Business context and reporting period
Dollar Tree’s 10-Q covers the 13 and 26 weeks ended August 2, 2014, compared with periods ended August 3, 2013. This differs from the request metadata identifying “2013 Q2”; the filing is for fiscal 2014 Q2. At quarter-end, the company operated 4,970 U.S. stores and 196 Canadian stores, with 44.8 million selling square feet. It opened 184 stores, expanded 48 and closed 10 during the first half.
Financial performance
| Metric | 13 weeks ended August 2, 2014 | Prior-year quarter | 26 weeks ended August 2, 2014 | Prior-year first half |
|---|---|---|---|---|
| Net sales | $2,031.1 million | $1,854.9 million | $4,031.4 million | $3,720.7 million |
| Operating income | $205.0 million | $201.3 million | $436.9 million | $417.8 million |
| Net income | $121.5 million | $124.7 million | $259.7 million | $258.2 million |
| Diluted EPS | $0.59 | $0.56 | $1.25 | $1.15 |
| Gross margin | 34.2% | 35.0% | 34.5% | 35.1% |
| Operating margin | 10.1% | 10.9% | 10.8% | 11.2% |
- Quarterly sales rose 9.5%; comparable-store sales increased 4.4% including currency effects (4.5% constant currency). First-half sales rose 8.4%; comparable-store sales increased 3.1% (3.2% constant currency). Growth reflected new stores, traffic and higher average ticket.
- Quarterly net income declined 2.6% even as diluted EPS increased, alongside a lower weighted-average share count. First-half net income was nearly flat, while diluted EPS rose from $1.15 to $1.25.
- Gross margin pressure reflected higher domestic trucking rates, lower initial merchandise markups and distribution costs, including costs from the Windsor, Connecticut distribution center. Quarterly operating margin also included $7.5 million of Family Dollar merger expenses; excluding these expenses, management reported a 10.5% operating margin for the quarter and 11.0% for the first half.
- Net interest expense increased to $8.4 million for the quarter and $16.6 million for the first half, mainly due to $750 million of Senior Notes issued in September 2013. The effective tax rate was 38.2% for both 2014 periods, slightly above the comparable prior-year rates.
- First-half operating cash flow was $365.3 million, versus $300.3 million; capital expenditures were $160.2 million, versus $199.6 million. Investing cash outflow was $159.9 million and financing cash outflow was $5.9 million. Cash increased $200.0 million to $467.7 million.
- At August 2, 2014, total borrowings were $757.0 million, with $737.1 million available under the unsecured credit agreement. Current assets were $1,663.2 million and current liabilities $783.0 million. Long-term debt was $757.0 million; the comparable total borrowings at August 3, 2013 were $269.8 million.
Material changes and outlook
- The July 27, 2014 agreement to acquire Family Dollar proposed consideration of $59.60 cash plus 0.2484 to 0.3036 Dollar Tree shares per Family Dollar share. The company expected closing by early 2015, subject to shareholder, regulatory and other conditions.
- Dollar Tree expected approximately $9.5 billion of bank and bond financing to fund the transaction and recapitalize the combined company. It estimated about $174 million in merger expenses and $172.2 million in capitalizable financing costs; approximately $7.5 million of merger expense and $12.8 million of deferred financing costs had been recorded in Q2.
- Management projected approximately $300 million in annual cost savings by the third year after closing, with $300 million of one-time costs to achieve them. It expected the transaction to dilute GAAP EPS during the first 12 months after closing, but to be accretive excluding those one-time costs. These are projections, not results.
- On August 18, 2014, after quarter-end, Dollar General announced a non-binding $78.50-per-share cash proposal for Family Dollar. The competing proposal, merger litigation, regulatory review, integration challenges and financing terms could delay or prevent Dollar Tree’s transaction or reduce its anticipated benefits.
- Other risks include cost inflation, economic weakness, competition, supplier and distribution disruption, technology and data-security incidents, debt covenant compliance and ongoing employment, lease, environmental and product-safety matters. The filing says potential losses for several proceedings cannot be estimated; it reports approximately 4,300 plaintiffs remaining in an FLSA collective action. An immaterial Pennsylvania lease settlement was accrued.
- The company hedged about 20% of domestic truckload diesel needs for August–October 2014 and entered additional contracts for about 20% for November 2014–January 2015. These contracts do not qualify for hedge accounting, so fair-value changes flow through earnings.
- No specific standalone sales or earnings guidance for the remainder of fiscal 2014 is provided in the filing. Management noted the seasonal working-capital peak typically occurs in September and October. The interim results are not necessarily indicative of full-year results.
Most important facts for investors to verify
- Confirm the reporting-period discrepancy: the filing is fiscal 2014 Q2, not 2013 Q2.
- Track whether Family Dollar shareholders and regulators approve the merger, and how the competing Dollar General proposal affects the transaction.
- Assess the proposed financing, resulting leverage and interest burden against the projected synergies, integration costs and EPS dilution.
- Monitor whether gross-margin pressure from freight, merchandise mix and distribution costs persists, and whether comparable-store growth continues.
- Review legal contingencies and merger-related litigation; the filing does not provide clear potential loss ranges for several matters.