Family Dollar Stores F1Q08 (Qtr End 12/1/07) Earnings Call Transcript

Jan. 8.08 | About: Family Dollar (FDO)

Family Dollar Stores, Inc. (NYSE:FDO)

F1Q08 Earnings Call

January 8, 2008 10:00 am ET

Executives

Kiley F. Rawlins - Vice President, InvestorRelations and Communications

Howard R. Levine - Chairman of the Board, Chief ExecutiveOfficer

Kenneth T. Smith - Chief Financial Officer, Senior VicePresident

R. James Kelly - President, Chief Operating Officer

Analysts

Charles Grom - J.P. Morgan

John Roberts - Lehman Brothers

Mike Schregast

Michael Exstein - Credit Suisse First Boston

Analyst for Deborah Weinswig - Citigroup Global Markets

David Mann - Johnson Rice & Company

John Zolidis - Buckingham Research Group

William Keller - FTN Midwest Securities

Michael Baker - Deutsche Bank

Operator

Good morning. My name is Matt and I’ll be your conferencefacilitator today. At this time, I would like to welcome everyone to the FamilyDollar first quarter earnings conference call. (Operator Instructions) I wouldnow like to introduce Ms. Kiley Rawlins, Vice President of Investor Relationsand Communications. Ms. Rawlins, you may begin your conference.

KileyF. Rawlins

Thank you, Matthew. Good morning and thank you for joiningus today. We appreciate your continued interest in Family Dollar. Before webegin, you should know that our comments today will include forward-lookingstatements which are made pursuant to the Safe Harbor provisions of the PrivateSecurities Litigation Reform Act. These statements address company plans and activitiesor events which we expect will or may occur in the future.

However, a number of factors, as set forth in our SECfilings and press releases, could cause actual results to differ from our plan.We refer you to and specifically incorporate the cautionary statementscontained in today’s press release and in our other SEC filings. You arecautioned not to place undue reliance on these forward-looking statements,which speak only as of today, January 8, 2008. The company does not undertaketo publicly update or revise its forward-looking statements except as requiredby law.

Now I’d like to introduce our Chairman and CEO, HowardLevine.

Howard R. Levine

Thank you, Kiley and good morning, everyone. With us on thecall today is Ken Smith, our Chief Financial Officer, and Jim Kelly, ourPresident and COO. This morning, I will provide you with an update on how weare recalibrating our operating agenda in response to the current environment,and then Ken will provide more detail regarding our first quarter results andour expectations for the remainder of fiscal 2008. After a few closingcomments, we’ll be happy to answer your questions.

When we first outlined our expectations for fiscal 2008 afew months ago, we suggested that the near-term environment for the low incomeconsumer would be challenging but even our forecast didn’t adequatelyanticipate the extent of the economic pressure on our customer.

Based on our customer research, we estimate that last yearour customers spent approximately 70% of their income on housing, energy, andfood. Today, these expenditures are most likely an even greater percentage oftheir wallet, resulting in our customers being severely strapped for cash,especially towards the end of the month. Yet they still want to take care oftheir families, even as they have less spending capacity. Consequently, theyare keenly focused on saving money wherever possible.

We saw this effect of this focus on our sales mix during thequarter. Sales of basic consumables like food and household chemicals performedas expected, while sales of more discretionary categories, such as apparel,home, and seasonal were softer than planned.

As Ken will discuss in more detail in a moment, the resultwas lower-than-planned top line growth and greater pressure on gross margin. Inaddition, despite delivering lower-than-budgeted SG&A expense during thequarter, our low comp performance resulted in more SG&A deleverage than wehad originally anticipated.

These trends continued through the December period and arereflected in our second quarter outlook. On Thursday, we will report finalresults for the December period but our preliminary results indicate thatcomparable store sales declined approximately 1%. Sales of consumable productscontinued to be the driver of sales, while sales in many discretionarycategories continued to be soft.

While the environment is challenging, let me assure you thatwe are not satisfied with these results. Over the next several months, we willmake changes in our assortment and merchandise presentations to better reflectour customers’ increased need for value and we will continue to workaggressively to reduce core expenses.

But even as we make adjustments to our fiscal ’08 agenda, wewill continue to invest in longer term initiatives designed to improve ourexecution and strengthen our competitive positioning.

Gift-giving is the most significant driver of shopping tripsduring the holiday season. However, post-holiday, consumables become a moreimportant driver of trips. Reflecting this more normalized mix of sales, wehave three significant initiatives to drive consumable sales going forward.

First, we will continue to aggressively develop our foodstrategy, which in this difficult environment can become an even more importanttrip driver. As you may recall, we expanded our food assortment in about 2,700stores last year and we have been very pleased with the results.

As we have discussed previously, we plan to expand theselling space for food in an additional 2,700 stores this spring and with thecontinued rollout of our store of the future platform, we expect to be able toaccept electronic benefits, such as food stamps, in about 30% of the stores byyear-end.

Second, as with most retailers, our laundry assortment ismoving to smaller but more concentrated formulations, an industry movesometimes referred to as compaction. This transition has allowed us to add somelarger sizes, value sizes, and expand the facings of better selling items, andselectively broaden the assortment, all within the same space.

This fall, we converted approximately 2,700 stores and we’repleased with the customer response. Approximately 3,600 additional stores willbe converted this spring.

Finally, we have created a new household paper fixture thatis easier to shop, merchandise, and restock. Our test results from this changehave been encouraging and we plan to change the presentation of paper goods inabout half the chain, so by the end of fiscal ’08, we expect about 75% of thechain will utilize this new fixture.

We have developed a plan to implement these assortment andfixture changes in our stores this spring. While these changes may result inpotential for near-term sales disruption, we are confident that they will drivestronger top line sales in the second half of fiscal ’08.

But even as we strengthen our assortment of key consumables,we are making changes in our discretionary categories to reflect our customers’more limited budgets. Even in challenging economic environments, treasure hunthas a role in helping our customers feel good about taking care of theirfamilies. We will continue to meet these needs while taking a restrainedapproach to manage inventory risk.

As we focus more aggressively on meeting the needs of ourcustomers, we will also step up our efforts to reduce our core operatingexpenses. On previous calls, we have discussed an SG&A leverage target ofapproximately 3%. As we adjust to the current environment, our goal is tomanage expenses at a level below this level in the second half of fiscal ’08.

Our centralized procurement efforts are delivering savingsas planned and our improvements in associate retention have resulted intangible savings in worker compensation claims. We believe there are additionalopportunities to lower our cost of doing business and our team is working hardto reduce expenses.

While we are adjusting our short-term plans to reflect thecurrent economic environment, we will continue to invest to improve ourlonger-term capabilities. We have great expectations for long-term growthpotential of our niche, but the current environment requires us to prioritizeour investment focus. Our investment priorities are project Accelerate, globalsourcing, the store of the future project, and our concept renewal program.

Project Accelerate remains an investment priority for us andis critical to our long-term goals of improving the shopping experience of ourcustomers, the productivity of our inventory, and the efficiency of our supplychain.

At the heart of Project Accelerate is significant culturalchange as we transition to more centralized processes that enable operationalspecialists, like our pricing group, to provide buyers with institutionalexpertise.

Since launching the project in the fall of 2006, we havemade great progress. For example, during the first quarter, we maintainedinitial mark-ups, improved inventory turns, and GMROI, despite inflationarypressures and lagging sales of higher margin discretionary items.

The development of our global sourcing initiative alsocontinues to progress as planned. With more than 40% of our merchandisemanufactured outside the U.S., improving the efficiency of our global sourcingprocesses represents a significant opportunity for us to reduce our cost overthe longer term. Although we are incurring additional costs near term as wedevelop this organization, this new team is helping us drive improved qualityand greater value for our customers.

We are also improving the technology in our stores throughthe continued rollout of our store of the future project. This new technologyplatform not only enhances the customer checkout experience but also providesstores with better workflow management tools and more robust communicationswith our buyers.

During the first quarter, we installed new equipment inapproximately 950 stores and we are well on our way to meeting our fiscal ’08implementation goals.

Our concept renewal effort is our longer term initiativefocused on delivering an enhanced shopping experience to more intuitive storelayouts and design. Since last spring, we have incorporated these ideas intonew stores and we have seen the benefit from these changes in improved newstore performance.

This fall, we begin to evaluate several renovationstrategies to assess the sustained impact of incorporating the concept renewalelements in existing stores. In addition, this month we have begun a rebrandingeffort in all stores, which incorporates many of the communication elementsfrom concept renewal, including our in-store handouts, promotional events, andin-store signage.

New store growth continues to be an investment priority forus and in fiscal ’08, we expect to invest approximately 20% of our capitalbudget in new stores. However, given our focus on improving processes to derivehigher shareholder returns, we will continue to constrain new store growth toan expansion rate of approximately 2% to 4% until we see an improvement in ouroverall operating margins.

In summary, while our first quarter financial results werenot as strong as we had planned, we have made progress in the pursuit of ourstrategic objectives. Over the next several months, we will work aggressivelyto strengthen our assortment of basic consumables while repositioning ourtreasure hunt strategy to reflect our customers more limited budgets. Theseefforts should result in improved performance in the second half of fiscal ’08.

Now, Ken will provide you with more detail regarding thefirst quarter results and our outlook for the rest of the year.

Kenneth T. Smith

Thank you, Howard. As Howard mentioned, the first quarterproved to be more challenging than we expected. Weakness in discretionarycategories led to higher markdowns and a less favorable than planned mix duringthe quarter. In addition, softer comp store sales contributed to a greaterdeleverage of SG&A expenses. The result was an increase in diluted earningsper share of approximately 3% to $0.37 compared with $0.36 last year.

Before we get into the details of our first quarter results,I want to remind you that the first quarter this year included one week ofpost-Thanksgiving sales. This creates some comparability issues as we look atresults for the first quarter and our expectations for the second quarter.

Let’s start with a review of sales. Sales for the quarterincreased 5.2%, driven by a 6% increase in sales of consumables and a 14.5%increase in sales of seasonal merchandise. Remember that the first quarter thisyear included a week of post-Thanksgiving sales, which benefited sales of toysand trim-a-tree during the quarter.

Comps for the quarter, which we report on a like periodbasis, declined 1%, driven primarily by lower registered transactions. Averagetransaction size increased slightly.

Gross margin as a percentage of sales declined 30 basispoints. Higher markdowns more than offset improved merchandise markup. Weincurred 60 to 70 basis points of additional markdown expense during thequarter as we moved aggressively to manage our inventory productivity in theface of soft sales in discretionary categories, particularly apparel.

However, continued strength in prepaid services and anadditional week of holiday sales during the quarter mitigated much of theimpact of the higher markdowns.

Inventory shrinkage increased in the quarter. Whileinventory shrinkage can be somewhat volatile from quarter to quarter, wecontinue to believe that the improvements we have made in store managerretention and inventory productivity will result in lower inventory shrinkageover time.

While SG&A expenses were lower than we had planned,SG&A expense increased to 29.2% of sales compared with 28.9% of sales inthe first quarter last year.

As a percentage of sales, store occupancy costs, expensesrelated to the rollout of our store of the future platform, and advertisingexpenses to support holiday sales were all higher during the quarter.Offsetting much of these increases were lower insurance expense andprofessional fees.

With the goal of better managing store occupancy costs, weare creating a more proactive facility management platform which includes theimplementation of a new lease management system that provides us with bettervisibility to store lease expenses and also includes a more proactive approachto maintenance and repair needs.

This total cost of ownership view is expected to result inbetter management of occupancy costs over the longer term but has created sometiming differences during the implementation period.

Over the last two years, as we have stabilized our storemanagement teams, we have seen benefits in other areas of our business -- mostnotably, workers’ compensation claims. In fact, in seven of the last eightquarters, we have experienced a reduction in insurance costs as a percentage ofsales. Clearly our focus on associate retention is producing positive results.

Professional fees were also lower in the first quarter thisyear. You may recall that last year, we spent approximately $4 million inexpenses related to shareholder derivative actions.

Net interest expense declined slightly in the first quarter,reflecting both higher interest income and lower interest expense, and theeffective tax rate declined slightly to 37.1%, reflecting the benefit of federaljobs tax credits and changes in state income taxes.

Average weighted shares in the quarter were approximately 10million lower than the first quarter of fiscal 2007, reflecting our stockbuy-back program.

Turning now to the balance sheet, we continue to driverhigher returns through more productive asset management. During the firstquarter, we maintained our focus on improving inventory turns and gross marginreturn on investment. Inventory per store declined approximately 1% on top ofan approximate 8% decline in the first quarter last year. I would remind youthat this is the seventh consecutive quarter of inventory improvement.

Capital expenditures for the quarter were approximately $37million. We continue to expect that capital expenditures for the year will bebetween $165 million to $180 million.

Now that we have reviewed our results for the first quarter,let’s talk about our outlook for the rest of the year. As a result of theimplementation of the sales driving initiatives that Howard discussed, weexpect that the comp store sales trend in the second half will improve modestlyand will contribute to earnings growth in the second half of fiscal 2008.

We expect that earnings per diluted share for the year willbe between $1.56 and $1.64. This guidance assumes that comparable store salesfor the year will be flat or increase slightly and that sales of consumableproducts will continue to outpace most discretionary categories.

However, we expect that better purchase markups, the impactof higher sales of prepaid services, lower inventory shrinkage, and ouraggressive focus on expense control can partially offset these pressures.

As I mentioned at the beginning of my comments, there aresome timing issues that make it difficult to compare operational performance inthe first half of 2008 to the second half of 2008. While the first quarterbenefited from one extra week of holiday sales, the second quarter has one lessweek of holiday sales as compared with the second quarter of fiscal 2007. Inaddition, the second quarter of fiscal 2008 includes 13 weeks compared with 14weeks in fiscal 2007.

As we evaluated these timing issues when establishing ourfiscal 2008 budget, we originally planned earnings per share to declinesignificantly compared with the second quarter last year. Given recentfinancial trends, we have further reduced our expectations. We now believe thatsales will decline 5% to 6% in the second quarter.

Lower sales, combined with a mix weighted more towardconsumables and higher markdowns, are expected to result in earnings perdiluted share for the second quarter between $0.40 and $0.44.

We expect that the first half of fiscal 2008 will bechallenging but we expect the second half to improve. Assuming an acceleration incomps resulting from the sales driving initiatives planned for this spring,less impact for markdowns, and our efforts to generate SG&A leverage at arate lower than our historical break-even point, we expect to return to solidearnings growth in the second half of fiscal 2008.

Now I’d like to turn the call back over to Howard for someclosing remarks.

Howard R. Levine

Thanks, Ken. We expect fiscal 2008 to remain challenging forour customers and our earnings guidance reflects this outlook. When times aredifficult, especially during the frenzied holiday selling season, retailers cansometimes run the risk of becoming overly short-term focused and lose theirview of the big picture.

At Family Dollar, we have served customers for almost 50years, weathering many different economic cycles. While there is no silverbullet, our success has been the result of effectively balancing short-termtactics with longer term investments.

We are taking immediate actions to better focus ourmerchandising efforts and lower inventory risk, and we are curtailing expensesto reflect a more challenging sales environment. These actions, along with thetransition to a more consumable weighted mix, are expected to lead toimprovements in the second half of this year.

The key to delivering longer term performance is execution.We have assembled a highly motivated and talented management team and they aredriving operational improvement despite some challenging headwinds. We continueto fund initiatives like Project Accelerate, store of the future, globalsourcing, and concept renewal even during these challenging times because theyform the catalyst for current and longer term performance improvement.

As we continue to become more cost effective while alsoinvesting aggressively to improve our longer term capabilities, we have anopportunity to strengthen our market share and position Family Dollar toaccelerate returns as the economy improves.

Now, Operator, we would be happy to open the call toquestions.

Question-and-AnswerSession

Operator

(Operator Instructions) Your first question comes from theline of Charles Grom.

Charles Grom - J.P.Morgan

Good morning. Thank you. I was wondering if you guys couldcomment on what the impacts will be to the second quarter from the shift, theextra week in December. If you could quantify that both from a sales and EPSimpact.

Kenneth T. Smith

We do have the impact, the timing impact between the firstand second quarters and that is the holiday week of sales that benefits thefirst quarter and hurts the second quarter. I probably won’t quantify an exactsales number but an estimate, which is, as you’re aware, tough to pin an exactnumber on the earnings effect, I would ballpark it around the $0.05 to $0.06range that is shifting between quarters.

Charles Grom - J.P.Morgan

Okay, that’s great. And if I recall, the 53rd week last yearthat impacted Q2 was about $0.05 as well, is that right?

Kenneth T. Smith

That’s correct.

Charles Grom - J.P.Morgan

Okay, and then a question for Howard; just competitively,based on our store checks, we’ve noticed that [DG] seems like they are gettingtheir act together a little bit more. I was wondering if you could comment onwhat you guys are seeing. I know you do a lot of cross-shopping comparisons,you know, what they are doing -- they are no longer doing pack-away. I’m justwondering how you position yourselves over the next couple of years as theystart to reemerge under the KKR brand.

Howard R. Levine

I’m not going to comment specifically on a competitor but Ican tell you what we are doing and how we are positioning ourselves, but as Italked about in my comments, in these difficult times we think there should bemore emphasis and focus on consumables and take a little risk out of ourinventory and curtail some purchases in some of the areas like apparel and someof the other seasonal areas.

So we think we’ve got the right focus and frankly think thatif we execute, and I’ve said this for many, many years when we look at talkingabout Family Dollar and comparing us to others in our niche, that we are doingabout $1 million a store. There is substantial opportunity for all of us toimprove our market share. It depends on who executes and that’s really what ourfocus is. We’re worried about how we execute and how we perform and history hasshown when we do a good job with that, that we’ll be fine.

Charles Grom - J.P.Morgan

Okay, and then the last question would be, in terms of yourguidance, in order to do flat to I guess modestly an increase in same-storesales, that would imply roughly about a two to three in quarters -- the thirdand fourth quarter. To me, that looks a little bit aggressive, knowing what weknow today. If you could comment on where you may be wrong in terms of youroutlook and the sensitivity to that on your guidance that you just providedthis morning. Thanks.

Howard R. Levine

Let me start off on that because Chuck, there’s no questionit’s very difficult to project and give guidance during the challengingeconomic environment that we are in today. I can’t over-emphasize that enough.We’ve spent quite a bit of time though reviewing our plans and think that whenwe look at where we’ve had success, for example, a couple of years ago wetalked about what the importance of food would be at our assortment. We’veadded coolers, we’ve expanded food in existing stores, we’re adding another2,700 stores the second half of this spring. We talked about other consumablesthat we are adding to our stores and incidentally, the food area has beenperforming quite well for us.

So yes, there are things that can happen. We’re noteconomists in here. We’re trying to look at what are customers facing today andbelieve strongly that we’ve got the right focus on at least positioning us theright way in a challenging economic environment.

Ken, you may want to give a little more color on the trendin the --

Kenneth T. Smith

I think the exact number -- our guidance, 2% to 3%,indicative for the second half is a little bit higher than our estimates butthey are positive so we are looking for a change in the trend from a slightlynegative first half to a slightly positive second half.

Charles Grom - J.P.Morgan

Okay. Thanks from clarifying.

Operator

Your next question comes from the line of Meredith Adler.

John Roberts - LehmanBrothers

John Roberts stepping in for Meredith today. With regard toyour markups, I assume a lot of that has to do with price optimization. Can youtalk a little bit about how that effort is going and the customer reaction tomaybe presumably some higher prices in individual markets?

R. James Kelly

Let me take a crack at that. What we have done by way ofbackground is to create a centralized pricing organization. We’ve also createdcategories with different objectives for each category and we’ve evaluatedprice elasticity for many of our items.

As a result of that, we have in a more systematic wayestablished prices as we’ve gone through this past year. So from a key itemperspective -- that is, those items that our customers are most sensitive aboutand have the greatest elasticity, we have actually lowered those prices in manycases. For less sensitive items, we have been able to pass through costincreases and as a result of that, we have maintained our purchase markups.

So that’s basically how we’ve attacked a very challenginginflationary environment and we are very appreciative of the efforts of thepricing team.

John Roberts - LehmanBrothers

So you are not seeing a negative reaction from those higherprices in terms of volume?

R. James Kelly

No, obviously our price perception by our customers is oneof the more valued assets of Family Dollar. We have a lot of differentmethodologies now for us to measure and ensure that that price perception ismaintained, and those include not only comparative shops but information fromA.C. Nielsen, IRI, and other independent sources, as well as direct surveys ofour customers.

So our price perception remains very, very strong today.

John Roberts - LehmanBrothers

And then if I could ask one other question, the flexibilitywith inventory, I know you mentioned that you are curtailing your risk there.How far out are you committed for purchases of apparel I guess would beprobably the riskiest category? How much flexibility is there longer term?

R. James Kelly

I think you are right. Apparel does have a very long leadtime and indeed, last January, February, March, we were committing for thewinter season. We began restraining our commitments early this fall, so we arein very good shape in terms of our commitments for receipts of the spring andsummer goods, and we expect to maintain a very conservative position throughoutthis time.

John Roberts - LehmanBrothers

Great. Thank you.

Operator

Your next question comes from the line of Mike [Schregast].

Mike Schregast

Can you just talk about your strategy with regard toincreasing consumables? I mean, already a very competitive category. Can youjust talk about I guess more of the gross profit margin benefit, how you canmanage that going forward as you try to push those sales?

Howard R. Levine

Sure. Let me start off by saying, as I indicated, we’ve donequite a bit of customer research, starting with the food initiative, startingwith adding the coolers, which put us in the business of getting a trip that weweren’t even eligible for a few years ago. Subsequent to that, we’ve addedadditional square footage to food, plan to add a little bit more, and as Iindicated, by the end of the year, we’ll be in a position to accept food stampsin about 30% of the chain.

Yes, all of those are areas that put pressure on our grossmargin but things that our customers are requesting. And as the economyimproves, the hope is that we’ll get the customer to continue to see increasesin purchases of some of these more treasure hunt items.

Longer term, we do believe the benefit of treasure hunt isextremely important to our mix and are not getting out of that business. Ithink it’s important to realize while we are curtailing expenses in an effortto control markdowns and inventory risk, longer term we still believe it isimportant to have that as part of our mix.

So we are navigating through some choppy waters right now.Hopefully as the economy improves and some of the improvements that we’remaking in consumables as well as some of the ways we’re attacking our treasurehunt strategy will position us nicely for the future.

R. James Kelly

Let me add on to that a couple of items relative to ourplans relative to gross margin. First of all, we’ve already discussed thepricing initiative, which has an impact over time of expanding the grossmargin. We’ve also talked about global procurement and that too is providing uswith opportunities to expand the margin on our existing mix.

And then finally, something we haven’t talked as much aboutbut that’s certainly in our game plan and in today’s reality, is the leveragingof our private labels. We’ve worked hard this year in improving the quality ofthose products and I think that provides a foundation for us to expand theassortment and the sales of those items.

So those are three merchandising-based areas that we arelooking at as offsetting some of the mix pressures. And in addition to that,through Project Accelerate, we are significantly changing how we buy and managethe supply chain with the hopes that that will help us better control ourmarkdowns. And also, through both the personnel issues, the loss preventionissues and processes, we’re targeting improvement in the shrink area.

So those are five different opportunities that we see thatcan actually expand the operating margin and clearly provide some foundationfor offsets relative to the mix.

Mike Schregast

Okay, and then one other question; where do transportationcosts fall in in your cost structure and what contribution have they -- whatkind -- I imagine that they’ve been up year over year and want to see how youare managing those.

Kenneth T. Smith

Our transportation, our freight costs are included in ourcost of goods sold and affect gross margin. We are obviously seeing thepressure of rising energy costs and particularly when you look year over year,a significant increase in diesel fuel in particular. So it is an impact on ourcost of goods sold.

It wasn’t a material variance for us this year, this quarterwhen we look at the effect on gross margin. We work hard to mitigate it withsome processes in here from both the routing perspective and cube utilizationthat our transportation group performs. But it is something we are watchingvery close as we move forward and expect to have pressure from rising fuelcosts as we move forward.

Mike Schregast

And some other retailers out there have spoken about howthey are seeing an impact in Florida, California, and Nevada and Arizona from aweakening consumer. Can you talk -- I realize some parts of those, some ofthose you’re not exposed to. Can you just talk about the geographic areas thatyou are seeing more weakness than others or where you might be seeing moreconsistency or strength?

R. James Kelly

Well, I think we continue to see some strength in many ofthe core areas but the weakest areas, I would say Florida, we’ve seen someimpact of the economy there. We’ve also seen some issues around some of theMidwestern cities where unemployment rates have increased significantly.

Mike Schregast

All right. Thank you very much.

Operator

Your next question comes from the line of Michael Exstein.

Michael Exstein -Credit Suisse First Boston

A couple of quick questions; number one, can you talk aboutthe impact of your coupon promotion, the $5 coupon that you had online, whetheryou saw much reaction to that or not, whether your customer does do anythingonline?

Number two, you’ve been in the process of doing these many,many initiatives, which I think are all imaginative and terrific and very much21st century, but how do we judge the relative success? How much worse wouldthings be without those initiatives? Could you give us a sense of that?

And finally, you are sort of rounding the beginning of therollout of the coolers and I don’t think there are very many stores leftincrementally to add coolers, so why do you think your comps actually improvein the second half of the year? Thank you very much. I know that’s a lot.

R. James Kelly

Okay, thanks. Yes, we’ve been pleased with the coupon, the$5 off coupon was a bounce-back opportunity for us to get customers to make anextra trip. The redemptions there were very positive, which indicates that ourcustomers are seeking to opportunities to save money. So we are pleased withthat initiative and we’ll use it again on an ongoing basis.

In terms of the initiatives, it’s always difficult if notimpossible to say how things would be but for. But what I would suggest is thatmany of the initiatives now are driven towards creating a structure that willenable us to have sustainable improvement. You’ve seen some indicators of thatwith our inventory management improving consistently for over seven quartersnow. You’ve seen some indicators of that improvement when you look at storemanager retention that has improved consistently now for several years and isat a level now that we are recognizing some benefits, not only in terms of theinsurance programs but also with the level of execution within our stores.

So I think the initiatives are an active part of who we areand what we are, and that differentiates us I think from many others who havenot tended to share the longer view and have not invested as much in thebuilding of a foundation to support that ongoing growth.

In terms of the food strategy, when we initially discussedthat, we talked about it as a multi-phase initiative that we believed woulddrive significant sales growth over a three- to five-year period. The coolerswas simply an initial launch of that and we were pleased with the results. Butwe’ve built on that cooler program by expanding and tailoring our foodassortment to trips that our customers most frequently make.

Now that tailoring and expansion continues and Howardmentioned today that we’ve got roughly half the chain that we are going toexpand this next spring. The results of simply that expansion has been tocontinue to driving our food sales.

The third phase of that program is the acceptance of foodstamps. So we still have several legs within our food program and it continuesto provide very consistent growth in our trips.

Michael Exstein -Credit Suisse First Boston

Thank you very much.

Operator

Your next question comes from the line of Deborah Weinswig.

Analyst for DeborahWeinswig - Citigroup Global Markets

-- on behalf of Deb. I was wondering if you could elaborateon some of the additional opportunities that you mentioned earlier regardingreassessing your cost structure?

Kenneth T. Smith

Could you repeat that question?

Analyst for DeborahWeinswig - Citigroup Global Markets

Sure. In your prepared comments, you had talked about thecentralized procurement and also just associate retention as ways that you aregoing to try to focus on reducing your expenses and I just wanted to see whatadditional opportunities that, you know, kind of referred to additionalopportunities and I wanted to see what areas they might come from.

Kenneth T. Smith

I think we, as we mentioned, we’re looking to -- we’vehistorically talked about an expense leverage point in the 3% to 3.5% range andin these trying economic times, we are taking a hard look at the expenses andlooking to move that leverage point down below our historic levels.

I think a couple of things of note where we look to focusand gain some expense benefits include the expansion of our centralizedprocurement efforts. We did mention that and that is an ongoing initiative thatwe have and we’ll look to use those processes and technology a little moreexpansively throughout the organization by trying to touch some additionalspend that we -- that are across the company.

A second area we will look to attack is the -- is at thestore facilities level. As we mentioned, we have initiatives in both thefacilities and the energy area where we have implemented a lease managementsystem and are working on our maintenance processes to be more proactive as welook at maintenance needs out in our stores. Our real estate lease managementsystem gives us better visibility and a better ability to manage accruals, etcetera, related to our rent costs.

And in addition, our efforts around associate retention,we’ll continue to work on turnover, reducing turnover and that provides someadditional expense benefits moving forward.

So those are three major areas that we’ll look to expandupon as we look to lower that leverage point.

Analyst for DeborahWeinswig - Citigroup Global Markets

Okay, thanks.

Operator

Your next question comes from the line of David Mann.

David Mann - JohnsonRice & Company

Will you be taking any --

Kenneth T. Smith

David? Operator?

KileyF. Rawlins

Matthew?

Operator

Your next question comes from the line of John Zolidis.

Howard R. Levine

Operator, we did not get the last question. Could we go backto the last question from David Mann, please? We did not hear that.

Operator

Yes, sir. Just one moment. Mr. Mann, your line is open.

David Mann - JohnsonRice & Company

Howard, can you hear me?

Howard R. Levine

Yeah, now we can hear you. Sorry about that, David.Something happened to the line.

David Mann - JohnsonRice & Company

Thank you. Just on the last question, will you be taking anycost out at the store level in terms of payroll? And will you be paying a bonusthis year?

R. James Kelly

The answer to the first part in terms of labor at the storelevel is basically no. We are focused very much on maintaining a compellingplace to shop and a big part of that is the execution at our store associatelevel, so we do not expect to leverage store labor in this current environment.

The second part is bonuses -- we will continue to pay ourstore managers a bonus as they operate and achieve their goals at the storelevel.

David Mann - JohnsonRice & Company

But within the budgets that you are sort of putting outthere with your guidance, does that assume that bonuses will be paid or arebeing accrued?

R. James Kelly

I think there is a significant amount of bonuses in there that’sreflective of the current projection, so that would be something that is lessthan full but is a significant amount of bonus expense still included in theprojections.

It all really depends on how we perform going forward.

Howard R. Levine

We’re four months into our year, David. I can tell you froma senior management perspective that we have not given up the focus on drivingthat bonus and think that we’ve got some initiatives that are going to help usget through that but we haven’t even reported December sales yet. We’ve givenan indication but we’ve got the second, third, and fourth quarter ahead of usand I want everyone on this call as well as the associates at Family Dollar tounderstand that we still have an opportunity and we are working very hard toachieve that bonus.

David Mann - JohnsonRice & Company

Okay, and then on shrinkage, can you give us a little moredetail in terms of why you think shrink did pick up in the quarter? Maybe whatcategories, or were there a group of stores where that was a problem?Especially in light of the fact I guess historically, you’ve talked about whenthe economy does go down, you tend to sort of see a little more shrink pick upunfortunately, with human nature.

R. James Kelly

I think that’s right. Basically, we have our most limitednumber of stores that are inventoried in any given quarter, so the stores thatwe inventoried represented a certain mix that provided us with a modestlyunfavorable shrink number.

However, we internally stay more focused on the leadingindicators and those leading indicators remain quite positive. For example,store manager retention rates continue to improve period over period. Inventorylevels continue to go down, so that’s really the foundation of why we believethat our shrink trend that we’ve had now for several years will continue.

David Mann - JohnsonRice & Company

Great. Thank you for the time.

Operator

Your next question comes from the line of John Zolidis.

John Zolidis -Buckingham Research Group

Good morning. My first question is on SG&A. Was theresome shift of SG&A dollars into the first quarter from the second quarterassociated with the calendar shift?

Kenneth T. Smith

I would -- there’s not a specific number you wouldanticipate shifting due to that shift of that holiday week. Obviously one couldsurmise that the movement of a higher week and a significant number of saleswould shift some variable costs because of that week but I would think that’sgoing to be a pretty small number.

John Zolidis -Buckingham Research Group

Okay, thank you. And then two quick questions on theguidance; for the second quarter guidance, and I realize that there’s a lot ofmoving parts with the prior year, but we’re looking for approximately 160 basispoints decline in operating margins, if you exclude the -- I guess thelitigation costs from the prior year period. Is the majority of that declinegoing to come on the gross margin line or due to deleverage of SG&A?

Kenneth T. Smith

I think it will be a combination of both when you look atthe raw numbers for the second quarter. The deleverage, as we talked about froma top line perspective, when we look at the second quarter was flat to slightlydown comp sales. We are anticipating the deleverage creates a fairly significantdeleverage from an expense perspective.

So I would think most of -- in our models, most of theoperating margin deleverage comes from expenses. There is a small amount comingfrom gross margin but the majority will be from the SG&A line.

John Zolidis -Buckingham Research Group

Okay, thank you. And then, looking into the back half, youcited three categories -- laundry, food, and paper -- as some areas where youexpected improvement to drive the overall comps from the slightly negativeterritory that we are in now into the slightly positive territory. I guess ifthose three categories are together about 20% of your sales, it looks like youare roughly expecting double-digit increases in each of those categories. Isthat a fair analysis?

R. James Kelly

I think what we are referring to is our core consumables,which are roughly 60% of our sales. So those will continue to trend on thesingle digit area, low to middle single digit area primarily, with food being abit higher than that. And that, combined with the fact that the mix ofdiscretionary versus consumable sales in the back half is much higher weightedtowards the consumables, should lead to the positive comp.

John Zolidis -Buckingham Research Group

Thank you. That’s helpful.

Operator

Your next question comes from the line of William Keller.

William Keller - FTNMidwest Securities

First off, when you mentioned the store growth plans forthis year, I think you said 2% to 4%. Does that represent a change at all fromguidance you’ve given previously?

And then, if you could talk a little bit about how you aredealing with food inflation, if you are making any changes in mix, especiallyI’m thinking in terms of the cooler merchandise. Thank you.

R. James Kelly

I think the 2% to 4% is representative of our broader,long-term view of where we are going. I think we are out there with a number ofroughly 250 and we are somewhere in that ballpark one way or another. But ourfocus, as we’ve mentioned, is not in trying to maximize the number of newstores that we open. Our focus is on driving the returns on our stores anddriving returns on our inventory.

I think we are still within the ballpark of what we’ve laidout but we’ll have to wait and see.

William Keller - FTNMidwest Securities

And then, is that 250 number, is that gross or a net figure?

R. James Kelly

That would be gross.

William Keller - FTNMidwest Securities

And then as far as the impact of food inflation, if any?

R. James Kelly

Food inflation has been challenging, as you know, but whatwe have had to do there is to really leverage our buyers within that category,as well as the pricing group. We’ve had some selective items that are very keyitems that the margin has deteriorated significantly, as we’ve maintained pricecompetitiveness. On the other hand, we’ve had some items that we have been ableto successfully increase the margins.

In the aggregate, our margin in the food categories isslightly positive to the prior year.

William Keller - FTNMidwest Securities

Great. Thank you very much.

KileyF. Rawlins

I think we’re ending at the 11:00 hour. Operator, we’ll takeone more call.

Operator

Your next question comes from the line of Michael Baker.

Michael Baker -Deutsche Bank

It doesn’t sound like you are going to give a number as towhere you leverage your SG&A, what 3% are we looking now -- more like zeroto one or one to two. I’m not sure if you are ready to quantify that.

Secondly, I may have missed this at the beginning -- if Idid, I apologize -- does your guidance assume -- what does your guidance assumefor the share count for the coming quarter and an average for the year?

And then lastly, what are you doing with the rebranding? Ididn’t quite understand that when you talked about rebranding in some of yourstores. Thanks.

Kenneth T. Smith

Pinpointing a number on our leverage, expense leveragepoint, we’re not prepared to put out an exact number there. As you are aware,we’ve talked historically in the 3% to 3.5% range and our efforts, as we’vediscussed on a few fronts here, are to move that leverage point down as we lookto the back half of the year.

Regarding the share count, our current outstanding sharesare around the 140.5 million shares. We have a $150 million authorizationoutstanding, of which we haven’t executed against at all. So we do -- theguidance does assume some repurchase of stock against that authorization in theback half of the year.

Did that answer the question for you?

Michael Baker -Deutsche Bank

It did. So I guess you’re not -- I mean, you must have inyour budget a number there. Is it just that you are not ready to share thatnumber?

Kenneth T. Smith

No, we’re not prepared to share that number at this time.

Michael Baker -Deutsche Bank

Okay, and then real quick, because I know people want tojump off the call, but thirty seconds on the rebranding effort -- are we stillgoing to be called Family Dollar?

Howard R. Levine

We’re going to be called Family Dollar and really, Iappreciate the question because when you ask about Family Dollar, the primaryfocus on the rebranding is on family. This started with all of our conceptrenewal efforts. Some of you might have been through some of those stores wherewe have changed colorizations, we’ve changed some fonts, tried to update thelook and what you will find in our store is a better coordination of signage,better messaging to our customer, and hopefully an improved look with bettercolorizations to just give a better look and feel to our store.

Michael Baker -Deutsche Bank

Okay, thanks.

KileyF. Rawlins

That concludes our Q&A session for today. Thank youagain for joining us. As always, we’ll be available after the call if you haveadditional questions. Thank you.

Operator

This concludes today’s Family Dollar Holdings Inc.conference call. You may now disconnect.

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