Family Dollar F4Q07 (Qtr End 9/1/07) Earnings Call Transcript

Oct. 4.07 | About: Family Dollar (FDO)

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Family Dollar Stores, Inc. (NYSE:FDO)
F4Q07 Earnings Call
October 4, 2007 10:00 am ET

Executives

Kiley F. Rawlins - Vice President, Investor Relations and Communications
Howard R. Levine - Chairman of the Board, Chief Executive Officer
Kenneth T. Smith - Chief Financial Officer, Senior Vice President
R. James Kelly - President, Chief Operating Officer, Director

Analysts

Eric Mace - Besso Capital
Christine Augustine - Bear, Stearns
Scott Mushkin - Banc of America Securities
Meredith Adler - Lehman Brothers
William Keller - FTN Midwest Securities
Deborah Weinswig - Citigroup
Adrianne Shapira - Goldman Sachs
David Cumberland - Robert W. Baird
Mark Miller - William Blair
Ryan Wrenteria - Carnes Capital

Presentation

Operator

Good morning. My name is Carol and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Family Dollar fourth quarter and year end earnings conference call. (Operator Instructions) I would now like to introduce Ms. Kiley Rawlins, Vice President of Investor Relations and Communications. Ms. Rawlins, you may begin your conference.

Kiley F. Rawlins

Thank you, Carol. Good morning and thank you for joining us today. We appreciate your continued interest in Family Dollar Store. Before we begin, you should know that our comments today will include forward-looking statements which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act. These statements address company 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 statements contained in today’s press release and in our other SEC filings. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today’s date.

The company does not undertake to publicly update or revise its forward-looking statements except as required by law.

Now, I would like to introduce our Chairman and CEO, Howard Levine.

Howard R. Levine

Thank you, Kiley and good morning, everyone. We are pleased you could join us this morning for a review of our fiscal 2007 results and a discussion of our 2008 plan. After over 10 years of participating in these conference calls, Jim Kelly, our former CFO and current President and COO, has passed the torch to Ken Smith, our new Chief Financial Officer. Today, Ken will provide you with an overview of our financial results but I’ve asked Jim to be available to answer questions at the end of the call.

Before Ken reviews our financial results, I want to share some of my thoughts about this year. A year ago, when we outlined our plans for fiscal ’07, we indicated that we expected comp sales to increase 2% to 4% and earnings per share to be in the range of $1.57 to $1.69. Our reported earnings of $1.62 per share for fiscal ’07, which includes $22 million of unplanned expenses relating to the stockholder derivative actions, are within our original guidance range, even though our comp performance of 0.9% was softer than we had planned.

We accomplished a lot this year. Let me give you some of the highlights.

We improved gross margin as a percentage of sales even as we added coolers in 1,300 more stores, enhanced our food assortment in all stores, and expanded the selling space for food in 2,700 stores. Clearly, our treasure hunt strategy is helping us mitigate the impact of adding more lower margin traffic drivers to our assortment.

We maintained our focus on improving inventory productivity despite lower-than-expected comp store sales, improving both inventory turns and gross margin return on investment, or GMROI.

We continued to improve store manager retention. Today, our store managed retention is at the highest level since 2003 and better manager retention and lower inventory levels are having a nice impact on shrink, particularly in urban initiative markets, which improved for the second consecutive year.

We improved the performance of new stores this year as we managed a more even flow of openings and increased our cross-functional support of new stores. And finally, with better inventory productivity, improved new store performance, and a more effective management of capital investments, we improved return on average shareholder equity to about 20% from about 15% last year.

Our leadership team has worked hard to deliver these results and I am pleased with our performance, especially considering the challenging macro environment.

Now Ken will review the results of fiscal ’07 in more detail, and then I’ll be back to discuss our plans for fiscal ’08. Ken.

Kenneth T. Smith

Thank you, Howard. Today we reported that net income per diluted share for the fourth quarter of fiscal 2007 increased 23.8% to $0.26, compared to $0.21 for the fourth quarter of fiscal 2006. For the full year, net income per diluted share increased 28.6% to $1.62 from $1.26 in fiscal 2006. These results include several factors worth mentioning.

First, fiscal 2006 includes litigation and accounting charges totaling approximately $0.22. These charges include a litigation charge of approximately $0.18 per share in the second quarter and a charge of approximately $0.04 per share in the fourth quarter, related to accounting adjustments for certain historical stock option grants.

Second, fiscal 2007 results include the impact of expenses related to the investigation and settlement of the company’s stockholder derivative actions and the extra week. On a net basis, the total impact in fiscal 2007 of these factors was about $0.04.

Net sales increased 6.9% for the year, driven by the addition of 300 new stores, an extra week of sales, and a 0.9% increase in comp store sales.

Sales in the fourth quarter increased 3.4%, resulting from new store growth and a 1% comp increase.

We continue to believe that our customers are consolidating trips in response to economic pressures and the volatility of gasoline prices. For the full year, customer transactions declined slightly while the average transaction increased approximately 1% to $9.69.

For the year and the fourth quarter, the highest sales increases were in the consumable category, reflecting the benefits of changes we made in our food assortment this year. We continued to build on our strategy of balancing growth from traffic drivers like food with growth from treasure hunt categories, like apparel, home, and seasonal.

The success of our treasure hunt program had a positive impact on our gross margin results, which expanded nicely this year. While we continued to aggressively utilize markdowns to manage our inventory levels, better merchandise mix, higher initial mark-ups in all categories, and a modest improvement in shrink contributed to a 90 basis point improvement in gross profit as a percentage of sales. These trends were also consistent in the fourth quarter.

As a percentage of sales, SG&A expense increased 80 basis points for the year. Most of this deleverage can be attributed to the below-target comp store sales performance and approximately $22 million in unplanned costs related to the stockholder derivative actions.

In addition, store maintenance expense as a percentage of sales was higher for the full year. In fiscal 2007, we reengineered our store maintenance processes with the goal of creating a more proactive, centrally controlled maintenance program. Offsetting these increases were more favorable trends in workers’ compensation and healthcare claims.

In the fourth quarter, SG&A expense as a percentage of sales increased 30 basis points. Our comp performance of 1% in the quarter resulted in the de-leveraging of many of our expenses. Factors affecting SG&A for the full year also impacted the fourth quarter, including store maintenance expenses and workers’ compensation and healthcare claims.

In addition, expenses related to the implementation of several of our key projects, including Store of the Future and Project Accelerate, resulted in higher professional fees in the quarter.

There are two other expense items impacting fourth quarter results that I would like to highlight. First, SG&A expense in the fourth quarter of fiscal 2006 includes about a $9 million adjustment to adjust non-cash, stock-based compensation expense. Second, expenses in the fourth quarter of fiscal 2007 include the effect of a non-cash cumulative adjustment of approximately $4 million to reconcile various store lease accounts related to the implementation of a new lease management system.

Turning now to the balance sheet, we ended the year with approximately $285 million in cash and investment securities, an increase of about 32% over fiscal 2006. For the second straight year, we improved both inventory turns and GMROI. Total merchandise inventories increased 2.7%, but on a per-store basis, inventory declined approximately 1% as we continue to improve the productivity of both our basic and fashion assortment. I would note that this is the sixth consecutive quarter of lower store inventory levels.

In fiscal 2007, we spent approximately $132 million on capital expenditures, including approximately $43 million for new stores, $35 million related to technology investments, including Project Accelerate and out Store of the Future platform, and $26 million for investments in existing stores.

As we mentioned in the press release, we’ve completed our current stock repurchase authorization. In fiscal 2007, we purchased approximately 8.2 million shares at a total cost of about $258 million. Since the end of fiscal 2007, we have purchased an additional $2.9 million shares at a total cost of about $81 million.

Now Howard will highlight some of our plans for 2008. Howard.

Howard R. Levine

Thanks, Ken. We began fiscal 2008 in a difficult macro environment with limited near-term visibility. Volatile gasoline prices that burdened our customers in 2007 will most likely continue in 2008, and the inflationary pressures we have seen in key consumables like food show no sign of abating. What is even harder to predict is the fallout of the recent mortgage crisis and a slowdown in the housing market.

In this environment, customers need the value and convenience that we offer even more. That is why we are making investments to improve the customer shopping experience and to drive process improvement.

I believe that balancing initiatives targeted to deliver short-term financial results with investments that may require longer term development will help us weather difficult macro environments and enable us to achieve our long-term financial goals.

Our investment agenda is focused on two objectives: one, increase revenues by enhancing the shopping experience, and two, expand operating margin and financial returns through process improvement. Let’s start with our plans to drive top line growth in fiscal 2008.

First, to capture more of our customers’ frequent fill-in food trips, we will continue the rollout of our food strategy. This year, we plan to wrap up our cooler rollout with the installation of coolers in approximately 575 stores, and we expect to expand the space for food in 2,800 additional stores.

Finally, we plan to install our new Store of the Future platform in approximately 1,500 stores. In addition to processing customers through the checkout more quickly, this new technology will facilitate the acceptance of food stamps, an important element of our food strategy.

Building on our successes in fiscal ’07, we intend to continue to develop and refine our treasure hunt strategy. We are simplifying our promotional planning to make it easier for stores to create exciting events for our customers and to manage residual inventory better. The continued development of our global sourcing group will play a significant role in our success this year as we strengthen our quality and value proposition in these categories. Finally, we plan to continue to selectively leverage national brands within our treasure hunt categories.

In fiscal 2007, we created concept renewal lab stores to test new ideas in store layout and design with the goal of enhancing the customer shopping experience. Last spring, we began to incorporate these ideas into new stores. In fiscal ’08, we intend to evaluate several renovation strategies to assess the impact of incorporating the concept renewal elements in existing stores. Finally, using our lab stores, we will begin to test new ideas intended to make stores easier to operate.

Last year, we increased our cross-functional focus on new store performance while continuing to enhance our site acquisition capabilities. The result, I’m pleased to say, was an improvement in new store returns. In fiscal ’08, we plan to continue our measured pace of new store openings so that we can continue to strengthen our support of new stores while also improving returns on our existing stores.

Our food strategy, treasure hunt strategy, concept renewal efforts, and new store development are all intended to drive top line growth, but increasing total revenues is only part of the equation. To deliver stronger returns, we must also improve the operating margin and better manage our capital. We are making a number of investments designed to increase our operating efficiency and improve our profitability.

I believe that sustainable process improvement requires a focus on three areas: people, processes, and tools. In fiscal ’07, we launched a multi-year process improvement initiative called Project Accelerate. Focused on five modules, including category management, price optimization, merchandise financial planning, assortment planning, and space planning, this initiative is intended to help us improve and optimize our merchandising and supply chain processes. Our goal is to improve the shopping experience of our customers, the productivity of our inventory, and the efficiency of our supply chain.

In fiscal ’07, we instituted a stronger category management framework for merchandising decisions. Using this framework, we have changed our merchandising and supply chain organization, creating teams around categories with clearly defined roles for each category. We have also created groups of operational specialists, like our pricing group, to provide our buyers with institutional expertise.

Our pricing group works with our buyers to develop pricing strategies for each category consistent with the category’s role. The team also supports pricing decisions, with improved linkage with various competitive pricing information sources and customer demand elasticity studies. In addition, the pricing organization maintains our expanded zone pricing structure, which provides needed flexibility across our franchise.

From a pricing perspective, fiscal ’07 was challenged with both increases in competitive promotional activity and inflationary cost pressures. The ability of our pricing specialists, teamed with our buyers, to maintain our price image with our customers while also improving profitability was critical to our success in fiscal ’07.

Going forward, I am expecting even greater results as our pricing strategies and processes mature.

In fiscal ’08, we intend to build upon the foundation established in fiscal ’07. We are incorporating our category management framework into our planning, buying, and logistical processes, and we have recently installed a new merchandising and financial planning tool that should result in greater visibility in underlying trends to support more timely responses. We also plan to continue the development of our space and assortment capabilities.

As I mentioned earlier this year, we plan to roll out Store of the Future project to approximately 1,500 stores this year. In addition to providing a customer checkout -- a faster customer checkout experience and expanding the payment choices for our customers, this technology refresh includes a number of online tools designed to provide our store managers with better analytics and workflow management. In addition, the Store of the Future platform includes the expansion of our automated hiring system and online training modules.

To help us manage our infrastructure costs as we grow, we are making investments in three additional areas -- associate retention, facility management, and centralized procurement. Retaining talented associates is critical to the long-term success of any organization. In fiscal ’07, we made great strides in improving our associate retention programs. Going forward, we continue to develop and strengthening our talent development programs in all areas of our business. We are clarifying career paths, strengthening the linkage between pay and performance, and improving our associate benefit plans. These efforts will help us ensure that we have the talent we need to support our future growth.

In 2007, we automated our lease administration efforts and we reengineered our maintenance programs to provide better service and reduce unnecessary cost. We also tested energy management tools to help manage rising utility costs. In fiscal ’08, we expect to begin to reap the benefits of these investments.

Also in 2007, we developed a new, centralized procurement organization designed to better leverage our size and buying power. Our initial focus is on the millions of dollars worth of indirect purchases we make each year. To help us strengthen our controls while enhancing accuracy and efficiency, we have developed a new e-procurement system that eliminates paper and strengthens our internal approval processes. We expect that these investments will help us lower costs in fiscal ’08.

Now that I have outlined our operating agenda for fiscal ’08, Ken will tell you what this all means from a financial perspective.

Kenneth T. Smith

Thanks, Howard. Given the limited visibility to the near-term health of our customer, we have taken a cautious approach to the year. We currently expect total sales to increase 4% to 6% and comp sales for the full year to increase 1% to 3%. Please note that fiscal 2008 will include 52 weeks compared with 53 weeks in fiscal 2007.

We expect that diluted earnings per share in fiscal 2008 will be between $1.74 and $1.85. We anticipate modest operating margin expansion, driven largely by continued improvement in gross margin. We continue to believe that we can mitigate the pressures from the implementation of our food strategy with the continued development of our treasure hunt strategy.

We have also planned modest gross margin benefit from our global sourcing initiative and from process improvements we are making in our merchandising and supply chain processes as part of our Project Accelerate initiative. As we continue to pursue our investment agenda, our ability to leverage SG&A will be primarily impacted by the level of comp sales growth.

Overall, we expect that performance in the second half will be stronger than the first half, resulting from the implementation of our initiatives. As we review the cadence of quarterly earnings this year, I would note that the first quarter will benefit from a calendar shift which will adversely affect the second quarter.

Because of the extra week in fiscal 2007, the week after Thanksgiving will move out of the second quarter and into the first quarter. This shift, plus the effect of one less week as compared with last year, will most likely result in less net income this year in the second quarter as compared with last year.

Reflecting the benefit of an extra week of holiday sales in the first quarter and operating margin expansion, we expect earnings per share in the first quarter will be between $0.43 and $0.47; we expect total sales to increase 7% to 9% and comp sales to increase 0% to 2%.

As we mentioned in the press release, sales in September have been softer than we had planned. We now expect to report a comp store sales increase between 0% and 1% for the September period.

One final comment; for the year, capital expenditures are projected to be between $180 million and $190 million. The increase compared with fiscal 2007 is primarily attributed to the Store of the Future rollout, Project Accelerate, and the anticipated construction of our tenth distribution center.

Now I will turn the call over to Howard for some final remarks. Howard.

Howard R. Levine

Thanks, Ken. I hope that our discussion today has reinforced for you our commitment to managing our business with a longer term perspective. Yes, the macro environment is tough but we have little control over these external forces. We do, however, have control over how we execute for the customer and what investments we make to deliver stronger returns in the future.

As a management team, it is our job to deliver performance even in difficult environments and we are making the investments required to drive the longer term health of our business.

As Chairman and CEO, I want you to know that our management team is committed to making Family Dollar a compelling place to shop, work and invest.

This concludes our prepared remarks. We are now available for questions. Operator, can we have the first question?

Question-and-Answer Session

Operator

(Operator Instructions) At this time, Ms. Rawlins, we seem to have no questions.

Kiley F. Rawlins

Carol, can you give us a couple of seconds? I think the Q&A queue may be inactive. Can you check that?

Operator

Okay, we do have questions coming in at this time, and your first question comes from the line of Eric [Mace] with [Besso] Capital.

Eric Mace - Besso Capital

Thanks. I’m glad it worked this time. I understand what you said about the comp recently being driven by a larger ticket but can -- do you have more data that can help differentiate between consolidation of trips and the possibility that some of your traffic is just going elsewhere?

Howard R. Levine

Let me take a stab at that and others may have something to add to that. I do think it’s important to put things in perspective. When we look at our results for fiscal ’07, we basically were flat from a transaction standpoint this year. When you consider some of the challenges that the low income consumer has been facing, along with the consolidation of trips that had been talked about by most of our competitors today, I think that indicates to us that we are maintaining our share pretty well today.

We think we continue to be focused as we have for the past 40 years on providing our customers with great value and convenient locations and I think that has kept our moorings correct on how we deal with the challenging issues that we are facing today.

Eric Mace - Besso Capital

Okay, thanks, and if I could just follow up on the subject of traffic; could you break down a little bit on the consumable side? Because you mentioned food as a sales driver. Could you break down other parts of the consumables mix as you add that to more stores and kind of what’s working, what isn’t?

Howard R. Levine

Let me try to answer what I think you’re asking, is food has been the primary driver of increased comps in the consumable areas as we’ve added space and grown the category over the last couple of years. This past year, we’ve seen a little softness in some other consumable categories, such as our paper product area and our household chemicals area.

I will tell you that it looks like in the fourth quarter we are beginning to see some stabilization in those areas but we are working very hard in this highly promotional environment, as others are looking to drive traffic in those categories to be more competitive in that area and look to see that those areas begin to contribute more significantly throughout the year.

Eric Mace - Besso Capital

Okay, that’s very helpful. Thank you.

Operator

Your next question comes from the line of Christine Augustine with Bear Stearns.

Christine Augustine - Bear, Stearns

Good morning. Thanks. Could you break out, of the increase in gross margins in ’07, how much of that was because of the difference in how prepaid wireless cards were accounted for? Could you also talk about what’s driving the higher mark-ups? Thank you.

Howard R. Levine

Let me start with the higher mark-ups, Christine and then Ken will jump in on the other part of the question.

We are very pleased with some of the results in the increase mark-ups. It’s primarily from three areas; the continued refinement and development of our treasure hunt strategy is working. When you look at all of the things we’ve done in adding consumables to our mix and come up with a gross margin improvement that we have, to me it’s a clear indication that areas like apparel, which had an improved year this year over last year, our home area which, in the fourth quarter of this year had the second strongest sales increase of our mix, along with the continued improvement of our global sourcing and pricing strategies I think has helped us navigate through a very challenging environment.

Bottom line, what I see is the areas that we are working on and investing in are beginning to contribute to our gross margin improvement and we expect that to continue in fiscal ’08 as they continue to mature.

Christine Augustine - Bear, Stearns

Howard, what are you seeing on the cost side? Because there is a lot that we are reading about with regard to China and inflation. I am just curious if you are starting to see any of that creep in.

Howard R. Levine

Yes, Christine, we certainly have, particularly in some of the consumable areas, with the raw material price increases we’ve seen in dairy, milk, and eggs included. All areas have had pressure that we are navigating through fairly nicely within this country. When you look at the global sourcing side of it, there too have been some raw material price increases but one of the things that we have done a good job on is growing our resource base overseas and changing and improving our resource base to have more competitors fighting for our business.

I think that has enabled us to navigate through some of those pressures a little easier than might have been in the past because things are changing so much internally with us in the way we are managing our business. And I expect that to continue as we improve our global sourcing capabilities and processes and build out the organization there that we will be able to continue to see some improvements from that side of the equation.

Kenneth T. Smith

I’ll jump in on the first part of your question, asking about the effect of the prepaid. That from a rough sense is about 40 to 60 basis points and it was consistent throughout 2007, affecting both the gross margin percent and the SG&A leverage percent, and is modestly or slightly accretive to operating margin as well.

Christine Augustine - Bear, Stearns

So then that goes away, right, because you are going to cycle that in the first quarter?

Kenneth T. Smith

It doesn’t go away. It depends on the -- the accounting treatment will be comparable from year over year but the impact of the comp of that product line, the prepaids, could have an impact on the comp percentage.

Christine Augustine - Bear, Stearns

Thank you.

Operator

Your next question comes from the line of Scott Mushkin with Banc of America.

Scott Mushkin - Banc of America Securities

This is actually Blakely filling in for Scott. I just had two quick questions; the first one, on the square footage, was that -- your plans for 300 new stores, is that a net 300 or is that a gross?

Howard R. Levine

That’s gross.

Scott Mushkin - Banc of America Securities

Okay, and just on that, I’m a little confused on your first quarter sales guidance because you said basically sales you expect to be up 7% to 9% and comp 0% to 2%, so are you planning on opening a significant amount of stores in the first quarter? Is that the read-through?

Kenneth T. Smith

No, the comparison there, from a comp perspective you have to remember those are comparable weeks, so that’s 13 equal weeks versus 13 weeks, the same 13 weeks. On the total sales, it’s a fiscal comparison so the shift of the week adds in this current year that additional week of holiday sales in the fiscal period for ’08 compared to ’07, so that drives that spread a little bit higher.

Scott Mushkin - Banc of America Securities

Okay, thanks. And then, just -- I’m still continuing to struggle a little bit with the trade-off between gross margin and comps. We talked about a couple -- you are getting some gross margin from better sourcing and some efficiencies but you also mentioned higher mark-ups a couple of times. But in the face of flattish, zero to one comp with some deleveraging, what’s the thought on trying to take some pricing down to drive some sales?

Howard R. Levine

If I understand your question, let me try to attack it this way; first, I think you are coming from the fact that it is a very competitive environment out there and we too are facing some of those challenges. We will plan to be slightly more promotional this year than in prior years as we look to continue to leverage advertising to show our customers what is new in terms of treasure hunt, along with driving consumables at great pricing every day.

But the bottom line is we are really focused on driving our overall operating margin and profitability and the challenge that we are facing today, I am very pleased that we were able to improve on our gross margin and the fact that the initiatives that we’re talking about, which I don’t want to minimize, are beginning to pay off for us. So we expect that to continue. We would love to see comps continue to grow and think that we have built a pretty aggressive plan to compete through this holiday and through the rest of the year.

Scott Mushkin - Banc of America Securities

Thanks very much.

Operator

Your next question comes from the line of Meredith Adler with Lehman Brothers.

Meredith Adler - Lehman Brothers

I would like to go back to some of the questions. You were talking -- I think Christine asked about prepaid. Is it possible to distinguish between the benefit to gross margin that came simply from the growth and what came from the change in accounting?

Kenneth T. Smith

I think we keep that the affect of the prepaids, as we said, is approximately the 40 to 60 basis points, which have been consistent. I think just from a rough cut, you can see the impact in the growth, isolate that impact of the prepaids there.

Kiley F. Rawlins

I think it has, as we’ve mentioned, we’ve been talking about better initial mark-ups and certainly the different treatment of the prepaids this year has an impact on that because we are in essence reporting, as you know, our profit on those categories as revenue, which is effectively 100% gross margin. So it is embedded in the mark-ups.

Meredith Adler - Lehman Brothers

Okay, and if you could talk about sales of prepaids, are you seeing any slowdown there or is it still growing very quickly?

Kenneth T. Smith

No, it’s growing very quickly.

Meredith Adler - Lehman Brothers

Okay, and then I have another question; somebody did ask a little bit about the consumables mix and I think it has been a bit of a concern that core categories like cleaning supplies and paper towels have been weak. First, how do you respond and if you had had normal sales in those categories, do you have any sense of what impact that would have had on the gross margin?

Howard R. Levine

First, let me say how we’ve responded; we’ve spent a lot of time analyzing a tremendous amount of data, both internally and externally and are trying to incorporate some of the analysis into the changes, which you’ll begin to see. And to go back to the prior question, some of that means some sharper pricing on some of those key categories to drive traffic.

While there is some pressure on the gross margin percentage, it does help improve our gross margin dollars, which is really what we are focused on here, and expect that to be a benefit to us from an earnings perspective. And as we’ve talked about and have been trying to communicate with everyone, is the investments on the treasure hunt strategy to offset some of those pressures. But we feel as though we’ve analyzed some of the areas that we were missing, made the adjustments and as I said, it looks to me in the fourth quarter we are beginning to see some stabilization in some of those areas today.

Meredith Adler - Lehman Brothers

My final question is just about the share count, and maybe I just went through the press release too quickly but can you tell me where your share count stands, where it stood at the end of the fourth quarter, the actual share count, not the average?

Kiley F. Rawlins

I don’t have that with me. I can probably give it to you after the call.

Meredith Adler - Lehman Brothers

Okay, great. Thank you.

Operator

Your next question comes from the line of William Keller with FTN Midwest.

William Keller - FTN Midwest Securities

Good morning, everyone. Thanks for taking my question. First thing, just looking at the balance sheet, working capital, and I was pleased to see this was down considerably at the end of the fiscal year versus last year. Is there a timing issue or anything of a one-time nature that is making that look artificially low right now?

Kenneth T. Smith

Not on the balance sheet. I don’t think there is anything that would give you an artificial look.

William Keller - FTN Midwest Securities

Like a timing of payables or anything like that? I know, depending on how fiscal months hit, that can happen.

Kenneth T. Smith

No, I don’t think so.

William Keller - FTN Midwest Securities

Okay, terrific. Next thing it said I think in the press release that you’ve exhausted now your repurchase authorization. Is there a timing for when the board would meet to discuss a new one?

Kenneth T. Smith

You’ll note that historically we have used stock repurchases fairly consistently in the past and currently, based on the share repurchases you noted in the press release, we’ve used up all of our current authorization so we don’t have any authorization outstanding.

I would expect that management and the board, as they always do, will continuously evaluate the need for an authorization, so as we look to next year I think they will be evaluating that.

William Keller - FTN Midwest Securities

Okay, last thing real quick, can you give us an idea of what sort of tax rate you are assuming in your guidance for fiscal ’08?

Kenneth T. Smith

It is in the mid 36 -- between 36 and 37, but a rough midpoint about 36.5.

William Keller - FTN Midwest Securities

Thank you very much.

Operator

Your next question comes from the line of Deborah Weinswig with Citigroup.

Deborah Weinswig - Citigroup

Good morning. Howard, I was very impressed with the improvement on the gross margin in the quarter. Can you dig a little bit deeper in terms of where you are with regard to shrink improvement and what we might expect in 2008?

Howard R. Levine

We’ve seen modest improvement in shrink over the last couple of years. I think a lot of that has to do with some of the investments we made in those urban initiative stores over the last couple of years. For this year, we also continued to plan for an additional or modest improvement in the shrink area. We believe we have opportunities to continue to drive that down lower and we are particularly pleased with the progress that we’ve made thus far.

Let me just mention, I think the reason we are seeing some improvement in shrink is all of the work that we’ve done to improve our store manager retention, as well as lower inventory levels in existing stores. As long as I’ve been looking at these things, better managers are having stability of our workforce as well as lower inventory levels, along with the efforts that all of our people are making to control shrink better, are positive indicators as to what we can do in the future.

Deborah Weinswig - Citigroup

Thanks, and then with regard, you discussed the new central procurement organization. Can you give us additional details in terms of just on for-resale product or not-for-resale product, and when should we actually see the results from the shelves in gross margins?

R. James Kelly

This is Jim, so I am here and doing well.

Deborah Weinswig - Citigroup

Nice to hear from you, Jim.

R. James Kelly

The centralized procurement effort this past year included one, the accumulation of some very talented people with expertise in the area; secondly, the creation of processes and reverse auctions and things of that nature; and third, the actual implementation of an e-procurement package to enable us to better control the spend throughout the franchise.

This year, as a result of those efforts, actually it was spend negative, which said that while we had a lot of consultants and a lot of new headcount, we actually saved money on the initiative and we would expect as that group matures for us to drive even further savings next year.

Deborah Weinswig - Citigroup

Great, well, thanks so much and best of luck in ’08.

Operator

Your next question comes from the line of Adrianne Shapira with Goldman Sachs.

Adrianne Shapira - Goldman Sachs

Thank you. We tried to kind of work through obviously the buy-back calculations and the fact that you bought back in the fourth quarter and it gets us to a share count of about 140, and if we start the year at 140 and use that along with your guidance, and exclude one-time items, it gets us to a net income down versus last year. This is in sharp contrast to the low double-digit growth over the past two years. We understand obviously there is some pressure due to the 52nd week versus 53rd week, but can you just help us understand one, if our math is right and two, in light of the fact that you are looking for comps 1 to 3 for the year and gross margin expansion, what sort of underlying pressures should get you to a down net income?

Kenneth T. Smith

I think the math may be -- and we are not anticipating a reduction in net income in the coming year, so I don’t know if the share repurchase, the share count assumption you are using may be too low. We are expecting modest -- as we look to the year with a 1% to 3% comp, we are expecting modest growth in our operating margin, as we said, primarily due to gross margin as we look to the coming year.

Adrianne Shapira - Goldman Sachs

Okay, so can you help us at all in terms of the share count, what sort of share count we should be using? Because that’s kind of what we back into based on the information you provided us in terms of the activity.

Kiley F. Rawlins

Adrianne, give us a couple of minutes to run some numbers and we’ll come right back to you.

Adrianne Shapira - Goldman Sachs

Great. Thank you.

Kiley F. Rawlins

Operator, if we could just have the next question?

Operator

Your next question comes from the line of David Cumberland with Robert W. Baird.

David Cumberland - Robert W. Baird

Good morning. Howard, can you give an update on the status of the urban initiative? Is that still an ongoing program? If so, it is going to be added to anymore existing stores?

Howard R. Levine

We are very pleased with the progress that we’ve made in the urban initiative stores. Just to back up a minute to explain as to why we continue to invest in those stores, is two-thirds of all consumption takes place in those top 50 markets. And when one looks at the competition in those markets, it’s a different kind of competition than what you would find in most other places. We’ve built a strong franchise in those markets and continue to invest.

For example, this past year, as well as this year, are going to be the primary beneficiaries of our Store of the Future investment, along with our new hiring system, automated hiring system. Both of those items are significant investments on our part.

We are not adding additional stores at this point other than new stores that may have opened in some of those existing markets but that does not have any indication as to our belief in the strength in the progress that we have made thus far. So to answer your question, we are very pleased. We think that we are beginning to build some significant competitive advantage and look to continue to leverage that.

David Cumberland - Robert W. Baird

My other question is related to the toy business. That’s been a good category for you recently. Have you seen any impact from the recalls and related to the recalls, are you making any changes to your approach or processes in the category?

Howard R. Levine

Yes, David, like most retailers, we have had some impact from some of the toy recalls, which we are on top of and handling appropriately. So we are working towards resolving those issues.

But I also am very pleased with the progress that the company has made on controlling quality. It is our belief at Family Dollar that our customers deserve to be fully protected and safe in anything that they buy in our stores and you’ve heard us talk over the years as to how we have improved some of that, those areas.

Our approach historically has been primarily decentralized, and what I mean by that is the control efforts have been primarily through our buying organizations. We have transitioned this year to having a separate or more centralized organization that has put much more emphasis and control on quality and specs, et cetera, and think that that will position us to ensure our customers have the best quality products for the price. So a lot of progress over the years, but this year even a more significant change in that area.

David Cumberland - Robert W. Baird

Thanks, Howard.

R. James Kelly

As relates to the impact at the consumer level, the toy part of our business has been a key focal point of the treasure hunt initiative. We have been growing those quite aggressively and have not noted any recent trend changes, so it continues to be a very good category for us.

David Cumberland - Robert W. Baird

Thank you.

Operator

Your next question comes from the line of Mark Miller with William Blair.

Mark Miller - William Blair

Good morning. I just wanted to clarify the sales guidance. So the 4% to 6% increase, is that 52 weeks versus 53 weeks then?

Kenneth T. Smith

Yes.

Mark Miller - William Blair

Okay, so on a same-week basis, you’d be looking for it to be up approximately 6% to 8%? And I’m trying to reconcile that relative to the comp sales increase of 1% to 3%. Essentially you’d be looking for sales growth of about five percentage points from new stores, yet the 300 gross stores you are adding would be around 4%. So is there something about the mix of these stores that you think the new store productivity would be up dramatically, or number of urban versus rural? If you could just help me understand that relationship.

Howard R. Levine

Mark, you are quicker with your numbers than we are with ours. It is probably a by-product of your personal acumen. What I would suggest to you is that you do have a slightly different period of time with calendar shifts, but why don’t you talk through that question with Kiley and we’ll certainly try to get you a detailed answer.

Mark Miller - William Blair

On the comp increase coming from the average ticket, if traffic’s been flat and your observation that customers have been consolidating trips, do you have data you can share with us on the number of items per checkout? And then I have a follow-up question as it relates to inflation.

Howard R. Levine

We haven’t shared that data. I think most of the average transaction has been through the consolidation of trips today but we have not broken out the number of items per transaction.

Mark Miller - William Blair

It looks like the pricing for you then has been I guess less than what I would think, given the inflation in some of the consumable categories. How are you able to offset that then?

Howard R. Levine

I think we have had some inflation in some key categories today but in other categories, we have not seen as much inflation as you might expect, particularly say, for example, in the apparel area. Some of those have not had some of the price increases. But when we have seen cost increases, we have been fortunate to pass most on and they have been accepted and would expect that to continue as we go through this year.

Mark Miller - William Blair

My last question in the gross margin outlook for 2008, you listed several factors that could drive gross margin. I wanted to understand your assumption for shrink. Are you assuming any change in shrink? And then also, based on your experience, has shrink tended to be I guess coincident with change in manager retention or has it tended to be a lagging financial result?

Howard R. Levine

It tends to be lagging for a couple of reasons, not the least of which if you improve retention for the next three months and you take an inventory, you have three months of improved retention results and six months of earlier results, so there is always that lag within the shrink area.

But I do think that we have consistently now reported improvement in retention. Next year, we are targeting further improvement and there is a very, very strong correlation with the improvement of retention and the six quarters, I think Ken said, of improved shrink results.

Mark Miller - William Blair

I guess I would like to know then your assumption for 2008. Are you assuming shrink improves further? And if not, why not? Are you trying to be conservative or is that what the accounting dictates? And then, just generally, if you could put in perspective where shrink is today versus the historical experience. Thanks.

Kenneth T. Smith

Shrink, when we look to next year, we have had what we would call a modest improvement, as Jim outlined, in shrink for the year. We’ve actually seen a slight improvement trend for the past two years.

We continue to work very hard and are very focused on shrink. We plan for again some modest directional improvement in shrink as we go forward.

Operator

Your next question comes from the line of Adrianne Shapira with Goldman Sachs. Adrianne, your line is open. Adrianne?

Adrianne Shapira - Goldman Sachs

We asked our question. We were just waiting.

Kenneth T. Smith

I wanted to follow up with your model, Adrianne. I’m not exactly sure how the numbers are working. I think there is probably some delta in the share count. The rough numbers around outstanding shares at year-end is about 143 million, in that neighborhood. So I think you can see our guidance and probably it would make the most sense to walk through with Kiley the details of the calculation to answer any specific questions on net income or pretax income growth.

Adrianne Shapira - Goldman Sachs

Sure, we can follow up with Kiley. It’s just that we see the 143 but to date, I guess in the press release you had mentioned you had bought back 3 million shares since, so that’s where we get to the 140 and like I said, just -- we can follow up with Kiley after the call. And as you had mentioned, on a GAAP basis, you are looking for modest lift in net income, but if you strip out the one-times, we were just wondering -- we were coming up with, based on this share count, down net income. We can follow up with Kiley post the call.

Kenneth T. Smith

Okay. That would be great.

Adrianne Shapira - Goldman Sachs

Thanks.

Kiley F. Rawlins

Carol, I think we are close to the top of the hour. Can we take one more question?

Operator

Your next and final question comes from the line of Ryan [Wrenteria] with [Carnes] Capital.

Ryan Wrenteria - Carnes Capital

Two questions; one is, what sort of buy-back activity does that 143 million share count presume? Is that none going forward?

Kenneth T. Smith

No, the buy-back that we’ve documented in the press release outlined the number of shares that we bought back after year-end, and that fulfills all of our current authorization so there is no more authorized buy-back post what you can see, what is documented in that press release.

Kiley F. Rawlins

Ryan, that 143 was at fiscal ’07 year-end.

Ryan Wrenteria - Carnes Capital

So basically you are assuming from today for no future buy-backs in your guidance?

Kiley F. Rawlins

I am not sure that we suggested that. I think Meredith had asked earlier what our share count was at the end of the year. We were able to get that number and wanted to provide that. I think as Ken mentioned earlier, we use stock buy-backs to help us manage our capital structure and expect to do so going forward.

I think also remember that we do have some dilution from stock options and PSRs, et cetera, so it’s not just a -- it should be, I hope, a net reduction but keep in mind there are some other moving elements.

Ryan Wrenteria - Carnes Capital

Right, so for the year, you are looking for an average diluted shares of 143 million, or the 143 was where you ended last fiscal year, or both?

Kiley F. Rawlins

It is where we ended last fiscal year. We have not provided an expectation for what the share count will be at year-end of ’08.

Ryan Wrenteria - Carnes Capital

I thought that’s what your answer to Adrianne’s question was. Okay. And can you help me understand why mix was a benefit to gross margins in the quarter, when consumables grew as a percentage of the mix and home and apparel were roughly flattish?

Howard R. Levine

I think the mix that we are talking about is that some of the higher margin treasure hunt items actually grew faster than the overall consumable category. I had mentioned toys earlier. I would mention in the same context the prepaids. Prepaids, as we also mentioned earlier, have been growing rapidly and as we record them today, that is a very favorable mix variance.

In the aggregate, the categories with larger margins grew at a very competitive rate and that was a plus for us this year.

Ryan Wrenteria - Carnes Capital

Thanks.

Kiley F. Rawlins

It’s 11:00 o’clock and we have exhausted our hour. Thank you very much for joining us today. We didn’t get to everyone’s questions but as always, I will be available for the rest of the day for your questions. Thank you. Have a nice day.

Operator

Ladies and gentlemen, that concludes today’s Family Dollar fourth quarter and year-end earnings conference call. You may now disconnect.

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