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FDO > SEC Filings for FDO > Form 10-K on 19-Oct-2012All Recent SEC Filings

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Form 10-K for FAMILY DOLLAR STORES INC


19-Oct-2012

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion summarizes the significant factors affecting our consolidated results of operations and financial condition for fiscal 2012, fiscal 2011, and fiscal 2010, and our expectations for fiscal 2013. You should read this discussion in conjunction with our Consolidated Financial Statements and the Notes to Consolidated Financial Statements, which are included in this Report. Our discussion contains forward-looking statements which are based upon our current expectations and which involve risks and uncertainties. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth in the "Cautionary Statement Regarding Forward-Looking Statements" in the General Information section of this Report and the "Risk Factors" listed in Part I-Item 1A of this Report.
Our fiscal year generally ends on the Saturday closest to August 31 of each year, which generally results in an extra week every six years. Fiscal 2012, fiscal 2011 and fiscal 2010 were 52-week years. Fiscal 2013 will be a 53-week year.
Executive Overview
We operate a chain of more than 7,400 general merchandise retail discount stores in 45 states, providing primarily low- and middle-income consumers with a selection of competitively priced merchandise in convenient neighborhood stores. Our merchandise assortment includes Consumables, Home Products, Apparel and Accessories, and Seasonal and Electronics. We sell merchandise at prices that generally range from less than $1 to $10.
During fiscal 2012 as compared with fiscal 2011, our net sales increased 9.2% to $9.3 billion, our net income increased 8.7% to $422.2 million, and our diluted net income per common share increased 14.7% to $3.58. Comparable store sales (stores open more than 13 months) for fiscal 2012 increased 4.7% compared with fiscal 2011. Our strong performance during fiscal 2012 was due primarily to our strong sales performance and an improvement in selling, general and administrative ("SG&A") expenses, as a percentage of net sales.
Several years ago, we slowed new store growth to focus on improving returns in existing stores and the chain overall. Over this period, we completed an end-to-end re-engineering of our merchandising and supply chain processes, enhanced the productivity of our store teams, refreshed our store technology platform, and created a store layout for new stores that is more convenient and easier to shop. As a result of these investments, we have upgraded our operational capabilities, increased profitability, gained productivity and expanded our financial returns. More importantly, these investments provided us with a strong foundation to accelerate revenue growth.
In today's uncertain economic environment, value and convenience continues to resonate with consumers. Our strategy of providing customers with value and convenience continues to attract not only our core low-income customers but also middle-income families with greater frequency. To continue to capitalize on this opportunity, we have launched several initiatives to increase our relevancy to customers by enhancing their shopping experience and to improve their perception of our value and convenience proposition.
During fiscal 2012, we continued to focus on achieving our four corporate goals:
build customer loyalty and experience; deliver profitable sales growth; drive continuous improvement; and develop diverse, high performing teams. These goals are designed to drive both short-term and longer-term financial results. The following are some highlights from these efforts.
• We accelerated our new store growth and increased our store openings by more than 50% from fiscal 2011 to 475 stores, including our first stores in California.

• We renovated, relocated or expanded 854 stores under our comprehensive store renovation program. This program is intended to increase our competitiveness and sales productivity by transforming the customer's shopping experience in a Family Dollar store. As a part of this program, we: expanded key consumable categories and created more intuitive merchandise adjacencies; improved the navigational signage; leveraged new fixtures that enhance customer sightlines, increase capacity, and simplify restocking and recovery processes; created a warmer, more inviting shopping environment that includes a refresh of the building façade and exterior signage; raised store standards; improved store operating processes and leveraged technology to increase workforce productivity; and raised our customer service standards by strengthening our team member engagement with enhanced training, improved recognition programs and more consistent team member branding.

• With a strong focus on increasing our relevancy with customers and driving sales productivity, we significantly expanded our merchandise selection in both food and health and beauty aids and added new consumer brands.

• We added tobacco products to our assortment in fiscal 2012. Based on our customer research, our customers are more likely to use tobacco products, and our customers who smoke make more shopping trips per year. With the addition of


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tobacco products to our assortment, we expect that we will drive trips to our stores to not only purchase tobacco products, but other products from our existing assortment while customers are in the store. At the end of fiscal 2012, tobacco products were being sold in more than 6,000 of our stores.
• We made significant progress in increasing our penetration of private brands. In fiscal 2012, private brands sales increased by approximately 9% over fiscal 2011. Private brands consumable sales performed especially well, increasing by 16% over fiscal 2011. In fiscal 2012, private brands sales represented approximately 25% of total sales and approximately 17% of total consumable sales.

Fiscal 2013 Outlook
Building on the improvements we made over the past several years, we plan to continue to execute on our initiatives designed to increase our relevancy with customers, deliver profitable sales growth, and strengthen our value and convenience proposition in fiscal 2013.
Our new store performance has improved significantly in the last several years as a result of the utilization of stronger site selection tools as well as enhancements driven by our strategic initiatives. During fiscal 2013, we plan to open approximately 500 new stores, which we expect will sustain our square footage growth goal of 5% to 7%, which we achieved in fiscal 2012. During fiscal 2013, we plan to renovate, relocate or expand approximately 850 stores.

In fiscal 2012, we formed a six year, exclusive partnership with McLane Company, Inc., a highly successful supply chain services company. This partnership will allow us to carry a consistent assortment and improve our in-stock levels in our refrigerated and frozen merchandise, consolidate a fragmented network of many regional wholesalers to one national wholesaler, and distribute tobacco products to our stores efficiently. All of these improvements are expected to drive additional trips into our stores. McLane will also distribute selected categories outside of refrigerated and frozen merchandise, providing flexibility to our distribution network for potential new SKUs. McLane began delivering merchandise to our stores in September 2012.
Building on the momentum of private brands growth in fiscal 2012, we intend to increase our penetration of private brands even further in fiscal 2013. We expect to launch several new brands that will offer our customers more quality and value while also refreshing a few of our existing brands to broaden their appeal. We intend to drive greater awareness of our private brands program through increased marketing and visual merchandising support.
To continue to deliver profitable sales, in fiscal 2013 we plan to continue to expand our Global Sourcing teams, develop stronger processes to help us integrate our sourcing activities with our category management efforts, and continue to expand our supplier network. We expect these efforts will continue to increase our profitability and help to mitigate some margin pressures. During fiscal 2013, we expect net sales to grow due to the acceleration of our new store growth and an increase in comparable stores sales. Additionally, as noted above, fiscal 2013 is a 53-week year, as compared to a 52-week year in fiscal 2012. We expect comparable store sales to increase as a result of our current strategic initiatives, as well as continued benefits from operational improvements over the past several years. We expect sales will continue to be strongest in the Consumables category as customers continue to respond favorably to our expanded merchandise selection in food and health and beauty aids as well as our introduction of tobacco products to our stores. We believe this shift to more sales of lower margin Consumables merchandise will pressure gross margin in fiscal 2013, as compared to fiscal 2012. However, as a result of our expectation for increased comparable store sales, we expect selling, general and administrative expenses to leverage in fiscal 2013, as compared to fiscal 2012.


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Results of Operations
Our results of operations for fiscal 2012, fiscal 2011 and fiscal 2010 are highlighted in the table below and discussed in the following paragraphs:

                                                                                Years Ended
(in thousands)                 August 25, 2012    % of Net Sales      August 27, 2011    % of Net Sales      August 28, 2010    % of Net Sales
Net sales                    $       9,331,005                      $       8,547,835                      $       7,866,971
Cost and expenses:
Cost of sales                        6,071,058           65.1 %             5,515,540           64.5 %             5,058,971           64.3 %
Selling, general and
administrative                       2,560,346           27.4 %             2,394,223           28.0 %             2,232,402           28.4 %
Litigation charge                       11,500            0.1 %                     -            0.0 %                     -            0.0 %
Cost of sales and operating
expenses                             8,642,904           92.6 %             7,909,763           92.5 %             7,291,373           92.7 %
Operating profit                       688,101            7.4 %               638,072            7.5 %               575,598            7.3 %
Investment income                          927            0.0 %                 1,532            0.0 %                 1,597            0.0 %
Interest expense                        25,090            0.3 %                22,446            0.3 %                13,337            0.2 %
Income before income taxes             663,938            7.1 %               617,158            7.2 %               563,858            7.2 %
Income taxes                           241,698            2.6 %               228,713            2.7 %               205,723            2.6 %
Net Income                   $         422,240            4.5 %     $         388,445            4.5 %     $         358,135            4.6 %

Comparison of Fiscal 2012 to Fiscal 2011 Net Sales
Net sales increased 9.2% in fiscal 2012 compared to fiscal 2011. The net sales increase in fiscal 2012 reflects an increase in comparable store sales of 4.7%, with the balance of the increase due primarily to sales from new stores opened as part of our store growth program. Comparable store sales include stores that have been open more than 13 months. Stores that have been renovated, relocated or expanded are included in the comparable store sales calculation to the extent that they had sales during comparable weeks in each year. The method of calculating comparable store sales varies across the retail industry. As a result, our comparable store sales calculation may not be comparable to similarly titled measures reported by other companies.
The 4.7% increase in comparable store sales in fiscal 2012 resulted from increases in both customer traffic, as measured by the number of register transactions, and the dollar value of the average customer transaction. During fiscal 2012, the customer count increased approximately 2.7%, and the average customer transaction increased approximately 2.0% compared to fiscal 2011. Sales during fiscal 2012 were strongest in the Consumables category.
During fiscal 2012, we opened 475 stores and closed 56 stores for a net addition of 419 stores, compared with the opening of 300 stores and closing of 62 stores for a net addition of 238 stores during fiscal 2011. Cost of Sales
Cost of sales increased 10.1% in fiscal 2012 compared to fiscal 2011. The increase was due primarily to additional sales volume. Cost of sales, as a percentage of net sales, was 65.1% in fiscal 2012 compared to 64.5% in fiscal 2011. Cost of sales, as a percentage of net sales, was negatively impacted by the shift in sales mix to lower-margin consumable merchandise, an increase in inventory shrinkage, and higher markdowns. These pressures were partially offset by an increase in the markups on the sales of merchandise. The growth in sales of lower-margin consumables (69.0% of net sales in fiscal 2012 compared with 66.5% of net sales in fiscal 2011) continues to pressure gross profit as a percentage of net sales. Inventory shrinkage increased during fiscal 2012 as a result of increased activities in the stores including renovations and significant merchandise expansions. We continue to use markdowns in our stores to drive revenue growth during challenging macro-economic times as well as increase market share. We continue to focus on improving our purchase markups through the continued development of our private brand assortment, the expansion of our global sourcing efforts, and improved price management capabilities.


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Selling, General and Administrative Expenses SG&A expenses increased 6.9% in fiscal 2012 compared to fiscal 2011. The increase in these expenses was due in part to additional sales volume and additional costs arising from the continued growth in the number of stores in operation. SG&A expenses, as a percentage of net sales, were 27.4% in fiscal 2012 compared to 28.0% in fiscal 2011. Most expenses in fiscal 2012 were leveraged as a result of a 4.7% increase in comparable store sales and continued productivity improvements. In addition, SG&A expenses, as a percentage of net sales, were leveraged as a result of a decrease in store payroll costs (approximately 0.3% of net sales) and a decrease in insurance expense (approximately 0.2% of net sales). These improvements were partially offset by increased marketing expense (approximately 0.1% of net sales) in fiscal 2012, as compared to fiscal 2011. The decrease in store payroll costs was a result of the continued benefit from improvements implemented to re-engineer many of our core store processes, which has increased workforce productivity. Insurance expense continues to benefit from favorable trends in workers' compensation and general liability costs reflecting improvements we have made in our store operations and risk management processes. Our marketing expense increased as a percentage of net sales as we expanded our customer communications, leveraged various marketing vehicles and improved our marketing and promotional materials. Litigation Charge
During the fourth quarter of fiscal 2012, we recorded an $11.5 million (approximately $0.06 per diluted share) litigation charge associated with the preliminary settlement of a lawsuit in the state of New York. This lawsuit involves claims for overtime pay from New York store managers who worked in our stores over the past nine years. See note 11 of the Consolidated Financial Statements for more information.
Investment Income
The change in investment income in fiscal 2012, as compared to fiscal 2011, was not material.
Interest Expense
Interest expense increased $2.6 million in fiscal 2012 compared to fiscal 2011. On January 28, 2011, we issued $300 million in senior unsecured notes with a coupon rate of 5.00% maturing in 2021 (the "2021 Notes"). The interest in interest expense in fiscal 2012, as compared to fiscal 2011, was primarily driven by the interest expense on the 2021 Notes. Income Taxes
The effective tax rate was 36.4% for fiscal 2012 compared to 37.1% in fiscal 2011. The decrease in the effective tax rate in fiscal 2012, as compared to fiscal 2011, was due primarily to foreign tax benefits realized in connection with the Company's global sourcing efforts and a decrease in liabilities for uncertain tax positions.
Comparison of Fiscal 2011 to Fiscal 2010 Net Sales
Net sales increased 8.7% in fiscal 2011 compared to fiscal 2010. The net sales increase in fiscal 2011 reflects an increase in comparable store sales of 5.5%, with the balance of the increase due primarily to sales from new stores opened as part of our store growth program.
The 5.5% increase in comparable store sales in fiscal 2011 resulted from increases in both customer traffic, as measured by the number of register transactions, and the dollar value of the average customer transaction. During fiscal 2011, the customer count increased approximately 4.0%, and the average customer transaction increased approximately 1.5% compared to fiscal 2010. Sales during fiscal 2011 were strongest in the Consumables category.
During fiscal 2011, we opened 300 stores and closed 62 stores for a net addition of 238 stores, compared with the opening of 200 stores and closing of 70 stores for a net addition of 130 stores during fiscal 2010. Cost of Sales
Cost of sales increased 9.0% in fiscal 2011 compared to fiscal 2010. The increase was due primarily to additional sales volume. Cost of sales, as a percentage of net sales, was 64.5% in fiscal 2011 compared to 64.3% in fiscal 2010. The increase in cost of sales, as a percentage of net sales in fiscal 2011, as compared to fiscal 2010, was a result of the impact of stronger sales in lower margin consumables merchandise and increased freight costs. These pressures were partially offset by lower inventory shrinkage and an increase in the markup of sales of merchandise. The growth in sales of lower-margin consumables


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(66.5% of net sales in fiscal 2011 compared with 65.1% of net sales in fiscal 2010) pressured gross profit as a percentage of net sales. Freight costs were negatively impacted by higher diesel costs. We believe that inventory shrinkage benefited from workforce stabilization in our stores and improved analytics and monitoring processes. We continue to focus on improving our purchase mark-ups through our price management, the continued development of our private brand assortment, and our global sourcing efforts. Selling, General and Administrative Expenses SG&A expenses increased 7.2% in fiscal 2011 compared to fiscal 2010. The increase in these expenses was due in part to additional sales volume and additional costs arising from the continued growth in the number of stores in operation. SG&A expenses, as a percentage of net sales, were 28.0% in fiscal 2011 compared to 28.4% in fiscal 2010. Most expenses in fiscal 2011 were leveraged as a result of a 5.5% increase in comparable store sales and continued productivity improvements. The increased comparable store sales volumes helped offset our investments to drive revenue growth, including store renovations, extended store hours and enhanced marketing efforts. In addition, SG&A expenses, as a percentage of net sales, were leveraged as a result of lower non-store payroll costs, including incentive compensation expense, (approximately 0.3% of net sales) in fiscal 2011, as compared to fiscal 2010. Reflecting our pay-for-performance philosophy, incentive compensation costs decreased as a percentage of net sales as a result of our relative performance against our target in fiscal 2011, as compared to fiscal 2010. Investment Income
The change in investment income in fiscal 2011, as compared to fiscal 2010, was not material.
Interest Expense
Interest expense increased $9.1 million in fiscal 2011 compared to fiscal 2010. On January 28, 2011, we issued $300 million in senior unsecured notes with a coupon rate of 5.00% maturing in 2021 (the "2021 Notes"). During fiscal 2011, we incurred $8.9 million in interest expense related to the 2021 Notes. We did not incur any interest expense during fiscal 2010 related to the 2021 Notes. Income Taxes
The effective tax rate was 37.1% for fiscal 2011 compared to 36.5% in fiscal 2010. The increase in the effective tax rate in fiscal 2011, as compared to fiscal 2010, was due primarily to an increase in our liabilities for uncertain tax positions and increases in valuation allowances, partially offset by an increase in federal jobs tax credits.
Liquidity and Capital Resources
General
We have consistently maintained a strong liquidity position. Cash provided by operating activities during fiscal 2012 was $369.4 million compared to $528.1 million in fiscal 2011, and $591.5 million in fiscal 2010. Our operating cash flows and credit facilities are more than sufficient to fund our regular operating needs, capital expenditure program, share repurchases, cash dividend payments, and principal and interest payments. We have availability under our two credit facilities to borrow up to $700 million (less standby letters of credit needed for collateral for our insurance programs of $26.1 million) to supplement operating cash flows. During fiscal 2012, to help supplement our operating cash flows and to support the build of inventory for the holiday season and other growth initiatives, we borrowed under our credit facilities from time to time and the balance was never greater than $75.0 million. As of the end of fiscal 2012, we had $15.0 million outstanding under the credit facilities. Working capital at the end of fiscal 2012 was $702.5 million compared to $516.8 million as of the end of fiscal 2011. We believe operating cash flows and capacity under existing credit facilities will continue to provide sufficient liquidity for our ongoing operations and growth initiatives.

Sale-Leaseback Transactions

During fiscal 2012, we completed two sale-leaseback transactions under which we sold 276 stores and received net proceeds of $359.7 million. Concurrent with these sales, we entered into agreements to lease the properties back from the purchasers over an initial lease term of 15 years. The master leases for each transaction includes an initial term of 15 years and four, five-year renewal options and provides for the Company to evaluate each store individually upon certain events during the life of the lease, including individual renewal options. The leases for all stores qualify for operating lease treatment for accounting purposes.


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Restricted Cash and Investments

We have restricted cash and investments to serve as collateral for certain of our insurance obligations that are held at our wholly owned captive insurance subsidiary. These restricted funds cannot be withdrawn from our account without the consent of the secured party. As of August 25, 2012, we held $55.3 million in this restricted account, of which $45.9 million was included in Restricted Cash and Investments and $9.4 million was included in Other Assets in the Consolidated Balance Sheets. The classification between current and non-current is based on the timing of expected payments of the secured insurance obligations. Previously, these obligations were collateralized using standby letters of credit under our revolving credit facilities. We made this change to achieve savings in the cost of collateralizing our insurance obligations.

Additionally, in conjunction with the sale-leaseback transactions completed during the second half of fiscal 2012, certain proceeds of the transaction were placed into an escrow account with an independent third party in connection with like-kind exchange transactions, which permits the deferral of a portion of the tax gain associated with the sale of the stores. We intend to use these proceeds to purchase additional new stores and must do so within 180 days from the closing of the transactions to realize the deferral. At the Company's option, the proceeds can be returned for general operating needs; however, the tax gain deferral would not be realized. As of August 25, 2012, the balance of this account was $80.4 million. These assets are classified as Restricted Cash and Investments in the Consolidated Balance Sheets.

Fee Development Program

We occupy most of our stores under operating leases. As part of our new store growth strategy, we have created a Fee Development Program ("Fee Development Program"), intended to provide us with a more cost effective means to finance the construction of new store locations. Previously, developers would use their own capital to fund the construction of new sites, which they would then lease to us. Under the new program, we work with select developers to construct the new sites using our own investment grade credit rating to achieve a lower all-in cost. Upon completion of construction we own the stores. We intend to continue to use sale-leaseback transactions as a source of capital, providing additional liquidity for the Fee Development Program. As a result, we expect to achieve a lower cost of occupancy when compared to the previous program. During fiscal 2012, we purchased stores at a cost of $135.3 million under this program. Credit Facilities
On November 17, 2010, we entered into a new four-year unsecured revolving credit facility with a syndicate of lenders for borrowings of up to $400 million. The credit facility matures on November 17, 2014, and provides for two, one-year extensions that require lender consent. Any borrowings under the credit facility accrue interest at a variable rate based on short-term market interest rates. The credit facility replaced the previous 364-day $250 million unsecured revolving credit facility.
On August 17, 2011, we entered into a new five-year unsecured revolving credit facility with a syndicate of lenders for borrowings of up to $300 million. The credit facility matures on August 17, 2016, and provides for two, one-year extensions that require lender consent. Any borrowings under the credit facility accrue interest at a variable rate based on short-term market interest rates. The credit facility replaced the previous five-year $200 million unsecured credit facility.
During fiscal 2012, we borrowed a total of $362.3 million from time to time under the credit facilities at a weighted-average interest rate of 1.6%. As of August 25, 2012, we had $15.0 million in outstanding borrowings under the credit facilities. There were no outstanding borrowings under the credit facilities as of August 27, 2011. The credit facilities contain certain restrictive financial covenants, which include a consolidated debt to consolidated total capitalization ratio, a fixed charge coverage ratio, and a priority debt to consolidated net worth ratio. As of August 25, 2012, we were in compliance with all such covenants.
Long-Term Debt
On January 28, 2011, we issued $300 million of 5.00% unsecured senior notes due February 1, 2021 (the "2021 Notes") in a public offering. Our proceeds were approximately $298.5 million, net of an issuance discount of $1.5 million. In addition, we incurred issuance costs of approximately $3.3 million. Both the discount and issuance costs are being amortized to interest expense over the term of the 2021 Notes. We may redeem the 2021 Notes in whole at any time or in . . .

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