Family Dollar Stores Management Discusses Q4 2013 Results - Earnings Call Transcript

Oct. 9.13 | About: Family Dollar (FDO)

Family Dollar Stores (NYSE:FDO)

Q4 2013 Earnings Call

October 09, 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

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

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

Analysts

Meredith Adler - Barclays Capital, Research Division

Deborah L. Weinswig - Citigroup Inc, Research Division

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

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

John Heinbockel - Guggenheim Securities, LLC, Research Division

Peter J. Keith - Piper Jaffray Companies, Research Division

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

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Operator

Good morning. My name is Shannon, and I'll 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

Thank you, Shannon. Good morning, 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 expenditure, 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, as 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, October 9, 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.

In addition, this morning, we will reference non-GAAP financial measures, which are intended to help investors understand Family Dollar's ongoing business performance. These measures include operating profit, net income and earnings per diluted share, each excluding litigation charges and a favorable adjustment related to a change in accounting for certain vendor allowances. 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.

Our call today will begin with some opening comments from Howard Levine, Chairman and CEO. Then Mike Bloom, President and COO, will share an operational update. And Mary Winston, CFO, will review our financial results for fiscal 2013 and our outlook for fiscal 2014. 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. This morning, we announced our fourth quarter and full year 2013 financial results. While this year was more challenging than we initially planned, we continue to make progress towards our goal of becoming a more compelling place to shop, work and invest.

In fiscal 2013, we had several key accomplishments. We exceeded the $10 billion milestone in total net sales, comparable store sales increased 3% and we increased our market share. Adjusted earnings per share increased 4.4% to $3.80 and we finished the year with adjusted earnings per share in the fourth quarter increasing almost 15% to $0.86. We opened 500 new stores and renovated, relocated or expanded 830 stores. We launched our partnership with McLane. This strategic partnership enabled us to strengthen our refrigerated, frozen supply chain and enhance our assortment of frozen and refrigerated food while also supporting our tobacco rollout.

We increased our direct-to-factory purchases and increased private brand consumable penetration. We opened our 11th distribution center in Utah to service our stores out west. We continued to strengthen our management team with key changes in merchandising, marketing and store operations. And we have begun to reduce our store manager turnover. Our team adjusted well to unexpected headwinds. And as a result, we have stabilized gross margin, reduced inventory levels per store and improved profitability. While we expect that our customer will continue to face near-term challenges, we are adapting to the slower sales environment and managing the business appropriately for the short term while continuing to invest for our long-term growth.

In fiscal 2014, we plan to open 525 new stores, including our 8,000th store location in Lancaster, South Carolina, which opens tomorrow. Our new store productivity remains strong. And our robust new store pipeline continues to reflect our opportunity to sustain annual square footage growth of 5% to 7%.

We will continue to invest in our comprehensive store renovation program. This strategic investment improves the shopping experience, strengthens the Family Dollar brand and places our chain in a much stronger competitive position. In 2014, we plan to renovate, relocate or expand about 850 stores. Our renovated stores continue to outperform the chain. And by the end of fiscal 2014, about 75% of the chain will reflect a much improved shopping experience.

And with that, I'll turn the call over to Mike, who will share more detail about our 2014 plans. Mike?

Michael K. R. Bloom

Thank you, Howard, and good morning, everyone. Before I talk about our plans for fiscal 2014, I'd like to take a few minutes to talk about our fourth quarter. As Howard mentioned, in the fourth quarter, earnings per share grew about 15% on an adjusted basis, our best earnings performance of the year. We increased gross margin, tightly controlled expenses and expanded operating margin while also making investments that will help us deliver greater profitability.

While we delivered strong earnings growth this quarter, our comparable store sales were flat versus last year and lighter than we had planned. We believe this sales weakness was due to a couple of key factors. First and most importantly, this quarter, we began to anniversary many of our sales-driving initiatives. In fiscal 2012, we launched about 1,000 new consumable SKUs in food, and health and beauty aids and we also introduced tobacco. As we anniversaried these additions, we generated a consumables comp of about 2% on top of a 10.5% increase in the fourth quarter last year. Second, our customer continues to struggle financially, and she is spending less in the market overall. However, we drove market share gains in both dollars and units during the quarter.

While sales were pressured, we had some big wins during the quarter. Our refrigerated and frozen food sales exceeded our expectations. And our customers are voting with their wallets on our improved cooler and freezer selection. Our McLane relationship continues to be a key differentiator and accretive to earnings. Our introduction of tobacco continues to drive traffic and sales. Our weekly per store selling average continues to increase and the basket characteristics have stayed consistent. The average ticket with tobacco and additional items is around $17. And the gross margin of those additional items remains at the company average.

In the fourth quarter, we also began to see stabilization in our discretionary businesses and we delivered our best comp performance of the year in these higher-margin categories. While our customer continues to make choices, we improved the sales trend in many key areas. We remain cautious on the outlook for our customer, but we do believe that we are turning the corner in several key discretionary businesses. Our teams are focusing on providing the right value to our customers. We are improving the quality of our assortment, and we are refining our mix to reflect the right trends for our customer in the marketplace.

And while our sales were challenged late in the year, the one thing that I am most proud of was the successful execution of our plans to stabilize key financial metrics. Our initiatives to drive gross margin and remove nonvalue-added costs are gaining momentum. Our efforts to improve initial markups are delivering results. And we will continue to execute on these initiatives to drive further margin improvement.

As we transition to fiscal 2014, we expect that many of the trends we saw in the fourth quarter will continue. While many higher-income consumers are feeling better and more confident about the future, our core customer continues to struggle. They are dealing with tepid job growth, higher taxes and reductions in government assistance programs. The uncertainty is likely to continue as our government debates the future of many of these programs. In addition, we will continue to face difficult consumables comp comparisons. Our most difficult comparison of the year will be in the first quarter as we anniversary about a 12% comp increase in consumables. These comparisons will ease as we move throughout fiscal 2014.

Within this environment, we are focused on what we can control to drive sales and higher profitability. Let's begin with sales. Over the last few years, we have significantly increased our assortment of food, health, beauty and personal care to become more relevant for our customers. The customer response has been very strong, and these enhancements are driving more trips. But we see further opportunities to make improvements in key consumables categories. As retailers, and you have heard me say this on several occasions, this is what we do. This year, we will continue to optimize our consumables assortment and continue to focus on being first with new items and with innovation. We will continue to sharpen our pricing strategy, making sure that we are priced right in key areas where the customer expects us to be right. We will continue to make strategic price investments to further enhance our strong value perception.

To drive higher customer awareness of our assortment additions and the values we offer, we will continue to optimize our marketing programs. We want to make sure that we invest where and when it has the most impact on our customer awareness and profitability. We are reviewing the frequency and promotional impact of our advertising strategy to increase our effectiveness and efficiency. And we will continue to refine our strategies while also leveraging other mediums, like digital marketing, radio and in-store communications.

Over the last few years, we have continued to refine our store layout to enhance the shopping experience. The latest change is our reinvigorated checkout area. This area has been redesigned to increase the speed of checkout, improve the customer and team member flow and experience and most importantly, drive sales of high-impulse and high-margin merchandise. The new checkout will be in all renovated and new stores beginning in January.

While we are clearly focused on increasing sales in fiscal 2014, we will continue to build on our momentum with our key profitability drivers. We've built a strong foundation over the last few years in our global sourcing and private brand businesses to improve initial markups. And last year, they delivered great results. We expect this momentum to continue. We increased our direct-to-factory purchases, and we remain on track to hit our goal of 13% of total purchases by the end of 2015. We have reduced costs by expanding our supplier base and increasing our geographical reach through new overseas offices in Shanghai and Bangkok. Initial markups on imported merchandise have improved significantly over the prior year, and we are introducing higher-quality merchandise to our customers.

Our private brands business also gained momentum. In 2013, total private brand sales increased about 10%, while private brand consumables sales increased about 20%. We added nearly 500 new Family Dollar private brand SKUs to our assortment. And this year, we will add about another 200. Our quality and packaging continues to improve on items like Family Gourmet nuts, toaster pastries and cereal, just to name a few, and our customers are responding. We will continue to make quality improvements, and we have consolidated our brands to create more uniformity across our assortment, which we believe will help make it easier for our shoppers.

Another key lever to improve initial markups is our supplier partnerships. We will continue to work with our supplier partners and engage in strategic business planning discussions to drive sales and traffic, and improve our profitability. Shrink has been a headwind for more than 2 years as we've managed higher store manager turnover and elevated inventory levels. We are making good progress to improve both of these areas. Store manager turnover decreased nearly 10% in the fourth quarter, our first improvement since the first quarter of 2012. In addition, our inventory levels were 3% lower per store at the end of the year.

While improving these 2 metrics is crucial to lowering shrink, we also -- we are also investing in new technology across the chain. This year, we will begin to roll out Checkpoint, our new electronic item surveillance system. We believe this system offers superior technology to our previous platform at a lower cost. And most important to our team members, Checkpoint allows the tagging process to be taken upstream to our distribution facilities or supplier partners as part of their manufacturing process. This will eliminate tasks at store level and free up our teams to provide improved customer service.

In supply chain, we also have several opportunities to increase our efficiency. We have added a key member to our senior leadership team, Jeff Macak, our new Executive Vice President of Supply Chain. Jeff has over 25 years of supply chain and logistics experience and joins us most recently from Bed Bath and Beyond, where he spent the last 13 years. Jeff brings a wealth of knowledge managing end-to-end supply chain, and we look forward to his contributions. In July, we began shipping from our 11th distribution center in St. George, Utah. St. George is an important addition to our supply chain network as it will drive transportation efficiencies through stem mile reductions to our stores out west.

Even as we are managing through near-term challenges, we are investing to improve the longer-term profitability of our business. We continue to open new stores, and we are improving the shopping experience through our store renovation program and continued enhancements to our store layout. In addition, we are investing to improve key operational processes and simplify tasks at store level. And one that will significantly change the game at Family Dollar is our new door-to-shelf process or pallet delivery program. To make it easier and more efficient for our store teams, we have streamlined our freight delivery and restocking processes. In our new pallet delivery program, goods will now be sorted by department and cleanly stacked and packaged on pallets, which can be taken straight to the sales floor.

We have been testing this for several months and recently rolled it out to all stores serviced by our North Carolina distribution center. Our team members love this new way to unload our trucks and can now restock merchandise more quickly. Early results suggest that this new process can also have a positive impact on sales, shrink, damages, workers' compensation claims and employee turnover. We plan to roll out the new process to 3 additional distribution centers this year.

In closing, our 2014 plans will continue to build on our progress from fiscal 2013. We are stabilizing critical metrics, like gross margin, inventory productivity and store manager turnover. We are reenergizing and optimizing key businesses to drive more trips. We are maintaining our long-term investments in new store growth, renovations and supply chain. And of course, we will continue to improve our processes and develop our talent. We have made good progress over the last year in the face of some unexpected headwinds, and I'm excited about our plans for fiscal 2014.

And now I'll turn the call over to Mary Winston, who will further discuss our financial results and introduce our financial outlook for fiscal 2014. Mary?

Mary A. Winston

Thank you, Mike, and good morning, everyone. I'll begin my remarks with a review of the fourth quarter, and then briefly discuss our full year results and finish with our fiscal 2014 outlook.

In the fourth quarter, we delivered strong bottom line results. While sales were pressured, we expanded gross margin, tightly managed our expenses, drove operating margin expansion and achieved a 14.7% earnings per share growth on an adjusted basis. In the fourth quarter, sales increased 5.8% to $2.5 billion and comp store sales were flat. During the quarter, we opened 120 new stores and closed 5 stores compared to 188 openings and 13 closings in the fourth quarter last year. The fewer number of new store openings in the fourth quarter versus last year was a function of our efforts to smooth out the new store openings throughout the year.

For the quarter, gross margin expanded 88 basis points as compared with the fourth quarter of fiscal 2012. Excluding a onetime $5 million benefit related to a change in accounting for certain vendor allowances, gross margin expanded 68 basis points. This was our best gross margin performance since the second quarter of 2011. And the improvement was the result of higher initial merchandise markups and lower freight costs. As expected, our merchandise margins continue to benefit from our foreign sourcing and private brand programs. In addition, we saw less pressure from mix as we began to anniversary last year's consumables assortment additions and we began to stabilize our discretionary business.

Our sales mix shifted by 170 basis points to lower-margin consumables in the fourth quarter as compared to a mix shift of 360 basis points in the third quarter of fiscal 2013. The decrease in freight expense was mainly due to transportation efficiencies and our supply chain relationship with McLane, which resulted in less merchandise being handled through our own distribution network.

Offsetting these improvements, shrink and markdowns increased as a percentage of sales. SG&A expenses increased 7.6% compared to the fourth quarter last year, and as a percentage of sales, increased 46 basis points to 28.5%. Our teams did an excellent job managing and prioritizing expenses in this quarter. And as a result, SG&A was flat on a per square foot basis. The SG&A deleverage in the quarter was mainly the result of our flat comp store sales.

Operating profit in the quarter increased 23.9% to $155.6 million as compared to $125.6 million in the fourth quarter of 2012. Excluding the litigation charge of $11.5 million in the fourth quarter of 2012 and the favorable $5 million accounting adjustment in the fourth quarter of fiscal 2013, operating profit increased 9.9% to $150.6 million and operating margin expanded 22 basis points to 6% of sales.

The effective income tax rate in the fourth quarter of fiscal 2013 was 34.9% as compared to 36% in the fourth quarter of fiscal 2012. The decrease in the effective tax rate for the fourth quarter of fiscal 2013 as compared to the fourth quarter of fiscal 2012 was due primarily to a decrease in the reserve for state taxes, partially offset by increases in U.S. tax for foreign operations and in reserves for uncertain tax positions.

Reported net income for the quarter increased 26.3% to $102.2 million compared to $80.9 million in the fourth quarter of fiscal 2012. The earnings per diluted share increased 27.5% to $0.88 compared to $0.69 last year. Excluding the onetime items I referenced earlier, adjusted net income increased 12.5% to $99 million and adjusted earnings per diluted share increased 14.7% to $0.86.

Now let's review our fiscal 2013 results. As a reminder, consistent with the National Retail Federation calendar, our fiscal 2013 included 53 weeks as compared to 52 weeks in fiscal 2012. We estimate the extra week contributed about $189 million in total sales and $0.07 of earnings per diluted share.

In fiscal 2013, total net sales increased 11.4% to $10.4 billion and comp store sales increased 3%. Both customer traffic and average customer ticket increased for the year. Sales were strongest in the consumables category, which increased about 17% for the full year.

Adjusted gross profit increased 8.9% to $3.5 billion. As a percentage of sales, adjusted gross margin declined 78 basis points to 34.2% of sales. Our continued investment in private brands and global sourcing capabilities resulted in higher markups. However, these improvements were more than offset by stronger sales of lower-margin consumables, increased inventory shrinkage and higher markdowns.

SG&A expense for the year increased 10.9%. As a percentage of sales, SG&A decreased 11 basis points to 27.6%. Our teams did a good job leveraging expenses on a 3% comp, which is at the low end of our historical comp breakeven point. For the year, lower incentive compensation expense was partially offset by higher store occupancy costs. Many other expenses were leveraged as a result of the 3% comp store sales increase.

Adjusted net income for fiscal 2013 increased 2.6% to $440.4 million and adjusted earnings per diluted share increased 4.4% to $3.80 from $3.64 in fiscal 2012. Merchandise inventories at the end of the year increased 2.9% to $1.5 billion compared to $1.4 billion last year. In the fourth quarter, we continued to anniversary many of our consumables assortment additions. And as a result, average inventory per store was down about 3% versus last year.

Capital expenditures for the full year were $744 million as compared to $603 million in fiscal 2012. The growth in capital expenditures was primarily related to increased investments in new stores, mostly due to investments in fee development stores. In fiscal 2013, we spent about $385 million related to new stores compared to about $200 million in 2012. In addition, we spent $149 million for our store renovation program; $76 million to support our supply chain, including the construction of our Utah distribution center; $81 million related to corporate and technology investments; and $53 million related to other investments in existing stores.

In connection with our fee development program, in the fourth quarter, we closed additional sale-leaseback transactions for net proceeds of around $182 million. For the full year, we completed sale-leaseback transactions generating net proceeds of about $345 million. Reflecting our commitment to return excess capital to shareholders, in fiscal 2013, we paid $108 million in dividends and repurchased $75 million of our common stock. At the end of the fiscal year, we had the authorization to purchase up to an additional $371 million.

Now let's turn to our expectations for fiscal 2014. Given the uncertainty of the near-term health of our customer, we have taken a cautious approach to the sales environment in fiscal 2014. In addition, our outlook includes the expectation that the 6 fewer selling days between Thanksgiving and Christmas will be a headwind during the holiday season. Based on these assumptions, we currently expect total sales to increase in the mid-single-digit range and comp store sales to increase in the low single-digit range. Please note that fiscal 2014 will include 52 weeks compared with 53 weeks in fiscal 2013. As a reminder, the extra week contributed approximately $189 million of sales and $0.07 of earnings per diluted share.

We expect that diluted earnings per share in fiscal 2014 will be between $3.80 and $4.15, including approximately $100 million of share repurchases. We anticipate modest operating margin expansion driven by improvement in gross margin. We continue to believe we can mitigate the sales mix pressure from our consumables assortment additions, through our global sourcing and private brand programs, and from process improvements we're making in our merchandising and supply chain areas. Our ability to leverage SG&A will be primarily impacted by our comp sales growth.

In addition, we face some expense headwinds in fiscal 2014, including about $0.07 related to the implementation of the Affordable Care Act. For the year, capital expenditures are projected to be between $550 million and $600 million, primarily to support the opening of 525 new stores and the renovation of 850 stores. This represents a lower capital investment than in fiscal 2013 despite the acceleration of new store openings and renovations, as we used multiple financing approaches to cost-effectively invest in our store base. In fiscal 2014, we plan to continue to open stores under our fee development program, but we also plan to open stores under a build-to-suit financing structure. This diversification of financing will result in less capital on our balance sheet but still enable us to achieve competitive lease rates. We also expect to execute a sale-leaseback transaction in the fourth quarter of fiscal 2014 for $200 million to $250 million.

As we look to the first quarter of fiscal 2014, we expect that comp sales will be pressured as we anniversary strong consumables sales growth in the first quarter of fiscal 2013. We expect total sales to increase 3% to 5% and comp sales to decrease in the low single-digit range. We expect that gross margin will expand 30 to 40 basis points and that top line pressure will result in SG&A deleverage. As a result, we expect earnings per diluted share in the first quarter will be between $0.65 and $0.75.

And now I'd like to turn the call back over to Howard Levine for some final remarks. Howard?

Howard R. Levine

Thanks, Mary. Fiscal 2013 was more challenging than we originally planned. We expect that many of the headwinds faced by our customers will persist. High unemployment levels, higher taxes and continued uncertainty in Washington will likely continue to pressure our customers' income. Although the near-term operating environment will remain challenging, we are focused on what we can control. We have repositioned the company for the tough sales environment and we intend to drive higher profitability through gross margin expansion, tight expense control and strong inventory management as we move through fiscal 2014.

Today, I believe that we are better positioned to compete and drive profitability. And I'm confident that our investments to deliver long-term profitable growth will deliver results for our shareholders. And now operator, we'd be happy to take some questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we will take our first question from Meredith Adler with Barclays.

Meredith Adler - Barclays Capital, Research Division

I guess I would like to talk a little bit about, I mean, I think you had a conference call about the third quarter, and trends seem to be fairly good for the first couple of months of the fourth quarter. Can you talk a little bit about what happened in August?

Howard R. Levine

Sure, Meredith. As we look at the trends for the fourth quarter, you're exactly right. June was the best month of the quarter. But as we progressed through the quarter, we did start to see a further acceleration of some of the consumable investments that we had made the prior year. So that did pressure results as we did move through the quarter.

Meredith Adler - Barclays Capital, Research Division

And can you talk at all about how you're addressing the weak consumable and the weak discretionary? It's really obviously not easy to do this. But do you have any particular plans that you think will at least will help sales? You said that there were some stabilization. But what category saw stabilization?

Howard R. Levine

Sure. Let me turn that over to Mike.

Michael K. R. Bloom

Yes, sure. Thanks, Meredith. Yes, as I mentioned in my prepared remarks, we're starting to see some slowing of our decrease to the discretionary. And some of the specific categories are ladies apparel, a lot of our basics categories. And as we've talked about before, there's obviously a lot of factors pressuring discretionary. But I think our team has done a really good job of making sure we're staying on trend for our customer. We refined our mix. We're improving our quality, our packaging of discretionary. So we're seeing -- we actually feel really good. Like I mentioned in my prepared remarks, we had our best comps of the year. Albeit still challenging, we're starting to turn that corner and seeing some nice trends going forward. So I think the team has done a good job.

Howard R. Levine

Meredith, I was just going to add that one of the things that we're very focused on is controlling inventories in those areas. And as I've talked in prior calls, we're not necessarily looking for strong comps in these areas. We're looking for margin stabilization and starting to see better markdown control and better sell-through. So we're pleased to see those trends and we expect those trends to continue but will be tight inventory control over those areas, given the macro conditions out there.

Meredith Adler - Barclays Capital, Research Division

And I just have one more question for Mary. You talked about maybe a bit of a shift away in terms of your capital investments, or the form, away from the fee development program. Is this a commentary on the sale-leaseback market? Or is it just that the build-to-suit market has become more vibrant?

Mary A. Winston

I think it's a little bit of both. It's definitely not an indictment of the sale-leaseback market. We still see that market as being robust. There's still a very -- a lot of interest when we go to market with a portfolio of stores. The rates continue to be competitive, although we know rates are ticking up a little bit all over. But our last sale-leaseback transaction, the rates were very competitive, the most competitive of the transactions we've done. So it's really not bad. It's that we are discovering other ways of getting rates that are almost equally competitive and still being able to free up some capital from our balance sheet to allow us to do other things, should we choose to do that. So we're still -- again we're opening more stores and we're renovating more stores. But we are, I would say, expanding our tool kit of financing vehicles that we can use to fund our store base, whether it's new stores or renovations. And so this is just part of that. So we're just rebalancing how we get that financing.

Operator

And next, we go to Deborah Weinswig with Citigroup.

Deborah L. Weinswig - Citigroup Inc, Research Division

Mike, I was wondering if you could go through some more specifics in terms of the fourth quarter and how we should measure the success of the sales-driving initiatives that you've put into place.

Michael K. R. Bloom

Yes. So like Howard just mentioned, we're seeing -- some of what happened in the fourth quarter was just cycling on some of our best comps the previous year. I think it was 10.5% comp in consumables the previous year. And as I mentioned, we're going to have -- we're up against a 12.5% comp in consumables in the first quarter. So our consumables shouldn't be -- we shouldn't be confused that our consumables strategy is working very well and we're driving traffic, driving trips and it's working. We're pleased with it. We're cycling on some fairly significant comps. I mentioned discretionary. From a discretionary perspective, while we had our best comps in the fourth quarter in discretionary, we feel good about the -- turning the corner on some of those. And what's most important is we're gaining trips in the areas where we are -- we have invested. So we see it in consumables, in food, in health and beauty aids, our trips are up and we're gaining market share. And that's a critical measure that we continue to stay focused on and continue to be proud of in a challenging environment, continuing to gain market share. So I don't know, Deb. Did I answer your question?

Deborah L. Weinswig - Citigroup Inc, Research Division

Yes. And as you look at tobacco, how has that been in terms of your expectations?

Michael K. R. Bloom

Yes. So certainly, another good question. We -- tobacco is actually right on our expectation. We're feeling good about tobacco. We continue to see growth in tobacco. Our units per store continue to increase. We haven't seen an impact. I'm going to get the question, so I'll answer it before I get it. We haven't seen an impact from the rollout of our competitor. And it's really -- what's most important about tobacco, Deb, is for everybody to remember is that the reason we did tobacco was to help sort of solidify our refrigerated and frozen food supply chain. And it has done that. And we are very pleased with what's -- with our results with McLane. And tobacco quite frankly was a nice by-product of that. And we feel good about it. The baskets -- the trips are -- we're driving trips. The baskets remained consistent since we added tobacco. So we feel good about it.

Deborah L. Weinswig - Citigroup Inc, Research Division

Okay. Then one last point. I thought your gross margin performance was amazing. And during the comments, it was stated that there was a removal of non-value cost. Can you be a little more specific on that?

Michael K. R. Bloom

Yes. So I think about store maintenance costs, we think about store maintenance contracts. And as we renegotiate those contracts and consolidate with SMS. We've got auctions going on, so we're seeing better cost there. We've got auctions going on in a lot of private brand and commodity-based type merchandise, both for resale and not for resale. So there's a lot of work going on here to reduce some of this, what we call non-value added costs.

Operator

And next, we go to Matthew Boss with JPMorgan.

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

On the discretionary stabilization, what is the gross margin delta versus consumables today? And also how much margin do think you've actually lost over the past couple of years, given the mix shift? I'm just trying to assess the opportunity here.

Howard R. Levine

Yes. The -- we're not going to be able to respond to the second part of that question. But the first part of the question, assuming that you get good sell-throughs on the discretionary items that you make and that you purchase, the margin is several hundred basis points better than that of consumables. Importantly, too, the discretionary businesses that we think are still very important to the channel and to our assortment help differentiate us. And we're very focused on driving that through our stores. We're excited about some of the changes we've made for the upcoming holiday season as we move into the first part of the calendar year as well.

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

Great. And then can you speak to the trend that saw over the last month? And in line with some of your more cautious commentary in the outlook, have you've seen any impact from the government shutdown and what's taking place larger-picture?

Howard R. Levine

Scott -- Matt, I'm sorry. The way I think about these kind of things is it's just not a help to consumer confidence. The threat of the shutdown, the uncertainty regarding some of the government assistance that our consumers impact, the uncertainty around job growth are very real to our customer everyday. We have over half of our customers are on government -- some sort of government assistance out there. So when they hear and read about all this uncertainty, I think it impacts their confidence regarding their outlook. I'll also tell you that as we move into the first quarter of this year, we're up against our biggest consumable comp, 12% or so. And I think that probably had the biggest impact on September, which was within the guidance that we talked about and that we provided this morning. So as we work through the year, we would expect some of those comparisons to ease. And hopefully, some of the uncertainty out there regarding the outlook begins to stabilize somewhat.

Operator

And next, we go to Matt Nemer with Wells Fargo Securities.

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

Could you just talk to what your comp guidance assumes for the consumables versus the discretionary categories? And then are there any space allocation changes or positioning within the store that could impact the discretionary businesses this year?

Mary A. Winston

This is Mary. I'll take the first part of your question about our comp guidance assumptions. I think the biggest factor, as Howard already talked about in our comp guidance for the first quarter and as we look into FY '14, is the cycling of the big comp that we had on the consumables. So in the first quarter of last year, our total comp was 6.6%. We've already talked about consumable comps being 10% and 12% in the first quarter. And so those numbers are really big numbers to cycle. So while our consumables business is still doing great, still driving trips, still picking up market share, again we're cycling some big comps. The second factor we took into consideration, I think, as we all mentioned in our remarks is the environment that we see our customer faced with. The uncertainty that exists there, we just think it's going to have some impact on customer buying habits. And so we've taken that into consideration in our comp guidance as well. Discretionary, we do expect to see that business continue to stabilize. But as Howard has mentioned, we're not looking for really robust comp sales growth in that business. We're looking for stabilization in that business. So that's where we are on those 2 pieces. And now I'll let Mike take the space question.

Michael K. R. Bloom

Yes. Matt, as far as space goes, we continue to review our total box for space productivity, sales productivity. And there's no immediate changes that we can speak of that are material as far the discretionary space increase or decrease goes. So we talked I think on the last call about our move of discretionary to the front of the store and we relocated food. And that's still happening in our newly remodeled stores, so pretty stable on that front as well.

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

And if I could just follow up with one question, which is your SG&A was flat per foot. And I'm wondering if you can talk to how sustainable that is over the next few quarters. If you could just give us a bit of color on how that could lay out through the year, SG&A per foot.

Mary A. Winston

I don't have with me specifically SG&A per foot. But let me just talk about SG&A in general. There are a number of factors that are putting pressure on our expenses. And of course, the comp is one. We've generally said historically that our comp breakeven point is around that 3% to 4% range. When we think about our expenses, our basic expenses are growing around the rate of inflation or so, so that 2% to 3% range. And then we're continuing to invest in our business. We believe in the long-term investments we're making, and we think that's the right thing to do for the business. So our square footage is growing between 6% and 7%, and we've got expenses associated with that growth and other expenses associated with initiatives. I think a couple things to keep in mind. I think we did a really good job this year of managing expenses, where we brought expenses in as a percent of sales, was great on a flat comp in the fourth quarter. And so we expect to continue the same focus on expense management as what we always do when we plan to continue that going into next year. But a couple of reminders. 2/3 of our expenses are occupancy and labor, which are relatively fixed. And we -- and then in addition to that, we do have some expense headwinds as we go into FY '14, particularly the Affordable Care Act, which as I mentioned in my remarks, is going to cost us $10 million to $12 million and about $0.07 of EPS. So that's a big headwind for us for next year as well.

Operator

And next, we go to John Heinbockel with Guggenheim Securities.

John Heinbockel - Guggenheim Securities, LLC, Research Division

So one for Mike, one for Howard. So I'll start with Mike. How much -- in fixing discretionary, how much room do you think there is to move the offering in more of the basic lower price point direction and get relevancy that way? And then as a tag on to that, when do you think you'll have a new head merchant in place? And what are you looking for him to bring to the table or her?

Michael K. R. Bloom

Yes. So let me answer your first one on discretionary. I think we're low-priced across the board, right? So I think for us, what we're most focused on is making sure we've got the right assortment. We're trend-right. We've got the right allocation by store. We're merchandising it right in the store. And that's -- I mean, the quality, that's where our focus is. I'll give you a quick example of this. I think we have a segment of our store right now that we call ath leisure, right? It's kind of like athletic leisurewear for women. It's on fire. It's doing really well. And most people know what I'm talking about. It's the black yoga tight with the waistbands that have colors. I mean, so there's a segment that you could call, "That's trend-right for our consumer." And we're doing very well. We did very well with long spring dresses that are called maxi dresses. We did really well with those this season. So I feel really good. We've got a great team in place down there. They're doing -- we're in New York all the time now. We've got trend companies helping us. We're overseas. I feel really good about where we're heading with discretionary. And I think there, to your point, I think there's plenty of runway for us. As far as I think your question, John, was on the Chief Merchandising Officer, yes, so here's how I'll answer that one. I mean, here's what I feel really good about. We've assembled a really talented, very diverse, experienced team downstairs. Whether it's Jason Reiser from Sam's and Walmart or Tammy DeBoer from Delhaize with food experience and Holly Shaskey-Platek, who's in internal promotion, managing our discretionary but has a lot of discretionary experience in mass market. I feel great about the team. They're working really well together. They're collaborating across the organization. Certainly, we're searching for a Chief Merchandising Officer. And I would just ask you to stay tuned on that one. But I feel really good that the business is in really good hands. Don't forget, I was a chief merchant for many years and I have a chief merchant as a boss. So we're in pretty good hands from that. But most importantly, I feel great about the team.

John Heinbockel - Guggenheim Securities, LLC, Research Division

All right. And then for Howard, when you looked at the opportunity you have on the EBIT margin front, right, compared to where you were a couple years ago, has there been any serious discussion of temporarily slowing down number of new store openings and renovations, getting the organization to focus more on existing stores? Or is that -- it's premature for that to really be a discussion?

Howard R. Levine

That's a very good question, John. And that's a question that we often discuss, particularly around the planning process every year. This year, we feel very good about our new store performance to begin with. They continue to be receiving benefits from a lot of the new assortment additions we made over the last year. The new store pipeline, as I've said before and let me say it correctly this time, robust and very strong. So we feel very good about our new store performance. We believe that a lot of the challenges with existing stores is not just the macro, but we are cycling some big comps. We are really looking aggressively to reenergize some of these consumable categories. And Mike and I have been through a number of these things and feel very good about it. All that being said, it is a tough macro. And the way we're dealing with those challenges is really watching expenses. We are optimizing quite a bit on the gross margin side of things and really focusing on growing more profitable sales. But it's not to be said, just as we did back in 2008, we did slow down some new store growth. We thought it was important at that time. As everyone recalls, the world looked like it was coming to an end at that point but have restarted that program since then and continue to enjoy good results there. The other important factor, and I've said this and I know you're probably tired of hearing me say this, but the renovation program that we've been working on for the last few years is just extremely important to our future. Those stores, and I know a number of you have been in those and you see what they look like, you get a sense of what they do from a shopping experience and the overall appearance of what we can do. Many have also seen some of our stores that haven't been renovated. So we're going as fast as we can there because we see how important that program is. So again we're staying focused and making investments on the long term but also very focused on some tactical changes and moves to manage the short term appropriately.

Operator

And next, we go to Peter Keith with Piper Jaffray.

Peter J. Keith - Piper Jaffray Companies, Research Division

I just wanted to ask a little bit on the gross margin, which was quite impressive for fourth quarter. But the various puts and takes that you quantified or at least mentioned for the Q4 were very similar to the puts and takes for Q3. Could you give us an idea of what changed that maybe -- what got better or what got less bad to drive that notable improvement?

Mary A. Winston

Sure. This is Mary, I'll take that question. There were a combination of things. There really was not any one big thing that impacted it. It was a number of things that added up to a great quarter from a margin standpoint for us. So shrink was a little bit better than we had planned. Markdowns were a little bit better than we had planned. We continued to see benefit from the initiatives that we've been investing in, in sourcing and private brands. And in many cases, some of those initiatives performed a bit better than we were expecting. Mix stabilized between consumables and discretionary. And so that was a positive. And so I think to your point, you're correct, it was the same things we've talked about. It's just that many of them, bit by bit, delivered a little bit better than we were expecting. And then we did mention in the call that we did have an accounting adjustment that also added about 20 basis points of improvement.

Peter J. Keith - Piper Jaffray Companies, Research Division

Okay. I actually wanted to dig in a little bit more, too, on the IMU improvement. So as you've been ramping up with some of your global sourcing and private label initiatives, I'm going to assume you probably don't turn on a light switch and have all of those come in all at once. Is that a program that is continuing to ramp? And could you drive further IMU upside going forward in the coming quarters?

Michael K. R. Bloom

Yes. It's Mike. Yes, absolutely. I mean, so if you think about -- I will use private brands as an example. If you think about the 500 items we added last year, so you start out the year, most of that was actually back half-loaded, just like the 200 items that we'll add this year. So we'll receive a lot of the benefit of those 500 items that we saw in the fourth quarter as well as moving into FY '14. And then -- so I don't know. Did that answer your question on...

Peter J. Keith - Piper Jaffray Companies, Research Division

When you talk about private label, you've got some new items. But like global sourcing, I know there's a lot of...

Michael K. R. Bloom

Okay. Yes, sure. Yes, so global sourcing, actually the same exact scenario, right? So as we continue to move, find factories, open new offices, move domestic goods or goods that we're purchasing from an agent to a factory, that all takes time. And you're right. So you get -- usually like for us in FY '13, a lot of that was also back half-loaded that we started seeing benefit from and we'll see that throughout FY '14. And we continue to move that. We continue to see that into FY '14. So yes, they all have lags.

Operator

And next, we go to Stephen Grambling with Goldman Sachs.

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

Just to turn back to the softer consumables and going up against a little bit more challenging comparisons, is the weakness really just that these categories are cycling? Or are they not building after year 1? And any kind of detail you can give in terms of, I guess, these new additions versus the core SKUs?

Michael K. R. Bloom

Yes, sure. I'll take that. It's Mike. So with consumables, so there's 2 things going on. One is we're certainly cycling. We've talked a lot about that. We've talked about the comps, where -- what's in front of us in the first quarter is our highest comp from last year. But it's also important to talk about what we're doing, which I think was really the base of your question. So I'll give you a couple of examples. So as we continue -- what we're excited about is we're building on the momentum that we currently have in food as well as health and beauty aids. We've got a fairly significant food reset coming out that will impact the back half of the year, right? We've learned a lot over the last couple of years, over the last year specifically. You've heard me say in the past, not everything always works. But what's most important is we've learned a lot, and we're going to -- we'll tweak the assortment and we'll tweak things like adjacencies within the department. And we're excited about the sort of significance of this revised food set. And you know what? We'll do that every year, and you will hear me say that over and over. I don't want people to think that this is a -- there's something wrong with our food consumables and we're redoing food. We'll redo food every single year. We just implemented our first refrigerated and frozen planogram since we implemented our McLane relationship last September. This September, this past September, we just executed a brand-new schematic in-store. So we've improved the mix again and the assortment and so forth. And then in health and beauty aids, we've been working on that for several months, learned a lot and tweaking the assortment. So it's an ongoing evolution. We continue -- we're happy with where we are from a growth perspective and we'll continue to tweak and sort of reenergize, as Howard mentioned, some of these consumable categories.

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

And so I guess, just a follow-up on that, are there specific categories that you added, where you've now lapped them and you're just not comping on top of the initial pickup?

Michael K. R. Bloom

No.

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

Okay. Then I'll squeeze one more if I can, it's just on capital allocation. As you look to next year, as you think about share repurchase plus CapEx requirements, I mean, is there any thought process in terms of the need to take on debt to finance some of these stores?

Mary A. Winston

Okay. This is Mary. I'm going to sound like a little bit of a broken record here, I guess, because our capital allocation philosophy really has not changed as we go into next year. So just to kind of repeat what our priorities are, our first priority is to invest in the business. And clearly, that's reflected in our capital programs. While we are spending less CapEx next year, we're still making hefty investments in our business and in our store base and in growing the business. And we think that is the best way to return value to shareholders. We're happy with the return on investments there. And it's well in excess of our weighted average cost of capital. So that continues to be our top priority. Our second priority is our dividend program. And as I mentioned in my remarks, we paid out $108 million in dividends last year. We've increased our dividend 36 consecutive years. And we plan to continue to maintain that program and maintain stability there and return value to shareholders in that way. And then our third priority is share buybacks. And so to your point, we will be doing share buybacks next year. We have put in our plans $100 million, as I mentioned in my remarks. We do have flexibility in our cash to be opportunistic in the market. And we'll continue to watch market conditions and make a decision about whether or not we think that makes sense. But investment grade continues to be important to us. So will we take on lots of debt in order to do a share buyback? That's not part of our plans right now.

Operator

And next, we go to Dan Wewer with Raymond James.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Mike, I just wanted to clarify your last answer that you're not seeing negative comps in these new categories. I mean, you noted that discretionary business has stabilized. Same-store sales in August were negative. And yet you had not reached the 1-year anniversary of the McLane benefit. It just seems like it's math that something has turned negative. And that was some of the additions, whether it's Pepsi products or cigarettes.

Howard R. Levine

Yes. No, Dan, I think in general, as we've lapped most of these investments, we continue to see positive trends. There still is a drag on the discretionary side that's impacting our business. But we feel very good about where we are here and think that the investments will continue to provide good returns. And we're excited about correcting and optimizing some of those additions that were not as strong as we would want. But as Mike said, we do that every year. We've got a major food set coming that will impact the back half of our year. We'll address some of those assortment additions that we need to address.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

When you look at the business, the same-store sales turning negative before the addition of McLane, and I guess that's the reason why the first quarter is sequentially worse than the fourth quarter, is it your thought that the business may not turn positive until the second half of fiscal year '14?

Howard R. Levine

No. I think what we talked about in terms of our guidance was some pressure in the first quarter. To your point that we are lapping the peak of all the investments to include McLane during September, as we work through the second and third quarters, those comparisons begin to ease. And we would expect to see a build in our comp store sales over the year as a result of the easing of the comparisons, as well as some of the adjustments and changes we're driving in the business.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

And just the last question I had revolving around shrink. I think, Mary, you noted that it came in below plan, but it was still higher year-over-year. With a reduction in the inventory per store and with the 10% drop in manager turnover, at what point will the shrink really actually begin to drop year-over-year? I would assume it's probably now, but I wanted to get clarification on that.

Howard R. Levine

Yes, sure. I think, Dan, we've -- this is Howard. You probably recognized it wasn't Mary, but -- what you're hearing us say today, and it's with our inventory and it's with our total business is we're really trying to optimize our business. We talked about this a couple quarters ago, is we're in the phase of the business where we add -- we're coming out of 1,000 SKU additions, which is huge for a company like ours, who has a minimal -- a reduced assortment to begin with. Not every SKU worked exactly the way we want it to, we threw a lot at our company at that time and we began working very hard to stabilizing our gross margin. We felt we needed to stop the bleeding there, and we're pleased with those results. Inventory is coming back in line. Again, the same thing, we're optimizing our inventory. The other thing that we're really focused on is our store manager turnover. That got a little away from us during the last year or so with all the work that we threw out at our stores. That's starting to stabilize. And as inventory is coming down, there's 2 great lead indicators as to what is going to happen to shrink. Additionally, Mike talked about the investment we're making with Checkpoint, which we think will also aid in our shrink management. But it's hard to see as we're working through this phase. But we feel like we're in the right spot in terms of where we need to be in optimizing the business. Yes, the headwinds were a little bit stronger than we thought they would be as we lapped some of the consumable investments. But we feel that as the year progresses, that we'll start to see some improvement in our comps along with the continued stabilization of our margin and good expense management. So again, it's hard to see sometimes as you're working through some of these in a business. But we feel good about where we are. We still see great opportunities for this business. We have tons of runway ahead of us in terms of new store openings. We've got management team that has now been with us and stabilizing as well. So we're hoping for a good year and continue to accomplish those important goals that we need to accomplish. So hopefully, that's helpful.

Kiley F. Rawlins

So it is a little bit past 11, and we are out of time. Unfortunately, we did not get through all of our questions today. As always, Kevin and I will be available after the call for any follow-up or additional questions you may have. Thanks for your interest in Family Dollar, and have a great day.

Operator

And that does conclude today's conference. We do thank you for your participation. You may now disconnect.

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