Good morning. My name is [Evan] and I will be your conference facilitator today. 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.
Thank you, Evan. 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 and 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, October 7, 2009. We have no obligation to update or revise our forward-looking statement 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; Jim Kelly, President and COO; and Ken Smith, Chief Financial Officer. We’ll begin our discussion this morning with a review of our fourth quarter and fiscal 2009 results. Then we’ll take a few minutes to discuss our plans and outlook for fiscal 2010. Following our prepared remarks you will have an opportunity to ask questions.
Because of the amount of information we intend to discuss, today’s call may be longer than usual. 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. Please also remember that the queue for the question-and-answer session will not be available until after we have finished our prepared remarks.
Before we get started with our formal discussion of fiscal 2009, I have a few topics to cover. First, this week we learned that the Supreme Court will not review the Morgan case. Clearly, we are disappointed, as we along with the National Retail Federation and the U.S. Chamber of Commerce believe that the issues presented in this case were important for the courts to consider. We continue to monitor the structure of the store manager position to assure compliance with federal law and we continue to believe that store managers should be paid as salaried employees. I would note that as recently as July, 2009, a Federal District Court in North Carolina issued a decision agreeing with our position. We do not believe that the Morgan decision will require us to make any significant changes to our operations.
Second, I’d like to remind you that we are hosting an analysts and institutional investor conference here in Charlotte on November 3rd. We hope that you’ll be able to join our management team for what I’m sure will be an informative day. If you have not received an invitation and would like to attend, please contact me after today’s call.
Now I’d like to turn the call over to Howard Levine. Howard?
Howard R. Levine
Thank you, Kiley, and thank you everyone for joining us today.
Twelve months ago we first introduced our plans and expectations for fiscal 2009. You may recall that we discussed the economic uncertainty we faced and that we outlined three key areas of focus, pursuing greater market share, mitigating inventory risk and containing costs. This morning I am pleased to report that we have exceeded our expectations in each of these areas.
We expanded our market share, increasing both trips and average spend with both our core, low income customer and more middle income customers. In addition, our efforts to improve merchandise quality and in store operating standards resulted in improved customer satisfaction scores.
We expanded our assortment of consumables, notably food, while constraining purchases in more discretionary categories to mitigate inventory risk. As a result, we reduced markdowns, lowered average inventory levels and increased inventory productivity.
And our efforts to manage margin better and contain costs resulted in 95 basis points of operating margin expansion and double-digit earnings growth, even as we accelerated investments to position future growth.
Economic conditions have changed significantly over the last 12 months. Some of these changes, like lower energy costs, have benefited our customers. Other changes, like the rapid rise of unemployment and the decline in average hours worked, have increased the financial pressure on our customers.
Some have suggested that the economic recession has been the sole driver of our strong performance. I have a different view. I would remind you that recessionary pressures disproportionately affect our core customer. Living paycheck-to-paycheck, lower income customers are extremely sensitive to price and income changes and frequently lack the safety net of credit cards or home equity loans. Often, this impact is most apparent in the curtailing of higher margin discretionary purchases.
Today, more middle income customers face many of these same challenges as they, too, have consolidated shopping trips, reduced discretionary purchases and increased their reliance on coupons and promotions for basic needs.
Our strategy of providing both value and convenience has resonated well with both groups of customers and the investments we have made to strengthen the appeal and quality of our assortment, combined with better store level execution, have resulted in increased market share. As I reflect on the progress we have made this year, I’m especially pleased with our fourth quarter performance.
As we indicated in earlier conference calls, we expected that the fourth quarter would be our most challenging quarter. And yet we delivered another quarter of double-digit earnings growth, even as we anniversaried the impact of last year’s stimulus package and absorbed the sales and expense impact of realigning space in almost 3,000 stores.
To accommodate continued growth in key traffic driving consumable categories, and to improve the in store experience, we initiated efforts this summer to realign space in our stores, expanding space in high growth areas while reducing space in under performing categories. To give you a sense of the impact, we touched on average 60 to 70% of the merchandise in these stores. Our store operation teams have executed these changes well. And we completed more stores than originally planned. Sales were temporarily disrupted as customers acclimated to the new layout. However, overall customer response has been very positive and we are gaining sales momentum.
Importantly, these improvements position us nicely as we head into 2010 and the holiday season.
The economic conditions in fiscal 2009 presented our team with both challenges and opportunities, but our ability to adapt quickly drove strong performance for the year. I’m very proud of the results and want to recognize the hard work and effort of all of our Family Dollar team members.
Now I’d like to introduce Ken, who will discuss our fiscal 2009 financial performance in more detail. Ken?
Kenneth T. Smith
Thanks, Howard. I’m going to start with the review of our full year results and then discuss the quarter.
As we reported this morning, earnings for fiscal 2009 increased 24.7% to a record $2.07 per diluted share compared with $1.66 per diluted share in fiscal 2008. Strong top line growth and better than planned gross margin performance more than offset de-leverage from increased incentive compensation and insurance expense. As a result, operating margin expanded approximately 95 basis points for the year.
Net sales for the year increased 6%, driven by a 4% increase in comp sales and the addition of 180 new stores. Both customer traffic, as measured by the number of transactions, and the average transaction value increased for the year.
Consumables continued to be the primary driver of sales in fiscal 2009, increasing about 12% to 64.4% of sales compared with 61% of sales in fiscal 2008. While our customers increased their reliance on us for their consumable needs, their constraint of discretionary spend has resulted in an adverse sales mix. However, lower fuel costs, reductions in inventory shrinkage, higher initial mark-ups and fewer markdowns resulted in a 120 basis point improvement in gross profit as a percentage of sales.
SG&A expenses as a percentage of sales increased approximately 30 basis points. Most expenses including store payroll and occupancy costs were leveraged during the year as a result of a 4% increase in comp store sales and continued expense management. However, these improvements were offset primarily by two factors, incentive compensation and insurance expense.
Reflecting our strong performance results and our pay for performance philosophy, incentive compensation expense increased approximately 30 basis points in fiscal 2009 as compared to fiscal 2008. This year we continued [audio impairment] favorable trends in workers compensation and general liability claims. However, the rate of improvement was lower this year as compared to fiscal 2008, resulting in approximately 30 basis points of de-leverage for the year.
Turning now to the fourth quarter, we delivered our sixth consecutive quarter of double-digit earnings growth and operating margin expansion, overcoming headwinds from anniversaring last year’s stimulus and the effect of realigning space in almost 3,000 stores. Strong gross margin performance offset the SG&A impact of our investments, resulting in about 40 basis points of operating margin [audio impairment] during the quarter. This performance, with the lower tax rate, resulted in earnings per diluted share of $0.43 compared to $0.38 per diluted share in the fourth quarter last year, a 13.2% increase.
Net sales for the fourth quarter increased 2.6% and comp sales increased 1%. I would note that customer traffic increased for the fifth consecutive quarter.
Consumables continued to be the primary driver of sales during the quarter, increasing to 66.2% of sales compared with 63.7% of sales in fiscal 2008. Despite this significant mix shift, gross profit as a percentage of sales increased approximately 160 basis points. Similar to trends we saw in the first three quarters of fiscal 2009, the improvement was driven primarily by lower freight expense, lower inventory shrinkage and higher purchase mark-ups which more than offset the margin effect of higher sales of lower margin consumables.
SG&A expense as a percentage of sales de-leveraged approximately 120 basis points during the quarter. As Howard mentioned, we incurred additional expenses in the fourth quarter related to our efforts to realign space in our stores to accommodate the expansion of high growth consumable categories. These investments combined with our aggressive roll-out of Store of the Future, pressured SG&A expense in the fourth quarter by approximately 80 basis points, but will support longer term revenue growth. In addition, the 1% comp for the quarter resulted in some de-leverage of expenses.
Our tax rate in the fourth quarter was 32.6% compared with 34.8% in the fourth quarter of fiscal 2008, adding about $0.02 to our earnings per share results. The lower tax rate was primarily a result of greater federal jobs tax credits.
Finally, we purchased 1.1 million shares of our common stock during the quarter.
Let me finish our discussion of fiscal 2009 with a quick review of some additional financial highlights. At the end of fiscal 2009, average inventory per store was about 5% lower than last year. Responding to changing customer demand, we have made select investments in traffic driving categories while also managing inventory risk. As a result, inventory levels in more discretionary categories were significantly lower at the end of fiscal 2009 as compared with fiscal 2008.
We continued to generate strong cash flows, generating almost $530 million in operating cash flow this year. As we previously discussed, our first priority for the deployment of capital is to reinvest in the business to drive higher financial returns. Reflecting this focus, we invested approximately $155 million back into our business this year, including $58 million in technology related projects; $57 million for improvements and upgrades to existing stores and $18 million for new stores.
We also funded $73 million in dividend payments and purchased $71 million of our common stock. At the end of fiscal 2009, cash and cash equivalents were $438.9 million as compared with $158.5 million at the end of fiscal 2008.
Now Howard will highlight some of our plans for fiscal 2010. Howard?
Howard R. Levine
Thanks, Ken. As we begin fiscal 2010 we continue to face economic uncertainty. Gas prices are projected to be relatively stable, but many economists predict that inflationary pressures will return. Consumer confidence may be showing some signs of improvement from recent lows, but consumer debt remains high. The pace of job losses is slowing, but overall unemployment is still rising. While economic conditions may be stabilizing, it is unclear when we will see conditions actually improve.
What is clear to me is that value will continue to be a key driver, even as conditions improve, as consumers of all incomes focus more on saving money and paying down debt. Our strategy of offering value and convenience positions us well, and with the investments we have made I believe that we are better positioned to deliver strong financial returns.
Today, 80% of our stores have the capability to accept food stamps and credit cards, and we will finish the point-of-sale roll out this spring. To date, we have improved the shopability of more than 3,500 stores through the realignment of selling space to support an expanded assortment of consumables. We have also increased the appeal of these stores through improved signage and more intuitive merchandise adjacencies.
We have expanded our customer research efforts and creative processes that enable us to apply this research more effectively in our merchandise and store layout decisions. We have established stronger testing protocols and raised our quality expectations. As a result, we are well positioned to make sure that we deliver the merchandise quality that our customers need and expect.
We have reduced inventory levels, particularly in more discretionary categories, creating an environment that is less cluttered and easier to shop, which is especially important as we head into the holiday season.
Finally, we have made great strides in stabilizing our work force, especially in stores where the benefit of experienced store teams has the greatest impact. Today, our store manager and assistant manager retention are at historical high levels.
I’m especially excited about the fact that almost 90% of our store managers have experienced at least one holiday season with us. We have the greatest opportunity to impress new customers during the holiday season and increased store manager experience during this very busy season positions us to offer stronger merchandise presentations while maintaining better in store standards.
Building on these improvements, we intend to continue to increase our market share, mitigate risks and drive profitability in fiscal 2010. Our improvements in traffic suggest that we are building momentum with both our core, lower income customer as well as more middle income customers who are trading down in search of value.
To drive continued market share growth, we have identified additional opportunities to broaden the appeal of our assortment and improve the in store shopping experience for both our core customer as well as customers who in the past have shopped us less frequently. For example, food has played an increasing role in our assortment. Facing continued economic pressure near term, we expect that consumers will continue to focus their spending on basic necessities. The completion of our Store of the Future roll out, the additional space provided by our space realignment efforts and the improvement of our private label offering combined with growth of the federal Food Stamp Program, position the food category well for continued growth.
While we are making improvements to broaden the appeal of our assortment, we are also working to make the shopping experience more convenient for our customers. The completion of the point-of-sale refresh this year will increase the convenience of our check out processes as it supports an expanded selection of payment choices. In addition to supporting food stamps as a form of tender, our new point-of-sale technology also enables us to accept credit cards. And while cash remains the tender type preferred by our customers, debit cards, credit cards and food stamps are becoming a larger part of our payment mix.
We also continue to adapt our operating hours, to be more convenient for our customers. These operational changes, combined with the space realignment efforts and the expansion of key consumable categories, will enable us to satisfy more of our customer shopping trips.
This year we plan to continue our measured pace of new store openings. In recent years, we have slowed our square footage growth to focus on improving the financial returns of existing stores. Our efforts over the last three years to improve shopability, combined with longer term investments including our food strategy, Project Accelerate and Store of the Future, have resulted in more than 400 basis points of improvement in average return on shareholders equity.
In addition, we have enhanced our site selection and development processes. And as a result the returns of our new store investments have improved. While we remain patient as real estate markets continue to soften, the cadence of opportunities to open new stores and relocate existing stores has increased. And we would expect acceleration of these activities to continue. Given the long lead times, the results of this escalation will be most visible in fiscal 2011.
Last year we saw a 330 basis point shift from higher margin discretionary sales to lower margin consumables. The economy was a major factor in this shift, as customer space with less disposable spending capacity constrained purchases of more discretionary items. From a gross margin rate perspective, this adverse mix shift created significant headwind. Nonetheless, even excluding the benefit of freight and shrink improvements, we saw gross margin rate expansion in fiscal 2009.
An improving economy has historically led to an acceleration in discretionary sales. While we are not ready to build this recovery into our financial plans, we are confident that we are well positioned for moderate margin rate expansion.
The investments we have made as part of our Project Accelerate have provided us with greater visibility in store planning, assortment and pricing capabilities as we have lowered inventory risk, increased inventory turns and improved gross margin return on inventory. To further improve gross margin in inventory activity, this year we intend to expand our private label offering, enhance our global sourcing capabilities and make additional investments to strengthen our pricing efforts.
In addition, we remain committed to operating as a low cost provider. We are particularly focused on being more effective with store labor, reducing store occupancy costs and leveraging our corporate infrastructure. These efforts to reduce our core expense structure will support a reinvestment in sales drive and initiatives such as the completion of the roll out of our new point-of-sale system and the expansion of our operating hours.
Today we introduced earnings guidance for fiscal 2010. Before we discuss the assumptions underlying our earnings guidance, I want to emphasize that we continue to face economic uncertainty and projecting financial performance within this context is difficult. Certainly improving conditions would result in growth in more discretionary categories, but continued economic volatility would most likely position continued customer focus on basics. Each scenario has implications on top line growth, margin expansion and SG&A leverage.
Now I’d like to turn the call back over to Ken to discuss our financial expectations for fiscal 2010 in more detail.
Kenneth T. Smith
Thank you, Howard. In fiscal 2010 we expect net sales to increase 5 to 7%. This revenue target assumes the addition of approximately 200 new stores and a comp store sales increase of between 3 and 5%.
Regarding the opportunity to expand gross margin in fiscal 2010, we expect that benefits from lower markdowns, the expansion of our private label program, improvements in price optimization and lower inventory shrinkage will continue to offset pressure from strong sales of consumable merchandise. I would note that these costs are projected to be relatively stable in fiscal 2010.
While we continue to focus on cost containment efforts, we are investing to drive stronger top line growth. These investments may pressure SG&A and constrain our ability to leverage expenses at the lower end of our comp plan. Based on these expectations, we estimate that earnings per share will be between $2.15 and $2.35 in fiscal 2010.
Reflecting our plans to complete the roll out of our store technology platform and investments to support our space realignment efforts, as well as other improvements to existing stores, we anticipate that capital expenditures for the year will be between $160 and $180 million.
In the first quarter, we expect net sales to increase 5 to 7% and comp sales to increase 3 to 5%. The September period just ended, and I’m pleased to report that we’re off to a good start, we estimate that comps for the September period increased approximately 5%. We expect to continue 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 continued roll out of Store of the Future, will pressure SG&A expense in the first quarter.
Given these expectations, we estimate that earnings per share for the first quarter of fiscal 2010 will be between $0.45 and $0.50 compared with $0.42 in the first quarter of fiscal 2009.
Now I’ll turn the call over to Howard for some final remarks. Howard?
Howard R. Levine
Thanks, Ken. The economic downturn has provided us with the unique opportunity to expand our customer base. And I believe that our expanded assortment of brand names, merchandise quality improvements and improved store operating standards have the potential to broaden our customer appeal. In addition, improving economic conditions would most likely result in a more favorable sales mix as customers resume their discretionary purchases.
Over the last several years we have made significant investments to understand our customer better, strengthen our merchandising and operational capabilities and build strong employee teams. As a result, our customer satisfaction ratings have increased and today I believe that we are more competitive than ever. I believe that these improvements will deliver continued strong performance as the economy stabilizes and improves.
Now operator we would be happy to open the call for questions.
(Operator Instructions) Your first question comes from Deborah Weinswig – Citigroup.
Deborah Weinswig – Citigroup
So with regards to thinking about SG&A for you know 2010, what comps do you need to lever? Because I think you said at a 1% you’re still de-levering.
Howard R. Levine
Well I think when we look at leverage and then our comp that we’re looking for in fiscal 2010, I would say first of all we continue to be very pleased with our cost containment efforts and our efforts around expense management, around the core expenses. And that has allowed us to invest in sales driving initiatives. So we feel well positioned. A great example of that is the space realignment initiative that we tackled in the fourth quarter. So we feel very well positioned and I would say you know that we have plans for sales driving initiatives certainly during the year and you know we’ll continue to manage the core expenses well. So you know I think again we’re very pleased with managing the core expenses.
Deborah Weinswig - Citigroup
My follow up question which relates to kind of what you’re seeing with regards to traffic, it sounds like not only are you gaining a greater share of wallet from existing customers but also bringing in new customers. Can you talk about anything that you’re doing from a marketing side to drive that and is there anything that you can provide in terms of additional color in terms of you know what you are seeing with regards to the new customers who are coming into your stores? Thank you.
Howard R. Levine
Sure, Deb. As I had indicated in my comments we are seeing new customers or different customers coming into our stores. We’re referring to them as trade down customers, more middle income customers. You know I think we’ve been working on a number of things for the last several years to help position us to capture those customers. You know for example our concept renewal efforts have been critical in our efforts to drive better merchandise presentations and improved shopping conditions for both our core customer and the trade down customers. We’ve worked very hard on improving our merchandise quality and our offering in both apparel and other merchandise within our stores.
The fact that we can now take credit cards position us very nicely with that trade down customer. So we started working on a number of those things several years ago and think that we’re in good shape to continue to hopefully hold on to those customers while our core customer is struggling somewhat. But as the economy improves, we would expect the core customer to equally appreciate some of the changes we’ve made in our store.
Your next question comes from Mark Miller - William Blair & Company, LLC.
Mark Miller - William Blair & Company, LLC
Howard, can you address how the business flowed I guess through the summer? I know you were lapping still tough comparisons, but in July and August the comps came in a bit weaker. What do you think happened there for the deceleration on a two year basis? And then what has changed in the business that’s causing the reversal or re-acceleration in sales in September?
Howard R. Levine
Sure, Mark. I think you know when we were looking at our results for the last fiscal year, last fourth quarter, we reviewed a couple of things. First as we’ve talked about we had the stimulus in June that was thought to have been dissipated through the quarter, very difficult for us to have given us good information on that, but clearly the stimulus was still going on during the quarter. We had excellent weather. I hate to talk about the weather, but we had very good seasonal sales in discretionary purchases which were also driven by the stimulus last year. This year we had a little more challenging weather.
And I think that you know as we worked through the quarter we began the realignment project which temporarily disrupted some sales. I think that may be a little bit more overblown at the Street level than what we actually observed, as we were pleased that we were actually able to accelerate and add stores to that initiative. And I think the positioning of the realignment going in September, the plans around Labor Day and the later back-to-school gave us some momentum going into September. And you know we’re hoping that that continues as we work our way through the year.
Mark Miller - William Blair & Company, LLC
On your point about the stores being realigned, can you give us a little more color around I guess what were the comps of those stores that were reset compared to those that were not reset? And I understand there was some initial disruption, so I mean how much might that have penalized you in the short run? And then I guess looking out to fiscal ’10 can you give us a rough range of how much do you think that might benefit your comp sales for the year?
R. James Kelly
Mark, this is Jim. Let me try to tackle that issue. As Howard said the fourth quarter was perhaps the most challenging we’ve faced in some time in understanding comp store performance. The stimulus impacted many different stores, many different ways, but it enhanced our overall sales, and then the weather differences. In third we had the store [relay] program.
Overall the relay program required us to move 60 to 70% of the merchandise in a given store. We executed on a very, very tight schedule so that we were in and out and done within a week in almost each and every store. So the initial disruption was very minor. The customer response was initially very, very positive. The challenge for some customers was that we’d moved some items. So they were very pleased that we had expanded some categories and were growing very rapidly in which they were increasingly shopping our stores. But the second level of disruption would be the fact that we hadn’t moved a lot of categories. We also improved signage, and I think this was helpful for many of our customers.
The good news is by September, which is fairly quickly for this type of change, the stores for which we had changed the merchandising were already outperforming the rest of the chain. So I think that was somewhat surprising and we’re certainly very pleased with that. The other thing is those stores continue to gain momentum as customers become more comfortable with the shopping experience.
So it’s still early. Initial results are very positive. We believe that the actions that we took in the fourth quarter position us particularly well as we enter the holiday season. So we’re excited but we’re not going to get ahead of ourselves on this one.
Your next question comes from Meredith Adler - Barclays Capital.
Meredith Adler - Barclays Capital
A couple of questions about the gross margin. Obviously the freight [inaudible] have come down substantially and that’s helped freight in the fourth quarter. One of the questions I have is if you could just quantify it would really help but also is that something that we’ll see continue because the lower fuel [inaudible]? Or does the fact that fuel prices are maybe up [inaudible] this quarter going to have a negative impact?
Kenneth T. Smith
Freight, Meredith, the story on freight has obviously been fairly volatile over the last 12 months. So what we saw was over the last three-ish quarters benefit in freight due largely to the rate, diesel rates. I think our transportation group continues to do a good job to support that as well. But what we are entering into as we move into fiscal 2010 is anniversaring some of that period where the rate declined fairly rapidly. So the first quarter is when that last year that price change moved as dramatic as any other quarter. So we expect continued freight benefit certainly in the first quarter. I think as you look at the time periods, you can largely look at the rate of diesel. You’re right that there is some effect in capitalizing some freight costs into inventory. But I think the trends flow with the rate pretty well.
Meredith Adler - Barclays Capital
And then I have another question about the gross margin. You obviously are making progress in shrink. There’s lots of reasons for that. How much more potential is there? I mean if when you think about where you’ve been at the lowest are you at the lowest you’ve ever been now and can you go further?
Howard R. Levine
Meredith, this is Howard. I think we do have continued opportunities to improve on our shrink. And what gives me the most confidence in making that statement is the workforce stabilization that we’re seeing, which I’d mentioned at historically high levels. We’ve been working very hard over the last several years to improve store manage retention. The last 18 months or so we’ve also taken that down to the assistant store manager level in driving some improvements there as well. And in fact all levels down to the clerks are showing retention improvements.
You know additionally we’ve made some investments in some equipment, utilizing technology in a better way to head off shrink before it gets to a level that’s unmanageable. We’ve also done some things in some of these urban markets like armored car service to help mitigate some of the risks there. But you know I think that there is opportunities to see a continued improvement there. We do plan for some improvement this fiscal year and I think that we’re well positioned to execute upon that.
Your next question comes from Dan Wewer - Raymond James.
Dan Wewer - Raymond James
Howard, could you give a bit more detail on the relays and how much selling space reduction is for apparel and other discretionary categories? And also I may have missed this, but did you indicate how many relays are scheduled for the first quarter and for fiscal year ’10?
Howard R. Levine
Yes, let me tackle the first part first, Dan. And you know we have over 6,600 stores and each one is a little different so it’s going to be difficult for me to nail down exactly what we did in each store. In fact one of the things that I think drove the execution at such a high level was the fact that we had a plan for each individual store and what we would do.
Some of the larger stores for example we did not have to reduce space in apparel as much as we did in some smaller stores. And in smaller stores we may have had to take out more apparel in those stores, but you know overall from a strategic point of view it’s pretty simple. What we did was we created more space for the categories that are doing well and took away from those categories that are not performing as well. And I think that you know as we talked about we’re trying to be more relevant to customers, we’re trying to drive more sales in those areas that are in demand right now and I think we’re well positioned you know as we approach this holiday season.
The second part of your question if you picked up in our comments we said we had done 3,000 stores through the end of the year. Thus far we’ve done an additional 500 stores and have about another 500 or so more stores to go. We have incorporated the expense and sales benefits from that into our first quarter guidance.
Dan Wewer - Raymond James
The additional 500 stores being for the first quarter, not fiscal year ’10?
Howard R. Levine
Your next question comes from William Keller - Paradigm Wealth Management.
William Keller - Paradigm Wealth Management
Looking at the decline in inventory, I wonder if you could elaborate a little bit on how much of that is sort of permanent efficiencies you’ve gained and how much of that is really tactical or situational conservatism still on your part. Thank you.
R. James Kelly
I think the productivity in the consumable area is clearly something we would expect to continue. In fact, we’re targeting even further improvement in the productivity of that arena. Some of the reductions in the more discretionary areas are reflective of conservatism if you will as we seek to manage sales risks during these challenging times.
On the other hand, we’re working very hard to improve the flow of our fashion inventories. So we would expect that we could manage significantly higher sales volume in discretionary areas on the same average inventory basis in the discretionary area. So looking forward we tend to model further inventory improvement even as sales become more robust.
Your next question comes from Adrianne Shapira - Goldman Sachs.
Adrianne Shapira - Goldman Sachs
Howard, you kind of mentioned that given some of the success that you’re seeing that we should expect the cadence of store growth perhaps to accelerate. Could you give us a sense of, you know, I know it’s still early as you kind of alluded to would be in 2011, but could you give us a sense of what sort of range you perhaps would be targeting.
Howard R. Levine
Sure, Adrianne. And just as a reminder to everyone you know a few years ago we did slow down new store growth. We wanted to focus on existing store profitability. And as I indicated that’s working well. We also are seeing improvements in our new store performance. And currently what we’re seeing is an increase in submissions. I think we’re looking for more new stores. I think the timing is good in that the real estate market is softening and continues to soften. We continue to monitor those submissions. But we have seen an increase.
It would be premature for me to give a number at this point but I think if you look back over the years we have been pretty careful and moderate in the way that we’ve looked at increasing new store growth from lower levels that we’re at today. And I think that that is probably a good way to look at what we’ll plan for fiscal ’11 in that area. So not a huge ramp up, but there will be a moderate ramp up. We want to make sure that we stay on top of the profitability of those stores, make sure our infrastructure is staying up with those new stores, and we’ll probably be a little more cautious in that area.
Adrianne Shapira - Goldman Sachs
And then the other somewhat strategic shift sounded as if on the private label front as well it sounds like there’s room for [inaudible] and perhaps given a sense what that accounts for today and what perhaps is a reasonable target and what you know should we be thinking about the expansion to be a gross margin driver going forward? Thanks.
R. James Kelly
Adrianne, our private labels represent roughly a $1 billion business today. Our customer surveys continue to indicate that as part of the value offering, customers are turning increasingly to private label. We’ve had a team working very hard, particularly in the last year, and they have really identified opportunities to significantly increase the private label penetration over the next two to three years.
We’ve already managed to upgrade a lot of our private label packaging as well as the products. I think throughout next year you will see a growing appearance in our stores of the more robust private label offering. I don’t think we’re prepared to break out the amount of growth that we expect from private label, but we look at it as an opportunity to grow both the top line in meeting the value needs of our customers and as a margin opportunity.
Your next question comes from Alan Rifkin - BofA-ML.
Alan Rifkin - BofA-ML
I have a follow up to Dan’s question earlier with respect to the space reallocation program. Can you maybe just provide a?
Howard R. Levine
We lost his line. Your next question comes from Wayne Hood - BMO Capital Markets.
Wayne Hood - BMO Capital Markets
Howard, I just wanted to come back to Adrianne’s question. A minute ago when you were talking about the ‘011 expansion, what do you think the maximum growth rate that you could absorb without stretching the infrastructure as you think about how it’s positioned now? And can you also speak around how much better the returns on capital on those new stores are looking right now or potentially could look, given that lease costs are coming down.
Howard R. Levine
I’ll let Ken take the second part of that question. And Wayne I’m reluctant to get into a lot of detail about that. I think you know the way we’re looking at new stores for next year is just as I’d indicated. You know we are seeing a ramp up in submissions. We are seeing improved results in our new stores. You know from an infrastructure standpoint, the biggest thing that we have to work through is just the store manager situation and the staffing of those stores. From a distribution standpoint we’re in good shape. From other infrastructure standpoint, technology, we’re in good shape. So it’s just the pacing of those openings to enable us to insure strong execution when we open up those stores.
Clearly we’ve had a history of open up over 500 stores. We’re not talking about going to that level immediately. And what I was trying to indicate would be that there would be a moderate ramp up over a few years.
Kenneth T. Smith
Just to touch on the return on capital issue on new stores, you know as we look at the history we back up and think when we several years ago we constrained new store growth and focused on the returns on the stores that we did open as well as the core. And we’ve seen great success in the performance of the new stores over the last couple of years. So clearly I think as the input costs so to speak we see some softening, that does provide us opportunities for store growth. And I think when we look at the submittal pipeline that is in fact what’s happening. So it’s hard to put what the exact return metrics become at different store opening levels, but clearly I think that we’re seeing that dynamic in the submittal pipeline today.
Once again Mr. Rifkin with BofA-ML, your line is open.
Alan Rifkin - BofA-ML
I just have a follow up to Dan’s question earlier with respect to space reallocation program. Can you maybe provide some color on the costs associated with that program and what is the sequential lift in revenues that you’re seeing? I know, Jim, you said that they are outperforming the rest of the chain but would you be able to provide a little bit more color around that? Thank you.
R. James Kelly
I think as the guidance that we’ve provided was the cost was going to be somewhere in the $10 to $12 million arena, we actually did 20% more stores than what we had planned so I think it was somewhat slightly above that. We haven’t really talked about the top line performance or targets of those stores. I think we’ll know a lot more after we get through the holiday season. Certainly we did expand the space allocated to consumables, but we also improved that space and adjacencies. And that’s going to enable us to present some of our holiday items much, much better. So I don’t think we’re prepared to present any further color in terms of the top line input or impact other than to say that the performance of those stores is moving forward and we’re very pleased with the fact that they are already out-comping those stores that we have not relayed.
Alan Rifkin - BofA-ML
Howard, certainly your decision to increase the consumables during the macroeconomic environment you know which has been pretty difficult the last couple of years has obviously paid dividends, but can you kind of share with us like philosophically if the environment starts to improve in 2010, whenever that may be, what is kind of the philosophy around merchandising with respect to other non-consumable category? I mean will you ultimately attempt to increase that as the environment gets better?
Howard R. Levine
Sure, Alan. I appreciate that question because I think there is some thoughts of the permanency of some of the changes that we’ve made. For some of you that have followed us over the last several years we have made a number of movements within our store. In fact the way that I like to think about it philosophically is the only thing that’s permanent is the four walls.
There’s a lot of things that we can do within our stores to incorporate economic changes, customer trend changes. And one thing that we learned through this most recent shift of 3,000 stores was that we’ve built some strong capabilities to execute something of this magnitude. You know I don’t want to underestimate the work and the effort that goes into touching the stores like we did through this fourth quarter. It makes me feel confident that we’ve got a group of people and a team that can make some significant changes.
So whether it’s making some tweaks to apparel which incidentally we’re working very aggressively on improving our apparel offering, potentially hoping to see some of that coming in the spring season. We’ve had some good results in the home area. Frankly when we compare our results to what we see in the market, I think the home area has performed pretty competitively and think that that’s an opportunity for us. In addition to that, seasonal categories which also were good margin categories for us, again we think we have opportunity to drive improvements there. So you know in our store we have a 7,000, 8,000 square foot store. We have a lot of opportunity to make tweaks and adjustments in there.
And most importantly I think we’ve developed some capabilities to help make some of those changes quickly and effectively. And we’ll move through the year and through time with that kind of thought.
Evan, I think we’re bumping up against the top of the hour. Let’s take one more question.
Your last question comes from Joe Feldman - Telsey Advisory Group.
Joe Feldman - Telsey Advisory Group
Two quick questions. One is obviously on the gross margin side very strong results it seemed and you had higher mark ups. I was wondering if you could talk about the sustainability of some of those mark ups and where you were seeing some of the best strength. And then the follow up question is just about the tax rate and how we should think about that given the volatility we’ve seen there.
R. James Kelly
I’ll start with the mark up issue and then Ken if you’ll help us out with the tax question. From a mark up perspective we have a lot of different things that are driving that today. Clearly we have focused on our global procurement efforts. Our global procurement team is partnering increasingly well with our merchants and they’re driving value. We’ve also worked hard at such things as auction process that has enabled us in a number of cases as relates to commodities to improve our initial mark up.
We’ve created a pricing team and a lot of information around customer elasticity to help the buyers make the pricing decisions that have been helpful. We’re targeting now improving tools, not only in the initial pricing but also that will help us more effectively manage promotional pricing and clearance pricing.
So there’s a whole series of things that are really focused on helping us continue to improve the purchase mark ups.
Kenneth T. Smith
And just to look at the taxes, we did see a rate decline as you compare this most recent quarter versus the prior. The driver there was the jobs tax credits and that’s a function of some processes we have in place, as well as a bit of timing. So that program we expect has been in place for quite some time and we expect it to continue. So as we look forward with taxes, we would tend to model taxes more in line with our historical rates that we’ve seen.
This concludes today’s question-and-answer session. I will now turn the call over to Miss Rawlins for a final comment.
Thank you, Evan. Unfortunately we ran out of time and did not get to all of the questions in the queue today. As always I’m available after this call for any follow up questions you may have. Thank you for your interest in Family Dollar and have a good day.
This concludes today’s conference call. You may disconnect at this time.
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