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Family Dollar Stores, Inc. (NYSE:FDO)

F1Q09 Earnings Call

January 7, 2009 10:00 am ET

Executives

Howard R. Levine – Chairman, Chief Executive Officer

R. James Kelly – President, Chief Operating Officer

Kenneth T. Smith – Senior Vice President, Chief Financial Officer

Kiley F. Rawlins – Vice President of Investor Relations and Communications

Analysts

[Ivy Jeff] – Barclays Capital Inc.

John Zolidis – Buckingham Research Group, Inc.

Deborah Weinswig – Citigroup Global Markets

Michael Baker – Deutsche Bank Securities Inc.

Adrianne Shapira – Goldman Sachs

David Mann – Johnson Rice & Company

Charles Grom – J. P. Morgan Securities, Inc.

Patrick McKeever – MKM Partners

Mitch Kaiser – Piper Jaffray & Co.

Dan Wewer – Raymond James & Associates, Inc.

Joan Storms – Wedbush Morgan Securities

[Jacob Strom] – ECP

Joseph Feldman – Telsey Advisory Group

[Brian Kowalchuk – Vitara Capital Management]

Operator

Good morning. My name is Julie 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 F. Rawlins

Thank you, Julie. Good morning, everyone, and thank you for joining us today. Before we begin you should know that our comments today will include forward-looking statements which are made pursuant to the safe harbour provisions of the Private Securities Litigation Reform Act. These statements address plans and activities or events which we expect will or may occur in the future. However, a number of factors as set forth in our SEC filings and press releases could cause actual results to differ from our plans. We refer you to and specifically incorporate the cautionary and risk statements contained in today’s press release and in our SEC filings. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today, January 7th, 2009. We have no obligation to publicly 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 today with a review of first quarter results from Ken. Then Howard will share some of his thoughts regarding our performance and our operating priorities this year. Following our prepared remarks you will have an opportunity to ask questions. Please remember that the queue for the question-and-answer session will not be available until after we finish our prepared remarks. So that we may accommodate as many people as possible, please limit your questions to one question with no more than one follow up question during the Q&A session.

Now I’d like to turn the call over to Ken Smith. Ken?

Kenneth T. Smith

Thanks, Kiley. This morning I will review some highlights of the first quarter and then discuss our outlook for the second quarter and the full year. Today we reported first quarter earnings of $0.42 per diluted share compared with $0.37 per diluted share in the first quarter last year; an increase of 13.5%. Although our sales results were near the low end of our original expectations, better than expected gross margin performance resulted in an expansion of operating margin.

For the quarter net sales increased 4.2% and comp sales increased 2.1%. Both customer traffic as defined by register transactions and the average customer purchase increased in the quarter.

Sales in the quarter were adversely impacted by two noteworthy calendar shifts at the end of the period. First, the later Thanksgiving this year resulted in one less week of holiday sales in the reporting period as compared with the first quarter last year. In addition, the first quarter ended on November 29th this year as compared to December 1st last year, resulting in a shift of the first of the month money flow and our corresponding advertising circular into the first week of the second quarter. I would note that, excluding the last two weeks of the quarter, comp sales increased approximately 4%.

Consumables continued to be the primary driver of sales, increasing approximately 10% on a comp basis in the first quarter. Sales in more discretionary categories continued to be weak, reflecting both the current economic environment and the impact of the previously discussed calendar shifts during the quarter. Consumables increased to approximately 66% of sales as compared with approximately 61% of sales last year.

Gross profit as a percentage of sales increased approximately 80 basis points in the quarter despite the significant mix shift. While we saw improvements in transportation expense, inventory shrinkage, and purchase mark-up, much of the improvement in gross margin can be attributed to lower markdowns. As you may recall, last year we moved aggressively to manage our inventory productivity in the face of softer than expected sales in discretionary categories. This year our continued focus on improving inventory productivity and managing inventory risk resulted in lower seasonal markdowns in the first quarter.

At the end of the first quarter average inventory per store was approximately 4.5% lower than average inventory per store at the end of the first quarter last year. We continue to invest selectively in consumable categories to drive customer traffic while reducing inventory levels in more discretionary categories to mitigate our markdown risk.

SG&A expense as a percentage of sales increased to 29.8% of sales in the first quarter this year as compared with 29.2% of sales in the first quarter last year. The increase in SG&A expense as a percentage of sales was primarily a result of higher insurance expense and higher occupancy costs. As you may recall, during the first quarter of fiscal 2008 we leveraged insurance expense by approximately 60 basis points.

Reflecting our ongoing efforts to lower store level inventories, increase store manager retention, and improve our operational processes, we have experienced improving workers’ compensation and the general liability trends for the last several quarters. This quarter the absolute number of workers’ compensation and general liability claims continued to decline. However, we also experienced a limited number of large claims. In addition, we faced some strong headwinds as we cycled last year’s improvements. As a result, insurance expense increased approximately 60 basis points as compared with last year.

As a percentage of sales, higher utility costs and higher property tax expense contributed to an overall increase in occupancy costs. However, these increases were offset by the leveraging of most other expense categories.

Our tax rate in the first quarter was 36.1% compared with 37.1% in the first quarter last year. The lower tax rate was primarily a result of higher federal jobs tax credits and increased tax-exempt interest income.

Turning to the balance sheet and cash flow statement, we have consistently maintained a strong liquidity position. Cash and cash equivalents as of November 29th, 2008, were approximately $153 million as compared with approximately $95 million as of December 1st, 2007. I would note that we did not incur any credit facility borrowings during the first quarter of fiscal 2009. We continue to believe that future operating cash flows in existing credit facilities will provide sufficient liquidity for our ongoing operations and growth initiatives.

Regarding our expectations for the full year, we expect net sales to increase 4% to 6% and comp store sales to increase between 2% and 4%. As you consider the cadence of quarterly earnings this year I would remind you that the fourth quarter will likely be our most challenging quarter as we anniversary strong comp sales performance. Clearly this may be offset by any additional government stimulus package, but we have not factored this potential into our guidance.

We expect that strong sales of consumable merchandise and weakness in more discretionary categories will pressure gross margin, but we anticipate the benefits from lower markdowns, lower transportation expense, and better inventory shrinkage may offset much of this pressure. Although we face some challenging headwinds from insurance and occupancy costs, we continue to target operating expense leverage at around a 2% increase in comp store sales. Reflecting these expectations, we now project that earnings per diluted share will be between $1.63 and $1.81 in fiscal 2009.

For the second quarter overall we expect net sales to increase 5% to 7% and comp store sales to increase 3% to 5%. We expect earnings per share for the second quarter of fiscal 2009 will be between $0.48 and $0.52 compared with $0.45 in the second quarter of fiscal 2008.

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

Howard R. Levine

Thank you, Ken, and happy New Year, everyone. First I would like to acknowledge the efforts of all of our hard working Family Dollar associates. Despite the challenging environment, our team’s commitment to providing customers with great value and convenience while also driving increased profitability has resulted in double-digits earnings growth. Today customers of all income levels are looking for ways to stretch their budgets. The value and convenience we offer at Family Dollar has great appeal in the current environment.

When reviewing third party market data it is clear that Family Dollar, as well as the dollar channel overall, is gaining share in this environment. While we continue to increase our share of spin from our core low income customer, we are also seeing additional trips from more middle income customers. Today, Family Dollar is well positioned for continued growth. Our priorities remain increasing our relevancy to the customer, mitigating risk, and managing our expenses.

Our efforts to drive customer traffic are clearly producing tangible results. Responding to customer demand, we continue to strengthen our assortment of basic consumables. As Ken noted, comp sales of consumables increased approximately 10% during the quarter. While food continued to be a strong driver of sales, our investments in the paper and household chemical departments also contributed to the strong performance of consumables.

Customer transactions increased again this quarter and the dollar value of the average transaction continued to expand. We saw these traffic trends continue through the holiday season. As reported in today’s press release, our sales results in December were strong with comp store sales increasing approximately 6%. While sales of consumables merchandise continue to be the primary driver of sales, sales trends in discretionary categories improved from the first quarter and we were pleased with our inventory levels at the end of the holiday season.

Managing inventory risk in the current environment is critical to driving financial returns. Our continued efforts to constrain our purchased in more discretionary categories has resulted in better returns on our inventory investments and increased profitability.

Today our inventory and assortment decisions are based on a category management framework. Embedded in this framework is a solid understanding of our customer and the way they shop our stores. This framework, combined with new merchandise financial planning tools and analytics that provide better visibility to sales and inventory trends has resulted in better merchandising decisions, lower markdown risk, and increased inventory productivity.

Armed with detailed customer and competitive research, our pricing group is helping our merchants navigate today’s volatile environment. Our goal is to strengthen our price perception while also increasing our profitability. I am pleased with our success on both fronts. Our ongoing pricing studies indicate that we are executing well against our pricing strategy and recent customer feedback indicates that our value proposition has never been stronger. Using demand elasticity, market research, and zone pricing, we have managed our purchase mark-ups well as supplier costs have increased. As raw material costs fall these capabilities will enable us to work better with our vendor partners to provide more value to our customers.

In addition to working to improve our gross margin we are also focused on managing our administrative costs. Although we face some headwinds from insurance and occupancy costs, I am pleased with our ability to leverage most expenses this quarter with a 2% comp increase. Recognizing that these headwinds may continue throughout the year, we will look for ways to mitigate these pressures. Although our investment cadence may result in some quarterly volatility, we will continue to target operating expense leverage at around a 2% increase in comp store sales.

While I am pleased with the progress we have made there are still opportunities for us to do better. Our company is financially strong and in today’s environment, while challenging, is an opportunity for us to drive continued market share expansion. Reflecting this opportunity we continue to invest aggressively in our business. While many retailers are slowing or curtailing unit growth all together, we continue to expect to expand square footage by approximately 2% this year.

Reflecting the growing use of food stamps, we continue to accelerate the roll out of our ‘Store of the Future’ platform. In today’s environment more families are relying on the federal government’s food stamp program to supplement their household budgets. As of September 2008 an estimated 14 million households relied on food stamps; an increase of approximately 17% from September of 2007. The expansion of our food assortment, combined with the upgrade of our point-of-sale technology, positions us well to serve this growing population of customers.

At the end of the first quarter approximately 3,000 Family Dollar stores accepted food stamps and credit cards. Given the increase in food stamp utilization, we’ve decided to accelerate our ‘Store of the Future’ roll out and now expect that about 75% of our stores will utilize the new platform by the end of our fiscal year. By this time next year we expect that virtually all of our stores will be able to accept these payment types.

We continue to invest and project accelerate our merchandising and supply chain optimization initiative. Since beginning this multi-year investment in people, tools, and processes in early fiscal 2007 we have made noteworthy improvements in gross margin, return on investment, and inventory productivity. We have reduced average inventory per store and improved gross margin, despite a significant increase in the sales mix of lower margin consumables.

This year we will begin to implement new planning processes that will help us provide customers with more tailored assortments and help our stores present the buyers’ vision more effectively. These investments will build on the progress we have already made and should result in greater sales and inventory productivity with less markdown risk.

Finally, we are investing to make Family Dollar a more compelling place to work, recruiting and retaining talented Family Dollar employees is critical to our future success. We have made tremendous strides in improving our store manager retention and today our store manager retention is at the highest level it’s been since we began tracking this important metric. In addition to our development of career path and leadership development programs we are improving associate retention throughout all parts of our organization.

As we position Family Dollar for future growth we are investing to build a sustainable corporate culture that promotes a more collaborative approach to managing our business. The end result should be continued improvement in associate retention and stronger financial returns.

Overall, I like where we are positioned today and I am excited about the opportunity that lies ahead of us. We have a strong balance sheet and a business model that produces robust cash flows. While there are opportunities to improve, we are growing our customer base, improving our financial returns, and accelerating the investments in our business. Although we continue to operate in an uncertain environment, I am confident that we are making the right long-term decisions for our business.

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

Question-and-Answer Session

Operator

We are now ready to begin the question-and-answer session. (Operator Instructions). Also, as we have limited time remaining, please confine your comments to one or two questions. One moment, please.

Your first question comes from Adrianne Shapira – Goldman Sachs.

Adrianne Shapira – Goldman Sachs

Good morning. Thank you. Perhaps, if you could just talk about the earnings drivers this past quarter. We clearly saw a shift, a flip-flop from the past few quarters with better gross margin and perhaps some SG&A deleverage. Help us think about directionally, is this perhaps the way we should be thinking about it going forward?

Howard, you talked about ways to mitigate some of the pressure on SG&A and still look to lever on a 2% comp. Obviously you highlighted how that didn’t happen this quarter. Perhaps share with us some of the efforts you’re putting into place to offset some of that SG&A pressure going forward. Thanks.

Howard R. Levine

Sure, Adrianne. I’ll start with that. I think what I’m most pleased about is the way the company has attacked the whole expense issue in the last 12 to 18 months. We’ve had a strong initiative to see how we can get rid of costs that aren’t necessary to our business. We’ve implemented a procurement program which is generating some tangible results for us. The pressures on the insurance line were not a surprise to us this quarter. We talked about some huge savings that we generated last year. We do expect some pressures from that throughout the year, but what my comments were about was overall, from an expense standpoint, I think we positioned Family Dollar to compete in an environment that is challenging out there. Ken or Jim, do you want to elaborate a little bit more on that?

Kenneth T. Smith

Yeah, I’d suggest, I mean, if your question around the earnings drivers, we take a look first at the gross margin side. I mean, clearly we had a significant mix shift in the second quarter. I’m sorry, in the first quarter. We were able not only to offset the pressure on margin from that mix shift, but even more so add to gross margin. I think there are many sources that contributed to that, the margin performance. Most significantly what we call that is the markdown comparison. As we’ve talked about coming into this season we were positioned from an inventory perspective to expect a difficult environment for our customer. We bought accordingly and took some risk out of our inventory coming into this season. That allowed us from a comparability perspective year over year has allowed us to have a lower markdown rate compared to the prior year. That is a significant driver to the margin benefit. We also saw a benefit in shrinkage and freight expense, as well as on the purchase mark-up. So a pretty solid story on gross margin from multiple facets.

On the expense side, we do structurally continue to target that 2% comp sales as our leverage point for expenses. Obviously the big driver this year on expenses as we call that was the insurance expense. I think when you think of insurance we need to break it into its two major components. One is the impact of prior year claims and the related reserves and the other is the current year claims. If you’ll remember, over the last three to five years we’ve, via our store manager turnover and retention policies, lower inventories, a lot of those leading indicators have given us positive trends in our workers’ comp and general liability claims. That came to culmination, if you will, last year with some reserve reductions on prior year claims. So in the current year our current claims pace is fairly steady. We had a few handful of large claims that created some deleverage, but the lion share of the insurance story is a comparability issue where we have significant adjustments in last year’s insurance number. So I think those probably the biggest drivers on the earnings side.

Adrianne Shapira – Goldman Sachs

Okay. So it sounds like the composition should continue in terms of what we saw this past quarter going forward. As you had mentioned, you’re obviously bracing yourself for the tough mix shift and given your inventory positions we should continue to expect gross margins to be a positive and perhaps, you know, some of the headwinds on SG&A to continue.

Just on the SG&A, I’m just wondering, on the acceleration of the ‘Store of the Future’ program to 75%, help us understand what that does to SG&A going forward.

Howard R. Levine

In effect, we’ve factored it in and made some adjustments in our back half expense plans to mitigate the impact of the additional costs. Most of it is a capital expenditure for us. But the benefits of the acceleration in the top line growth clearly outweigh the expense and that’s why we’re pushing forward with it at an accelerated pace.

Adrianne Shapira – Goldman Sachs

Great. Thank you.

Operator

Your next question comes from Patrick McKeever – MKM Partners, LLC.

Patrick McKeever – MKM Partners

Thanks, everyone. Howard, you mentioned that you were pleased with the inventory, the seasonal inventory levels after the holidays. I was just wondering, I mean, you ran big sales this year again, 50% to 75% off some of the decorative items and 40% off toys. How much merchandise, how much of the clearance merchandise is still in the stores, seasonal clearance, and how much did you end up packing away this year? Did you pack away more this year than last year or would it be fairly consistent on a year-over-year basis? Thanks.

Howard R. Levine

Patrick, let me start and then Jim can pick up, but no, we were very pleased with the overall sales on our seasonal categories this holiday. In fact, there will be less pack away this year than last year. Every year at the end of the season we do begin aggressive clearance strategies to liquidate as much of the merchandise as we can and this year is no different than in prior year.

R. James Kelly

Yeah, I think that’s right, Howard. As you know, we bought very conservatively into the seasonal area. The sales response in some of these discretionary areas do include some of the toys, as well as the Red Green merchandise. It was moderately higher than our expectation, which gave us good solid sale throughs. We’ll end the season with the Red Green merchandise in the low double-digits down from the prior year.

Patrick McKeever – MKM Partners

Okay. That sounds good. And then just a related follow-up question. How late did your Christmas business come this year? Was it a nail-biter? Was it really compressed into those last few days or was it not quite as intense as you thought it might be?

Howard R. Levine

No, it was a nail-biter. It seems like every Christmas, and particularly this Christmas with the five fewer days, that things were going to be consolidated. But we were very pleased with our results. We saw steady, basically pretty steady sales and then a big acceleration towards Christmas.

Patrick McKeever – MKM Partners

Okay. Good stuff. Thank you.

Operator

Your next question comes from Michael Baker – Deutsche Bank Securities Inc.

Michael Baker – Deutsche Bank Securities Inc.

Hi. Thanks. My first question is just on the comp guidance. A subtle point, but you were up 6% in December. The guidance is less than that. I assume that implies a deceleration in January and February. Is that because December was helped by a couple points, it sounds like, from that calendar shift or is it other just general conservatism or something that you’re seeing here the first seven days in January.

Kenneth T. Smith

I think it’s just spread out. I mean, there was some shift between November and December, but we see January and February continuing at a pretty steady pace of the business.

Michael Baker – Deutsche Bank Securities Inc.

Okay. And then one more follow up, if I could. Just on pricing, you made some comments there already, but I’m wondering if you guys are seeing any impact from deflationary pressures. Have you seen competitors taking down prices on some of the basic products that have seen some deflation and therefore you need to follow and does that negatively impact your comps?

Howard R. Levine

Michael, there’s tremendous competitive pressures out there. To date we are beginning to see raw material prices come down and the deflationary issue is actually a very positive thing for our customers and our job will be to manage through some of those challenges. Overall from a customer standpoint lowering prices is a good thing for us and, as I said, I think we’ve got a nice infrastructure today just as we did working through the inflationary periods to work through a deflationary period as well.

Michael Baker – Deutsche Bank Securities Inc.

Okay. Thanks. That makes sense.

Operator

Your next question comes from Dan Wewer – Raymond James & Associates, Inc.

Dan Wewer – Raymond James & Associates, Inc.

Hi, good morning. I just wanted to get a clarification on the SG&A increase. The news release states that it was due to both insurance, what you talked about, as well as occupancy. But it looks like all of the 60 bp increase was due to insurance. What actually is happening with occupancy?

Kenneth T. Smith

Dan, there is some slight deleverage on the occupancy costs, but we were able to mitigate those in other areas where we leveraged via our procurement plans and some successes we’ve had with some other programs. So the, you know, from a high level basis the deleverage of 60 basis points can be accounted for solely by the insurance, but we did see some offsets with some positive leverage points and some areas that offset some slight deleverage in occupancy.

Dan Wewer – Raymond James & Associates, Inc.

I was curious about the occupancy increasing. Other retailers in your type of properties are telling us that their rents are actually declining in this kind of real estate environment. And then on top of that you’re only growing your store base 2% a year. So it’s surprising that your occupancy rates would increase.

R. James Kelly

Dan, let me clarify the elements there. We tend to look at overall facility costs and refer to it as occupancy costs as opposed to rent alone. In our case rent did not deleverage this quarter. But there are a number of other elements. For example, the roll out of the ‘Store of the Future’ provides some increase in the telecommunication charges associated with our stores. We include that in the occupancy number. There’s also some timing differences year to year based on property tax accruals for the store. So in the aggregate, if you looked across the year, we think we’re in fairly good shape in the occupancy line item. It is not rent. We are indeed seeing some of the same trends that other have seen with a softening of the real estate market. I’d say those are early trends as opposed to mature trends, but we expect to be able to leverage current economy to more effectively leverage our occupancy costs.

Dan Wewer – Raymond James & Associates, Inc.

And then just a follow-up questions. How are the uptick and demand for discretionary products such as toys during the month of December as an improvement from what you’ve seen in prior holiday seasons? Do you think that this is some signal that perhaps your customer is now in a position to begin buying more wads, perhaps, because her gasoline prices are dropping each month?

Howard R. Levine

Well, Dan, I like to believe that’s going to happen, but to be candid with you, we’re planning all discretionary categories very conservatively. Particularly apparel. What we saw in December was excellent sales in our toy business. Seasonal sell throughs were strong. Apparel was still somewhat soft, but we anticipated that and bought a lot less and frankly we’re going to continue to do that over the next several months.

Dan Wewer – Raymond James & Associates, Inc.

Okay. Great. Thanks. Good luck.

Operator

Your next question comes from David Mann – Johnson Rice & Company.

David Mann – Johnson Rice & Company

Yes. Thank you. Nice quarter, guys. A couple of quick questions. Can you give us a sense now of what percentage of your sales are coming on food stamps and where you think that might go?

Howard R. Levine

As I talked about in my prepared response, what the government publishes shows as large an increase in food stamp utilization as I can remember in recent memory. We’re not going to break out our food stamp sales, but obviously with those kind of numbers we feel pretty good. The fact that we’re accelerating the roll out of our point-of-sale platform to be able to accept more food stamps in more stores gives you an indication of how bullish we are about that opportunity.

David Mann – Johnson Rice & Company

Okay. And then in terms of a follow up on the earlier inflation question, can you give us a sense on how much the food inflation consumables has been helping comps and how you think, what you’re building into your guidance for the rest of the year in terms of the benefit?

Howard R. Levine

When we look at inflation and the impact on our customers it’s perhaps a little bit different than many retailers in that our customers have very, very limited resources and they very quickly adjust to price increases. So a price increase in one item in the food arena might lead them to more aggressively transition to a private label item or other lower-cost items. So when we do our inflationary impact work we see that transitioning of our customers from one item to the next, moving very aggressively, and largely offsetting inflationary benefits that some other retailers are seeing. I guess in a word we’ve not been able to really identify the overall impact of inflation. We think looking back over the trailing 12 months that it is likely to have had a positive impact on comps. We think looking forward the next 12 months it’s likely to present some minor head winds. However, as we’re planning our product mix we are addressing that as an opportunity.

David Mann – Johnson Rice & Company

Thank you.

Operator

Your next question comes from John Zolidis – Buckingham Research Group, Inc.

John Zolidis – Buckingham Research Group, Inc.

Hi. Good morning. I was wondering if we could dig into the gross margin performance a little bit. You identified the categories that drove the improvement and offset the mix. I was wondering if you could, as you have in the past, quantify the individual components. In particular, the IMUs and how much the mix shift hurt.

Kenneth T. Smith

I don’t think historically we’ve quantified and don’t typically break out the components number related to each component on the gross margin components. I would suggest, again from a size sense of magnitude, that the call out of the markdowns is a significant one and the year-over-year comparison markdown rate this year versus last year would have a significant impact on the improved margin.

John Zolidis – Buckingham Research Group, Inc.

Last year you indicated that the markdowns negatively impacted the gross margin by 60 to 70 bps. Is it fair to say that was a greater swing to the positive this year?

Kenneth T. Smith

No, I wouldn’t say it was, I wouldn’t say it was greater, but I would say it was significant.

John Zolidis – Buckingham Research Group, Inc.

Okay. One last question on the gross margin. Is there any impact from the timing of markdowns related to the calendar which had an effect on the reported gross margin? Thank you.

Kenneth T. Smith

No, there wouldn’t be any. The calendar wouldn’t have any impact on the timing of markdowns period to period.

John Zolidis – Buckingham Research Group, Inc.

Okay. Thank you.

Operator

Your next question comes from Charles Grom – J. P. Morgan Securities, Inc.

Charles Grom – J. P. Morgan Securities, Inc.

Thanks. Good morning. Howard, can you guys speak to how the 6% comp trended throughout the five-week period of December? You mentioned the circular shift in the beginning of the month. I’m just wondering if there’s any additional promotions, any additional circulars or 5-for-25s. And also if you could address the 5-for-25 program, you seem to be doing that more often. Is that the plan going forward to do maybe one a month? Thanks.

Howard R. Levine

Good morning, Charles. We, our advertising is pretty comparable for holiday season this year versus last year. There were some timing differences between the end of November as we talked about and called out in our remarks here. The way sales trended I talked about in a prior question. It was a light holiday and we ended up gaining momentum throughout the month.

Kiley F. Rawlins

Chuck, I would add that we saw strength, as you would expect, in the first week of the period with the shift of the money flow and the advertising circular.

Charles Grom – J. P. Morgan Securities, Inc.

Okay. So week one and week four were your best weeks?

Howard R. Levine

Yes.

Kiley F. Rawlins

Yes.

Charles Grom – J. P. Morgan Securities, Inc.

Okay. And then, just Jim, just to follow back on your earlier question of price inflation, Kroeger, Wal-Mart, they’ve all spoken of the food inflation benefitting, you know, or being roughly 5% or 6%. Would you say that’s a fair estimate for what you guys saw through your pipeline in 2008? Kroeger’s talked about that number falling to, call it 1% to 3% for next year. Is that what you guys are thinking as well in your outlook? Thanks.

R. James Kelly

I think in terms of if you look at branded merchandise food costs increased in that the range has been what we experienced. But again, I’d note in terms of our customers they very, very quickly go from the better best categories to the good category. That basically mitigates the impact on the comp number.

Kiley F. Rawlins

Julie, I think we can take the next question.

Operator

Thank you. Your next question comes from [Ivy Jeff] – Barclays Capital Inc.

[Ivy Jeff] – Barclays Capital Inc.

Hi. How are you? Question for you. With respect to discretionary sales, and particularly apparel, are there any trends in the business that you’re seeing right now that gives you comfort that you will see sales of discretionary items pick up once the economy improves and once the shift from consumables goes back the other way?

Howard R. Levine

Ivy, while I hope that occurs, you know, December did give us an indication that consumers, when buying for specific events like Christmas, we saw increases in our toys category. I think that goes back a lot to the way we planned for this Christmas. This time last year when we were doing our post mortem we had a game plan that was going to really try to address compelling value or compelling price points in toys and seasonal. We executed to that very strongly and we saw some nice results. I think we’re trying to take some of those examples and apply them as we go forward, but from an apparel standpoint we did not see quite as big a jump as we did in some of the other categories and are continuing to plan very conservatively on the apparel side. I do think there’s some opportunities for us. Again, it has to be tremendous value and presented in the right way. With our ‘Bugle Boy’ presentation, which has been accepted very favourably from our customers and among a few other things on the quality side, I think there is opportunity. But we are still planning those categories cautiously.

[Ivy Jeff] – Barclays Capital Inc.

Also, second question, you commented that you think you’re seeing more middle income-ish type customers. Is there any kind of data or example you can give us that kind of lets you know that you are attracting new customers in addition to getting more trips out of your core customers?

Howard R. Levine

Primarily the data we look at is the third party data that is provided to us which shows that we are seeing some trade down. I think it makes a lot of sense when we think about what we’ve done over the last several years in improving the shopping conditions of our store to improving our assortment, our quality improvement initiative, leveraging national brands, all of our investments in making Family Dollar more compelling place to work, acceptance of credit card, etcetera, I think has really positioned us well not only to gain share with our core customer or gain wallet with our core customer but also positions us nicely for the more middle-ish income customer as well.

[Ivy Jeff] – Barclays Capital Inc.

Thanks.

Operator

Your next question comes from Mitch Kaiser – Piper Jaffray & Co.

Mitch Kaiser – Piper Jaffray & Co.

Thanks, guys. Good morning. Nice quarter. I was hoping you could talk a little bit about the ‘Store of the Future’ roll out. Clearly it makes sense given the increase in food stamps. Could you give us a sense for what you’re seeing in terms of comp lift or margin performance on those stores relative to the stores that don’t have that?

Howard R. Levine

Mitch, we’re not breaking out specific sales results of our various initiatives, but I think a good way to think of it is the fact that we are accelerating the investment based on macro conditions. We’re accelerating investments because we’re pleased with results. I’m not going to go into any specifics, but overall we’re increasing and accelerating the ‘Store of the Future’ roll out because of the benefits that we’re seeing from that.

Mitch Kaiser – Piper Jaffray & Co.

Okay. And then I don’t know if you commented on the prepared remarks, but is there anything you can say just regionally in terms of sales trends or things like that, just commenting on that?

Howard R. Levine

No, we’re not going to get into any specifics on regions within the country.

Mitch Kaiser – Piper Jaffray & Co.

Okay. Thank you.

Operator

Your next question comes from [Jacob Strom] – ECP.

[Jacob Strom] – ECP

Hi, guys. Great quarter. Congratulations. Just had a quick question in terms of kind of the global picture. We’re seeing lower dollar against Asian currencies. How does that affect you guys going forward?

Howard R. Levine

I would say it’s probably no different than other points in the company’s history where we’ve had to deal with a number of different variables and this is just another variable that we’ll have to deal with. We’ve been successful in working through some of those challenges in the past and I would expect us to continue to work on those going forward. One of the nice things is the development of our global sourcing group, which is really supporting our merchandising team in developing a better strategic approach to the way we source goods all over the world today. I feel good about where we are there and I feel comfortable that we’ll be able to work through those challenges.

[Jacob Strom] – ECP

Okay. Did we see much of that flow through on the last quarter or is that more kind of a next six months from the buying perspective.

Howard R. Levine

We won’t break that out specifically, but I can tell you, over time we have had many issues, as I’ve said before, with a number of different things in dealing with buying goods globally and we’ve been able to work through all of those.

[Jacob Strom] – ECP

Thanks, guys.

Operator

Your next question comes from [Tina Wang] – Citigroup Global Markets.

Deborah Weinswig – Citigroup Global Markets

Oh, it’s actually Deborah Weinswig. Thanks so much. A few questions. One, can you give us an update in terms of where you are with regard to global sourcing and also what kind of timelines should we expect there in terms of continuing to increase your penetration there?

R. James Kelly

Well, I think overall we continue to work hard in the area of global sourcing and there are a couple of specific things. What we’re trying to do is get the right balance between global procurement specialists, quality control specialists, and our buying team. We have restructured how we go to market and are much more efficient now in the selection of vendors and our quality control efforts, and the ability to identify opportunities to improve purchase mark-up. So we’re continuing to work hard on each of those. The penetration level in terms of absolute terms, that is the percent of our goods that are imported, will not change or will change predominantly as the nature of the items that we sell change. As we’ve indicated before, because we have a slightly higher discretionary mix than some we have a slightly higher opportunity in the global procurement arena than some. What our target today is is to improve the effectiveness of global procurement and to include the selection of how you source. Whether you’re using an agent, a trading company, or going directly to the factories. We’re seeing a gradual shift, if you will, from left to right in that order which then provides greater margin opportunities in many cases.

Deborah Weinswig – Citigroup Global Markets

Okay. And then with regards to the change in same store sales outlook for 2009, I think your original guidance was 1% to 3% and it was raised to 2% to 4%. What has been different in terms of either traffic or ticket than you would have expected when you originally laid out the 1% to 3% guidance?

Kenneth T. Smith

I think when we originally gave that 1% to 3% guidance we were just starting the year. we weren’t, we were planning and budgeting based on those kind of numbers and the results to date, even looking at the year-to-date number, is pretty much in that range.

Howard R. Levine

Yeah, I think that becomes the key for us. These are very, very uncertain times. As you know, we no longer provide monthly comp sales information in part because with every month you can always decide there’s a day shift here, first of the month event, etcetera. But if you collapse all of that and look over a period of time you get a much, much better read in terms of the underlying nature of your business. When you look at the last four months now we have had more solid comp performance that we initially expected given this economy. And as a result of really the cumulative four month experience we feel more confident that we’re going to be able to navigate this current environment more successfully and therefore the comp guidance really basically reflects the experience today.

Deborah Weinswig – Citigroup Global Markets

Okay. And then last question, with lower seasonal markdowns it sounds like you did a better job in terms of buying discretionary for the holiday season. Was there a change in process or can you maybe elaborate on that a little bit.

R. James Kelly

I could, but I think it basically falls into the category of, look, we’re facing some uncertain times and we’ve added resources in our planning group and working along with our merchants, decided that we needed to be a little more careful and cautious about how we buy discretionary goods. That’s really what we executed to.

Howard R. Levine

I think we were much more strategic in the development of our mix this year. We made some bets and those bets were in areas that we thought would be most appropriate given this current economy. Fortunately for us, in those select areas where we did place bets we had very strong comps. So while the overall framework was one of more conservatism, there was a lot more structure in the development of the mix in the presentations this year.

Deborah Weinswig – Citigroup Global Markets

Well, thanks so much and congratulations again on an amazing quarter.

Operator

Your next question comes from Joe Feldman – Telsey Advisory Group.

Joseph Feldman – Telsey Advisory Group

Yeah, hi, guys. Just a question to follow up. CapEx, last time I think we spoke with you all you had mentioned that it was going to be around $140 million to $160 million. I was just kind of curious if that is still the same targeted range that you’re looking at. Maybe you can give us an update as to the allocations of how you plan to spend it.

Kenneth T. Smith

Yeah, the CapEx plans are fairly similar. We did raise our estimates for the year about $10 million, from $140 million to $160 million. We now estimate it to be between $150 million and $170 million. That is driven primarily by the acceleration of our store of the future project so that expansion of that initiative caused a slight increase from our original plans. But that’s really the key driver or change from our original plans.

Joseph Feldman – Telsey Advisory Group

Got it. That’s helpful. And then one other question. What about the need to cull the store base at all? Are there stores that you have out there that you are closing or may need to close this year? Is that going up as a percentage of what you’ve normally done as a regular course of business?

Howard R. Levine

I think we have a cadence to store closing that’s been fairly consistent over the last dozen years or so. What the current real estate market does is give us a lot of opportunities to upgrade, if you will. So we’re looking at opportunities to reduce rent. We’re looking at opportunities to perhaps upgrade the quality of the space given today’s lowering rent market.

Joseph Feldman – Telsey Advisory Group

That’s good to hear. And then also just to stay on the real estate for one more question. Any change in locations or strategy, or is it, you know, in terms of where you’re going to open stores this year or is it pretty much kind of the same plan you’ve been on?

Kenneth T. Smith

It’s going to be pretty consistent with the prior year.

Joseph Feldman – Telsey Advisory Group

Okay. Excellent. Thanks. And good luck in the next quarter. Thanks, guys.

Operator

Your next question comes from [Brian Kowalchuk – Vitara Capital Management].

[Brian Kowalchuk – Vitara Capital Management]

Thanks for taking my questions and congratulations on outstanding results in light of the current backdrop. Quick question to clarify the comment regarding seasonal inventory. I think I heard you say it was down low double digits. Is that for the November quarter ending period or for the December or current inventory numbers?

Howard R. Levine

That was after, the comment relative to seasonal goods was directly related to how we ended the Christmas season.

[Brian Kowalchuk – Vitara Capital Management]

At Christmas season?

Howard R. Levine

Yes.

[Brian Kowalchuk – Vitara Capital Management]

Okay. And can you give us some colour on seasonal sales? You talked about seasonal inventory ending, but with the sales of seasonal merchandise on a year-over-year basis.

Kenneth T. Smith

During the month of December?

[Brian Kowalchuk – Vitara Capital Management]

Primarily in the month of December.

Kenneth T. Smith

As I’ve mentioned before, we had a very good toy year. Our seasonal trim-a-tree categories had good sell throughs. Home had a nice rebound in the month of December. The only really category that was softer was the apparel side.

[Brian Kowalchuk – Vitara Capital Management]

So the comp for the seasonal category?

Kenneth T. Smith

We’re not breaking that out.

[Brian Kowalchuk – Vitara Capital Management]

Okay. Appreciate that. And just some clarification on the ‘Store of the Future.’ I think you mentioned that you have 3,000 stores currently accepting food stamps and credit cards. Can you give us some idea of what that number was at this time last year?

Kenneth T. Smith

It was about half of that.

[Brian Kowalchuk – Vitara Capital Management]

About 1,500 at this time last year and then another 1,500 as of the end of fiscal 2009, it looks like.

Kenneth T. Smith

Yeah.

[Brian Kowalchuk – Vitara Capital Management]

And the incremental investment on a per store basis, just doing some quick math, looks to be about $5,000 per store. Is that fair?

Kenneth T. Smith

We haven’t disclosed the specifics of the investment for our initiatives, so don’t have that number to disclose.

Howard R. Levine

But it would be higher than that.

[Brian Kowalchuk – Vitara Capital Management]

It would be higher than that?

Howard R. Levine

Yes.

[Brian Kowalchuk – Vitara Capital Management]

Okay. Appreciate the call. Thanks, guys, and good luck.

Kiley F. Rawlins

Julie, I think we have time for one more call.

Operator

Your next call is from Joan Storms – Wedbush Morgan Securities.

Joan Storms – Wedbush Morgan Securities

Hi, good morning. Good quarter. Most of my questions have been answered, but I wanted to ask about the mix shift to consumables. That’s about 5% in the holiday quarter, which I guess typically would be more dependent on discretionary. What should we think about for the mix shift going forward over the next couple of quarters as you begin to anniversary the big shift to consumables towards the fourth quarter.

Howard R. Levine

I think you’ll see some mix shift as we’ve experienced now for about seven or eight years. Clearly the current economy is driving an acceleration of the mix shift. I would caution you though; when looking at the first quarter mix shift it was really exasperated by the fact that the week after Thanksgiving, which triggers the holiday purchasing, shifted from one quarter to the other. In other words, it was in December this year and November last year. So we would not expect the level of mix shift that you saw this quarter to be indicative of the mix shift throughout the rest of the year.

Joan Storms – Wedbush Morgan Securities

Thank you very much.

Operator

I would now like to turn the call over to Ms. Rawlins for final comments.

Kiley F. Rawlins

Thank you, Julie. Well, we’re at the top of the hour and unfortunately we didn’t get through all of the questions today. As always, I’ll be available after the call for any follow up questions that you have. Thank you for your interest in Family Dollar and have a good day.

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