Family Dollar Stores (NYSE:FDO)
F4Q10 Earnings Call
September 29, 2010 10:00 a.m. ET
Kiley Rawlins – VP, IR and Communications
Ken Smith – SVP and CFO
Howard Levine – Chairman and CEO
Jim Kelly – President and COO
Joseph Parkhill – Morgan Stanley
Meredith Adler – Barclays Capital
Scot Ciccarelli – RBC Capital Markets
Paul Trussell – JP Morgan Chase
Scott Kaufman-Ross - Goldman Sachs
Shane Palahicky - Citigroup
Mark Miller – William Blair & Company
Mike Baker - Deutsche Bank
Mitch Kaiser - Piper Jaffray
Wayne Hood – BMO Capital Markets
I would like to welcome everyone to the Family Dollar earnings conference call. [Operator instructions.] I would now like to introduce Ms. Kiley Rawlins, vice president of investor relations and communications. Ms. Rawlins, you may begin your conference.
Thank you operator and good morning everyone. 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 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, September 29, 2010. We have no obligation to update or revise our forward-looking statements except as required by law, and you should not expect us to do so.
With me on the call this morning are Howard Levine, Chairman and CEO, Jim Kelly, President and COO, and Ken Smith, Chief Financial Officer. We will begin our discussion this morning with a review of fiscal 2010, and then we'll take a few minutes to discuss our plans and outlook for fiscal 2011.
Because of the amount of information we intend to discuss, our prepared comments this morning will be longer than usual. We will of course host a question and answer session after our prepared comments, and please remember that the queue for the question and answer session will not be available until after we have finished our prepared remarks.
Before we get started with our formal discussion of 2010, I'd like to cover a couple of housekeeping issues. First, as announced in our earnings release, we will no longer report quarterly sales separate from quarterly earnings. We expect to report sales and earnings for the first quarter on January 5, 2011.
Second, I would note that the balance sheet presentation reflects the reclassification of certain insurance liabilities. In short, we had previously recorded our insurance liabilities net of expected recovery. The revised presentation includes the recording of both the gross insurance liability as well as an insurance asset related to claims. In addition, we have broken out the insurance liabilities and related assets into both current and long term portions.
Finally, I'd like to announce that we're hosting an investor update meeting in New York on October 6. If you have not received an invitation, and would like to attend, please contact me after today's call.
Now I would like to turn the call over to Howard Levine for some opening comments. Howard?
Thank you Kiley, and good morning everyone. This morning we reported another year of strong earnings growth, with earnings per diluted share for fiscal 2010 increasing 26.6% to $2.62 per share compared with $2.07 per share in fiscal '09.
We also significantly improved the shopping experience at Family Dollar to include the following accomplishments. We expanded our assortment of consumables, increased our focus on quality, and incorporated more customer and market data into our merchandising strategies to provide our customers with even greater value.
We grew our private label program, we enhanced our advertising and pricing capabilities to successfully maintain our strong price image with customers, despite a more promotional competitive environment. We reduced clutter and improved adjacencies through better inventory management and the installation of new, more efficient fixturing. Through the completion of our store technology refresh, the expansion of our store operating hours, and our space realignment efforts, we increased the convenience of the Family Dollar shopping experience.
We also made great progress in our efforts to be a more compelling place to work. We strengthened our pay for performance culture and expanded our training and development programs. As a result, we drove continued improvement in our employee retention and internal promotion metric, delivering more consistent execution for customers, increasing productivity and reducing costs.
Finally, our efforts to be a more compelling place to shop and work delivered strong results for our shareholders. Our investments to drive new growth delivered a comparable store sales increase of 4.8%, driven by an acceleration of growth in the second half. Our efforts to maintain gross margin better and contain costs resulted in 110 basis points of operating margin expansion and another year of double-digit earnings per share growth, even as we invested aggressively to position Family Dollar for future growth. And we increased our overall return on shareholders' equity to approximately 25%, the strongest level in more than 10 years.
I'm very proud of our achievements and performance, and want to recognize the hard work and effort of all of our Family Dollar team members.
Now I'll turn the call over Ken, who will discuss our financial performance in more detail, and then I will come back to review our plans and objectives for fiscal 2011. Ken
Thanks Howard. I'm going to start with a review of our full year results, and then I'll discuss the fourth quarter.
As Howard mentioned, earnings for fiscal 2010 increased 26.6% to $2.62 per diluted share, compared with $2.07 per diluted share in fiscal 2009. Strong top line growth, combined with gross margin expansion, and SG&A leverage, resulted in operating margin expansion of more than 110 basis points.
As we reported several weeks ago, net sales increased 6.3% and comp sales increased 4.8% for the year. Customer traffic continued to be the primary driver of comp sales, while the average transaction value was approximately flat, at just under $10.
While our consumable business continued to drive traffic, we also saw improved performance in more discretionary categories. We are particularly pleased that sales of apparel began to show modest growth, especially as we lowered inventory levels by more than 10% per store through our space realignment and inventory management efforts.
Gross profit as a percentage of sales increased approximately 90 basis points in fiscal 2010. This improvement was the result of a number of investments we have made to lower our cost of goods. First, our continued focus on increasing employee retention, combined with enhanced processes and exception reporting, all contributed to continued improvement in inventory shrinkage.
In addition, the expansion of our private brand assortment, improvements in our direct sourcing efforts, and the continued leverage of our pricing capabilities all contributed to improved purchase markups. And our ongoing efforts to increase inventory productivity and mitigate risk resulted in lower markdowns for the year.
Finally, lower diesel costs in the first half of the year more than offset increased transportation expense in the second half of fiscal 2010. SG&A expense as a percentage of sales decreased approximately 30 basis points for the year. Most expenses, including occupancy costs, were leveraged during the year as a result of a 4.8% increase in comp store sales and our continued focus on driving productivity improvements.
We continued to benefit this year from favorable trends in our workers' compensation and general liability costs. The net impact for the full year was about 20 basis points. We also continued to see returns from our energy management efforts, which contributed another 20 basis points of improvement in fiscal 2010.
Partially offsetting these improvements was an acceleration of investments in revenue driving initiatives, including the expansion of operating hours.
Turning now to the fourth quarter, net sales for the quarter increased 8% and comp sales increased 6.1%. Similar to the trend we saw throughout fiscal 2010, traffic was the primary driver of sales. During the quarter, consumables increased approximately 10% to 67.3% of sales, compared with 66.2% of sales in the fourth quarter last year.
Despite this mix shift, gross margin increased approximately 20 basis points. Lower inventory shrinkage and higher purchase markups more than offset higher freight expense, higher promotional and clearance markdowns, and stronger sales of lower margin consumable merchandise.
I would note that we continued to reinvest many of the cost savings from our global sourcing and private brand investments to enhance quality and protect our price image, and we have seen encouraging trends in both these metrics. These investments support our strategy to enhance our appeal to growing numbers of trade-down customers.
SG&A expenses as a percentage of sales decreased 60 basis points during the quarter, reflecting the effect of the 6% comp increase in the quarter and our continued focus on driving productivity improvements. Most expenses, including occupancy costs, were leveraged in the quarter.
SG&A expenses increased 5.8% in the quarter, driven by expenses related to sales driving initiatives including expanded operating hours, increased advertising, and expenses related to new store openings. In addition, we incurred expenses related to the launch of our store renovation efforts and the further expansion of store operating hours. The impact of these investments was partially offset by the impact of a favorable insurance settlement of approximately $9 million and lower professional fees.
Net income for the quarter increased 23% to $74 million, compared with $60.1 million for the fourth quarter of fiscal 2009. Earnings per diluted share increased 30.2% to $0.56 this year compared with $0.43 per diluted share in the fourth quarter of fiscal 2009.
Let me conclude our discussion of fiscal 2010 with a review of some additional financial highlights. Reflecting the expansion of key traffic driving consumables, as well as our efforts to improve in stocks, average inventory per store at the end of fiscal 2010 was about 1.5% higher than last year. We continued to manage inventory levels in more discretionary categories well.
We continue to generate strong cash flows, generating about $590 million in operating cash flow this year. 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 invested approximately $212 million back into our business this year, including $92 million for improvements and upgrades to existing stores, $55 million in technology related projects, $29 million for new stores, and $27 million for distribution center improvements. We also funded $79 million in dividend payments and purchased $332 million of our common stock during the year.
Now I'll turn the call back to Howard, who will discuss our plans and objectives for fiscal 2011. Howard?
Thanks Ken. While we have delivered 10 consecutive quarters of double-digit earnings growth, we are not satisfied with our relative sales performance. To close the competitive gap, we are moving faster to leverage the important progress we've made.
Several years ago, we began to slow new store growth to focus more on improving returns in existing stores and the chain overall. Since then, we completed an end to end reengineering of our merchandising and supply chain processes through our Project Accelerate initiative.
We enhanced the performance of our store teams and refreshed our store technology platform in all stores through our Store of the Future project. And through our Concept Renewal efforts, we created a store layout for new stores that was more convenient and easier to shop.
As a result of these investments, we upgraded our operational capabilities, increased profitability, gained productivity, and expanded our financial returns. More importantly, these investments provided us with a strong foundation to accelerate revenue growth going forward.
In fiscal 2010, as many of these infrastructure investments were fully implemented, we began to drive faster top line growth. We extended operating hours, and strengthened our marketing efforts. Leveraging our space realignment efforts, we expanded our assortment in key consumable categories and increased our selection of national brands. And we introduced new, more productive fixtures to reduce clutter and improve our merchandise presentations.
The result was an acceleration in comp sales from the 2% to 3% range in the first half of fiscal 2010 to the 6% to 7% range in the second half of the year. Importantly, many of these investments are expected to continue driving results in fiscal '11.
Building on these improvements, this year we intend to continue to strengthen our value and convenience proposition. In addition, we plan to reaccelerate new store growth while also launching an aggressive store renovation program.
Our new store performance has improved significantly in the last several years, as a result of stronger site selection tools as well as enhancements driven by Project Accelerate, Store of the Future, and Concept Renewal. As we indicated last year, in our fiscal 2009 conference call, these operational improvements, combined with softening real estate markets and a growing customer base, have resulted in additional opportunities for new store growth.
As our cadence of new store openings in the fourth quarter would suggest, we have begun to ramp up the pace of unit growth. In fiscal '11, we plan to open approximately 300 new stores, a 50% increase over 2010 openings. We also expect to build a pipeline to return to square footage growth of 5% to 7% over the next two to three years.
Reaccelerating new store openings is an important component of our plans to drive greater revenues, but we recognize that to deliver sustainable long term growth, we must balance growth from new stores with growth from comp stores. I'm excited to announce today that we are launching an aggressive renovation program this year.
Leveraging what we learned from Concept Renewal, enhanced merchandising and supply chain capabilities, a refreshed store technology platform, and a better trained, and more productive workforce, we are initiating a comprehensive renovation program intended to reenergize the Family Dollar brand.
While concepts and merchandise differ across retailing channels, customer satisfaction is essentially determined by three basic factors. One, can I find what I needed? Two, was the store clean and inviting? And three, was my interaction with employees pleasant?
Through this renovation effort, we intend to impact all three of these drivers of customer satisfaction. I want to give you a high level appreciation of this effort by noting the following merchandising changes. Utilizing a race track flow, we have created a store-within-a-store presentation, with more customer friendly adjacencies and improved navigational signage. With the goal of enhancing customer sightlines, while also increasing merchandising capacity, we are utilizing new fixtures that are designed to simplify restocking and recovery, while also providing greater flexibility for future merchandising mix shifts.
We have further expanded our assortment in key consumable categories, like food and health aids, while also strengthening our seasonal presentations. Finally, we have adjusted our check out to encourage more customer interaction while also supporting our shrink control efforts.
Merchandise assortment and quality are important drivers of satisfaction, but the condition of the store itself also plays a role. This renovation will not only address the interior of the store, but will also include an exterior redesign effort to help strengthen our brand identity.
Finally, customer satisfaction is dependent upon the interaction with our team. Consequently, we have increased our focus on customer service, and raised our expectations regarding store standards. Leveraging our store technology platform, we are expanding our employee training and investing in new work flow management tools.
We are implementing new employee branding to ensure that customers can find help when they need it and we are initiating a new store manager incentive program that more clearly links compensation with sales growth.
Simply put, we are launching a comprehensive renovation program that will result in more customer focused assortments and layouts, rejuvenated physical stores, and more customer-centric teams. We will discuss these improvements in more detail at our meeting in New York.
Our plan is to renovate 600 to 800 stores in fiscal 2011 at a projected cost of $100,000 to $130,000 per store. From a timing standpoint, we plan to have the first 200 completed before the holiday season begins. We initiated the process in a number of stores in August, and while it is very early, the feedback we're getting from our customers and our team members is very encouraging.
While we are making significant investments to drive revenue growth, we will also continue to pursue opportunities to further enhance our profitability and financial returns. Key areas of focus will include the continued expansion of our private brand penetration and the continued development of our global sourcing capabilities as well as our ongoing efforts to improve operational productivity.
At our analyst day last November, we articulated our goal of increasing sales of private brands, and we have made significant progress towards this goal in fiscal 2010. Over the last year, we have launched or refreshed 10 Family Dollar brands, impacting around 1,000 items. As a result of these efforts, private brand sales increased 19% to about 22% of sales in fiscal 2010, up from 19% in fiscal 2009.
And while I'm pleased with the progress we have made, we still have a significant opportunity to increase our penetration of private branded consumables. In fiscal '11 we expect to continue to enhance and develop new private brand programs with increased focus on consumable categories. And we plan to leverage our enhanced marketing capabilities to drive greater brand awareness and strengthen our overall quality perception.
Our efforts to expand global sourcing capabilities will also support our private brand goals. Since launching our global sourcing effort, we have improved the quality of our private brands through the establishment of standardized product specifications and more rigorous testing protocols.
We believe that we have additional opportunity to manage our costs better through the diversification of our supplier network, and in support of these efforts we expect to establish a local presence in China in the next several months.
Finally, we remain focused on aggressively managing our core cost structure and driving additional productivity improvements. As we have discussed in previous presentations, we look to limit the growth of our core cost structure to 2% to 3% annually. Of course, with increased pressures from energy, healthcare, and other external factors, that means we have to drive improvements in productivity, especially of our workforce, every year.
Over the last several years, we have stabilized our workforce, significantly increased our store level training, and raised our performance expectations. As a result, we have improved both our execution for the customer as well as our sales per labor hour. To help us drive further improvements, we are introducing new technology and processes to improve workflow management and leverage our labor hours more effectively.
In closing, I want to reiterate how excited we are about the opportunities that lie before us. With a strong foundation of improved capabilities in place, our team has worked hard over the last year to develop the plans we announce today. We presented our plans to our board back in April, and with their support began working in earnest to lay the groundwork to reaccelerate revenue growth.
Although the economic environment continues to be challenging, I believe that our commitment to providing customers with greater convenience, combined with our intensive efforts to improve the shopping experience in our stores, will enable us to continue to expand our market share, drive double-digit earnings growth, and improve our financial returns.
Now I'd like to turn the call over to Ken, who will provide more specific details about our financial expectations for fiscal '11. Ken?
Our expectations for fiscal 2011 reflect the continuation of the momentum established in fiscal 2010. As Howard discussed, we intend to continue to invest aggressively to increase customer traffic and drive sales growth. We will also continue to pursue opportunities to further enhance our financial results.
We expect that the new store opening and renovation plans, combined with investments we are making to drive productivity in all stores, will result in net revenue growth of between 8% and 10% and comp store sales growth between 5% and 7%.
We expect that gross margin in fiscal 2011 will be similar to fiscal 2010 levels, reflecting several offsetting factors. We believe that the investments we are making to improve quality and protect our price perception, combined with continued pressure from transportation expense, will mostly offset expected benefits from lower markdowns, the expansion of our private brand program, improvements in price optimization, and lower inventory shrinkage.
While we continue to focus on cost containment efforts, we are investing to drive stronger top line growth. Expanded operating hours, the acceleration of new store growth, and our renovation program will all result in SG&A expense growth. However, we expect to leverage these investments and expand operating margin in fiscal 2011.
Regarding cap ex, as we indicated in the earnings release, we expect that cap ex in fiscal 2011 will be between $300 million and $350 million, reflecting our new store opening and renovation plans. I would also note that we expect to begin construction on our tenth distribution center later this year. Based on these expectations, we estimate that earnings per share will be between $2.95 and $3.15 in fiscal 2011.
Before I move to our expectations for the first quarter, I would also note that our board has authorized the repurchase of $750 million of our common stock. As indicated in our press release, we intend to fund the repurchases through a combination of cash on hand, cash from operations, and potential debt financings.
We expect that the buybacks will be accretive to earnings per share and will enhance shareholder return on equity by lowering our effective cost of capital. We have not yet finalized our plans, but are currently considering a balanced cadence of repurchases over the next 12 months. We will provide further details as our plans are finalized. As noted in our press release, our earnings per share guidance for fiscal 2011 does not incorporate the effect of stock buybacks or potential debt financings.
Regarding the first quarter of fiscal 2011, we expect comp store sales to increase between 5% and 7%. While the September period is not over, we are pleased with our sales performance so far.
We expect that consumables will continue to drive sales in the first quarter, resulting in continued mix pressure, and similar to our experience in the fourth quarter of fiscal 2010, we expect that transportation costs will continue to increase as a percentage of sales. However, we expect that lower shrink and lower markdowns will offset these pressures. As a result, we expect modest gross margin expansion in the first quarter.
In addition, our investments to drive top line growth to include expanded operating hours, accelerated new store operations, and our store renovation program, will most likely result in additional expense growth and constrain our ability to leverage SG&A at the lower end of our sales guidance. Given these expectations, we estimate that earnings per share for the first quarter of fiscal 2011 will be between $0.55 and $0.60, compared with $0.49 in the first quarter of fiscal 2010.
Now, operator, we would be happy to open the call for questions.
Yes sir. We are now ready to begin the question and answer session. [Operator instructions.]
Now I've seen that the queue has filled up rather quickly this morning, and since we only have about 20 minutes left on the call, I'd ask if you could please limit yourself to one question so we can accommodate as many people as possible. Operator, can we please have our first question?
Yes ma'am. Our first question comes from Joseph Parkhill with Morgan Stanley. Your line is open.
Joseph Parkhill – Morgan Stanley
One quick confirmation. Did you mention that you would lever above 5%? But if the comp for some reason came in below that would you still be able to cut back on SG&A and still defend your operating margins?
Are you talking about for the year or the quarter?
For the year, sorry.
Yeah, I mean our plans are to lever - drive operating margin first and foremost as we look to the year, and certainly as we look at the expense leverage for the year a key component of that is the investments in revenue driving initiatives. Certainly as we move through the year we have the ability to adjust and adapt as needed be based on either macro conditions or other conditions within the business.
Okay. And just on your remodels, are these stores that you've touched before? You've done a lot of allocation of space to consumables in the past two years over half your store base. Are you focusing these remodels on stores you haven't touched? And then also you've done remodels in the past. Is there any type of sales guidance that we can look to to expect as far as a lift in these remodels?
I think in looking at the current remodel program it's much more comprehensive than any of our earlier efforts in that it deals with three different elements - our team's interaction with customers, the physical attributes of the store, as well as the introduction of a format.
This really goes back several years to our introduction of Concept Renewal, in which we first introduced a new format that featured improved adjacencies, signage, etc. At that time we mentioned that we would use that format going forward, but we needed a vehicle to roll back some of these learnings.
Over the last several years we've gone through numerous tests of various ways of rolling back some of these improvements and with this announcement this morning we're saying that in a comprehensive way we're going to roll back our best learnings around our formats and customer traffic flows, and the customer shopping experience. So I think that it will incorporate some stores that we've had different work in the past, such as some of our space realignment efforts, but it's far more comprehensive than what we have done before.
In terms of expectations we try not to put too fine a point on any individual project, but we are very excited that our customers are excited about these efforts, and we would have expectations that sales growth in these stores would be in the double-digit area.
Our next question comes from Meredith Adler with Barclays Capital.
Meredith Adler – Barclays Capital
I guess I would like to follow on a little bit on the discussion about real estate and just talk about - when you look at new stores, I'm interested in whether most of it is in moving into existing geography or are you moving into new geographies. And then I believe in the last few years you've done a lot of work actually taking a look at where your stores are positioned, where you can dense up. I was just wondering how far along are you on that and is that something that's really driving both the remodels and the new store plans for 2011.
Yes, Meredith. I think as we've talked about, number one the softening of the real estate market provides us with what we believe to be more opportunity, so we're certainly going to leverage that. But as we look to continue to grow new stores and look at the fourth quarter cadence, as I mentioned in my comments, we're encouraged by what we see there in terms of the openings as well as the new submittals that are coming in. Most of those are all in the existing operating area. To your point, to increase density, to provide better leverage from a management point of view and a marketing point of view and a transportation point of view, the state out west on the left coast is certainly out there and we are looking to open stores out in the west. Not in this fiscal year, more than likely some time at the beginning of the following fiscal year.
And then just real quickly, the new distribution center. Is that being driven by the growth, or will this actually improve the efficiency of your distribution center network?
The answer to that is that it will do both. It improves density from a transportation standpoint and is driven by our growth so this distribution center will be located within our existing operating area and is driven more from what we've seen in growth in the past, not what's coming out in California right now.
Next in queue we have Scot Ciccarelli with RBC Capital Markets. Your line is open.
Scot Ciccarelli – RBC Capital Markets
I guess my question is, you guys did provide the guidance, but I'm a little curious why you provided 5% to 7% comp guidance for the year despite what is obviously going to be a more difficult comparison and what you guys have experienced which has been a bit of volatile performance from quarter to quarter.
You know, briefly, we're excited about what we've done over the past couple of years. I agree with you there's been some volatility in our sales as we've been working very hard to improve our capabilities. As we discuss today we basically restructured our merchandising supply chain through our Project Accelerate process. That has positioned us to feel very good about growing comps more aggressively. Further, we've improved our store level execution. The Store of the Future has been a big part of that. So we're very pleased with what we've done there.
Additionally, as we've talked about, we've really worked hard through realignment efforts to improve our adjacencies. We've expanded consumables to adding not only national brands but growing our private label. We've increased our store operating hours. More recently, we've expanded our hours even further. We're looking to see continuation of that. We've basically reworked and remerchandised the whole center aisle of our store. We've expanded our marketing. Our in-store signage has shown great promise and is proving a lot to help our customers navigate through our stores.
We've launched this aggressive renovation program and we're talking about spending $100,000 to $130,000 per store. For any of you that have followed us historically, that is quite a number, and what that does is addresses the three components that we think are really important to position us for future growth. We're addressing the physical plant of the store to include the façade, new exterior signage. We're really cleaning up the store on the inside as well with the new layout that we're very excited about that addresses a number of the shortfalls we felt we had with our assortment. And we continue to grow our private brand. So we think we've done a lot to try to position ourselves for that growth.
No question it's aggressive, but when we met with our board, and we've been meeting with our management team, it's something that we feel we need to do from a competitive standpoint. The environment, while challenging, has given us a lot of confidence that we've navigated and survived and operated very nicely through what was the toughest economy in many many years. So we feel very good about the opportunities, but at the end of the day it's all about execution. So we're going to be focused very hard on executing these programs and looking forward to reaching our goals.
Next in queue we have Charles Grom with JP Morgan Chase. Your line is open.
Paul Trussell – JP Morgan Chase
Hi it's Paul Trussell on for Chuck. Just a question on your margin guidance. If you can just take a minute or two and kind of go back over some of the puts and takes when it comes to merchandise margins being flat over the coming year. Obviously we're seeing the pace of expansion slow, but just would like to hear a little bit more on the headwinds and tailwinds you see in the first half and what you're expecting in the second half. And then from an expense standpoint, you also spoke about core expense growth of roughly 2% to 3% but obviously with all the initiatives there has been more of a mid-single-digit pace over the last two years or so. Can you kind of give us an idea of what we should think about in terms of the ramp up with the remodels and the new stores for this upcoming fiscal? Thank you.
Okay, let's break those in two. If we start with gross margin and I think the themes as we think about them are fairly consistent as we look to each of the quarters of fiscal 2011. I think the first thought there is we are very pleased with the results we're seeing out of our efforts around our private brands and program as well as global sourcing. And we are reinvesting the savings we're getting there into quality and really strengthening, maintaining our strong price perception.
So we look for that investment, the gains to continue to be invested as we look to next year. We do expect consumables to lead the way. That being said, that tends to put some mix pressure on the margin line and as we look out towards '11 expect that to continue. We look for both markdowns and shrinkage to continue their trends, which is to give us some benefit there, so we continue to look for those trends to continue as we move to '11. And freight is the one area that as we saw in the fourth quarter we expect that has to shift and it indeed has from a tailwind in the first part of 2010 to a headwind starting in our fourth quarter, and we see that as a headwind on gross margin as we look to 2011.
So those are roughly the puts and takes. The net effect is in the first quarter as we said we expect modest gross margin improvement. As we get out into the rest of the year obviously the further we go out there's a bit more uncertainty and we're modeling flattish gross margin rate for fiscal '11.
From an expense perspective, I think the key theme around expenses is the investment to drive the top line, and we see that in the form of extended hours, ramped up new store growth and the strong renovation program that we're launching. So all of those, while they do add a bit of expense, are - we're looking for nice strong returns out of those and we look for those to drive the top line.
On the other side, our core expenses, we do have aggressive plans to manage those core expenses in that 2% to 3% range and continue to look for opportunities such as outsourcing, examples being in our maintenance area, and continue cross functional cost controls within our core expenses. So we'll continue to do that. Obviously your point is well taken with the investment agenda. All in, that comp leverage point does move a bit north of our 2% to 3% focused on the quarter.
Our next question comes from Adrianne Shapira with Goldman Sachs.
Scott Kaufman-Ross - Goldman Sachs
Hi, this is Scott Kaufman-Ross on for Adrianne. I just wanted to ask a question on the square footage growth. You obviously said the 300 new stores next year. Assuming that you have a similar level of closures in the year, that would get you about 3.5% square footage growth, and then you said it could get up to about 5% to 7% in the next coming year. So just kind of wondering if I'm thinking about that the correct way in terms of the closures and 3.5% level for this year and then expanding potentially in 2012.
Yeah, I think you're in the ballpark.
Okay, great. And then just a followup on the repurchase. You mentioned that the cadence, you think that might be about balanced and you're still working through that. Would that be all this year for the 750?
What we were thinking was over the next 12 months is what we were currently thinking and as we indicated we're still working through our plans at this time and as we work to finalize those plans we'll look to provide further updates.
Next in queue we have Shane Palahicky with Citigroup. Your line is open.
Shane Palahicky - Citigroup
Hi, calling on behalf of Deborah Weinswig here. Just wanted to - had a quick question, just to kind of go back on your view of the consumer. And just wondering what the trends in terms of apparel are going to be. Obviously it was growing in the second half and just wanted to see how that's going to continue going into 2011.
Sure, I'll take that. We were very pleased as we worked our way through the spring summer selling season. One of the stronger years we've had in a while. I think some of the initiatives that we've been talking about have really taken hold from our customers. As we move into the back half of the year, the fall and winter selling season, which is a much more condensed, tighter selling season, we think we're well positioned and look forward to continuing the improvements in GM, ROI, and sales in that category, despite some of the reductions in space that we've made through our realignment programs. We think that's a pretty decent performance. Candidly, I think we still have opportunities to do even better and look forward to getting the renovation program out there and our continued improvements in the apparel area.
And then, sorry, then just going into next year as well?
Yes sir. I would say the same thing for next year, looking to make continued improvements, continuing to redefine the roll that apparel plays in the dollar store space today, and looking forward to seeing continued growth.
Next in queue we have Mark Miller with William Blair. Your line is open.
Mark Miller – William Blair & Company
I like the idea of increasing the accountability and incentives for store managers. As you're looking to tie that more to sales, I was wondering what you think might be the risk of managers adding more inventory. I'm sure you thought of that, so my question is really how do you ward against it?
Our inventory flows are centrally controlled, so I don't think there's risk that store managers will adversely impact inventory. On the other hand, I think they can positively impact the sales and the customer environment in our stores, so we wanted to expand our incentive program, which is a [bonus] program that deals not only with the relative profitability of the store as controlled by the store manager but also a stronger focus on top line growth.
Just another quick one. As you're stepping up store expansion, in your pro formas what do you assume will be your sustainable comp growth for the period of the rental agreement?
What we model as we look at new stores as a maturity over the three to four year period we see comps above the chain average. So there's a clear maturity of a new store. Our new stores do tend to start with sales in the neighborhood of 90% to 95%-ish of average, so we look for above that maturity curve to go over the first three to four years of a store's life and be above company average.
I understood the ramp. I guess I was just wondering kind of from here what kind of comp growth you'd be looking for. Thanks.
I guess I would just leave that without giving specific numbers. It would build on top of our full company guidance and we would look for those new stores to contribute to above-average comps.
Yeah, Mark, the basic longer term formula that we try to focus on is a balance between comp store performance and new store performance. Both in that mid-single-digit range. So the new stores will enhance the overall chain comp. The renovated stores will enhanced the overall chain comp, but I would say that that mid-single-digit is reinforced by those in other activities, and would be a broad view of what we see going forward.
Our next question comes from Mike Baker with Deutsche Bank. Your line is open.
Mike Baker - Deutsche Bank
So I just wanted to focus on the first quarter if I could. First of all, the 5% to 7% guidance. As I recall last year September was the strongest month of the quarter by far and then things faded, so how do you incorporate that into your guidance? In other words, I guess what I'm really asking is, are you in that 5% to 7% range now for the quarter? Or are you below it, but expect it to ramp because comparisons get so much easier? And then also on the gross margin, can you just reconcile positive gross margins in the first quarter, flat for the year, which presumably means down at some point. I guess what's different in the first quarter on the gross margins than the rest of the year, particularly as now you're cycling up against the freight being harder?
Okay, as we said from a first quarter sales perspective, September isn't quite finished but we are pleased with what we've seen. So you recognize the cadence of last year's. I think we're pleased with how September started and would say it is in line with our first quarter guidance. I think the themes from margin hold true throughout the year. I think it's a subtle difference. When we look at modest growth in the margin rate in the first quarter to what I'll call flattish as we move further out. I would suggest part of it's a bit of timing as we look at some of the key components to include markdowns. Freight is uncertain in nature, and we are modeling it to continue to be a headwind throughout the year. If the themes for margins throughout the year follow the themes we see in the first quarter would suggest it's just a subtle difference in the levels of increase.
Next in queue we have Mitch Kaiser with Piper Jaffray. Your line is open.
Mitch Kaiser - Piper Jaffray
Just in thinking about the comp guidance for the year, certainly a lot of initiatives on improved merchandising and store format and the store remodel program are helping. You've got the extended hours. But could you just give us your view on your core consumer and some of the impact that the stimulus might be having on that customer, and what your view is embedded in the guidance range for this year?
Mitch, I think when you take a look at the consumer today, low income consumers have been struggling for quite a long time now, and have been struggling and I think have really appreciated some of the value and convenience that we offer. Additionally one of the things we're also seeing is that continued trade down impact as more middleish income consumers are starting to shop with us. We think that we have a great opportunity here to try to get some stickiness to that customer and when you talk about all the initiatives to include the renovation program, our new layout, the way we're addressing our assortment, the quality improvements, the expanded hours, etc. etc., I think that we are well positioned to keep some of those customers. Everything we're doing is to create a better shopping experience for not only the low income customer but for all of our customers, so there's nothing that would be offensive to any of the customers shopping in our stores. In fact I think if anything there's some great benefits, some improvements there. So our consumer is still challenged. I'm not sure what happens from the stimulus. I'm assuming your comment means that some of that was a benefit to our customer. I don't know that the verdict is out on that yet, frankly. What we're doing is looking for continued choppiness out there and think that we're well positioned to grow our business during that type of environment.
I think we have time for one more question.
Our final question today comes from Wayne Hood with BMO Capital. Your line is open.
Wayne Hood – BMO Capital Markets
Howard, I guess when you look back at this industry overall, any time there is an acceleration with new store growth or remodels there's - as you mentioned earlier in your comments, there's execution risk, and I guess can you deep dive into that a little bit more? Because you're asking a lot of the stores organization and you're saying shrink is actually going to improve, which typically it doesn't improve. So can you talk about that? And then on the remodel side, how much - if you get those remodeled stores up to the chain average - what impact just by having those remodels up to the chain average would have on the overall consolidated margin?
Let me start by saying that, as we've talked about, if you look back over the last few years, after some pretty rapid store growth and even going back to the '90s, where we had some very aggressive remodel programs. Nothing to the scale that we're doing today, but still very very strong. We had some great comp, so I also want to point out that there is opportunity when we do attack something like we're doing here to grow our business. I always qualify something as major as this that there's execution risk.
I think we've done a good job of trying to mitigate as much of that as possible with all of the investments we've made over the last couple of years to include all the Store of the Future, to include Project Accelerate, all the in store operational execution problems and issues that we've worked on to improve. Having stability of our work force has been a very big help of getting some of the training fully implemented throughout the company.
So we're always sensitive to the potential of execution snafus, but I think today we're very well positioned to work through those, make adjustments as we see fit. One of the things that we mentioned is we're going to have 200 stores completed pretty soon. We're almost done with almost 100 to date.
What we're going to do is monitor those through the holiday season, and I can promise you we'll have some tweaks and some adjustments that we'll make as we go forward, but are very excited about how we're positioned and the way we've enhanced our management team to ensure better execution throughout the process. So we're excited but certainly appreciate the comments and the caution in terms of execution, but as I've said we feel very good about where we are today and are ready to reaccelerate growth.
I think we've the top of the hour, and unfortunately we didn't get though all of the questions, so of course as usual I'll be available after the call for any followup questions. As a reminder we are hosting a meeting in New York next week. We'll talk about the renovation program and provide some visuals that I think will help you all get a better sense of what we are planning to do. We look forward to sharing that in more detail with you then. Have a good day.
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