Family Dollar Stores, Inc. Q3 2009 (Qtr End 05/31/09) Earnings Call Transcript

 |  About: Family Dollar Stores Inc. (FDO)
by: SA Transcripts


Good morning. I would like to welcome everyone to the Family Dollar earnings conference call. (Operator Instructions) I would now like to introduce Miss Kiley Rawlins, Vice President of Investor Relations and Communications. Miss Rawlins, you may begin your conference.

Kiley Rawlins

Good morning everyone and thank you for joining us today. Before we begin, you should know that our comments today will include forward-looking statements regarding various operating initiatives; sales and profitability; capital expenditures; as well as our expectations for future financial performance. While these statements address plans or events which we expect will or may occur in the future, a number of factors as set forth in our SEC filings and press releases, could cause actual results to differ from our expectations. We refer you to and specifically incorporate the cautionary and risk statements contained in today’s press release and in our SEC filings.

You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today, July 8, 2009. We have no obligation to publicly update or revise our forward-looking statements except as required by law, and you should not expect us to do so.

With me on the call this morning are Howard Levine, Chairman and CEO; James Kelly, President and COO; and Kenneth Smith, Chief Financial Officer. We’ll begin our discussion today with some comments from Howard, then Ken will discuss our financial results. Following our prepared remarks you will have an opportunity to ask questions.

Please remember that the queue for the question-and-answer session will not be available until after we have finished our prepared remarks. So that we may accommodate as many people as possible, please limit your questions to one question with no more than one follow up question during the Q&A session.

Before I turn the call over to Howard, I’d like to announce that we plan to host an Analyst meeting here in Charlotte, on November 3rd. We’ll provide more details later this summer, but I hope that you’ll be able to join our management team for what I’m sure will be an informative day.

Now I’d like to turn the call over to Howard Levine.

Howard Levine

Thank you Kiley and good morning everyone and thanks for joining us today. This morning we reported record results for the third quarter. Earnings per share increased 35%, operating margin expanded 160 basis points, and inventory turns and GMROI continued to improve.

These results reflect the hard work and commitment of all of our Family Dollar team members and I want to recognize their efforts. I’m especially proud of how well our management team is working together to increase our relevancy to the customer, manage risk, and drive profitability.

In today’s environment there is a renewed focus on value and thriftiness among higher income consumers, but our core low-income customer has always understood the importance of value. Living paycheck to paycheck, she knows how to stretch her income and satisfy her family needs.

Extremely sensitive to price changes and income changes, she adjusts quickly, often trading down to less expensive brands and private label merchandise to make her dollar go further. As economic pressures have increased over the last few years, she has adjusted quickly, consolidating shopping trips, curtailing discretionary purchases, and increasing her reliance on coupons and promotions for basic needs.

Understanding the pressures facing our customers we have reacted quickly to serve our customers better. Using insights from customer research, we have expanded our assortment of consumables, notably food to satisfy more fill-in trips. We had reduced inventory levels, especially in discretionary categories mitigating markdown risk, improving our store standards, and enhancing the overall shopping experience.

Through our concept renewal efforts, we began to look at ways to improve the look and feel of our stores through better in-store signage and more intuitive merchandise adjacencies. And we initiated the rollout of our new POS technology to support the acceptance of a wider variety of payment types including food stamps.

These investments have resulted in tangible improvements to the in-store experience and our customers have noticed. As we talk to our customers about their overall satisfaction with shopping at Family Dollar, our satisfaction scores are improving and our customer loyalty ratings are increasing.

As I reflect on the changes of the current environment and our performance so far this year, I believe that a unique opportunity lies before us. Value has become very important to more and more families, regardless of household income. And our assortment of brands, our increased focus on quality, and our improved store standards have positioned us well to capitalize on this opportunity.

As a result our customer traffic and average transaction have increased over the last four quarters. This increase in shopping trips is supported by our customer research which suggests that our core low-income customer is shopping us more frequently and spending more when she shops with us. In addition, we are seeing growth in trips from more middle-income customers.

Our challenge as a management team is to retain these customers and continue to expand our market share as the economy stabilizes and improves. We are taking aggressive steps to ensure that we maximize this unique opportunity.

I believe that this growing importance of value is not a temporary fad. For more families, this recession has altered their views on spending and savings in a structural way and I believe that going forward value will remain a key decision driver.

Since opening our first Family Dollar Store in 1959, we have provided customers with value in a convenient shopping experience. This consistent strategy combined with continuous reinvestment has enabled us to successfully weather a number of challenging economic cycles. Going forward if we can deliver a better, more satisfying shopping experience, we can build stronger customer loyalty and drive greater market share.

To capitalize on the opportunity that lies before us, we are investing aggressively in our business. Most notably we are accelerating our rollout of our store of the future technology and realigning space in our stores to improve the in-store shopping experience. While our aggressive pacing will pressure near-term expenses, we are confident that these investments will deliver higher returns over the longer-term.

Two years ago we began the rollout of a new store technology platform which we often refer to as our store of the future project. In addition to providing our store teams with better workflow management tools and computer-based training modules, this technology supports the acceptance of additional tender types including credit cards and food stamps.

And we are seeing a meaningful return on this investment. Today, food stamps represent a significant opportunity for us as the number of households who rely on food stamps to supplement their income continues to grow rapidly.

As of March, 2009 an estimated 15 million households relied on food stamps; an increase of approximately 19% from March of 2008. In addition, this year’s stimulus program provides approximately a 13% increase in average benefit and [wades] some eligibility requirements. I would note that we have seen a significant increase in food stamp transactions since these program changes went into effect in April.

The continued expansion of our food assortment, combined with the upgrade of our store technology positions us well to serve this expanding population of customers. Today, approximately 60% of our stores have the capability to accept food stamps compared with about 25% of the chain a year ago. And we are on track to complete the rollout in all stores by spring of 2010.

As we have discussed, sales of consumables have been the primary driver of sales for several quarters. To give you a sense of the magnitude of these increases, three years ago consumables were approximately 58% of sales. This year, consumables are trending closer to 64% of sales.

Yet despite this shift, our gross profit has actually expanded significantly over the same time period. Our investments in project accelerate and global sourcing as well as improvements in freight optimization, inventory management, and employee retention have enabled us to offset pressures from inflation and mix.

Ideally we want to balance traffic-driving consumables with profit driving discretionary categories, but we also want to satisfy customer demand. As a result we continue to expand our selection of these key categories. To accommodate this growth and to improve the in-store experience we are realigning space in our stores.

Not only will this initiative provide more space for high growth categories like food and paper, but these efforts will enable us to develop multiple but manageable prototypes to facilitate future space allocation efforts. In addition we intend to incorporate some of the most customer impactful elements of our concept renewal work into the stores; such as signage and more intuitive merchandise adjacencies.

Since initiating these resets in late May, we have completed work in about 1,500 stores with minimal disruption to the customer. While ultimately all stores will incorporate many of these changes we expect to impact about 40% of the chain during the fourth quarter. Yes, we are moving quickly but we have worked to mitigate disruption risk as we implement these changes.

We have developed a comprehensive workflow plan and established multiple implementation teams throughout the store organization to execute the space changes. Our supply chain group has positioned additional inventory in stores prior to implementation to minimize out-of-stocks. And we have structured the pacing in such a way that we can speed up if execution exceeds our expectations, or slow down if changes prove to be too disruptive to the customer.

I am very pleased with our execution to date and I’m confident that our customers will appreciate the changes we are making to improve the shopping experience. While our aggressive pace will pressure our near-term results, these investments will position us for longer-term sustainable growth as we improve the in-store shopping experience, build stronger customer loyalty, and drive greater market share gains.

Now I’d like to turn the call over to Kenneth for a discussion of the third quarter financials and our outlook for the fourth quarter.

Kenneth Smith

Thanks Howard, this morning we reported results for the third quarter. For the fifth consecutive quarter we reported double-digit earnings per share growth and an expansion of our operating margin. We also increased fourth quarter guidance which is impacted by the anniversarying of last year’s stimulus.

We’ll flush out the fourth quarter in more detail in a moment, but let’s first review our third quarter performance. Earnings for the third quarter increased 35% to $0.62 per diluted share compared with $0.46 per diluted share in the third quarter last year. Strong top line growth and better than expected gross margin performance resulted in approximately 160 basis points of expansion of operating margin during the quarter.

As we reported a few weeks ago, net sales for the quarter increased 8.3% and comp sales increased 6.2%. While consumables continued to be the primary driver of sales during the quarter, increasing approximately 11% on a comp basis, we also saw improving trends in more discretionary categories. Sales of home products continued to strengthen and sales of apparel while still negative, improved from the trends we saw in the first half of the year.

From a mix standpoint, consumables increased to approximately 65% of sales as compared to approximately 63% of sales last year. Despite this significant mix shift, gross profit as a percentage of sales increased approximately 160 basis points in the quarter as compared with the third quarter last year.

The improvement in gross margin was driven primarily by lower freight expense, lower inventory shrinkage, and higher purchase markups. These improvements more than offset the margin effect of higher sales of lower margin consumables.

SG&A expense in the quarter as a percentage of sales was flat compared with the third quarter last year, reflecting the effect of the 6.2% comp in the quarter and our continued focus on expense control, most expenses including store labor and occupancy costs, were leveraged in the quarter.

Offsetting these improvements, incentive compensation and insurance expense again pressured SG&A deleveraging by about 50 basis points for the quarter. Now let’s take a look at the balance sheet, at the end of the third quarter merchandise inventories were 3% higher than inventories at the end of the third quarter last year.

Average inventory per store increased approximately 1% as compared with last year. Although average inventory per store was slightly higher at the end of the third quarter, we continued to improve GMROI and inventory turns. As Howard indicated, we are making selective investments in traffic-driving consumable categories to meet growing customer demand.

As a result consumable inventory levels at the end of the third quarter this year were higher than consumable inventories last year. Highly consumable merchandise often has terms which include payment discounts. The taking of these discounts combined with the timing of these receipts late in the quarter resulted in a temporary reduction of our accounts payable leverage at the end of the quarter.

Reflecting our continued focus on managing risk, inventory levels in more discretionary categories were lower at the end of the third quarter this year as compared with the third quarter of fiscal 2008. We continue to maintain a strong liquidity position. Through the first three quarters of fiscal 2009, we generated more than $323 million in operating cash flow; more than adequate to fund approximately $103 million in capital expenditures and approximately $54 million in dividend payments.

As of May 30, 2009, cash and cash equivalents were approximately $296 million as compared with approximately $84 million as of May 31, 2008. Reflecting our expectations for the continued rollout of our store technology platform, as well as investments in the fourth quarter to support or expanded consumable assortment and related space changes, we expect that capital expenditures for the year will be between $160 million and $180 million.

Finally, during the third quarter we purchased 1.2 million shares of our common stock at a cost of $38.5 million. As of May 30, 2009 we had outstanding authorizations to purchase a total of $94.6 million of our common stock.

Now let’s turn to our outlook for the fourth quarter, starting with sales, we expect that consumables will continue to drive comps in the fourth quarter, driven by both our expansion of key traffic driving categories as well as continued consumer focus on basic needs.

However as we have indicated in prior conference calls, our overall comp results will be impacted in the fourth quarter as we anniversary last year’s stimulus package. Of course this year our customers are also benefiting from a government stimulus, but the impact is somewhat different from a timing standpoint.

Last year’s stimulus program benefited most of our customers with a single lump payment distributed primarily in June and July. While favorable weather and incremental advertising certainly impacted our fourth quarter comp last year, we also saw a benefit particularly in more discretionary categories as consumers spent their stimulus checks.

This year, the federal stimulus package is intended to provide assistance to low income families for the rest of 2009 through tax credits, an expansion of the food stamp program, and increased unemployment benefits. All of these programs should benefit our customers but over a prolonged period.

In addition the minimum wage increase which will be effective later this month, could also provide customers with additional income. The June period just ended and I am pleased to report that we cycled last year’s 8% comp well. We estimate that comps for the June period increased approximately 2% which on a two-year basis, represents one of our strongest performances this year.

Consumables continued to drive sales, while the sales of discretionary categories were more challenged reflecting last year’s benefit from the stimulus checks. For the full quarter we expect comps will increase between 2% and 4%. This year we have seen strong expansion of gross margin driven by lower transportation expense, better inventory shrinkage, and higher purchase markups, which have offset increased mix pressure.

As we look to the fourth quarter we expect that these trends will continue but may moderate somewhat. In addition, as Howard discussed, we are accelerating some significant investments to position longer-term returns. As a result, we expect to incur additional expenses this quarter related to our efforts to realign space in our stores to accommodate the expansion of high growth consumable categories.

We estimate that these investments combined with our aggressive rollout of store of the future, will pressure SG&A expense in the fourth quarter by around $8 million to $12 million but will support longer-term revenue growth. As a results of these expectations, we now project that earnings per diluted share could be between $0.39 and $0.43 for the fourth quarter.

Reflecting our performance year to date, and our expectations for the fourth quarter, we now project that earnings per diluted share for the full year will be between $2.03 and $2.07 as compared with $1.66 in fiscal 2008.

Now I’ll turn the call over to Howard for some final remarks.

Howard Levine

Thanks Kenneth, since the beginning of this year we have indicated that the fourth quarter would be our most challenging quarter as we anniversary strong comp performance. While we continue to believe that the underlying trends remain strong, cycling last year’s stimulus checks, will create some short-term noise.

In addition we are investing aggressively in our store of the future project and also in efforts to realign space in our stores to accommodate stronger customer demand. These investments will add incremental expense pressure in the fourth quarter, but will position us to drive sustainable growth beyond the current quarter.

Throughout our 50-year history we have continuously invested in strengthening and expanding our capabilities to serve our customers better, while also delivering short-term financial returns. This balanced approach has enabled us to successfully weather a number of challenging economic cycles.

As we evaluate the current economic environment, we believe that we have a unique opportunity to increase our market share as value becomes a stronger driver of shopping trips among customers of all incomes. To ensure that we capitalize on this opportunity, we are investing aggressively to improve the in-store shopping experience and increase customer loyalty.

I’m very pleased with our performance so far this year, but I am even more excited about the opportunity that lies before us. I believe that the investments we are making in building strong employee teams, enhancing merchandise capabilities, and improving the shopping experience will enable us to deliver sustainable, profitable growth over the long-term.

Now we’d be happy to take some questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Charles Grom - JPMorgan

Charles Grom - JPMorgan

Just on the 2% comp in June, can you give us a little bit of color on week-to-week trends and I guess how much the calendar shift and advertising adjustment that hurt the last week in May helped out the first week in June.

Kiley Rawlins

I’ll do my best to try and answer that, I think that as we’ve talked about June benefited from really two first of the months’, so the first of June as well as the first of July, similar to what we saw in last year. But as we’ve talked about the first of the month money last year, fell a little bit into the May period. It did not do that this year and so we saw a little bit of noise toward the end of the third quarter reflecting that shift.

As you also mentioned we, our promotional activity around the first of June also moved into the June period so there’s quite a bit of noise around the first of the month this year. You combine that with some of the beneficial weather we had last year when it finally got hot as well as the stimulus checks and the impact there, its pretty hard to get to a specific impact as it relates to just the first of the month.

I think as we’ve talked the first 12 weeks of the third quarter we were running closer to a 7% comp, obviously the last week had an impact on the overall quarter. There was probably I’d say a similar but probably less of an impact in June because you’re dealing with a larger dollar basis then you are in May and of course as we start to really cycle some of the stimulus checks, that creates some additional noise.

Charles Grom - JPMorgan

And just moving down the P&L a little bit, on the gross profit up 160 basis points in the third quarter, up 100 basis points in the second quarter, if I recall you’ve called out now the same three factors, shrink, freight, IMU in both periods, I’m just wondering which of those three helped you out a little bit more in the third quarter and I guess just why would that slow in the fourth quarter given that my understanding is that the IMU benefit should probably continue. So if you could maybe just flush it out for us, that would be great.

Howard Levine

I think you’re spot on, I think the three call outs are similar in the third quarter to the second quarter. We have seen some nice benefit in both in freight and in shrinkage and have continued to manage IMU well so those three all continue to be contributing factors.

And we expect as I mentioned that those trends will continue into the fourth quarter. I would suggest that one of the very difficult things to project out into the future is the energy side of things so freight becomes challenging for us to predict out into the future so we are anticipating and guiding that those could moderate somewhat.

And the other factor is the mix. We do expect some mix change in the fourth quarter that will wane on the gross margin a bit.

R. James Kelly

That mix is primarily a reflection of the stimulus plan last year which stimulated some discretionary spends whereas we won’t have that level of stimulus this year.

Charles Grom - JPMorgan

If you could just give us the ticket traffic breakdown on that 6 comp in the third quarter.

Kiley Rawlins

We’ve seen in the last several quarters both increases in ticket and traffic contributing to the comp. As we’ve seen in the last couple of quarters, traffic has been a bigger piece of that so roughly traffic is probably two thirds or so of the increase in the third quarter.


Your next question comes from the line of Neil Currie - UBS

Neil Currie - UBS

Congratulations on a great quarter, I just wanted to ask about some of your comments on getting more business from middle-income groups, just two questions around that. First of all who do you think you’re getting your business from, is it a balance of different retailers or is there any one particular format you think you’re being successful at attracting customers from. And secondly given the fact that you are getting more middle-income customers and it sounds like you think this is going to be sticky, does this change your view on store growth and neighborhoods that you think might now be available to you whereas previously they were out of bounds.

Howard Levine

Regarding the middle income and who we’re taking share from, obviously those in our channel are doing quite well and I also include Wal-Mart in that and think that the benefits that we all are seeing are coming from the fact that as I said in my comments, we are all offering great value and convenience in a very challenging environment and that’s exactly what customers are looking for today and you heard all the initiatives that we’re talking about to position us well to capture and keep those customers.

So we believe that the short-term investments that we’re making in our business or the investments we’re making in our business in this fourth quarter will position us well to not only keep some of these middle-income customers but also position us very well for our core low-income customer.

We’re taking share from grocery stores, from convenience stores, obviously I don’t think we’re taking share from those within our channels, our entire channel is showing market share growth. Moving on to the second part of your question in terms of real estate opportunities and how this might change, we’ve always been focused on the value conscious consumer. The value conscious consumers’ income ranges from very low numbers to more of $50, $60, $70,000 so we’ve always viewed these types of locations when positioning ourselves for new store growth.

Obviously in this type of economy and the impact that it will have on real estate opportunities, hopefully we’ll see even more of these opportunities but we’re going to stay focused on the value conscious consumer, continue to drive value, and really grow market share with income levels, all income levels.

Neil Currie - UBS

So you’d say that its not necessarily a new demographic, you’re just getting more success with the upper end of your target demographic.

Howard Levine

Well we’re seeing growth across the middle income area, that growth has continued, its actually ramped up over the last few quarters. Some of the data we’re looking at is somewhat delayed there, so we would continue to see that grow, but our core focus is on the value conscious consumer and don’t really see this as a new demographic opportunity.

In fact all the things that we’re doing, things like improving the shopping experience which incorporates concept renewal, improved focus on quality, additional brand names. All the things that we’re doing don’t prejudice one income level. I think all people like clean, shoppable stores. All customers like great value so I think the things that we’re doing keep us focused on that value conscious consumer and will not misdirect any efforts to something that we don’t think is sustainable.

R. James Kelly

I would comment that in terms of assessing potential sites for new stores, we use various forecasting models which are, which adapt continuously to actual demand patterns. Over the last several years we’ve had a significant change in demand patterns, improved demand patterns, and consumers with household income of $30 to $40,000.

So that in and of itself changes where we can locate stores. Subsequently to that and more recently as Howard pointed out, we’ve seen significant growth in the $40 to $70. We’re going to have to see how that continues to develop but our location of stores will be driven by the customer demand and the attributes of that demand.

So the more customers shop us, the more opportunities for growth we have.

Neil Currie - UBS

And just a quick one on the payables being down and offsetting that with better terms, is that going to continue into the fourth quarter and perhaps into the first quarter of next year.

Kenneth Smith

No, I mentioned in my comments, we believe that it’s a temporary reduction in the AP leverage numbers due to the timing and flow of some very highly consumable receipts and it should normalize as we look forward.


Your next question comes from the line of Mark Miller – William Blair

Mark Miller – William Blair

I was hoping you could address the opportunity to capture lower rental expenses, can you remind us what percentage of your store leases are renewing each year and are you seeing something on the order of a double-digit decline in rents or if you could help us size that, that would be helpful.

R. James Kelly

As you know the real estate market typically trails other economic indicators. What we have seen is that it is softening. We don’t think its at the bottom yet. We do see an opportunity and it worked well structurally to prepare ourselves to capitalize on it in that roughly 15% to 20% of our stores will have leases up for renewal this year.

So far, let’s say over the last couple of quarters, we’re seeing some fairly meaningful concessions as a part of this renewal effort. We would expect for that trend to continue and potentially if real estate continues to be pressured which many economists think it will, then that opportunity will grow.

Mark Miller – William Blair

The company has always from my standpoint been an efficient allocator of capital, you slowed growth when returns fell. Obviously with the type of sales and margin improvement you’re seeing coupled with the lower rents, returns on new stores would seem to be nicely improving. So my question is what is the appropriate store growth rate for the company, the current pace would seem to be below what you might want to pursue. I guess what kind of growth can the organization handle, what infrastructure that you’d need to build and are you taking steps to do that for future expansion.

Howard Levine

I agree with your comments. I think that as we talked about several quarters ago that we thought it was appropriate to slow down new store growth to focus on improving returns on existing stores. That decision has proven to be a good decision as we’ve seen improved ROIC, more focused on improving shopping conditions, quality issues, etc.

Currently we continue to believe that we still have substantial opportunities to focus on improving existing stores. That’s where our focus is when you heard the initiatives that we outlined today particularly those that we’re working on in the fourth quarter but over the long-term we certainly understand the importance of new store growth.

The most successful retailers I think have a nice balance between comp store growth and new store growth over the longer-term. We understand that. We have plenty of opportunities ahead of us. Fortunately we have a strong financial position to enable us to take advantage of that. And the slowing of the real estate market will also create even further opportunities for us.

So over the long haul we continue to see new store growth coming back to stronger levels but in the near-term our focus is remaining on continuing to improve performance in existing stores.

Mark Miller – William Blair

Just a follow-up then to that, I assume you want to complete the realignment of space, so this is probably another year or two years out before we’d see any kind of meaningful pickup. Is that fair.

Howard Levine

I don’t want to put a timetable on it. Frankly I think we’re going to constantly be tweaking space within our stores. You heard us talking about one of the things that we’re going to be able to get out of the current realignment is some prototypes which will enable us to facilitate an easier move in the future when we contemplate these sorts of things but really two separate issues from that standpoint but I do believe that you’re right, in the next year plus, we will continue to focus on the execution, performance in existing stores.

But we’ll be mindful of the new store growth opportunities.


Your next question comes from the line of Ivy Jack - Barclays Capital

Ivy Jack - Barclays Capital

Great quarter, can you talk about kind of the cost impact from having a larger mix of consumables, kind of on your infrastructure and how you’re going about managing that as we see consumables become a larger percentage of the mix.

Howard Levine

I would say, we’ve managed through, you’ve seen our consumables business be strong for some time now and we’ve paced that growth in shifts toward consumables as we manage our cost structure. So clearly there are some costs as that shift occurs when you, through distribution costs etc. that can be different with those slightly higher mix.

But we’ve managed that well. Planned for it well I think and have that well planned into our core expense plans.

Ivy Jack - Barclays Capital

Can you just remind us how many more stores, or how much more capacity you have in your current distribution network.

R. James Kelly

I think that number flexes depending upon how the assortment continues to shift. One of the things that Kenneth was implying but didn’t specifically mention, you get in many of the consumable areas a lot of cross stocking opportunities that really change the dynamics of our distribution center.

So in theory we have many opportunities to become more cost efficient during this shift. Indeed we have a number of our teammates working on the concept of [lean] retailing in the store. From an overall capacity perspective we’re not seeing the addition of a DC in the near-term.

Ivy Jack - Barclays Capital

Shifting gears a little bit, I think you mentioned that the comps for consumables was around about 11%, is there any way to give us a sense of kind of what food was, was it higher or to get a sense of the impact of increased food stamp benefits.

Kenneth Smith

We saw certainly food was strong. We probably aren’t going to be that granular as to breaking down the consumables but certainly the growth of food stamps has, we’ve seen some strong benefits there. So food was strong and is a key part of that consumables number that you’re seeing.


Your next question comes from the line of Joseph Parkhill – Morgan Stanley

Joseph Parkhill – Morgan Stanley

I was just wondering if you’ve looked past fourth quarter when a lot of the benefits from lower diesel prices presumably fall off and gross margin comparisons get a little more difficult, like what comp do you think you need to lever SG&A going forward.

Kenneth Smith

As we plan, we haven’t put specifics to next year obviously and are in the planning stages of that as we evaluate various investment opportunities. Our core, we still continue to begin with our core expense rate from a break-even perspective around that 3% level. Now that can be, that’s kind of the core baseline that we begin with and as we look at investments and the pacing of those strategic investments from a quarter to quarter basis, obviously you can see some fluctuations from that number.

And other factors impact it as well. A strong comp can certainly impact the actual SG&A number. So we begin our core planning with that 3-ish percent number and then what we’re very pleased with is in the current environment, we’ve very pleased with our efforts to manage costs and control those costs that we’ve embarked on this year.

So we’re looking to take advantage of this unique opportunity and our financial strength to be strategic in our investments and we’ll plan that investment agenda with our core expense rate as we look forward.

Joseph Parkhill – Morgan Stanley

And then also just for your guidance of 2% to 4% comp, do you expect the acceleration just because June would be the most difficult overlap with respect to stimulus, or are there other factors that you think will cause sales to accelerate.

Howard Levine

Just to provide a little color on the quarter from last year directionally, last year as we entered in the Memorial Day holiday we had not seen summer open up yet. So one of the big issues and benefits was the opening up of the summer season as we finished May and went into June. The other big benefit was the peaking of the distribution of the stimulus checks to our customers.

I know that there’s data out there that indicates that some of that started going out in early spring. I think most of that was electronic filers that benefited from that so most of our customers received those checks within the first half of the fourth quarter. Once we got through the first half of the fourth quarter we did see things begin to get back to more normalized levels and would expect that the comparisons in the second half of the quarter would also as a result of that, be a little bit easier.

Right now we’re facing some pretty heavy headwinds but do see them softening as we get through the quarter.

R. James Kelly

As a reminder, the cadence last year of comps was 8% in June, 5% in July, and roughly 3% in August. So again if you just focus on the underlying trends and the two-year stack you see an opportunity or a suggestion that the current year comp should improve through the quarter which is what is being implied with the 2% to 4% guidance.

We also have a lot of underlying momentum. We have significantly more store of the future stores operating in the fourth quarter this year versus last year. We have successfully reallocated space in 1,500 of our stores and we think just those two items alone will help position us to continue with solid sales results during the fourth quarter.


Your next question comes from the line of Patrick McKeever – MKM Partners

Patrick McKeever – MKM Partners

On the, I have a question on your urban stores and just wondering if you’re seeing any variations between urban store performance and more rural or small market store performance just given the high unemployment rate for African American consumers and even for Hispanic consumers.

R. James Kelly

I think our urban stores continue to show improvement year over year and solid growth in the sales area. Its difficult to isolate too much because the urban stores are located throughout the country and obviously in some parts of the country the weather has been particularly challenging. But overall the operating margins and relative profitability of the urban markets continue to be very strong.

Patrick McKeever – MKM Partners

So do you think that the new stimulus package is providing enough offset then to the higher, the climbing unemployment rate in urban markets.

R. James Kelly

I think there is a combination of economic events occurring some of which are plusses and some of which are minuses. In addition to that we have a lot of internal events. I would suggest when you look back over this year, we have been very successful as value and convenience has become increasingly important in driving our comp sales.

So net, net the environment is leading to increased shopping trips of our core customer as well as those that have slightly more income.

Patrick McKeever – MKM Partners

What are you thinking about for the back to school season. Each year it seems like Wal-Mart gets even more aggressive than the prior year with promotional pricing and marketing and that kind of thing. What are you thinking about this year in terms of how you’re positioning yourselves for back to school.

Howard Levine

Back to school is not what it once was years ago with the timing of school starting sometimes as early as the first or second week of August all the way through mid-September so its spread out over a longer period of time. But the way, I think the best way to think about back to school is just as you would some of the past holiday events, whether its Easter more recently, or Valentine’s Day or even this past Christmas that we plan events around those things and as we’ve talked about Easter was quite successful this year.

Valentine’s Day was quite good, so we’re looking forward to the season and would expect to continue to grow our market share.


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

Michael Baker – Deutsche Bank

So the comps in the discretionary category, if you just sort of weighed them by sales, were as good as they’ve been and I think in about seven quarters which is interesting considering you took space away from those areas. I should say the total sales growth. So can you discuss what is behind that relative improvement in the discretionary categories and then within those categories any specific items doing well that are interested to call out.

R. James Kelly

We have worked very hard through the structure added with the project accelerate and focusing on our customers with greater visibility of underlying trends within our discretionary areas and the result of that has been the inventories that we have of discretionary items have improved in their productivity.

So while our assortments have been tailored and the risk profile of the assortment has been reduced, in many respects we still have the items that our customers desire and we are aligned with them better than we’ve ever been. So I expect to continue to see productivity gains in the discretionary area and I expect us to be able to drive positive sales in those areas notwithstanding a reduction of space and inventory.

Howard Levine

And just a clarification, the space realignment really did not begin until the late part of May so there really was not a space reallocation move going on during the third quarter. Inventory reductions were made but not space realignment.

Michael Baker – Deutsche Bank

And then one more follow-up, I notice you bought back stock for the first time in I think four or five quarters this quarter, does that have to do with the auction rate security market, which I think it held back some buybacks previous quarters or more just confidence in what you’re seeing in your business or if you could just discuss that decision to start buying back stock after about a year.

Kenneth Smith

I think we’re very pleased with the cash flow generation we’ve seen and the strength of our balance sheet so certainly a year and a half or so ago the auction rate issue arose, but currently we had an authorization and as we look at capital deployment we have a very consistent philosophy in that we look first to invest in our business internally and our strategic initiatives back into the business.

Secondly we fund our very consistent dividend program and then third, we look at the opportunity to return money to our shareholders via buybacks. So we felt confident about that and began buying back in the third quarter and as we consistently have, we’ll evaluate the opportunity to buy further stock back on an ongoing basis.

Howard Levine

And I would add, it’s a tough economy out there and we got pretty cautious as a number of companies did during the last year. I think the indication shows that we feel good about the underlying positive trends or our business. And just to add that impacts, that is indicative of how we feel about new store growth as well as there’s still plenty of opportunity for new store growth out there. Its something that is very important to us and just wanted to make sure that all understand the importance of that as we move through the various cycles that we’re in.


Your next question comes from the line of Bernie Sosnick – Gilford Securities

Bernie Sosnick – Gilford Securities

Your accounts payable dropped by $58 million and you called attention to that. I noted there were opportunities to get discounts on consumables. Could you flesh out for us a little bit the benefits that you’ve derived from such discounts and whether or not there are issues in retail and generally amongst retailers that don’t have cash that gives you an opportunity to employ cash in a beneficial way.

Kenneth Smith

I think certainly we benefit from a strong cash position. We did in fact without quantifying it, we have seen as we’ve compared to both our plans and last year the amount of purchase discounts that we have related to our purchasing of inventory, we have seen obviously some positive impacts there.

So it is again the accounts payable leverage is a timing issue and relates more to the receipts and the type of merchandise we’ve received toward the end of the quarter.

Bernie Sosnick – Gilford Securities

Since it is a timing issue I’m wondering whether or not you have a forecast of cash for the end of the year since the timing issue would imply maybe a $50 to $60 million increase in cash as you derive the benefits from the early payment of accounts payable.

Howard Levine

The way I would think about it and I think you were implying this, is our strong and stable cash flow and financial position enable us to do some things that other weaker retailers might not be in a position to do. Having money in the bank today is not deriving much of a return and one of the things that we did in anticipation of some of our moves, was build up some inventory levels to ensure a stronger in-stock position.

Without getting into a lot of details about what it means over the next couple of quarters, I think the best way to think about it is over the long run we’ll continue to manage a strong financial position and hopefully be in a position to utilize that when opportunities exist. So I hope that helps you a little bit.


Your final question comes from the line of Laura Champine – Cowen and Company

Laura Champine – Cowen and Company

On the, I think you called out $8 to $12 million in expenses expected in the fourth quarter from the store of the future and the change in space allocation in the stores and that sounds one-time but I know its part of ongoing expenses on those projects. Can you quantify what you spent there in Q3 that you’ve just reported and also talk to your expectations from those two projects for expense on the P&L in 2010 and then can you also talk in terms of Q4, that $8 to $12 million is that where you had planned it in your previous guidance or is that a change.

Kenneth Smith

I would say the $8 to $12 million is a function that the callouts there are the acceleration of our store of the future and the space allocation program that we discussed that is underway. So when we think of where we were thinking, what we’ve done is obviously placed a sharper pencil on it as, over the last several months, as we’ve ramped up.

So we, as compared to where we were, our expectations. There is some incremental aspects to that as we sharpen the pencil and fine-tune the rollout in our guidance for the fourth quarter. From an investment agenda, as we look to next year, as I said we’re still in the planning stages. We, as is consistent with our history, we’ll have a strategic investment agenda that we’ll work into our financial plans as we move to the future and plan accordingly.

Laura Champine – Cowen and Company

So in Q3 just as a follow-up, what was the expense on those two projects in Q3.

Kenneth Smith

I would just say there was a modest amount of expense added into Q3. We have accelerated our store of the future as we mentioned several quarters ago. The space reallocation really was very early innings in the third quarter and not as impactful. There were some modest ramp up costs, but I would say it was more modest in the third quarter.

Kiley Rawlins

As always I will be available for questions after the call. As a reminder we’re going to host an Analyst Meeting November 3rd so mark your calendars and we’ll distribute more information later this summer. Thank you and have a good day.

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