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Executives

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

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

Michael R. Bloom - President and Chief Operating Officer

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

Analysts

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

Bernard Sosnick - Gilford Securities Inc., Research Division

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

Stephen Shin - Morgan Stanley, Research Division

Laura A. Champine - Canaccord Genuity, Research Division

Meredith Adler - Barclays Capital, Research Division

Unknown Analyst

Deborah L. Weinswig - Citigroup Inc, Research Division

Matthew R. Boss - JP Morgan Chase & Co, Research Division

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

John Heinbockel - Guggenheim Securities, LLC, Research Division

Mark K. Montagna - Avondale Partners, LLC, Research Division

Family Dollar Stores (FDO) Q2 2012 Earnings Call March 28, 2012 10:00 AM ET

Operator

Good morning. My name is Tanya, 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, Tanya. 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 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, March 28, 2012. 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.

Our call today will begin with some opening comments from Howard Levine, Chairman and CEO. Then Michael Bloom, President and COO, will share an operational update; and Ken Smith, CFO, will run through our financial results and outlook for the rest of fiscal 2012. [Operator Instructions]

Before I introduce Howard, I'd like to announce that we intend to host an analyst day in New York on July 18. We'll share more details with you as we get closer to the date. Now I'd like to turn the call over to Howard Levine. Howard?

Howard R. Levine

Thanks, Kiley, and good morning, everyone. This morning, we reported our 16th consecutive quarter of double-digit EPS growth. Our investments to drive greater shareholder value are delivering results, and I want to thank all of the Family Dollar team members who have been working hard to serve our customers better and deliver this performance.

Revenue growth is accelerating. Year-to-date, we've opened 184 new stores, and we are on track to achieve the upper end of our plan of 450 to 500 new stores this year. In addition, our investments to expand key consumable categories are gaining momentum and driving greater comp store growth. We are delivering a more compelling shopping experience for our customers. Since launching our renovation program last year, we have refreshed more than 1,300 stores through our renovation effort, providing both existing and new customers with an improved shopping experience and a broader merchandise assortment.

By the end of fiscal 2012, we expect that nearly half of the chain will reflect a newer, more competitive shopping experience. And we have rolled back many of the assortment changes to the rest of the chain so that all of our customers can take advantage of our improved selection and great values. Customers are responding well to these improvements. We are expanding our share of wallet with both lower and more middle-income customers, and we are increasing trip frequency. Sales in renovated stores continue to significantly outperform stores that have not been renovated. Customer satisfaction in renovated stores continues to improve. And overall customer value perception is increasing across the chain.

As we look to the second half of fiscal '12, we are beginning to see some signs that the economy is slowly starting to improve. Yet consumers still face some headwinds, especially from rising gas prices, which could strain discretionary purchases and impact the pace of recovery. Regardless of whether the economic environment is improving or contracting, Family Dollar is well positioned to drive profitable growth. While our results have outperformed many other retailers during the recent recession, I would note that in every instance over the last 40 years, as the economy has improved, Family Dollar has benefited. Historically, as customers have seen their incomes expand, they have increased their spending, particularly in discretionary categories, at Family Dollar. Whether or not this economic recovery is similar to past recoveries remains to be seen. Regardless, I believe that value and convenience will remain an important driver for consumers. That is why we are making significant investments to broaden our assortment and drive market share.

Since the beginning of fiscal 2011, we have expanded our basic SKU assortment by about 15%. Most of these new items have been in food and HBA, which have significant potential to drive market share with little markdown risk. For example, in February, we added 300 new food items to our assortment and eliminated 150 underperforming SKUs. These new items, combined with the additions we introduced last April, have helped to drive an 18% sales increase in the food category so far in fiscal 2012. We believe we have significant opportunity to increase average sales per square foot. Broadening our assortment in key consumable categories will enable us to become more relevant and satisfy more of our customers’ shopping trips. But it will also require additional inventory investment. In the second half of fiscal 2012, we will add even more new merchandise to our stores to enable us to satisfy more shopping trips and drive greater revenues.

Overall, we expect to add more than 1,000 new consumable SKUs to our assortment, which will likely result in 15% to 20% growth in average inventory by year end. Inventory productivity will be constrained for the next several quarters as customers get more familiar with our expanded selection. But we're very excited with how well positioned we will be to drive market share growth, increase sales per square foot and drive further operating margin expansion. To provide you with a little more color on these investments, I'd like to introduce Michael Bloom, our President and COO. Mike?

Michael R. Bloom

Thanks, Howard, and good morning, everyone. I've been here now for 6 months, and I can't tell you how happy I am to be a part of the Family Dollar team. Family Dollar is a great company with a strong culture and a proven track record of success. The channel is growing. The customer base is expanding, and I truly believe that we have tremendous opportunity to further expand our market share and take Family Dollar to new levels of profitability. I'm very excited to share with you what we've been working on during my first 6 months to drive profitable sales in the second half of fiscal 2012 and beyond.

But first, let me share some highlights from the second quarter. Consumables continued to gain momentum, increasing about 13% overall in the quarter, driven by food and health and beauty aids. We are making significant inventory investments in these categories, and customers are clearly voting with their wallets on our expanded assortment. Our market share in consumables grew about 10% over the last 12-week period. The home and apparel categories continued to be pressured in the quarter, although our basic home and apparel businesses continued to perform well. More weather-sensitive items like fleece and winter accessories were not as strong as we had originally planned. As a result, we proactively took additional markdowns throughout the quarter to manage inventory levels.

Now while the warmer weather adversely impacted our fall and winter sales, it is having a positive impact on sales of spring and summer merchandise, which have gotten off to a great start. These early trends, combined with our team's efforts to reduce inventory risk through the reduction of spring and summer receipts, should result in better inventory productivity in these categories in the second half of fiscal 2012. Our seasonal and electronics category continues to perform well, increasing more than 9% in the quarter. We are particularly pleased with the performance of Valentine's Day, the strong sales growth of party supplies and the early trends we are seeing in Easter. Clearly, our customers want to celebrate holidays and events with their families. And they know that at Family Dollar, we can help them celebrate and have fun at a great price. The increasing momentum in consumables, the performance of our basic apparel and home businesses and the growth of our seasonal business all tell us that our strategy is working. And we plan to build on this success.

Now let's switch gears and review our new growth plans for the second half of fiscal '12 and beyond. Our team is moving very quickly to increase our relevancy to the customer and drive greater sales and margin momentum. Over the next several months, we will expand our food assortment again. We will double the refrigerated and frozen food capacity from 5 doors to 10 doors. We will begin selling cigarettes and tobacco products. We will add Pepsi to our assortment. We will expand our health and beauty aids assortment further. And we will introduce a new fixture to capture impulse sales at our checkout to include candy bars, snacks, magazines and gift cards. And I would note that magazines and gift cards are new categories at Family Dollar. As you can see, we are moving fast to become more relevant to our customer and drive more profitable sales per square foot. And we are just getting started.

Let me take a few minutes and share some additional color about some of the most significant initiatives. Over the last 18 months, we have expanded our food assortment by about 20%, and our customers have responded very well. Over the next few months, we intend to expand our selection even further, adding approximately 500 new items to the assortment. We're expanding our existing selection of private and national brands and adding new brands like Red Bull, Wise Snacks and Gerber baby food. As a loyal consumer of Diet Mountain Dew, I am especially excited about our new partnership with Pepsi. As our core customer index is very high with many of the Pepsi brands, such as Pepsi, Diet Pepsi and Mountain Dew, for the first time, our customers will be able to buy Pepsi products in our stores in addition to our Coca-Cola brands.

As we expand our selection of grocery items, we are also investing to expand our assortment of refrigerated and frozen food. In new and renovated stores, we have doubled the space for refrigeration from 5 doors to 10 doors, and the customer response has been fantastic. To help us expand these key trip-driving businesses more quickly, we plan to expand coolers in an additional 1,300 stores in the second half of fiscal 2012, which will bring our chain to an average of about 8 cooler doors per store. The increased capacity will enable us to offer customers more options for breakfast, lunch and dinner, such as breakfast sandwiches, waffles, pizza, frozen vegetables and, of course, frozen dinners.

In addition to our investments in existing business like food, we are also investing in new businesses to drive more traffic into our stores. Tobacco is about a $90 billion business that drives very frequent trips. We know that many of our customers purchase these products today from other retail outlets. And our customer research tells us that Family Dollar customers overindex on cigarettes and tobacco products. Soon, our customers will be able to come to our stores for these products.

Even as we invest to drive more trips to Family Dollar, we are also working to increase the size of the average basket. Health, beauty and personal care items help to increase the overall basket and profitability. We know from our category research that our customers are buying a wide variety of health, beauty and personal care items today. They're just buying most of them at other retailers because our current assortment isn't broad enough to allow them to complete their shopping trip at Family Dollar. As we consider the average age of our baby boomer customer and her health-related ailments, we have a significant opportunity to increase our relevance and capture more of her wallet.

Over the last 18 months, we have expanded our health and beauty aids assortment by about 25%, and our customers have responded extremely well. Building on this initial investment, this quarter, we will expand our health and beauty aids assortment by an additional 500 items, with key additions in categories like first aid, shaving, hair care and cough and cold, just to name a few. In addition to expanding our assortment of private brands, we're adding new national brands like Maybelline and L'Oreal and expanding our selections of brands like Schick, Allegra and Oil of Olay to fulfill more of our customers' health, beauty and personal care needs.

To help mitigate the margin impact of stronger sales of lower margin categories, we are also accelerating our plans to expand our private brand penetration and our global sourcing capabilities. We continue to increase our penetration of private brands. Year-to-date, private brand sales have increased about 10%. More notably, sales of private-branded consumables have increased about 16% year-to-date. As we expand our assortments in national brands in our food, health, beauty and personal care categories, our assortment of private brand items within these categories will grow proportionately. This year, we will add new private brand items in food, health, beauty and personal care, increasing our private brand consumable assortment by more than 50%. To support the introduction of these new items, we are enhancing our in-store presentation and expanding our compare and save messaging to emphasize the savings that quality private brands can offer when compared to national brands.

Although we continue to benefit from investments we have made to expand our global sourcing capabilities, we are confident that substantial additional value can still be captured. A year ago, we opened offices in Hong Kong and Shenzhen, China. I've met with these teams, and I'm excited about the leadership team and the work that they are doing to help us strengthen and expand our supplier partnerships. So far in fiscal 2012, they have enabled us to significantly increase our direct-to-factory purchases, resulting in concrete margin savings and improved merchandise quality. These efforts have resulted in savings that have offset much of the margin pressure, resulting from increased consumable sales.

Now while enhancing our merchandise assortment and accelerating our investments in global sourcing and private brands are part of our strategy to increase our market share, we are also investing to improve the customer shopping experience in our stores. Last year, we launched a multiyear renovation effort intended to create a more appealing and more consistent shopping experience across our franchise. Both customer satisfaction and team member engagement are strong in renovated stores, and we remain pleased with the sales lift and financial returns. We continue to experience about a 10% lift in sales performance from the renovation and assortment expansions. And although it's still early and our data is limited, stores that have anniversary-ed their grand re-openings are comping well on top of their initial lift.

As we look to the second half of fiscal 2012, we expect to renovate, relocate or expand approximately 600 more stores in addition to the 342 stores we've already refreshed this year. Reflecting on what we've learned over the last year, we continue to make changes to the layout and assortment to enhance the customers' experience. For example, to support the further expansion of food, health, beauty and personal care that I discussed earlier, we have adjusted the layout to position these categories on opposite sides of the store to give us maximum flexibility to expand and contract these areas as needed. In addition, we are expanding refrigerated and frozen cooler capacity to approximately 18 doors in all new stores and in new renovations where it makes financial sense.

As we expand our merchandise assortment and invest to improve the shopping experience, we are also enhancing our value messaging to customers. As Howard mentioned earlier, our customers' value perception of Family Dollar continues to improve. We have great prices and excellent values every day. But we have an opportunity to communicate our value proposition better, both in stores and in our circulars. We've already begun to change the way we communicate in our circulars. Some of you may have noticed the changes in our February and March ads. Our customers certainly did. We're emphasizing our great values, focusing on items that will drive biggest response, creating more excitement for the customer, making our ads easier to shop for our customers and reinforcing that we are more relevant.

To wrap up, I'd like to reiterate how excited I am to be part of the Family Dollar team. I think we have significant opportunity to increase our relevancy to our customer and expand our market share. And our team is working very quickly to capitalize on the opportunity. Now Ken will review our financial results and outlook. Ken?

Kenneth T. Smith

Thanks, Mike. Before we discuss our outlook for the second half of fiscal 2012, let's quickly review our second quarter results. Diluted earnings per share increased 17.3% to $1.15 in the second quarter compared to $0.98 in the second quarter of fiscal 2011. We expanded operating margin 14 basis points to 9% of sales, and our operating income grew 10.4% to $221.1 million.

Total net sales in the quarter rose 8.6% to $2.46 billion, and comparable store sales increased 4.5%. This is on top of a 5.1% comp increase last year. The comp was primarily driven by customer traffic and a slight increase in the average customer transaction value.

Gross profit in the second quarter increased by 6% or $50 million over the prior year. The gross margin rate declined 80 basis points to 34.9% of sales compared with 35.7% of sales in the second quarter last year. The largest impact on the gross margin rate was our sales mix as consumables continued to significantly increase as a percentage of sales.

In the second quarter, our consumables sales mix shifted again about 240 basis points to 64.6% of sales. Similar to the first quarter, we successfully offset most of the mix shift with higher purchase markups resulting from our global sourcing, private brands and pricing capabilities. Higher markdowns and higher inventory shrinkage also pressured gross margins.

As we discussed on our last earnings call, the unseasonably warm weather this winter impacted sales in many of our discretionary categories. We reacted by taking additional markdowns to proactively manage inventory levels. As expected, shrink as a percentage of sales was again higher this quarter as a result of the merchandise changes and transitions that we completed in stores in the second half of fiscal 2011. As we implement our second half plans and expand our assortment further, we expect that shrink will remain a modest headwind for the rest of the year.

Moving to SG&A. Our expense rate in the second quarter of 2012 declined from 26.8% to 25.9%. The 94 basis point improvement was primarily due to a 40 basis point decline in store labor expense, a 40 basis point decline related to lower insurance costs and a 20 basis point decline in store occupancy costs. We continue to realize benefits from our process improvement efforts, which are driving increased workforce productivity in our stores. In addition, similar to what we saw in the first quarter, improved risk management programs and workforce retention efforts have resulted in positive trends in workers' compensation and general liability claims. These improvements were offset by about 10 basis points related to higher marketing costs as we responded to the promotional environment and accelerated our efforts to reinforce our value position and drive more trips into our stores. The income tax rate during the quarter was 36.5% as compared to 37.2% last year. The decrease was primarily due to the foreign tax benefit from our global sourcing efforts and an increase in federal jobs credits.

At the end of the second quarter, total merchandise inventory increased approximately $163 million or about 15% above the second quarter last year. Average inventory per store increased about 11%. Most of the inventory growth was related to the expansion of our consumable assortments. Consumable inventory increased about 18% in the quarter and drove about a 13% increase in sales. As Howard indicated in his earlier comments, we expanded our food assortment late in the second quarter.

Capital expenditures in the first half of fiscal 2012 were $236.3 million compared to $139 million in the first half of 2011. The increase was mostly due to the construction of our 10th distribution center; a greater number of store renovations, relocations and expansions; increased new store openings; and the impact of our fee development program. As part of our commitment to return excess capital to shareholders, in the first half of fiscal 2012, we purchased 1.3 million shares at a cost of $72.1 million and paid out $42.3 million in dividends. As of the end of the quarter, we had the authorization to purchase up to an additional $265.2 million of our common stock.

Now let's discuss our financial outlook for the third quarter and the rest of fiscal 2012. In the third quarter, we forecast earnings per diluted share to be between $1.01 and $1.11. This is based on an expected 5% to 7% increase in comp store sales, expense leverage and continued gross margin pressure. March sales have gotten off to a good start, with comps trending well within our guidance range, and we expect this pace to continue throughout the quarter.

For the full year, we expect earnings per diluted share to be between $3.55 and $3.75, an increase of 14% to 20% over fiscal 2011. This is based on the following assumptions. We expect the merchandising changes planned for the second half of the year to further accelerate sales growth as we move through fiscal 2012. As a result, we expect total sales to increase between 9% and 10% and comp store sales to increase 5% to 6%. We anticipate gross margin rate pressure for the full year with less pressure in the second half as compared to the first half. We expect this pressure will primarily be driven by the acceleration of lower-margin consumable sales. We expect to partially offset this pressure through improved purchase markups and benefits from lower markdowns as we have reduced some discretionary receipts for the second half. We also expect SG&A expenses to increase between 6% and 7%, the tax rate to be around 37% and our weighted average shares outstanding to be around 118 million. Capital expenditures are now expected to be between $600 million and $650 million, an increase of $50 million from our original guidance.

The increase in our assumptions reflects further cooler expansions, fixtures related to our assortment expansions and our successfully moving through the pipeline of our fee development store projects faster than we originally planned. Now I'll turn the call over to Howard for some closing remarks. Howard?

Howard R. Levine

Thanks, Ken. We shared a lot of information with you this morning, and I think it's important to review a few key points before we take your questions. Back in 2006, we decided to slow down new store growth and strategically invest in our core capabilities and processes. We reengineered our supply chain and merchandising processes, introduced new store level technology and developed a new store layout that we are continuously tweaking to drive productivity. We needed to take these crucial steps to reposition our business model to drive further long-term sustainable growth.

During the same time period, the world as we knew it changed. The recent recession has resulted in a new normal, where people have been forced to think differently about their finances and, as a result, are living more within their means. Our strategy of value and convenience continues to resonate well. The economic changes, combined with the investments we have made to broaden our appeal and improve the shopping experience in our stores, have resulted in a unique market opportunity.

More and more people are visiting their local Family Dollar to save money on the things they need every day. And we are investing to solidify and expand our market share. We are moving quickly, but similar to last year, our teams have done a tremendous job to plan and prepare for these changes. We have leveraged our insights from our customer research and category management tools to help us make important assortment decisions. We are leveraging third parties where appropriate, and we are improving our supplier relationships. Most importantly, we have strengthened our management teams.

We are operating from a position of strength, and I'm confident we are making the right decisions to drive sales per square foot, expand operating margin and deliver greater returns to our shareholders. Now operator, we would be happy to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Aram Rubinson with Nomura.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

Thanks so much for the clarity and the comments. We're looking forward to see those developments in the store. Two questions if it's okay. One, a lot of merchandising change. And I'm just curious about your philosophy, Mike, if it's okay, on testing and how that applies to merchandising change. For example, tobacco and some of the other branded goods. How are we thinking about testing those, rolling those out? What's your general philosophy? Worrying about cannibalization maybe from tobacco and higher-margin things, how do we know the things we're putting forth are the right things to be doing?

Michael R. Bloom

Sure. So let me address the testing component first. We made these -- we take the decisions very seriously. And we've actually been testing tobacco in, I don't know, I think it's 100 stores over the last several months. So we feel very confident that we've read the results and we understand and are confident in what we're communicating to you today. As far as the -- whether or not it's going to be -- cannibalize or be totally incremental, here's what we know. We know that our customers are currently purchasing these products in other retail outlets today. So that's the sole purpose for adding that to our stores in addition to driving trips. So we feel very confident. We've measured it. We've tested it. And we do a lot of testing here at Family Dollar. And also if you think about where we've been in the past through our renovations and you think about the initiatives that I just highlighted on the call, most of those initiatives, if not all of them, have been tested throughout the years as we've continued to expand, whether it be health and beauty aids or food or like tobacco I just mentioned. So again, we feel very confident with our direction.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

And just as a second, can you tell us about your branded penetration today, where you are and where you think that ought to go and how you think that fits and squares with the value proposition of the chain?

Kiley F. Rawlins

I think, Aram, our national branded penetration at the end of last year was approaching about 60% of our sales. I suspect that given all of the brands that Mike mentioned on the call, that we will see that expand from this level going forward.

Operator

Our next question comes from Bernard Sosnick with Gilford Securities.

Bernard Sosnick - Gilford Securities Inc., Research Division

The traffic improvement in the stores is very impressive, and yet the average transaction didn't grow much. Considering that so much has been done for the assortment, why would you say that there's stickiness in the average transaction? And secondly, as the assortment expands in consumables and health and beauty aids and refrigerated doors, et cetera, is space being contracted for apparel and home?

Howard R. Levine

Sure, Bernie. Let me address the first question regarding the basket size. Through the second quarter, I think the lack of some of the discretionary core category sell-throughs impacted the basket size in the quarter. But understand, with all of the trips that we're trying to drive, particularly with the tobacco, Pepsi and the health and beauty aid items, is all around not only creating the trip but also going to help enhance the growth of the basket for us. So I hope that helps there. And in terms of the space issue, there's a number of things that we've looked at about with dealing with space in our stores and how we can become more productive with our space. Most recently, we've created the space to add coolers and grow the food and HBA categories by reducing apparel and actually utilizing higher-capacity fixtures in place of rounders in a number of stores. If you've been in our renovated stores, you've seen those fixtures, and we've decided to roll those back to the chain in a number of stores even prior to the renovation. So those customers in stores that have not been renovated will have the benefit of the added assortment. But what these fixtures do is allow us to merchandise apparel inventory levels appropriate to the space and will actually improve inventory productivity in that area and, as I said, at the same time, create the space to add the categories that we're looking to grow.

Kiley F. Rawlins

And Howard, I would add that apparel is actually up in those stores where we have moved to the higher capacity of fixturing. It is the first time that we have seen a reduction in space lead to a sales lift.

Operator

Our next question comes from Adrianne Shapira with Goldman Sachs.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

A lot of changes, Mike, that you shared with us in terms of brands and categories. And I think we've started to see a little bit higher marketing spend to articulate these changes. I'm just wondering if you could shed some light as to what other changes and how you plan to articulate the store renovations, the environment changes, the new brands to customers and, as a result, what -- how we can expect marketing spend to trend through the year.

Michael R. Bloom

Yes. So as far as how we're going to communicate this sort of new message to our consumers, I think there's several key components. First and foremost, our primary vehicle today is our circular and our in-store presence. So if you've been watching our circular, you've seen the circular change. It started around with the January 29 ad and every ad since then. What we've done in the ad is several things. One is we've made the ad easier to shop. We've made the ad, from a creative perspective, more appealing. We've shown more relevance in our ad, specifically on the front and back pages. You'll start seeing more health care and beauty care and personal care items. And we're using a new tool to help us drive some of that marketing change with a new lift tool that we have in place that helps us determine which offers drive the most trips and are most profitable for us. So we're really excited about that as well. When you move to in-store, we're doing several things. One is we've added significantly more compare and save signs as it relates to private brands to drive more value. But in addition, our entire remodel package, if you think about the adjacencies, the traffic flow, all of that helps our consumer with navigation and shopability. You'll also see, we're currently -- speaking of testing as one of the last questions, we're currently testing a value-messaging component in our stores that again should help drive the consumer to see improved mix, some of the increased health and beauty aid items and personal care items. So again, we feel very confident with where we're heading with this mix of product. And to answer your last part of your question, which is the frequency of marketing or the marketing spend, I think you'll -- we've increased a couple of events this year over last year. And I think you'll continue to see that trend going forward. So we're going to remain competitive. Our customers are expecting us to drive to have circulars. And she uses our circular before she starts her shopping trip, so to help her decide where she's going to shop. So again, I hope that answers your question.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

It does. And then just a follow-up, Mike. As you mentioned earlier, you know that your customers are buying these other products and categories, and that share of wallet is going to other retailers. Given your past life at another competitor, maybe if you could share with us sort of the early days what you're seeing that is perhaps an upside surprise or maybe a little bit more challenging than what you had expected when you joined Family Dollar as you're looking to kind of bring some of those best practices and lessons to Family Dollar.

Michael R. Bloom

Yes. I would certainly classify it as an upside surprise. Again, if you think about where we've been, health and beauty aids aren't new to Family Dollar. The expansion and acceleration of health and beauty aids are new to Family Dollar. And we continue to say, "Look, we're going where our customer wants us to go. She's voted. It's clear as day to the organization that this is the mix that she wants in our stores at great value, convenience." So hopefully that answers your question. But an upside surprise, I would classify it as and very excited about it.

Operator

Our next question comes from Joseph Parkhill with Morgan Stanley.

Stephen Shin - Morgan Stanley, Research Division

This is Stephen Shin sitting in for Joe. Just a question on the gross margin. Given the expanded offering in consumables that you're planning for the second half, do you expect the mix shift to be materially greater than the 240 basis points that we've seen in 1Q and 2Q?

Kenneth T. Smith

No. I mean, clearly, as we launched the investments and initiatives Mike talked about, we expect to drive consumables at a very strong clip. I think -- I would think of the mix to trend fairly similar to the first half of the year. So not a dramatic shift from what we've seen from a mix perspective in the back half.

Stephen Shin - Morgan Stanley, Research Division

Okay. And as a follow-up, so it seems like with the expansion of consumables, maybe private label will be a smaller portion of sales going forward. Is that a correct conclusion?

Michael R. Bloom

No. Private brand sales will continue to grow. And as the SKU mix will grow proportionately to -- as we add more national brands, private brands come right along with them. So -- and with what I mentioned earlier about what we're doing in-store to help her understand the savings with our expanded compare and save messaging, I still see significant growth in private brands going forward.

Operator

Our next question comes from Laura Champine with Canaccord.

Laura A. Champine - Canaccord Genuity, Research Division

Could you talk about how much you think the new products and new categories will add to that comp in the back half? And then also if you can separate it out or even talk about it qualitatively, how much of a lift do you think you're getting from better weather this spring?

Howard R. Levine

Let me address the first part, the additional sales regarding -- in relation to the new SKUs are reflected in the comp guidance that we've provided with you. So it is stating bluntly that there will be an acceleration in consumables. And as we talked about earlier, we're very pleased with the results of early spring and summer in the apparel categories. Frankly, I don't like talking about weather. But if we complain about it, we've got to talk about the fact that it did aid early sales this March. But it's nice to see that we're getting some really good traction in some of the new things that we've done in the apparel area. So we remain very excited about what the future calls for spring and summer. That is the stronger season for us -- the strongest season for us in terms of apparel. So when it's off to a good start, that's a good thing. And we hope to see it finish on a strong note as well.

Laura A. Champine - Canaccord Genuity, Research Division

Any way you could put a number or even a ballpark figure on what kind of a sales lift will come from new products, new categories in the back half?

Howard R. Levine

Laura, I could. I don't know that I want to take the time to do that right now. I would suggest you kind of look back in the rearview mirror at some of the prior quarters where we did have significant SKU lift in the performance of the consumable categories. Frankly, in the second quarter, we saw some very strong acceleration in sales in the January and February period in the consumable categories. It was just as we had talked about. We didn't see the acceleration in the apparel and some of the other discretionary categories, which kind of took a little off of the comp in the second quarter. But the cadence of sales was basically as we expected. And as we went into the month of March, as we talked about, we're well within the range of the guidance we've provided.

Operator

Our next question comes from Meredith Adler with Barclays.

Meredith Adler - Barclays Capital, Research Division

I was wondering if you could talk -- you did a great job actually in first half of the year managing expenses, but your guidance for the full year is for a faster pace of dollar growth. Could you talk a little bit about what you're anticipating in the second half?

Kenneth T. Smith

Sure. When you compare the 2 halves, we are very excited about how the team has managed core expenses. I think when you look at the first half, expenses all-in grew about 4.5%. And when you think of new store growth contributing about 4%, we're real happy with the performance managing core expenses. And we're going to continue that in the second half. A couple of things to think about when you compare first to second half. The new store ramp-up, it is more pronounced in the second half. So if you think of 4% new store growth on average in the front half, probably be closer to 5%, so an additional percent. And that has related expense implications from a new store perspective. And secondly, we'll manage core expenses well. We did get some benefit in the front half from insurance. And that's the culmination of some outstanding work from our team to manage and put programs in to aggressively manage claims. This will be the fourth quarter where we've seen nice benefit from that insurance. So we don't expect the same level of benefit related to insurance in the second half than we saw in the first half. So a couple -- I think we will manage core expenses well, and I think the structure sets up very well for the back half. But there will be a bit more growth than in the first half.

Meredith Adler - Barclays Capital, Research Division

Got it. That was very clear, very helpful. If I could just have a follow-up, I just wanted to kind of confirm what Mike was talking about in adding -- doubling the number of cooler doors. I just wanted to make sure that's going to be a process. Does it happen in line with as you do the renovations? Or are you going back and doing other stores? Like how many stores a year would be getting coolers, more coolers?

Michael R. Bloom

So that happens with our renovation process as well as we do have a project for 1,300 additional stores in the back half of this year.

Kiley F. Rawlins

So Meredith, just to be clear, those 1,300 stores are in addition to what we would do with the renovation or through expansions or relocations. So in essence, we're going back and saying for those stores where we can accommodate from a space standpoint relatively easily, we're go to expand the coolers again in about 1,300 stores.

Laura A. Champine - Canaccord Genuity, Research Division

And the plan for the future in terms of rolling out more coolers?

Howard R. Levine

Well, if I could add. I think the best way to think about our vision for coolers and the role they play in our stores, in the new stores and the renovated stores, currently, our new store setup calls for about 18 cooler doors, which is a substantial increase of where we started back in 2005 with the 5-door cooler set. What you'll see as we work through renovations is we will consider whether 18 doors can be financially justified, in other words, the returns justify that kind of investment. But our goal really longer-term is to at least get that average up to about 10 doors per store. We're right around 8 now. So as we continue to add new stores and renovate stores, you'll start to see that average creep up. I hope that helps.

Operator

Our next question comes from Jack Balos [ph] with Focus Research [ph].

Unknown Analyst

My question concerns gross margins, and that is because of your expansion in consumables, the negative impact of that has overwhelmed the positive impact of foreign sourcing and private brands. In fact, in the second quarter of last year, you actually had an increase in gross margin. My question is, going forward, like the fiscal '13, are you going to get to a point where the negative impact from more consumables might be offset by other factors? Or do you continue to expect a lower gross margin in fiscal '13?

Howard R. Levine

Sure, Jack [ph]. And thanks for the question. I think there is a lot of noise around gross margin out there. I think just as a general comment, we knew this going into the consumable additions that we brought to our assortment in the last few years. Given that we began to build global sourcing capabilities to try to offset that impact, we've gotten some nice traction in our global sourcing capabilities and the buildout of our offices, et cetera, and that's going very well. And we look to accelerate those benefits. A very important part of our strategy is to offset the consumable mix. Secondly, we've talked about private brands at Family Dollar. I would compare that to the same kind of situation as we've seen global sourcing is. We've now built up a strong team in our private brand categories. We're starting to see some nice traction there. We've really improved the quality in our Family Gourmet. I'd encourage you to test and taste some of those things if you haven't had a chance to, Jack [ph]. There are cookies, the cereal, everything is really delicious. And I think our customers are reacting very favorably to that. And again, that's a gross margin story for Family Dollar as well as enabling our customers to have a choice between, perhaps, an overpriced brand and getting value from a private brand at Family Dollar. So we clearly see the headwinds that we're facing with that. And then the final note I would add, and this has had some impact in the last couple of quarters, is the lack of sales in some of the discretionary categories. Last quarter's call, I talked about the fact that we bought up some of those categories, anticipating a better fall and winter selling season. That did not happen. We took our markdowns. We took the medicine. We've cleared that out and are positioned nicely for spring and summer. At the same time, we talked about that last quarter call about reducing our purchases in some of those discretionary categories to mitigate the risks given the uncertainties with where gas prices are going. So we don't think we'll have the drag on the discretionary side that we've had in the past. So while we haven't given guidance for fiscal '13, I would stay tuned for that. We continue to manage through a very difficult gross margin story. And given how the fall and winter season started, I think it's a clear indication that our assortment is getting more basic. And I think, again, with the uncertainties of the economic situation out there, we're playing to our customers’ needs, and wants are secondary in that point. So when I sit back and look at the position of our inventory today, we feel very good about how we're satisfying more of our customers' trips, more of their needs and focused on being in stock and taking care of their everyday basic needs.

Unknown Analyst

Okay. I just have a quick question for Mike. I was just wondering, in addition to Mike, if there are other executive positions that have been added and in what areas and if that's going to make a difference.

Michael R. Bloom

Some of the new hires -- is that...

Howard R. Levine

Yes, I would tell you, Jack [ph], we're constantly looking at seeing how we can enhance our management team. Mike's been with us about 6 months. We talked about the promotion of our Senior Vice President of Discretionary to the Chief Merchandising Officer position not too long ago. There'll be some other additions. But as far as we can see, we're in pretty good shape there and pleased with the way things are going.

Operator

Our next question comes from Deborah Weinswig with Citigroup.

Deborah L. Weinswig - Citigroup Inc, Research Division

Two quick questions. So I guess this one is probably for Mike. What inning are you with regards to global sourcing? And is this mainly going to be a gross margin driver? Or will this also be an opportunity to source unique product?

Michael R. Bloom

That's a great question. I think it's actually both. Certainly, we are laser-focused right now on the gross margin story and moving how we source products, either domestic or agent to as much direct-to-factory as we can. But I also believe that there is a story that will be developed for new products, new offerings from overseas. So I think it's both.

Deborah L. Weinswig - Citigroup Inc, Research Division

Okay. And then with regards to the SG&A improvement, I think 40 basis points of that was due to a decline in the store labor expense. Is that due to new systems or process improvements or both?

Michael R. Bloom

I think mainly process improvements, but certainly, we're leveraging technology in the stores to help us as we manage labor. But I think our store teams have done a great job looking for different ways to increase productivity in the store while still providing great service to the customer.

Kiley F. Rawlins

So I know that our comments today ran a little bit longer than usual, so we're going to take a few more questions. We'll probably go a few minutes past the hour. But I just wanted to let you know that we're going to extend it to just a few minutes. Operator, can we have the next question, please?

Operator

Our next question comes from Matthew Boss with JPMorgan.

Matthew R. Boss - JP Morgan Chase & Co, Research Division

Can you update us on your preferred developer program? How many stores are involved today? And what would be the timeline for any potential balance sheet-enhancing initiative?

Michael R. Bloom

Yes. Matt, we're real pleased with what we refer to as the fee develop program. It lets us partner with some strong developers and get some real economics out of some of our real estate deals. So it's going very well. As I mentioned, it's moving a little bit faster than we had planned, which is positive. Probably think in terms of 20% to 25% kind of a range of the deals that we expect to be in the program. And we are looking at -- the structure requires capital, so as we put these stores up on our balance sheet from the program, it does require capital. And we are investigating and working hard at looking at the potential for a sale-leaseback transaction as a part of the program. So it's a little early to talk in detail about that. But we're working on that as a source of capital to fund the fee develop program, and stay tuned on that.

Howard R. Levine

So Matt, if there was one thing I could just add to that program, the financial benefit to Family Dollar in this fee development program is the utilization of our capital or our cost of capital compared to many of the smaller developers. And what we have found is it's somewhere in the neighborhood of 200 basis points improvement. So that enables us to reach out for more site locations, more potential for us as a company. There's some pain in terms of the use of capital to start the program up and fund it. But once we get that going, it'll be a regular cadence of these sorts of deals.

Matthew R. Boss - JP Morgan Chase & Co, Research Division

That's great. And then just real quick, can you break out your inventory build out of 2Q on the discretionary side? I know there were some concerns about around potential pack-away inventory. And when should we expect inventory to be better aligned with sales?

Howard R. Levine

Sure. But before I get started on discretionary, let me again just reiterate that, by far, the majority of our growth in inventory is driven by the assortment expansions in food and health and beauty aids. And again as we talked about, we're getting some nice traction on those investments and feel very good about the early returns there. On the more sensitive seasonal categories that were clearly impacted by the soft macro and the warmer winter, we took a lot of markdowns. As I said earlier, we took our medicine to clear out those goods. We feel like we're in a manageable position there, and again, it's not material to the inventory position that we're seeing today and feel very good about how we're positioned. And I think a great indication of that is some of the early sales that we're seeing, particularly in the apparel categories.

Operator

Our next question comes from Scot Ciccarelli from RBC Capital Markets.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Howard, you made the comment you thought the economy was starting to improve. And I think that's the first we've heard that from you in quite a long time. But it seems like your trends are pretty similar to what we've seen certainly for a while. So what is it that you're seeing that makes you think that the economy is starting to get a little bit better?

Howard R. Levine

It's a good question. Frankly, I'm going out on a limb here trying to be an economist, but -- which I'm really not qualified to talk about. But when I think about Family Dollar and where we've been over the last couple of years, clearly, there's been a great acceleration in our consumable business. We've seen some nice sales, some nice increases there, and a lot of that is driven by some of our SKU additions, the renovation programs and some of the things that we've talked about. We expect that to only continue to accelerate with the SKU additions that we're talking about in the back half and have seen historically when the economy is strong or gets stronger that we'll have some benefit from discretionary. We're not really forecasting a huge benefit on the discretionary side this year. What we're focused on is better sell-throughs so it isn't the drag on the margin it has been over the last year or so, which in my opinion is clearly from the economic environment out there. We feel a little bit better as we go into the spring season because that is a better season, a longer season for the discretionary side, and we’d hope to see some acceleration in those categories in the back half of the year. But I would tell you that, overall, our core customer is stressed and continues to be stressed. Where we're seeing increases, in the more middle-income customer that is now shopping with us that are beginning to see some of the improvements we made to our business and with a renovation program that has continued -- is ongoing. Our quality improvement initiatives would continue to occur. Our improved shopping conditions, we think we're doing some things that position us well for that middle-income customer and is not offensive at all to our core customer. So we're kind of managing both sides of the spectrum there and hope to come through with continued success.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Okay. I think I understand. And then just real quickly, I guess this is for Mike. With all the extra SKUs you guys are adding to the stores, is there any risk that stores start to look too cluttered?

Michael R. Bloom

Yes, I think it's a good question. Again, if you think about the SKUs that we're adding, again, primarily in consumables and a significant number in health and beauty aids, these are generally small SKUs, efficient SKUs. So I don't think we're going to be too cluttered. We're not talking about big, bulky tonnage-type of SKUs, big paper products. So I don't fear that. And also, when you deal in a small box like we live in, customers have different expectations. And so I think our customers are clearly voting that she wants the relevancy in the mix, and that's what we're giving her. So I don't fear that at all.

Operator

Our next question comes from John Heinbockel from Guggenheim Securities.

John Heinbockel - Guggenheim Securities, LLC, Research Division

Guys, a couple things. When you looking at adding the 1,000 SKUs, sort of as a follow-up to that last question, where does the space come from? Is it deletion of other items, less facings from some items? Or do you go more vertical? Where do you think it comes from?

Michael R. Bloom

Yes, so I think -- John, it's Mike. I think it comes from multiple areas. So as Howard mentioned earlier, we're picking up a lot of our health and beauty aids space from the new apparel fixture, getting rid of the rounders and using more of a waterfall-type fixture. That move alone allowed us to put another gondola in the store for health and beauty aids. And then in some stores, we'll end up going up because again, as I mentioned, in a small box, she has different expectations. So whether we go up an additional 6 inches or, in our very small stores, closing off one of the aisles because in a small store, again, she doesn't have the same expectations. She votes for the relevance versus having an extra couple of end caps. So I've always said also this -- one thing that Family Dollar is really, really good at it is living in this small box world as long as they have, they're really good at finding space and making space efficient.

John Heinbockel - Guggenheim Securities, LLC, Research Division

Before you do the renos, though, the stores that are not renovated, right, so you won’t put your apparel changes in yet so that's not the source. Is it then more vertical displays?

Michael R. Bloom

Yes.

John Heinbockel - Guggenheim Securities, LLC, Research Division

Okay. Secondly, you look at the traffic pickup, which looks like it picked up nicely quarter-to-quarter, do you have any way of telling is that the core customer shopping more frequently or new customers who had not been exposed to the box before?

Kiley F. Rawlins

It's actually a combination of all the above. In fact, we are seeing our strongest growth on a per shopper basis from this middle-income, trade-in shopper. But our core shopper has also been growing her trips with us. I think there was a question earlier about basket. What we’ve found is we have this kind of magic $10 in our pocket. And so the way we drive loyalty is she comes to see us more often.

John Heinbockel - Guggenheim Securities, LLC, Research Division

Okay. And then finally, just one for Ken. If I look at what's happening with CapEx and working capital, so it looks like 2 things. You may have some funding needs back half of the year. Is that more drawing down the revolver or doing something more permanent? And then secondly, it also looks like buyback activity, just by definition, has to be very modest for a while. Is that also fair?

Kenneth T. Smith

Yes. I think when we look at that cash flow picture and the balance sheet -- as I mentioned to the earlier question, I think that the upcoming news is related to our fee development program when you look at the cash picture. And as I said, we are looking and working at the potential for a sale-leaseback transaction that essentially seeds or provides a source of capital for our fee development program, which is a big driver of the CapEx and sets up a use of our operating cash flow. So we're very -- the balance sheet remains very strong. The liquidity that we have, very strong. So I think we remain in great position. Buybacks, we're pretty conservative in the buybacks. As we've disclosed, about 118 million shares outstanding is embedded in the guidance. So we'll be opportunistic and take a look at the market, but that gives you a sense of what our thoughts are in our guidance.

Kiley F. Rawlins

So Tanya, I think let's take 1 more question.

Operator

Our question comes from Mark Montagna with Avondale Partners.

Mark K. Montagna - Avondale Partners, LLC, Research Division

A couple questions on gross margins and inventory shrink. Are you -- it sounds like you're projecting gross margin for both third and fourth quarter to decline, and then perhaps, should we expect an increase next first quarter?

Kenneth T. Smith

Yes. I think what we're indicating, I think as we look at the back half, I mean, clearly we've had pressure in the first half primarily driven, first and foremost, by mix and the strength of the consumables. We then -- as the season's discretionary side were a bit tougher, we took some more markdowns in the first half than expected to make sure the inventory was in good shape. And thirdly, shrink gave us some pressure, as we’ve talked about. As we look to the back half, we certainly -- we're driving the business. And a lot of the items Mike talked about are driving the consumable side. So we expect mix pressure. And that's what we're planning for a bit more probably than we anticipated at the beginning of the year. So when I look at the back half, you start with mix, a bit of shrink, pressure, we're expecting. But we do expect to have fewer markdowns in the back half from a margin perspective. So some pressure in the back half but not as much as we saw on the front half.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. So then you were just mentioning about shrink. Are we getting to the point, I think, in maybe the third or fourth quarter where we’re going to anniversary that and it will potentially not be a headwind?

Kenneth T. Smith

I think that opportunity exists probably more in the fourth quarter. But from a shrink perspective, we've seen some pressure. We've had a lot of activities in our store in the back half of the year. What I'd tell you on shrink is we're very accomplished at managing shrink, and when you look over a 5-year period, the trends are tremendous. We've seen a little uptick recently. Our teams are very focused on shrink. You probably can't talk to a manager that doesn't think about shrink or know about it. So we have the confidence that shrink trends will improve from where they are and have a keen focus on it.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. And then just lastly, when we were talking about apparel in terms of basic and fashion, can you give us an indication as to where you think that's headed in terms of what percentage of sales you expect to be basic and where was that? And I guess the same thing would apply also to the home sector.

Howard R. Levine

We don't have an end goal there, Mark. I think we kind of have done what we've always done, and that's react to what the customer is telling us. And just as a clarification, we talked about basic apparel. We're talking about things like underwear, socks, basic items that they use every day as opposed to hanging apparel. And as I talked about in the call earlier today, we plan to be more cautious on those kinds of purchases in the next year or so, given the economic uncertainties out there.

Mark K. Montagna - Avondale Partners, LLC, Research Division

Okay. But then with home, is there a certain scaling back in terms of the SKU count in home, maybe towards some less seasonal-type products, like say maybe certain towels that tend to be more for the fall or the spring?

Howard R. Levine

Again, it's the same kind of situation as in apparel. We're going to be more cautious on some of the discretionary areas in home. We have a very good basic home business that is getting refreshed as we speak. So our consumers will actually see an enhanced and a much stronger towel program this coming season. With that, we've made some other tweaks and adjustments there. But we have been very strong in the home categories historically and continue to believe that, that's an important category for our consumers and look to continue to improve our offering there.

Kiley F. Rawlins

So thank you for your patience this morning. I know we went a little over our time. And unfortunately, we didn't get to everybody in the queue. But thank you for your interest in Family Dollar. As always, I'll be available after the call to take any questions you may have. And I hope you have a great day. Thanks.

Operator

Thank you. And thank you for joining today's conference. You may disconnect at this time.

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