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Family Dollar Stores Inc. (NYSE:FDO)

2012 Analyst and Investor Conference

July 18, 2012 1:00 pm ET

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

Mary A. Winston - Chief Financial Officer, Chief Accounting Officer and Executive Vice President

Analysts

John Heinbockel - Guggenheim Securities, LLC, Research Division

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

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

Deborah L. Weinswig - Citigroup Inc, Research Division

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Meredith Adler - Barclays Capital, Research Division

Joseph I. Feldman - Telsey Advisory Group LLC

David Schwartzman

Kiley F. Rawlins

Good afternoon, and welcome to the Family Dollar 2012 Analyst and Investor Conference. We're really glad that all of you could join us today. My name is Kiley Rawlins, and I lead our investor relations effort here at Family Dollar. Today, we'd like to give you an update on what we think the opportunity is for Family Dollar and the progress that we're making in pursuit of our growth agenda.

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 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 that are on the screen and that are contained in our SEC filings. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today, July 18, 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.

Today's presentation will include certain information that has not been derived in accordance with generally accepted accounting principles. Reconciliations of such information to the most directly comparable GAAP information are in your handouts and available on our website. As a reminder, this information is intended to provide color and should not be considered a substitute for any GAAP measures.

Today, you'll hear from our senior leadership team, including: Howard Levine, Chairman and CEO; Mike Bloom, President and CEO; and Mary Winston, our new CFO. Following the presentations, we will have some time for your questions. But just to level-set expectations, we want to focus today on our longer-term plans and visions. We plan to provide more specific color about the fourth quarter and our expectations for fiscal '13 on our year-end conference call in October.

Now I'd like to introduce Howard Levine, Chairman and CEO.

Howard R. Levine

Thank you, Kiley, and welcome, everyone. I hope it's not too hot out there. Being from down South, it feels pretty comfortable out there to me but I might shed the coat in the Q&A section. Glad to see so many of you have been able to join us today. I know that there are a number of people that are listening in our discussion on our webcast as well, so welcome to all and thanks for coming.

Before we get started, I'd like to introduce some of our management team members here. So if you guys would stand and wave to the crowd, that would be great. First, Mike Bloom, our President and COO; Mary Winston, our Chief Financial Officer; Paul White, our Chief Merchandising Officer; Barry Sullivan, the tall guy over here in the corner, Head of Store Operations; Jim Snyder -- can't have a meeting without Jim Snyder, General Counsel; Steve Burt, Vice President and Treasurer; Beth MacDonald, Assistant General Counsel, back in the back there; Mtu Pugh, our VP of Strategy; Mike Vickers, our store's VP for this area, back in the back; Jorge Amador, our RVP up in this market. Jorge is in the back. And if all the red shirts will just stand up, this is the store team in this area. A lot of these guys helped set the store and are doing a terrific job up here. And I'd like to give you guys a round of applause.

It's been almost 2 years since we got together in this same room in New York, but a lot has changed at Family Dollar during this time. We've opened or remodeled approximately 2,100 stores. We have added more than 2,000 consumable items to our assortment, along with some new businesses, and we've welcomed some new talent to our leadership team. And in our stores, we have a lot of change happening right now. Over the last few months, we have asked our teams to implement more initiatives than ever. And I'm very proud to say that they have executed these changes beautifully. More importantly, our customers can now shop an expanded assortment of food and HBA, or health and beauty aids, in all stores.

Over the last 2 years, a lot has changed at Family Dollar, but what hasn't changed is our commitment to being a more compelling place to shop, work and invest. Our mission and core values have not changed, but we are thinking differently about the Family Dollar brand. Today, I want to share with you what we want our brand to mean to our customers, our team members and our shareholders, how we are executing against this vision and how we intend to measure our success.

Let's start with our vision of what the Family Dollar brand will stand for. When customers see the Family Dollar brand on the front of the store, in a circular or in their community, we want them to know that they can count on Family Dollar to have what they need when they need it. We want them to know that they will save money and get good quality merchandise. We want them to know that they will be able to visit a store that is close and convenient to their home or work and that their total trip should take less than 10 minutes. And we want them to know that they can have a positive store experience in addition to the great value and convenience that we offer.

For team members, we want the Family Dollar brand to represent an organization, where, if you work hard, you can have a very successful career. We want Family Dollar to be known as a place where compensation programs are fair and strong performance is rewarded. We want to be an organization that is recognized for having teams that work together and achieve a common goal. And we want to nurture a work environment that is respectful and recognizes outstanding performance. For our shareholders, we want the Family Dollar brand to stand for a consistent, long-term, strong financial returns and have an efficient capital structure.

So now that we've defined what we want the Family Dollar brand to stand for, let's talk about how we're executing to this vision. Let's start with how we're executing our vision for our customers.

Since opening our first store more than 52 years ago, we have continued to change and evolve our assortment to serve our customers better. Over the last 5 years, we have increased our assortment of food significantly. And more recently, we have started to increase our selection in HBA. In addition, this year, we have added a number of new consumer brands like Pepsi and entered new businesses like tobacco. As Mike will discuss further, we are working quickly to become more relevant to our customers and drive greater sales productivity per store.

Value is the combination of price and quality. And we are committed to protecting and improving the customers' perception of both. Today, we enjoy a strong value perception among customers. Our customers have given us high marks for providing value and maintaining consistently good prices. But maintaining a strong price image isn't about having the lowest price on every item. It's about providing good values on every item and being competitively priced on the right items, that is the items that have the greatest impact on overall price perception. Later this afternoon, we will share more detail about our pricing strategy.

We are also making investments to increase our quality perception. National brands drive greater quality perception. And over the last 2 years, we have increased our selection of national brands in a number of consumable categories, including food and HBA. In addition, our selection of national brands, we are also committed to meeting and exceeding our customers' expectations in our private brand offerings. Every item we place in our stores has a quality standard that must be met to ensure our customer satisfaction. We manage compliance to these standards and develop processes and partnerships that reach across the globe to ensure we deliver value to our customers.

Our investments to become more relevant to customers will help us increase the convenience that we offer. Our effort to improve adjacencies through enhanced store layouts will help our customers find what they need faster. And as we open more new stores and increase our footprint, we will offer this increased convenience to even more customers.

Finally, we are investing significantly to improve the customer shopping experience. More than just the store renovation program, I view this effort as a platform for change as we work to refresh our entire chain. Our goals are to create a more consistent customer experience across the chain, improve our competitiveness and establish a foundation for future assortment and productivity growth.

Specifically, we are rebranding our stores both inside and out. We have improved the navigation and shopability in our stores to make it easier for customers to find what they need quickly. And we have improved our in-stock levels to make sure that we can satisfy her needs better. We have also enhanced the checkout process to improve customer flow and we have raised our customer service expectations.

Now here's a picture of store #12, which is in Rock Hill, South Carolina, which is not too far from Charlotte. I actually worked in this store probably 25 years ago. And I'll be honest with you, it was old as heck back then. But this store opened back in the early '60s, thus store #12, and has been a very, very profitable store for us for almost 40 years. Now here's what it looked like after the renovation. Kiley, that can't be right. That looks too good. But that's the store, I promise. It's amazing what happened here, same store. But let me tell you what we did. We built the façade. You can see the raised area there. We added awnings, and overall, made a significant change to the presentation of our brand. From a customers' perspective, this is just like a brand-new store. We also enhanced the interior. We eliminated speed tables, stack-outs, rounders and added new more productive fixtures. We continue to change and improve the layout of the stores. We've moved our fastest-growing categories, food and HBA, to opposite sides of the store to give them both room to grow. And we've changed the placement of gondolas and added height to gondolas to give us more holding capacity and shelf space.

We continue to be very pleased with the performance of our renovated stores. 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 renovations and the assortment changes we've made. And although it's still early, stores that have anniversary-ed their grand reopenings are comping well on top of their initial lift. More importantly, and what means so much to me, our customers love it.

Our goal is to refresh the entire chain by fiscal '15. We expect that more than 90% of our stores will have been renovated or opened within the last 5 years. Team members who are happy make customers happy. To that end, we are also building a strong team member brand. We are implementing new reward and recognition programs to motivate and encourage team members. We have continued to integrate our goal and objective setting processes to make sure that all 55,000 of our team members know what our priorities are and know how they contribute to the company's success.

We've updated our online training programs and we've expanded our leadership development programs. We've added some development support and mentorship programs for team members who want to progress in their careers. We have increased our team member training significantly this year. Today, team members can access additional training anytime. And we've taken steps to ensure that the learning doesn't stop when a team member leaves the classroom or finishes an online module.

And finally, we've enhanced our succession planning processes. The leadership changes we've made this year are a good reflection of the successful implementation of these processes. Mike Bloom and Mary Winston both joined our team as a result of our succession planning processes relating to Jim Kelly's retirement. And Paul White's promotion to Chief Merchandising Officer 8 months ago was also a result of succession planning work. While these illustrate some of the high-level changes we've made, we've also taken succession planning all the way down to the store level.

If we execute for our customers and we execute for our team members, I'm confident that we will deliver strong results for our shareholders. We are targeting 5% to 7% annual net new store growth. Between 2006 and 2007, we actually slowed new store growth and accelerated capability-building investments. These investments in people, processes and tools have given us a solid foundation for improved execution and decision-making. With this foundation in place, we began reaccelerating growth last year and expect to be within our targeted range in fiscal '12. We believe that we can effectively manage and sustain annual net new store growth in that 5% to 7% range.

Certainly, when we look at real estate opportunities, we believe that we can more than double the size of the chain. New markets like California represent significant growth opportunities. This year, we've opened 27 stores in California and we expect to open around 50 by calendar year end. While this is a new market, there will be an investment period, but we continue to be very pleased with the early results. Customers in California seem to appreciate the value as much as our customers throughout the rest of the country. As we think about the long-term opportunity in California, we expect that we could operate as many as 1,000 stores in the state.

We also are seeing more real estate opportunities surface as we expand our assortment, increase our unit productivity and attract more trade-in customers. And as we look longer term, we believe that international markets or strategic acquisitions could represent additional growth opportunities.

We continue to invest in our supply chain to support this expected growth. This month, our 10th distribution center in Ashley, Indiana began shipping to stores. Not only will this new distribution center provide needed relief from a volume perspective, it will also help us reduce our transportation expense by reducing our stem miles. Our 11th distribution center in St. George, Utah, which is scheduled to open sometime in the fourth quarter of fiscal '13, will support our West Coast expansion and enable us to reduce stem miles even further. And finally, our new partnership with McLane will fortify our refrigerated and frozen supply chain, allowing us to improve our in-stocks and improve our assortment.

Expanding operating margin is a key driver of shareholder returns. I believe that we have an opportunity to expand this important metric further. While a growing mix of consumables will continue to pressure margin, longer-term, our investments in global sourcing and private brands, as well as opportunities to reduce shrink and markdowns, will help us to mitigate the impact of greater consumables sales on gross margin. Accelerated sales driven by new store growth and improved sales productivity, combined with continued productivity improvements in our supply chain and workforce management, should also help us continue to leverage SG&A more effectively. As you can see from this slide, we have expanded operating margin despite the growth in consumables as a percent of sales. Later this afternoon, Mary will talk more about the productivity of our business model.

And of course, we are focused on increasing our return on invested capital. Operating margin is an important element of driving higher returns on capital, but we also maintain our disciplined approach to capital spending. As we have discussed before, our first priority for deployment of capital is to reinvest in the business of higher financial returns. Our model historically has generated strong cash flows and we continue to look to return excess capital to shareholders through dividends and share repurchases.

Accountability is an important issue in every organization. So let's talk about how we'll measure our success. We continually measure customer satisfaction through our CASH score. CASH stands for cleanliness, assortment, service and high-speed checkout, all of which are attributes that drive brand loyalty. The CASH score allows us to track the customer experience in a tangible way and helps our teams focus on the elements that drive customer satisfaction. So here's how it works. We evaluate our performance on a 7-point scale, but only perfect scores count in this metric. In the third quarter, 74% of our customers gave us a perfect score. If we included scores of 5 or 6, our cash score metric would have been 90%.

Value perception is another important metric. We routinely measure our customers' value perception and have seen meaningful improvement over the last 2 years, driven primarily by our efforts to improve merchandise quality. As you can see, we have made significant progress in improving the quality perception of both our national brand assortments and our private brands. And we will evaluate our success by measuring our ability to capture more trips and more of our customer spend.

We will evaluate our success in building strong team member brand by measuring our team member engagement. Since completing our first engagement survey in 2010, we have improved team member engagement results in every category and in every department. And this is on a scale of 5.

We will measure our employee retention. Our store managers are the heart of our organization. And over the last several years, we have reduced our store manager turnover significantly. Our store managers build great teams that execute every day for the customer. Our ability to retain talented, engaged store teams will drive customer satisfaction and, ultimately, our profitability. And I had a chance to talk to some of our team members in the back today, and I got to tell you, I'm impressed. I was telling them with all we just asked them to do in the last 3 months, it's amazing. So again, my hand off to the team in the back there.

And we will measure our success in building our bench and promoting talented team members from within our organization. This is especially important in our store operations organization. As we think about supporting our long-term growth objectives, our talent development programs will ensure that we can staff new stores with experienced, talented team members who are building their careers with Family Dollar.

Finally, as we turn to how we will measure our success in delivering results for our shareholder, the ultimate measurement, of course, is our stock price. Over the last 5 years, the price of Family Dollar stock has increased approximately 100%. While there are always short-term market fluctuations, we believe that as we build the Family Dollar brand and execute our vision, that our performance will continue to deliver strong long-term returns for our shareholders.

So I shared with you our vision for the Family Dollar brand and our efforts at a high level to realize our mission. Now I'd like Mike to share more details about how our efforts are to be a more compelling place to shop. Mike?

Michael R. Bloom

Thanks, Howard, and good afternoon, everyone. It's great to be here with all of you today. And it's great to have some of our leadership team and our team members here as well. They are so instrumental in everything that we do.

So I've been here about 10 months, and it's certainly been an exciting and a rewarding time. It's exciting to be part of such a great organization with so much history of success and so much opportunity for growth and to work with such a strong leadership team and our over 55,000 dedicated, hard-working team members across the country, because in the end, it really is all about them. We live in an evolving channel with an evolving customer and we are evolving as well. Over the next hour, I will be sharing with you our strong history of success, the drivers of change in this current environment and how we are evolving our business model to adapt to these changes.

Family Dollar, founded in 1959, has an incredible rich history and an impeccable track record of success. Zeroing in on the last 10 years, we have added nearly 3,000 stores, which is a store every 29 hours, and that's simply amazing. Sales have grown nearly $5 billion over the last 10 years. And this growth alone would be a Fortune 500 company. Over the last 10 years, our turns have improved by about 45% to 5 turns annually. And most importantly, over the last 10 years, our vision, strategies and our ability to execute have delivered results. Our earnings per share have nearly tripled to $3.12. So as you can see, we clearly have a strong foundation, which will support our continued long-term growth.

So let's look at where Family Dollar is today, a Fortune 300 retailer approaching $10 billion in annual sales. We operate more than 7,300 stores in 45 states that average about 7,000 square feet and we service over 14 million customers every single week.

Since opening our first store more than 53 years ago, our philosophy has not changed. We take care of our customers by providing great value and convenience. We know that our continued success hinges upon staying true to this philosophy. However, our continued growth requires us to enhance one key component to that strategy, we must remain relevant for our customers.

And to ensure that we remain relevant, we must continue to be flexible and be able to adapt. The customer continues to change, the economy continues to be challenged and the competition continues to evolve. I don't have to remind you of the many retailers that did not evolve their business model based on these 3 key factors of change. Blockbuster Video and Circuit City come to mind as companies with great business models during a period of time. But they both failed to evolve. And let me explain why I believe it is critical that Family Dollar continues to evolve.

First, our customer base is evolving. You can see here that our core customer, who makes less than $40,000 per year, is still a vital piece of our model. And what I'm most excited about is the growth that we are experiencing in the $40,000 to $70,000 income level, the over $70,000 income level and even over the $100,000-plus income level. These trade-in customers have experienced Family Dollar and they like us. And they have more disposable income, and more disposable income means more sales and more profit.

Our everyday value proposition or EDVP, which I will talk about later, resonates well with most of our customers. We offer great brands, great quality and a great convenient shopping experience at over 7,300 nationwide convenient locations. And it is important to note, while these new higher-income consumers are growing, we will not take our focus off of our core consumer. This new higher-income trade-in customer just opens up more opportunities as we continue to evolve. And as you can see here, at Family Dollar, we are experiencing double-digit growth in annual spend per customer across nearly every income level.

When we talk about the customer, we must first begin with our core shopper. They are core to every decision that we make at Family Dollar every single day. Our core customer is a female head of household. And these customers make less than $40,000 per year. They skew older and ethnic, have a high school education or less and often live in nontraditional family households. They live paycheck to paycheck and many of them rely on government assistance for their everyday shopping needs. Their shopping trips are driven by when they have money. They do not have the liberty of saving money. Our core shopper is extremely price-savvy, and she knows how to stretch a dollar. Family and community are very important to her. She appreciates a neighborhood store and familiar team members. And as I'll discuss later, there are more of these customers in our country today than there were 5 years ago. And it is crucial that we continue to remain relevant for our core consumer to get more of their trips and to increase our share of their wallet.

In addition to our core customer, we are very excited about our trade-in customers. We have always had customers that trade into our channel. They have just been doing it at a much faster pace over the last 5 years. We define our trade-in customers as someone who makes between $40,000 and $70,000 per year, is slightly younger, less likely to be ethnic and has more education than our core consumer. For this customer, merchandise quality, assortment and the in-store experience are more important. These factors will often be a dealbreaker for whether they shop at our stores or at a competitor.

Let's talk about how life has changed for this customer over the last 5 years and the growing role that we now play in their lives. To help bring this to life, let's hear from a few of our customers.

[Presentation]

Michael R. Bloom

So as you've just heard, these shoppers have been hit very hard by the economy. They've been laid off, forced to take pay cuts, had their working hours reduced, haven't seen a raise in years. Rent, food, gas, utilities, in addition to many other costs, have all increased. Times have become far more difficult for this shopper. They have less income, higher living costs and, in many cases, have more people to care for. They are strained by the rising cost of everything. So how are they shifting their behavior? Well, they take fewer or no vacations. They delay car repairs. They delay home repairs. They eat out less. They are doing more paycheck-to-paycheck purchasing and staying much leaner between paychecks. They are using coupons much more aggressively, searching for quality national and private brands for less. They are laser-focused on price and are moving from wants to only real needs. Does this sound familiar? While we have grown our share of their wallet over the last 5 years, we have a tremendous opportunity to grow more share of their wallet.

Turning to the economy. Consumer confidence continues to remain at recessionary levels. Unemployment rates continue to hover in the high single-digits. And most disappointing is that there is a growing number of people making less money today than they did 5 years ago. And as you can see here, more people are making less money today than before the recession. Those earning below $25,000 a year has grown 11%. These are our customers. They live paycheck to paycheck, and there are more of them.

This also helps explain why we are experiencing such growth from our customers trading in from higher income levels. Customers feel smart when they shop at Family Dollar and we help them stretch their dollar. The value we provide to our current customers and to potential new customers is more important today than it has been in our company's rich 53-year history. At Family Dollar, we are in the camp that believes that the economy will not be improving in the near future. Now having said that, many people have different views on the economy and where it is headed. Some of you may think that we only do well during economic downturns. I would argue that we do well in both downturns and recoveries. And a review of our historical performance would actually support this view. Certainly, our value proposition resonates very well with consumers when times are difficult. And we often appeal to customers of all income levels who are looking to stretch their dollar.

But if you look at the historical trend, as you can see here from the red circles on the slide, Family Dollar has actually experienced strong earnings growth as the economy recovers. In economic downturns, consumers often pull back their discretionary purchases and focus on basic needs. In recovery periods, our customers have more money and can often treat themselves to more discretionary purchases, which are more profitable purchases for Family Dollar.

We talked about the customer and the economy, so now let's take a look at our competition. And our competition is changing, whether it's Walmart Supercenters or their new Express format; J.C. Penney's new price value campaign or the new JCP; Dollar Tree's deals format and the many other formats in food, mass and drug. Our competition is getting better and we must always believe that they are a threat. We cannot become complacent. Our competition is evolving and we must continue to evolve.

So just a quick recap. We talked about our rich history and our foundation for long-term sustainable growth. We've confirmed that our customer is changing and that the economy continues to be challenging and that our competition continues to evolve. So let's switch gears and talk about how Family Dollar is evolving.

As our business model evolves, we are focused on the following priorities. First, we must become more relevant and stay more relevant so that our customer can complete more of their shop at our stores. We do not want to force her to go to other retailers for basic items that we do not carry.

Next, we will use the customer as a filter in every decision that we make every single day. We exist to take care of our customers' needs so they must be a factor in every decision that we make. And we will be laser-focused on driving incremental trips to our stores. The key is to drive these incremental trips at our average basket size or even greater. And our focus on providing great value will never waver.

We must also enhance our relationships with our supplier partners and leverage their resources. We want our supplier relationships with our supplier partners to be a win-win relationship. We want our suppliers to come to us first with their most innovative ideas and new products and we want to be open and share the facts. I want Family Dollar to always win with our supplier partners, especially when there is a tie. And most important, we must always remember that whatever we do has to be able to be executed and sustained by our over 55,000 team members across the country.

Now I've been talking about relevancy for the last 10 months. So why are we so obsessed with becoming more relevant and staying more relevant? Well, let's look at the opportunity. Our shopper currently spends about $6,000 per year in the marketplace. They make 183 trips per year to various retailers for various reasons and spend, on average, $33 per trip. At Family Dollar, we are only getting $84 of their spend and averaging 6 of those trips.

To help increase our sales productivity, we need more of her trips. So how are we going to do that? Our initiatives are focused on our consumers' most common trip drivers: food; household chemicals and paper; health care; beauty care and personal care; and our newest category, tobacco. The majority of our customers’ trips for these businesses are currently not made in our stores.

As we look at these trip-driving businesses, such as household chemicals and paper, these are businesses that we enjoy a commanding market share that we have to defend. Our strategy for these 2 categories is to defend them and continue to innovate and grow our market share. Unlike household chemicals and paper, we have an offensive strategy for food, health care, beauty and personal care and, of course, tobacco. And as I mentioned, earlier, these are our customers' most common trip drivers and our go-forward strategies revolve around these businesses.

So let's drill down into food. Our customer makes 114 trips for food per year in the marketplace. At Family Dollar, we get very few of these trips. Over the last 5 years, we have expanded our food assortment by about 1,100 SKUs. The key drivers behind the expansion are refrigerated and frozen food, beverages, prepared food from mealtime relevance, snacks and candy. The expansion includes a significant increase in both national brands and private brands. With the recent addition of 250 SKUs this past June and July, we believe that our food assortment is competitive with any small-box retailer in our channel and in the marketplace. And as we continue to evolve, our goal is to continue to drive sales productivity through SKU optimization.

Looking at the results of our evolution in the food business, you can see that we have generated a 15% CAGR over the last 5 years and that we have grown our penetration 38% from 16% to 22% of sales, and the trend continues. When looking at our fiscal 2012 year-to-date, food sales are up 18% and our penetration has grown to 23% of our total sales.

And when we look at the various metrics around food, it is clear that the consumer has voted with their wallet, and we are more relevant. Our market share continues to grow and, in fact, is up 56%. Our annual spend per customer grew 63%, while our trips have grown 18% and our purchases per trip have grown 38%. Our strategy is working. Our customers love to shop at Family Dollar for their food needs.

Now while we've expanded our food assortment by about 1,100 SKUs, we are enjoying improvements in productivity. This slide shows that while we have added significant inventory in food over the last 5 years, the customer is responding to the assortment as turns continue to improve.

As we mentioned on our recent third quarter earnings call, we were in the middle of another 250 SKU expansion -- food expansion. And I'm happy to report that we have just completed this expansion in all stores. And as Howard mentioned earlier, I couldn't be more proud of our store teams who have executed this expansion. Right now, we have a fully competitive food assortment and I would put it up against any small-box retailer.

One of the most exciting initiatives at Family Dollar is our 6-year, channel-exclusive partnership with McLane. Let me reiterate that this is an exclusive agreement between Family Dollar and McLane in the value channel for at least 6 years. McLane is the largest wholesaler of tobacco in the U.S. with roughly 25% of the market. This new relationship will help us improve our in-stocks and stabilize our previously fragmented and fragile refrigerated supply chain. We have consolidated about 50 regional wholesalers of refrigerated and frozen food to 1 wholesaler, McLane. And we will be able to leverage McLane for a national assortment, as well as regional clustering. McLane has over 40,000 items in their portfolio and will add any item that we want them to add. McLane will be distributing select categories to include not only national brands within those categories, but also Family Dollar private brands.

One of the benefits of this partnership is the flexibility that it provides our distribution network to expand our SKU capacity. Said another way, as McLane distributes items that are currently in our distribution centers, this opens up slots for us for potential new SKUs. This strategic partnership is very important to Family Dollar as we accelerate our store growth, expand coolers in our stores and as we continue to remain relevant for our customers. As a reminder, McLane won't start servicing our stores until mid-September.

Now I heard based on the store visits -- I'm going to go off a little bit and talk about the store visit for that many of you were on. I heard that there were a lot of questions around McLane and the potential margin pressure that this may put on our model. And I'm assuming that's going to be a question we're going to get at the end. So I'm going to try to give you a little bit of insight here.

First, remember, many of the items that are being distributed through McLane were currently being distributed through these 50 wholesalers, okay, at similar costs and sometimes, we're even paying less for them now, okay, because regional wholesaler, national wholesaler. Keep in mind why we're doing this. We've invested a lot of money in coolers, 5 doors to 10 doors, 10 doors to 18 doors, new stores, 18 doors. We needed a supply chain that could support that expansion and that investment.

I told you about the national assortment. I told you about the 40,000 SKU portfolio. But the reason we're doing it is for our customer. That is why we do it. We're doing it to remain relevant and be able to give her what she's asking for. You've all been in our stores. With the exception of the store you were just in, you've been in our stores and you've seen our coolers. And I've been in our stores and I've seen our coolers. And we're not happy with in-stocks in our coolers, because of the fragmented and fragile refrigerated supply chain.

In addition, tobacco is a critical part of this business model. Think about it from McLane's perspective. It's high-volume, low-cube [ph] for them. So cigarettes help make this model work, okay? And in addition, we believe that any margin pressure we're going to get is going to be offset by incremental sales from in-stock, from clustering, from the national assortment, from the abilities that we are able to garner from going with McLane, as well as, and I'm going to talk about it in a few minutes, our continued and accelerated growth in global sourcing and private brands, okay?

So moving on. We know from our customer research that refrigerated food drives the greatest number of shopping trips. In fact, of the 114 food trips that I referred to earlier, refrigerated and frozen food account for 66 of those trips. In our current renovation program, we are expanding our coolers from 5 doors to 10 doors and to 18 doors, where it makes financial sense. Outside of our renovation program, we were able to identify an additional 1,400 stores, where we are managing a special project to convert these stores to 10-cooler doors. And throughout June, we've completed about 1,250 of these stores. And in all new stores, we are expanding to 18-cooler doors. So I hope you're beginning to understand the critical importance of this exclusive 6-year McLane relationship.

Now at 37 trips per year, health care, beauty care and personal care are very important to our customer. But only 4 of those 37 trips are currently being made at Family Dollar. We have a significant opportunity to gain market share in health care, beauty care and personal care. Of the 37 trips in HBA, 20 of those trips include over-the-counter medications. And as we look at our customers' demographics related to health care, one thing became crystal clear, and that is that our customer overindexes in 18 of the top 20 ailments affecting the U.S. population, ailments like hypertension, heart burn, cholesterol and diabetes, just to name a few. And our focus on our assortment of health care will be to provide solutions and to help our customers take care of themselves and their families.

And over the last 2 years, we've expanded our HBA assortment by about 1,000 SKUs. The key drivers behind this expansion are over-the-counter medications, beauty care and personal care. And with the recent 600 SKU addition in May and June, we believe our HBA assortment is competitive in our channel. Unlike food that has faster consumption rates, HBA sales, due to their rate of sale, build at a much slower rate. And as we continue to evolve, we will continue to listen to our customers and expand and contract our assortment where it's appropriate.

And looking at the results over the last 5 years, you can see the steady sales acceleration as we've added to our HBA assortment. And we expect sales to further accelerate due to our recent assortment expansion. Remember that our HBA expansion is very early and began in May and was just completed earlier this month. Now over 7,000 of our stores carry a more complete health care, beauty care and personal care assortment. And when we look at the various metrics around HBA, like food, it is clear that the consumer has voted with their wallet and we are becoming more relevant.

Our market share continues to grow and, in fact, is up 22%. Our annual spend per customer grew 21%, while our trips have grown 7% and our purchases per trip have grown 13%. As our customer gets used to our new assortment, we expect all of these metrics to continue to grow. But it's important for me to note again that the frequency of purchase of health care, beauty care and even personal care is just slower than food. And one thing is for sure, our customers are beginning to use Family Dollar for all of their HBA needs. And this slide illustrates the fact that sales lag the inventory investment required to become relevant in HBA. And as I mentioned previously and due to the need-based nature of these items and their frequency of purchase, this ramp-up is just going to take a little longer.

Following up on the most recent expansion of those 600 HBA SKUs that began in May, I'm happy to report that we have completed this expansion. And while it's very early, we are pleased with the results here as well. And I would be remiss again if I didn't mention how proud I am of our store teams and their execution of our HBA expansion. I have been in the small-box business for 31 years, and I don't remember accomplishing as much as Family Dollar has in such a short period of time and with such accuracy. Barry, thank you to you and your store operations team and all of our team members, great job, unbelievable.

One of the most talked about initiatives to drive trips into Family Dollar stores is our addition of tobacco. So let me add a little color around tobacco. At Family Dollar, we have explored many new businesses to drive trips and profitability. The 2 businesses that tend to get the most attention are tobacco and beer and wine. We are interested in both. We don't see these 2 businesses as an either or choice.

We chose tobacco as our first major new business for several, very easy and compelling reasons. First, it only takes 4 feet of space behind the checkout, so it was relatively easy to find space. Second, we decided to distribute tobacco through a third party, McLane, so we didn't have to disrupt our distribution network. Third, the licensing process for tobacco is a lot shorter and significantly less expensive. Fourth, we can add tobacco to a larger number of stores because there are less restrictions than beer and wine. And lastly, we believe tobacco is a larger opportunity because it is more frequently purchased and drives substantially more trips than beer and wine, in fact, 16 trips versus 10 trips.

Let me give you some background. Tobacco is approximately a $90 billion business in the U.S. marketplace. At Family Dollar, our shoppers overindex with tobacco products, and our shoppers who smoke make more trips. Now while we're in the middle of our tobacco rollout, when we are complete at the end of our fiscal year, we will carry tobacco products in over 6,000 stores. Our strategy is to be priced competitively in the marketplace.

And again, while it is still very early, let me share some very early results. The average basket size for a tobacco transaction is $13. 60% of the baskets that include cigarettes have additional items in the basket and that basket averages $17. When you back tobacco out of that basket, the remaining basket is 8% higher than our original basket. It's important to note that, again, while it's still very early, the gross margin of those additional items in the basket are in line with our company -- overall company gross margin. Hopefully, we brought some clarity and facts around the tobacco business at Family Dollar and you can see why we are so excited about this opportunity.

We've just reviewed our key traffic-driving initiatives. All of the initiatives that we have spoken about, thus far, have an impact on our mix of sales and our margin profile. As you can see here, consumables are a larger percent of our sales, and conversely, home and apparel are declining. An important note here is that through fiscal '11, discretionary made up a very important 34% of our overall sales. And although discretionary categories have had sales pressure over the last several years, we have worked hard to increase inventory productivity. As we drill down into the discretionary categories over the last 5 years, you can see that while sales have been declining, we have managed risk effectively. And as a result, inventory has been declining at a faster rate, thus, improving productivity.

As we look at our current priorities surrounding our challenging discretionary business, it is a mixed bag of opportunity. First, we see significant sales and margin growth opportunity in our seasonal businesses. Our plans call for expanded seasonal space during holiday times and new and exciting assortment opportunities.

In the Home and Apparel businesses, with the exception of our basic assortments such as socks and underwear, which are actually on a growth trajectory, our plans call for making sure that we are trend-relevant, as well as managing receipts and markdowns, thus again, expanding margin and productivity. Now while we are managing the downside, we are still looking for growth opportunities, such as quality improvements, trend improvements and clustering opportunities. One of the things that intrigues us and that we look forward to understanding is that the potential impact that the trips that we are driving with our more complete and relevant assortments in food, health care, beauty care and personal care will have on our Home and Apparel businesses.

And as we've stated on previous occasions, many of our current sales and traffic driving initiatives generate lower gross margins than our company average. So we are laser-focused on 2 key initiatives to help mitigate these lower-margin sales: global sourcing and private brands. And both are on an accelerated track.

When you take a look at the global sourcing opportunity, of the $5.6 billion in purchases that we made last year, about 1/3 of those purchases were manufactured overseas. And of those purchases, a very small percentage were sourced directly from the factory overseas. We have a significant opportunity to move purchases away from domestic importers and agents to either agents or direct to factory.

And as many of you know, last year, we opened our first global sourcing offices in Shenzhen and Hong Kong. Today, 70% of what we import comes from China. As we research and open new offices in new countries through 2015, like Indonesia, Vietnam, Thailand, India or Central America, our global sourcing will naturally increase in those regions. Our goal, as indicated by the countries shown here in red, is that by 2015, 80% of what we import will come from over 20 countries as opposed to just 5 today.

And as we look at our fiscal 2012 distribution of purchases, you can see that 70% of our total purchases are coming from domestic national brand suppliers like the Procter & Gambles and Colgate. 15% come from domestic importers or companies that import products for us that we purchase on an as-needed basis. 11% is purchased through import agents in the country of origin that act as a middleman. And the smallest percent or 4% this year is purchased direct to the factory.

Let me describe the opportunity. Direct to factory has the highest margins. And as you can imagine, national brand domestic suppliers typically have the lowest margins. And as you can imagine, as we reallocate these purchases to either agent or direct to factory, we improve our profitability. And looking ahead to 2015, you can see where we will be making improvements.

The second margin expansion opportunity is private brands. Private brands have 3 main objectives: drive sales and margin dollars; build customer loyalty through branding, quality and value; and gain leverage with our national brand supplier community. As we think about our private brand portfolio, we think about it in 3 buckets. First, the bucket of family brands, Family Gourmet, Family Pet, Family Wellness. These Family brands are brands where the standard is national brand equivalent or better. The second bucket consists of brands that are associated with discretionary products, such as Home, Apparel and Seasonal, brands like Outdoor Designs [sic] Outdoors by Design, Highland Outfitters and Kidgets. And the third bucket is a brand that we're testing called Value Options, and this is a Consumables brand, where the customer expects us to have a value option, but the quality is not national brand equivalent. And therefore, we will not put our name on it.

And when we take a look at private brand penetration, Consumables has nearly doubled over the last 5 years to 17%. Now our original goal for Consumables penetration was 20% over the next couple of years. However, while our merchandise introductions and plans have not changed and, in fact, have been accelerated, the fact that we are expanding food, health care, beauty care, personal care and tobacco, our penetration will be impacted. Again, it is important to note that nothing has changed with our strategy or our plans to do more and accelerate.

It is also important to note that as you measure private brands in the rest of our business segments, like Home or Apparel, due to the lack of national brands in these segments, there will not be significant penetration improvement there. Our goal is to double the size of our private brand business by 2015, and the majority of that growth will be in Consumables, in the Consumables categories. And in order to double the sales by 2015, we will double the private brand SKU count in Consumables. The growth in SKUs will be in all of our key initiative categories such as, and you know them, health care, beauty care, personal care and food.

The final 2 topics that I want to discuss today are marketing and pricing. Both of these focus areas are instrumental to how we maintain and even improve our strong value position with our consumer. Our strategy in marketing is to improve our value perception, increase our brand awareness and increase customer loyalty. And we will accomplish this through 2 key focus areas: the Sunday circular and our in-store messaging.

Now while digital is likely on everyone's mind, for Family Dollar, it's currently a small piece of our business strategy for the following reasons. Digital opportunities in most brick-and-mortar stores are currently generating low sales and margin dollars, and therefore, are just lower on our priority list. Now while we have a digital plan and we have over 1 million Facebook fans and we issue digital coupons and we have email campaigns, it's just a very small piece of our business today and for the foreseeable future. We do continue to monitor digital closely, and we will react when it is appropriate and we can see the return.

So moving on. And as I have discussed earlier, our consumer is extremely value-conscious. And she uses the Sunday newspaper for her national brand coupons and to assist her with where she is going to shop during the week. So let me give you a little color on where we are focusing our marketing efforts.

So as it relates to the Sunday newspaper, there are 3 key initiatives that are driving our change: relevancy, shopability and distribution. Keeping in mind that we are using the customer in every decision that we make, the assortment in our circular is more relevant. It's easier to shop through in-ad adjacencies and we have improved our in-ad value messaging. Starting this past Sunday, we started distributing our circulars in the Sunday newspaper. We will continue to use shared mail in a small way to reach those customers that we can't reach through the Sunday newspaper. Based on several tests that we have run in several markets, Sunday newspaper distribution not only reaches more people at each and every week, but more importantly, it generates incremental sales lift versus shared mail distribution.

Let me tell you why we're so focused on the paper. It is because our customer is value-conscious and uses the Sunday coupons. Over -- of the 100% universe of consumer packaged goods coupons, 89.4% of them are in freestanding inserts in the newspaper and the remaining 10.6% are within a category called all other media, which includes digital.

Total U.S. CPG coupon redemption is up 35% over the last 5 years. Total U.S. CPG coupon redemption is up 6% in '11 versus 2010. And this recent increase in redemption is up in spite of a decrease in coupon distribution of 8%. And probably most importantly, 49% of low-income customers are buying more items with coupons.

Our Sunday newspaper strategy is nothing more than listening to the customer and staying relevant. I hope this brings some clarity to why we are focused so heavily on the newspaper distribution. And as we think about our overall value image for our customers, it is important to clarify our overall value strategy.

I would like to share our view on everyday low price or EDLP. EDLP, as defined, indicates having everyday low price all of the time. Our view is that there are very few exceptions where any retailer has EDLP all of the time. The only retailers that we believe could even qualify as everyday low price would be single price point retailers, retailers that sell only things for $1 or $0.99. A more realistic view is that retailers have strong everyday value pricing, or EDVP, and even stronger value pricing during special events such as the Sunday circular, where most retailers discount items in the circular or clearance markdowns or in-store events. We consider ourselves everyday value-priced or EDVP.

Let me give you some quick highlights on in-store value messaging. Many of you have heard me say in the past that Family Dollar has terrific values and our value perception scores confirm this. However, we can do a better job communicating those unbelievable values in our stores to our customers. And in the second half of fiscal 2013, we will introduce new signage that will shout value to our customers. The new signing package will consist of very bold price messaging throughout the store, on end caps, on gondolas, on power panels and on the coolers. We will also have more Compare & Save signing for private brands and more navigational and seasonal signing. Our goal is for our customers to walk into our stores and be able to clearly see our incredible values.

The last topic that I would like to review with you today is pricing. And our pricing strategy is actually quite simple: to continue to enhance our value perception while also improving profitability. And I want to be sure that you leave here crystal-clear that we are committed to providing everyday value pricing to our consumer with no exceptions and that we have a zero-tolerance policy against trying to waver off of this strategy.

Let's spend a little bit of time talking about how we bring this to life. First, through competitive price shops that we execute quarterly throughout the country in various retailers. Second, through identifying what our customers believe our KVIs or known value items, items that she knows the price of, and I will talk about this in just a minute. Third, through our Sunday circulars that I just reviewed. Fourth, through our private brand pricing, making sure that we maintain our value proposition to the national brand. And fifth, and something that we have been doing for several years, is our zone pricing structure, which allows us to group stores based on various attributes and manage different prices.

And it is also important to note as various pricing surveys are distributed, comparing Family Dollar against other retailers, that it is very difficult to compare one competitor versus the other unless you know for sure that they live within the same price zone. As an example, you cannot compare a store in Brooklyn, New York to northern New Jersey. They just live in different price zones.

A few moments ago, I mentioned known value items. Let me bring some facts and clarity around known value items at Family Dollar. When we think about known value items, we think about it as awareness of price and frequency of purchase. And this chart helps illustrate this point. The stapler, which is a low frequently purchased item, hopefully, has a very low price awareness, moving up the chart to cigarettes, which are very frequently purchased and has a very high price awareness. Cigarettes are known value items, staplers are just not. Cigarettes must be priced right, and I'm pretty sure that we have some flexibility in pricing with the stapler.

Pricing is an art and a science. Let's talk about elasticity. Every item has some level of elasticity. The key is to know the level of elasticity and the breakpoint where units start to decline. The goal is to understand where your price elasticity meets your unit decline. This is how you give yourself flexibility to adjust pricing without losing units, thus maintaining your sales and value perception while improving your profits. This also illustrates that you need to invest in price and bring prices down where you have confirmed that she knows the price with no exceptions.

Let me give you a real world example at Family Dollar. In a recent survey of 2,000 customers that shop at Family Dollar and other value retailers and who purchased pet food, which is a frequently purchased segment in the value channel, customers were asked 2 questions. First, do you know the exact price of the pet food items you buy most often? And second, how much did you spend on the last pet food item that you bought? And as you can see, the numbers speak for themselves. Less than 25% of the customers could provide a price for last item that they purchased. Now that does not mean that you run out and raise the prices to the point that you lose units. But what it does mean is that you explore a price point that can drive profitability without losing units. And to me, that just makes good business sense.

And as I've mentioned on several occasions, we are in an exploratory phase with pricing. We are currently conducting several tests in several markets and learning an awful lot. But let me reiterate, we are committed to providing everyday value pricing for our customers. And these efforts will help us continue to learn and enhance our value perception while improving our profitability.

So in closing, I would like to summarize just a few of the key takeaways. First, Family Dollar has a strong history of success. Our customer, economy and competition is changing. And we are evolving our business model to adapt to these changes. We are enhancing our relevancy and driving more trips. And based on our mix change to more consumables, we are accelerating global sourcing and private brands. And we are an everyday value-priced retailer.

I thank you very much for your time. And at this point, I will turn it over to our new CFO, Mary Winston. Mary?

Mary A. Winston

Thank you, Mike, and good afternoon, everyone. It's certainly obvious how excited Mike is about the opportunities that lie ahead for Family Dollar. And even though I'm the newest member of the leadership team, I'm also very excited about the long-term potential for the business.

I came to Family Dollar knowing that it's a great company with a long history of success and solid financial performance. We have a great business model, a clearer vision for the future and the brand, a great team to execute that vision, a growing customer base and a significant opportunity to expand our share of her wallet. I've joined the team with a focus on partnering with Mike, Howard and our other business leaders to ensure that we make the best possible decision and investment decisions.

Finance should play a valuable role as a strategic partner, a thought leader and the financial contents of the business. As CFO, my focus will be on strengthening our ability to fulfill that role through stronger analytics and enhanced forecasting capabilities, as well as refining our financial metrics to measure our success. Ultimately, we're committed to delivering solid growth and even stronger shareholder returns.

As Howard indicated earlier in his presentation, we want to make Family Dollar a more compelling place to invest by delivering consistent long-term growth, delivering strong financial returns and by maintaining an efficient capital structure. We believe that delivering these objectives will result in strong, long-term returns for shareholders.

Let's define what we mean by consistent long-term growth. Over the next 3 to 5 years, we want to continue to deliver 5% to 7% net new store growth, mid-single-digit comp sales growth, operating margin expansion and double-digit EPS growth. Certainly, these are attractive goals. Now let's discuss how our recent performance as compared to these objectives and how we plan to continue delivering comparable results going forward.

We are targeting 5% to 7% annual net new store growth. Beginning last year with the opening of 238 net new stores, we began to accelerate new store growth. And this year, we expect selling square footage to increase around 6%, well within our targeted range. As we look forward, we continue to believe that maintaining net store growth in this range is both manageable and sustainable. Manageable, because over the last several years, we have built strong processes and leveraged new tools to help us locate, negotiate and open strong new stores. We are confident that we can manage this rate of expansion while driving productivity higher. Sustainable, because we have identified more than 11,000 new store opportunities beyond our current chain. By maintaining our targeted net new store growth rate, we think we have a runway of 15 to 20 years before saturation becomes an issue.

Building on the investments we made last year in food and HBA, we're continuing to invest to increase our relevancy to the customer. We're focused on assortment expansion and marketing efforts that will drive more trips to our stores. And once the customer arrives, she'll be greeted with a more pleasant shopping experience as a result of our store renovation and expansion programs. We believe these activities will enable us to maintain mid-single-digit comp store sales increases over the next several years. In addition, as we open more new stores, their contribution will have a larger impact on our overall comp performance. I would note that new stores often outperform the chain average in terms of comp sales growth for 4 to 5 years after their opening.

Expanding operating margin is an important driver of shareholder returns. And we continue to believe that we have opportunities to expand this important metric. One key element of driving operating margin expansion is the acceleration of sales growth. Certainly, as we accelerate our sales growth, we have to manage gross margin effectively and drive more gross margin dollars. In the near-term, we face some challenges to gross margin. The growth in lower-margin Consumables, combined with softness in more discretionary categories, has resulted in recent gross margin pressure. But we have successfully mitigated much of this pressure through improving markups and effectively managing our costs. We've improved markups through our initiatives in global sourcing and private brands. And we expect this to continue as we accelerate investments in these areas.

In addition, we're focused on managing our shrink and freight costs. We've had success in both and believe we have further opportunity to reduce these expenses as a percentage of sales. Longer-term, we continue to believe we can offset the mix pressure from our growing Consumables business.

Over the last several years, we've made meaningful progress in reducing shrink. This graph looks at shrink as a percentage of sales indexed to fiscal 2007 levels. You can see that our teams have made great progress in reducing this important cost. These improvements have been the result of work stabilization and inventory management efforts, as well as improved analytics and reporting. While shrink may continue to be a headwind in the near-term as we expand our assortment, we're working hard to minimize the impact.

We have also managed freight expense well. While the declines we saw in diesel prices in fiscal 2009 certainly helped, our supply chain teams have done a great job managing rising cost pressures over the last 2 years. Efforts to increase cube utilization, increased backhauls and improved routing efficiency have all had a tangible impact on our results. The opening of our 10th distribution center in Indiana last month and the opening of our 11th DC next summer in Utah will give us additional opportunities to reduce stem miles and transportation costs.

Our expense structure is predominantly fixed in nature. Our 2 largest expenses are store labor and occupancy costs and both of these expenses are relatively fixed. While there is some variability in labor as sales increased, we must have an appropriate amount of labor coverage regardless of the store sales. And while a smaller percentage of our stores have a variable rent structure, most have fixed rent that doesn't change with sales volumes. So as sales accelerate and gross profit dollars increase, the opportunity to leverage SG&A expands.

So the power of our business productivity model is clear. Accelerating sales growth and generating more gross margin dollars enables us to leverage our cost structure more effectively, resulting in operating margin expansion. Our results so far this year are a good example of this productivity loop.

We can see from this graph that as we began to accelerate sales growth and expand operating margin, we have delivered double-digit EPS growth. Between fiscals 2007 and 2011, we grew EPS at a compounded average growth rate of about 18%. With the initiatives we have on the horizon, both the strong sales growth and to manage expenses effectively, we plan to continue our track record of delivering strong EPS growth.

As we remain focused on making Family Dollar a more compelling place to invest, our second area of focus is on driving strong financial returns and increased shareholder value. It is the combination of generating strong cash flow and making prudent investments in the business that will result in strong return on invested capital.

This chart illustrates our history of consistently generating strong cash flow, which has funded the capital investments in our business, as well as our annual dividend payments. For purposes of illustration, we have shown capital expenditures in fiscal 2012 net of the proceeds received in the third quarter for our sale leaseback transaction. I would remind you that in June, we closed a second transaction, generating an additional $179 million.

As we've already discussed, we have a number of efforts underway to drive both strong sales growth and a comp sales basis from comp sales and from new store growth. Additionally, we've reviewed our business productivity model, which outlines how we plan to continue expanding our operating margin. These 2 elements are fundamental to generating strong cash flow that can be reinvested at appropriate returns to drive shareholder value.

We continue to invest in our business to drive returns. As we discussed earlier, we're delivering net new store growth of 5% to 7% annually. This clearly requires quite an investment in the business. However, we strongly believe that this is one of the best investment we can make and the most productive use of our capital. On average, new stores produced sales that achieved 85% to 90% of the average -- of the chain average in their first year, and most stores are profitable within their first 12 months of operation.

Our average capital investment in new stores is relatively low. Minimal capital investment and quick profitability result in strong financial returns. On average, our new store pretax return on investment ranges between 15% and 20% and achieves payback in around 1.5 years.

We're also investing significantly in our existing chain. Our renovation and expansion programs are about investing in the 7,000 stores we already have and maintaining our competitiveness and to drive continued customer and market share growth in our existing store base.

Inventory productivity is critical to increasing cash flow, and we're focused on improving inventory turns over the long term. Between fiscal 2007 and fiscal 2010, we made significant progress in this area as we reduced our inventories in discretionary categories and expanded our consumable assortments. In the near term, inventory productivity is likely to remain under pressure. Broadening our assortment in key consumable categories will enable us to become more relevant and satisfy more of our customer shopping trips, but will also require additional inventory investment. We're moving quickly and investing aggressively to expand our assortment in all stores. Similar to what we have seen in the past, we expect that as customers get more familiar with our expanded selection, we will see inventory productivity stabilize and improve.

We have a nice track record of improving return on invested capital. Certainly, strong sales growth and operating margin expansion impact ROIC, but we are also committed to maintaining a disciplined approach to capital spending. Even as we increase our level of investment in the business, our returns continue to improve.

Our first priority for deployment of capital is to reinvest in the business to drive higher financial returns. We believe that reinvesting back in the business is the best way to generate returns for shareholders. Our business model has historically generated strong cash flows, so we continue to return excess capital to shareholders through dividends and share repurchases.

As we think about opportunities for capital deployment, reinvesting back into our business to drive higher returns is our highest priority. Today, we're making significant investments in our business to expand our footprint and refresh our existing chain. We also continue to invest in new fixtures and equipment to support our assortment expansions and merchandising strategies.

Finally, we're continually investing in our supply chain and technology infrastructure to drive greater productivity and efficiencies. In fiscal 2012, we will have a significant increase in capital expenditures. The primary drivers behind the growth are the acceleration of new store openings, our fee development program and capital investments in our new distribution centers. Given our expectation to maintain store growth in the 5% to 7% range, our expanding fee development program and our ongoing renovation efforts, I expect that capital expenditures will stay in this range for the next few years. I also expect that we will continue to generate funds from additional sale leaseback transactions as we continue to monetize owned stores as a source of capital for the ongoing fee development program.

Our second priority for capital is our dividend program. We have increased our dividends in each of the last 36 years, creating one of the longest dividend paying records of all publicly traded companies. We intend to maintain this impressive trend.

And then finally, we look to return excess capital to shareholders through our share repurchase program. We have maintained a disciplined, opportunistic approach to repurchasing our common stock. And over the last 3 years, we have purchased more than $1 billion worth of Family Dollar stock. This year, as we have ramped up capital expenditures, we have had less excess capital available for stock repurchases. Through the third quarter, we completed about $92 million in stock repurchases.

Our third financial priority is to maintain an efficient capital structure. Our priorities here continue to be focused on ensuring access to adequate liquidity at the best possible cost to support our business operations and growth.

Preserving our investment grade rating is very important to us. It gives us better access to bank credit market with unsecured lines and fewer covenants. It provides us with efficient access to high-grade debt capital markets, and it helps us manage a more efficient and effective real estate leasing program. Our goal is to maintain our investment grade rating and leverage profile by maintaining our average debt ratio -- adjusted debt ratio.

Last year, our lease adjusted debt to EBITDAR was 3.2x, and we expect some modest improvement this year. We want to manage a lease adjusted debt to EBITDAR within the range of 3 to 3.3. Longer term, we have the flexibility to execute additional sale leasebacks and additional debt, while preserving our investment grade rating.

We continue to maintain a strong liquidity position, with 2 available undrawn revolving credit facilities totaling $700 million of capacity. And our staggered maturity ladder minimizes risk and gives us plenty of time to consider refinancing options and timing.

So in closing, I think it's appropriate to end where we started. Our mission is to provide investors with a more compelling place to invest. And we are laser-focused on delivering consistent long-term growth, on driving strong financial returns and on maintaining an efficient capital structure.

And now I'd like to reintroduce Howard for some closing remarks.

Howard R. Levine

Thank you, Mary. Before we go to Q&A and just a few closing comments, let me recognize Kiley Rawlins for a wonderful job that she did putting this thing together. Let's give her a big round of applause. I can't even see the bags, when the lights are down, around the eyes. And Kevin Powers -- Kevin, raise your hand. Kevin certainly put in and burned a lot of night oil also. Thank you, guys, very much.

So this morning, as I was reviewing this presentation for not the first, second, third, fourth or fifth time, having an opportunity for closing comments with this group kind of made me a little nervous because I said, "Here's a chance in just a few minutes to tell you the way I think and what I really want you all to walk away from." So I gave it a stab here. So these are just some of my thoughts about why I believe Family Dollar has got such a great future ahead of itself.

Number one, this is a great business. I mean, I think everybody sitting in this room understands the cash flow we generate, the customer we serve and the opportunities out there.

Second, we've had a great track record. You look at the history, as I've talked in my prepared remarks, 100% increase in our stock price, but we've had consistent growth since the company started back 50-something years ago.

Third, we've got a great game plan for success. You all heard the SKU counts we've added. You all have heard the resets we've done at our stores. You've heard about Pepsi. You've heard about tobacco. You've heard about the role that the new third-party supplier is going to provide to us, McLane. A lot of great things happening. I mean, it's just obvious when you think about that.

Fourth, we've got a great team in place. All of you all have been worried about the execution of all the initiatives. Let me tell you where I've been worried about and something that I don't think has been mentioned enough is -- and something that I think CEOs and boards have a huge responsibility of doing and that's succession planning in making a transition in our leadership team here. That kept me up at night. Very glad to have Mike and Mary here and think that we've gotten that behind us and they're in place. And I don't know, I haven't told everyone this story, but Mike resigned on a Tuesday and was down starting to work on Wednesday. That's no lie. I've never had anything like that. And it's 7:00 in the morning. I told him I was going to be there at 7 a.m. to let him in, but we would certainly make sure that somebody was there. And Mary, the same way, just got thrown into it and just started absorbing it. So great plan, great team.

And then, let me just take my CEO hat off for a second, because I'm a shareholder in this company and got a lot of eggs in this basket from an investment profile. I haven't done a very good job of diversifying. I'm not complaining. But when I think about Family Dollar as a shareholder, just like everyone of you all do, and as we use the customer for a filter for many of our decisions, I also use my shareholder objective as a filter. I'm just like you guys. I want a sustainable, consistent [indiscernible] earn on our investment, and we're getting that.

And then finally, the last thing is I can't think of a better place to invest. When I think about -- I don't know what your belief is in the economy. You think it's going to improve, it's going to contract, it's going to go sideways. I don't know exactly. But you can look over the company's history. We have been a good place to invest in either good times and/or bad times, and there's just not many choices out there like that. Trust me, I've looked.

So with that, give us a few minutes to set up with some questions, if you all have any, maybe not have any, maybe you want to go right on home. But if you do, we'll be happy to take some questions. And again, thank you for your interest in coming today, and we'll take your questions in just a second. Thanks.

Question-and-Answer Session

Kiley F. Rawlins

While we're getting set up, if you have a question, if you can raise your hand, Josh has a mic and Bren [ph] has a mic in the back. And so they will be surrounding. This mic does not count.

Howard R. Levine

Okay. John.

John Heinbockel - Guggenheim Securities, LLC, Research Division

So 2, I think for Mike. One, as you start with McLane, I assume there's an opportunity there for re-planogramming the whole cooler. To what degree do you think assortment will go up, SKU count will go up and the cooler? What percentage should -- maybe given that some thought, or is it more facings? And then I have a follow-up.

Michael R. Bloom

I can tell you that we're actually reviewing the SKU. We're actually reviewing the planning tomorrow afternoon. The SKU count is going to go up. I actually don't know the percentage. It's going to go up, I think, fairly significantly because if you've been in our stores today, you know things are spread out. And the reason we're expanding the cooler is not to spread out and have 12 facings of the same pizza. It's to have different pizzas and frozen foods and meats, and proteins, and veggies, et cetera, so the SKU count would definitely go up in our refrigerated and frozen. I just -- I don't know the exact number. I don't know if any of these guys know the number, but I just don't know the number.

John Heinbockel - Guggenheim Securities, LLC, Research Division

All right. And then sort of as a follow-up to that, when you talk about adding 1,000 private label SKUs, there will be other consumables, items that you add. Where does that space come from and at what point, as you shrink discretionary, do you get irrelevant in certain portions of discretionary by shrinking it so much that it's better to get out of those sub-categories entirely? What might be some of those where it's just not worth being relevant anymore?

Howard R. Levine

Yes, you may have seen -- for those of you that were in the store today, that's our latest prototype, what we call a CR3. That store actually had flex space for expanded consumables. You saw probably sections of bulk, either paper, I forget what -- beverages, because we built that into our model. So a lot of the space will come from there. A lot of the space will come from continuing to revisit how we distribute from our DC, full cases, half cases, et cetera. And third, we'll continue to look for efficient fixtures. I mean, that's how we picked up the space the first time. If you remember, we had a pair of rounders in the stores. We eliminated the rounders, came up with the – or executed the waterfall fixtures and actually kept just about the same mix of apparel in less footage. So that's where the space is going to come from. Right? We think we've got enough built in it. And then also, you have to -- I also want to make one other point, not everything we add is going to work. We're going to continue to SKU-optimize. So if we add 1,000 SKUs, what are the odds that 20% of them aren't going to work? Probably pretty good unless we move on to a -- whether it's the next 20% or new items or different business, et cetera. So we'll continue to make the space we have even more productive. We're not just -- I can tell you and I talk about it all the time internally, we want these initiatives to bake. We've done a lot in our stores, and we need them to bake. We need to measure them, and we need to make them more productive. And that's what we're going to do, so It's not necessarily expansion. It's more about productivity.

Kiley F. Rawlins

[indiscernible]

Howard R. Levine

Oh, okay, we'll go into the middle.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

It's Adrianne. [indiscernible] and Mary talked about [indiscernible]

Kiley F. Rawlins

Howard, can you repeat the question first or Mary?

Mary A. Winston

Yes, I'll take it or at least, I'll start and then Howard can certainly chime in. You're right, we haven't been specific in terms of dollars or specific time points and specific target rates. And I think we'll be in a better position to do that as we look out into the future, but we're not prepared to do that today. So today, the best I can do is re-emphasize all the things that we're doing. And I assure you that we're not losing sight of overall operating margins, returns and profitability. That's at the top of our priority list. As I think about it, I think we're in a little bit of a transitionary period, and we've talked a lot about the things that we're doing to accelerate sales growth and the pressure that that's putting on our gross margin levels as we roll out more consumables that are at a lower margin rate. We've also talked a lot about the things that we're doing to offset that. And clearly, those investments are ramping up at a slower pace than some of our sales accelerating investments. So thinks like what we're doing in private brands and global sourcing, we made great progress, but we're still in the early days of that. So we're looking to see those things, again, offset some of the pressure that we're seeing. And I would say from a general standpoint, certainly as we look at the next quarter and into the first half of next year, we're going to continue to see pressure at the gross margin level. But we're also going to continue to be focused on leveraging SG&A and driving those cost improvements.

Adrianne Shapira - Goldman Sachs Group Inc., Research Division

And then a follow-up to that. Given all the strategic initiatives and changes, remind us the level of comps you need to lever expenses.

Mary A. Winston

The level of comps that we need to lever expenses? Well, as I said, we are driving comp, say -- new store growth anyway in the 5% to 7% range. We're looking at mid-digit single comp sales growth. And at that level, we believe our business model certainly does work, and we can leverage our margins -- our expenses, expand margins.

Unknown Executive

We have Dan here.

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

Howard, you reminded us that your customers will need some time to become aware of the expanded inventory assortment before it begins driving higher sales volumes, and that makes a lot of sense. But this is not a new initiative. In fact, I believe in 5 of the last 6 quarters, that your inventory per square foot has grown over 10% and yet the sales per square foot has been growing about 4% or 5%, your gross profit dollars per square foot is growing 2% or 3%, is there a period in front of us, 1 quarter, 2 quarters away, that if you don't see the sales growth begin to converge with your inventory growth, that you'll say, "Something is not working. We need to re-address the inventory that we're adding, take a fresh look at our marketing programs?" Maybe you could give us a sense as to your level of patience with this gap between inventory and sales growth?

Howard R. Levine

Sure. Let me see if I can add some wisdom to that, Dan. We have been adding SKUs now for a few years, so the inventory has methodically continued to grow. And when we take a step back and look to see how we are positioned with an inventory -- average inventory per store versus many of our competitors, you can see there was a huge gap. So as Mike said, we've added a lot of SKUs and done a lot. And we want to have some time to let them bake and analyze and make some adjustments, but this isn't the first period of time that we've added SKUs. Every time we've done this in the food category, every time we've done this and that we've got a good history there, we've seen leverage. We have not forgotten about what inventory productivity means. Our customer is dying to have this merchandise in the stores. They've been able to get it from our competitors. And all we're doing is leveling the playing field to get an inventory per store comparable to what many of our competitors have. And yes, sure, we're going to make adjustments. And if things don't work, we will have to make other adjustments. But we're pretty confident in what we've done and the early results that we talked about, both in the HBA expansion and the food expansion have been very positive. So we think we're on the right track. Difficult to predict the timing. But hopefully, you're like me, we make investments for the long term. Very difficult to predict from a quarter-to-quarter basis, but think over the long-haul that this will be successful and work just as it have been for the -- we started adding SKUs back in the late '90s in the consumable categories. And every time we've done that, we've seen success. So I'm not sure I see a reason why it wouldn't and think that the job to the team has done is as good as we've ever had, so we'll take back a look at it.

Unknown Analyst

I was curious if you can talk a little bit about the blend between art and science as it relates to merchandising or operations. I know you didn't have a chance to get everything today. But you've had a huge and successful record in the past. There have been some bumps along the way, some surprises, at least from an investor's standpoint. What are you doing on the systems front, on the planning front, on the visibility front to help at least us as inventors figure out that it's going to be kind of a smoother path with a little less uncertainty?

Howard R. Levine

Are you talking specifically about guidance or could you clarify the question because I'm not sure I completely followed you?

Unknown Analyst

Sure. I mean, on an annual basis, your results have been consistent and steady and good. But every now and again, we find a little bit of a surprise where there's bps [ph] in the gross margin or an inventory line or other things like that. And your job isn't manage us, but just curious if there are things that you're doing to add...

Howard R. Levine

Sometimes I feel that it is.

Unknown Analyst

I mean, signs or planning so that there's precision, I guess, and there's continuous compounding rather than any [indiscernible]

Howard R. Levine

Yes, first of all -- and I'll let Mary comment on this, but first of all, I think it's important to appreciate all the change that we're going through today. I can share with you as we started to finalize our plans for fiscal '13, there's not a good history of what we actually did to make those projections, so it's tough given where we are right now. All I can tell you is it's difficult to do a quarter-to-quarter and be as accurate as you all would like, or frankly, as accurate as I would like. Again, over the long term, we feel confident that we're doing the right things, making the right investments and that they will consistently pay off for us. Mary has come in. And why don't you talk about some of the things you're working on, Mary?

Mary A. Winston

Yes, I'll just to add a couple of comments to that. But first of all, to just build on what Howard said, I do think that we're in a unique period of time for the business. I mean, the customer is changing. We're rolling out lots of initiatives. The competitive environment continues to evolve, so there's lots of shifting dynamics that create craze uncertainty in the business and in our ability to know exactly which levers are going to move in which direction in the business. That said, I think we do have a good handle on it. I have been impressed by the soundness of our financial practices and the way we manage the financial aspects of the business. Now that said, we can always be better at certain things. And as I mentioned early in my remarks, a couple of the things that are on my radar do relate to our systems infrastructure within the finance organization and enhancing our reporting and analytics capabilities. And I think we do have some opportunities there, again, not a burning crisis but an opportunity to do something better and then maybe making some enhancements to our forecasting process. We know you guys don't like surprises and neither do we, so it's not our intention to provide guidance that's not going to come to fruition.

Howard R. Levine

Deb?

Deborah L. Weinswig - Citigroup Inc, Research Division

Two separate questions. Number one, how should we think about the sales opportunity from both improving in stocks and national advertising? And then secondly, I was really struck by the slide related to customer demographics where it said that Family Dollar shoppers over index in 18 of the top 20 ailments. And considering the changing landscape in health care and your underserved customer, how might Family Dollar look to serve that customer in a better way?

Howard R. Levine

Yes. So from the health care perspective, as most of you know, that's a sweet spot of mine from the past. I think what we're going to end up doing, I think you're seeing it today, is the expanded mix in OTC medications. Now whether that means we're going to eventually be able to provide services, and I know we talked about it before, pharmacies on everybody's mind, I don't know what that piece of the business means today. I know that our customers self-medicate. That I know. I know that our customers have less insurance than the average customer or more of our customers don't have insurance, so they self-medicate. So we need to be right for them. I mean think about diabetes as an example. I mean, our customer over indexes significantly in diabetes. And you look at our stores today, with the exception of a few SKUs, we don't really offer a diabetic solution to help them manage their diabetes. And we probably should. How we do that is something we need to figure out, but you'll see it through an expansion in OTC, those items that really mattered our consumers. And you're seeing it today, and I mentioned it. And we're seeing good results from those self-medicated items. And your first question in regards to how we're going to reach our customers and communicate more effectively?

Deborah L. Weinswig - Citigroup Inc, Research Division

[indiscernible]

Howard R. Levine

Yes. So many of you that have followed us, like Dan and Deb over the years, have seen the role that sales and advertising and marketing have played in this channel. In the mid-'90s, we were close to the number we were today, 25 to 30 pieces. We had gotten down to about 4 or 5 per year. What we've seen happen is the industry has changed, as competition has changed, as the economy has changed, I think the consumer is looking for specials and deals, particularly in the discretionary categories. Apparel, if it's not reduced some way with some kind of special, it's just hard to sell apparel. Consumables, not so much. I think what we've seen is a consistent flow there with the sales mix of consumables, and Mike’s talked about needs are very much a focus of our customer, but the way we look at the marketing program is to reach out to more customers to try to get more people educated about what we're doing. In addition to that, educate them to all the changes that we've made because just as we've talked about today, the SKU count in the HBA and food categories have been unbelievable. So we want to let people know what's new and different in our stores. And then finally, just using the seasonal components, so whether it's July 4, Labor Day coming up and of course, the holidays, being active in the market in those times just to keep your name out there and continue to keep top of the mind as much as we can with the consumer on an everyday basis.

Unknown Analyst

Howard, 2 years ago, when we were here, the story was really expansion and consumables. And now the story is about expansion and consumables. We're nearly 70% of the mix. Where do you top out there or at some point, you just add a produce aisle and call it a day?

Howard R. Levine

I wish it was that simple. Again, our view is relating to customer research, what our customer wants from us today. And I can tell you it's more than just 2 years ago that we added consumables. If you heard us 5 years ago, as I said, back in the early '90s, we started this shift. I mean, the late '90s started adding a number of consumables to our stores. Ultimately, where we go, we don't have a target. I would tell you the way I think about it is, we'd like to sell as much of the consumables as we can possibly sell. We'd like to see more out of some of the discretionary categories. And it's so important for the channel to see, in my opinion, our mix and our model to see that come to us. That's where the margin is. That's where the differentiation is. And if you all that went on the store tour, I think we're getting much better there. Unfortunately, sometimes it's hard to see it in the results, but I think our [indiscernible] presentation for the spring and summer was as good as it has been. Our productivity in that inventory continues to improve too, so, Dan, that's an area on the discretionary side where we are seeing inventory productivity. And that's the way we've managed that business and probably the way we’ll manage that business in the future. But we're going to react to what our customers say. And it's Mike and Mary's job to make sure that we get the profitability from that mix. And I think we'll continue to do that and feel very good about how we're working through the changes that we're going through right now.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Scot Ciccarelli. Can you talk about the execution risk with the transition to McLane? And then also, how do you go about quality control, because it seems like you're sitting on an awful important part of the store to kind of somebody else's control?

Howard R. Levine

Yes, I guess from an execution risk, it's a little easier for me to sit here and talk about execution risks because of all the initiatives we just executed so -- and I would tell you, you heard me say it, I have been doing this for a long time and I have never seen an organization do so much in such a short period of time and do it so well. I haven't seen it, and so I feel good. Now, remember, the McLane -- let me talk a little bit about the McLane transition. Those items we carry today, a lot of the items, with the exception of the refrigerated food. The candy that's going to McLane, we carry that today. We're just changing the distribution model. That will be transparent to the store. The refrigerated and frozen will be a new planogram. We do planograms all the time. So it's going to be an 18-door planogram or 10-door planogram. We do those all the time. It will be part of our planogram execution model. It will be part of our hours that we allocate to the stores. The only difference, and I think you may have talked about in the store today, is that our team members are going to be putting up the refrigerated and frozen versus the local wholesaler. Right? So McLane drops it off. And the team member has to put it up in a relatively short period of time because it's refrigerated and frozen. And so we've allocated the hours and the model to do that, so actually feel really good about the – now if you asked me 6 months ago, I would have told you we had the same risks as we did with the other initiatives. But because of the way that our internal operations team and our team members have executed the plans, the process, we practice it, we train it. We have an annual meeting coming up in August for the first time in Florida with a thousand of our associates. There's I think it's a 3-hour session or a 2-hour session just on McLane that we're teaching them. So I feel really good that we're going to pull this one off as we did the rest of our initiatives.

Michael R. Bloom

Now if I could just add to that. We made the decision to go with McLane months and months ago. There are complications involved with that transition, but we set aside a team of 7 to 8 people. And that's all they've been doing is ensuring that we're doing the right things because there are a lot of moving parts, they're changing. Over the long haul, though, we continued to be very comfortable with this move and what that will mean to our customers from a selection standpoint and then in stock. But I feel very good about the way the team has put together a game plan to ensure success there. I'm sure it will be bumpy, but we feel very good about what we set up and think that it's going to execute flawlessly. And I'd say, the most important thing longer term, it's the right thing to do for the customer.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

I was just wondering if you could talk about all the initiatives you have been doing right now. Would this be characterized as the highest watermark of execution risk in your -- and on a go-forward basis, is it more of a fine tuning of your program or are you going to use next year to take on another 20 major projects or whatever you want?

Howard R. Levine

No. Again, we've got to react to what our customers want. We have to be relevant. We candidly were tremendously behind with our assortment, particularly in HBA and food. [indiscernible] why are you guys going so fast? What are you all fired about? And it's because we've been living and breathing this every day. I almost can say we've gone to battle with our customer and our competition with one arm tied behind our back because we didn't have the assortment that we thought we needed to really capture the complete trip. We think we've satisfied a lot of that, but a lot is going to depend on what the customer is telling us. You notice today we didn't introduce one new initiative. We realized where we are and we realized the work that we have ahead of us, so we won't disappoint you. We'll probably have a few things we'll throw out, but -- and that's good. What I told the store team in the back there is if anything, with what we've just been through, we have more confidence to do things and move things around and change things than we've ever had before. But we planned it. We thought through it. And it wasn't just stores. It wasn't just the merchants. It wasn't just the suppliers. It was all those pieces coming together, and it's a great thing to see. If there was one thing that was clear in the presentation, it was a lot from our view as much as it was from your view. And we're getting towards the end of that and feel very good about where we are.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Dan Binder, Jefferies. I have 2 questions for you. First, Howard, you mentioned that acquisitions and international growth could be a part of your growth story at some point. I'm curious if you have a time line on that. And secondly, why you mentioned this today? I don't think we've heard that before. Given the lack of success that other retailers have had on both fronts, what is it you're seeing? That was the first question. The second question had to do with California. Given your comments around an investment period, I'm just curious what your initial expectations are for four-wall sales productivity and EBITDA and cash payback versus a more typical market.

Howard R. Levine

Let me answer the second question first, then I'll come back to the first. In terms of profitability in California, we need the distribution center out there. Those goods are getting shipped from our Odessa, Texas facility, a 1,300-mile trip. When we opened up Utah, we cut that by more than half. So it's going to be very difficult for those stores to be profitable until we get that facility up and going. But the good news is it's about a year out, and we're going to continue to open up stores. Understand that, that it is clearly an investment on our part right now. Longer run, great future there, lots of stores and the customer really likes what they see from us there. Believe it or not, they like some of the discretionary more than what we've seen in some of the other areas, so that's actually a positive thing. On the -- I knew I was going to get asked about international and acquisition, and let me break down acquisition and international. It's not new thoughts for us. We've made trips to Mexico. We've made trips to Canada. I have to like those 2 countries because they're continuous to the United States. But we don't have any immediate plans there. We've seen the opportunity, and I can tell you there's lots of customers in both those countries that love the value that we offer. In Canada, we've seen the success of the Dollarama operation there. We've seen some other competitors start to go in there. They'll have a timetable. I should have said very long, but who knows? We've got a team in place today that gives us more confidence to take on something like that, but nothing is pending. In terms of acquisition, I've talked about acquisitions. And over the years, we've always looked at everything that makes sense and try to evaluate it. And every time, they’ve come back and said, "We're better off opening up one store at a time." But as the world changes, as we evolve and grow and change, just wanted to make sure that we stay visible and continue to look at all of the opportunities out there. It didn't mean to intend there's something around the corner at the next moment.

It's hard for me to see, so please say your name.

Meredith Adler - Barclays Capital, Research Division

Meredith Adler, Barclays. I have 3 questions about pricing. I'll start with you've historically priced items in $0.25 increments, and I was wondering whether you were moving away from that. And then I have 2 other questions.

Michael R. Bloom

Yes, we've moved away from that a while ago. So that's probably 2 or 3 years, particularly on some of the lower units. And with all the inflation, whether it's inflation or deflation in the last few years, we decided that we would do that when we had to. So we've already handled that.

Meredith Adler - Barclays Capital, Research Division

And then you commented that -- I think maybe Mike commented that you're checking prices quarterly, competitive prices on a quarterly basis. I follow the grocery retailers and they don't do price checks quarterly, they do price checks weekly. And you are going to be much, much bigger in food. Can you continue to only do that, to be checking, especially if you have more price knowns?

Michael R. Bloom

Yes, so we used to do it monthly on an ad hoc basis. We saw that we could move to quarterly because we didn't see enough change that we needed to react to. I will also tell you, depending on the category, i.e. cigarettes, we do cigarettes much more frequently so -- and milk. Cigarettes and milk, we do more frequently. Commodity-type items, right? Those are probably the 2 most price sensitive that I think we have in our store. But the rest, I mean, to be fair, when you talk about whether it's Tide or NyQuil or paper towels, these prices just don't move that often. And so we feel really comfortable, only because we've done it monthly. Now we're going it quarterly. And I'll tell you, if we can move it out, we're going to move it out even more because I don't want to do price -- competitive price shops when we're not learning anything. I want to do it at the right time. And if we have to shorten it, we will. If we have to extend it, we will. So right now, we feel comfortable with quarterly.

Meredith Adler - Barclays Capital, Research Division

And then my final question about pricing is the optimization. Does it need to be done in a store-by-store basis? Are there meaningful differences in elasticity for different stores and are you capable of doing it on a store-by-store basis?

Michael R. Bloom

It's a great question. So I would tell you that -- and again, please understand, this is really early and exploratory. And I think I've mentioned to you before, I've done a lot of pricing work over the last several years. And the answer is yes to your question, which is you not only -- you have to do it by zone. You're never going to be by store. I can't have 7,000 price zones, but I can have meaningful clusters of price zones based on different attributes. So one example might be the distance to a competitor by category. So if I'm within the same strip center with a grocery store, that's a different zone than if the closest Dollar General is 8 miles away, right, or if the party store is 1 mile away and in our channel, party is big, then I need to think differently about party than if it is 10 miles away. And you can cluster by category, by segment, based on geography, based on demographics, based on disposable income. There's lots of different ways that you can think about it, and that's right now what we're trying to learn about our customer. And we knew going into this, I can assure you, Howard has made it crystal clear to me that -- how important pricing is to our customer and not to screw it up. But I will tell you that -- I can tell you that, so I hear it all the time, and the intention is just to be smarter about it where we can. And using the examples I just gave you, I think we've learned. We've done a lot of testing, and we've learned that there is increased profitability when you think about it differently instead of -- if you're using one competitor to drive your price shops, it's a mistake. I can tell you there are states right now that we don't even have Dollar -- we don't even compete with DG and yet they are obviously on our competitor watch list. Right? And we don't even compete with them in some states. So that's sort of the way we're thinking about it. Meredith, thanks for breaking those questions down one at a time. You knew we couldn't remember all 3. Thank you.

Unknown Executive

All right. We're coming over here.

Unknown Analyst

Jack Balos [ph], Focus Research [ph]. I have 2 questions. One is how important is your Sunday promotions and price-off coupons? How big is that expected to add to sales? And second question, regarding tobacco sales, my understanding is that tobacco is about half the gross margin of the store. The question is how much of the sales increase do you need in that basket of goods to have a lower SG&A ratio to offset that gross margin decline?

Howard R. Levine

So the tobacco question, so you saw in my prepared remarks that -- what we're excited about is that 60% of the baskets that have tobacco in it have other merchandise in it. And I don't think we thought it was going to be the high but 60% -- and it's a $17 basket at our company margins. So we don't look at tobacco individually, like we don't look at soda individually, like we don't look at Tide detergent individually. We look at it as a total basket. And it’s -- right now, and I know it's really early, so I don't want to get too excited but again, I've got a lot of history with tobacco. Tobacco has been out there in most retailers for a long time, so there's a lot of data out there that should prove to come to fruition. So we feel good about it. Again, a $17 basket at our company margin with those extra items at our company margin is what we expected, and it's driving trips.

Unknown Analyst

When you get that mix, what's the overall gross margin compared to where it had been?

Howard R. Levine

We don't break that down, Jack. In terms of your first question about the Sunday inserts, we've tested that. We're not going to tell you the exact benefit of that. But obviously, we wouldn't make that change unless there was some benefit coming to that. And I think Mike outlined in his presentation pretty good what those reasons were.

Joseph I. Feldman - Telsey Advisory Group LLC

Joe Feldman, Telsey Advisory Group. Could you talk a little bit about the cost related to this -- the newer renovation, the CR3, how it compares to the past one? Obviously, you've done a lot of things in the stores that are time period. But from the larger renovation format, how long will that take compared to the last?

Howard R. Levine

[indiscernible] you can help me out if I get off track here. But I'm glad you asked about CR3 because we really didn't talk a lot about that today. CR3 is our third generation of what our new vision is. There was a few things that we wanted to accomplish with our CR3 format. First, as Mike had indicated, one of the things we want to do is create potential growth in some consumable categories. So by separating HBA and food, it enabled us to grow those categories without having to relay the entire store. So we've got additional capacity to grow. We've done several -- was it 50 to 100 of those, so far? Okay, 350. And while it's very early, those stores are doing even better than the CR2 format, and they cost less. Our team has done a fantastic job of trying to get costs out of those things to make the hurdle rates lower. Some of that work that we outsourced is being in-sourced, and that cut a lot of costs down. And we're just being more careful and cautious about some of the fixturing and so on. But that's a good story. We're very excited about what we're seeing there in the early stages. And again, I think it sets us up for growth without having to reset and go through some of the work that we've just been through in a lot of those newer formats.

Mary A. Winston

Howard, I think we have time for 1 or 2 more questions.

David Schwartzman

David Schwartzman, Seix Investment Advisors. I see that you're at the lowest point of investment grade. And with the move to using sale leasebacks to finance the growth, that will again pressure that lease adjusted ratio. It seems like -- I'm trying to understand, I guess, the capital, the cash uses because I see the share repurchases are way down. Is that the way you would basically manage that ratio, by keeping your share repurchases to a very low level, if you start to bump again to 3.3 or how do you manage that or can that get away from you?

Mary A. Winston

Yes. First of all, we have no intention of letting you got away from us. And I would say we're going to manage all of those levers, so that's obviously a component of it. We're very focused, as I mentioned, on maintaining our investment grade rating. We know kind of what the top end of that is, and we're keeping our eye on that. And so as we look at that, it's really all about then thinking about what are the sources of liquidity, where do we tap into those and how we do maintain the right leverage ratio in doing that? So we've got tons of liquidity, as I showed on the undrawn line. We have a growing sale leaseback program that we can certainly tap into, and we will use that. And then as part of our investment priorities, as I've mentioned, the repurchase program is probably our third priority. So I wouldn't say it's a lever that we're going to flex if we need extra capital, but it is something we will do opportunistically when the price is right and when we have excess cash.

Kiley F. Rawlins

Any other questions? Okay, Howard, do you want us to wrap up?

Howard R. Levine

Okay. Thank you all again for coming. Kiley, did we finish early? It's early. Again, thank you all for taking time out of your day listening to us, and we look forward to seeing you in our travels. Take care. Thanks a lot.

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