer to Dollar Tree Stores, Inc. and its direct and indirect subsidiaries on a consolidated basis.

 

A WARNING ABOUT FORWARD-LOOKING STATEMENTS: This document contains “forward-looking statements” as that term is used in the Private Securities Litigation Reform Act of 1995. Forward-looking statements address future events, developments or results and typically use words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “view,” “target” or “estimate.” For example, our forward-looking statements include statements regarding:

 

  our anticipated sales, including comparable store net sales, pretax margin, net sales growth and earnings growth;

 

  our growth plans, including our plans to add, expand or relocate stores, our anticipated square footage increase;

 

  the average size of our stores to be added in 2004 and beyond;

 

  the possible effect of inflation and other economic changes on our future costs and profitability, including the possible effect of future changes in fuel costs, mileage cost and import freight rates;

 

  our cash needs, including our ability to fund our future capital expenditures and working capital requirements;

 

  our gross profit margin, earnings, inventory levels and ability to leverage selling, general and administrative costs;

 

  our seasonal sales patterns including those relating to the length of the holiday selling seasons;

 

  changes in our merchandise mix and the effect on gross profit margin and sales;

 

  the capabilities of our inventory supply chain technology and other new systems;

 

  the impact, capacity, performance and cost of our existing and planned distribution centers;

 

  costs of pending and possible future legal claims

 

  the adequacy of our internal financial reporting controls;

 

  the possible effect on our financial results of changes in generally accepted accounting principles relating to accounting for stock-based compensation.

 

For a discussion of the risks, uncertainties and assumptions that could affect our future events, developments or results, you should carefully review the risk factors described below and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” sections in our Annual Report on Form 10-K filed April 13, 2004:

 

  The outbreak of war and other national and international events, such as terrorism, could lead to disruptions in the economy. Adverse economic conditions, such as reduced consumer confidence and spending, or bad weather could significantly reduce our sales.

 

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  Our profitability is vulnerable to future increases in operating and merchandise costs including shipping rates, freight costs, fuel costs, wage levels, inflation, competition and other adverse economic factors because we sell goods at the fixed $1.00 price point.

 

  Our merchandise mix relies heavily on imported goods. An increase in the cost of these goods, for example because of inflation in their country of origin, or disruption in the flow of these goods may significantly decrease our sales and profits because any transition to alternative sources may not occur in time to meet our demands. In addition, products and alternative sources may also be of lesser quality and more expensive than those we currently import.

 

  We could fail to meet our goals for opening or expanding stores on a timely basis, which could cause our sales to suffer. We may not anticipate all the challenges that our expanding operations will impose and, as a result, we may not meet our targets for opening new stores and expanding profitably. In addition, new stores or expanded stores will cause sales at nearby stores to suffer, and we could have difficulties profitably renewing or replacing expiring leases.

 

  Our sales may be below expectations during the Christmas selling season, which may cause our operating results to suffer materially.

 

  The performance of our distribution system is critical to our operations. We must expand or replace existing distribution centers and build new ones in a timely manner or we will not meet our growth plans. Unforeseen disruptions or costs in operating and expanding our receiving and distribution systems could harm our sales and profitability.

 

  Disruptions in the availability of quality, low-cost merchandise in sufficient quantities to maintain our growth may reduce sales and profits.

 

Our forward-looking statements could be wrong in light of these and other risks, uncertainties and assumptions. The future events, developments or results described in this report could turn out to be materially different. We have no obligation to publicly update or revise our forward-looking statements after the date of this quarterly report and you should not expect us to do so.

 

Investors should also be aware that while we do, from time to time, communicate with securities analysts and others, it is against our policy to selectively disclose to them any material nonpublic information or other confidential commercial information. Accordingly, shareholders should not assume that we agree with any statement or report issued by any analyst regardless of the content of the statement or report. We generally do not issue financial forecasts or projections and we have a policy against confirming those issued by others. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.

 

Overview

 

Our net sales are derived from the sale of merchandise. Two major factors tend to affect our net sales trends. First is our success at opening new stores or adding new stores through mergers or acquisitions. Second, sales vary at our existing stores from one year to the next. We refer to this change as a change in comparable store net sales, because we compare only those stores that are open throughout both of the periods being compared. We include sales from stores expanded during the period in the calculation of comparable store net sales, which has the effect of increasing our comparable store net sales. The term ‘expanded’ also includes stores that are relocated.

 

At May 1, 2004 we operated 2,579 stores, in 47 states, with 18.1 million selling square feet compared to 2,319 stores with 13.9 million square feet at May 3, 2003. During the quarter ended May 1, 2004, we opened 79 stores, expanded 44 stores and closed 13 stores, compared to 55 stores opened, 30 stores expanded and 8 stores closed during the quarter ended May 3, 2003. In the first quarter of 2004, we added approximately 1.2 million selling square

 

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feet, of which approximately 0.3 million was added through expanding existing stores. The average selling square feet of stores opened during the first quarter of 2004 was approximately 11,000 square feet. For the remainder of 2004 and beyond, we continue to plan to open stores that have approximately 10,000 to 15,000 selling square feet. We believe this size store allows us to achieve our objectives in the markets in which we plan to expand. These stores generate higher sales and operating income per store than our smaller stores and they create an improved shopping environment that invites customers to shop longer and buy more.

 

Our point-of-sale technology provides us with valuable sales information to assist our buyers and to improve merchandise allocation to the stores. It has enabled us to better control our inventory, which has resulted in more efficient distribution and store operations. We expect the benefits of our supply chain systems, particularly our point-of-sale technology to help improve our inventory turns 10-20 basis points in 2004. At May 1, 2004, we operated point-of-sale systems in approximately 2,100 stores compared to approximately 1,000 stores at May 3, 2003. By the end of 2004, we expect to have rolled out point-of-sale systems to virtually all of our stores that will benefit from the technology.

 

While we did experience a decline in comparable store net sales of 0.4% in the first quarter of 2004, our stores greater than 10,000 square feet continued to produce favorable comparable store net sales results. In the second quarter of 2004, we expect comparable store net sales growth to be flat to slightly positive, net sales to be $700 million to $715 million and pretax margin to be at least 7%. Our expectations for pretax margin include a continued increase in depreciation expense due to opening larger stores, installation of new technology assets and the opening of new distribution centers.

 

We expect slightly positive to 3% comparable store net sales growth and net sales of $3.2 billion to $3.3 billion for fiscal 2004. We also expect gross margin, as a percentage of sales, to be approximately 36% for 2004, despite increases in import freight rates and fuel costs, due to better buying focus and cost control. We expect our import freight rates to increase by as much as $5.0 million in 2004. While fuel costs have risen in 2004 and our mileage costs as charged by our domestic carriers are increasing compared to prior years, we do not expect these costs to have a material impact on our results of operations, in part, because of the opening of two new distribution centers in the current year which will reduce the average distance between our distribution centers and the stores that they service. Despite expecting a 36% gross margin as a percentage of sales for 2004, quarterly gross margin results are likely to fluctuate due to factors such as seasonality and shipping and receiving patterns. For example, historically, our first and second quarter gross profit margins have been lower than those in the third and fourth quarters.

 

Results of Operations

 

The Quarter Ended May 1, 2004 Compared To The Quarter Ended May 3, 2003

 

Net sales. Net sales increased 15.4% in the first quarter of 2004 compared to the prior year first quarter. This $94.5 million increase in net sales resulted from sales in our newer stores, which continue to be in the 10,000-15,000 square footage range. Total selling square footage increased 30.2% in the first quarter compared to the prior year quarter. This increase was partially offset by a decline of 0.4% in comparable store sales in the current quarter. Comparable store net sales were negatively affected by an Easter selling season that was nine days shorter than last year’s. Comparable store net sales are positively affected by our expanded and relocated stores, which we include in the calculation, and, to a lesser extent, are negatively affected when we open new stores or expand stores near existing stores.

 

Gross Profit. Gross profit margin was 35.4% in the quarters ended May 1, 2004 and May 3, 2003. While gross profit margin remained consistent as compared to last year, the changes in the components of gross margin are detailed below:

 

  Merchandise cost, including inbound freight, increased approximately 65 basis points due to a change in merchandise mix in the first quarter of 2004. In the current year approximately 63% of our purchases were domestic compared to 56% in the prior year. This shift in merchandise mix is due to our buying a higher proportion of consumable merchandise for

 

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our larger stores. This increase in domestic purchasing resulted from our managing inventory better as we were able to bring goods in closer to the time that they would be sold and balance inventory levels by category. We also shifted some of our import purchasing out of the first quarter this year to later in the year to bring it in closer to the time it will be sold.

 

  Also offsetting the increase in merchandise costs was an approximately 75 basis point improvement in shrink and markdown costs. These improvements are the result of the use of point-of-sale data to better manage the inventory and buying processes and better allocate merchandise across store classes through the use of our supply chain systems.

 

Selling, General and Administrative Expenses. Selling, general, and administrative expenses for the first quarter of 2004 increased to 27.1%, as a percentage of net sales, compared to 26.5% in last year’s first quarter. Store operating costs increased 45 basis points primarily due to decreased leverage associated with the decrease in comparable store net sales. Depreciation costs increased 25 basis points in the quarter as a result of our larger new and expanded stores and the continued installation of our point-of-sale systems and other technology assets. These increases were partially offset by an approximately 15 basis points decrease in payroll related costs, primarily resulting from continued improvements in store-level labor related productivity.

 

Operating Income. Due to the reasons discussed above, operating income decreased as a percentage of net sales to 8.3% in the first quarter of 2004 compared to 8.9% in the same period of 2003.

 

Interest Income/Expense. Interest income increased to $0.9 million in the first quarter of 2004 from $0.8 million in the first quarter of 2003. This increase resulted from increased levels of cash and cash equivalents and short-term investments for the first quarter of 2004. Interest expense increased to $2.9 million in the first quarter of 2004 compared to $2.1 million for the first quarter of 2003 due primarily to $0.7 million of deferred financing costs that were charged to interest expense as a result of the refinancing of the $150.0 million credit facility and the repayment of the $142.6 million of variable rate debt in March 2004.

 

Changes in fair value of non-hedging interest rate swaps. The $0.6 million and $0.1 million in income for the first quarters of 2004 and 2003, respectively, is the result of reflecting our non-hedging interest rate swaps at their fair values in accordance with SFAS No. 133. The change in the fair values for each quarter is primarily the result of changes in interest rates. Due to the many variables involved in determining the fair value, our management is not able to predict changes in the fair values of our interest rate swaps.

 

Liquidity and Capital Resources

 

Our business requires capital to open new stores, expand our distribution network and operate existing stores. Our working capital requirements for existing stores are seasonal in nature and typically reach their peak in the months of September and October. Historically, we have satisfied our seasonal working capital requirements for existing stores and funded our store opening and expansion programs from internally generated funds and borrowings under our credit facilities.

 

The following table compares cash-related information for the quarters ended May 1, 2004 and May 3, 2003:

 

     Quarter ended

 
     May 1,
2004


    May 3,
2003


 
     (In millions)  

Net cash provided by (used in):

                

Operating activities

   $ 45.2     $ (54.3 )

Investing activities

     (150.3 )     (87.0 )

Financing activities

     83.1       (6.2 )

 

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The $99.5 million increase in cash provided by operating activities was primarily the result of better inventory and payables management. We achieved better inventory management through the use of our point-of-sale technology.

 

The $63.3 million increase in cash used in investing activities was primarily the result of purchases of short-term government-sponsored municipal bonds partially offset by a decrease in capital expenditures due to lower than expected costs on our distribution center projects.

 

The $89.3 million increase in cash provided by financing activities was primarily the result of borrowings under our credit facility, net of the repayment of our variable rate debt for our distribution centers. We also paid $20.9 million in the quarter ended May 1, 2004 to repurchase shares under a $200 million authorization granted by our Board of Directors in November 2002. As of May 1, 2004, we have paid a total of $58.9 million to repurchase shares under this authorization.

 

In March 2004, we entered into a five-year $450.0 million Revolving Credit Facility. This facility bears interest at LIBOR, plus a 0.475% spread. We used availability under this facility to repay $142.6 million of variable rate debt related to our distribution centers and to invest in short-term government-sponsored municipal bonds. As of May 1, 2004 we had $250.0 million outstanding under this facility. We also have a $125.0 million Letter of Credit Reimbursement and Security Agreement, under which approximately $74.2 million was committed to letters of credit issued for routine purchases of imported merchandise.

 

Expected Future Accounting Pronouncements

 

In March 2004, the Financial Accounting Standards Board issued an exposure draft addressing the accounting for stock-based compensation. A final standard is expected by the end of 2004. Proposed changes to the existing rules require companies to recognize compensation expense for stock option grants. When the new rules are enacted, we expect our results of operations to be materially adversely affected; however, our cash flow and the underlying economics of our financial condition are not expected to be materially affected. We will continue to monitor the development of the new standard and review our stock-based compensation plans accordingly.

 

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

We are exposed to various types of market risk in the normal course of our business, including the impact of interest rate changes and foreign currency rate fluctuations. We may enter into interest rate swaps to manage our exposure to interest rate changes, and we may employ other risk management strategies, including the use of foreign currency forward contracts. We do not enter into derivative instruments for any purpose other than cash flow hedging purposes. Certain of our interest rate swaps do not qualify for hedge accounting treatment under SFAS No. 133, as amended by SFAS No. 138, because they contain provisions that “knockout” the swap when the variable interest rate exceeds a predetermined rate.

 

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Interest Rate Risk

 

The following table summarizes the financial terms and fair values of each of our interest rate swap agreements at May 1, 2004:

 

Hedging Instrument


  

Receive

Variable


  

Pay

Fixed


   

Knockout

Rate


    Expiration

   Fair Value

 

$19.0 million interest rate swap

   LIBOR    4.88 %   7.75 %   4/1/09    $ (1,269,550 )

$10.0 million interest rate swap

   LIBOR    6.45 %   7.41 %   6/2/04    $ (48,904 )

$5.0 million interest rate swap

   LIBOR    5.83 %   7.41 %   6/2/04    $ (21,636 )

$25.0 million interest rate swap

   LIBOR    5.43 %   N/A     3/12/06    $ (1,426,718 )

 

Due to the many variables involved in determining the fair value, management is not able to predict the changes in fair value of our interest rate swaps. The fair values are the estimated amounts we would pay or receive to terminate the agreements as of the reporting date. These fair values are obtained from an outside financial institution.

 

During the first quarter of 2004, we refinanced our debt facilities. In spite of the refinancing, we do not believe there have been any material changes in our interest rate risk exposure.

 

Item 4. CONTROLS AND PROCEDURES.

 

(a) Evaluation of disclosure controls and procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to our management, including our Chief Executive Office and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

Pursuant to SEC Rule 13a-15, as of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that as of the date of our evaluation, our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Exchange Act) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

 

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(b) Changes in internal controls

 

During the period covered by this report, there have been no significant changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. In accordance with Section 404 of the Sarbanes-Oxley Act of 2002, we are evaluating our internal controls and are in the process of making changes to improve the effectiveness of our internal control structure.

 

PART II. OTHER INFORMATION

 

Item 1. LEGAL PROCEEDINGS.

 

From time to time we are defendants in ordinary, routine litigation and proceedings incidental to our business, including:

 

  employment-related matters;

 

  product safety matters, including product recalls by the Consumer Products Safety Commission;

 

  personal injury claims; and

 

  the infringement of the intellectual property rights of others.

 

On July 11, 2001, we were sued in California state court by several employees who allege that our store managers in California should have been classified as non-exempt employees under California law. Therefore, they allege, our store managers should have received overtime compensation. The suit requests that the court certify the case as a class action on behalf of all California store managers, assistant managers and merchandise managers and, among other things, award overtime compensation to these managers from July 11, 1997 through the end of the case. We currently operate 164 stores in California.

 

On September 19, 2002, we were sued in Alabama Federal Court by a former store manager who alleges that all of our store managers should have been classified as non-exempt employees under the Fair Labor Standards Act. Therefore, he alleges, our store managers should have received overtime compensation. This suit requests that the Alabama Federal Court certify the case as a collective action on behalf of all salaried managers in all our stores and, among other things, award overtime compensation to these managers from September 19, 1999 (or earlier) through the end of the case.

 

On November 3, 2003, we were sued in California state court by several employees who allege that our California store employees failed to receive meal period breaks and paid rest periods as required by California law. The suit requests that the California state court certify the case as a class action on behalf of all California store employees. Among other things, the suit requests the court to award each of these employees one hour of pay for each meal period break they failed to receive in accordance with law plus one hour of pay for any day in which they failed to receive all rest breaks as required by law. The suit asks that damages be awarded for the period from October 1, 2000 through the end of the case. After the suit was filed, the first California law suit originally filed on July 11, 2001, was amended to include a meal period and rest break claim for our California store managers, assistant managers and merchandise managers.

 

We will vigorously defend ourselves in all these law suits. We do not believe that these suits, individually or in the aggregate, will have a material adverse affect on our business operations or condition. However, we can give no assurance that these suits, individually or in the aggregate, will not have a material adverse affect on our results of operations, accrued liabilities and cash.

 

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Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF SECURITIES

 

The following table presents our share repurchase activity for the first quarter of 2004.

 

ISSUER PURCHASES OF EQUITY SECURITIES (1)

 

Period


  

Total number

of shares

purchased


  

Average

price paid

per share


  

Total number

of shares

purchased as

part of publicly

announced plans

or programs


  

Approximate
dollar value
of shares that
may yet be
purchased under
the plans or
programs

(in thousands)


February 1 to February 28, 2004

   102,000    $ 32.76    102,000    $ 158,000

February 29, 2004 to April 3, 2004

   516,600      29.52    516,600      142,700

April 4, 2004 to May 1, 2004

   81,100      28.31    81,100      140,400
    
         
      

Total

   699,700    $ 29.85    699,700    $ 140,400
    
         
      

(1) In November 2002, our Board of Directors authorized the repurchase of up to $200 million of our common stock.

 

Item 6. EXHIBITS AND REPORTS ON FORM 8-K.

 

(a) Exhibits

 

  10. Material Contracts

 

  10.1 Credit Agreement among Dollar Tree Distribution, Inc., as Borrower, Certain of the Domestic Affiliates of the Borrower from Time to Time Parties Hereto, as Guarantors; the Lender Parties Hereto, SunTrust Bank and National City Bank, as Co-Syndication Agents, Fleet National Bank, as Documentation Agent, and Wachovia Bank, National Association, as Administrative Agent, dated as of March 5, 2004.

 

  31. Certifications required under Section 302 of the Sarbanes-Oxley Act

 

  31.1 Certification required under Section 302 of the Sarbanes-Oxley Act of Chief Executive Officer

 

  31.2 Certification required under Section 302 of the Sarbanes-Oxley Act of Chief Financial Officer

 

  32. Certifications required under Section 906 of the Sarbanes-Oxley Act

 

  32.1 Certification required under Section 906 of the Sarbanes-Oxley Act of Chief Executive Officer

 

  32.2 Certification required under Section 906 of the Sarbanes-Oxley Act of Chief Financial Officer

 

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(b) Reports on Form 8-K:

 

The following reports on Form 8-K were filed during the first quarter of 2004:

 

  1. Report on Form 8-K, filed February 5, 2004, included a press release regarding the sales results for the fourth quarter ended January 31, 2004.

 

  2. Report on Form 8-K, filed February 24, 2004, included a press release regarding the earnings results for the fourth quarter and fiscal year ended January 31, 2004.

 

  3. Report on Form 8-K, filed February 27, 2004, included a summary of information discussed in the fourth quarter and fiscal year 2004 earnings conference call.

 

  4. Report on Form 8-K, filed March 19, 2004, included a press release regarding the Company’s plans to make a presentation at the Merrill Lynch Retailing Leaders Conference and the closing of a $450.0 million revolving debt facility.

 

  5. Report on Form 8-K, filed March 31, 2004, included a press release announcing that the Chief Financial Officer and Corporate Secretary, Frederick C. Coble, plans to transition to a full-time role as Corporate Secretary.

 

  6. Report on Form 8-K, filed April 6, 2004, included a business update for the first quarter of 2004.

 

Also, in the second quarter of 2004, we filed the following reports on Form 8-K:

 

  1. Report on Form 8-K, filed May 6, 2004, included a press release regarding the sales results for the first quarter ended May 1, 2004.

 

  2. Report on Form 8-K, filed May 26, 2004, included a press release regarding the earnings results for the first quarter ended May 1, 2004.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

DATE: June 10, 2004

 

DOLLAR TREE STORES, INC.
By:  

/s/ Frederick C. Coble


    Frederick C. Coble
    Chief Financial Officer
    (principal financial and accounting officer)

 

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