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Family Dollar Stores, Inc. (NYSE:FDO)

F1Q08 Earnings Call

January 8, 2008 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

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 conference facilitator today. At this time, I would like to welcome everyone to the Family Dollar first quarter 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, Matthew. Good morning and thank you for joining us today. We appreciate your continued interest in Family Dollar. 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 plan. 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, January 8, 2008. The company does not undertake to publicly update or revise its forward-looking statements except as required by law.

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

Howard R. Levine

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

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

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

We saw this effect of this focus on our sales mix during the quarter. Sales of basic consumables like food and household chemicals performed as 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 result was lower-than-planned top line growth and greater pressure on gross margin. In addition, despite delivering lower-than-budgeted SG&A expense during the quarter, our low comp performance resulted in more SG&A deleverage than we had originally anticipated.

These trends continued through the December period and are reflected in our second quarter outlook. On Thursday, we will report final results for the December period but our preliminary results indicate that comparable store sales declined approximately 1%. Sales of consumable products continued to be the driver of sales, while sales in many discretionary categories continued to be soft.

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

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

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

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

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

Second, as with most retailers, our laundry assortment is moving to smaller but more concentrated formulations, an industry move sometimes referred to as compaction. This transition has allowed us to add some larger sizes, value sizes, and expand the facings of better selling items, and selectively broaden the assortment, all within the same space.

This fall, we converted approximately 2,700 stores and we’re pleased with the customer response. Approximately 3,600 additional stores will be converted this spring.

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

We have developed a plan to implement these assortment and fixture changes in our stores this spring. While these changes may result in potential for near-term sales disruption, we are confident that they will drive stronger 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 hunt has a role in helping our customers feel good about taking care of their families. We will continue to meet these needs while taking a restrained approach to manage inventory risk.

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

Our centralized procurement efforts are delivering savings as planned and our improvements in associate retention have resulted in tangible savings in worker compensation claims. We believe there are additional opportunities to lower our cost of doing business and our team is working hard to reduce expenses.

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

Project Accelerate remains an investment priority for us and is critical to our long-term goals of improving the shopping experience of our customers, the productivity of our inventory, and the efficiency of our supply chain.

At the heart of Project Accelerate is significant cultural change as we transition to more centralized processes that enable operational specialists, like our pricing group, to provide buyers with institutional expertise.

Since launching the project in the fall of 2006, we have made great progress. For example, during the first quarter, we maintained initial mark-ups, improved inventory turns, and GMROI, despite inflationary pressures and lagging sales of higher margin discretionary items.

The development of our global sourcing initiative also continues to progress as planned. With more than 40% of our merchandise manufactured outside the U.S., improving the efficiency of our global sourcing processes represents a significant opportunity for us to reduce our cost over the longer term. Although we are incurring additional costs near term as we develop this organization, this new team is helping us drive improved quality and greater value for our customers.

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

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

Our concept renewal effort is our longer term initiative focused on delivering an enhanced shopping experience to more intuitive store layouts and design. Since last spring, we have incorporated these ideas into new stores and we have seen the benefit from these changes in improved new store performance.

This fall, we begin to evaluate several renovation strategies to assess the sustained impact of incorporating the concept renewal elements in existing stores. In addition, this month we have begun a rebranding effort in all stores, which incorporates many of the communication elements from concept renewal, including our in-store handouts, promotional events, and in-store signage.

New store growth continues to be an investment priority for us and in fiscal ’08, we expect to invest approximately 20% of our capital budget in new stores. However, given our focus on improving processes to derive higher shareholder returns, we will continue to constrain new store growth to an expansion rate of approximately 2% to 4% until we see an improvement in our overall operating margins.

In summary, while our first quarter financial results were not as strong as we had planned, we have made progress in the pursuit of our strategic objectives. Over the next several months, we will work aggressively to strengthen our assortment of basic consumables while repositioning our treasure hunt strategy to reflect our customers more limited budgets. These efforts should result in improved performance in the second half of fiscal ’08.

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

Kenneth T. Smith

Thank you, Howard. As Howard mentioned, the first quarter proved to be more challenging than we expected. Weakness in discretionary categories led to higher markdowns and a less favorable than planned mix during the quarter. In addition, softer comp store sales contributed to a greater deleverage of SG&A expenses. The result was an increase in diluted earnings per 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 of post-Thanksgiving sales. This creates some comparability issues as we look at results for the first quarter and our expectations for the second quarter.

Let’s start with a review of sales. Sales for the quarter increased 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 this year included a week of post-Thanksgiving sales, which benefited sales of toys and trim-a-tree during the quarter.

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

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

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

Inventory shrinkage increased in the quarter. While inventory shrinkage can be somewhat volatile from quarter to quarter, we continue to believe that the improvements we have made in store manager retention and inventory productivity will result in lower inventory shrinkage over 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 in the first quarter last year.

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

With the goal of better managing store occupancy costs, we are creating a more proactive facility management platform which includes the implementation of a new lease management system that provides us with better visibility to store lease expenses and also includes a more proactive approach to maintenance and repair needs.

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

Over the last two years, as we have stabilized our store management teams, we have seen benefits in other areas of our business -- most notably, workers’ compensation claims. In fact, in seven of the last eight quarters, we have experienced a reduction in insurance costs as a percentage of sales. Clearly our focus on associate retention is producing positive results.

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

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

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

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

Capital expenditures for the quarter were approximately $37 million. We continue to expect that capital expenditures for the year will be between $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 the implementation of the sales driving initiatives that Howard discussed, we expect that the comp store sales trend in the second half will improve modestly and will contribute to earnings growth in the second half of fiscal 2008.

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

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

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

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

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

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

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

Howard R. Levine

Thanks, Ken. We expect fiscal 2008 to remain challenging for our customers and our earnings guidance reflects this outlook. When times are difficult, especially during the frenzied holiday selling season, retailers can sometimes run the risk of becoming overly short-term focused and lose their view of the big picture.

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

We are taking immediate actions to better focus our merchandising efforts and lower inventory risk, and we are curtailing expenses to reflect a more challenging sales environment. These actions, along with the transition to a more consumable weighted mix, are expected to lead to improvements 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 are driving operational improvement despite some challenging headwinds. We continue to fund initiatives like Project Accelerate, store of the future, global sourcing, and concept renewal even during these challenging times because they form the catalyst for current and longer term performance improvement.

As we continue to become more cost effective while also investing aggressively to improve our longer term capabilities, we have an opportunity to strengthen our market share and position Family Dollar to accelerate returns as the economy improves.

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

Question-and-Answer Session

Operator

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

Charles Grom - J.P. Morgan

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

Kenneth T. Smith

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

Charles Grom - J.P. Morgan

Okay, that’s great. And if I recall, the 53rd week last year that 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 getting their act together a little bit more. I was wondering if you could comment on what 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 just wondering how you position yourselves over the next couple of years as they start to reemerge under the KKR brand.

Howard R. Levine

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

So we think we’ve got the right focus and frankly think that if we execute, and I’ve said this for many, many years when we look at talking about Family Dollar and comparing us to others in our niche, that we are doing about $1 million a store. There is substantial opportunity for all of us to improve our market share. It depends on who executes and that’s really what our focus is. We’re worried about how we execute and how we perform and history has shown 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 your guidance, in order to do flat to I guess modestly an increase in same-store sales, that would imply roughly about a two to three in quarters -- the third and fourth quarter. To me, that looks a little bit aggressive, knowing what we know today. If you could comment on where you may be wrong in terms of your outlook and the sensitivity to that on your guidance that you just provided this morning. Thanks.

Howard R. Levine

Let me start off on that because Chuck, there’s no question it’s very difficult to project and give guidance during the challenging economic 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 when we look at where we’ve had success, for example, a couple of years ago we talked about what the importance of food would be at our assortment. We’ve added coolers, we’ve expanded food in existing stores, we’re adding another 2,700 stores the second half of this spring. We talked about other consumables that we are adding to our stores and incidentally, the food area has been performing quite well for us.

So yes, there are things that can happen. We’re not economists in here. We’re trying to look at what are customers facing today and believe strongly that we’ve got the right focus on at least positioning us the right way in a challenging economic environment.

Ken, you may want to give a little more color on the trend in 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 but they are positive so we are looking for a change in the trend from a slightly negative 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 - Lehman Brothers

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

R. James Kelly

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

As a result of that, we have in a more systematic way established prices as we’ve gone through this past year. So from a key item perspective -- that is, those items that our customers are most sensitive about and have the greatest elasticity, we have actually lowered those prices in many cases. For less sensitive items, we have been able to pass through cost increases and as a result of that, we have maintained our purchase markups.

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

John Roberts - Lehman Brothers

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

R. James Kelly

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

So our price perception remains very, very strong today.

John Roberts - Lehman Brothers

And then if I could ask one other question, the flexibility with 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 be probably the riskiest category? How much flexibility is there longer term?

R. James Kelly

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

John Roberts - Lehman Brothers

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 to increasing consumables? I mean, already a very competitive category. Can you just talk about I guess more of the gross profit margin benefit, how you can manage 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 done quite a bit of customer research, starting with the food initiative, starting with adding the coolers, which put us in the business of getting a trip that we weren’t even eligible for a few years ago. Subsequent to that, we’ve added additional square footage to food, plan to add a little bit more, and as I indicated, by the end of the year, we’ll be in a position to accept food stamps in about 30% of the chain.

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

Longer term, we do believe the benefit of treasure hunt is extremely important to our mix and are not getting out of that business. I think it’s important to realize while we are curtailing expenses in an effort to control markdowns and inventory risk, longer term we still believe it is important 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’re making in consumables as well as some of the ways we’re attacking our treasure hunt strategy will position us nicely for the future.

R. James Kelly

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

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

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

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

Mike Schregast

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

Kenneth T. Smith

Our transportation, our freight costs are included in our cost of goods sold and affect gross margin. We are obviously seeing the pressure 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 our cost of goods sold.

It wasn’t a material variance for us this year, this quarter when we look at the effect on gross margin. We work hard to mitigate it with some processes in here from both the routing perspective and cube utilization that our transportation group performs. But it is something we are watching very close as we move forward and expect to have pressure from rising fuel costs as we move forward.

Mike Schregast

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

R. James Kelly

Well, I think we continue to see some strength in many of the core areas but the weakest areas, I would say Florida, we’ve seen some impact of the economy there. We’ve also seen some issues around some of the Midwestern 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 about the impact of your coupon promotion, the $5 coupon that you had online, whether you saw much reaction to that or not, whether your customer does do anything online?

Number two, you’ve been in the process of doing these many, many initiatives, which I think are all imaginative and terrific and very much 21st century, but how do we judge the relative success? How much worse would things be without those initiatives? Could you give us a sense of that?

And finally, you are sort of rounding the beginning of the rollout of the coolers and I don’t think there are very many stores left incrementally to add coolers, so why do you think your comps actually improve in 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 an extra trip. The redemptions there were very positive, which indicates that our customers are seeking to opportunities to save money. So we are pleased with that initiative and we’ll use it again on an ongoing basis.

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

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

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

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

The third phase of that program is the acceptance of food stamps. So we still have several legs within our food program and it continues to 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 Deborah Weinswig - Citigroup Global Markets

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

Kenneth T. Smith

Could you repeat that question?

Analyst for Deborah Weinswig - Citigroup Global Markets

Sure. In your prepared comments, you had talked about the centralized procurement and also just associate retention as ways that you are going to try to focus on reducing your expenses and I just wanted to see what additional opportunities that, you know, kind of referred to additional opportunities 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’ve historically talked about an expense leverage point in the 3% to 3.5% range and in these trying economic times, we are taking a hard look at the expenses and looking to move that leverage point down below our historic levels.

I think a couple of things of note where we look to focus and gain some expense benefits include the expansion of our centralized procurement efforts. We did mention that and that is an ongoing initiative that we have and we’ll look to use those processes and technology a little more expansively throughout the organization by trying to touch some additional spend that we -- that are across the company.

A second area we will look to attack is the -- is at the store facilities level. As we mentioned, we have initiatives in both the facilities and the energy area where we have implemented a lease management system and are working on our maintenance processes to be more proactive as we look at maintenance needs out in our stores. Our real estate lease management system gives us better visibility and a better ability to manage accruals, et cetera, 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 some additional expense benefits moving forward.

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

Analyst for Deborah Weinswig - Citigroup Global Markets

Okay, thanks.

Operator

Your next question comes from the line of David Mann.

David Mann - Johnson Rice & Company

Will you be taking any --

Kenneth T. Smith

David? Operator?

Kiley F. 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 back to 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 - Johnson Rice & 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 - Johnson Rice & Company

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

R. James Kelly

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

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

David Mann - Johnson Rice & Company

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

R. James Kelly

I think there is a significant amount of bonuses in there that’s reflective of the current projection, so that would be something that is less than full but is a significant amount of bonus expense still included in the projections.

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 from a senior management perspective that we have not given up the focus on driving that bonus and think that we’ve got some initiatives that are going to help us get through that but we haven’t even reported December sales yet. We’ve given an indication but we’ve got the second, third, and fourth quarter ahead of us and I want everyone on this call as well as the associates at Family Dollar to understand that we still have an opportunity and we are working very hard to achieve that bonus.

David Mann - Johnson Rice & Company

Okay, and then on shrinkage, can you give us a little more detail in terms of why you think shrink did pick up in the quarter? Maybe what categories, 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 when the economy does go down, you tend to sort of see a little more shrink pick up unfortunately, with human nature.

R. James Kelly

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

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

David Mann - Johnson Rice & 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 there some shift of SG&A dollars into the first quarter from the second quarter associated with the calendar shift?

Kenneth T. Smith

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

John Zolidis - Buckingham Research Group

Okay, thank you. And then two quick questions on the guidance; for the second quarter guidance, and I realize that there’s a lot of moving parts with the prior year, but we’re looking for approximately 160 basis points decline in operating margins, if you exclude the -- I guess the litigation costs from the prior year period. Is the majority of that decline going 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 at the raw numbers for the second quarter. The deleverage, as we talked about from a top line perspective, when we look at the second quarter was flat to slightly down comp sales. We are anticipating the deleverage creates a fairly significant deleverage from an expense perspective.

So I would think most of -- in our models, most of the operating margin deleverage comes from expenses. There is a small amount coming from 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, you cited three categories -- laundry, food, and paper -- as some areas where you expected improvement to drive the overall comps from the slightly negative territory that we are in now into the slightly positive territory. I guess if those three categories are together about 20% of your sales, it looks like you are roughly expecting double-digit increases in each of those categories. Is that 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 the single digit area, low to middle single digit area primarily, with food being a bit higher than that. And that, combined with the fact that the mix of discretionary versus consumable sales in the back half is much higher weighted towards 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 - FTN Midwest Securities

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

And then, if you could talk a little bit about how you are dealing with food inflation, if you are making any changes in mix, especially I’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 of roughly 250 and we are somewhere in that ballpark one way or another. But our focus, as we’ve mentioned, is not in trying to maximize the number of new stores that we open. Our focus is on driving the returns on our stores and driving returns on our inventory.

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

William Keller - FTN Midwest Securities

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

R. James Kelly

That would be gross.

William Keller - FTN Midwest 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 what we 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 key items that the margin has deteriorated significantly, as we’ve maintained price competitiveness. On the other hand, we’ve had some items that we have been able to successfully increase the margins.

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

William Keller - FTN Midwest Securities

Great. Thank you very much.

Kiley F. Rawlins

I think we’re ending at the 11:00 hour. Operator, we’ll take one 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 to where you leverage your SG&A, what 3% are we looking now -- more like zero to 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 I did, I apologize -- does your guidance assume -- what does your guidance assume for the share count for the coming quarter and an average for the year?

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

Kenneth T. Smith

Pinpointing a number on our leverage, expense leverage point, 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’ve discussed on a few fronts here, are to move that leverage point down as we look to the back half of the year.

Regarding the share count, our current outstanding shares are around the 140.5 million shares. We have a $150 million authorization outstanding, of which we haven’t executed against at all. So we do -- the guidance does assume some repurchase of stock against that authorization in the back 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 in your budget a number there. Is it just that you are not ready to share that number?

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 to jump off the call, but thirty seconds on the rebranding effort -- are we still going to be called Family Dollar?

Howard R. Levine

We’re going to be called Family Dollar and really, I appreciate the question because when you ask about Family Dollar, the primary focus on the rebranding is on family. This started with all of our concept renewal efforts. Some of you might have been through some of those stores where we have changed colorizations, we’ve changed some fonts, tried to update the look 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 better colorizations to just give a better look and feel to our store.

Michael Baker - Deutsche Bank

Okay, thanks.

Kiley F. Rawlins

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

Operator

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

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