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Executives

Howard R. Levine - Executive Chairman, Chief Executive Officer and Member of Equity Award Committee

R. James Kelly - Vice Chairman

Kiley F. Rawlins - Vice President of Investor Relations & Communications

Kenneth T. Smith - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

John Heinbockel - Guggenheim Securities, LLC, Research Division

Charles X. Grom - Deutsche Bank AG, Research Division

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

Meredith Adler - Barclays Capital, Research Division

Deborah L. Weinswig - Citigroup Inc, Research Division

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Family Dollar Stores (FDO) Q4 2011 Earnings Call September 28, 2011 10:00 AM ET

Operator

Good morning. My name is Vicky, and I will be your conference facilitator today. I would like to welcome everyone to the Family Dollar Earnings Conference Call. [Operator Instructions] I would now like to introduce Ms. Kiley Rawlins, Vice President of Investor Relations and Communications. Ms. Rawlins, you may begin your conference.

Kiley F. Rawlins

Thank you, Vicky. Good morning, everyone, and thank you for joining us today. For those of you who have dialed in, please note that we have posted accompanying slides on the Investor Relations page of our website. 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 the 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 28, 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, Vice Chair; and Ken Smith, Chief Financial Officer. We'll begin our discussion this morning with a review of fiscal 2011, and then we'll take a few minutes to discuss our plans and outlook for 2012. Because of the amount of the information we intend to discuss, our prepared remarks this morning will be longer than usual. We will host a question-and-answer session after our prepared remarks. Please remember that the queue for the question-and-answer session will not be available until we have concluded our prepared comments. Now I'd like to turn the call over to Howard Levine. Howard?

Howard R. Levine

Thank you, Kiley, and good morning, everyone. This morning, we reported another year of strong earnings growth, with earnings per diluted share increasing 19.1% to $3.12 per share. Importantly, we made meaningful progress in our efforts to accelerate revenue growth, expand operating margin and optimize our capital structure.

Our customer base is expanding, and our relationship with our customers is getting stronger. In fiscal '11, we increased our brand awareness, strengthened our value perception and improved customer satisfaction. Through our renovations, the continued expansion of our Consumable assortment and improvements in store-level execution, we continued to enhance the customer shopping experience in our stores. As a result, comp store sales increased 5.5% for the year. This performance, combined with the addition of 238 net new stores, resulted in an acceleration of revenue growth to 8.7%.

Despite challenges from an increasingly inflationary environment, an adverse merchandise mix and an ambitious investment agenda, we leveraged SG&A to drive continued operating margin expansion and reported our 14th consecutive quarter of double-digit earnings per share growth. Finally, we optimized our balance sheet and increased shareholder returns. In fiscal '11, we repurchased $670 million of the company's common stock and distributed approximately $83 million in dividends.

We completed an initial public debt offering of $300 million in 10-year notes and secured an investment grade rating from both Standard & Poor's and Moody's Investor Services. And we increased our return on shareholders' equity to approximately 32%.

The progress we have made this year positions us well to further improvement in fiscal '12. As we will discuss in a moment, our plans for fiscal '12 reflect an acceleration of the investments that drove value in fiscal '11. We are pursuing an ambitious growth agenda to expand our market share and drive greater financial returns, and we continue to build our leadership team to better support our growth aspirations.

In February of this year, Paul White joined us as Senior Vice President of Apparel, Home and Seasonal. And last week, we announced the appointment of Trey Johnson, Senior VP of Food, to help us further develop the Food strategy.

Reflecting the investments we have made in our leadership development efforts and our succession planning processes, yesterday, we announced additional changes to our leadership structure. First, Jim Kelly is retiring. During his 15-year tenure at Family Dollar, Jim has had a significant impact on almost every aspect of our business. Upon joining the company, he provided leadership, as we built infrastructure, accelerated new store growth and improved profitability. As President and Chief Operating Officer, he has provided strong strategic and operational vision, and I sincerely appreciate his partnership and support.

I'm pleased to announce that Mike Bloom has joined our team as President and Chief Operating Officer. Mike joins us most recently from CVS Caremark, where he served as Executive Vice President, Merchandising, Supply Chain and Marketing. A seasoned and well-respected merchant, Mike will assume responsibility for major operational functions, including store operations, merchandising, marketing, global sourcing and supply chain.

In addition, I am pleased to announce the promotion of Dorlisa Flur to Vice Chair, Strategy, and Chief Administrative Officer. Since joining Family Dollar in 2004, Dorlisa has been instrumental in driving a number of key strategic initiatives, including the launch of our Food strategy, the development of our concept renewal format and the repositioning of our private brand program. Most recently, Dorlisa has served as our Chief Merchandising Officer, leading our ongoing efforts to improve the shopping experience and enhance customer loyalty. In her new role, she will continue to develop and lead major growth initiatives, including the chain-wide renovation effort. She will also assume executive responsibility for strategy, customer research, information technology and human resources. Both Mike and Dorlisa will report directly to me.

Over the next 6 months, Jim will serve as Vice Chair and work closely with Mike and Dorlisa to assist in the transition. I want to thank Jim for all his years of dedicated service and many valuable contributions to Family Dollar, and we wish him the best in his retirement.

Now I'll turn the call over to Ken, who will discuss our fiscal '11 financial performance in more detail. Ken?

Kenneth T. Smith

Thanks, Howard, and good morning, everyone. As Howard mentioned, earnings per diluted share for fiscal 2011 increased 19.1% to $3.12 per share compared with $2.62 per share last year. This performance was well within the original guidance we provided at the beginning of the year after adjusting for share repurchases and interest expense related to the issuance of our 10-year notes. This morning, I'll start my discussion with a review of our fourth quarter results and then conclude with a review of the full year.

As expected, fourth quarter sales were strong, with comp sales increasing 5.6% on top of a 6.1% increase last year. Although gross margin was pressured a bit more than anticipated in the quarter, better-than-expected SG&A leverage resulted in 32 basis points of operating margin expansion in the quarter.

Net sales in the fourth quarter increased 9.1% to $2.1 billion. The 5.6% increase in comp store sales was driven both by increases in customer traffic and average customer ticket.

Looking at the cadence of business through the quarter, June and July were fairly consistent while August accelerated nicely. During the quarter, we opened 94 new stores and closed 14 stores compared to 75 openings and 14 closings in the fourth quarter of fiscal 2010.

From a category perspective, sales for the quarter were strongest in our Consumables and Seasonal and Electronics categories. Consumable sales increased 12% year-over-year, reflecting our expanded assortment of Food and Health and Beauty Aids across the chain. Seasonal and Electronics sales were also very strong in the quarter, increasing 9.2% over last year.

As a percentage of sales, gross profit declined 68 basis points to 34%. Although we are driving more favorable purchase markups through our investments in price management capabilities, private brands and global sourcing, the impact of stronger sales of lower-margin consumables pressured gross margin. In addition, inventory shrinkage and promotional markdowns increased slightly during the quarter.

To more effectively position our stores to meet the growing consumable demands of the customer, we implemented substantial merchandising and operational change this year. In addition to launching a comprehensive renovation program, we significantly expanded our assortment of Food and HBA in more than 5,700 stores. To introduce these changes to customers, we leveraged a number of promotional tools. As a result, sales of Consumables increased to 69.1% of sales in the quarter compared to 67.3% last year, a mix shift of 182 basis points. And promotional markdowns increased slightly during the quarter.

While our team successfully executed these merchandise expansions quickly, the changes and transitions resulted in a slight increase in shrink this quarter. I would note that inventory shrinkage continued to show improvement for the year.

Turning to expenses. SG&A expense increased 5.3% to $594 million. As a percentage of sales, SG&A expense decreased 101 basis points to 27.8% in the fourth quarter of 2011 as compared to 28.8% in the fourth quarter of 2010. Most expenses were leveraged in the quarter as a result of the 5.6% comp store sales increase. As a percentage of sales, lower insurance expense, incentive compensation and store labor more than offset our investments to drive revenue growth.

Over the last several years, we have worked to stabilize our workforce and improve our store management processes. We have increased our store training and enhanced our risk management programs. As a result, we continued to experience positive trends in workers' compensation and general liability claims. The impact in the fourth quarter was about 60 basis points.

Reflecting our performance this year and our pay-per-performance philosophy, incentive compensation expense decreased approximately 30 basis points in the fourth quarter this year as compared with last year. Last year, our performance significantly exceeded our internal goals. This year, our performance was more in line with our original targets. These improvements were offset by about 60 basis points related to revenue-driving investments, including store renovations and the acceleration of new store growth.

Moving on with the P&L. Operating profit in the fourth quarter increased 15.1% to $131.8 million. Operating profit as a percentage of sales expanded to 6.2% as compared to 5.9% in the fourth quarter of 2010. The effective tax rate in the fourth quarter was 36% compared with 33.8% in the fourth quarter of 2010. As a reminder, our tax rate last year was unusually low, reflecting the favorable impact of concluding a federal income tax examination.

Net income in the fourth quarter increased 8% to $79.8 million, and earnings per diluted share increased 17.9% to $0.66.

Now let's take a few minutes to quickly review the full-year results. Strong sales growth, coupled with core expense discipline, during an accelerated investment period resulted in operating profit growth of 10.9% to $638 million. Operating profit expanded to 7.5% of sales.

Net sales for the year increased 8.7% to $8.5 billion, and comp store sales increased 5.5%. Similar to trends we saw in the fourth quarter, comp store sales were driven by increases in both customer traffic and the average customer ticket. Sales for the year were strongest in the Consumables category.

Reflecting the impact of higher sales of lower-margin consumables and higher diesel costs, gross profit as a percentage of sales decreased 22 basis points in fiscal 2011. These pressures were partially offset by improvements in inventory shrinkage and the impact of our investments in price management capabilities, private brands and global sourcing.

For the year, SG&A expense increased 7.2%, reflecting investments to drive revenue growth, including store renovations, expanded operating hours, the acceleration of new store growth and increased marketing efforts. Despite a significant investment agenda, our team maintains strong core expense control as we continued to optimize infrastructure improvements to drive greater efficiency.

As a percentage of sales, we leveraged SG&A by 37 basis points. Most expenses were leveraged during the year as a result of the 5.5% comp store sales increase and continued productivity improvements. In addition, lower incentive compensation was offset by about 60 basis points related to revenue-driving investments.

Interest expense in fiscal 2011 increased to $22.4 million compared with $13.3 million in fiscal 2010. As a reminder, we issued $300 million of senior unsecured notes in the second quarter of fiscal 2011.

Moving to the balance sheet. Our inventories reflect the investments we have made to expand our Consumable assortments. Merchandise inventories at the end of the year were 12.3% higher than at the end of fiscal 2010. The average inventory per store increased about 9%, driven primarily by our planned expansion of Food and Health and Beauty Aids. Our stronger sales of Consumables in the fourth quarter confirmed that our customers appreciate the expanded offering. I would note that we continue to manage inventory levels in more discretionary categories well.

Turning to the cash flow statement. We generated $528 million of operating cash flow in fiscal 2011. As I have mentioned on previous calls, our first priority when deploying capital is to invest back in the business, and we continue to see nice returns from our investments. Reflecting this focus, we invested approximately $345 million in capital expenditures this year, including approximately $91 million for renovated, expanded and relocated stores, approximately $50 million for new stores and approximately $37 million for supply chain projects, including the initial construction of our 10th distribution center. In addition, we invested about $50 million to purchase 44 stores.

After investing in our business, our next priority is to return excess capital to our shareholders through dividends and stock buybacks. This year, we increased our dividend per share by about 16%, resulting in a total of $83 million in dividend payments. We also purchased approximately $670 million of our common stock as part of our efforts to optimize our balance sheet. At the end of fiscal 2011, the company had the authorization to purchase up to an additional $87.3 million of its common stock.

I would note that our Board of Directors has authorized the additional repurchase of $250 million of our common stock. By most accounts, fiscal 2011 was another strong year. We invested aggressively, delivered double-digit earnings per share growth and improved returns.

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

Howard R. Levine

Thanks, Ken. With a stronger infrastructure in place and an opportunity to capture an expanding customer base, last year, we launched an ambitious plan to drive revenue and earnings growth. While at the time our plans may have seemed aggressive, I am pleased to announce that we achieved most of our goals.

Building on the progress we have made, we expect to accelerate our pace of investment in fiscal '12 to drive even stronger returns. This year, we intend to increase customer loyalty and continue to improve the shopping experience in our stores, continue to develop high-performing teams that can successfully execute our plans, deliver more profitable sales growth and leverage our enhanced capabilities to drive continuous improvements.

In today's uncertain economic environment, value continues to resonate with consumers. Our strategy of providing customers with value and convenience continues to attract, not only our core low-income customers, but also middle-income families with greater frequency.

With an increased focus on customer service, refreshed store layouts and an expanded assortment of consumables, we have improved the shopping experience in our store and strengthened the Family Dollar brand. Our customer satisfaction scores have improved, and we have increased our overall value perception. With this strong foundation in place, we are expanding efforts to reinforce our value perception and improve customer satisfaction further, while also leveraging expanded marketing capabilities to communicate our improvements to customers and strengthen our brand.

Customer satisfaction is strongly linked with employee engagement. That is why we continue to invest in our teams. In fiscal '11, we increased our team member engagement, improved our rate of internal promotions to almost 80% and strengthened our leadership development programs. Additionally, we enhanced our succession planning processes throughout the organization. Building on these improvements, we will expand our focus in fiscal '12. We are improving our on-boarding efforts, expanding our leadership development programs and enhancing our succession planning processes even further.

In addition to investing to increase our brand awareness and strengthen our employee teams, we are accelerating efforts to deliver profitable sales growth. In fiscal '11, we invested aggressively to broaden our consumer appeal and increase our competitiveness over the last 12 months. Almost every store in our chain has been improved in some way to serve customers better. In fiscal '12, we intend to expand these efforts. We plan to accelerate new store growth, extend our efforts to improve the shopping experience in existing stores. We also plan to further expand our Consumable assortment and refocus our discretionary business, and we intend to increase our penetration of private brands.

After increasing our pace of new store openings last year by 50%, we intend to increase new store growth again this year by more than 50%. A year ago, we announced our intention to return to square footage growth of 5% to 7% by fiscal 2013. With the progress achieved in building the pipeline in fiscal '11, I am pleased to report that we expect to achieve our goals in fiscal '12, a year earlier than originally planned. This year, we plan to open 450 to 500 new stores, including our first stores in California, which we expect to open before Christmas.

Recognizing that to deliver sustainable long-term growth, we must balance growth from new stores with growth from comp stores. We are also continuing our efforts to refresh existing stores. In fiscal '11, we renovated, relocated or expanded more than 1,000 stores. In these stores, we have created a more inviting shopping environment that includes a refresh of the building façade, an exterior signage and raise store standards. We have expanded key Consumable categories and created more intuitive merchandise adjacencies. We have improved navigational signage and leveraged new fixtures that increase capacity and simplify restocking and recovery processes, and we have raised our customer service standards. In fiscal '12, we will continue these efforts. We again plan to renovate, relocate or expand more than 1,000 stores.

By the end of fiscal '12, just under half of our chain will reflect a new, more competitive shopping experience. While we are maintaining an ambitious pace, it will take us several years to fully transform the chain. To help us increase productivity in all stores, we will continue to enhance our merchandise assortments. Our objective is to drive traffic with an expanded selection of consumables, while also driving a larger basket with more impulse purchases and greater in-store excitement.

In fiscal '12, we will continue to focus on driving greater trips with a strong focus on Food and Health and Beauty Aids and look to drive baskets by being more seasonally relevant and emphasizing a more coordinated vision across discretionary categories. While national brands continue to play an important role in building our overall brand, private brands represent an opportunity to drive more profitable sales, while also increasing customer loyalty.

In fiscal '11, we made material progress in increasing our penetration of private brands. For the year, private brands increased approximately 22%. I'm especially pleased with the growth we have seen in our private brand consumables, which increased 26% this year.

Private brands now represent about 25% of our total sales. Private brand consumables have grown to about 16% of sales. Building on this momentum, in fiscal '12, we intend to increase our penetration of private brands even further. With the stronger focus on expanding our assortment of private brand consumables, we expect to launch several new brands that will offer customers more quality and value, while also refreshing a few of our existing brands to broaden their appeal. And we intend to drive greater awareness of our private brand program through increased marketing and visual merchandising support.

Finally, even as we accelerate our investments, we remain sharply focused on managing our cost structure and driving additional productivity improvements. As Ken mentioned, we continued to manage our core cost structure as we optimize infrastructure improvements to drive greater efficiency.

For example, our investments to drive team member engagement and improve operational processes have resulted in improvements in workers' compensation claims, our more stabilized workforce and better store-level execution. Global sourcing and workforce productivity are additional areas of focus, as we look to manage our cost structure to support our investments.

Today, approximately 40% of our purchases are manufactured overseas. While we continue to rely on third parties to help us procure this merchandise, we are progressively moving toward a more efficient, direct model. In fiscal '11, we opened offices in Hong Kong and Shenzhen. And today, these teams are helping us strengthen and expand our supplier network.

We also invested in new tools to help us manage the product development life cycle better. As a result of these investments, we increased our direct imports in fiscal '11 by about 24%.

As store labor is one of our largest expenses, improving the productivity of our workforce is critical to maintaining a low cost structure. In fiscal '11, we expanded our training and development programs, leveraged new tools to help us manage execution better and implemented new processes to improve workflow management to leverage our store labor hours more effectively. Building on this foundation, in fiscal '12, we plan to enhance our payroll allocation and labor scheduling processes, further improve our execution management and enhance our core operational processes.

Now Ken will provide more specific details about our financial expectations for fiscal 2012. Ken?

Kenneth T. Smith

Building on the momentum from 2011, we believe Family Dollar is positioned for another strong year in 2012. We expect that fiscal 2012 net sales will increase between 8% and 10%, driven by increases in both comp store sales and accelerated new store openings. Comp store sales are expected to increase between 4% and 6%. We expect Consumables will continue to drive sales growth. And we expect this mix shift, along with increasing freight and input costs, to pressure gross margin. We expect our investments in pricing, private brands and global sourcing will mostly offset these headwinds.

For the year, overall, we expect that gross margin will be flattish with more pressure in the first half and greater opportunity in the second half, as we cycle many of the inflationary pressures we faced in fiscal 2011.

In fiscal 2012, we will continue to focus on driving greater efficiencies and keeping our core costs low. At the same time, we are accelerating our investment agenda, and this will drive expense growth. However, we plan to leverage these investments through strong top line growth and expect to deliver operating margin expansion for the year.

Continuing with the investment theme, we believe our best use of capital to generate optimal financial returns is to deploy it back into the business. As a result, our capital expenditures are expected to increase this year into the range of $550 million to $600 million. The increase is due to 3 primary factors.

First, we plan to open between 450 and 500 new stores in fiscal 2012. Within our new store portfolio, we also expect to increase our number of owned stores. This strategy will enable us to leverage our lower cost of capital versus the developer's higher borrowing rate and reduce our effective cost of ownership. While we are taking advantage of the current real estate environment, we expect that leases will remain the prominent form of financing in our real estate portfolio.

Second, we expect to renovate, relocate or expand more than 1,000 stores in 2012. Third, we plan to complete construction of our 10th distribution center and begin construction of our 11th distribution center. Based on these expectations, we forecast that earnings per diluted share will be between $3.50 and $3.75 in fiscal 2012.

Looking to the first quarter of 2012, we expect comparable store sales to increase between 4% and 6%. We expect that sales trends in the first quarter will be similar to trends we saw in the fourth quarter, with consumables continuing to drive the sales increase. While we're only 4 weeks into the first quarter, our sales trends are in line with these expectations.

Reflecting these assumptions, we expect that gross margin will be pressured modestly during the quarter. Given these expectations, we expect earnings per diluted share in the first quarter of 2012 to be between $0.65 and $0.73 compared with $0.58 in the first quarter of fiscal 2011.

Howard R. Levine

Before we take your questions, I want to reiterate how proud I am of the progress our team has made. 2011 was not without challenge. Economic conditions have not improved as some expected and, in fact, have worsened for many families. Inflationary pressures have presented tough challenges, adding to the financial pressures facing consumers. Our team pursued an ambitious plan, worked through these challenges and delivered on our objectives. As we look to 2012, I suspect that many of these challenges will persist. Within this tenuous environment, our strategy of providing customers with value and convenience has great appeal. And I'm confident that the investments we are making to improve the shopping experience in our stores will continue to position us to deliver strong financial returns. And now, operator, we would be happy to open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from John Heinbockel of Guggenheim Securities.

John Heinbockel - Guggenheim Securities, LLC, Research Division

A couple of things. You talked about revitalizing the Non-Consumables business. Obviously, the Consumables traffic is terrific. Can you go into that a little deeper, particularly in this economy? There's obviously some limitation on what people can spend on that side of the store, but it looks like there's a big opportunity to take the existing traffic in Consumables and get people to put another item or 2 in their basket. So maybe there's a tangible example or 2 how you think you can do that here over the next year and capitalize on the existing Consumables traffic?

Howard R. Levine

Sure. Thank you for the question. First, I agree with you. I think we do have an opportunity to leverage the traffic on the Consumables side and try to gain more sales in some of the discretionary categories. I think as everybody knows, it is tough out there. And what we have seen, particularly with the low-income consumer, is they have really retracted their purchase in some of the discretionary categories and really focused on basic needs, and we believe that, that is a headwind that we're facing, but nevertheless, continue to believe we have opportunity to improve both sales in Apparel and Home, as well as the Seasonal categories. And as we look into approaching the holiday season, we're very excited about the assortment that we put together there. While we do believe it's going to be a challenging Christmas, I think our merchants, our marketing teams who worked very hard to put together a great toy selection, a great trim-a-tree selection, our Home selection, I think, is outstanding. And we're supporting that with strong promotional plans throughout the holiday season. So we continue to believe that we will face some headwinds in the discretionary side, but I'm with you with the additional traffic coming in our store. We've really worked hard to leverage that to get her to come over to the other side of the store and take advantage of some of the great values that we're offering on the discretionary side.

John Heinbockel - Guggenheim Securities, LLC, Research Division

All right. And then just secondly, do you have a general sense when you look at the older customers, 65 and up, or however you might measure that, what percent of your business comes from that type of customer? And obviously, there's a great opportunity going forward to market merchandise to that customer a bit more. How do you think about what you may need to tweak, either operationally or in terms of merchandising, other than HBA, which is kind of the big opportunity. But how do you think about optimizing that customer more going forward, which looks like a big opportunity for you as well.

Howard R. Levine

Thanks, John. I can't think of a better person to answer that question than Jim Kelly.

R. James Kelly

I think that was a compliment. We are very focused on baby boomers from a lot of perspectives. Certainly, they're going to be of growing significance to all retail. From a starting point, that group is particularly focused on value, and they're very, very focused on the convenience of the neighborhood store. For many of what I affectionately call my people, we really enjoy the smaller shopping environment. You've seen Family Dollar expand Food and expand things like ready-to-serve food that really indexes very well for this population group. We've also expanded our Health and Beauty Aids section, so we're very, very aware of the potential of this group. Today, we actually index very, very strongly with this group and are looking for opportunities to even improve our positioning going forward.

Operator

Our next question comes from Adrianne Shapira of Goldman Sachs.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Just on the comps, had a few questions. Traffic and ticket, you have called out, they were both up. They have both been up over the last few quarters. I'm just wondering if you can give us any more color there in terms of the composition, especially as you saw gas prices pull back in the quarter, wondering if you saw any impact there on traffic?

Kenneth T. Smith

I think we've seen some consistency when we look at traffic and ticket. So both for the year and for the quarter, both contributed. So I don't think there was a dramatic movement of the needle, so to speak, inside the quarter as -- that you could track right to gas prices. But I think the focus remains on both sides of the equation, and we've seen some nice consistency throughout the year.

Kiley F. Rawlins

Adrianne, ticket and traffic cost contributed pretty equally in the fourth quarter to the comp.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Okay. That's helpful. Then the question on SG&A, obviously, very impressive leverage despite the fact that comps came at the low end of the range. Maybe give us a little bit more color on that, walk us through how you were able to deliver such impressive leverage.

Kenneth T. Smith

Well, it looks -- it is a good story from an expense control perspective, again, in the fourth quarter. A couple of the things we called out: Nice performance on the insurance side that gave us some benefit. I think that's a benefit from multiyear efforts around our risk management processes and focus in the store. So that and the incentive helped our leverage. But I think more importantly, we have -- when I look at expenses, really focus on the core. And we talked about focusing prior to new stores and investments, targeting that 2% to 3% area, and we beat that this quarter. And I think that's from some across-the-board focus on expense control. Howard mentioned this in his comments, the impact of our investments in the workforce. And when you think of payroll, both in-store and across-the- board, we've invested a lot and are seeing nice productivity gains that help from a core perspective. We're also focusing within non-merchandise spends, both at the corporate side and in the stores, to leverage processes and procurement tools. And that's also helping kind of across-the-board. So I think we've got a nice focus on managing the core, and it has delivered nicely over the last couple quarters.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Great. And then just a last question as it relates to guidance. I'm wondering, the $3.50 to $3.75, is that inclusive of the $250 million in buyback, because it seems to us, it would add about less than $0.10. And I'm just wondering if that's already captured in your guidance.

Howard R. Levine

Well, the guidance we outlined from a share perspective, and I think we bulleted it in the press release, 118 million shares is the outstanding diluted shares we're using for our guidance. Just from a buyback perspective, we did a year ago authorize the $750 million and plan to execute against that repurchase over a 12-month period, which would end in the first quarter this year. We have executed about $670 million of that. So we expect in -- by the end of the calendar year, our plans are to finish out that authorization. Again, our Board authorized the $250 million, and that gives us some flexibility as we look forward to evaluate the market conditions and evaluate the opportunity for additional buybacks.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Okay. So just to be clear, the $118 million that you outlined does not include the incremental $250 million in buyback?

Howard R. Levine

Correct, correct.

Operator

Our next question comes from Charles Grom of Deutsche Bank.

Charles X. Grom - Deutsche Bank AG, Research Division

First question is on 2012, when we think about the SG&A growth you're going to encourage -- ramp growth and do more of the CR2 remodels, just wondering what your base assumption is for a fixed cost hurdle rate? And then, I think you said in your prepared remarks that the new or the costs to support the revenue driving the initiatives was about 60 basis points. What's your expectation for next year?

Kenneth T. Smith

When I think when we frame out the expense structure, it's consistent again next year with what we saw in '11. We are going to be investing aggressively again. So when -- you can think about the 3 buckets of the impact of new stores in that 450 to 500 store range. And then, we break the rest of our expense picture into the core and expenses related to our investments. So again, when we look at the core, I look at -- we want to manage that core increase to that 2% to 3% level, and expect the investment agenda to be around that same 2% to 3% level as we go into next year. So we're balancing strong management with the core, again, with an aggressive investment agenda to include the renovation program.

Charles X. Grom - Deutsche Bank AG, Research Division

So do you expect SG&A dollar growth to be up more than it was in 2011 or about equal? It would seem that if your GPM is flat, and we used the sales assumptions that you've given that the SG&A growth will need to be sort of in the 8% to 9% range. Just trying to get a sense for how we should frame out the margins.

Kenneth T. Smith

Yes, I think you just look at new store growth as the big delta. So we grew expenses 7.2% this year. If you factor in the increase in new store growth, I'd expect it to be north of that in fiscal '12.

Charles X. Grom - Deutsche Bank AG, Research Division

Okay. And then just a follow-up to Adrianne's question on buybacks. It looks like your free cash flow is going to be pretty low next year, depending on working capital assumptions and maybe $50 million. And just wondering, in order to do more buybacks as you get into next year, it seems like you would need to lever up to do so. And I guess the question is, would you be willing to do that, similar to the $300 million that you did earlier this fiscal year?

Howard R. Levine

Rather than willing to lever up, certainly, we evaluate our balance sheet. So I would tell you we are going to continually look at the balance sheet and work to optimize it. We don't have -- we have plenty of liquidity as we look at our plans. So the -- any decisions on leverage, certainly, we'll evaluate throughout the year, but nothing currently that we would talk about as we look into '12.

Kenneth T. Smith

If I could just add to that, I think as we've talked about for a number of years, our first desire in deploying capital is to invest back into the business. The prior few years, we did not have as an aggressive plan to invest into the business, and we were able to utilize stock buybacks more effectively. We're in a cycle this year where -- which I think is great, is we're investing in the business. We're growing new stores. We're investing back in our existing stores. So obviously, there'll be less available to do stock buybacks. Our dividend policy is very important to us, and we look to continue to maintain the strong record there. But this year, you will see more investments back in the business, which is, from my perspective, an opportunity to generate strong returns. So and in terms of additional debt, I think one of the things that we talked about that's important to the company is maintaining an investment grade rating. So we're always contemplating the optimization of our balance sheet, and we'll continue to do so with that point in mind.

Charles X. Grom - Deutsche Bank AG, Research Division

Great. And if I could have one follow-up, just on the whole inflation theme, just wondering as you guys have seen the increase in prices across your store, whether it's in Food or Apparel or Home, any observations of note on demand disruption, where the consumer's been pushing back on units, elasticity, et cetera?

Howard R. Levine

Sure. I think, no, you're right. There still is some inflation pressures out there. You'll see it particularly in the Apparel, in our Apparel assortment this fall and winter. Some of the other price increases have started to slow a little bit, but there's still pressure out there. One of the things that we have seen is how our customer reacts. They do react very quickly. So we're very careful in the way we approach, raising our retails, and we attack it from a number of different perspectives, utilizing our pricing team, working with our merchants through price shops, managing that price perception, which is extremely important to us, which by the way, we continue to execute very strongly with. But clearly, it's something that is another headwind for the consumer out there, but I think it's something that we're effectively dealing with and managing through as we work through the year.

R. James Kelly

Chuck, I would add one observation there. It's our customer base is becoming increasingly diverse. At the lowest income level, let's say households earning $20,000 and less, clearly, inflation means that they have to immediately change buying pattern, and those changes tend to be even a greater focus on opening price points, a greater focus on private brands and a further limitation on discretionary items. On the other hand, inflation is forcing many middle-income households to pursue more aggressively their search for value. So we continue to see an uptick in traffic from those households and we see an opportunity there. Overall, as Howard mentioned, our private brands increased over 20% this past year. And we're gaining penetration, we have plans to introduce many more items next year. So this inflationary environment is giving us an important opportunity to improve the penetration in the more profitable private brand area.

Kiley F. Rawlins

We are getting close to the top of the hour, and we have a pretty full queue, still. So I would ask those of you still left in the queue to try and limit your questions to one with one follow-up question, please. Vicky, can we have the next question?

Operator

Our next question comes from Deborah Weinswig with Citigroup.

Deborah L. Weinswig - Citigroup Inc, Research Division

So Howard, just wanted to ask you to elaborate on your comments regarding the fact that the customer base is expanding, and also that your relationship with customers is getting stronger.

Howard R. Levine

Yes. I think Jim touched on that with the prior answer. What we have seen, as the economy, I guess, characterized is bumping along is that our core customer is extremely stressed right now, whether it's some of the government entitlements or particularly the job growth prospects out there are very challenging for our low-income customer, and they're very stressed. In addition to that, what we've seen is more trade down from that more middle-ish income customer, which is creating a lot of new customers coming into our stores. And frankly, we're very pleased with the initiatives that we've outlined to take advantage of what that opportunity brings to us today. When you think about the aggressive renovation program, our efforts to improve our quality, the upgrades in our private brand program, the improving shopping conditions in our stores, all things that are important to that trade-down customer, and also, not at all offensive to that core customer. So what we're excited about is what that opportunity brings to Family Dollar despite some of the economic challenges for our core customer. There is still quite a bit of opportunity to capture more of this trade-down customer. And importantly, the initiatives that we're executing to position us very nicely to capture that.

Deborah L. Weinswig - Citigroup Inc, Research Division

Okay and then my follow-up would be, was there anything special in terms of promos or otherwise that drove the strength in August?

Howard R. Levine

Without talking specifically about one month too much, I don't think so. Back-to-school season was successful. As we talked about, some of the other discretionary categories were a little slower than we expected. But hopefully, as we move into a cooler fall season, we'll see a pickup of some of those categories, but nothing really important to point out.

Operator

Our next question comes from Meredith Adler, Barclays Capital.

Meredith Adler - Barclays Capital, Research Division

A question about the remodels. I think it sounds like you're not going to be quite as aggressive as you might have originally thought. I think you were saying at one point you could do as many as 1,500, 1,600 this year. Could you just talk a little bit about how that's going and why the decision to moderate it a little bit?

Howard R. Levine

No, Meredith, if we indicated that. I think what we've done is really group renovations, remodels and expansion together, so that may be limiting that. But between the 2, we said we'd at least do 1,000. We're actually increasing the number of relocations this year and expect to do at least 1,000 renovations, but we wanted to see how the progress went this year. We are operating in an uncertain environment and wanted to see what kind of progress we would make this year.

Meredith Adler - Barclays Capital, Research Division

So do you have a target now for when the entire store base will be done?

Howard R. Levine

We don't have an exact date. As we've indicated, it's going to take us several years. By the end of this fiscal year with 1,000-plus renovations, we'll have touched half of the chain, so far. So we've got the rest -- the other half to go. And again, very pleased with the results of the program, the customer comments. Our associate comments have been extremely positive, and we're pleased with the results. We are also ramping up new store growth in addition to that, with 450 to 500 new stores, opening up our first stores in California. So I think we've got a lot on our plate. We feel good about that and are excited to get going on executing those this year.

R. James Kelly

Excuse me, Meredith. I would comment that the dimensions of the renovation program are playing out in many, many different ways. For example, we took the major merchandising learnings, particularly in the Food and the Health and Beauty Aids area, and over a 2-month period, expanded our assortments in over 5,800 stores to leverage those learnings from the renovation program. We're also taking other things such as many of the HR-related areas, store operations-related areas, training programs, et cetera, and systematically rolling those out to the store. Many of the changes that we're making in the, what we refer to as hot zone area, that zone where you have a particularly large amount of impulse buys to include a new fixture you'll be seeing in our store is being rolled out to virtually all of our stores. So we are taking a paced view of the physical construction, but we're taking a very aggressive view of the learnings from these renovations in terms of leveraging them throughout the chain.

Operator

Our next question comes from Dan Wewer of Raymond James.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Howard, I want to talk with you about inventory growth for a second. So the 12% increase in inventory dollars for the year is faster than your revenue growth, faster than your gross profit growth. It was more or less in the first quarter for the year just ended when you began to ramp inventories at a faster rate. Do you have a sense as to what the inventory growth will look like in FY '12?

Howard R. Levine

Sure, Dan. Let me remind everybody that during the third quarter of this year, we did invest aggressively to expand our assortments in the Food area and the HBA area as part of our efforts to continue to improve our productivity, as well as present relevant assortments to our consumer. We have not given up on inventory productivity. Over the next few quarters, we think we will see a moderation of that inventory growth more in line with sales growth, as it is important to us to continue to do that. But again, I think the initial buildup was an investment that we made to drive productivity. So as we get through the year, we'd expect to see better leverage from our inventory.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

But are you concerned that you made the inventory investments that have inherently higher turnover sales velocity, and yet if you look at your inventory turns or your sales velocity from a dollar inventory, it actually dropped in the last years, which you wouldn't normally expect if that inventory growth is coming through an HBA?

Howard R. Levine

Yes. No, I'm comfortable that the investments we made will be accretive. What I worry about is inventory growth in discretionary categories, Apparel, in particular, and I think those are well-controlled and will continue to be monitored closely. So we will get the proper sell-throughs in those areas, but we're pretty comfortable with where we are. Inventories are up, as you pointed out, but our plan is to see a moderation of that growth over the next few quarters.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

And Howard, just real quickly, on the 500 new stores opening in fiscal year '12, can you discuss the type of markets those are going into? I know in the past you would break down your real estate between cities of under 40,000 and larger, and I'm assuming you're making a bigger focus on urban and suburban markets, but if you could confirm that? And in particular, are you trying to locate closer to traditional drugstores and food stores in an attempt to take share from those competitors?

Howard R. Levine

Dan, I think I'd characterize the new store growth as more balanced this year. We will be taking advantage of whatever opportunities are out there in terms of existing space. Most of our new stores though are freestanding buildings, as we can create the assortment that we think is appropriate for our customer in a freestanding building and really make a stand in terms of the convenience that we offer. But we continue to have a lot of flexibility in the way we approach various types of locations.

Kiley F. Rawlins

So Vicky, I think we'll take one more question.

Operator

Our last question comes from David Mann of Johnson Rice.

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

In terms of the first quarter gross margin, you talked about, it sounds like, the gross margin pressure moderating, yet you also said that the mix pressure would still be there. So can you just elaborate on why you expect the margin to be a little better versus Q4?

Kenneth T. Smith

I think mix is -- it's a balance from a mix perspective. We don't expect them quite the same level of mix pressure when you're comparing it straightforward, first versus the quarter we just completed, but we do expect mix pressure. Again, we expect continued traction from the investment areas, where we continue to work and get traction in private brands, global sourcing and our pricing capabilities. And then, freight is another area. As we look at -- we expect freight to be similar in the first quarter as the fourth quarter with a slight bit of pressure. So we're going to continue to work hard on the margin line and think -- we do expect a bit of pressure, but not quite as much as the fourth.

David M. Mann - Johnson Rice & Company, L.L.C., Research Division

And then for a follow up, in terms of the remodels, you've gotten a year under your belt. Can you give us a little bit of sense on maybe the comp or store contribution benefit or, at least, comparability to the rest of the chain of those remodels? And how would the next tranche of remodels, how do you think that'll compare to this first tranche in terms of, do you think you get better performance, worse performance? Or how do you think that will play out?

Kenneth T. Smith

Well, I think the most important thing is that the remodeled stores are positioned much better to provide customer service and it's a much more compelling place to shop. And that's evidenced by not only the customer surveys that we received, but also the fact that they're buying more. So yes, we are continuing to have very strong results. That can be defined in the area of double-digit comp store performance, so we're pleased with it. The selection of the initial tranche of stores was dictated by a number of things, not the least of which were logistical concerns, as well as store operating concerns in terms of the building and enhancing of their teams. So it shouldn't necessarily create a bias going forward that would say that we would expect less or more returns from the next wave. So this program is positioning us nicely with our customers, and we feel great about it as indicated by our decision to continue the very aggressive pace of the program.

Kiley F. Rawlins

So we are a little bit past the top of the hour. And unfortunately, we didn't get through all of the questions in the queue. As always, I'll be available for any follow-up questions you may have. Thank you for your continued interest in Family Dollar and have a good day.

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