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Family Dollar Stores (NYSE:FDO)

Q1 2013 Earnings Call

January 03, 2013 10:00 am ET

Executives

Kiley F. Rawlins - Vice President of Investor Relations & Communications

Howard R. Levine - Executive Chairman, Chief Executive Officer and Member of Equity Award Committee

Mary A. Winston - Chief Financial Officer, Chief Accounting Officer and Executive Vice President

Michael K. R. Bloom - President and Chief Operating Officer

Analysts

Matthew R. Boss - JP Morgan Chase & Co, Research Division

John Heinbockel - Guggenheim Securities, LLC, Research Division

Meredith Adler - Barclays Capital, Research Division

Deborah L. Weinswig - Citigroup Inc, Research Division

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

Mark K. Montagna - Avondale Partners, LLC, Research Division

John Zolidis - The Buckingham Research Group Incorporated

Charles X. Grom - Deutsche Bank AG, Research Division

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Edward J. Kelly - Crédit Suisse AG, Research Division

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

Operator

Good morning. My name is John, and I will be your conference facilitator today. I would like to welcome everyone to the Family Dollar 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

Thanks, John. Happy new year, everyone, and thank you for joining us today. Before we begin, you should know that our comments today will include forward-looking statements regarding various operating initiatives, sales and profitability metrics and capital expenditures, as well as our expectations for future financial performance. While these statements address plans or events, which we expect will or may occur in the future, a number of factors set forth in our SEC filings and press releases could cause actual results to differ from our expectations. We refer you to and specifically incorporate the cautionary and risk statements contained in today's press release and in our SEC filings. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today, January 3, 2013. We have no obligation to update or revise our forward-looking statements except as required by law, and you should not expect us to do so.

Our call today will begin with some opening comments from Howard Levine, Chairman and CEO; then Mary Winston, CFO, will review our financial results for the first quarter of fiscal '13 and our outlook for the rest of the year. Then Michael Bloom, President and COO, will share an operational update. Following our prepared comments, you will have an opportunity to ask questions. [Operator Instructions] Now I'd like to turn the call over to Howard Levine. Howard?

Howard R. Levine

Thanks, Kiley, and good morning, everyone. I hope everyone had a nice holiday and a happy new year. This quarter, we continued to make progress towards our goal of becoming more relevant for our customer and driving market share gains. Over the past year, we have significantly expanded our Consumables assortment to meet this demand and drove a very strong 6.6% comp store sales increase in the quarter. While our discretionary categories remained under pressure, our sales-driving initiatives are working and building momentum.

Early results from our assortment expansions are exceeding our expectations as our consumable sales increased nearly 19% over the same period last year. While the timing of sales-driving initiatives won't line up perfectly with our longer-term investments to improve gross margin to include global sourcing, private brands and pricing, I feel good about our ability to drive more profitable sales as we move into the second half of fiscal 2013 and beyond.

Near term, the environment remains difficult. Recent consumer confidence commentary and muted holiday sales results confirm to us that our customers remain cautious. We saw this uncertainty reflected in our discretionary sales trends in December. Historically, December has had a greater mix of discretionary sales, and as a result, the softness in sales had a disproportionate impact on the overall comp for the month. As we move through the rest of fiscal 2013, we expect that discretionary sales will become a smaller portion of the sales mix and have less of an impact on our overall comp. As a result, we continue to expect that comp store sales for the year will increase between 4% and 6%.

Based on our first quarter results and December sales, we have lowered our earnings expectations for the year. However, we continue to expect to drive double digits earnings growth for the full year as our sales-driving initiatives and gross margin drivers mature and deliver higher returns. Mary will provide more color on our outlook in a few minutes.

As we balance the short-term headwinds and the long-term opportunities, I am confident that we are driving the business to higher levels of profitability. We have been around this -- I have been around this business for my entire life, and while there will always be difficult economic periods and volatility from quarter-to-quarter, we have and will remain focused on investing and growing the business for the long term.

As we navigate through this uncertain period, we will maintain our unwavering commitment to these key strategic goals. We will provide customers with value and convenience. We will increase our relevancy to customers and drive further trips and market share gains. We will improve the shopping experience for our customers and renovate the entire chain over the next few years. We will continue to open new Family Dollar stores around the country to help serve the communities that rely on us. We will provide our team members with a compelling place to work, and we will drive strong long-term returns for our shareholders. While we expect challenges in the near-term, I believe our strategy positions us well to achieve our long-term financial goals.

And now I'd like to turn the call over to Mary Winston. Mary?

Mary A. Winston

Thank you, Howard, and good morning, everyone. Over the last 4 quarters, we have made progress in accelerating the pace of comp store sales growth, and this quarter's performance of 6.6% was a nice addition to the trend. The investments we have made to improve the shopping experience are driving great top line momentum.

In the first quarter, strong sales of consumables helped us deliver sales that were above our guidance, but also resulted in more gross margin pressures than we had originally expected. This mix pressure combined with headwinds from insurance expense resulted in EPS that was at the low end of our guidance. As expected, our sales growth continued to accelerate with total sales increasing 12.7% to $2.4 billion and comp store sales increasing 6.6%.

During the quarter, we opened 125 new stores and closed one store, compared to 101 openings and 4 closings in the first quarter last year. Sales in the quarter were strongest in the consumables category, which increased 18.5% over last year. To provide our customers with more value and convenience, last year, we launched a number of growth initiatives to increase our relevancy to the customer and drive greater sales productivity. This drove both increased traffic and a higher average ticket during the quarter. The completion of these initiatives, combined with the transition to McLane to stabilize and enhance our cooler program, resulted in consumable sales that exceeded our expectations.

We were especially pleased with the growth in our frozen, refrigerated and tobacco categories. Strong consumable sales growth combined with soft discretionary sales resulted in about a 350 [ph] basis points mix shift during the quarter. In the first quarter, consumables increased to 73.9% of sales compared to 70.3% of sales in the first quarter last year. While other margin levers, including markdown, inventory shrinkage, markup and freight were all in line with our expectations, the substantial mix shift resulted in additional pressure on gross margin during the quarter. For the quarter, gross margin declined 112 basis points as compared with the first quarter of fiscal 2012. We expect this pressure to continue through the second quarter and we also expected to get greater margin benefit from our investments in global sourcing, private brands and pricing in the second half of the year. Mike will talk more about our plans in a few minutes.

SG&A expense as a percentage of sales decreased 31 basis points to 28.9% in the quarter. Most expenses were leveraged during the quarter as a result of the 6.6% growth in comp store sales. Reflecting continued improvement in workforce productivity, store labor expenses leveraged about 30 basis points in the quarter. We are particularly pleased with this performance as it includes additional store labor related to investments we are making to improve the shopping experience, including our partnership with McLane. Consistent with trends we saw in the fourth quarter of fiscal 2012, this improvement was largely offset by higher insurance and higher marketing expenses.

As expected, we experienced about 40 basis points of pressure from insurance expense in the first quarter. Over the last several years, we have improved our risk management programs and managed our workers' compensation and general liability claims better, and we continue to drive improvements. However, the trends for prior year claims have stabilized, creating some near-term comparability challenges as we anniversary the benefits realized last year. As a reminder, in the first quarter last year, we saw about $10 million of benefit from lower insurance expense. We will continue to face strong but diminishing headwinds from insurance expense over the next 2 quarters.

To increase customer awareness and to expand -- of our expanded assortments and to drive market share expansion in a very promotional holiday environment, we continue to expand our marketing efforts during the quarter. As a result, marketing expense as a percentage of sales increased about 10 basis points. The income tax rate was within our expected range at 36.4% in the quarter as compared to 37.4% last year. The lower tax rate was due primarily to foreign tax benefits associated with our global sourcing efforts and favorable resolution of uncertain state tax positions. These improvements were partially offset by a decrease in federal jobs tax credits as compared to the first quarter of fiscal 2012. Net income for the quarter was $80.3 million compared to $80.4 million last year and earnings per diluted share was $0.69 per share compared to $0.68 per share last year.

Now turning to the balance sheet and cash flow statements. Merchandise inventories at the end of the quarter were $1.6 billion compared with $1.3 billion at the end of the first quarter last year. Average inventory per store at the end of the quarter was about 15% higher than last year. The growth in inventory was a result of our recent expansion of consumables, and our accelerating sales trends confirm that our customers appreciate the enhanced selection. I would note that average discretionary inventory per store was down slightly at the end of the quarter compared to last year.

At the end of the quarter, short-term borrowings totaled $209 million compared to $75 million last year. As we have moved through the holiday season, we have repaid the outstanding balance and our overall liquidity remains strong. Capital expenditures in the first quarter increased to $196.4 million as compared to $130.9 million in the first quarter last year. The growth in capital expenditures is related to increased investments in new stores, particularly an increased number of fee development stores.

During the first quarter, we invested $90 million in fee development stores as compared to $12 million last year. Through our fee development program, we work with developers to build new stores and upon completion of construction, we own the stores. Ultimately, our goal is to convert these owned assets into leased assets through a series of sale-leaseback transactions. Last year, we closed 2 sale-leaseback transactions, generating net proceeds of about $360 million

[Audio Gap]

6 [ph] stores, generating net proceeds of about $162 million. As our fee development program matures, we expect to continue to leverage sale-leaseback transactions to monetize owned stores as a source of capital for the ongoing fee development program.

Now lets turn to our expectations for the remainder of fiscal 2013. As we announced in this morning's press release, comp store sales in December increased about 2.5%. While the pace of sales growth in the consumables category was similar to what we saw in the first quarter, sales in more discretionary categories were softer than we have planned. It is clear that the current financial uncertainty has had an adverse impact on consumer purchases.

Based on these trends, we expect comparable store sales in the second quarter will increase between 4% and 5%. We believe that the softness in December discretionary sales combined with continued strong consumable sales growth and some additional discretionary markdowns in the quarter will likely result in gross margin pressure similar to or slightly more than what we saw in the first quarter. We also expect to continue to face headwinds from insurance in the second quarter as we anniversary benefits realized in fiscal 2012. As a reminder, in the second quarter of fiscal 2012, we experienced about 40 basis points or about $7.5 million of benefit from lower insurance expense.

Taking these considerations into account, we expect earnings per diluted share in the second quarter of 2013 will be between $1.18 and $1.28. As a reminder, our second quarter will include 14 weeks in fiscal 2013 compared with 13 weeks in fiscal 2012. Included in our guidance is about $0.09 related to the extra week.

For the full year, we continue to expect that total net sales will increase between 13% and 15% and that comp store sales will increase between 4% and 6%. We believe the sales growth will be driven by consumables and that discretionary categories will remain pressured as we work through the current economic uncertainties.

Based on our first quarter results and our expectations for the second quarter, we have adjusted our margin expectations for the full year and now expect that earnings per share for fiscal 2013 will be between $3.95 and $4.20. We still expect to drive strong earnings growth in the second half of the year as our sales and gross margin investments mature and we cycle expense headwinds from fiscal 2012. We remain on track to deliver double-digit earnings per share growth for the full year.

And now I'd like to turn the call over to Mike Bloom. Mike?

Michael K. R. Bloom

Thank you, Mary. Good morning, everyone, and happy new year to all of you. I will begin my discussion this morning with more color on our first quarter results, and then I will provide an update on our business initiatives. As Mary mentioned, comp store sales in the first quarter increased 6.6%. This was our best quarterly performance in 2 years as we continued to make progress toward our goals of becoming more relevant to customers, driving trips and gaining market share.

We were particularly pleased with our sales trends in October and November as we delivered comp sales growth in the high single digits. Customers continue to vote with their wallets and our strong comp sales growth clearly indicates that our customers love our new expanded Consumables assortment. Sales are running at or above plan in nearly every area where we have expanded our assortment in food, health, beauty and personal care.

As Mary discussed, we have been especially pleased with our refrigerated and frozen food sales. Refrigerated and frozen food is one of our biggest trip drivers and we have been investing to expand our assortment capacity. As we have talked about in the past and so just to remind you, last year, in 1,400 stores that had yet to be remodeled, we expanded our refrigerated and frozen capacity from 5 doors to 10 doors. In addition, today, all of our new stores opened with 18 cooler doors, and all renovated stores get between 10 and 18 doors, depending on space.

To help support the significant growth potential of this business, last spring, we signed a 6-year exclusive agreement in our channel with McLane to service our stores. And McLane provides us with a consolidated supply chain solution that replaces a fragmented network of over 50 wholesalers around the country. This long-term strategic partnership enables us to dramatically expand our assortment, improve our cooler in-stocks with re-deliveries in all stores, cluster our assortment by region and accelerate our development of private brand refrigerated and frozen food.

McLane began servicing our stores back in September. The transition has been very smooth, and I am pleased to report that the customer response to the improved assortment has exceeded our expectations. Customers love our new assortment and we are seeing strong double-digit growth across multiple categories. In addition to supporting our cooler program, McLane also enables us to sell tobacco. About 6,600 stores are currently selling tobacco and the tobacco characteristics remain consistent. The average ticket with tobacco and the additional basket remains about $17, and the gross margin on those additional items has stayed consistent and remains in line with our overall company gross margin.

While it's still early, we are very pleased with the financial returns from our McLane partnership. We are driving higher sales with improved markups in our coolers, and our tobacco sales continue to exceed our expectations. While higher sales of lower margin categories are pressuring our gross margin rate, our strong sales performance in these categories is driving higher gross margin dollars. We are very pleased with our strategic partnership with McLane and we look forward to the days ahead.

Now while our Consumable sales growth remains very strong, our discretionary sales remained under pressure and have recently slowed further than we anticipated. The volatility in our sales trends in the first quarter and December, worsening consumer confidence and the soft retail December comps reported this morning have all led us to believe that the macro environment has deteriorated beyond our original expectations.

While discretionary sales were soft, we did have some bright spots during the holiday season. We had good sell-throughs in sleepwear for the family, trim-a-tree, holiday candy, greeting cards, personal beauty kits and our holiday air care program. One of the more competitive and challenging categories for us during the holiday season was our toy business. Consumers this holiday season were especially value conscious, which resulted in increased promotional activity across multiple retail channels, especially heading into the final days before Christmas.

We expect in the near term our discretionary categories will remain challenged, but we are not waiting around for the tough macro environment to improve. We are taking proactive steps to improve our performance. We will continue to manage receipts, but we are also taking steps to improve sales productivity. This year, we will continue to learn, continue to listen to the customer and refine our assortment, advertising and in-store presentation to improve our performance. While our mix continues to shift towards lower margin consumables, it becomes increasingly important that we invest in other areas to drive profitability.

In the first quarter, we continue to make good progress in our sourcing programs. Over the last year, we have established 25 to 30 new factory direct relationships, and we have another 75 to 100 that we are currently evaluating. We just opened our third overseas sourcing office in Shanghai. And while we still source the majority of our merchandise from China, we have expanded our business into the key developing markets like Vietnam and Indonesia, and we have a much stronger foothold in places like Bangladesh and Cambodia.

Our teams are making nice progress. In the first quarter, our direct-to-factory purchases nearly doubled. And over the last year, we have converted 350 to 400 SKUs, primarily in Home and Apparel, from the U.S. to the country of origin. We have laid a strong foundation in our sourcing programs, and we are executing to improve the long-term profitability within these categories. We expect these returns to accelerate as we move throughout the year, and we still have a lot of runway in front of us.

We also continue to develop our private brand program. Private brand consumable sales in the quarter increased about 20% over last year, and private brand food growth increased nearly 50%. Similar to last year, private brand food sales outpaced national brand food growth, and this growth speaks to our investments in quality, branding and assortment. Customers love our Family Gourmet brand and we will continue to look for select categories to increase our penetration.

Private brand health and beauty aid sales were also strong in the quarter and increased about 16% over last year. The growth was driven by new Family Wellness SKUs in vitamins, headache, fever, pain and cold and allergy, and in the second half of fiscal 2013, we will introduce another large wave of Family Wellness SKUs in our assortment. We will continue to convert existing health and beauty aid SKUs from a control brand to a Family Dollar private brand while also introducing new private brand alternatives to our customers' favorite national brands.

As we continue to operate in a tough economic environment, value is becoming even more important to consumers. Through the remainder of fiscal 2013, we will continue to invest in our pricing capabilities to drive customer loyalty, improve our price and value perception and increase profitability. Our customers' price perception of Family Dollar remains among the best in retail and we will continue to be right where our customer needs us to be right.

In closing, several months ago, we invested aggressively to expand our assortment and increase our relevancy to the customer, and these investments are delivering strong results. Our consumable comp sales are accelerating and we are increasing market share. Our initiatives are just beginning to gain traction and we continue to believe that there is significant opportunity to capture more trips, expand our market share and increase profitability.

Now I'll turn the call back over to Howard for some closing remarks. Howard?

Howard R. Levine

Thanks, Mike. Before we take your questions, I just like to make a few final remarks. The business climate remains uncertain. Our customers are clearly making choices, but a few certainties still do exist. Family Dollar will continue to play a vital role for customers across the country who rely on us to meet their everyday needs. Our stores will continue to offer a great values with a convenient shopping experience, and this combination will continue to differentiate us from much of the competition.

Our model has a very strong history of success. Having been in this business for more than 53 years, we have successfully weathered periods of uncertainty by maintaining our focus on the customer, adjusting to short-term circumstances while -- when necessary, while also maintaining our focus on longer-term growth opportunities. While we cannot predict the economic challenges ahead, we will continue to focus on aspects of our business that are within our control. Although the environment this year has proven to be more challenging than we originally expected, we will continue to focus on the customer, enhance our assortment and improve the shopping experience, and we will continue to invest to drive long-term shareholder returns.

Our initiatives are working. We are becoming more relevant for our customers and we are driving market share gains. While the first half of fiscal '13 will likely be more challenging than we expected, we remain on track to drive double-digit earnings per share growth in fiscal 2013.

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

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Matthew Boss with JPMorgan.

Matthew R. Boss - JP Morgan Chase & Co, Research Division

Can you speak to any changes on the competitive front over the past 3 months and anything incremental seen in December that we should consider looking forward?

Howard R. Levine

Sure, Matt. As we look back over the last few months, particularly the holiday selling season, I would tell you that there were more events out there from our competition and that's the entire market, not calling out any one specific competitor. I'll also add that while there were more events, the promotional pricing activities seem to be fairly rational during the time period, but definitely a very competitive environment and a lot more events that were posted by the market this year.

Matthew R. Boss - JP Morgan Chase & Co, Research Division

Okay, great, and then a quick follow-up. Mike, since coming on board, the stores have clearly seen substantial improvements. Can you speak to any branded wins over the last couple of months? And what should we look forward to in the stores in the back half of the year?

Michael K. R. Bloom

Yes. Matt, as far as branded wins, I mean, if you think about all of the brands that we've added over the last 6 months to a year and looking at the sales growth that we have in our consumables area, we're seeing nice wins across the board. It's not beverages versus health and beauty aids versus tobacco. We're seeing a real nice balance of growth within all of the brands. And clearly, look, we've talked about this before, we continue to monitor -- not everything we added is working and we'll continue as the year progresses. It's what we do as retailers continue to look for new items and weed out the ones that are not working. And as far as what to look forward to in the stores for the balance of the year, I would tell you, store simplification. I think we've talked about this in the past as well. Our goal -- we're laser-focused on simplifying activities for our stores. You know our stores, we worked them hard last year and they rose to the challenge and did an exceptional job executing these initiatives and we're seeing the results. And now we need to simplify for them everything from planogram execution to delivery to processing customers at the checkout. So we're pretty focused on making sure our stores are easier to run.

Operator

We'll take our next question from Matthew Ross -- I'm sorry, from John Heinbockel with Guggenheim.

John Heinbockel - Guggenheim Securities, LLC, Research Division

Guys, so a couple of things, one on tobacco and then sort of a longer-term question. As you look at the experience so far, is tobacco accretive to EBIT, are you finding that? And then how impactful was tobacco on maybe order of magnitude in the quarter on both comp and gross?

Michael K. R. Bloom

I'll start. John, it's Mike, I'll start. So let me just -- a couple of things. First, as we mentioned, it's in 6,600 stores. I think we've got a few hundred stores more to go that we're going to add tobacco this fiscal year. It's ramping up. It's performing well above our expectations. Our basket remains like we talked about before. 60% of the baskets include another item, and the basket -- that margin is consistent with the rest of -- with the storewide margin. It's clearly driving trips. We don't believe that cigarettes -- the fact that we're selling cigarettes, people are trading off in other item. We don't believe there's more smokers. We believe we're capturing that cigarette trip from some -- from another retailer that was selling tobacco. So I think -- look, at the end of the day, I'd like to believe that while we're experiencing some margin pressure, we're generating margin dollars.

Mary A. Winston

John, I will just add to that, to your comment about the profitability and whether or not it's accretive, and we really don't get into specific profitability by category, but I view tobacco as obviously a critical component of our overall portfolio of consumable products, and consumable sales are up nicely. Tobacco was a big piece of that. And just as Mike referenced, we're seeing nice attachment. We're seeing an increase in trips, so it's driving traffic as we would expect. So I think it's having a positive impact on the business as all of our consumables are.

John Heinbockel - Guggenheim Securities, LLC, Research Division

All right. And then finally, the strategic question, because we seem to have this conversation, not just with you, but with others a lot in every quarter, about the discretionary business. If you assume that because of the condition the consumer and the economy is in, we're going to be under pressure for quite some time. At what point do you start to think about doing -- making fundamental changes, space allocation, cost structure inside the store, and then what would those changes be to mitigate the impact of mix?

Howard R. Levine

Sure, John. I think -- no, you're right. I've been asked the question about discretionary sales for many, many years. And there has been, just for some of the people newer to the channel, there has been, over the last 10 or 15 -- a pretty major shift from discretionary to consumables as the marketplace has decided that our channel is a great place to buy consumables. We've got a lot of convenient locations. We've got great pricing, and that's resonated very nicely with it. And I'll also add that one of the things that have been consistent is that our customers also like the discretionary component of our assortment. They like the treasure hunt aspect of it. They like the fact that our stores are located within their neighborhood. It's easy to get in, easy to get out and pick up some of these items. Clearly, the economic environment is pressuring our discretionary categories, and as we've indicated, we've been more defensive in those businesses. I think while markdowns are up a little bit here in the second quarter as a result of some of the lack of sell-throughs in some of the seasonal categories, apparel was actually pretty decent in terms of sell-through. We do have some additional markdowns in some other areas. And so we will continue to refine our strategy. I don't think I would look for anything dramatic other than a tight control on receipts to make sure that we've got good sell-throughs on what we buy, try to mitigate markdowns and balance out the assortment a little more as time goes on. We are as much a consumable house as we have ever been, up to 70% to 75% of the mix, driving nice sales up 19% as a result of our Consumables assortment. So if you ask me, what I think happens over the next few years, I think we'll see further growth in consumable categories and hopefully a mitigation of some of the loss and decreases that we're seeing in some of the discretionary categories. Candidly, I think we'll need some help from the economy. We're not standing by waiting for that though. We're taking some actions ourselves internally, which we'll talk about when we're prepared to do so. But I think there's still plenty of opportunity out there despite some of the significant headwinds that we're facing.

Operator

We'll take our next question from Meredith Adler with Barclays.

Meredith Adler - Barclays Capital, Research Division

I'd like to follow up on what Howard was just talking about in terms of markdowns. You said apparel sell-through was pretty good. Some of the seasonal didn't sell well. You mentioned that there were markdowns in other areas. Did that mean the seasonal or is there some sort of third area that -- where you saw a lot of markdown?

Howard R. Levine

Well, in the first quarter specifically, we had some markdowns to clear the refrigerator and freezer doors for the new McLane assortment. In addition to that, we had some residue to clean up from spring and summer. As we progressed through the quarter, of getting into the second quarter, which we'll give more color to in the second quarter call, we saw, as Mike pointed out, a lack of sell-through on toys, so we'll have some markdowns there. The good thing about toys is that you don't have the sense of urgency that you might have on other categories in that they don't go bad overnight. But we did have some clearance markdowns on some of the seasonal goods and some of the other holiday goods. We've incorporated those markdowns into our forecast, so we think we're covered from that standpoint. But with the soft discretionary sales, you would expect some additional markdowns as a result of some of the lack of sell-throughs there, and it's important to us to keep our inventory clean and fresh. And I'll just add that by quarter 2 end, of the end of the second quarter, the majority of our inventory growth continues to be in the consumable categories. Discretionary categories still are under pretty good control and will continue to get better as the year moves on.

Meredith Adler - Barclays Capital, Research Division

Right. I'm just changing gears a little bit. I think the common wisdom out there is that the higher payroll taxes are going to have a negative impact on your consumer and therefore, on your sales. I was just wondering what your view is on that?

Howard R. Levine

No. Meridith, I view things like payroll taxes, increased gas prices as things that go against our customers' wallet. Clearly, they do not have as much today for discretionary purchases as they did. Things like increase in payroll taxes are not a positive from my perspective. What I think happens is there will be some further impact to our core customer as a result of some of these tax increases. And in another 2 months, we're going to have other things to consider as well. But I also think we're positioned very nicely for a trade-down customer. One of the things we've seen over the last several years is that our core customer is a smaller percent to the total than they had been, and where we're making that up is in this trade-down customer. And I think the initiatives that we've been working on, everything from our renovation program, which substantially improves the shopping experience for the customer, the 40% increase in our food and HBA assortment over the last 2 years, the improvements in our quality, not only in our private brand offering, but in our overall offering, continues to position us well for that trade-down customer. So I think being in a place where value and convenience are your main part of your business is a good thing in this environment, albeit there's clearly pressure on the discretionary side.

Operator

We'll take our next question from Deb Weinswig with Citi.

Deborah L. Weinswig - Citigroup Inc, Research Division

Great, yes, from Citigroup. You talked about another large wave of Family Wellness SKUs. Can you talk about how many more SKUs you can fit into the boxes and is this taking away from existing SKUs?

Howard R. Levine

Yes, sure. For Family Wellness -- or actually for private brands in total this year, we'll add about 450 to 500 items, and a lot of those will obviously be in our -- a majority of those will be in our consumables area, and the majority of those will be in our health and beauty aids area. Do they take away from national brand sales? The answer to that is sure, there's a transfer from national brand to private brand, albeit at higher margins though. So while the sales may be lower, the margins are higher. So it's a trade-off that we're happy to make.

Deborah L. Weinswig - Citigroup Inc, Research Division

Okay. And then can you just talk about the mix shift has been different than you originally expected?

Michael K. R. Bloom

Sure. I'll take that one, Deb. What we have seen over the last several quarters is a trend towards consumable sales. I think we had a huge impact on that with the addition of the 40% SKU count in food and HBA, the moves we made in tobacco, the improvements in our cooler and refrigerated. So clearly the company's initiatives impacted the shifting to the consumable side of the business. I think it exacerbated as we move through the quarter and into the month of December further than we had expected as a result of lack of discretionary sales. We've kind of seen something that just continued to grow as the month of December progressed, customers very focused on basic needs, and the discretionary business was much softer than we had thought. But we continue to be pleased with the number of the sales-driving initiatives, as Mike talked, all of them are at or above plan. And we'd -- as we reflected in our guidance, we would expect those trends to continue as the year progresses.

Operator

We'll take our next question from Stephen Grambling with Goldman Sachs.

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

Just to follow up on some of the margin questions here, how should we think about the potential gap between the domestic importers and direct-to-factory? And then how long do you think this will take before we see some of the impact of these new relationships?

Michael K. R. Bloom

So as we talked about, I think in the past, what we've said is 50% of our purchases are made abroad or come from overseas, and -- I'm sorry, I'm sorry, I'm sorry, my mistake, 30%, I apologize. And within that, a very small percentage are direct-to-factory in the single digits. And our goal is to take that -- well, like I said, we've doubled that in the first quarter and to continue to grow that. As you move from domestic to agent to direct is where the margins continue to improve. I don't think we talk about the percentages between those. But as you can imagine, a lot of our purchases are being currently made through domestic importers, a significant portion through agents overseas and then a very small percentage direct. And our goal, we are working feverishly to move as much to direct to factory as we can, which is where the largest margins are.

Stephen W. Grambling - Goldman Sachs Group Inc., Research Division

Okay. And then one quick follow-up to an earlier question, I think this is Matt's on the competitive environment. You highlighted the discretionary side of the store, but I'm curious if you're seeing anything on the Consumables side more recently or maybe if you can shed any light on what channels are increasing the number of promotional events.

Howard R. Levine

No. I would tell you, Steve, that it's the whole market, it appeared to us, that increased their promotional events without calling any one specific retail. I think it was pretty broad and encompassing. The good news was while there are more events, as I said earlier, the pricing seems to be fairly rational. As we work through some of these economic challenges, we believe that we took part and part of that increase in advertising as well. We believe we have some good plans for the back half of our year to continue to drive sales, to talk to our consumers about what is new in our store with our -- to talk to our consumers about what is new from a Consumables perspective and to also do a better job of highlighting some of the discretionary categories as we work through the year.

Operator

We'll take our next question from Mark Montagna with Avondale Partners.

Mark K. Montagna - Avondale Partners, LLC, Research Division

When you look at your guidance, it almost implies that the second half seems like it's going to be pretty -- you're still sticking with your original plans or very close to it. I'm just wondering, what gives -- if that's correct, what gives you the confidence that you can stay so close to those plans? And then just with Consumables, I just want to clarify, it sounds like all -- any of the markdown pressure within Consumables was really related to the McLane conversion, am I hearing that correct also?

Mary A. Winston

Okay. I'll take certainly the question on our guidance for the back half. We've obviously gone through a pretty rigorous process to forecast what we think is going to happen in the back half. It does result in guidance that's very similar to what we had previously for the back half, but there are some ups and downs, and we've taken into consideration everything that we think is a significant factor for the back half of the year. So we expect to see continued acceleration in Consumables sales similar to the trends that we saw in the first quarter, and we expect discretionary to continue to be very challenged, so we are continuing to expect that. What's different in the back half that we've talked about previously is the acceleration of the investments that we're making in our margin-enhancing initiatives. So the global sourcing program, we expect to see that start ramping up in the back half of the year and providing more benefit, and that was always part of our plan and that continues to be what we expect. Same story for our private brands and same story for some of the initiatives that we're looking at under pricing. So we have a number of things that are going to alleviate some of the gross margin pressure that we're seeing in the first half as we get to the back half of the year. Then when we think about SG&A, the insurance situation is a big factor. As we've talked about in the first half of the year, we've got significant headwinds from insurance benefits that we realized in 2012 and those are diminishing as we go through the year. And so as we get into the third quarter and the fourth quarter, that's much less of a headwind for us than it was earlier in the year. Finally, I'll say, clearly with the challenges we're seeing on the discretionary side and economic backdrop that we're facing, we're obviously managing expenses very tightly. So we're looking at every component of our expenses and thinking through where we can take cost out, where we can continue to manage to maintain our profitability. So the back half of the year is more optimistic than the first half of the year. But it's not a reflection of not having looked at it and just held our guidance, it's just how it works out when we take into consideration all the factors that we think are going to impact the business.

Howard R. Levine

And Mark, if I could just add one of the things that you also might have a question about is the sale acceleration even in the second quarter. One of the things that we've seen over the last several years is December is still a heavy discretionary month. January and February become much more basic consumable months. So the reliance on the discretionary becomes less in the second quarter and as we progress through the year. And I think the team has done a very good job of curtailing expense -- curtailing receipts in the back half of the year in some of those discretionary categories to help offset or minimize our markdowns in those categories. And I accidentally said expenses, but I would be negligent not to reinforce what Mary said that Family Dollar continues to be very focused on expenses. We look at our core expense rate as something that we want to manage very tightly. We've got some further cuts in our expense plans in the back half, but we have continued to remain focused on investing in our renovations and our new stores as we believe there's still substantial white space out there, substantial opportunity for us to continue to grow. And at this point, we feel good about those investments for the long term of the business.

Operator

We'll take our next question from John Zolidis from Buckingham Research Group.

John Zolidis - The Buckingham Research Group Incorporated

A few questions. First, I was wondering if you can help us reconcile the gross margin performance in the August quarter with the November quarter. It looks like the increase in consumables as a percentage of total sales was fairly similar from August to November, yet we only saw 20 bps of gross margin pressure in August versus 120 in November. What were the differences beyond the consumables?

Mary A. Winston

Well, I think, clearly, the consumable shift was the biggest factor. There is no question about that. And we did, in the first quarter, see 360 basis point shift in terms of mix distribution of our sales going up to 73.9%, so almost 74% of our sales. I think at the end of the fourth quarter, it was -- that shift was about 250 basis points up to about 72%. And then there's the mix within Consumables. As we look at the items within the Consumables category that are accelerating the most, they're the ones that have the lower margins. So the strength in tobacco, the strength in food that we're seeing, while that's great from a sales and a comp standpoint, that's putting added pressure on the margin.

John Zolidis - The Buckingham Research Group Incorporated

Okay. And as a follow-up, since no one's asked about new stores, it appears that new stores were quite strong during the first quarter, which I guess is consistent with the very solid comp increase you reported. Can you just comment on new store openings, the availability of real estate, the competitive environment for new stores and how you feel about that?

Howard R. Levine

Yes, sure, John. We continue to be very excited about the -- our new store opportunities. We still are on track to open 500 new stores for this year. Our backlog of openings is as strong as it has ever been, and the opportunities are as great as they've been. I will also add that I think a lot of these opportunities are driven by the increases in our Consumables assortment. Being a stronger food player, a stronger player in the HBA categories, has only increased the potential opportunities for new stores. So we continue to see that as a very bright spot in our future.

Operator

We'll take our next question from Charles Grom with Deutsche Bank.

Charles X. Grom - Deutsche Bank AG, Research Division

Just a follow-up in John's question. Mike, how much of the 112 basis point reduction in gross profit margins was tobacco?

Mary A. Winston

Chuck, we don't break any of the pieces of gross margin out, much less the impact of one particular category.

Charles X. Grom - Deutsche Bank AG, Research Division

Okay. But it's fair to assume that, that was probably disproportionate effect on the margin performance in this quarter relative to the fourth quarter?

Mary A. Winston

I think if you look at the full impact of all of the consumables, we had a pretty big mix shift and that drove the lion's share of the pressure on gross margin in the quarter.

Charles X. Grom - Deutsche Bank AG, Research Division

Okay. And then as you kind of look into the back half, I mean, it just looks like you're being a little bit optimistic about the opportunity for margin improvement. Is it really just the focus on private brands and global sourcing that you expect to get there, because it seems like the headwind from tobacco will stick with you until you cycle it sometime in the summer?

Mary A. Winston

Yes, I think that's a good point, but I don't view our guidance in the back half as being overly optimistic. I think, as I talked about a moment ago, I think we've taken into consideration a number of risk factors that we also see and what we expect to see in terms of the discretionary business. So I think, we think we do expect our initiatives that we've talked about to deliver benefits to gross margin and that certainly reflected in the numbers as you point out. But we also have taken into consideration the shifting mix and the pressure that we expect to see and all of that.

Operator

We'll take our next question from Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

You guys have mentioned a couple of things that you're trying to take into consideration, consumer backdrop, et cetera, for the second half. Any consideration given specifically to some of the things that we've heard recently from Dollar General regarding rollout of tobacco as well as some of the price changes that they're anticipating?

Mary A. Winston

Scot, are you asking about the competitive environment?

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Yes, I mean, the simple fact that you guys have, pretty heavy store overlap. It's a similar box and I would assume that they are rolling out tobacco largely because you're rolling out tobacco as a competitive response. And I would assume, maybe it's right or wrong, but I would assume at this point that you would have some sort of negative impact on some of your direct pricing from the competitive aspect as well as on the tobacco sales rate or sales trends given the fact that one of your biggest competitors with heavy store overlap would also be rolling it out.

Michael K. R. Bloom

Yes, so -- I mean, I'll start and maybe others would jump in. I would tell you that -- look, we feel really good about where we're at with our strategy, our consumable strategy, our driving trips becoming more relevant. We're going to stay focused on our customer and our strategies and continue to drive and meet her needs, which I think we've done and we continue to do. So look, others adding tobacco, others doing different strategies. We're -- we feel real good about where we are. We feel real good about the timing of our initiatives and we feel good about how we're positioned in the marketplace. I think we're in a good place right now.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Has the addition of tobacco shifted your male versus female mix at all?

Mary A. Winston

I don't think we've seen anything with that.

Howard R. Levine

No.

Operator

We'll take our next question from Scott Nemer with Wells Fargo Securities.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

It's Matt Nemer. So just a quick question on the Consumables' acceleration over the last 2 quarters. Along with that acceleration, you've seen a deceleration in your discretionary categories and I'm just wondering if you think that's purely a function of external environment or are we -- could we actually be seeing some substitution within the basket?

Howard R. Levine

Yes. Matt, I think when we look at our business and what we've looked at over many years, not just the last quarter or 2, is the growth in consumables can come as well as growth and discretionary sales. I don't think it's an either-or proposition. I think what is really important is to drive traffic into your store. That's what we use tobacco for, that's what we use a number of our Consumables categories for, is to drive traffic in our store and hope that she picks up a seasonal item or a home item or an apparel item to help grow our margin. That piece of the business has been challenged right now. I'll be the first to tell you, I think that we could do a better job from an execution standpoint and so we're not taking anything lightly from our own opportunities to execute better, but we've taken space away from apparel over the last few years. We haven't promoted it as discretionary as much as we have in the past. We're looking at all those opportunities over the next several months. But clearly, there will be a strong headwind that's facing us and we'll be taking more of a defensive posture just to mitigate markdowns as a result of that headwind. So we're doing a lot of things, yet there's no question, it's a tougher business right now.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Did the marketing push in the quarter or the increased marketing spend actually have a much higher focus on Consumables than discretionary?

Howard R. Levine

Yes.

Operator

And we'll take our next question from Edward Kelly with Credit Suisse.

Edward J. Kelly - Crédit Suisse AG, Research Division

Have you baked in any real improvement in the underlying discretionary business as you progress through the year? I know you've talked about some new initiatives to maybe get it going, but what does your comp guidance imply in terms of the underlying trend of that business?

Howard R. Levine

I would tell you, Ed, that we have not factored in an improvement in our discretionary businesses in the back half. In fact, we've reduced receipts at a level that we think will not necessarily drive a comp, but will hopefully improve gross margin sell-throughs and generate higher gross margin dollars in the back half that we did at that time last year.

Edward J. Kelly - Crédit Suisse AG, Research Division

And a second question for you. As you think about the payroll tax increase, I know there's puts and takes to it, your customers are going have less to spend, but there could be some trade down as well. Is that a risk to your forecast or do you see that as properly included in the way that you're thinking about the [indiscernible]?

Howard R. Levine

I think we've properly included it. We'll know soon enough whether we did or not, but I think we thought about that and we thought about some of the pressures that bring, but we also looked at what's happened in the past, that we've had have pretty good trade down over the last few years. I would expect that to continue given all the investments that we've made as I talked earlier to position ourselves for that trade-down customer.

Edward J. Kelly - Crédit Suisse AG, Research Division

So is it your view that trade down offset most of the impact? I don't want to put words in your mouth. I'm just trying to get your sense.

Howard R. Levine

Well, I think it has historically over the last couple of years offset even more than what we lost from the core customer. So we'll see whether that continues given the new economic circumstances that all of our customers are facing.

Operator

And we'll take our next question from Aram Rubinson with Nomura.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

It's clear that most of your top line initiatives entail lower margins with -- not a surprise that gross margins are being pressured. Perhaps the surprise is that we maybe just didn't see it sooner than we are. My question though is what are you doing from a procedural or a process standpoint to make sure that the finance department and the merchants are aligned and planning together to prevent margins from surprising in the future.

Mary A. Winston

Okay. Well, I'll start on that and then Mike or Howard can join in. But from a process standpoint within finance, we've done a number of things to shore up our analytical capability, our forecasting process. We've linked, made sure that it is a collaborative and aligned process where finance, merchandising, retail operations all look at what we're projecting in terms of sales forecasting and margins and what the impact of that is going to be. So I think our processes are sound in that regard and all the groups that are close to the business are involved in making those projections, and we think our projections take into consideration everything we're aware of.

Howard R. Levine

I would just add to that, that I think our finance departments and our merchants have worked very nicely together. I don't think there's anything that I would address as an issue with the company in terms of their working relationship. I think it's as we've talked about. It's a tough environment out there, the consumer is challenged. We've made some significant investments in Consumables and those are at or above plan in every one of those categories that we've added. It's a discretionary issue with us. We're taking some proactive steps. And as I just said earlier, it's a tough headwind out there, but I would not read anything into relationship between our finance department and our merchandising. I wish it was that easy. Frankly, it is not that easy. There's more to it than that. And we think we've got the plans and initiatives in place and we're working as a team to accomplish those goals.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

And your systems are integrated across merchandising and finance to enable as much communication as you'd like?

Howard R. Levine

They have been for years.

Kiley F. Rawlins

So it is now the top of the hour and unfortunately, we didn't get to all of the folks in the queue this morning. As always, I'll be available after the call for any follow-up questions you may have. Thank you for your interest in Family Dollar and have a great day.

Operator

That concludes today's conference. Thank you for your participation.

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