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Executives

Kiley Rawlins – VP, IR and Communications

Howard Levine – Chairman and CEO

Ken Smith – SVP and CFO

Jim Kelly – President and COO

Analysts

Dan Wewer – Raymond James

Adrianne Shapira - Goldman Sachs

Vincent Sinisi - [BAM Maryland]

Meredith Adler – Barclays Capital

Charles Grom – JPMorgan

Scot Ciccarelli – RBC Capital Markets

Patrick McKeever – MKM Partners

Deborah Weinswig - Citigroup

Joseph Parkhill – Morgan Stanley

Family Dollar Stores (FDO) F1Q11 Earnings Call January 5, 2011 10:00 AM ET

Operator

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.

Kiley Rawlins

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, January 5, 2011. 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 our results for the first quarter of fiscal 2011. Then we'll 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. In consideration of others on the call, please limit your time to one question and one followup question if necessary. Remember that the queue for the question and answer session will not be available until after we have finished our prepared remarks.

Now I'd like to turn the call over to Ken Smith. Ken?

Ken Smith

Thanks Kiley, and happy new year everyone. This morning we reported sales and earnings results for the first quarter in line with the guidance we provided at the end of fiscal 2010. As expected, net sales increased 9.5% to just under $2 billion, and diluted earnings per share increased 18.4% to $0.58.

Reflecting the impact of investments we are making to drive revenues, comp sales increased 6.9%. Similar to the trend we saw throughout fiscal 2010, customer traffic continued to be the primary driver of sales.

During the first quarter we opened 85 new stores and closed 18 stores, compared with 43 openings and 33 closings in the first quarter of fiscal 2010. We are well on our way to meeting our plan of 300 new stores this year, a 50% increase over last year.

Taking a look at sales by category, we continued to build momentum in all merchandise categories. However, sales of consumables continued to be the greatest driver of sales this quarter, reflecting double-digit growth in food. As a result, consumables increased to 67.9% of sales in the first quarter, compared with 67% of sales last year. As a reminder, in the second half of fiscal 2010, we expanded our assortment of grocery items, adding a number of national brands.

While sales came in at the upper end of our expectations, gross margin was pressured a bit more by merchandise mix than we originally planned. Gross margin as a percentage of sales declined 10 basis points in the first quarter to 36% of sales, compared to 36.1% last year.

This modest decline in gross margin was primarily a result of strong sales of lower margin consumable merchandise, especially national brands and higher freight expense. We continue to reinvest many of the benefits from our global sourcing and private brand investments to enhance the quality and appeal of our assortment. And of course, diesel costs continue to be volatile, reversing many of the tailwinds we saw last year.

The pressure from mix and higher freight expense was mostly offset in the quarter by lower inventory shrink. I would note that this is the ninth consecutive quarter of shrink improvement. I'm also pleased to report that our team did a good job managing core operating expenses this quarter. As a percentage of sales, SG&A expense decreased 15 basis points during the quarter, reflecting the effect of the 6.9% comp increase in the quarter and our continued focus on driving productivity improvements.

Most expenses, including occupancy costs, were leveraged in the quarter. These improvements were partially offset by investments related to expanded store operating hours, store renovations, and increased marketing efforts. In total, these investments pressured SG&A expense by about 90 basis points during the quarter.

The effective tax rate during the quarter was 37.3%, compared with 36.6% last year. The increase in the effective tax rate was due primarily to a decrease in federal jobs tax credits.

Let me conclude our discussion of first quarter results with a review of some additional financial highlights. Starting with inventory, average inventory per store at the end of the quarter was about 8% higher than last year. This increase reflects our ongoing efforts to improve in-stocks, as well as our investments to support the expansion of key consumables categories. I would note that we continued to manage inventory levels and more discretionary categories well.

Turning to the cash flow statement, as we have previously discussed, our first priority for the deployment of capital is to reinvest in our business to drive higher financial returns. Reflecting this focus, capital expenditures were approximately $39 million during the quarter, primarily to support new stores and store renovations. We also funded about $20 million in dividend payments and purchased $258 million of our common stock during the quarter.

As a reminder, in late September our board authorized the purchase of up to $750 million of our outstanding common stock, and we continue to expect to complete this authorization by the fall of 2011. As we have previously indicated, we intend to fund these repurchases through a combination of cash on hand, cash from operations, and potential debt financings. I would remind you that the terms and availability of debt financing will depend on market conditions.

In early October, we took an initial step toward the completion of the repurchase authorization with the execution of a $250 million accelerated share repurchase, or ASR, transaction. This transaction should settle sometime in the second quarter. Reflecting the financing of the ASR with cash on hand, our cash balance at the end of the first quarter was about $85 million compared with approximately $366 million at the end of the first quarter last year.

Now let's talk about our expectations for the rest of fiscal 2011. This morning we fine-tuned our fiscal 2011 earnings guidance to include two factors. First, reflecting our performance year-to-date through December, we have reduced the top end of our earnings guidance by $0.05. Second, we have included the estimated impact of the continuation of our stock buyback program, which increased our guidance by about $0.04. As a result, we now expect that diluted earnings per share for fiscal 2011 will be between $3.08 and $3.23.

Now let's discuss our expectations for the second quarter in more detail. As discussed in our press release, December comp sales increased about 4% on top of a 4% comp increase last year. While our December results were good, they were slightly softer than we had planned.

Reflecting December results and our expectation that sales in January and February will be more consistent with first quarter trends, we expect that comp store sales for the second quarter will increase between 5% and 6%. Similar to trends we saw in the first quarter, we expect that gross margin will be pressured modestly by a higher mix of consumables and higher freight expense, and that SG&A expense growth will continue to reflect our investments to drive revenues.

Given these expectations, we estimate that earnings per share for the second quarter of fiscal 2011 will be between $0.92 and $0.97, compared with $0.81 in the second quarter of fiscal 2010. I would note that our guidance assumes that the weighted average diluted shares for the second quarter will be around [$]127 million.

For the full year, we continue to expect that our new store opening and renovation plans, combined with investments we are making to drive productivity in all stores, will result in net revenue growth for the year of between 8% and 10%, and comp store sales growth of between 5% and 7%.

We continue to expect modest operating margin expansion for the year. We expect that mix, higher freight expense, and our continued focus on increasing quality will continue to pressure gross margin. We expect that these pressures will offset expected benefits from the expansion of our private brand program, improvements in price optimization, and lower inventory shrinkage. As a result, we believe that gross profit as a percentage of sales will be approximately flat for the full year.

While we continue to focus on cost containment efforts, we are investing to drive stronger top line growth. We expect that investments in expanded operating hours, the acceleration of new store growth, and our renovation program will result in annual SG&A expense growth of around 8%.

Reflecting current trends, we now expect that our tax rate for the year will increase slightly to about 37%. We continue to expect that cap ex for the year will be between $300 million and $350 million, reflecting our new store openings and renovation plans. I would also note that we expect to begin construction on our 10th distribution center later this year.

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

Howard Levine

Thank you Ken, and good morning. I hope everyone had a safe and happy holiday. Ken has taken you through our financial results. Before I provide an operational update, I'd like to provide some additional color on our December results.

December comps increased about 4%. Consumables continued to drive sales during the period, but sales and discretionary categories were more mixed. We saw good results in key holiday categories like toys and seasonal, but we saw some softness in other discretionary categories like home.

Leveraging our niche of value and convenience, we are working aggressively to improve the Family Dollar shopping experience and broaden our appeal. Our recent sales and traffic trends indicate that our investments are having a positive impact.

As we outlined on our fiscal 2010 year-end conference call, we have put together an ambitious plan this year to drive greater revenue growth and expand our market share through both accelerated new store expansion and strong comp store sales growth.

In fiscal '11, we plan to open around 300 new stores and more importantly we are building the pipeline to return to square footage growth of 5-7%. We're off to a good start this quarter with the opening of 85 new stores. As I have indicated before, reaccelerating new store openings is an important component of our long-term plans. But to deliver sustainable long-term growth, we must balance growth from new stores with strong sales growth from comp stores.

As expected, many of the initiatives we launched in 2010 continue to deliver results. As a reminder, last year we extended operating hours, expanded our assortment of key consumable categories, and introduced new, more productive fixtures. Each of these investments continues to contribute to our comp store performance.

Building on these investments, we are launching a multi-year renovation program that I believe is a significant transformation for us and will enhance our competitiveness and drive sustainable improvements in productivity. Building on the learnings from our previous concept renewal efforts and leveraging enhanced merchandising and supply chain capabilities, a refreshed store technology platform, and a better trained and more productive workforce, we are working hard to strengthen the Family Dollar brand.

Our vision is to holistically transform the customer shopping experience through significant improvements to the merchandise assortment, the physical store, and most importantly the way we interact with customers. Key changes include more intuitive merchandise adjacencies and improved navigational signage; an expanded assortment of key consumable categories including food and health aids; the utilization of new fixtures that enhance customer sightlines, increase merchandise capacity, and simplify restocking and recovery; and a more customer friendly checkout area that encourages greater customer interaction while also supporting our shrink control efforts.

In addition to strengthening our merchandising presentations, we are also addressing the physical condition of the store with the goal of creating a warmer, more inviting shopping environment. We're also upgrading the physical plant, including a refresh of the building façade and exterior signage to create a more consistent brand experience.

Finally, through these renovations we are addressing the most critical element to an improved shopping experience: our customer service. We know from our customer research that customer satisfaction is highly dependent on the interaction with our team, so we continue to enhance our employee training with an increased focus on customer service and recovery, and we are investing in new labor scheduling and workflow management tools.

I believe that this renovation effort is one of the most significant investments we've ever made. In fact, it's difficult for me to adequately describe the impact of these changes without showing you the improvements. If you have a chance, take a look at the video we've posted in the investor relations sections of our website. I'm sure that you'll be as excited about the enhancements as I am.

As planned, we completed the initial 200 renovations during the first quarter. The reaction of our customers and our team members to the improvements has been very positive and as expected, these stores are significantly outperforming the rest of the chain.

I'm really excited about the enhancements we have made to the shopping experience in these stores and the opportunity to drive greater market share. As I visit these stores and talk to customers, I've heard a lot of great comments about the changes we're making, and our teams are enthusiastic and proud of the improved experience we're offering for our customers.

While these comments from customers are encouraging, we've also verified the reactions through extensive customer surveys, and our customer satisfaction scores post-renovation have confirmed that we are moving in the right direction.

I'm especially proud of how our teams have worked cross-functionally to execute these renovations. The initial phase has been a great opportunity for us to test different implementation processes and we have learned a lot from the initial 200 stores. As we go forward, we will continue to adjust the implementation process to reduce the disruption to customers, increase our executional efficiency, and reduce cost.

Based on the success of the initial 200, we now expect to renovate and additional 600 stores, for a total of around 800 stores this year. And we intend to impact all stores within the next four years.

In addition to our renovation program, we are investing to improve our in-stock position, expand our consumable assortments to include more national brands, and improve our value proposition. We are also expanding our marketing efforts and accelerating our private brand programs.

Several months ago, we began to focus on opportunities to drive greater sales through the improvement of our in-stock position in key areas. As evidenced by our inventory growth in the first quarter, we have invested in a number of initiatives to improve in-stocks. These investments are already having an impact on our sales and customer satisfaction survey results, and we continue to test opportunities to drive additional sales growth through in-stock improvement.

In recent quarters, expansion of our consumable sales was primarily realized through the addition of national brands. The expansion of national brands is a relatively quick way to increase our assortment in key driving areas and improve overall quality perception, but the growth of national brands doesn't generally contribute to gross margin expansion. Consequently, we are working aggressively to better balance sales of national brands and sales of private brands.

Our initial focus has resulted in the introduction of a few new Family Dollar brands as well as the conversion of vendor control labels. As a result, we have more control over quality standards and a greater opportunity to leverage brand value more effectively.

During the first quarter, we continued to expand our penetration of private brands. For example, today our Kidgets assortment accounts for half of our diaper sales, and this fall we introduced even more Kidgets baby care items for our customers.

We also continue to expand our assortment of Family Gourmet products. If you get a chance, try our new Family Gourmet breakfast items such as our pancake mix and syrup or our assortment of Family Gourmet coffee and creamers. I think you'll be more than satisfied by the quality and very pleased with the price.

While we have made significant progress in expanding our penetration of private brands, we want to move faster. As a result, I'm pleased to announce that we recently established a strategic partnership with a leading sales and marketing company dedicated to the private brand space. Leveraging their extensive experience and resources, we intend to accelerate our efforts to expand our penetration of private brands.

While our investments are driving nice momentum on the top line, our efforts to improve in-stocks in fast-growing categories, the growth of new consumable businesses, and our efforts to improve merchandising quality are adding some near-term pressure to gross margin. We are working aggressively to offset the impact of these trends.

The expansion of our assortment of private brands should lead to gross margin expansion over time. In addition, our investments to build an integrated global supply chain will support our private brand goals while also enabling us to reduce our merchandising costs.

Last year, less than 10% of our purchases were imported directly by us. We believe that we can reduce cost and improve quality with a better balance between direct relationships, agents, and U.S.-based trading companies. This year we have taken a significant step toward this goal with the opening of an office in Hong Kong.

Clearly, we continue to operate in an uncertain environment. Even as higher income customers have been more confident about their finances in recent months, middle income and lower income families have remained concerned or become even more anxious about their personal finances. Of course, this uncertainty is more impactful to the discretionary categories where the purchasing decision is still primarily based on "want" rather than "need."

While there are a number of things we cannot control, we can control how we impact our customers and how well we meet their needs for value and convenience. The changes we are making to broaden the appeal of our assortment, raise our operating standards, and improve the customer shopping experience are delivering results. '

Although I cannot predict the pace of the recovery, I am confident that the improvements we are making will position us to drive greater market share and sustainable productivity improvements.

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

Question-and-Answer Session

Operator

Thank you. We are now ready to begin the question and answer session. [Operator Instructions.] Dan Wewer from Raymond James, you may ask your question.

Dan Wewer – Raymond James

Question on the inventory build. I understand the strategy of adding more inventory to improve in-stocks driving extra sales, but when you look at the inventory per store, this was the fastest year-over-year increase since 2005 I believe. And further, the inventory per store is growing at a faster rate than your sales per store or sales per square foot. And it begs the question whether or not you're seeing diminishing returns from this extra inventory investment.

Howard Levine

Let me let Jim take that question. Jim?

Jim Kelly

There are a couple of things that are going on that are part of what I would refer to as the investment cycle that has resulted in a larger investment in inventory than what you've seen over the last five years. So let's kind of go through some of those things.

First, we're expanding consumables and we have been doing that, but we are more aggressively expanding and positioning ourselves to drive sales in the back half. This has been done through such things as raising the shelf heights in areas like food. We've added higher-capacity fixtures that have enables us to add SKU count and add inventory in areas such as pet.

And as you know, through various programs we've shifted space in our stores to the higher productive consumable areas. To support all of that, we've had an inventory buildup. For the most part, that inventory buildup is helping us drive sales and has been fairly productive.

Now, in addition to that, we have the in-stock program that we have invested significant dollars behind. That resulted from first, a detailed study that identified the opportunity. We then went down and identified specific actions that could be taken and have made our initial investments in that arena.

What we're seeing is in some categories response has been fairly quick. Overall, other categories' response has been a little slower, but we continue to manage and we're focused on a longer-term view in terms of the favorable aspects in stock levels.

Now, one positive thing is we just received our latest quarterly customer survey info and our customers have given us much higher marks this past quarter in the in-stock area. So we believe that the productivity of that inventory will begin to show improvement.

Dan Wewer – Raymond James

That ties into my follow up question. Looking at the high end of your same-store sales guidance for the second quarter of 6% would imply that January and February would be up more than 7%, I guess. Is this just a repeat of what we've seen over the last, say, 10 years? That is, December's a challenging month for Family Dollar, because the shift is toward discretionary items. And then in January and February demand shifts to your strength, consumables, and that's why you're so optimistic on the next two months?

Howard Levine

I think what we've seen, and just to expand upon that for a second, you're right, the month of December is very unique in that a large portion of those sales are discretionary. And as I've indicated in my comments, we had some signs of strength in some of the discretionary categories such as toys and some of the seasonal categories. Apparel was okay. We had good sell-throughs on that. Home was a little light.

But what we've seen over the years, and you're right, as you transition into January and February, they're more basic months, which is more suited to where our inventory investments have been. And I think to just expand on your first question I think having better in-stocks coming out of Christmas is actually something that in addition to some of the other things that we've talked about gives us confidence that the sales will continue to resume as they had in some of the prior quarters that we're facing.

But you couple that with the investments we've made in national brands, in the extended hours that we're facing, improved marketing, we think that we've got a realistic goal out there for the next two months and we're working very hard to make it happen.

Operator

Adrianne Shapira from Goldman Sachs, you may ask your question.

Adrianne Shapira - Goldman Sachs

Howard, maybe we could just kind of follow on with the comp outlook. Appreciate it sounds like the December slowdown you're looking for January/February to resume to Q1 levels, but when we look about the year, you kind of maintained that 5-7% for the year and yet in the back half we're obviously going to be lapping much tougher comparisons. It sounds like some of the initiatives of the expanded hours and the space realignments could wane and by that point we'd only have about 800 remodels in the fleet. So kind of help us think about your confidence in the 5-7% in the back half when you're lapping meaningfully tougher comparisons.

Howard Levine

Sure. Jim is going to take that question.

Jim Kelly

I think the fundamental impact is we expect a continuation of the growth of our consumables business. We have invested in that throughout the year, so much of the investments that we had were in the fourth quarter last year. For example, the refixturing, which added a lot of capacity. So we have a lot of runway relative to some very key initiatives that have been driving us throughout this current year.

The expansion of consumables is a theme now that we have been working on for several years, and I think you will see that continue as we go into the back half of the year. We're not ready to provide the exact details, but I think the cadence of that expansion of our assortment to support those key strategic areas will continue and that will provide us with further sales momentum.

As you indicated, the renovation program has had a positive impact, but as you continue to expand that it's only 200 now. With 800 stores by the end of the year that too will be positive. About a year ago we began looking at our marketing programs and have made significant changes in that area, both from a personnel standpoint and a process standpoint, and we've added different media. So those programs are becoming increasingly effective for us and we look at those as being significant as relates to the back half.

Our in-stock program as well as the expansion and growth of private brands are but two other areas. Indeed, if you look at our private brand program it's gained some fairly significant momentum. In the first quarter we had roughly a 24% increase in that area and a 30% increase in our private brand program in the consumable arena.

So I think you're going to see us linking some of our improved marketing with our improvements and acceleration of private brand to really effectively grow sales in that arena, and as you know that will also take some of the margin pressure off. So those are the key drivers that lead us to feel confident relative to our sales forecast.

Adrianne Shapira - Goldman Sachs

And then maybe a followup. My question related to just on the SG&A side. We saw a 7% comp and you levered by 15 basis points. Perhaps if you could remind us - as we recall, the leverage point that you needed, it sounded like 2-3% was core, 1-2% investment, got us to sort of a 3-5% comp to lever. And yet we only got the 15 basis points in the quarter on a 7%. So help us think through what is the right comp leverage point going forward. Thanks.

Ken Smith

I think when we do look at the expenses specifically for the first quarter and how our expenses build up, you hit on the three key buckets, which are our core expense growth, in that 2-3ish range. As we ramp up new stores, new store growth in that closer to the 3% range. And then our key investments, which are part of the overall sales driving strategy, where the key investments are in that 2-3% range.

In the first quarter specifically, we called out three specific sales driving initiatives, which include expanded hours, the start of our renovation program, along with some expanded marketing, and those three added about 90 basis points of expense to the quarter. So I think when you think of that as they key investments, then the store growth, and then our core 2-3ish growth plans of the core expenses, it lines up pretty well.

You know, when we take a bit of a longer view and look over the year, expenses did grow around 9% in the first quarter. As we look to the back half, we expect expense growth to drop a bit and our current thoughts are that expenses for the full year will grow around that 8% number. So that should give you some color as to how we think expenses will pace throughout the year.

Operator

[Alan Riskin from BAM Maryland], you may ask your question.

Vincent Sinisi - [BAM Maryland]

This is Vincent Sinisi in for Alan, and thanks for taking my question. Wanted to ask a bit about the gross margins a little bit more. I know that you folks noted that relative to your expectations the merchandise mix caught you a little off guard as well as continuation of higher freight expense. Just wondering if you could tell us, maybe for freight, what measures you're taking to try to help hedge against the higher freight costs. And then in relation to the mix part of the equation, maybe changes you're making to your marketing efforts for example that may be a help to you in future quarters.

Howard Levine

Sure, let me address gross margin at just a higher level for a second so you all can get a perspective on how we're thinking about that. First of all, we're very excited about the opportunity to expand our overall operating margin. Much progress has been made in the gross margin line over the last few years, even as our consumables business has become a greater part of the mix. We do think longer run we do have an opportunity for further improvement in gross margin. The economic recovery will contribute. Hopefully we get a more balanced mix, i.e. some help from the discretionary higher margin categories.

We're working very hard internally in our stores within our layouts and to improve adjacencies to try to get more affinities in our sales to build the basket and help the margin. We talked a lot about global sourcing. Global sourcing is still early on where we are in that area and think that has a significant opportunity to help drive our margin, as well as the growth in private brands.

Private brands thus far has not been a contributor to the gross margin expansion. What we've talked about is a very strong effort to improve the quality, to take over a better role in making sure that when we put our name on a product that we're hitting name brand equivalence there and have worked very hard and spent a lot of money to do that. We're starting to see some benefits from that, not only in the consumable areas, but also in the apparel area. I think that's been one of the areas that has helped us increase our sell-throughs with that.

Near term, there is going to be pressure on our gross margin. We've talked about flattish gross margin. We've talked about flattish gross margins for the year. With the growth of the national brands and the expansion of our consumables, we will feel some pressure, but over the long haul we do continue to believe that there's greater opportunity to improve our margins.

Vincent Sinisi - [BAM Maryland]

And then as to my followup, Howard, you mentioned that the initial 200 renovations that were completed are significantly outperforming the rest of the chain, and now you're on track for the 800 of initially the 600-800. Just wondering if with those initial 200, have your learnings from those kind of given you the direction now or confidence where as you go forward - I know at the start you were testing different ways of completing the renovations. Do you feel like you've kind of hit that sweet spot where going forward you have a better grasp on exactly how to successfully complete that?

Howard Levine

Yes, I think we've learned a lot from the first 200 stores and we've more importantly seen some very, very positive comments from our customers. The results have been very positive. Sales trends continue to be positive. What we've done with this first 200 is primarily tweaked the processes to see how we can improve upon that to reduce costs and to have even less disruptions to our customers during the renovation process and we've made some improvements there. I suspect as we get going and start ramping up that we'll continue to tweak and improve upon the process there.

Additionally, as we get more time under our belt there, we'll be able to evaluate some of the merchandising changes we've made to continue to improve upon that offering along with the things we're doing in the broader chain. I think we'll see more of that start to get traction in the chain as well as in these stores.

So I hope it came out that we're very excited about what we're doing here. This is really what I would say is our new vision for Family Dollar and the role that we want to play with our customers is one that provides great value and convenience. They can count on us for quality. And I think those are the main things we're looking at through our renovation program and directionally we feel very, very positive about it.

Operator

Meredith Adler from Barclays Capital, you may ask your question.

Meredith Adler – Barclays Capital

I'd like to follow up a little bit on the SG&A question. You've obviously said that you'll see slower growth. If you're going to get to an average of 8% dollar growth for the full year you're going to be slower. Do you have any sense of how that plays out over the next three quarters? Is it more at the back end? Or do you expect a meaningful drop even in the second quarter.

Ken Smith

I think if you think of what's driving the growth and particularly the initiatives, the second quarter continues to have heavy initiatives spend from the perspective of the expanded hours continues to haven't fully anniversaried yet. So as we look to the back half that's probably where we would see more of the reduction that gets us to that 8%.

Meredith Adler – Barclays Capital

Great, and then I have a question about inventory. When you think about improving your in-stocks would you say that the increase in the inventory is product that's sitting in the back room now or have you increased the inventory at your distribution centers?

Jim Kelly

No, what we're thinking about is a number of potential opportunities. Clearly, inventory in the back room and getting it on the sales floor is always an opportunity, but we did a fairly comprehensive and extensive study to help us identify where the problems are and the in-stock or the stock being in the back room wasn't one of the larger ones. So in identifying causes for in-stock opportunities, we have kind of methodically said we're going to tackle each one based on our estimates of their potential impact on our customer and potential impact on our sales. In so doing, it's been more of a rifle shot than a shotgun approach and in most of the areas where we have fired a rifle we have seen that the customers noticed the change fairly quickly and sales have improved. But there still is a cycle, I think. In-stock opportunities has to be viewed as a longer-term investment.

Meredith Adler – Barclays Capital

Okay, and I just want to ask one more question if I could quickly. You were talking about your plans for stock buybacks, the other $500 million using internally generated cash, cash on hand and then some borrowings. Is there a chance that you would be borrowing even more to buy back stock? I know you want to stay investment grade, but is there the potential to do more than $500 million additional buyback?

Howard Levine

You know, right now we have a $750 million authorization that our board has approved. We're acting on that right now. Clearly if you look over time we've been a pretty aggressive buyer of our stock, but I think we've got a pretty aggressive plan out there right now and we'll contemplate future buybacks once we get through the current buyback.

Operator

Charles Grom from JPMC, you may ask your question.

Charles Grom – JPMorgan

Just trying to get a better sense for the mix here in the first quarter if you could. You comped at the high end of the range, but your EPS came only at the midpoint, maybe even a tad below the midpoint. So was it all in the margin line? Can you flesh that out for us a little bit?

Ken Smith

I think when we look at the first quarter we're very pleased with where the first quarter came in and it came in in the middle of our guidance and the midpoint of our expectations. So certainly the comp performance was strong. As I indicated in my comments, from a margin perspective there was a bit more pressure from the strong consumables sales than we had planned, and so I think that's probably the callout when we look at the first quarter. And secondly, the tax rate was a bit above the rate we had planned going into the quarter as well. So probably those two areas. But again, the first quarter I think very strong, results came in very close to our expectations, and positioned us well for the rest of the year.

Charles Grom – JPMorgan

And then as a followup to the SG&A, when you look into the 90 bps of the headwind here, it looks like about $17 million in dollars, can you break out for us how much was from extra hours, versus renovations, versus the marketing efforts and maybe give us a little bit of a glimpse of what you think will persist into the back half given that you'll start to cycle the rollout of the extra hours, I believe, in February?

Howard Levine

We're not looking to break out each of the initiatives into their detail, so the combination of the three, the color [inaudible] was that at 90 basis points. When you think of each of those three, as we go forward, certainly expanded hours - we completed the rollout to the chain at the end of the second quarter last year, so that begins to change as we look to the back half. On the other hand, our renovation program, we've done the 200 stores prior to Christmas, and are looking to add an additional 600, so that will change in the other direction and will add a bit more expense to the back half. So those two would be going in different directions. And we'll continue - you know marketing has become very key to us, and again is giving us nice returns in the additional investment we're making there, and would expect some continued investment there as well.

Scot Ciccarelli from RBC Capital Markets, you may ask your question.

Scot Ciccarelli – RBC Capital Markets

Two questions. First of all, we do appreciate the qualitative commentary and we know it's early in the process, but can you put any numbers on the renovated stores? Are you guys kind of hitting the investment amounts you previously suggested? Can you size the impact on sales or margin lift or expected ROI? Anything you can put on it in terms of numbers would be great.

Jim Kelly

Well, let me address that a little bit, but probably not in the detail you're looking for. We are very pleased with the initial 200 stores, but we have thousands of stores to do, so we're trying not to get overly enthused in terms of granular analysis while at the same time we know that directionally we like where we're going.

As Howard indicated, we've learned a lot from the first 200 stores. We're pleased with the performance from a sales-driving perspective, but part of that learning was we've identified a number of opportunities through extensive customer surveys where we can even do a better job at meeting our customer demands. So we see opportunities to continue to leverage the initial investments and actually see some opportunities to expand the contribution of those stores.

From a cost perspective, we have also discovered a number of options relative to the actual renovation program that can have a fairly meaningful impact on our cost of implementing the program as well as the potential or the obvious disruption to the customer. So we're going to minimize customer disruption going forward. We're going to deliver the renovations at a lower cost than we saw in the first 200, and we believe that there are also opportunities to even drive more sales through those.

So what all of that says, without giving you the numbers that you need, is that we're hitting our return on investment targets and we expect to further improve those targets going forward.

Scot Ciccarelli – RBC Capital Markets

And then the other question is just on cap ex. It looks like cap ex was a little less than $40 million this quarter, but you're still calling for what looks like $90 million a quarter on average for the balance of the year. Is there some timing stuff in there? Is that the DC that's hitting incrementally? Because it looks like your store openings were kind of on plan.

Ken Smith

Yeah, I think you hit it on the head there. It is a timing issue. When you think of the key drivers of cap ex, you think of our renovation program, ramped up new stores, as well as the beginning of a tenth DC. And most of the dollars for those key drivers are post-first quarter. So we still feel that we're looking at that $300-$350 million for the year, but the first quarter tends to be a bit lighter.

Operator

Patrick McKeever from MKM Partners, you may ask your question.

Patrick McKeever – MKM Partners

On the expanded hours, it sounds like you'll cycle the big piece of the rollout at the end of the fiscal 2nd quarter. But did you then raise or expand the hours further later in the fiscal year last year? So that's my first question. Then just secondly, any - I know you've been reluctant to talk about the benefit to sales from expanded hours, but I'm wondering if you could provide any color on how much that has been helping sales over the past few quarters and how the cycling of the big piece of the rollout might impact comps going forward here into the second quarter and beyond.

Howard Levine

Well, the expansion of store hours has improved the relative convenience of our stores. I think intuitively you would believe that the day that you expanded hours is not the day that 100% of your customers learned of that expansion. So there's a maturation period that we are continuing to learn about, so therefore it's been a challenge to quantify [inaudible]. I would say that the expansion of store hours was one of about five or six things that have been driving comps, and that while the major expansion may be over, I would suggest to you that we still have some expanded hours that will be seen after that major anniversary and we're still testing other opportunities there. I went through a series of, I think, four or five different things that we believe will successfully drive our comp store performance in the back half and based on our analytics we remain comfortable that those are going to be successful and that we will be within the guidance that was reiterated today.

Operator

Deborah Weinswig with Citigroup, you may ask your question.

Deborah Weinswig - Citigroup

It sounds like a pretty important initiative for 2011 is price optimization. Can you talk about where you are with that and when you'll hit the sweet spot?

Howard Levine

We've made a lot of progress in our pricing area, but I'll start off by saying we have a substantial opportunity ahead of us in terms of optimization. What we've done primarily thus far is to refine the zoning process to make sure that we have the right stores in the right zones. We continue to learn about that and continue to make tweaks there, but that's been in place and I think is a big part of what we've done thus far. We've also, to handle all this, built out the group of analysts and have a leadership over the area that is an investment to us that we're starting to some nice traction between the merchants and the pricing group to understand opportunities as they may exist there. But ahead of us is still an optimization opportunity in the promotional area, also still some opportunities with everyday pricing, perhaps there's even some clearance optimization out there that we will see some benefits from in our future. But you're right, we do view the pricing opportunity as a margin play as well as ensuring, and this is probably the most important part of it, that we maintain our strong price perception in this highly promotional competitive environment that we're in. So when you look out in the future, and I know everybody knows about all the inflationary pressures that we're seeing. We feel confident that we have the right process and systems in place to evaluate and work through any of those challenges that will probably be ahead of us.

Deborah Weinswig - Citigroup

And I know that Kiley is done with the acronyms for now, but what are some of the other important technology initiatives on the docket for 2011 and beyond?

Howard Levine

We got through a major implementation on our POS this past year, so there's nothing quite as big as that, but there's a number of things that we're working on on the promotional side to drive. There's a number of things that we're doing internally with handheld devices to manage our inventory more appropriately, and a number of other projects out there that we're looking to drive productivity improvements.

Jim Kelly

I think the right way to look at that is that this is a year of optimizing the major investments in our store technology and in our merchandise technology. Howard mentioned in the promotional area, yes, we have some back office technology that we've applied there, but equally important we're adapting our point of sales to give us a lot more flexibility to manage promotional programs. So that's an example. The entire area of optimization, whether it be a building, an assortment, or whether it be an inventory optimization from a supply chain perspective, are all areas that we have defined improvement objectives from a technology perspective going into next year.

Kiley Rawlins

Operator, I know we still have a pretty full queue, but it is the top of the hour, so I think we'll take one more question.

Operator

Thank you. Joseph Parkhill from Morgan Stanley, you may ask your question.

Joseph Parkhill – Morgan Stanley

I'll just ask one quick question. As far as inventory levels go, can you comment a little bit on where your discretionary inventory levels are versus a year ago?

Howard Levine

Sure, and I appreciate you bringing that up, because that's an important fact for us to consider. One of the things that we've talked about is the discretionary sales and how they've impacted our business through the economy and we've been very cautious on the discretionary side to include the apparel area and some of the others that you do have some markdown exposure in. That is not where the growth of inventory is. It's more on the basic side, and that's where we're getting the benefit from improved in-stocks. But good question. We continue to carefully monitor discretionary inventories.

Kiley Rawlins

Again, I'm sorry we didn't get through all of the questions in the queue today. As usual, I'll be available after the call for any followup questions. Thank you for your interest in Family Dollar, and have a good day.

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