Family Dollar Stores Q3 Earnings Call Transcript

123jump.com Staff
12 Jul, 2011
New York City

The retail discount stores operator net sales for the quarter increased 7.8% to $2.153 billion on comparable store sales rise of 4.7%. Net quarterly income rose 6.5% to $111.1 million. Earnings per share climbed to 91 cents compared to 77 cents a year-ago quarter.

Family Dollar Stores, Inc. ((FDO))
Q3 2011 Earnings Call Transcript
June 29, 2011 10:00 a.m. ET

Executives

Kiley F. Rawlins – Vice President of Investor Relations and Communications
Howard R. Levine – Chairman and Chief Executive Officer
R. James Kelly – President and Chief Operating Officer
Kenneth T. Smith – Chief Financial Officer

Analysts

Bernard Sosnick – Gilford Securities
Adrianne Shapira – Goldman Sachs
Jack Balis – Focus Research
Laura Champine – Cowen and Company
Daniel Binder – Jefferies & Company
Mark Montagna – Avondale Partners
Joseph Feldman – Telsey Advisory Group
Anthony Chukumba – BB&T Capital Markets
Dan Wewer – Raymond James
Adam Sindler – Deutsche Bank

Presentation

Operator

Good morning. My name is Evan [ph] and I will be your conference facilitator today. I would like to welcome everyone to the Family Dollar earnings conference call. All lines have been placed on mute to prevent any background noise. After the company''s prepared remarks, there will be a brief question-and-answer period. The question-and-answer queue will not be available until after the company has concluded their prepared remarks. So please wait until after the speakers have finished their remarks before attempting to enter the queue. I would now like to introduce Ms. Kiley Rawlins, Vice President of Investor Relations and Communications. Ms. Rawlins, you may begin your conference.

Kiley Rawlins

Thank you, Evan. Good morning, everyone and thank you for joining us today. For those of you who have dialed in, please note that we have posted accompanying slides on our investor relations page of our website.

Before we begin, you should know that our comments today will include forward-looking statements regarding various operating initiatives, sales and profitability metrics and capital expenditures as well as our expectations for future financial performance. While these statements address plans or events that we expect will or may occur in the future, a number of factors, as set forth in our SEC filings and press releases, could cause actual results to differ from our expectations.

We refer you to and specifically incorporate the cautionary and risk statement contained in today''s press release and in our SEC filings. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today, June 29, 2011. We have no obligation to update or revise our forward-looking statements except as required by law and you should not expect us to do so.

With me on the call this morning are Howard Levine, Chairman and CEO, Jim Kelly, President and COO, and Ken Smith, Chief Financial Officer. We''ll begin our discussion this morning with a review of our results for the third quarter and the first three quarters of fiscal 2011. Then we will take a few minutes to discuss our plans and outlook for the rest of the year. Following our prepared remarks you will have an opportunity to ask questions. Remember that the queue for the question-and-answer session will not be available until after we have finished our prepared remarks. Now, I would like to turn the call over to Ken Smith. Ken?

Kenneth T. Smith

Thanks, Kiley. This morning we reported that diluted earnings per share for the third quarter increased 18% to $0.91 compared with $0.77 last year. Softer-than-expected sales, particularly in seasonally-sensitive categories and greater than expected gross margin pressure resulted in earnings per share that was a penny below our original guidance. Despite these pressures, I would note that strong expense control resulted in modest operating margin expansion for the quarter.

Let''s start our discussion with sales. Net sales for the quarter increased 7.8% to $2.2 billion compared with $2 billion in the third quarter last year. Comparable store sales for the quarter increased 4.7%. The increase in comps store sales was driven by both increased customer traffic and a higher average ticket.

During the quarter, we opened 60 new stores and closed five stores compared with 39 openings and four closings in the third quarter of fiscal 2010. From a category perspective, sales were strongest in Consumables and Home Products, which increased 10.6% and 8.2%, respectively.

Sales of apparel and seasonal merchandise varied widely by region, reflecting the volatility of this year''s transition to the spring season. In areas with more normalized weather patterns, our spring merchandise performed well and more recently, these categories have responded as hot weather has become more prevalent. From a mix standpoint, Consumables increased to 67.3% of sales compared to 65.6% of sales last year.

Turning to gross margin, gross profit as a percentage of sales decreased 36 basis points to 36.2% of sales. The decline in gross margin was primarily a result of the impact of stronger sales of lower-margin consumables, increased promotional markdowns and higher freight expense. These pressures were partially offset by benefits from our continued investments in price management capabilities, private brands and global sourcing, as well as lower inventory shrinkage.

Although EDLP continues to be the foundation of our pricing strategy, we are increasingly leveraging promotional capabilities as well as other programs to drive traffic. For example, we finished the winter season well, but our spring season began more slowly than expected. To create additional excitement, we selectively promoted our seasonal assortment this quarter.

As expected, higher freight costs continued to pressure gross margin. Through network optimization and expanded backhaul programs, we have been able to mitigate some of the pressure from higher diesel prices, which on average this quarter were 33% higher than last year.

Expenses were well-managed during the quarter. Total SG&A expense increased 6.3% to approximately $595 million compared to about $560 million last year. As a percentage of sales, SG&A expense in the quarter decreased about 40 basis points as compared with the third quarter of fiscal 2010. Most expenses were leveraged in the quarter. As a percentage of sales, lower incentive compensation expense and lower store labor expense offset investments to support revenue growth.

Reflecting our performance year-to-date and our pay for performance philosophy, incentive compensation expense decreased approximately 26 basis points in the third quarter this year as compared with last year. In addition, increased workforce productivity resulted in the leverage of store payroll. These improvements were offset by about 65 basis points related to revenue-driving investments, including store renovations, the acceleration of new store growth and enhanced marketing efforts.

Operating profit in the quarter increased 8.4% to $184.4 million compared with $170.1 million last year. As a percentage of sales, operating margin expanded modestly to 8.6% of sales in the third quarter this year as compared to 8.5% of sales in the third quarter last year.

Finishing up the review of our income statement, interest expense in the quarter increased by $3.8 million, reflecting our second quarter debt issuance. The effective tax rate during the quarter was 37.5%, slightly below last year''s third-quarter rate of 37.6%. As a result, net income for the quarter increased 6.5% to $111.1 million compared to $104.4 million in the third quarter last year.

Let me conclude our discussion of third-quarter results with a review of some additional financial highlights, starting with inventory. Reflecting investments to expand our consumable assortments, average inventory per store increased about 11% this quarter as compared with the third quarter last year. The increase was primarily a result of the growth of consumable inventories to support an expanded assortment.

Driving increased sales productivity and higher returns on inventory remain key priorities. In support of these goals, this quarter we completed a significant expansion in two traffic-driving consumable categories, Food and HBA. These investments, combined with the inventory needed to support our renovation effort, are expected to drive market share, but will continue to pressure inventory productivity and margin in the near-term as we ramp up these programs.

Turning to the cash flow statement, we are accelerating our capital investment in support of growth priorities. Through the third quarter, we invested approximately $230 million in capital expenditures, primarily to support new stores, store renovations and select store acquisitions. This compares with approximately $136 million in capital expenditures in the first three quarters of fiscal 2010.

Through the first three quarters of fiscal 2011, we opened 206 new stores and renovated 680 stores. In addition, we purchased 27 stores as we looked to opportunistically deploy capital in the current real estate environment.

Even as we have increased our capital investments, we have returned about $574 million to shareholders through dividend payments and share repurchases. Through the first three quarters of fiscal 2011, we purchased 10.9 million shares for a total cost of approximately $513 million. As of May 28, 2011, we had about $245 million remaining under our current stock repurchase authorization. We continue to expect that we will complete this authorization by this fall.

Now let''s talk about our expectations for the fourth quarter and the full year. As we look to the fourth quarter, we expect that consumable expansions, store renovations and improved promotional programs will continue to drive sales momentum. For the quarter, we expect comps to increase between 5% and 7%. Although the June period isn''t over, the sales trend through the first four weeks is consistent with this range.

As we look to the fourth quarter, the inflationary environment continues to present challenges and we expect that gross margin will continue to be pressured by an adverse mix shift and higher fuel costs. We intend to mitigate some of this pressure through benefits from better price management, the expansion of private brands and our global sourcing efforts.

For the fourth quarter, we believe that the net impact on gross margin will be similar to what we saw in the third quarter. Reflecting our comp plan, we intend to generate continued SG&A leverage in the fourth quarter. As a result, we expect modest operating margin expansion.

Finally, we expect that the tax rate in the fourth quarter will be around 37.5% as compared to 33.8% in the fourth quarter last year. Given these expectations, we estimate that earnings per share for the fourth quarter of fiscal 2011 will be between $0.62 and $0.70 compared with $0.56 in the fourth quarter of fiscal 2010.

I would note that our guidance assumes that the weighted average diluted shares for the fourth quarter will be around 120 million. For the full year, we have fine-tuned our earnings guidance to reflect our performance year-to-date and our expectations for the fourth quarter. We now expect that diluted earnings per share for fiscal 2011 will be between $3.08 and $3.16 as compared with $2.62 in fiscal 2010.

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

Howard R. Levine

I''m especially pleased that these results were achieved even as we accelerated our investments to drive revenue growth. Reflecting the volatility which sometimes accompanies seasonal transitions and increased economic pressure, we didn''t meet all of our financial goals this quarter. However, I’m extremely pleased with the progress we have made in pursuit of our longer-term vision.

This quarter, we opened 60 new stores, 54% more than we opened in the third quarter last year. We renovated 367 stores, a company record, and we successfully completed a significant expansion of our Food and HBA assortments in 5300 stores.

We are also making significant progress in our efforts to expand our private brand penetration and strengthen our global sourcing processes. In addition, customers continue to respond favorably to our ongoing quality improvement efforts. Our customer satisfaction scores continue to increase and our value perception, the combination of price and quality, remains strong.

Today, many consumers remain financially constrained. Higher gas prices, combined with rising food costs and sluggish income growth, have left many families believing that the economic recovery has yet to take hold. Within this tenuous environment, our strategy of providing customers with value and convenience continues to have great appeal, not only with our core low-income customers but also with our middle income families.

Over the last six months, we have seen a significant number of cost increases and our merchants are working hard to create the right merchandise value proposition for our customers. Protecting our strong price perception and delivering value to our customers is critical to our long-term success.

For more than 50 years, we have remained committed to this strategy and although we certainly face more challenges from inflationary pressures today, our strategy has not changed. Our customers need the values we offer and we are leveraging expanded capabilities in price management, private brands and global sourcing to help us maintain our commitment to customers, while also balancing our responsibility to shareholders.

Prices are increasing and customers have noticed. While we are not immune to cost pressures, our customers tell us that our price image remains strong. We are committed to protecting this strong price perception and delivering great value to our customers.

Over the last several years, we have invested significantly in new merchandising processes to include price management capabilities, customer research and category management. These investments, combined with our expansion of private brands and enhanced global sourcing efforts, are helping us navigate an environment that continues to be very challenging.

In addition, we are leveraging our expanded zone pricing and price optimization capabilities and we are working hard to mitigate the impact on both our customers and our profitability goals. So far, our market and price checks are confirming that our competitiveness remains strong.

We continue to expand our assortment of private brands, offering customers with new alternatives to national bands brands. Under Family Dollar brands like Family Gourmet, Kidgets and Family Chef, we have introduced more than 500 brand products to our assortment this year and our customers are responding.

Year-to-date, private brand sales have increased approximately 22% and I am especially pleased with the growth we have seen in our private brand consumables, which have increased about 27% so far this year. Importantly, our expansion of private brands is also enhancing our profitability.

Our continued efforts to build an integrated global supply chain are supporting our private brand objectives while also helping us mitigate rising costs. Our teams in both Hong Kong and Shenzhen are ramping up quickly and helping us to strengthen and expand our supplier network. As a result, we are on track this year to increase our direct imports by 20%.

Although the near-term environment is not without challenge, we believe we have an opportunity to continue to expand our market share and improve our productivity. That is why we are accelerating investments to drive revenue growth.

We continue to accelerate the pace of new store openings. As we have discussed on previous calls, operational improvements combined with softening real estate markets and a growing customer base have resulted in additional opportunities for new store growth.

Year-to-date, we have opened 206 new stores compared with 125 stores last year and we are on track to meet our goal of 300 new stores for the year. At the same time, we are building the pipeline to further accelerate the pace of the openings next year.

We are also developing the infrastructure and processes to support growth in new markets and we expect to open our first stores in California before Christmas. We are also accelerating our store renovation program. As you know, this year, we launched a multiyear store renovation effort intended to increase our competitiveness and our unit productivity by transforming the customer shopping experience in a Family Dollar store. Simply put, this renovation effort represents our vision for the future.

We have expanded key consumable categories and created more intuitive merchandise adjacencies. We have improved the navigational signage and leveraged new fixtures that enhance customer sightlines, increase capacity and simplify restocking and recovery processes.

We have created a warmer, more inviting shopping environment that includes a refresh of the building facade and new exterior signage and implemented higher maintenance standards. We are improving store operating processes and leveraging technology to increase workforce productivity. And finally, we have raised our customer service standards. We have strengthened our team member engagement with enhanced training, improved recognition programs and more consistent team member branding.

Through the third quarter, we have completed 680 renovations and customers have continued to respond favorably to the changes. Our customer satisfaction scores in renovated stores reflect meaningful improvement above the chain average.

Importantly, the enhanced customer experience is translating into double-digit sales increases, driven by greater transaction and higher average ticket. Although our original plan this year was to renovate 600 to 800 stores, we are so pleased with the customer response that we now intend to renovate more stores than initially planned.

We now expect to renovate around 250 stores in the fourth quarter, bringing the total for the year to more than 900 stores. Although this acceleration will add some incremental expense in the fourth quarter, I believe that it positions us well to achieve our productivity goals faster.

While we are accelerating our renovation program, it will take us a few years to fully transform the chain. To help us increase productivity in all stores, this quarter, we introduced much of the expanded food and health and beauty aid assortments into the rest of the chain.

While we have added a number of private brand items to the mix, with this expansion, we have also increased our selection of national brand items in these categories. Leveraging slightly higher shelf heights and consolidating space in some discretionary categories, we have expanded our food assortment by about 20% and our HBA assortment by about 25%.

I’m especially proud of our store operations teams, who executed these changes in 5300 stores in eight weeks with minimal disruption to the customer. While this investment was a big driver of the inventory increase this quarter, it positions us well to drive strong sales growth through the fourth quarter and into fiscal 2012.

Despite an increasingly challenging environment, we are accelerating our investments to drive revenues and increase productivity. We''re expanding our new store openings and building the pipeline to return to annual net square footage growth of between 5% and 7%.

We have launched an ambitious store renovation program to enhance our competitiveness and drive sustainable productivity improvements. And we are accelerating the pace of these renovations. And our teams have worked quickly to broaden our assortment in all stores to capture more shopping trips.

Although the current macro conditions make it difficult to project near-term performance, I remain confident that our strategy of providing customers with value and convenience, combined with the investments we are making to improve the shopping experience in our stores, will continue to position us to expand our market share and improve our unit productivity and deliver strong financial returns.

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

Question-and-Answer Session

Operator

We are now ready to begin to question-and-answer session. If you wish to ask questions, please press star one. As a reminder, if you press the star one key during the company’s comments, you are now placed under the queue. If you would like to ask a question, once again, please press star one. Also as we have limited time remaining, please combine your comments to one or two questions. One moment for the first question. Our first question comes from Bernard Sosnick with Gilford Securities. Your line is open.

Bernard Sosnick – Gilford Securities

Good morning. You had mentioned that sales in June are in line with your expectations for the fourth quarter. Some of that is due to improvement in apparel and seasonal, but you really didn''t give us the background on apparel and seasonal sales in the third quarter and how they might have picked up in the fourth quarter to get your sales -- in June to get your sales to where they are.

R. James Kelly

Well, Bernie, as we mentioned, when we saw the softness of apparel sales in the third quarter, we began to react by promoting that area more aggressively. That gave us more units and kind of flattened out apparels from a sales dollar perspective.

Once the seasonally warm weather was more consistent throughout the country, we saw more consistent performance throughout the country. Prior to that, we were seeing very strong sales in certain climate zones and very, very weak sales in others.

So the biggest thing we saw in June was what we expected. That is, our customers had given us indicators where it had been warm that they like our assortment and they responded well throughout the country in June to the assortment. So we are pleased; we are off to a good start but as you know, that season lasts more than a couple of weeks.

Bernard Sosnick – Gilford Securities

And what about the rest of the seasonal product, the outdoor -- equipped toys and whatever? How did that fare during the third quarter and in June?

R. James Kelly

Basically, it ran in parallel to what we saw in apparel, Bernie. Our customer buys very, very close to need. So if they don''t need a new fan or they are not ready for a summer toy or a lawn and garden, they simply don''t buy it. So as the weather hit, we saw a strong response throughout our seasonal areas.

Bernard Sosnick – Gilford Securities

Okay. And if they -- and you are suggesting that if they continue at the current rate, apparel and seasonal would be on your plan for the fourth quarter?

R. James Kelly

That''s right. We are still looking for a smooth transition between the summer seasonal goods and the fall and winter. So we adjusted the inventory levels through the promos and also through cancellation of the limited number of receipts. Given those two actions and the sales trends right now, we feel fairly comfortable with this area.

Bernard Sosnick – Gilford Securities

Okay. Thank you very much.

Operator

Our next question comes from Adrianne Shapira with Goldman Sachs. Your line is open.

Adrianne Shapira – Goldman Sachs

Thank you. Two questions. First, on the gross margin, appreciate the list of pressures that you called out. But I am wondering if maybe you could speak a little bit to pricing, inflationary pressures. Howard, we heard your comments of being mindful of your perception with your customers and we''ve obviously heard from some of your competitors in terms of their strategy on pricing. Could you share with us a little bit more specifically what impact it had on gross margin in terms of passing on prices and what your strategy is going forward in terms of passing on prices or holding back? Thanks.

Howard R. Levine

Sure. Thanks, Adrianne. First of all, let me point out that we have been dealing with this low to low-middle income customer for years and understanding their behavior and the way they react, particularly during inflationary periods, is critical to our decision as to how we manage through some of these challenges. Our customer lives paycheck to paycheck. When they have to spend more money at the gas tank for their gas or more money for food, it has to come from somewhere, as they don''t have the cushion that many others might have.

So their shopping patterns are adjusted primarily out of the discretionary categories into more basics and consumables, which, incidentally, is where all of our investments have been going, and we are enjoying some nice double-digit increases in some of those consumable categories.

But, as I indicated in my comments, we are fighting with the best of them. The inflationary pressures are hitting our customers. We are committed to protecting that price perception. Our customers, more importantly, are also telling us that -- through the customer research that we conduct -- that we are reaching our goals in terms of price perception as reported in our most recent reports.

You know, in terms of the investments which you made mention of, those are critical to help mitigate some of this. In terms of zone pricing, we have been able to zone price for many, many years at Family Dollar and are continuing to improve and adjust as market conditions change. So our zone pricing capabilities have been very important to us and we continue to leverage that.

Additionally, our price optimization efforts and the way we are able to evaluate certain changes before we actually make them and they impact our customer are also very important. And I am very pleased with the traction we are starting to see in our global sourcing area. Global sourcing has been a big investment for us over the last few years. I indicated in my comments that today, we expect to increase our direct source goods, which -- what I mean by direct source is eliminating the middleman -- is going to be up over 20% -- we continue to see a lot of opportunity there.

And I am also very pleased with the progress we made in our private branding strategy. The quality that we put into our Family Gourmet is being very well received by our customers. Our Kidgets name in the kids'' area is getting great traction. We still have additional names to roll out that you will be seeing in the next few weeks in our health and beauty aid area. But I can''t think of a better time to roll out this private brand strategy with customers struggling today. Today, we are able to give our customers a legitimate choice between a brand and a private brand and I think that is resonating extremely, extremely well with our customer.

So there is a number of levers we are pulling, including the old-fashioned way of just fighting with our vendors and continuing to drive value for our customers. And I think you have seen in our IMU the way that we have been able to balance sales and margins; or said another way, how do we balance our initiatives with driving benefits to our customers and also continuing to provide good returns for our shareholders.

So a lot happening on that front. It is something that is receiving a lot of attention from all of us here and we feel comfortable in navigating through that kind of climate.

Adrianne Shapira – Goldman Sachs

Howard, that''s helpful. And maybe just to follow up on that, you mentioned the IMU. Given that you are working hard to offset some of those inflationary pressures with some of the levers you point to, could you give us some specifics on what you are seeing on IMU?

Howard R. Levine

You know, it is improving. I think a lot of that could be misconstrued that we are passing on excessive price increases to our customers. I don''t think that is the answer. I think we have been able to hold the line there through all of the initiatives that we are dealing with, as well as just negotiating better deals and getting stronger with our relationships with some of our branded suppliers.

R. James Kelly

I think stated slightly differently, our IMU has stayed fairly consistent through this period, but we have utilized a lot of the benefits from these initiatives to offset some of the inflationary pressures and continue to make sure that we are delivering competitive values to our customers.

Adrianne Shapira – Goldman Sachs

That''s helpful. And then just my second question, related to SG&A. As we think about heading into the back half, your prior guidance had talked about a 7.5% expense growth rate is what we should be thinking. You came in better than that in the third quarter. It seems it largely was because of the incentive comp a bit. How should we think about the leverage point now in the fourth quarter, especially as you balance lapping some of those initiatives -- now most of them are behind you in terms of store hours and the marketing and ramping up remodels? Where is the leverage point in the fourth quarter? Thanks.

Kenneth T. Smith

Yeah, I think from an expense perspective, we continue to want to take folks back to the three major buckets. And when we think of expense growth, we think of our core expenses, the impact from new stores and our investment agenda. When we think of those -- new stores are running in around that 3% level and are fairly transparent.

When you look at the third-quarter performance and adjust out for the two things I called out, which are the investments and then some expanded marketing, as well as our renovation program as well as going the other way, the incentive comp, we are very pleased with what that leaves from a core perspective. Our core expenses were managed well this quarter as a result of a lot of hard work across the entire organization and when you adjust for those two factors, you see us performing slightly below that 2% to 3% level that we look at from a core management perspective.

So, I think that framework and that structure is intact as we move forward. We continue to expect to manage the core expenses at that 2% to 3% level and our investment agenda continues to be aggressive. We have the anniversaried expanded hours but we’re accelerating our investments in the renovation program, certainly as the number one callout.

So I think that structure remains intact. The one callout I would remind folks of specifically to the fourth quarter is last year we did receive a $9 million benefit related to an insurance settlement, which is a non-recurring event that did occur last year as a benefit.

Adrianne Shapira – Goldman Sachs

Thank you.

Operator

Our next question comes from Jack Balis [ph] with Focus Research. Your line is open.

Jack Balis – Focus Research

Hi, I have a couple of questions. First, regarding your Consumables sales for the quarter and the year so far, they did not -- were not enhanced that much by the increased inventory so far. Do you expect Consumable sales to accelerate in the fourth quarter and could you explain why Home Products was so strong?

Howard R. Levine

Sure, Jack. You know, when we think about Consumable sales, we are very pleased with the progress we made. We are seeing double-digit sales increases. The rollout of the HBA and expanded Food to the remainder of the chain was really completed in the last six to eight weeks of the quarter. So while the inventory investment was fully in place in the quarter, some of the sales benefits are yet to come, and are part of the reason why we continue to give the guidance that we talked about in the fourth quarter, as we believe those sales will start to develop more aggressively but we are very pleased with the start and the reception thus far.

And I will remind you that much of this assortment expansion is what we did in these renovated stores and we saw the initial investment in inventory and what that did. But over time, we were able to leverage that inventory. In terms of the Home sales in the quarter, a lot of that was driven by what Jim had talked about in terms of driving some promotional activity to increase sales in some of those areas that we were satisfied with. That is something that we did in a number of areas to try to spur sales and we would expect to continue to do that, if necessary.

Jack Balis – Focus Research

I think you mentioned that incentive compensation was lower than a year ago. What caused that to happen?

Kenneth T. Smith

Well, it''s a comparison issue. Last year, we performed -- our increase in income that drives our incentive programs was well above plan. So this year, we are in line but as it compares to prior year, we had -- we were up against a higher-than-planned performance.

Jack Balis – Focus Research

What happens in the fourth quarter in that comparison?

Kenneth T. Smith

There is no specific callout right now. We performed well but expect that relative to be in line. There might be a slight change when compared to prior year, but relatively in line.

Jack Balis – Focus Research

Thank you very much.

Kiley F. Rawlins

So before we take the next question, I just want to remind you all -- we have quite a full queue this morning and so if you all could try to limit your questions to one or two, it will help us get through more people on the web. Evan, can we take the next question?

Operator

Yes. Our next question comes from Laura Champine with Cowen and Company. Your line is open.

Laura Champine – Cowen and Company

Good morning, guys. I heard the explanation for the 15% inventory growth. It sounds like most of it was planned by Family Dollar. Is there any excess inventory still in the channel in some of those softer categories that you were not able to clear?

R. James Kelly

Our fashion or seasonal inventories were up a bit but when you look from a macro perspective, the dominant reason for the increase is in the core consumable areas. As I said earlier, we do have a plan that we are tracking that will basically bring fashion inventories back in line as we end the season.

Laura Champine – Cowen and Company

Got it. Thank you.

Operator

Next in queue is Dan Binder with Jefferies. Your line is open.

Daniel Binder – Jefferies & Company

Hi, good morning. You commented earlier that the remodels are still seeing double digit lifts. And I was just curious -- as you look at that incremental sales lift, can you give us a little bit of color on where you are seeing the dominant part of the increase and what kind of margins -- incremental margin is related to those sales?

R. James Kelly

Sure. Those stores are comping very well and we feel good about the customers'' reception to them. When you look overall, the biggest assortment changes in those stores were in the consumable areas as you might imagine, Food and HBA. The customers responded very well, which really provided the foundation for our decision to -- this quarter or in the third quarter -- extend the assortments through a much larger part of our chain. In other words, we used the learnings from Fast Break -- I''m not supposed to use special terms -- from our renovation program to support the decision to further expand our assortments. Those items have a blended margin of slightly less than what the chain is.

On the other hand, we have been working very hard on some of the higher-margin components of our renovation program. And more recently, we have seen some nice response from customers as we have improved the layout relative to these items and improved their presentation. So the renovation program has been successful to date, but our philosophy is to drive continuous improvement and we are doing that, and so we are seeing further improvement.

Daniel Binder – Jefferies & Company

Thank you.

Operator

Our next question comes from Mark Montagna with Avondale Partners. Your line is open.

Mark Montagna – Avondale Partners

Hi, just a question about inventory. It sounds like you had a little bit more apparel and seasonal merchandise than you could have used for the third quarter. Do you have plans to reduce your investment in inventory for those two categories on a go-forward basis for future quarters? Thank you.

Howard R. Levine

Sure, Mark. As we talked about, the primary increase in the inventory was to continue to drive market share in the consumable areas and we feel very good that over the next several quarters that that will began to leverage. We are also very sensitive to what you point out in terms of seasonal goods or goods that might have exposure in terms of markdowns and have been very aggressive through the third quarter. As some of those areas softened, we took some promotional marks to drive units. That was successful.

And as we talked about, we feel good about where we will end at season''s end with some of the pickup in the June sales and going into the July 4 holiday. And, just as important, one of the things that we are sensitive to in small-box retail is clearing out the old goods to position ourselves for the back-to-school season and we feel very comfortable with that transition.

Mark Montagna – Avondale Partners

Okay. But is that causing you to reassess on a go-forward basis? Because I know you are committed to whatever your fourth-quarter inventory is already. But on a go-forward basis, with such a focus by the customer on consumables, is it causing you to refocus how much you might want to invest in apparel or seasonal?

Howard R. Levine

Yes, Mark and that is a very good point. One of the things that I have mentioned over time is when the consumer is stretched, it generally comes out of some of those discretionary categories. So we are watching those inventories and those planned receipts very cautiously but we continue to believe we have opportunity there.

One of the things that I have seen over time -- and that is in good times and tough times -- is when we buy the right merchandise and what I mean by that is that that really screams value to our customer -- despite softness, we are able to see some great sales in some of those areas. So there is a renewed emphasis on making sure that we are projecting or presenting the right value to our customers and leveraging the traffic that we are driving with these increased consumable assortments.

So it is a delicate balance there. We continue to believe we have opportunities to drive sales in both categories, but given some of the softness in the economy, we are a little more sensitive to some of the discretionary areas.

Mark Montagna – Avondale Partners

Okay. Thank you.

Operator

Next question comes from Joe Feldman with Telsey Advisory Group. Your line is open.

Joseph Feldman – Telsey Advisory Group

Yeah, hi. Good morning, guys. Wanted to drill down -- maybe sort of the inventory question, I guess, but from a different angle. Can you talk a little bit more about the promotional markdowns that you had? Because it seems that you at the same time got some effectiveness from your pricing systems that you have in place and the price management tools, and yet you had some promotional markdowns. And wanted to understand what was driving that.

Howard R. Levine

Joe, if I understand your question right, really what we utilize promotional marks were to drive a number of things, whether it was an unadvertised special within our store, something that we may have communicated over the digital network, to even promoting some things through some of our advertising events. What we saw was the need to move some of those units. We have always felt the first markdown that we take on some of those are usually the best and we were just trying to move some units to try to get those inventories back in line as we go into our fourth quarter.

Joseph Feldman – Telsey Advisory Group

Got it. That''s helpful. Thank you, guys.

Operator

Our next question comes from Anthony Chukumba with BB&T Capital Markets. Your line is open.

Anthony Chukumba – BB&T Capital Markets

Thanks for taking the question. I just had a question in terms of free cash flow, what your expectations are for fiscal year ''11? And then I thought you said $245 million remained under share repurchase authorization. Just wanted to check that and see what your thoughts are going forward in terms of future share repurchases. Thanks.

Kenneth T. Smith

Yes, I think as you can see from the cash flow statement, we have got some accelerated investments that affect our free cash flow. Specifically in inventory, as we ramp up our renovation program and reset Food and HBA, and we have talked a bit about inventory and the investment there as well as our CapEx. We are aggressively investing in the store and we are excited about that deployment of capital.

As we have said before, we firmly believe the best deployment and use of our capital is first back into our business. So we are real excited about accelerated new stores, the renovation program, where we are deploying more capital into our stores to drive store productivity and increase returns for our shareholders. So a bit of adjustment from a free cash flow perspective on how we are using that cash, primarily in CapEx.

As it relates to the buyback, your numbers are right. We have around $245 million left on the authorization. As a reminder, that was a $750 million authorization last October and we have executed slightly north of $500 million of buybacks against that and expect to complete that this fall.

Anthony Chukumba – BB&T Capital Markets

Okay. Thank you.

Operator

Our next question comes from Dan Wewer with Raymond James. Your line is open.

Dan Wewer – Raymond James

Thanks. So, Howard, in the last couple of years, both Family Dollar and Dollar General successfully improved gross margin rate, despite the growing sales contribution from lower-margin consumables. I guess what appears to be changing now is your callout of promotional pricing. I haven''t seen that used in your prior releases. So in thinking about both the companies accelerating their store growth rate, you have Walmart making another stab at a smaller box format, do you think that the gross margin expansion cycle is ending for family and for this sector?

Howard R. Levine

Good morning, Dan. You know, I would say that we believe we have continued opportunities in the gross margin. We are in a cycle today where we are facing some challenges that we hadn''t faced the prior few years. A couple callouts there -- primarily the freight area, where diesel fuel is up somewhere in the neighborhood of 30% plus, that certainly is a headwind for us.

The inflationary environment and how we navigate through those are certainly causing some more near-term pressures that we are all navigating through. And yes, it is competitive out there and we are doing some different things and utilizing some capabilities to drive units out when we can. So while you may not have heard this term promotional marks before, there is a reason for that. The way we are utilizing that, being able to address certain stores or certain regions that may be in a different inventory position than others, it is really a way to utilize marks in the most efficient ways, because not every store is in the same position. So we would expect to continue to use that capability throughout the next several quarters.

You know, on the positive side, I think we still have opportunities on price optimization and I am talking about every day pricing. Our stores are in a lot of different kind of competitive markets, some very, very competitive and some that aren''t as competitive and have higher pricing opportunities. We continue to learn more about those opportunities, particularly as we open up more and more stores in urban markets, where that is a lever that we can pull to help the margin. I talked about the improvements in our global sourcing capabilities. Those are certainly still in the early innings. We are just now getting those new offices ramped up.

And, finally, private brand, we had a dramatic strategic shift in the way we position private brands over the last few years. We have got a more centralized control effort there. We have brought in a number of resources to improve the quality and to ensure that our customers are getting what they deserve in terms of quality. That is starting to resonate very nicely with our customer. The packaging is still an area that we continue to work and evolve to and I think when you are dealing with a value-conscious consumer, as we are, I think having choices is only a good thing.

So we continue to learn and evolve about the role that private brand plays with the company. So there are some pushes and there are some takeaways there that certainly make the near-term more challenging. And as I said before, we are fighting with the best of them to ensure that we maintain that competitiveness out there and will continue to do so.

Dan Wewer – Raymond James

Could I just -- as a follow-up -- a question about what I see as somewhat aggressive sales guidance we had both in the third quarter and now we''re looking for a 5% to 7% increase in the fourth quarter. And so you think about the period just ended, most retailers would give their right arm for a high 4% comp sales growth. You noted yourself that it is difficult to forecast the changes in season and weather patterns. So with such a high comp sales guidance, you have a much greater chance of a shortfall than you actually have in exceeding that external plan.

Howard R. Levine

Yes, thanks for the comments, Dan. A number of those things you mentioned are things that we have talked about for a long time around here. But maybe I can add a little color to it, because I do think there is some clarity that I could bring to that area. You know, first of all, I will admit it is aggressive. A 5% to 7% comp, which is the guidance we gave back in September of 2010, when we rolled out some of our revenue-driving initiatives and I will mention to you that since September 2010, we are within that range.

So as aggressive as it sounds, we do believe we have the opportunity to hit those kind of goals and, you know, the way I think about it is we have got some very aggressive initiatives out there that we are rolling out. You have heard a number of them. The store renovation program, we are going to have close to 900 plus stores at the end of the year. We didn''t think we were going to do that many but the customer response has been so favorable, we are stepping it up.

And let me not only mention that that is not only a record, the size and scope of these renovations are huge compared to some of the more recent historical renovations that the company has undertaken. We are spending close to $100,000 plus per store, which is three to four times what we customarily have spent. So when our teams leave that store, it is just tremendous the way that store looks and the levers that we have with getting more and more customers into those stores is really where the excitement is.

You know, we know we are not going to complete this renovation program for the next few years. So what we considered was rolling out the best of some of those consumable categories in the remainder of the chain to begin to leverage and allow those customers to benefit some of those items and some of those changes. We are increasing new store openings; we have got great plans there.

Frankly, the inventory investment, which is substantial, was to drive revenue growth to increase productivity and while there is some near-term inventory productivity issues, it will improve our sales productivity. And we feel very comfortable with the direction and the momentum that that is going to take us. So that, coupled with some of our promotional capabilities and efforts to drive sales, are out there, we feel confident that we are on the right path.

The third quarter came in a little softer and we think we are going to get back. And we were glad to see that in the month of June. We hope to finish the fourth quarter in a positive way but I admit it is aggressive, but we think we have a lot of initiatives to back that up and are excited to execute on those initiatives.

Dan Wewer – Raymond James

Great. Thanks for the help.

Howard R. Levine

Sure.

Kiley F. Rawlins

Evan, I think that we have time for one more question.

Operator

Yes. And our next question in queue is from Michael Baker with Deutsche Bank. Your line is open.

Adam Sindler – Deutsche Bank

Yes, hi. This is actually Adam Sindler calling in for Mike. Just to wrap up real quickly on the gross margins. When looking at this quarter relative to last quarter, do you think it was maybe mix that hurt more or markdowns on the gross margin? And then sort of to follow up on that, do you think that the markdowns was more due to competitive pricing or was it weakness in things such as home and apparel?

R. James Kelly

Well, I think, as we said, most of the markdowns were in response to an initial softness, which when we looked at various seasonal categories, that was fairly consistent. So most of the markdowns were there and they were very productive. So we feel fairly good about the decisions. They positioned us well to wrap up this season without major disruption. So I think we feel fairly comfortable there.

Clearly, the mix is always going to be a factor but we have managed through that mix shift now for years and years and years. If you look back over the last five years, you have seen fairly consistent shift to more consumables. We believe that through private brands, global procurement, pricing and other activities that we have the initiatives in place that will enable us to manage both adverse mix and also the challenges of inflation.

So we are not looking at this as an area that net-net we will see a lot of immediate expansion due to all these pressures, but we continue to work hard to mitigate the negative side of the gross margin factors today. Ken, anything to add to that?

Kenneth T. Smith

No, I think that the major -- I think we have outlined -- if you''re comparing quarters to quarters, they are a bit different quarters when you compare second to third quarter, the second being more of a clearance markdown quarter but the main drivers are in place. Mix, as Jim discussed. Freight certainly continues to pressure us and shrink is providing benefits.

Adam Sindler – Deutsche Bank

That''s perfect. Thank you, guys.

Kiley F. Rawlins

So it is now the top of the hour and unfortunately, we did not get to everyone in the queue. As always, I will be available after the call for any follow-up questions that you may have. Thank you for your interest in Family Dollar and have a nice day.

Operator

This concludes today''s conference. You may disconnect at this time.