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Executives

Kiley Rawlins – Vice President of Investor Relations and Communications

Howard R. Levine – Chairman and Chief Executive Officer

R. James Kelly – President and Chief Operating Officer

Kenneth T. Smith – Chief Financial Officer

Analysts

Michael Baker – Deutsche Bank

Mark Miller - William Blair & Company, LLC

Joseph Parkhill – Morgan Stanley

Deborah Weinswig - Citigroup

Analyst for Alan Rifkin - BOA-ML

Bernard Sosnick – Gilford Securities

Meredith Adler - Barclays Capital

Scott Ciccarelli – RBC Capital Markets

Dan Binder – Jefferies & Co.

Joe Feldman - Telsey Advisory Group

Adrianne Shapira - Goldman Sachs

Wayne Hood - BMO Capital Markets

Karen Lamark – Federated Investors

Family Dollar Stores, Inc. (FDO) F1Q10 Earnings Call January 6, 2010 10:00 AM ET

Operator

Welcome everyone to the Family Dollar first quarter 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

Thank you. Good morning everyone and Happy New Year. 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, January 6, 2010. 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 will begin our discussion this morning with a review of our first quarter results. Then we will take a few minutes to discuss our plans and outlook for the rest of fiscal 2010. Following our prepared remarks you will have an opportunity to ask questions.

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.

Now I would like to turn the call over to Kenneth Smith. Ken?

Kenneth Smith

Thank you, Kiley. This morning we reported earnings per diluted share of $0.49, a 17% increase over the first quarter of fiscal 2009. While the top line was slightly below our original expectations, strong gross margin performance offset the SG&A impact of our investments resulting in 80 basis points of operating margin improvement during the quarter.

As we reported several weeks ago net sales for the quarter increased 3.9% and comp sales increased 2.4%. As we discussed on our last conference call sales for the quarter started off strong with September comps increasing about 5%. While calendar shifts resulted in some noise between months in the quarter, November sales were softer than we expected. This softness was driven largely by lower sales of apparel and other weather-sensitive categories.

While the average transaction value flattened this quarter I would note that customer traffic continued to increase. Gross profit as a percentage of sales increased approximately 110 basis points in the quarter. This improvement was driven primarily by reductions in freight expense and inventory shrinkage. In addition, our ongoing efforts to increase inventory productivity and mitigate risk resulted in lower seasonal mark downs during the quarter.

At the end of the first quarter average inventory per store was approximately 7% lower than last year. SG&A expense as a percentage of sales increased approximately 30 basis points during the quarter. The deleverage of SG&A expense in the quarter was primarily a result of the investments we are making to drive revenues including the continued roll out of our store technology refresh, our space realignment efforts and expanded store operating hours. Partially offsetting these increases were benefits from targeted cost improvement initiatives in a number of areas including insurance and energy management.

Turning now to the balance sheet and cash flow statement we have consistently maintained strong liquidity. Cash and cash equivalents as of November 28, 2009 were approximately $366 million as compared with approximately $153 million at the end of the first quarter last year. Capital expenditures for the quarter were approximately $39 million. We continue to expect that capital expenditures for the year will be between $160-180 million.

Finally, I would note that we continued our stock buyback program this quarter purchasing about $25 million of our common stock. As a reminder, our board authorized an additional $400 million in November. As a result we currently have approximately $437 million remaining under outstanding buyback authorizations.

Now let’s turn to our outlook for the rest of the year. For the second quarter we expect comp store sales to increase 2-4% and we expect earnings per share will be between $0.65 and $0.70 compared with $0.60 in the second quarter of fiscal 2009. As Howard will discuss further in a moment, we are accelerating investments to drive stronger top line growth and expect to build sales momentum through the second half of the year.

Reflecting the cadence of these initiatives, we expect comps will increase 3-5% in the second half. I would note these investments may exacerbate the adverse mix impact and constrain our ability to leverage expenses at the lower end of our guidance. Reflecting these expectations, we continue to project that earnings per diluted share for the full year will be between $2.15 and $2.35.

Now I will turn the call over to Howard for some remarks. Howard?

Howard Levine

Thank you Ken. Good morning everyone. I hope you had an enjoyable holiday season. Speaking of the holidays, as we reported this morning our December comp sales increased about 4% with strong performance in the seasonal and toy area. I especially want to thank our store teams who were instrumental in delivering these record results. Particular recognition goes to those teams heavily impacted by winter storms. Without their dedication and commitment we would not be reporting record sales this morning.

Over the last several years we have made significant investments to increase our market share, strengthen our merchandising and operational capability and build strong employee teams and these investments are delivering tangible results. During the first quarter we increased customer traffic, expanded operating margin, improved inventory productivity and importantly we increased employee retention. I am especially pleased that despite softer than expected top line growth we delivered our seventh consecutive quarter of double digit EPS growth.

While general economic conditions appear to be stabilizing the pressures on low and middle income customers continued to be challenging. For customers with limited or no financial safety net, saving money continues to be a key driver of shopping trends and our strategy of providing value in a convenient shopping experience as resulted in growth in both customers and shopping trips.

For the sixth consecutive quarter customer traffic increased. Although our core low income customers continue to account for about 2/3 of our total sales, customers making more than $40,000 a year continue to grow as a percentage of our new sales.

Over the last several years we have invested significantly to understand our customers better. As a result we have gained an appreciation of the many subtle, but meaningful differences among them while also understanding their similarities better. As we strive to satisfy more of our customer’s needs, our investments in category management capability has led to more relevant assortment especially in consumable categories.

We have seen particular strong customer response when we have been able to tailor our assortments to reflect customer preferences. While we have made progress in increasing our appeal with a variety of customers I believe we have an opportunity to accelerate our top line growth. To that end, we are investing to strengthen our assortment, enhance our customer communication and improve the shopping experience in our stores.

As a result of today’s economy, our customers have significantly constrained discretionary spending and focused more on basic needs. We have improved our assortments across consumables areas and as a result have realized both increased sales and trips but we are also focused on becoming more relevant to customers in more discretionary areas. Our solid December sales results, especially in toys and holiday, reflect our progress in this area.

Looking forward we also see further opportunity to expand our private label program. Customers are turning increasingly to private label brands to help better meet their need for value. To capitalize on this opportunity and to offset the mix pressure from stronger sales of lower margin consumables we are investing to expand our penetration of private label. Over the last year we have created a dedicated team to work with our buyers to reposition and rebrand many of our store brands. We have defined our strategy, prioritized our focus and built processes to ensure that our quality expectations are met. This spring you will see more of the results of these efforts in our stores.

In addition to greater acceptance of private brand, today customers are increasingly sensitive to promotions, sales and coupons. Responding to this shifting landscape we are changing the way we communicate with our customers. While we continue to utilize circulars to communicate the values we offer, we are experimenting with a variety of online tools that enable us to increase our brand awareness. We are enhancing our in-store communications with better shelf; aisle and end cap signage and reinforce our compelling price points.

This new signage not only communicates the value we offer, it also improves the shopping experience by helping customers find what they need faster. In addition to better navigational signage we are making other improvements to the in-store shopping experience. The completion of our points of sale refresh, the expansion of operating hours, space realignment efforts and ongoing team retention efforts will result in stores that are more convenient, less cluttered and easier to shop.

The completion of our point of sale refresh this year will increase the convenience of our check out process as it supports an expanded selection of payment choices including food stamps, credit cards and Family Dollar gift cards. We are on track to have all stores on the new platform by the end of our second quarter.

Another way we are working to increase the convenience of the shopping experience is through expanded operating hours. During the first quarter we expanded operating hours in approximately 15% of our stores. Based on the positive response from customers we intend to accelerate this initiative and expand operating hours in substantially all stores by the end of our second quarter.

To support an expanded assortment of key traffic-driving categories into improved merchandise adjacencies, last year we initiated efforts to realign space at our stores. Today approximately 55% of our stores have completed these layout changes. I am pleased to report that these stores are out-performing stores that have not yet made these changes. This year we will continue these efforts, focusing our attention on about 1,000 additional stores.

Finally, we continue to increase our employee retention. I am especially pleased with the improvements we have made to stabilize our store teams with the benefit of experienced employees has the greatest impact on the customer shopping experience. Our store manager and assistant manager retention continues to increase and we are seeing the benefit of this experience in stronger, more consistent store standards, lower inventory shrinkage and more satisfied customers.

While economic conditions may be stabilizing it is unclear when things will improve for our customers and projecting short-term financial performance within this context remains challenging. Clearly the values we offer and the investments we have made to improve the shopping experience are appealing to a diverse range of customers. Our initiatives are delivering results but I believe we have an opportunity to further accelerate top line growth. I am confident that our efforts to broaden the appeal of our assortment, strengthen our customer communication and improve the in-store shopping experience will result in market share growth and strong financial returns.

Now operator we would be happy to open the call for questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Michael Baker – Deutsche Bank.

Michael Baker – Deutsche Bank

On the second quarter guidance, with December up 4%, quarter guided 2-4% it would suggest a slowdown in January and February although historically I think your business has gotten better in January. What is behind that guidance? Was there anything in December in terms of first of the month or payroll cycle that artificially inflated December or is it the idea that toys are so strong and those don’t continue into January and February or is it just being conservative and you know last quarter you started off strong and then the quarter kind of petered out?

Howard Levine

I don’t know if that was a multiple choice question or I should select all of the above. I think you made some good points. Yes we were very pleased with the December results and as you know you are correct that January and February are more consumable driven months which is generally good for us but January and February are also transitional months. With the shortfall in sales we experienced in the October/November period we thought it would be more prudent to be a little more conservative there. We gave a range of 2-4% so we think it was appropriate given the circumstances we are facing today. We continue to believe that the initiatives that we are implementing will keep us focused on driving the comp.

Michael Baker – Deutsche Bank

So nothing like the first of the month fell or anything like that that artificially impacted December?

Howard Levine

No.

Michael Baker – Deutsche Bank

The expanded hours in 15% of the stores can you tell us how many additional hours you added to those stores?

Howard Levine

We are not going to get that granular. I think just as a note, as I mentioned in my prepared comments, we did expand the hours in about 15% of the stores with a very favorable response from the customers and kind of like the POS rollout being in a position to be more competitive, as well as satisfy more customers and be more convenient is really driving that. So we are really looking forward to getting that rolled out.

Operator

The next question comes from the line of owaHMark Miller - William Blair & Company, LLC.

Mark Miller - William Blair & Company, LLC

Can you expand on your comments regarding the consumer sensitivity to promotions and coupons? I guess expand on your initiatives. Does this represent a change in how you are thinking about EDLP relative to high/low and what do you think is causing this change amongst the customer?

Howard Levine

That is a good question. Having been involved in this business for a number of years it is interesting to take a look back and see how the role of marketing and sales promotions has changed over time. The first part of my answer is I believe it will continue to change and evolve and we will continue to learn to adapt and appropriately utilize marketing to drive market share out there today. I do think there has been some structural change out there not unlike what happened after the great depression where for a generation or two there was a change in the way people thought about value.

I think that positions us very nicely and what we are trying to do in terms of our marketing focus is utilize some different tools to help let our customers know what we are doing. Through our POS implementation we will have more flexibility in terms of what we decide to do in different types of marketing events. Marketing will continue to evolve. We are still an EDLP retailer and as I have said over the years utilizing circulars to notify our customers of great deals and what is going on seasonally is the way we are going to continue to operate. Frankly not too much different than what you see out of Wal-Mart today where it is more of a hybrid of EDLP that is getting supplemented with various sales promotions. No question today the customer is very focused on saving money. We like to be in that space and are just trying to learn more ways to utilize communication that lets our customers know about some of the things we are doing.

Operator

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

Joseph Parkhill – Morgan Stanley

Could you elaborate a little bit more on what you are seeing in the stores that have been reset specifically to have categories performing within those stores? Is the outperformance being driven by consumables or are you seeing out performance in all categories due to increased traffic trends?

Howard Levine

I think the outperformance is across a number of categories. Obviously our first objective in the realignment of space was to give adequate space to the consumable categories that have been growing at a very rapid rate now for awhile. By giving them more space it enabled us to stay in stock better and in some cases to broaden our assortment.

In addition to that, the realignment enabled us to improve some adjacencies so that has helped not only those departments that were moved but some of the others. I think the third thing we were able to accomplish is we cleaned up some space with a better presentation of our seasonal area. Quite candidly I think some of that had a very positive impact on our holiday season as it relates to both toys and seasonal merchandise.

Joseph Parkhill – Morgan Stanley

Secondly, recently you have talked about a more pronounced paycheck cycle and I am assuming perhaps you didn’t see that due to the holiday season. Is that a correct assumption?

Kenneth Smith

I would agree with you December is a month that is not like many other months that we face. Not including December I think there continues to be a pretty good exacerbation around that paycheck cycle.

Operator

The next question comes from the line of Deborah Weinswig – Citigroup.

Deborah Weinswig - Citigroup

With regard to the sales guidance for 2010 I think the original guidance was for 5-7% improvement and I think the new guidance is 4-6%. Could you provide some additional color around the change in the guidance?

Howard Levine

What we tried to communicate at least in my prepared comments is we are very excited about what we see coming in our second half. First of all we talked about we will be expanding hours and we are going to have that completed by the end of February. I think that is a pretty material shift that as I said before makes us more competitive and more convenient. Secondly, we will have completed our POS rollout. I know I am tired of talking about it and I am sure you are tired of hearing when we are going to complete it but it will actually come to completion also at the end of the second quarter so what that does is position us to be fully food stamp eligible in all of our stores, it enables us to take credit cards and process our customers faster through the check out. So we are very excited about that particularly with what we see going on nationally in the trends of food stamp utilization.

The third thing we are excited about is the completion of the space realignment program in about 55% of our stores. That continues also in the second half of the year where we are going to touch another approximately 1,000 stores. Finally, one I am not going to get into a lot of specifics on I would like to talk to you after we have completed a number of different assortment changes. Through our category management efforts, increased customer research and what not we believe you will see some exciting changes in our assortment as we begin to complete many changes in that area also in the second half of the year. So those are a few of the things we are excited about to drive our comp in the second half of the year.

Deborah Weinswig - Citigroup

But if you look at where December was, it is almost a 10% stack on a 2-year run rate. That was a pretty impressive number. Is there anything we should think about differently as we move through the rest of 2010?

Howard Levine

I think the 2-year stack analysis is certainly a data point to look at when looking at what the future holds but I don’t want to only look at that. I think what we are really focused on is implementing and executing properly on the initiatives we have been working on now for several months and getting those in our stores and hopefully that continues some of the positive trends we have seen in December.

Kiley Rawlins

I would note that we really haven’t changed our outlook for the second half. As Howard noted earlier our first quarter was a little bit lighter than we had planned. So when we put our first quarter actual together with our guidance for the second quarter and our expectations for the second half you end up in that 4-6% range for the year.

Deborah Weinswig - Citigroup

If we think about the gross margin improvement in the quarter and we look out the rest of the year what should we look at from the first quarter that would also present the greatest opportunities for the remainder of 2010?

Kenneth Smith

I think from a gross margin perspective we are obviously very pleased with the results we have seen over the last several quarters. As we look forward from a gross margin perspective we do expect continued improvement in margin albeit at probably a slower pace than we have seen recently. When we look at the drivers we continue to see nice results from our global sourcing efforts, our efforts with our price management teams that have worked very hard on our pricing initiatives, private label that Howard discussed is another nice driver that positions to utilize as a gross margin driver. So we continue to look for those initiatives to drive margin.

On the flip side we do also expect the mix dynamic that we have seen as consumables remain strong to present a bit of pressure. The one change we do see is in the freight area moving forward. We have seen a nice tailwind from freight over the last several quarters. That in comparison, freight is very dependent on the input costs of diesel and the comparisons of diesel costs have been very favorable and that changes a bit beginning in the November/December time period and so that strong improvement will wane from a freight perspective as we move forward. Again, we expect to continue to drive gross margin improvement albeit at a slower pace.

Deborah Weinswig - Citigroup

On shrink, what inning would you say you are in on the shrink initiative?

Howard Levine

This is a ball game that doesn’t have a ninth inning. We have made significant progress over the last several years. Starting with stabilizing our work force, creating a more aggressive culture at the store level has helped not only customer service but also managed shrink more effectively. We have introduced a lot of new processes and a lot of new equipment and technology into the store that is enabling us to react much quicker to problems.

We are managing inventory much more effectively so that is giving us a platform to continue to drive shrink. So I think all three of those areas are key factors in shrink and all three of those areas continue to show improvement. I am not looking for any particular slow down in the shrink savings in the near term.

Operator

The next question comes from the line of Analyst for Alan Rifkin - BOA-ML.

Analyst for Alan Rifkin - BOA-ML

My question is revolving around the space realignment program. I know you had said certainly in the stores that have been touched are outperforming those that have not been but if you could give any further clarification or quantification on exactly what type of lift you are seeing or even to the extent of how the 465 or so stores that have been realigned in the first quarter the performance of those versus the initial 3,200?

Howard Levine

As we indicated, we are seeing a positive customer reaction in those stores. One of the interesting things right now is that most of our stores have one or more initiatives impacting them now from the addition of new, in-store capabilities from technology that is the acceptance of various currencies to the realignment of space to the store hour expansion. It is really not appropriate for us to isolate I think on any one of the initiatives because so many stores you have all three, or one or two of the initiatives. At this point in time we did perform tests early on.

We confirmed that the sales performance of those stores are accretive. As a broad group they continue to be accretive but defining the exact contribution of any given initiative is challenging and not appropriate.

Analyst for Alan Rifkin - BOA-ML

A follow-up to that, the 1,000 additional stores targeted to have the realignment for the rest of this year can you give any proportion by quarter? Is it going to be fairly evenly spread out or skewed more towards one or two quarters?

Howard Levine

We are going to wrap that up fairly quickly in terms of the second and third quarter.

Operator

The next question comes from the line of Bernard Sosnick – Gilford Securities.

Bernard Sosnick – Gilford Securities

With regard to discretionary items I got the impression that your inclination is to move a little bit more aggressively towards the toys and holiday items. Is that part of the category assortment changes you are alluding to?

Kenneth Smith

No, what I was referring to with the category management effort was more along the lines of some of our consumable categories. In terms of the increases we saw in our toys and holiday that really started about this time last year when we contemplated our plans for this holiday and determined we thought it was going to be a pretty competitive, tough holiday season and sent the merchants off to develop some exciting presentations and items for this holiday season.

What we saw was some great value out there that was clearly recognized by our customers. So we would like to leverage that to continue to drive those discretionary categories and believe we have a lot of good things that we are working on to do so.

Bernard Sosnick – Gilford Securities

Are you speaking about leveraging during the year or again as the next holiday season?

Kenneth Smith

Both. In fact after this call today we have the meeting to begin the planning process for next holiday as many of our merchants will be making their overseas trips within the next few days. There are also several other events that come out through the year whether it is Easter, July 4th holiday, Labor Day or Memorial Day. There are many numbers of events that we can leverage to drive some discretionary categories. That includes the apparel area too. We haven’t really talked about that much but we have not given up on apparel. We think we still have further opportunities there to drive some business and are really looking forward to our new assortment for this spring and summer.

Bernard Sosnick – Gilford Securities

Can you share with us your inclination with regard to the expansion rate and perhaps acceleration looking forward?

Howard Levine

Of what?

Bernard Sosnick – Gilford Securities

Your expansion rate. Store openings.

Howard Levine

What we have said is the 1-2% rate we have been achieving over the last couple of years is not the rate that we want over the longer term. We slowed things down. We significantly improved our processes so new store performance is excellent right now. The market has also softened from a real estate perspective providing additional opportunities which we are realizing in our lease negotiation process but we are also realizing that in the pace of the new store contracts. So we are seeing a slight increase in our volume there. We expect to accelerate from where we are today and we will be talking more about that as we discuss our 2011 plans.

Operator

The next question comes from the line of Meredith Adler - Barclays Capital.

Meredith Adler - Barclays Capital

I was wondering if you could just talk about how hard it is to execute the longer hours. You are going to do a lot in the second quarter and then maybe talk about how long it takes for the customer to notice that the hours have changed.

Howard Levine

A couple of good points there. We began this process several quarters ago and we were fairly conservative in approaching it for several reasons not the least of which is we have made some major progress with our store teams and we wanted to make sure we could manage this in a way that would be positive not only to our customers but our associates in the stores. So our test indicated we could do that. We initially discussed expanding store hours over a much longer period of time. As we indicated this morning we expect to have substantially all of our stores with expanded hours by the end of the second quarter. So the first point is I think we have through our processes determined the right approach and made it a win/win at the store level.

The second part of your question is also very valid. We expect the incremental hours will be leveraged differently across the chain. Obviously their productivity will not be competitive with some of our best hours today but on the other hand our tests have indicated two things; one, we believe the expansion will be accretive to our bottom line very quickly. Two, we have seen an accretion of the productivity of those hours through time. In other words your customer base becomes more familiar with the change and finds more opportunities to come to you during these incremental hours.

So we think it will be a gradual process but very quickly accretive.

Meredith Adler - Barclays Capital

I have a question about food stamp usage. We know the government is being more generous with food stamps and it is important to low income consumers. Are you actually seeing in the stores that you accept food stamps that your penetration is rising on a steady basis?

Howard Levine

We are seeing a reasonably steady increase in the use of food stamps. In addition we are still introducing food stamps to new stores and we see that upon that introduction it has a very favorable impact on particularly our traffic in those stores.

Meredith Adler - Barclays Capital

My final question is about freight costs. Obviously diesel being the most important factor, but during the time diesel costs were very high, a year or so ago, did you put a lot of effort into improving the efficiency of how you use your trucks and how much of that will survive because we are going to see costs start to move up again?

Howard Levine

From an operational perspective our transportation and distribution network has shown consistent efficiency on a [Q] base notwithstanding the costs of diesel fuel. We expect that many of their initiatives that are currently in process will continue that fairly long tradition of improving productivity. So notwithstanding the impact of diesel costs there are things we can and are doing to continue to drive efficiency improvements.

Operator

The next question comes from the line of Scott Ciccarelli – RBC Capital Markets.

Scott Ciccarelli – RBC Capital Markets

Can you just help us understand a little bit about the changes in sales trends from what you saw in September which was pretty good; October/November soft; December an improvement? Was there a change in customer activity or was there a change in mix at all or was it just that was the natural ebb and flow of the business?

Kenneth Smith

I wish I could tell you exactly what happened. We were disappointed with our first quarter sales particularly after a good start in September. I think there are a number of issues we were facing. What we decided though was we were going to focus on those initiatives I had talked about to try to get back into the 3-5 comp store guidance.

But if I had to isolate on one, I think what we saw was first of all traffic has been pretty consistent and even through the first quarter we saw that. We saw a slight fall off in transaction value. That was flattish and I think that can be attributed primarily to the softness in discretionary categories. Our mix of discretionary is pretty high compared to some others in the channel. I think with the warmer November that did hurt and the softer October also contributed to that. Once we got into December we did see discretionary pick up quite a bit and I think that did help give us the momentum in the month.

Scott Ciccarelli – RBC Capital Markets

It sounds like you have already outlined a number of times on this call the different things you are planning to help accelerate comps in the second half. But you have also referenced you are going to be spending more to get there. I guess the question is how concerned are you that you go ahead and make the investment and add extra hours, the technology, etc. but you don’t get the sales lift that you are kind of outlining for investors? Or related to that how quickly could you or would you adjust the cost side if the sales lift you are forecasting doesn’t materialize?

Howard Levine

I think the first thing we would like to highlight is that each of these major efforts have been substantially tested over time whether it be the store of the future initiative, or the macro initiative which didn’t permanently elevate costs but had some one-time considerations or the expanded hours. So we are fairly confident in the ability of these programs to be accretive to our bottom line.

On the other hand there is a lot of flexibility around the costs associated with particularly the store hour expansion. We will continue to monitor that very closely. We are very confident in the actions we have taken. If you are asking what happens in a meltdown environment then our costs will melt away. We have to react accordingly although we don’t expect it.

R. James Kelly

I might add that we kind of bucket expenses into two categories; our core run rate as well as those expenses that are attributed directly to some of the initiatives. From a core expense perspective we are very focused on driving costs out. As Ken has talked about over the last several calls whether it is from energy or overhead there are a number of different things we are trying to do to make sure we maintain a stringent cost structure at Family Dollar. We aren’t turning our head to the costs. We do look at them very carefully. We do want to be the low cost provider and to be in a position to do that we have to manage our expenses appropriately.

Operator

The next question comes from the line of Dan Binder – Jefferies & Co.

Dan Binder – Jefferies & Co.

A question on the expanded store hours what kind of SG&A dollar growth we should be looking for in Q2 if you can give us any sort of range on that? Secondly, it looks like Wal-Mart has gotten a little bit more competitive on pricing. I have heard that from some of their other competitors. I am just curious how that impacts you if at all and what you are seeing it in your survey of the landscape?

Kenneth Smith

From an expense perspective I would reiterate Howard’s comment as we look at the second quarter and on into the year where we are really focused on balancing and tightly managing those core expenses along with an accelerated investment pace for the sales driving initiatives. So we are targeting the expanded hour’s completion by the end of the second quarter and that will be one of those balancing factors falling into the category of investment to drive sales. It will balance against some of our cost saving initiatives. So we won’t put an exact dollar amount on that but as we look at the second quarter and throughout the year we will be balancing those two areas of expense.

Dan Binder – Jefferies & Co.

Maybe another way to ask the question is if you are thinking about a 2% comp as a point where you get expense leverage what would you say every incremental point is worth? Is it 10 basis points? 5? Any sense on that?

Kenneth Smith

I probably wouldn’t calculate that. I would say as we talk about core expenses and I talk about those buckets we still do target that 3-ish% comp breakeven level. I think that should set a benchmark of where we look to break even from a comp perspective. The other area of expenses again is those sales driving initiatives that can make that number move up or down slightly depending on where we are in the pace of an investment.

Dan Binder – Jefferies & Co.

On the competitive front?

Howard Levine

No question Wal-Mart is the low price leader. They continue to drive that through increased marketing and advertising. We continue to monitor pricing. Price perception is something that is very important to us and is an area we have talked about we have invested significantly in over the last several months. But I would like to remind you it is a different shopping trip going to the Wal-Mart versus the Family Dollar Store. The fact we have been able to compete with them for a number of years gives us confidence that we will continue to be able to compete. In today’s environment as I talked about where people are trying to save money and are looking value I think they are positioned nicely and I think we are as well.

Dan Binder – Jefferies & Co.

More what I was looking to drive at is if they are getting incrementally more aggressive on some of their traffic driving consumables. Do you typically respond lock step or do you sort of let a certain gap open up a bit?

Howard Levine

Maybe I can answer it this way. We have a goal in terms of where we want to position our company against our competitors and we are managing for that and are pleased with where we are today.

Operator

The next question comes from the line of Joe Feldman - Telsey Advisory Group.

Joe Feldman - Telsey Advisory Group

Just to follow-up again on the hours thing, can you quantify what kind of an impact you are getting from the longer hours in terms of a comp lift? Is it 50 basis points? 100 basis points? How much of a lift relative to the control stores is it?

Howard Levine

As I indicated, we have a number of initiatives going now. I think it is fair to say that expansion of store hours is one of the most significant of our initiatives. It has been nicely accretive and it is a big part of our overall comp plan going forward. We are not going to isolate on each initiative and the relative lift derived from that.

Joe Feldman - Telsey Advisory Group

A follow-up on the gross margin, could you break down how much of a margin lift you got from the lower freight versus lower product costs versus mark downs and shrink? How we should think about those things going forward?

Kenneth Smith

We haven’t historically broken down each and every component. I think just to reiterate the components in the second quarter we did see the positive benefits in the freight area and the shrink area as well as our seasonal mark downs. I think to add to that we again saw our efforts to manage initial markup whether in the pricing area, global sourcing and private label those initiatives offset continued pressure from mix as we continue to see consumables be strong. Again, as I look forward without breaking the magnitude of each of those components, we continue to expect as we move forward to drive positive margin. The one area that you would call out is freight which has a dynamic that will change from where we have seen it the last 3-4 quarters.

Operator

The next question comes from the line of Adrianne Shapira - Goldman Sachs.

Adrianne Shapira - Goldman Sachs

My question relates to private label. Clearly it sounds as if it is an opportunity to drive margins. Can you give us a sense of what percentage is represented today and what you think the opportunity is to drive penetration higher there?

Howard Levine

I think the percentage today, again how you define that is if you look at those like-kind items, UPC items, we are still in that low teens arena. When you look at the potential in that area which is the biggest part of our sales, probably in the arena of 20’s. We have seen some nice improvement. We have had double digit improvement over the past 12 months and I think what you will see is more visibility as to our efforts as we go into this spring.

Adrianne Shapira - Goldman Sachs

How do you think about striking the right balance there? Clearly you have benefited from a trade down customer and I am just wondering does private label strike a chord as much with that trade down customer as much as your core customer and what is that right balance between branded versus private label to ensure that you hold onto that trade down customer?

Howard Levine

Clearly branded merchandise is very, very important to many of the trade down customers. On the other hand, even the trade down customers are at Family Dollar looking for value. As we establish that value/quality combination that is appropriate for the customer then there is a private label appeal through both our core customer and the trade down customer. You will see basically now a greater shift from control labels into private label where we can build some brand loyalty versus the shift from branded merchandise to private label. So that is seeking to strike that balance from a customer perspective closer to where we are today yet building some value in the private label side.

Adrianne Shapira - Goldman Sachs

Switching to product sourcing costs, another source of opportunity for margins we clearly have come off of a pretty deflationary environment. Can you give us a sense of what trends you are seeing in sourcing costs going forward as you are looking out and making those buys today? Are you seeing any change in those trends? Are we starting to move a little bit less deflationary? Any more deflationary? Any change there would be helpful.

Howard Levine

I think we are seeing the uncertainty of the global economy. There are a few commodities that are beginning to strengthen and others are not. I would say overall global demand remains very soft so that presents some opportunities for savings we are targeting as we move forward.

Adrianne Shapira - Goldman Sachs

Any quantification overall in terms of where it has been and where you are seeing it today?

Howard Levine

I think we would say we are not feeling significant inflationary impact right now. Not necessarily deflationary but somewhat net/net flattish.

Operator

The next question comes from the line of Wayne Hood - BMO Capital Markets.

Wayne Hood - BMO Capital Markets

The sales in apparel and accessories were down about 2% in the quarter and that was an improvement from kind of a run rate of down 9 over the last four quarters. Can you peel back a little bit what was the high net improvement and are we at a point where as we move through the quarters and coming years where apparel and accessories and home could start to turn into positive ground and be a surprise to where margins could be better? Kind of around that do you feel good about your apparel pricing given now that there are a lot of people in the marketplace that are at $10 price points for tops and things like that? Then I have one follow-up.

Howard Levine

Let me start off by saying we saw a great start to apparel sales in September and it really fell off in October and November and ended up in the area that you talked about. Another important metric is the way we were able to manage inventories during that time period as inventory levels were down in the mid-teens in our apparel areas and to be able to drive those kinds of numbers did show a nice improvement in productivity. So I am very pleased with the direction that we have gone there and I think that speaks nicely coming out of this holiday season too with the cold December and some good sales in some of those areas positioned us nicely from a clearance perspective.

There has been a bottoming out and we have had a huge effort in trying to improve our apparel business starting with quality, starting with price points, starting with a number of areas we think we can do a much better job in. I haven’t talked a lot about that because I like to see the goods and I would like to see some of the results of the early spring and summer selling season. We continue to focus on driving sales in those areas. As I said earlier our mix is more leaning towards discretionary than others. We have purposely kept it that way but have done a very nice job of managing the risk as we have gone through a pretty difficult economic cycle here. I think there are a number of things we are working on and I would rather talk about the results of some of the positive things than talk about what might happen there. I think it is important to note that we have a huge effort in the home area and other discretionary categories including apparel in trying to get those things jump started in spite of some of the challenges there. We are looking forward to seeing some of those results.

Wayne Hood - BMO Capital Markets

Embedded in your full year guidance does that imply you would see a third quarter EBIT margin improvement given the difficult comparison you are up against or does it all come in the fourth quarter given the easier comparison?

Kenneth Smith

I think as we model without breaking the quarters too specifically it is very well balanced across quarters. So we have continued to look as we focus on operating margin expansion we are very pleased we have gotten seven consecutive quarters of expanded operating margin and look to continue that into the back half.

Operator

The next question comes from the line of Karen Lamark – Federated Investors.

Karen Lamark – Federated Investors

Going back to the extended hours is there anything unique about the 15% or so you currently are encouraged enough to push out more aggressively? Related, were they sort of highly managed at all? Then I have a follow-up.

Howard Levine

I think we were very cautious in considering how to approach the expansion. Other than the fact that we were developing an approach to the expansion of hours there was nothing unique about those stores. In fact our effort was to make those stores representative. So nothing unique. We don’t think the roll out of the expanded hours to the remaining part of our chain will have different results from those that we saw in the tests.

Karen Lamark – Federated Investors

Separately, on the buyback can you talk a little bit about your approach? I was surprised that the buy backs in the quarter were small at least relative to the capacity on the authorization. Maybe you can comment on that?

Kenneth Smith

We are very pleased with the increase in authorization our board made around stock buy backs increasing the authorization by $400 million. What that does more than anything is give us flexibility. So our strategy as we look to buy backs is on an ongoing basis evaluate the opportunities and what is going on in the market. So you have seen a fairly consistent pace over the last three quarters. We have the flexibility now and we will continuously monitor the market for the appropriate buy back opportunities and execute as appropriate.

Operator

I will now turn the call over to Ms. Rawlins for final comments.

Kiley Rawlins

Thank you. Thank you for joining us today. Unfortunately we did not get through all of your questions. As always I will be available after the call for any follow-up questions you may have. Thank you for your interest in Family Dollar. Have a good day.

Operator

This concludes today’s conference. You may disconnect at this time.

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Source: Family Dollar Stores, Inc. F1Q10 (Qtr End 11/28/09) Earnings Call Transcript
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