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Executives

R. James Kelly – President & COO

Howard Levine – CEO

Kenneth Smith – CFO

Kiley Rawlins – VP IR

Analysts

Joseph Parkhill – Morgan Stanley

Deborah Weinswig - Citigroup

Mark Miller - William Blair & Company

Bernard Sosnick – Gilford Securities

Adrianne Shapira - Goldman Sachs

Charles Grom – JPMorgan

Meredith Adler - Barclays Capital

Dan Wewer – Raymond James

Scott Ciccarelli – RBC Capital Markets

John Zolidis – Buckingham Research

Dan Binder – Jefferies & Co.

Family Dollars Stores, Inc. (FDO) Q2 2010 Earnings Call April 7, 2010 10:00 AM ET

Operator

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

Kiley Rawlins

Good morning everyone. Thank you for joining us today. Before we begin you should note that our comments today will include forward-looking statements regarding various operating initiatives, sales and profitability metrics 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, April 7, 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, James Kelly, President and COO, and Kenneth Smith, Chief Financial Officer. We will begin our discussion this morning with the review of our results for the second quarter and first half of fiscal 2010.

Then we will take a few minutes to discuss our plans and outlook for the rest of the year. Following our prepared remarks you will have an opportunity to ask questions. Please remember that the queue for the question-and-answer session will not be available until after we have finished our prepared remarks.

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

Kenneth Smith

Thanks Kiley, this morning we reported diluted earnings per share of $0.81, a 35% increase over the second quarter of fiscal 2009. While revenue growth was in line with our original expectations a more favorable sales mix and improvement purchase mark-ups, combined with benefits from targeted cost improvement initiatives resulted in 195 basis points of operating margin expansion during the quarter.

As we reported several weeks ago, net sales for the quarter increased 4.9% and comp sales increased 3.6%. Customer traffic continued to be the primary driver of comp sales but average ticket also increased. While our consumable business continued to drive traffic, increasing 5% this year on top of a 15% increase last year, we also saw improved performance in more discretionary categories.

Both the home products category and the seasonal and electronics category increased nicely this year reflecting a strong focus on compelling price points, better in store presentations, and improved marketing support.

After several quarters of declining sales, sales in the apparel and accessories category were flat this quarter. Through our space realignment initiative, and inventory management efforts, we have reduced inventory levels in this category by more than 15%.

Given these significant reductions, we are pleased that sales of apparel have stabilized. As a percentage of sales, consumables increased 10 basis points to 60.8% of sales, as compared to 60.7% of sales last year. I would note that the second quarter typically has the highest mix of discretionary sales.

Less pressure from an adverse sales mix combined with higher purchase mark-ups resulted in a greater than expected expansion of gross margin. As we continue to leverage our pricing capabilities and begin to expand our assortment of private label products, we are seeing an impactful benefit on our cost of goods.

Reductions in markdowns, freight expense, and inventory shrinkage also contributed to the 175 basis points of gross margin expansion during the quarter. As a reminder, during the second quarter last year, we incurred approximately $8 million in inventory write-offs for products containing low levels of lead and phthalates, due to the passage in interpretation of the Consumer Products Safety Improvement Act.

SG&A expense as a percentage of sales, decreased approximately 20 basis points during the quarter. Reflecting our ongoing efforts to manage inventories, increase employee retention, and improve processes, we continued to benefit from favorable trends in our Workers’ Compensation and general liability costs.

The net impact during the quarter was about 30 basis points of leverage, which helped to offset the impact of additional store labor related to expanded store operating hours. In addition, our ongoing energy management efforts resulted in lower utility expenses, which offset higher maintenance and repair costs related to the extreme winter weather we’ve experienced this season.

Turning now to the balance sheet and cash flow statement, we continued to manage inventory levels well, especially in discretionary categories. At the end of the second quarter average inventory per store was approximately 10% lower than last year.

We continued to produce strong cash flows, generating about $317 million in operating cash flow during the first half of fiscal 2010. As we have 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 have invested approximately $83 million in capital expenditures this year, compared with $62 million last year.

For the full year, we now expect that capital expenditures will be between $190 and $210 million reflecting additional investments in store fixtures and distribution center enhancements to support our efforts to expand and tailor our merchandise assortments.

Year to date we have also funded approximately $37 million in dividend payments. As a reminder in January our Board of Directors approved a 15% increase in the quarterly dividend. Finally I would note that we accelerated our stock buyback program this quarter, purchasing about three million shares in the open market during the quarter for a total cost of $91 million.

In addition during the second quarter we entered into a structured agreement to purchase an additional $50 million of stock. Under this agreement our agent will purchase shares in the open market and deliver them to us at specified intervals during the contract term.

The actual number of shares purchased will be based on the volume weighted average price during the purchase period, less an agreed upon discount. At the end of the second quarter we had $296 million remaining under current repurchase authorizations.

Now let’s turn to our outlook for the third quarter and full year, since the fourth quarter of fiscal 2009, we have seen a gradual escalation in our comp performance, and we expect this acceleration to continue through the second half. As Howard will discuss further, we continue to invest to drive revenue growth.

Specifically, we are expanding our assortment of traffic-driving consumables and increasing our marketing efforts. These changes combined with the completion of significant initiatives including our point of sale refresh and expanded operating hours, should result in the continued acceleration of comp growth through the second half of fiscal 2010.

While we expect that the expansion of consumables will result in greater top line growth, it will most likely also result in greater mix pressure. I would also note that the cost of diesel, which has been favorable for the last several quarters, is now higher year over year.

As a result of these trends we expect that the pace of gross margin expansion will slow in the second half. In addition our investments to drive top line growth to include expanded operating hours and ongoing space realignment efforts, will most likely result in additional expense growth and may constrain our ability to leverage SG&A at the lower end of our sales guidance.

Overall we expect continued operating margin expansion through the second half. Regarding the third quarter we’re off to a great start. As we disclosed in our press release this morning, comp sales for the March period increased approximately 11%.

For the third quarter we expect that comp sales will increase 6% to 8%. I would remind you that the holiday shift which benefits March will adversely impact April sales results. Based on our current sales, margin, and expense expectations, we estimate that earnings per diluted share for the quarter will be between $0.71 and $0.76, compared with $0.62 in the third quarter of fiscal 2009.

For the full year, we expect that earnings per share will be between $2.48 and $2.58 compared with $2.07 in fiscal 2009. Now I’ll turn the call over to Howard for some remarks.

Howard Levine

Thank you Ken, and good morning everyone. This morning we reported stronger than planned results for the second quarter. These results reflect our successful efforts to provide our customers with more vale, more convenience, and a better shopping experience.

In 2006 we began to slow new store growth and shift our investment focus to improve the [shopability] of our stores and strengthen our financial model. Since then we have invested significantly to improve processes, build merchandise capabilities, and stabilize our work force.

And these investments are clearly delivering results. Most notably we have increased our relevancy to the customer. Today, more customers are shopping us more frequently and spending more when they shop. We’ve expanded our assortment of consumables, increased our focus on quality, and incorporated more customer and market data into our pricing strategies to provide our customers will even greater value.

With the completion of our POS refresh, the expansion of our store operating hours, and our space realignment efforts, we have increased the convenience of the shopping experience and we have reduced employee turnover to the lowest levels that I can remember, resulting in more consistent execution for the customer, increased productivity, and reduced operating costs.

And most important for our investors, we have expanded our operating margin, increased our inventory productivity, and improved our financial returns. I am pleased that we have delivered our eighth consecutive quarter of double-digit EPS growth.

While we continue to leverage the foundational investments we have made, we are increasing our focus on driving stronger top line growth. Our strategy of providing value in a convenient shopping experience has resonated well with both low and middle-income consumers, resulting in an increase in both traffic and average ticket.

While we have made progress in broadening our customer base, I believe we have an opportunity to further expand our market share. To that end, we are increasing our investments to broaden the appeal of our assortment, increase our customer communications, and further improve the in store shopping experience.

To drive greater market share we intend to grow our consumable business while also refocusing on increasing the productivity of our more discretionary categories. To satisfy our customers’ needs better, we have made significant investments to improve our selection of consumables. For example, several years ago we began to increase our assortment of food to capture a greater share of the small fill in food trips.

We added coolers, expanded our assortment of non-perishable foods, and began implementing new technology to facilitate the acceptance of food stamps. As the economy contracted and customers increased their focus on basic needs, we continued to expand our assortment of food and other consumables. As a result of these investments, we have increased customer traffic and our share of wallet. Building on this foundation, we intend to continue to increase our assortment of traffic-driving consumables, expanding both our assortment of national brands and quality private label products.

Our goal is to both broaden our customer reach while also increasing the productivity of these important categories. While basic needs are still the primary driver of recurring shopping trips, we recognize that families want to celebrate holidays and other events in ways that are both fun and affordable.

For example, during this past holiday season, we saw that a strong focus on value combined with appealing in-store presentations in marketing can drive sales of discretionary categories. I’m particularly pleased that our seasonal electronics category increased 7% anniversarying last year’s 8% growth.

In February we applied this strategy to our home category. Our merchandising teams assembled a great assortment of quality merchandise for the home at compelling price points. Our store teams created more engaging presentations and our marketing team produced stronger customer communications.

As a result sales in the home category increased 6% during the quarter; the strongest performance that we have seen since 2007. As we indicated in our press release this morning, these trends have continued through March. We had strong sell throughs of Easter related merchandise and the early warming trend has benefited the sales of apparel.

And we continue to manage our inventory levels well, resulting in continued improvements in inventory productivity. While these results are encouraging I believe that they reflect what we have often seen during this economic recession. Consumers want to celebrate with their families but they want and need to celebrate in ways that don’t compromise their budgets.

Reflecting this focus on value, consumers continued to be sensitive to marketing, promotions, and coupons. In response we are investing in how we communicate with our customers. To reinforce our value proposition and increase awareness of, and loyalty to, the Family Dollar brand, we are working to better integrate all of our customer touch points including our print advertising, our in-store communications, and our digital media tools.

We have increased the frequency of direct communications and we have improved our in-store communications to reinforce our values and brand offering. While an appealing assortment and compelling prices influence customer satisfaction, we know that the customers’ experience in the store will often determine if she becomes a loyal shopper.

Consequently we are making improvements to enhance the [shopability] of our stores, including improved layouts, new fixtures that will facilitate stronger merchandise presentations, while reducing clutter. In addition we have upgraded our store level technology to increase our competitiveness and productivity.

Four years ago we began a refresh our store technology platform and I’m very pleased to announce that we have now completed the rollout in all stores. This platform which includes new point of sale technology enables us to accept a variety of payment choices, including food stamps, credit cards, and Family Dollar gift cards, again increasing our competitiveness and convenience.

While this technology improves the way we interface with our customers, it also fundamentally changed how we communicate, train, and drive execution in our stores. Now that the system is in place in all stores, we can more fully leverage these new capabilities to improve the consistency of our operating standards, strengthen our in store presentations, and better support our efforts to enhance team productivity and effectiveness.

In closing we continue to operate in an uncertain environment. While economic conditions appear to be stabilizing, it is unclear when we will see sustainable improvement. Several years ago we slowed growth to focus on improving returns and these investments are clearly delivering results.

We have increased our profitability, improved inventory productivity, and increased the effectiveness of our work force. As this investment cycle winds downs, we are shifting our focus to reaccelerate growth. I’m confident that our efforts to broaden the appeal of our assortment, strengthen our marketing programs, and improve the in-store shopping experience, will result in market share growth and stronger financial returns.

And now we would be happy to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Joseph Parkhill – Morgan Stanley

Joseph Parkhill – Morgan Stanley

Good morning and congratulations, first one is to ask you a little bit about your guidance for the third quarter, on the gross margin line you mention consumable mix shift in view of the fuel pressure gross margins, but you also said that March had strong seasonal apparel sales which I thought would be good for the overall company, so I was wondering if there’s anything else impacting gross margins, are you making any investments in pricing or promotions or is there something else going on there to give, for a little bit of conservative guidance.

James Kelly

I think the main issue is that the guidance is for the third quarter and as we look at the aggregate sales guidance at 6% to 8%, we’re most confident in the acceleration of our consumable sales growth and that’s a result of a number of initiatives that we just mentioned but the space realignment has given us more space to dedicate and broaden our assortment in those categories.

And we’re seeing excellent acceleration of our consumable sales. So in providing guidance I think we reflected the sales that we had the greatest visibility to. While we’ve seen some improvement in the discretionary area I think it may be a little premature to become overly optimistic as to the state of the consumer as it relates to the discretionary sales area.

We have worked hard in those areas and we’re very well positioned to respond to our customer needs but we’re simply not projecting a further acceleration of discretionary right now. That results in an adverse mix shift in the third quarter as consumable sales acceleration exceeds what’s currently expected in the discretionary area.

Joseph Parkhill – Morgan Stanley

And then your confidence in the consumables sales, is that driven through the stores that have been realigned or throughout the entire base and can you give us an update as to how those stores that have been realigned are performing versus the rest of the chain.

James Kelly

Those stores that we have repositioned space to be able to invest more aggressively in consumables are doing quite well, but what we are seeing is a broad based trend because still other stores we have implemented the store of the future technology and for the first time are able to accept food stamps.

So we have a number of initiatives that are successfully driving our comps.

Joseph Parkhill – Morgan Stanley

Have you also implemented new apparel merchandising over the past few months and can you give your outlook for that.

Howard Levine

What we’ve seen and maybe ought to start with the conclusion of the fall/winter season, as a basis, we saw excellent sell throughs through the second quarter on our fall and winter categories. Our inventories are really squeaky clean in those areas and it enabled us to position our spring /summer categories in a very nice way in our stores where we didn’t have clutter.

We had nice clean presentations there and as you would expect with this warmer weather we saw some nice results of sales in the month of March which we hope continues through the quarter.

Operator

Your next question comes from the line of Deborah Weinswig - Citigroup

Deborah Weinswig - Citigroup

Thanks so much for the detailed call and congratulations, can you talk about the home events in February and the success that you had there.

Howard Levine

We’ve had home events in our stores in prior years and its seen gaining momentum in those presentations. As the economy slowed we were impacted somewhat but as we looked at what the opportunity [brang] we talked to the merchants, we got our store teams together and we started with a great assortment of goods that our merchants sourced.

It then was shipped to our stores and presented in a great way and if some of you had a chance to see some of the merchandise particularly some of our private label indoor by design merchandise, I thought it was fantastic. I thought the value that we offered there was the best I’ve seen in years and I think the customers appreciated it and were able to treat themselves without breaking the budget.

We look to continue similar approaches throughout the year but in the home category something that has been very slow during the economic recessions, we were very excited to see when we have all cylinders clicking properly what that brings to us.

James Kelly

I think to add on to that comment, one of the things that we did as a part of project accelerate which is when we restructured our merchandising process, is look at the flow of inventory particularly between seasons. And what we saw was a great opportunity here to adjust the flows to provide an improved presentation of merchandise that our customers are buying.

So while we were double-digit down in some categories such as apparel as a result of these flow changes, we actually improved our relative investments in our relative presentations in other areas such as the home.

Deborah Weinswig - Citigroup

And then on the advertising front I think that there’s a lot that you’re testing right now but there’s also kind of a mid month incremental advertising that you’re doing but it sounds like there’s a lot that you’re doing online, can you just maybe draw up for us what you’re doing, what’s working, and in addition to that might you be considering a loyalty program at any point in the game as well.

Howard Levine

You’re right, our marketing area continues to evolve and if you’ve listened to me through the years the way we’ve looked at marketing is to utilize it during the seasons to present new seasonal merchandise to our customers, let them know what’s new and different in our stores and obviously we have a lot of things going on that is new and different that we do want to communicate to our stores.

But we continue to test different things particularly online. We’re just starting to get some traction there but have a long way to go with that area. We continue to utilize circulars, not only at the first of the month, but during the middle of the month. But we’re a little more surgical in our approach there and in deployment to try to place these ads in the right areas.

Something else that you’ve seen on the marketing front is an improved in-store signage, very pleased with some of the things particularly in some of the food areas and with the introduction of our new [Kidgits] private label. We’ve gotten off to a great start with that and I think I attribute a lot of that in addition to the great merchandising, to some of the presentation, some of the signage that we’ve been able to integrate there.

So, we’ve invested in our team as well. In the last few months we hired a new Senior Vice President of Marketing, brand new position here who’s working very nicely with our existing team. So we continue to learn, we continue to challenge ourselves but very excited about what that opportunity brings to us.

Deborah Weinswig - Citigroup

And then I think you stated in your prepared remarks that you have more customers who are shopping you more frequently, do you think its truly marketing that’s driving that, or what do you think the key drivers are of that.

Howard Levine

I think there’s a few things, I think first of all in this environment value and convenience is the place to be. A lot of people are talking that way today but that’s really been the fundamental philosophy of Family Dollar is to provide great value and convenience and as the economy has gotten tougher I think more people have appreciated what we offer there.

So we’re seeing growth in not only core customers but we’re also seeing what we call a trade in customer shopping our store which would in most cases be a lighter shopper or more medium shopper that is beginning to shop us more frequently and we believe that we have a great opportunity to continue to grow that area.

All the things that we’re doing in our stores from a merchandising standpoint, to a presentation standpoint, to the efforts to improve our quality, our in-store signage and navigational signage, I think all lead us to believe that we’ve continued to have great opportunity to grow market share with all customers today.

Operator

Your next question comes from the line of Mark Miller - William Blair & Company

Mark Miller - William Blair & Company

Good morning and job well done, two questions on the gross margins, the first as it relates to purchase markups, I know there’s a number of factors that are driving that but can you talk about the largest drivers here in this current period and then what are you seeing in terms of cost inflation on imports and how do you think that will impact the markup six to 12 months out.

James Kelly

I think when you break down the purchase markup by individual business unit or category you see that there’s still some fairly consistent improvements going on as the result of the introductions and the growth of our private label business, as a result of some of our global procurement efforts, as a result of some of our pricing initiatives.

On the other hand there is a mix shift going on and that mix shift is having or expected to have an unfavorable impact in the third quarter. In terms of globally and inflation I think that there hasn’t been any extreme pressure to date. There are spots out there that have created some challenges.

For example cotton prices have risen of late but overall I think inflation is very modest, I’d describe it as flattish at this point.

Mark Miller - William Blair & Company

My other question is on the markdowns, how much more opportunity is there for inventory reduction. The company has done a fabulous job here but I’m wondering what inning you think you might be in, in terms of overall markdown improvement through reduction of the clutter and improvement there.

James Kelly

I think we’re very pleased with the progress to date which has really come from a lot of different angles. As we move forward we see numerous other opportunities quite frankly. We think we can still make some meaningful progress in flowing our inventories differently.

I think we can make a more aggressive investment in some areas. For example we just added some new technology that was designed to enhance profitability through more aggressive investing in select number of SKUs. So at this stage I would say that we’ve really gained good traction but that traction is likely to continue.

Now it does change from season to season so I would be looking at most of the productivity gain over the next quarter or two to be more related to being able to get higher sales comp out of the same level of inventory as opposed to further inventory reductions. But there’s still quite a bit of productivity enhancing that I believe that you’ll see over the next two to three years.

Howard Levine

If I could add, one of the things that we’re really seeing and even also in the early innings on is this part of project accelerate, our assortment planning tool which we’re still very early in the utilization of that tool, as our buyers are being trained and starting to roll that out.

But what that is going to enable us to do is really tailor assortments to specific stores. So it doesn’t necessarily mean more inventory has to be purchased, it means just getting that merchandise to the stores that we think we have the best chance to selling that.

So, something that’s a very complex rollout for us but is going well and we hope to see more benefits from that initiative as well.

Operator

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

Bernard Sosnick – Gilford Securities

Could you review for us the number of stores that you expect to open and close this year.

James Kelly

I think the rough estimates are around 200 stores open and somewhere in the, what 60 to 80 stores closed.

Bernard Sosnick – Gilford Securities

Now your return on equity is probably going to be well over 20% this year, your operating margin is recovered, looks like more than 200 basis points since the low of 2005, wouldn’t this be a time as you speak about reacceleration for a reacceleration of your expansion rate and what do you have in mind. I know you’re not ready to discuss it with particular numbers for next year, but what is your thought process.

Howard Levine

I think just to point out if it wasn’t clear in our comments that the primary theme today is a shift to driving more revenue and more sales growth and really touches on three areas. We’ve been talking primarily today about the area of comp store improvement which we’re seeing some nice acceleration there in both the consumable area and improving trends in our discretionary areas.

The second area that we also believe we have substantial opportunity on is in a remodel, relocation opportunity. We are so excited about what some of our new stores are doing in terms of the layout and what that really shows the way we want our Family Dollar brand to be presented to our consumers that we will be rolling out a program that we’re not ready to talk about at this point, but going back and remodeling a number of stores.

And then finally relocations and new stores, another important part of revenue growth. As we’ve talked about many times we slowed things down. We’re seeing much better returns in our new stores. The market conditions are prime for us to really start to see an acceleration in that and in fact we are seeing increased submittals here and with the strong financial position that we do have we do plan on growing each of those categories.

And plan to provide more details in our fourth quarter call on that, but stay tuned.

Operator

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

Adrianne Shapira - Goldman Sachs

Clearly an impressive acceleration on the comps, can you give us a sense of the March, the benefit from Easter, that holiday shift, and anything else you can share with us in terms of the extended hours, what that might have helped in terms of comps gain.

Howard Levine

The trends that we’re seeing from prior quarters with an acceleration of comps continued into the month of March. We’ve got the POS rolled out to all stores. We expanded hours in almost all stores. Space realignment that we went through not only helped us with better presentation of consumables, but I think had a lot to do with our strong toy and holiday presentations and sell throughs and we’re seeing some stabilizing trends in the home and the seasonal areas.

You couple that with the focus on strong value message that we’ve talked about, we feel very good about that. There’s no question the month of March was aided by earlier Easter sales and the warmer weather and I think the best way to think about how we feel about that is the guidance that we provided for the quarter.

That way you take out Easter impact and you really get an idea of how we feel about the acceleration of our business.

Adrianne Shapira - Goldman Sachs

And then just shifting gears to the SG&A side, it sounds as if, if I understand the prepared remarks we had needed a 3% comp in the past to leverage expenses, now it sounds like we need a 6% comp, first is that correct in terms of we should expect that acceleration in spend, help us understand the sources of the incremental spend, was it the marketing that you talk about and also give us a sense of the time frame in terms of is this a third quarter or the back half of the year, how long should we expect to need a 6% comp to leverage expenses.

Kenneth Smith

I think when I think of the expenses and our comments there I really break them into two distinct buckets so we think of our core expenses, core operating expenses and we’re very pleased with how we’ve been able to manage those core expenses.

And we’ve talked in the past about that 3%-ish leverage point and we still challenge ourselves and work very hard on the core expenses. Some examples of successes we’ve had include our efforts around [e] procurement. We continue to look for opportunities for savings there.

A second area we’ve seen recent success is around our energy management systems and are pleased with our success in managing demand of energy. So we think of that side of the expense picture and continue to work to manage those core expenses and target that 3%-ish comp break-even point.

The other side is more cyclical. So it depends on the pace of your investments. So when we think the other piece of expenses, we think of our initiatives and right now what we’re ramping up is some clear investments to drive the top line and we’re seeing the successes, early signs of success for those. Examples of expenses related to those initiatives would be the extended hours.

We felt very good about early results there and we moved fast and rolled that to the entire chain by the end of February. Additional efforts around space realignment, again, carries some expenses but deliver some top line growth. And then some additional expense around customer communications or marketing and the many forms that could take.

So we do, the guidance does suggest that a slightly higher break-even point in the back half but it certainly is dependent on the pacing of our initiatives and what we’re real excited about is what those investments are driving from a top line growth. So, I think we’ll see that for the back half of this year.

Operator

Your next question comes from the line of Charles Grom – JPMorgan

Charles Grom – JPMorgan

Just a quick question thinking about the buying environment, I think you said that what you’re seeing right now pricing being flattish, can you just let us know how far out you’ve already seen orders placed this holiday already in the books, and you’re starting to look to spring 2011.

James Kelly

I think that’s right, we’re looking at quotes and solidifying transactions as it relates to this fall and we began to turn towards the spring. If you have visibility out there I’d say from a price perspective a couple of quarters out.

Charles Grom – JPMorgan

And then is that inclusive of the inbound ocean rates and freight rates that go along with that on the pricing side.

James Kelly

Well certainly we have estimates of the freight rates that we are incorporating within that, the major contracts that we execute are really a couple of months out yet.

Charles Grom – JPMorgan

And then just a quick question on the consumables push, as you think about an increased presence there in consumables, was that in the planning as you thought about your space realignment a few quarters ago or is this in addition to that.

James Kelly

I think it was largely contemplated and the space realignment was really just one of the foundation moves. As we’ve talked about there are a number of others, for example, the last couple of years we’ve been at a structural disadvantage by not being able to accept food stamps in all our stores. That disadvantage has been eliminated now as Howard said, we have rolled out new technology to all our stores.

So I think that the acceleration of our food business is incremental to the space reallocation program and also the expansion of store hours has had a nice impact primarily in the consumable area.

Charles Grom – JPMorgan

So then just to follow-up on that, in terms of thinking about adding more product to consumables, how much of the store needs to be touched, what do you flex down to put more of that product in the store.

Howard Levine

Each store is a little bit different and the way we make those sorts of decisions are on a case by case basis. Some stores are very large and have plenty of opportunity. Some stores are a little tighter that require a little more work so there’s really not a one size fits all in this.

In fact I think that’s one of the benefits that we’re seeing from this and one of the things that we feel very good about is our teams have been very capable and done a great job of doing these various layouts really on a store by store basis. And I think that again provides the foundation for future moves as we contemplate our future.

Operator

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

Meredith Adler - Barclays Capital

I have a couple of related questions about how long it takes for the customer to recognize certain changes in the business, maybe particularly extended hours, and the fact that you now accept food stamps. Is that something using extended hours for an example that even when you cycle it the customer will still be seeing [inaudible] about it and that will drive comps.

Howard Levine

I think the best way to think about that is the maturation of both of those initiatives is long. Obviously the customers that are very heavy shoppers get notice of that immediately but some of our other customers it takes a little bit longer. One of the things that we’ve really worked on if you heard our, listening to our comments today, is we’re doing a much better job with in-store signage to talk to our customers in a way that helps them understand what’s new and different.

As well as using the various marketing vehicles that we have to communicate the new initiatives that we have going on, but it takes some time.

Meredith Adler - Barclays Capital

And then just maybe a question about you made great progress in shrink and Workers’ Comp which are clearly both tied to turnover, some of that is also tied to the economy and the weak labor market, any sense about how much your own changes in your business are contributing to that reduction in turnover, that’s a hard question I know, but—

James Kelly

I really think it is difficult but we’ve been talking to you about this I think for about five, six years now. And we did an end to end process evaluation and it changed throughout in terms of how we select people, how we hire people, how we train people, how we motivate people, how we compensate folks.

All of those that had about a three year track record of generating some very meaningful positive response from our team. So the economy then arrived and I think that also tended to help solidify the base. What we are doing is we have ongoing satisfaction surveys with out team members so that we know that its not simply the economy.

They are finding Family Dollar a more compelling place to work and as a result they’re becoming a more effective team. So I think overall I can’t give you a number but we do feel very good about the fact that we’ve got a great culture here and a great team here and as a result of that our customers are finding a better place to shop and our team is finding a better place to work and I hope our investors are finding it a great place to invest.

Meredith Adler - Barclays Capital

Just one quick follow-up question about, you talked about tailoring the assortments and that that was complex, does the complexity lay at the merchants’ level or the distribution level or both.

Howard Levine

The complexity that I was referring to was the training and understanding how to use the tool. Once you understand how to utilize the tool, its been great and I’ve talked to a number of buyers who were further along in the training and you get comments like, “wow, I can’t believe I see this. I’ve never had visibility, this opportunity” and I just believe that momentum will carry on as we get further into the implementation and training of that.

And the complexity is there from an understanding and learning but once we get through that, its like anything, nothing comes easy. The hard work really pays off and I think is an opportunity for us.

Operator

Your next question comes from the line of Dan Wewer – Raymond James

Dan Wewer – Raymond James

You noted that your apparel inventory is down 15% per store, does that simply reflect the change in the space allocated to apparel, as part of the realignment effort, or do you have a fewer number of items [per round] than a year ago.

Howard Levine

There’s a little bit of it related to space realignment but most of it has to do with the flow of the spring and summer season. We started shipments of spring and summer a little later this year. When we analyzed results from last year it just didn’t make a lot of sense to have a lot of spring and summer goods in the dead of winter.

That enabled us to sell through and get better sell throughs on our fall and winter without confusing our customers and it allowed us to also get off to a great start on presenting our spring and summer in a more positive way.

So its really a combination of both of those areas.

Dan Wewer – Raymond James

And then the 10% reduction in inventory per store, that’s not just the reduction of apparel inventory, there must be a reduction in inventory in other categories. Is that simply reflecting the faster turns as you SKU more to the consumables, or do you just simply have less safety stock inventory than you needed in the past.

James Kelly

I think it reflects some of the benefits the new merchandise processes. As I relates to the seasonal items, we’ve adjusted seasonal flows and we’ve adjusted quantities and as a result during seasons such as Easter we had a much, much better sell through today.

So we need less inventory to support growing sales in those areas. In addition to that we have worked more aggressively in monitoring our inventory in all stores so that we have more aggressively exited those inventories that are residual fashion goods, so our aged inventory if you will, is at an all time low.

And then third point would be as relates to the core replenishment items, we have gotten more and more effective with our demand forecasting and that has yielded lower inventories yet higher in stock positions.

Operator

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

Scott Ciccarelli – RBC Capital Markets

Can you talk about the consistency of the sales growth and specifically has there been any change in the pace around the pace cycle that’s obviously something you talked quite a bit about just as recently as a few months ago, and then it looks like the pace of business has changed over a little bit, can you just talk about that.

Howard Levine

A couple of things there, first as we’ve talked about we do see an acceleration in our business over the last few quarters and more recently even through the month of March and on the second comment about the pace cycle, I think with our customer, when you’re dealing with low income and low middle income, you’re always going to have a pretty strong exacerbation around the first of the month and the pay period.

That is something that we continue to see, when our customers have money you can really see an acceleration. So I don’t know how much different it is from the prior quarter when we talked but it is still there and its pretty apparent.

Scott Ciccarelli – RBC Capital Markets

But its no more, no less than it had been.

Howard Levine

We don’t have a tool that exactly measures the number but as I said, when you’re dealing with low income you always will see that even in a very strong economy. I think its been exacerbated through this economic recession and I don’t really see much change in that from the prior couple of quarters.

Operator

Your next question comes from the line of John Zolidis – Buckingham Research

John Zolidis – Buckingham Research

Just have a question on your extended hours, how much do you think that benefited your comps in March and do you think that you’ve achieved leverage off the incremental store labor expenses.

Howard Levine

We’re not going to give a lot of color to the benefit from expanded hours, as I talked about we’ve seen an acceleration in our business over the last few quarters. One thing that we could attribute to that in addition to many other things is the addition of expanded hours.

We’ve gotten all stores as of the end of February, first of March, or just about all stores, under the program now and as I’ve said earlier that’s, there’s a maturation curve there which we’re looking to see the timing of, but just really getting started in that.

Operator

Your final question comes from the line of Dan Binder – Jefferies & Co.

Dan Binder – Jefferies & Co.

Couple of questions, first was on your comments about enhanced customer communications and going after accelerating top line growth, just curious where price plays into that, aside from increased marketing is there an increased promotional posture going forward.

Howard Levine

Price perception not only during promotional events but every day pricing is something is that we’ve talked about and is something that is very important for us to maintain that strong price perception. It is a competitive environment out there. We’ve grown our capabilities in managing pricing as the competitive environment has also grown.

And in a nutshell the key is to manage and improve your price perception while also improving profitability. And that is a challenge but that’s something that we’ve grown more comfortable in over time with our increased capabilities in that area.

Dan Binder – Jefferies & Co.

I know you don’t want to comment on the benefit from increased store hours, can you give us an idea of how much comp store hours were up year over year.

Howard Levine

You can see in our stores, when you walk in the store and you can see the additional hours there. We’re basically open from 8 to 9 and extended hours on Sunday in the neighborhood of 10 to 6.

Kiley Rawlins

I think we have added on average a couple of hours a day per store per day. So, we started expanding hours really in a test last summer, expanded the program to about 1500 stores in fall, and then finished up the expansion in all stores during the second quarter. So year over year we have expanded hours this year in all stores, versus no expansion last year.

Dan Binder – Jefferies & Co.

Just final question was on inventory growth going forward, you’ve done a great job of describing the various benefits in getting inventory down, just in terms of the relationship to sales going forward, should we be thinking about inventory growth relative to sales growth for the remaining part of this year as sort of half the rate of sales growth or a quarter of the rate of sales growth, any color on that.

James Kelly

I would say that we’re targeting inventory levels to be relatively flattish, so on no inventory growth, but 6% to 8% comp growth for the next quarter.

Kiley Rawlins

So that takes us to the top of the hour. Thank you very much for joining today. Unfortunately we did not get through all of the questions, but as usual, I will be available after the conference call. Again thanks for your interest in Family Dollar and have a good day.

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Source: Family Dollars Stores, Inc. F2Q10 (Qtr End 02/27/10) Earnings Call Transcript
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