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September 28, 2006

Family Dollar Stores F4Q06 (Qtr End 8/26/06) Earnings Call Transcript (SeekingAlpha)

Filed under: Conference Call Transcript — Tags: — admin @ 12:00 am

Executives

Kiley Rawlins – Divisional VP, IR, Communications

Jim Kelly – President, COO, Interim CFO

Howard Levine – Chairman, CEO

Analysts

Dan Wewer – Raymond James

Bernard Sosnick – Oppenheimer

Scott Malat – Goldman Sachs

Michael Baker – Deutsche Bank

David Mann – Johnson Rice

Barclay Smith – Banc of America

John Zolidis – Buckingham Research

Deborah Weinswig – Citigroup

Meredith Adler – Lehman Brothers

Presentation

Family Dollar Stores (FDO) F4Q06 Earnings Conference Call September 28, 2006 10:00 AM ET

Operator

Welcome to the Family Dollar fourth quarter and year end earnings conference call. (Operator Instructions) Now I will turn the meeting over to Ms. Kiley Rawlins, Divisional Vice President of Investor Relations and Communications. Ms. Rawlins, you may begin.

Kiley Rawlins

Good morning, everyone and thank you for joining us today. With me this morning are Howard Levine, Chairman and CEO; and Jim Kelly, President, COO and interim CFO. Before we begin, you should know that our comments today will include forward-looking statements which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act. These statements address company plans and activities or events which we expect will or may occur in the future. However, a number of factors as set forth in our SEC filings and press releases could cause actual results to differ from our plans. We refer you to and specifically incorporate the cautionary statements contained in today’s press release and our other SEC filings. You are cautioned not to place undo reliance on these forward-looking statements, which speak only as of today’s date. The Company does not undertake to publicly update or revise its forward-looking statements.

In addition, this morning we will discuss non-GAAP financial measures, which are intended to help investors understand Family Dollar’s ongoing business performance. These measures include operating expenses, net income, and earnings per diluted share, each excluding litigation charges. A reconciliation of these non-GAAP financial measures to the comparable GAAP financial measures is included in our earnings release issued this morning and available on our website in the news releases section of our investor page.

Before we begin our discussion this morning, I want to remind you that we’re hosting an Analyst Day here in Charlotte on October 17. Details are available in the calendar of events section of our website and registration will close October 13. If you have any questions, please contact me after this call.

Now on to the heart of the call. We will begin our discussion this morning with some comments on our recent financial results from Jim and then Howard will share some of his thoughts with you.

Jim Kelly

Thank you. Good morning and thanks for joining us. Last year during the fourth quarter conference call, we reported a 28% decline in earnings per share. During the call, we highlighted a plan to slow down certain areas of our business, while accelerating other areas that were performing well. We also talked about leveraging our key initiatives and focusing on enhancing productivity throughout our company.

Today, we reported that net income for diluted shares for the fourth quarter of fiscal 2006 increased 44% to $0.26 compared to $0.18 for the fourth quarter of fiscal 2005. For the year, net income per diluted share, excluding the litigation charge incurred in the second quarter, increased roughly 14% to $1.48 compared to $1.30 in fiscal 2005.

Other financial metrics also signal operational improvements. Most importantly, comp store inventories were down 10% at year end, helping to make our stores easier to shop and to operate. Our guidance for next year reflects a continuation of the cadence and direction set in fiscal 2006. We will continue to manage a portfolio of initiatives designed to improve traffic in our stores and drive sales of higher-margin merchandise. We also continue to pursue opportunities to further enhance our financial results. More on that in a moment, but first a little more detail on fourth quarter and fiscal 2006 results.

Sales increased approximately 10% for the year, driven by the addition of 350 new stores and a 3.7% increase in comp sales. Sales in the fourth quarter increased 10% driven by new store growth and a 4.9% comp increase. For the year, the highest sales increases were in the electronics department and the consumables category. This year, we began offering prepaid cell phones and minutes in our stores, and our customers have appreciated the flexibility of these services, driving nice increases in our electronics department. The continued rollout of coolers, as we seek to better meet our customer’s frequent food needs has contributed to solid sales in our consumables category.

Sales in the fourth quarter were driven by increases in food, electronics, and apparel. Our well-executed apparel clearance event in July attracted customers into the apparel area, where they not only bought marked-down product, but also appreciated our well presented, regular price merchandise.

While sales trends during the fourth quarter were consistent with those reported in earlier quarters to include a larger transaction size and slightly lower transaction counts, the rate of decline in transaction counts has decelerated nicely. In the first quarter, our transaction counts declined 2%; and in the fourth quarter, transaction counts declined less than 1%. We believe that these trends may reflect stabilization of shopping habits.

Gross margin has been well managed this year. While we continue to feel the pressure of higher fuel costs, a more favorable sales mix, slightly higher initial markups, and a modest improvement in shrink contributed to a 20 basis point improvement in fiscal 2006 gross margin as a percent of sales. As a percent of sales, the effect of markdowns was neutral. These trends were also consistent in the fourth quarter. The percent of sales of consumable merchandise remained relatively flat in fiscal 2006 compared to fiscal 2005, even as we expanded our cooler program to an additional 2,800 stores this year.

As we indicated two years ago when we began investing in our key initiatives, our goal was to leverage the traffic-driving food strategy with a profit-driving benefit of the Treasure Hunt merchandise strategy. Our gross margin results for fiscal 2006 and the fourth quarter reflect this balanced approach.

For the year, SG&A expenses as a percentage of sales increased 20 basis points. As a percentage of sales, the effect of expensing equity-based compensation and an increase in annual bonus compensation adversely impacted SG&A expenses by approximately 40 basis points, and higher utility costs added another 20 basis points. Most other expense categories were leveraged as a result of improved cost control and the 3.7% growth in comp store sales.

We were particularly pleased with the improved performance of our urban initiative stores. In the fourth quarter, we leveraged SG&A expenses as a percentage of sales by approximately 30 basis points, reflecting a solid comp performance, the continued improved performance of our urban initiative markets, and other cost containment efforts, all of which more than offset continued pressure from utility costs.

The expensing of stock options this year added about 20 basis points to fourth quarter expenses.

There are two other expense items impacting the fourth quarter results that I would like to highlight. As you may recall, last year the fourth quarter was negatively impacted by approximately 60 basis points related to the recording of property taxes on leased properties. Also last year, we reversed bonus accruals recorded earlier during the year resulting in a credit in the fourth quarter. This year, we had a more normal bonus accrual in the fourth quarter. This difference in the bonus accrual added approximately 60 basis points to this year’s fourth quarter expenses. In other words, these two items had offsetting impacts.

Now we would like to update you quickly on a few other financial matters. We continue to improve the inventory productivity of our basic and fashion assortment. As I mentioned earlier, inventories at the end of fiscal 2006 were approximately 10% lower on a per-store basis than at the end of fiscal 2005. The continued expansion of our store replenishment system has resulted in lower inventory levels of basic merchandise and better in-stock levels. While inventories were lower in all categories, the apparel and accessory category had the most significant improvement with inventories on a per-store basis more than 20% lower than last year.

In fiscal 2006, we spent approximately $192 million on capital expenditures, including approximately $63 million for new stores, $46 million for new distribution center investments to expand our distribution capacity, and $26 million in support of the cooler rollout. As we mentioned in the press release, in fiscal 2006 we purchased 15.4 million shares of stock at a total cost of $367.3 million.

Now for our outlook for fiscal 2007 and the first quarter. First, let me remind you that fiscal 2007 is a 53-week year. Like most other retailers, the extra week will occur in the January period. Consequently, our second quarter will include 14 weeks in fiscal 2007 compared with 13 weeks in fiscal 2006.

In the press release this morning, we provided earnings per share guidance for fiscal 2007 of between $1.57 and $1.69 representing a range of up 6% to 14%. This excludes the litigation charge incurred in the second quarter of fiscal 2006.

We have assumed the macro environment will continue to be challenging for our customers in fiscal 2007. We will target a 5% net increase in square footage growth to allow us to continue to focus on improving our financial returns, and we will continue to build upon the foundation we’ve established and focus on our three comp-driving initiatives.

We plan to install coolers in an additional 1,000 stores, expand our new food assortment to 1,300 stores, and expand our food stamp acceptance capability to 750 stores. We will continue to refine and improve the execution of our Treasure Hunt strategy, to include the development of more impactful displays, and even greater emphasis on fashion inventory turns.

Urban markets continue to represent a significant opportunity to provide under-served customers with value and neighborhood convenience. This year, we will continue to focus on driving improved returns in existing urban markets. Our plans include implementing a new technological platform that will facilitate better customer service and make our stores easier to operate. We also will test new price optimization processes. We believe these investments will deliver same-store sales increases in the 2% to 4% range.

Overall, we expect pressure on gross margin from higher transportation costs and a mix shift led by the expanded food strategy. There’s a great deal of uncertainty in the global energy environment today, and while we are encouraged by current trends, we’re not prepared to build the improvement into our projections for the next 12 months. On the other hand, we expect to largely mitigate these pressures with lower overall markdowns and less shrink.

Overall, we’re modeling a flat to down slightly gross margin. We continue to focus on increasing our productivity through process improvement and limited cost growth so that at a 3% to a 3.5% comp store growth rate, we would expect to leverage expenses modestly. These are the underlying assumptions supporting our guidance of earnings per share between $1.57 and $1.69.

Now for a few comments about the first quarter. As we mentioned in the press release, September sales are trending slightly below our plan. As you will recall, last year we had a number of hurricanes affect operations in the September period. Frankly, forecasting the impact in September of this year has proven to be more challenging than we anticipated. While over the long term we believe that the impact of a typical hurricane is neutral, there can be significant abnormalities in the short-term as customers stock up in anticipation of the storm, our stores are disrupted during the storm, and as customers begin to clean up after the storm. Stores in areas which were not impacted by storms last year are performing in line with current plans.

In the first quarter, we expect comp sales to increase 2% to 4% and expect earnings per share to be between $0.34 and $0.38. Our underlying assumptions include expected pressure on gross margin from higher transportation and markdown expenses, which may be somewhat mitigated by lower shrink.

One final detail. We plan capital additions in fiscal 2007 to be in the range of $190 million to $200 million. Now Howard will add the strategic perspective.

Howard Levine

Thanks, Jim. Good morning. Two years ago, we began to implement an aggressive investment agenda in support of our mission to create a more compelling place to shop, work, and invest. We focused on four key initiatives to increase our relevancy to the customer and improve our operational execution. At the time, we discussed with you that the short-term impact would likely deviate from our historical performance, but that we intended to build a foundation that would support stronger, long-term returns.

In fiscal ’06, we continued to focus on these key initiatives, accelerating investments where appropriate and slowing investment in areas where we needed to stabilize processes. We have made considerable progress, but we are not where we want to be.

Our customers are some of the most under-served in retailing, and we are committed to providing them with a compelling place to shop. Over the last ten years, this commitment has been reflected in the expansion of our merchandise assortment to satisfy more basic needs and in the move away from a high/low promotional pricing strategy to an everyday pricing strategy. More recently, our commitment has been reflected in our expanded food assortment and Treasure Hunt strategy.

We know that our customers frequently make small fill-in food trips. To capture these trips, we began to enhance our food assortment. The first phase of this initiative was the roll out of coolers, and we have been very pleased with the results. Today, about 3,800 stores, or about 60% of the chain, have refrigerated coolers for the sale of perishable food. This year, we will continue to expand the cooler program and we will begin the next phase of the initiative by broadening our non-perishable food assortments.

For the last several months, we have tested an expanded assortment of food designed to leverage the coolers and this spring we will launch a new enhanced food assortment in approximately 1,300 stores. The linkage will enable us to capture more frequent food trips. In addition, this year, we will expand our EBT acceptance capability, including food stamps, in 750 stores.

When we began our enhanced food initiative, we recognized that while it would drive traffic, it would also pressure gross margin. That is why we also launched the Treasure Hunt merchandise program. While our customers depend on us for basic needs, they like the unexpected surprises they can find in our stores. We define Treasure Hunt merchandise as higher margin goods that create customer excitement, differentiate us from our competition, and require better merchandising and marketing, including clearly defined exit strategies.

We have a long history of managing fashion and seasonal businesses and we have invested in systems, people, and processes to develop a strategic capability in these categories. The most recent chapter in the evolution of Treasure Hunt strategy focused on item selection, presentation, and marketing. Our next chapter will focus on improving inventory flow, planning, and allocation. In addition, we will continue to focus on enhancing the appeal and productivity of our apparel selections.

Offering an assortment that fulfills our customer’s needs is an integral part of creating a compelling place to shop, but creating an appealing shopping experience is also critical. Frankly, consistently providing a pleasant shopping experience for our customer has historically been one of our biggest challenges. Our urban initiative and our focus on improving productivity are two examples of how we are working to improve the shopping experience.

We have served customers in urban markets for more than 30 years, and we know how challenging operating in an urban market can be. Yet often in these markets, low-income customers have few retailing alternatives that provide both value and convenience. And this provides an exciting opportunity for us.

To consistently provide a pleasant shopping experience, we needed industrial-strength tools to adjust to the fast-paced urban market. We began addressing these needs several years ago by introducing technology tools to help our field teams manage by exception. We created hiring, screening, and selection processes designed to help us select talent that could be successful in these more challenging markets. More recently, we created a new operating structure with additional resources that enable us to respond more quickly to the velocity of the urban markets.

While we have made a lot of progress this year, we still have tremendous amount of opportunity to improve. To help us improve customer service and increase our productivity, this year we will begin a multi-year implementation of a new store technology platform as part of our Store of the Future program. This new system will enable us to process customers faster, improving the customer shopping experience. In addition, the exception-based reporting and enhanced management tools will make our stores easier to operate.

Another key to providing a pleasant shopping experience is better inventory management. High inventory levels can often lead to a cluttered feel and often make presenting merchandise difficult. We have new leadership in our merchandising area who are working with supply chain and store operations to make our stores more shoppable. As Jim mentioned, inventory levels in fiscal ’06 were much better controlled and we believe we have an opportunity to continue to increase our inventory productivity.

This year, we will initiate a new multi-year effort to optimize our merchandising and supply chain operations through a review of processes, personnel needs, and technology tools. These efforts will include price optimization, store clustering, category management, space management, and improved assortment planning. As part of this effort, we will begin a more robust testing of a new price optimization strategy this year, partnering with some outside expertise to gain a better understanding of price elasticity and customer segmentation. While this is only the beginning of a multi-year effort, it is another step towards making our stores a more compelling place to shop.

As we seek to maintain a continuous pipeline of initiatives to sustain profitable growth, we have created a research and development effort we call concept renewal. We have developed processes where we can incubate new ideas and evaluate customer reactions. This summer, we opened our first concept renewal store where we are testing different design elements and layouts. If you are able to join us for our Analyst Day in October, we will show you some of the things we are thinking about as we try to improve our assortment, adjacencies, and overall customer experience. Our current plan is to incorporate some of these new ideas into new stores that we open in calendar 2007.

To support our aggressive growth agenda, we must recruit, develop, and retain talented associates. Over the last several years, we have automated our screening and selection processes to make it easier to recruit and select talent and we have established clear career paths to give our associates the opportunity to develop a career with us and to increase our appeal as an employer.

To retain talented associates, we must create a workplace in which they can succeed. For several years, we have made investments designed to simplify processes and make our stores easier to operate. As an example, several years ago we developed order shelf processes that make it easier to unload a truck and restock shelves. In addition, this year our focus on improving inventory productivity and flow has made it easier for managers to operate our stores.

We have experienced some of the benefits of these efforts in our store manager retention trends. This year, we have seen progressive improvement in our store manager retention rates. We are especially pleased with the trends in urban markets, where store manager turnover declined 11%. While we are pleased with these trends, we still believe that we can do better. As with many measurements, a small group of stores disproportionately affects the total results. We have drilled down on the issues driving turnover and have created a plan to address specific issues as we seek to increase overall store manager retention.

While our returns improved in fiscal ’06, we have tremendous opportunity to drive even stronger returns for our shareholders. To create a compelling place to invest, we must balance investments to support new store growth with investment that drive improved returns from existing assets. While recently we have slowed our growth, I believe that we have the potential to increase square footage at a faster rate, but I am determined that we will have the capability to do so in a profitable, return sensitive way.

We have worked this year to improve our site selection and development processes, but we still have work to do to make sure that we make the best first impression for customers with each store that we open.

Improving our overall performance is our top priority and we saw some progress in fiscal ’06. While we will continue to open a significant number of new stores, we will constrain this growth in favor of improving our performance in existing stores. As we continue to see overall performance improve, I expect that we will begin to gradually increase our square footage growth.

What differentiates us is our commitment to systemically build a foundation that will support our long-term goals. We have accomplished much over the last several years, but we still have a lot of work to do. We have a strong management team and we are working together in pursuit of our strategy. We will stay patient, balanced, and focused as we pursue an aggressive investment agenda designed to deliver a better shopping experience for our customers, a more successful work experience for our associates, and a stronger investment for our shareholders. Now, operator, we would be pleased to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Dan Wewer, you may ask your question.

Dan Wewer – Raymond James

I wanted to follow-up up with a few questions on inventory management. This is the first year since 2002 that you’ve increased your turns. What do you think that the rate of inventory turns could go, let’s say over the next two years, with the initiatives that you talked about?

Howard Levine

Dan, we’re very pleased with some of the improvements that we’ve made this year in inventory productivity. Our goal in continuing to reduce this is really to make our stores more shoppable. One of the things that we’ve talked about and seen is that that is a big opportunity for us, as I talked about in my comments. We think that with the continuation of our investments in some of the tools as well as some of the management changes and improvements that we’ve made that we can continue to drive productivity.

The benefits are clear when you talk about all areas of our business, whether it’s in the basic assortment or in some of the Treasure Hunt strategies that we’ve talked about. So we’d like to see that continue to improve over the next several years.

Dan Wewer – Raymond James

Let me ask the question this way: in the third quarter of the year just finished, your inventory per foot was down 3% and then it was down over 9% during the fourth quarter. When you look at the 2007 year, do you think the inventory reduction will be closer to 3% or closer to the 9%?

Howard Levine

Probably somewhere in between those numbers, Dan. I think we’ve got opportunity in improving productivity in all areas of the business. I am very pleased with the improvements that we made in the apparel area, something that I’ve been talking about for several quarters. Inventory is down about 20% on a comp basis without any degradation of sales.

We’ll keep driving it and improving it and particularly pleased where we are going into the holiday season and the fact that we’re well positioned to take in our Christmas goods this year.

Dan Wewer – Raymond James

All right. Then the last question I have. In September a year ago, same-store sales were up only 2.6%, so the comparison is relatively easy. How do we know that the 10% reduction in comp inventories is not leading to this below-planned sales performance this month? Thanks.

Howard Levine

One of the things we’ve done, as Jim talked about in his comments, is looked at the areas that have been impacted by the hurricanes and seen what we’re up against there, and compared those to other areas that were not impacted by the hurricanes. What we’ve seen is the areas that are not impacted by the hurricanes are performing in line to our plans. That’s probably the biggest indicator that we’re looking at.

Dan Wewer – Raymond James

Okay, great. Thanks.

Operator

Our next question comes from Bernard Sosnick – Oppenheimer.

Bernard Sosnick – Oppenheimer

Hi. I think your closing comments, Howard, with regard to building the foundation for long-term growth are very clear in the results. I would like to, perhaps, get a little bit more comment on peripheral things that seem to be troublesome to the marketplace, including the comment the other day — whether or not it’s substantiated, is what I want to find out — that a committee has been formed regarding stock options? Secondly, what is the status of a possible appeal to the litigation lost in the second quarter?

Howard Levine

Let me first address the appeal. We’re currently in the process of appealing the Morgan lawsuit. That is going to be a longer process, but continue to believe that we have good defenses there and are looking forward to that appeal. Unfortunately, I’m unable to comment on the stock option litigation.

Bernard Sosnick – Oppenheimer

Was there a committee formed, et cetera, as was reported as a leak just the other day?

Howard Levine

We had disclosed that a special committee of our Board has currently formed a special committee to investigate the issues surrounding the lawsuit.

Bernard Sosnick – Oppenheimer

With regard to inventories which were superlatively controlled, yet you still are in the first quarter in terms of planning, looking for flattish growth and some pressure from markdowns. Wouldn’t that seem inconsistent with the great positioning of your apparel inventories and the markdown risk that seems modest there?

Howard Levine

One of the things that we’ve talked about, Bernie, in running the Treasure Hunt business is that it’s important to have clearly defined exit strategies. We talked about this towards the end of last year. One of the things that we think is important is that we need to have a clearly defined exit strategy and have events surrounding some of these clearance exit strategies. So for example, this July we were talking about changing our approach and being a little more aggressive in clearing goods. Created a very exciting event for our customers during that time period and were able to liquidate apparel inventories very successfully which helped us be in a better position to present the newer goods that are coming in. So I think it’s just our philosophy of marking goods down at the end of the season to clear out, make room for the new goods that are coming in.

Bernard Sosnick – Oppenheimer

Finally, there’s been a significant change in the management team. Could you comment overall on your view of your own role and the support that you’re looking for from this new team?

Howard Levine

Sure. Bernie, we’re very pleased with the changes that we’ve made in our management team over the last several months. I think that is demonstrated primarily by our results. We’ve got a group that are working very nicely together. Most of the initiatives that we talked about are very cross functional in nature, which require all areas of the business to communicate with one another. That’s where I spent my time, ensuring good communication between all areas of the business. It has allowed me to focus more strategic than I have been able to do in the past.

We’ve got a nice blend though of veterans within the Company and have blended that very nicely with some newcomers. So I am very pleased with the management team and the direction that we’re heading today.

Bernard Sosnick – Oppenheimer

Well, thanks. I’m sure you’ll amplify on that subject at the investor’s day. I look forward to it.

Howard Levine

Yes, I will.

Operator

Our next question comes from Scott Malat – Goldman Sachs.

Scott Malat – Goldman Sachs

Good morning. I was wondering if we could just drill down a little bit more on the urban initiative? I know you’ve said in the past that 80% of urban stores have higher profit margins than before. Can you give us an update to that number?

Also talk about going forward what we can expect in terms of changes. I know you’ve mentioned the urban pricing strategies and maybe some merchandise processes and possibility of some customized assortments for those urban stores.

Howard Levine

Yes. I think all of those are elements of what we view as the urban strategy, and we view the urban strategy in the context of multiple years. The focus this year has been on stabilizing things, begin to confirm those process changes that work particularly well and those that we needed to tweak. As a result of that effort, we are better positioned than we were a year ago to operate those stores in a more consistent and a more profitable way.

There are a number of additional elements. I mentioned in our comments this morning that we are changing the technology platform in those stores next year and that’s going to improve the speed of customer service, as well as provide the management in those stores with some tools to more effectively manage the stores. For those of you who are able to attend the upcoming analyst day, you’ll be able to see some of the new technology and how it will impact.

We’re at the same time working through a series of initiatives relative to inventory flow into the urban markets. As you know, you have far greater velocity on a square footage basis and that requires a refinement of some of our inventory flow concepts. We’re making progress there. We still see some nice upside opportunities there.

As we also mentioned this morning, the price optimization initiative is moving along well and we expect to be able to apply some of the results of that work next spring. So there’s a whole series of initiatives that will impact the urban markets specifically, but also have greater potential to impact our overall chain.

Scott Malat – Goldman Sachs

Just on unit expansion, you’re saying 400 units, that’s up from the 350. Can you talk about recent results of new store productivity and returns on new units and what kind of progress you’re making there?

Howard Levine

I think we’re seeing improved performance as we are seeing improved execution around that, making the initial impression with our customers. When we comment on new store performance, there’s really two ingredients. One is, are we opening the new store as well as we can open it? Are the sites the best sites that we can select?

The other is, our company, as you know, has had a significant decline in the overall operating margin, particularly in fiscal 2005 where we lost 180 basis points. We’re focused on recovering that 180, which will impact not only all of our existing stores, but will make new stores more profitable.

Scott Malat – Goldman Sachs

Thank you.

Operator

Our next question comes from Michael Baker with Deutsche Bank.

Michael Baker – Deutsche Bank

Hi, thanks. Just a few. One, on the food tests that you described, so what happens in those test stores when you put in the expanded foods? Does the gross margins in that store go down, but the gross profit dollars up, or something along those lines?

Howard Levine

Hi, Mike. Let me just comment on the thinking behind the food enhancement strategy. First as we talked about the first phase of this was to install coolers, which were in 60% of the chain and we’re going to add another 1,000 or so stores this year. What we have tested more recently is an expanded presentation of the non-perishable part of our food, and what the purpose behind that is to better link what we’re doing in the coolers with what we’re selling in line to try to create more frequent trips and specific trips.

So for example, as we’re selling milk, eggs, and bread, one of the things we’re going to be expanding upon is our cereal presentation to better capture and take and better serve our customer’s needs on the breakfast trip. I would say the same thing with lunch and other meals and ready-to-eat preparations.

There are pressures from a gross margin standpoint as a result of this program, but the purpose behind all of our initiatives is to have balance between them. So while this initiative is to drive traffic, we’ve also had equal number of resources on our Treasure Hunt strategy to try to balance those and in fact have given guidance of slightly down to flat gross margin for the year.

Michael Baker – Deutsche Bank

That makes sense. That would lead to my follow-up question, which is this year gross margins were up a little bit, it sounds like you’re doing most of the same things that you did in ’06, so I would expect then that gross margins could actually even be up a little bit. Is there a measure of just being a little bit conservative in that gross margin estimate? In other words, what is different in ’07 than in ’06 when gross margins were actually up a little bit?

Howard Levine

We try to do the best we can in projecting and planning our margins and our goals for the coming fiscal year and we think we’ve given the appropriate guidance for where we are today.

Michael Baker – Deutsche Bank

Okay, fair enough. If I could ask just in a little bit of a shorter-term nature, how long do you think the lift in those stores affected by the hurricanes, how long do you think that lasted last year, how many months? Anything new or different that you guys are planning for Halloween? I just saw some NRF report that expect Halloween sales to be up big this year, I am wondering if you guys are planning for that?

Howard Levine

As far as the hurricane impact, it becomes smaller and smaller as we go through the year. The largest impact was in September. But we think we’ve reflected our thoughts about that in our guidance for the first quarter.

In regard to Halloween, the way we categorize Halloween is that falls under our Treasure Hunt strategy. We feel very good about the progress that we’ve made there and this is going to be a big event for us. Halloween isn’t nearly the size of Christmas, but we think that we’ve developed some good thoughts and are getting the goods out to our stores and have some very strong presentations. We are expecting a pretty good Halloween as a result.

Michael Baker – Deutsche Bank

Great. Thanks.

Operator

Our next question comes from David Mann – Johnson Rice.

David Mann – Johnson Rice

Yes, thank you. Just to piggyback on an earlier question on the urban stores, if the profitability is improving on the stores you’ve already done, what was the major factor in your decision to not roll it out to more of your urban stores?

Howard Levine

First, Dave, I want to just let everyone know that we’re very pleased with the progress that we’ve made in our urban stores. We think that we are creating some competitive advantage there and just to reiterate, that’s where two-thirds of consumption takes place and we don’t have the kind of competition in some of those markets as we do in other markets, but we have choices and we think that the choices that we’ve made to continue to improve profitability in the existing stores makes more sense to us at this point in time, prior to going after profitability or expanding stores in the initiative. Continue to be very positive about the improvements, but as Jim mentioned earlier, we’ve got a number of plans for those existing stores in those urban markets and are investing significantly in this initiative this year.

David Mann – Johnson Rice

Okay. And in terms of the 400 openings you’re doing this year, how would that break down between urban and perhaps non-urban or more rural?

Howard Levine

We think it’s going to be pretty balanced this year.

David Mann – Johnson Rice

On advertising, can you give us a sense on your thoughts of what percentage of sales in the upcoming year you might spend versus ’06 and any more plans on adding circulars or expanding number of pages, things like that?

Howard Levine

Right now, we believe we’re going to be fairly consistent from an advertising perspective to last year. That doesn’t mean we’re going to be the same though. I think that one of the things that I’m very pleased with is the improvement that we’ve made in our Treasure Hunt strategy. We’ve become much more event driven, and as we’ve talked about, we have a balance in our circulars of driving the customers in with hot pricing on consumable items, but it’s primarily used to display and let our customers know what’s new and different around the holidays or other events that are important to our customers. I believe that we’ve made a lot of improvement in that area, particularly as it pertains to the upcoming Christmas season, where that’s what it’s all about, is Treasure Hunt goods. We are excited about the opportunities and where we are from a positioning standpoint, and we believe that our stores will be very well-positioned during this holiday season.

David Mann – Johnson Rice

Great, thank you very much, Howard.

Operator

Our next question comes from Scott Mushkin with Banc of America.

Barclay Smith – Banc of America

This is actually Barclay Smith sitting in for Scott. Could you talk a little bit about shrink and comp trends within the urban initiative? Is there any news there?

Jim Kelly

Well, I think as I indicated in my remarks, shrink has been improving consistently in fiscal 2006. It’s a result of a number of factors: the slowing down in new store growth and focusing on operations had an impact very broadly throughout our organizational structure to include the urban markets. The second point that is really influencing shrink today is the stabilization of the workforce. As Howard indicated in his remarks, we are showing consistent improvement of store manager turnover and that is one of the most significant contributors to one’s ability to control inventory within the store.

So both store manager turns, stabilization, and focus on the blocking and tackling of retail this past year and the addition of some new technology to help us detect transactions that are indicative of a problem in a store. All three of those have helped us, the trend lines in terms of forward-looking data is very positive, but we still have much work to do.

Operator

Our next question comes from John Zolidis with Buckingham Research.

John Zolidis – Buckingham Research

Hi, good morning, thanks for taking my question. A question on the hurricane impact. Can you quantify how many of your stores, or what percentage of your store base you consider to be impacted by hurricanes? A second question on the 53rd week, can you quantify the impact that that has on the bottom line? Thanks.

Jim Kelly

Yes. If you look at the percentage of stores, it really varies over various periods of time as you recall, there were storms that impacted Texas, Louisiana, and various Florida areas, Mississippi, et cetera. So it really is a number of stores at different points in time. The key indicator that we pointed out this morning is, when you strip those stores that had abnormal fluctuations out of the base this year, the remaining stores that were not impacted by storms last year are performing consistent with our guidance.

In terms of the second part of your question was the impact of the 53rd week. I think that one is always a difficult one for a retailer to pinpoint, but you can start out by saying it’s roughly, or only slightly less than 2% more time. So somewhere in the 1% to 2% is probably not a bad estimate.

John Zolidis – Buckingham Research

Just as a follow-up, just doing some very quick math, it looks to me like about only 5% of your store base is in the states impacted by the hurricanes. So it seems difficult to see how you’d have 100 basis point or more impact to your overall comp just from those stores?

Second on the 53rd week, while it might only be 2% of sales because of the accounting rules, that typically has a larger impact on the bottom line, so if you could help us out a little bit more there, it would be appreciated. Thanks.

Jim Kelly

Okay. John, I don’t know what numbers you are looking at, but I think the impact was much greater than what you are calculating. We have tried to isolate internally and have done that and we have provided you with an indicator of what the stores not impacted by storms are doing. I don’t think there’s a whole lot more we can do right now.

Howard Levine

John, if I could add, I’m not sure you knew the number of days that the different stores were closed to do your calculation. I’m not sure where you got that data. So perhaps after the call, Kiley can help you with that.

John Zolidis – Buckingham Research

Okay. Obviously the stores that were closed should be benefiting this year versus last year, it’s the stores that weren’t closed that you’re having a negative impact at?

Jim Kelly

Yes.

John Zolidis – Buckingham Research

We can talk about that more after the call, okay.

Jim Kelly

Yes. What you’re seeing is that the stores that were closed are not in the comps this year, but the impact on stores like those in Baton Rouge and Houston and Birmingham and areas that were hugely impacted on the upside, many of those markets had 20%, 30% comp increases last year as a result of the migration of folks fleeing the storms. It is those stores’ performance year-over-year that are having the impact on September sales.

John Zolidis – Buckingham Research

That drag going forward is going to be much lower?

Jim Kelly

Oh, significantly lower, yes.

John Zolidis – Buckingham Research

Thank you.

Operator

Our next question comes from Deborah Weinswig – Citigroup.

Deborah Weinswig – Citigroup

Good morning. Can you just add a little bit of color in terms of what kind of comp you need to leverage these days? In light of that, how should we think about 2007?

Jim Kelly

Yes. We continue to focus on productivity. As I indicated in my remarks, assuming a comp in the 3% to 3.5% area, we would expect to have some modest leveraging of expenses.

Deborah Weinswig – Citigroup

With regard to 2007 specifically, there’s obviously a lot of initiatives in place. How should we think about the net-net impact on SG&A just as a result of the initiatives specifically?

Jim Kelly

We have considered all of the costs in the various initiatives in the guidance that we will leverage at 3% to 3.5%. One of the things that we have done consistently over time is to make sure that our ongoing operating budgets year-over-year include a fairly aggressive agenda for investing. In this way, we’re building a foundation that will enable us to sustain sales growth and sustain profitability growth. So fiscal 2005 was a bit unique in that the amount of the investment was over and above that normal area. Fiscal 2007 is more in that normal range of our year-in, year-out investments.

Deborah Weinswig – Citigroup

In terms of the comp expectations going forward, how should we think about that broken down between traffic and ticket? There was obviously a lot of initiatives on both sides.

Jim Kelly

Well, we have strived to balance those over time and if you look at our underlying initiatives, there’s a lot of work that’s going on to continue to balance it. The food initiative should help us drive traffic in our stores. The Treasure Hunt initiative should help us expand the size of the basket. So we’re trying to keep those things in balance as we go forward.

Deborah Weinswig – Citigroup

Okay. And then last question, I was very excited to see that you are going to be testing a price optimization strategy as many other retailers have talked about it, but haven’t actually been able to find a strategy that works. Can you talk a little bit about the outside expertise you’re partnering with, and what gives you confidence in this going forward?

Jim Kelly

Well, I think we are dealing with established vendors in testing. The vendor community reflects not only those with the technology for optimization, but also the vendor community that supports market research. What gives us confidence, is the experience of some of other retailers. You’re correct in that many retailers have talked about it. A few have been very, very successful at it. So we are really trying to follow the leads of those who have implemented in a methodical way and have realized the benefits of doing so.

Deborah Weinswig – Citigroup

Great. Well, best of luck, thanks very much.

Operator

Thank you. Our last question comes from Meredith Adler with Lehman Brothers.

Meredith Adler – Lehman Brothers

Hey, guys. One of the questions I have is about sales of apparel. I was wondering whether you succeeded in getting people to more consistently cross the aisle to look at apparel after you did your big event, or was most of the improvement in full-priced sales just tied to the timing of the event?

Howard Levine

Hi, Meredith. We were actually successful in getting people to cross over the aisle. As we mentioned, the fact that we had signage and presentation and better shoppability on that side of the store during the clearance event, we not only sold through on our clearance goods, we were able to see some nice sales in some of our regular-priced merchandise, so there was some benefits on both sides, both clearance goods and regular-priced merchandise.

Meredith Adler – Lehman Brothers

My question is, is that continuing beyond the timing of the clearance event?

Howard Levine

We have seen that continue as the events ended, the fact that our racks were more shoppable, that regular-priced merchandise is also selling very nicely.

Meredith Adler – Lehman Brothers

Great. Then just another question, you did have better initial markup in the fourth quarter. Could you just talk a little bit about what might be driving that? Is there something improved in your procurement?

Howard Levine

Yes. I think that we’ve had some benefits on the procurement side. One of the things that we are pleased with, that with some of the changes we have made in the merchandising areas, we have seen better sourcing of product that is contributing to our markups, both in the apparel area and in some of the consumable areas.

Meredith Adler – Lehman Brothers

Great. And then my final question is about the fact that you are going to be putting EBT software into 750 stores. Could you talk about what made you decide to roll it out? Is that still considered a test, or did you see results that you were happy with?

Howard Levine

We were talking about that yesterday, Meredith. We were happy with the results of our test. We had been testing now for close to a year and believe that with what we’re doing with the coolers, what we’re doing in the expanded food presentation that we’ve talked about that this is really the third leg of a completed food initiative for us and think that when you look at our customer and our customer base, particularly in some of these urban markets, we are very excited about the potential of this capability.

Meredith Adler – Lehman Brothers

Is it tied into the new platform that’s going into the urban stores, or is it a completely different initiative?

Howard Levine

No, it is tied into the new platform.

Meredith Adler – Lehman Brothers

Okay, great. Can I ask just one more question?

Howard Levine

Sure.

Meredith Adler – Lehman Brothers

About minimum wage, I don’t think that there’s likely to be a change in the federal minimum wage this year, but we’re just wondering if you guys have taken a look at what it might do to your costs? I know you’ve said that it probably is a net benefit to your customers overall, but have you ever quantified what impact it might have on your costs?

Jim Kelly

Well, I think that we’ve obviously modeled different things over time. If you’ll recall, and I’m sure you’ve looked at the numbers, Meredith, almost half the states now have minimum wages that are significantly greater than that of the federal government. We have absorbed those minimum wage increases during this past year into our model and believe that we’re going at the 3% to 3.5% comp level be able to continue to leverage overall store labor.

Meredith Adler – Lehman Brothers

Okay, great. Thank you very much.

Kiley Rawlins

Well, it’s the top of the hour again and we have run out of time. Unfortunately, there were several folks in the queue that we did not get to today. If you have additional questions, as always, I’m available after the call. We appreciate you joining us this morning. Thank you.

Operator

This concludes today’s conference.

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