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Family Dollar Stores (NYSE:FDO)

Q4 2012 Earnings Call

October 03, 2012 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 R. Bloom - President and Chief Operating Officer

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

Analysts

Deborah L. Weinswig - Citigroup Inc, Research Division

John Heinbockel - Guggenheim Securities, LLC, Research Division

Daniel T. Binder - Jefferies & Company, Inc., Research Division

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Meredith Adler - Barclays Capital, Research Division

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

Joseph Parkhill - Morgan Stanley, Research Division

Operator

Good morning. My name is Wendy, and I will be your conference facilitator today. I would like to welcome everyone to the Family Dollar Earnings Conference Call. [Operator Instructions] Today's conference is being recorded. 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, Wendy. Good morning, everyone, and thank you for joining us today. For those of you who have dialed in, please note that we have posted accompanying slides on the Investor Relations page of our website.

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, 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 3, 2012. 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'll reference some non-GAAP financial measures, which are intended to help investors understand Family Dollar's ongoing business performance. These measures include operating profit, net income, earnings per diluted share, return on invested capital and return on equity, each excluding litigation charges. A reconciliation of these non-GAAP financial measures to the comparable GAAP financial measures is included in our earnings release issued this morning and available on our website.

Our call today will begin with some opening comments from Howard Levine, Chairman and CEO; then Michael Bloom, President and COO, will share an operational update; and Mary Winston, CFO, will review our financial results for fiscal 2012 and our outlook for fiscal 2013. [Operator Instructions]

Now I'd like to turn the call over to Howard Levine. Howard?

Howard R. Levine

Thanks, Kiley, and good morning, everyone. Thanks for joining us today. 2012 was a great year to be a Family Dollar team member, a Family Dollar customer and a Family Dollar shareholder. Operating in a tough economy and a very competitive retail environment, we delivered another great year. In fiscal 2012, total sales increased 9.2%; comparable store sales increased 4.7% as we built nice momentum throughout the year; and on an adjusted basis, we grew earnings per share by about 17% to $3.64; and we improved return on equity to 35.4%.

We finished the year on a high note as comps in the fourth quarter increased 5.4%, our best quarterly performance of the year. Adjusted earnings per share increased about 14% to $0.75, resulting in our 18th consecutive quarter of double-digit EPS growth. This is a great accomplishment that speaks to the consistency of the Family Dollar business model.

2012 was full of significant accomplishments, and I can't remember a time in our company's 53-year history when we accomplished so much so quickly. We accelerated square footage growth and opened 475 new stores, including our first stores in California. These stores are off to a great start, and we are excited about our future growth opportunities. As part of our renovation program that began in the fall of 2010, we renovated, relocated or expanded 854 stores. And we introduced a new store layout that better positions the company for growth in our consumable categories. Our renovated stores continued to outperform the chain in year 1, and more importantly, we continued to see growth in year 2.

We continue to expand our supply chain to support our growth. In June, we opened our 10th distribution center in Ashley, Indiana. Ashley is now fully operational, servicing over 600 stores. With the opening of Ashley, we have reduced stem miles and added capacity to support our square footage growth and rising comps. And this summer, we broke ground on our 11th distribution center in St. George, Utah, which is expected to open in late summer 2013. St. George will be key to supporting our growth out west.

In an effort to become more relevant and to drive more trips, we successfully executed a number of merchandising initiatives in fiscal 2012 to increase our consumable assortment. We expanded our health, beauty and personal care assortment by about 600 SKUs. We introduced new impulse fixtures to carry popular items like candy, snacks, magazines and mall gift cards. We added Pepsi in April, and I'm pleased to report that all stores are now selling both warm and cold Pepsi products.

Building on our investments over the last couple years, we expanded our food assortment in all stores by another 400 SKUs in 2012. In 1,400 stores that have yet to be remodeled, we expanded refrigerated and frozen capacity from 5 doors to 10 doors. I'd like to mention that while we have greatly improved our food and HBA assortment, I still think we have an opportunity to improve the adjacencies in stores operating in our older formats. As we go back and renovate these stores, we will be in a better position to capitalize on these expansions and improve the shopping experience.

In addition to our food and HBA expansions last year, we introduced tobacco in our stores beginning in May. And at the end of the fiscal year, about 6,000 stores were selling tobacco products.

And to support our cooler expansion and tobacco introduction, we introduced or announced a 6-year exclusive strategic partnership with McLane to service our stores. McLane enables us to establish a national supply chain for refrigerated and frozen merchandise that will support this growing segment of the business. I've been in our stores over the last couple of weeks to check on the progress and -- of our new cooler set. And I have to tell you, it looks great. The new items really improve the assortment, and I'm sure our customers will appreciate the changes.

Importantly, the additions we've made over the last year to increase our relevancy and to capture more trips are progressing as planned. Comps accelerated through the year, and we increased our market share in Consumables over the last 12, 24 and 52 weeks.

Before I turn the call over to Mike, I'd just like to thank our teams for a great 2012. We delivered strong results and completed an important period of strategic positioning to prepare us for our next phase of growth. We expect that the return from these investments will continue to drive momentum in fiscal '13 and beyond. This year, we will open another 500 stores; renovate, relocate or expand another 850 stores; and we are on track to complete the refresh of our entire chain within the next few years. So again, 2012 was a terrific year for Family Dollar, and I'm excited about our prospects for 2013.

And now I'd like to turn the call over to our President and COO, Mike Bloom. Mike?

Michael R. Bloom

Thanks, Howard, and good morning, everyone. 2012 was a great year for Family Dollar. We were laser-focused on becoming more relevant and driving more trips into our stores. We successfully executed multiple merchandising initiatives to expand our food, health, beauty and personal care assortments, and our early results indicate that these strategies are working.

Before I discuss our focus for 2013, I want to talk about our sales trends in the fourth quarter. As Howard mentioned, comp store sales in the fourth quarter increased 5.4%. As we discussed on our third quarter call, the beginning of the fourth quarter started off a little soft. But as expected, sales in July and August accelerated nicely as we gained traction from our consumable initiatives. Consumable sales increased 16% in the fourth quarter. While the new items haven't been in our stores very long, it's clear that our customers are voting with their wallets and really like our new expanded assortment. As expected, food delivered double-digit comp increases in the quarter. And just as importantly, private brand food growth outpaced national brands. Key private brand additions, like our new Family Gourmet water, canned vegetables and cereals, give our customers new private brand options with national brand quality at a great price.

We were also pleased with our refrigerated and frozen food sales in the quarter. And as we add our new expanded and more relevant assortment from McLane, we expect the sales momentum will accelerate. We have completed the transition to McLane, and the conversion has been smooth. Once again, our store teams did an exceptional job managing the transition. Every store in a chain now receives weekly deliveries of frozen and refrigerated food, and this consistency will help improve our in-stocks. Our coolers now carry a consistent assortment that can be advertised nationally, and we now have key national brands available in all stores. Some of these new exciting brands include DIGIORNO pizza, Eggo waffles and Stouffer's lasagna, just to name a few.

The second major growth segment in our Consumables category, health, beauty and personal care, performed very well in the quarter. Sales continued to accelerate, and our customers are really responding well to the new assortment. The biggest focus of our recent HBA expansion was in the OTC area. Our customer research indicates that our customers over-indexed in 18 of the top 20 ailments affecting the U.S. population. Many of our customers do not have health insurance, so we are providing them with more solutions to take care of themselves and their families. We are encouraged by the early results in these categories, which typically take longer to ramp up.

Tobacco sales were also very strong in the quarter, and we are happy with the current sales trajectory. Weekly sales continue to ramp, and the basket characteristics remain consistent with the information that we provided at our Analyst Day back in July. The average basket size for tobacco -- for a tobacco transaction is still around $13. And 60% of the baskets that include cigarettes have additional items in them, and that basket still averages $17. And it's important to note that the gross margin of those additional items in the basket has stayed consistent and remains in line with our overall company gross margin.

Home and Apparel sales in the fourth quarter continued to be difficult. While we expect Home and Apparel sales to remain under pressure moving forward, we remain focused on driving profitability through direct sourcing and improving inventory productivity.

Seasonal sales increased 4.8% over last year. And as a reminder, Seasonal sales in the third quarter increased about 15%, reflecting an early start to the spring season. While June was challenged by cooler weather, we built good momentum through July and August, giving us a nice foundation heading into the holiday season. And as you've heard me say over the last year, Seasonal remains a huge growth opportunity for us. Our customers love to celebrate events and holidays with their families. They just don't want to spend a lot of money doing it. And this holiday season, our stores will offer a more fun, relevant and value-packed assortment. We have a great marketing plan in place for what we think will be a very competitive holiday season. And our in-store presentation will scream excitement and value.

Our 2013 holiday marketing plan will build on the marketing improvements we've made over the last year. Using the customer as a filter for every decision that we make, we upgraded the look, content and distribution model of our circulars. We improved our circular sales lifts through featuring a more relevant product mix, introducing new promotions, such as the item of the week, and enhancing our distribution model by moving to the Sunday newspaper. This year, we will continue to explore ways to upgrade our marketing program, and we will continue to work on promotional efficiencies.

So now switching gears and looking ahead to fiscal 2013, this year, we will build on our momentum from 2012. We have significantly increased and improved our merchandise assortment. We are more relevant, we are more competitive, we have accelerated comps and we are driving market share gains. This year, for the most part, large-scale SKU additions are behind us. Going forward, we are primarily focused on SKU optimization, inventory productivity, improving our store-level execution and driving profitability. As we've discussed, our sales mix has evolved with the economic climate and customer demand, and our assortment continues to shift towards lower-margin consumables. Recognizing our model was changing in 2012, we accelerated our investments in global sourcing and private brands to improve our initial markups and drive profitability. We are still in the early innings of capturing the full potential in these areas, but our teams did a great job successfully offsetting much of the margin pressure in 2012.

As our mix shift accelerates this year from our recent SKU additions, it will become increasingly important that we invest in these programs to drive profitability. In the first half of the year, as tobacco and food sales continue to ramp, these lower-margin sales will further pressure our gross margin. But as the year progresses, we expect to see some relief as our benefits accelerate from private brands, global sourcing and pricing.

In 2011, we opened our first overseas office in Shenzhen and Hong Kong. And over the last 2 years, we've scaled up our sourcing teams. Our investments drove substantial progress in 2012, and we increased our direct-to-factory purchases to about 4% of total purchases. In 2013, we plan to open a new sourcing office in Shanghai, and we will continue to look at additional markets to increase our international presence. These milestones put us on track to meet our goal of 13% of total purchases coming direct from factory in 2015.

Our private brands program also made significant progress in 2012. We introduced nearly 400 new SKUs and improved the quality of our assortment. This resulted in private brand consumables sales growth of about 16%. In 2013, we will accelerate our SKU additions and introduce over 500 new private brand items to our selection. And we are on pace to reach our goal of doubling our private brand sales by 2015.

So now with these merchandising levers in place and delivering results in fiscal 2013, we'll focus on improving the in-store experience and driving best-in-class store-level execution. Our strategy is simple. We will focus on improving store-level processes and making things easier on our store team members. We will work to get more efficient and more productive in our stores, improve our in-stocks and manage the workload better for our team members. If we take care of our team members, we will take care of our customers. This is key to improving customer satisfaction, improving customer loyalty and driving higher sales.

To kick off this renewed focus, back in August, we hosted a company-wide sales meeting with over 1,000 members of our field leadership team. We brought this team together with our merchandising organization and senior leadership team for 3 days to unite the entire team and share one consistent message about the company's strategy, performance and goals. This meeting was an important step to further strengthening the Family Dollar brand across the entire chain.

So again, I am very excited about the progress we've made over the last year and the opportunities we have to further leverage our investment. Our initiatives are working and comps are accelerating. In 2013, we will be laser-focused on execution, store simplification and improving the customer experience.

And now I'd like to turn the call over to our Chief Financial Officer, Mary Winston. Mary?

Mary A. Winston

Thank you, Mike, and good morning, everyone. Fiscal 2012 was another strong year for Family Dollar. We invested aggressively, delivered double-digit earnings per share growth and improved our returns. As expected, fourth quarter sales continued to accelerate, with total sales increasing 10.8% to $2.4 billion. This growth was a result of both an accelerating comp and more new store openings.

To provide our customers with more value and convenience, we launched a number of growth initiatives to increase our relevancy and drive greater sales productivity. As these changes gained traction through the fourth quarter, the impact on sales accelerated. Comp store sales increased 5.4% in the quarter, driven both by increased customer traffic and average customer ticket. During the quarter, we opened 188 new stores and closed 13 stores, compared to 94 openings and 14 closings in the fourth quarter last year.

Gross profit in the fourth quarter increased 10% to about $800 million. As a percentage of sales, gross profit exceeded our plan, declining only 17 basis points in the fourth quarter to 33.8% of sales.

Reflecting the success of our assortment expansion, Consumable sales grew 330 basis points to 72.5% of sales compared with 69.1% of sales in the fourth quarter last year. As expected, this mix shift, combined with higher inventory shrinkage, resulted in more pressure on gross margins during the quarter. However, higher markups, lower markdowns and lower freight expense, all as a percentage of sales, offset most of this pressure in the quarter.

SG&A expense as a percent of sales decreased 9 basis points to 27.7% in the quarter. Store labor costs leveraged about 35 basis points due to better workforce productivity. In addition, we saw lower expense related to our renovation program, reflecting both ongoing efforts to reduce the cost of each renovation and the effect of fewer renovations completed this quarter. These improvements were largely offset by higher insurance expense and higher marketing expense.

Over the last several years, we've worked to stabilize our workforce, improve our risk management programs and manage our workers' compensation and general liability claims better. As a result, over the last 4 quarters, we have reduced overall claim frequency and experienced significant reductions in the amounts reserved for prior year claims. In the fourth quarter this year, we began to anniversary these benefits, and as expected, we experienced about 30 basis points of pressure from insurance expense in the quarter. As a reminder, in the fourth quarter last year, we saw about $10 million or about 60 basis points of benefit from lower insurance expense. In addition, marketing expense as a percent of sales increased about 25 basis points, reflecting additional promotional events in the quarter.

Finally, this quarter we incurred a litigation charge of approximately $11.5 million associated with the preliminary settlement of a class action lawsuit in the state of New York. This lawsuit involved claims for overtime pay for New York store managers who worked in our stores over the past 9 years. While we decided to settle the New York litigation, I would note that each lawsuit is unique. For instance, in the past 3 years, the federal court of North Carolina, overseeing the national multi-district litigation, has repeatedly ruled in our favor that our store managers are exempt from overtime pay. Excluding the litigation charge, adjusted net income in the quarter increased 10.3% to $88.1 million, and adjusted earnings per diluted share increased 13.6% to $0.75.

Now let's review fiscal 2012 results. In fiscal 2012, sales increased 9.2% to $9.3 billion, and comp store sales increased 4.7%. Both customer traffic and average customer ticket increased for the year. And our investments to become more relevant to the customer and expand our selection of consumables resulted in a nice acceleration of sales through the year. Sales were strongest in the Consumables category, which increased about 13% for the full year.

Gross profit for the year increased 7.5% to $3.3 billion. As a percentage of sales, gross margin declined 53 basis points to 34.9% of sales. Our continued investments in private brands and global sourcing capabilities resulted in higher markups in fiscal 2012. However, these improvements were more than offset by stronger sales of lower-margin consumables, increased inventory shrinkage and higher markdowns.

For the year, SG&A expense increased 6.9%. As a percentage of sales, SG&A decreased 57 basis points to 27.4% of sales. For the year, lower store labor expense and lower insurance cost were partially offset by higher marketing expense. Most other expenses were leveraged as a result of the 4.7% comp store sales increase.

Adjusted operating profit increased 9.6% to $700 million. As a percentage of sales, adjusted operating profit was up slightly as compared to fiscal 2011 at 7.5% of sales. Adjusted net income for fiscal 2012 increased 10.5% to $429 million, and adjusted earnings per diluted share increased 16.7% to $3.64.

Now turning to the balance sheet and cash flow statement. Merchandise inventories at the end of the year were $1.4 billion compared with $1.2 billion at the end of fiscal 2011. Average inventory per store at the end of fiscal 2012 was 16.6% higher than at the end of fiscal 2011. The growth in inventory was a result of our recent expansion of food, tobacco and health and beauty aids. And our accelerating sales trends confirm that our customers appreciate the enhanced selection of consumables. I would note that average discretionary inventory per store was about flat at the end of fiscal 2012 as compared with the end of fiscal 2011.

Capital expenditures for the year were $603 million, up significantly as compared to fiscal 2011 but below our guidance due to the timing of some fee development projects. Our first priority when deploying capital is to invest back in the business, and we continue to see improving returns from these investments. In fiscal 2012, we invested about $205 million in new stores, including $119 million for stores in our fee development program. We also invested about $154 million for renovated, expanded and relocated stores; about $94 million for existing stores to support our merchandise efforts; and about $84 million for supply chain projects, including the completion of our 10th distribution center and the start of our 11th distribution center.

As a reminder, in fiscal 2012, we initiated a new fee development program. Through this program, we work with developers to build new stores, and upon completion, we own the stores. Ultimately, our goal is to convert these owned assets into leased assets through a series of sale-leaseback transactions. In fiscal 2012, we closed 2 sale-leaseback transactions, generating net proceeds of about $360 million. Going forward, we intend to continue to leverage sale-leaseback transactions to monetize owned stores as a source of capital for the ongoing fee development program.

In fiscal 2012, we purchased 3.2 million shares of our common stock for $192 million and paid $91 million in dividends. As of August 25, 2012, we had the authorization to purchase up to an additional $146 million of our common stock.

And now let's talk about our outlook for fiscal 2013 and the first quarter. As we discussed previously, our financial goals over the next 3 to 5 years are to consistently deliver 5% to 7% net new store growth, mid-single-digit comp sales growth, operating margin expansion and double-digit EPS growth. Our plans for fiscal 2013 align nicely with these long-term goals. In our press release this morning, we provided earnings per share guidance for fiscal 2013 of between $4.10 and $4.40, representing a range of up 13% to up 21%, excluding the litigation charge incurred in the fourth quarter of fiscal 2012.

As a reminder, fiscal 2013 is a 53-week year. Like most other retailers, the extra week will occur in the January period. Consequently, our second quarter will include 14 weeks in fiscal 2013 compared with 13 weeks in fiscal 2012. Included in our guidance is about $0.10 related to the extra week.

To provide our customers with more value and convenience, in the third quarter of fiscal 2012, we launched a number of growth initiatives to increase our relevancy to the customer and drive greater sales productivity. As these changes gained traction through the fourth quarter, their impact on our business accelerated. The completion of these initiatives, combined with the transition to McLane, position us well for strong growth in fiscal 2013.

As a result, we expect that Consumables sales growth will continue to accelerate in fiscal 2013. We also believe that the macro environment will continue to be challenging for our customers, resulting in continued pressure on more discretionary categories. As a result, we are planning net sales increase for the year between 13% and 15%, and we're modeling a comp store sales increase between 4% and 6%. Consistent with our long-term square footage target, we plan to open about 500 new stores and close between 70 and 90 stores in fiscal 2013.

For the year overall, our goal is to expand operating margin, driven by SG&A leverage. We expect that Consumables will continue to grow as a percentage of our sales mix, and we believe that this mix shift will continue to pressure gross margin in fiscal 2013. As we experienced in fiscal 2012, we expect our investments in pricing, private brands and global sourcing will partially offset these headwinds, with more benefit in the second half of the year than the first half as our initiatives mature and gain more traction. As a result of these expectations, we are modeling higher gross profit dollars but lower gross margin rate.

In fiscal 2013, we continue to focus on driving productivity and keeping our core expenses low. At the same time, we face some headwinds from the insurance benefits achieved in fiscal 2012. Regarding capital expenditures, as we indicated in the earnings release, we expect to invest between $600 million and $650 million in fiscal 2013.

As we look to the first quarter of fiscal 2013, we believe that sales of Consumables will continue to accelerate. But we also expect to face some of our toughest headwinds of the year on both the gross margin and the expense lines. We're targeting a comp store sales increase of between 4% and 6%, driven primarily by growth of Consumables. While we're only a month into the quarter, our sales trends are in line with these expectations. We expect that the increasing impact of our sales initiatives and the resulting growth of Consumables sales will drive additional gross margin dollars, but will also accelerate the pressure from mix. In addition, we expect that higher markdowns and higher shrink in the first quarter will exacerbate this pressure. We expect that the benefits from our ongoing investments in global sourcing, private brands and pricing initiatives will offset these pressures more as we progress through the year.

We also face headwinds from insurance in the first quarter, similar to what we saw in the recently reported fourth quarter. As a result, in the first quarter of fiscal 2012, we experienced 60 basis points or about $10 million of benefit from lower insurance expense. Given these expectations, we expect earnings per diluted share in the first quarter of 2013 to be between $0.69 and $0.78.

And now I'll turn the call over to Howard for some closing remarks. Howard?

Howard R. Levine

Thanks, Mary. 2012 was certainly a year of change at Family Dollar. I'd like -- and I'd like to thank our team members again for their terrific accomplishments. Our teams did a great job reacting quickly to manage a difficult environment. We listened to the customer, we made a lot of changes to improve our merchandise assortment and we became more relevant in the market. Our initiatives are working, and we feel very good about our long-term competitive positioning. We've had some great traction from our sourcing and private brand initiatives that have helped to sustain margins, and we expect that this momentum will accelerate in fiscal '13.

Our commitment to providing value and convenience for our customers will once again drive our investment decisions and lead to higher returns. Our 2013 plan puts us on track for another year of mid-single-digit comps, 5% to 7% net store growth, double-digit earnings growth and higher returns on invested capital. It's a great time to shop, work and invest at Family Dollar, and we look forward to another successful year.

And now, operator, we'd be happy to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Deborah Weinswig with Citi.

Deborah L. Weinswig - Citigroup Inc, Research Division

So I thought it was very interesting where you talked about basically over-indexing with your customers in terms of the top 20 ailments. Can you talk about how you are not only merchandising, but also potential services that you might be offering in your stores as a result?

Howard R. Levine

Sure, Deborah. Now one of the things that -- and it's common, it's data that's available to the public, and it just shows that a lot of our customers skew to a lot of the ailments that are very prevalent in the country today, from high blood pressure to overweight, et cetera. And our assortment continues to focus on how they can at least get some benefit from shopping Family Dollar and treating some of those things. As we look out over the next couple years, particularly with the healthcare changes coming on, it's something that we'll pay a lot of attention to in terms of how we may be able to better service some of the markets that we're in with some additional benefits. But there's nothing really specific that I can talk about at this time, as we just want to wait and see how things develop further with what's going on in healthcare overall.

Michael R. Bloom

Deborah, it's Mike Bloom. I would also add, we're doing a lot in-store. When you think about cough and cold season and allergy season, you'll see a lot more off-shelf activity, floor stands, cough drops, private brand allergy medications. You'll also see a significant presence in our circulars throughout the appropriate seasons of more healthcare items. So we're also -- that's also another area that we're focused on. And in addition, we've got email campaigns that we'll be sending out to our customers related to cough and cold, allergy, et cetera. So we do have a lot of activity going on.

Deborah L. Weinswig - Citigroup Inc, Research Division

Okay. And as a follow-up, I mean, 2012, you accomplished so much. As we think about 2013, do you think that gross margin or SG&A will be the bigger opportunity?

Howard R. Levine

I think we have an opportunity in both areas over the long term; specifically, when we talk about 2013, as we've indicated, that there is going to be quite a bit of pressure on the gross margin line, particularly in the first half of the year. As we recently completed the introduction of all the McLane items, we are now selling tobacco in 6,000 stores, along with all the other HBA and food items that we have, we still continue to face some pretty good headwinds going into the first half of the year. So there's a little timing difference. What Mike had talked about is the growth and the accelerated plans in the global sourcing area and the private brand areas begin to accelerate. So most of those benefits will come into play more in the back half of the year. So when we look at the year in total, pressure in the first half, waning a little bit in the second half. But talking to expenses, we think that's where the significant operating margin benefit is going to come, with the improved comp sales growth that we're having will enable us to hopefully leverage expenses better. But again, we're up against some heavy workers' comp benefits from the prior year that we're going to have to work through during the first 3 quarters of the year. But let me just be clear that our goal with all the things that we're working on, our plans here for the next few years, are to drive improvements in operating margin. We think we're on track with everything that we're doing. The timing of every initiative is not perfect, but we are definitely focused on driving operating margin and believe that we will continue to see improvements of that over the next few years.

Operator

Our next question is from John Heinbockel with Guggenheim Securities.

John Heinbockel - Guggenheim Securities, LLC, Research Division

Two things. Now that the planograms are done on the cooler sets, how many SKUs were added as a result of McLane? And generally speaking, what percent increase would that have been in SKU count?

Michael R. Bloom

Yes, so John, it's Mike. In the -- as far as refrigerated and frozen goes, we added between 50 and 70 items to the mix. As a percent, you know what, I don't know. I don't know. I mean we can get back, but I don't know as a percent.

John Heinbockel - Guggenheim Securities, LLC, Research Division

And I mean whatever the percent was, what you added was -- the lift that, that gives you to cooler sales, I imagine would probably be less than the percent increase in SKU count, right? Because you already had all the high-volume dairy items in there.

Michael R. Bloom

Yes. No, I think, John, I think the way we think about the changes that we've made to our assortment and the utilization of McLane in this is that the SKU count increase is one aspect of it. But what we're really excited about is the improvement in the actual items that we're selling. We're going to have true national brands to offer to our customer. We've got McLane that has a huge inventory of SKUs that we can select from, and frankly, they'll add some if we'd like for them to that we would like to consider to carry. Further to that, I think the other huge benefit to us is the improved in-stock in our cooler and refrigerated areas. It's one thing that I have noticed over the years that we have just not hit an adequate in-stock level in our coolers. With McLane making weekly deliveries to our stores, we feel that that's going to substantially improve. So in the long haul, with the improvement of our in-stock and the improvement of the items for our customer to shop and our ability to now advertise nationally some of the things that we're doing there, we think in the long run, this is going to be a real win for us.

John Heinbockel - Guggenheim Securities, LLC, Research Division

All right. And then secondly is kind of an involved question, but think about the discretionary categories on 2 levels. One, what do you think you need to do with regard to the upcoming fiscal cliff to make those work in the shorter term? And then do we get to a point where, when you look at it secularly, you want to shrink space and/or fundamentally change what you're carrying in those discretionary categories? So what do you do tactically and how you think about those businesses secularly?

Michael R. Bloom

No, that's a great question, John, and it's something that we spend a lot of time thinking about here at Family Dollar. And over the years, our discretionary categories, particular the Apparel categories, have substantially been reduced. When we think specifically about the year that we're getting ready to enter, some of the things that we did that are quite a bit different than the prior year is, number one, from the get-go, we are severely curtailing receipts in some of these discretionary categories. If you recall last year, we had bought up some Apparel categories in the first half of the year. We didn't sell those items. We had to mark them down. Given the uncertainties with the things you mentioned, the fiscal cliff, the election, the uncertainties in our macro environment out there, we just think our customer is struggling there. And it made a lot of sense to curtail receipts there to be a little more conservative, focus not on comps as much, but focus on sell-throughs and improving our gross margin dollars from those businesses. And we've got those plans in place. And as we said, at the end of the year, discretionary inventories are flat to last year. And I think that's real important when we look at markdown management over the remainder of the year. Your bigger question, one that I think is more strategic in nature and something that we're continue to work on and I think we've made a lot of progress, is what is the proper role that Apparel plays in the Dollar store channel today. I think that Family Dollar has enjoyed a lot of success in the Apparel categories over the years, but it's been extremely volatile. It's an important category to us, in that I think it brings us margin, number one; it brings us some differentiation, number two. But I think we still continue to work and focus on what the right role is. We've had a lot of success in some items, things that our customers really look for us to carry at Family Dollar, obviously, basic categories, underwear and socks. But I think there's further opportunities when you look at some of the hanging Apparel categories to really properly identify what SKUs our customers are looking for us to have and how can we properly and easily merchandise those items within our stores. It's easy to talk about, very difficult to execute in our channel, but something that I think we'll start to enjoy some progress in over the last few years. We're not giving up in those categories. They're very important to the overall mix. But they will be reduced in terms of the overall presence in our stores, particularly with the challenging macro environment out there. So stay tuned. We continue to focus on and work hard and look to see some benefits from the discretionary side, but not this year.

Operator

Our next question is from Daniel Binder with Jefferies.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

I have 2 questions. First was around pricing. You mentioned in your formal remarks that you had higher marketing expense related to additional promotional events. I'm just curious what you're seeing in the competitive landscape. Obviously, Walmart's been making a lot of noise. So I'm curious what you're seeing there and how you're responding, that's my first question.

Michael R. Bloom

Yes, so it's Mike, Daniel. So there's no question the competitive environment is heating up. You mentioned it, Walmart, we've seen significant incremental events, pages, TV. You've seen them, I've seen them. So what are we doing to respond to that? We're doing what we do best, and that's why you heard us, a lot of focus on store execution and in-stock. But we've added -- our customer wants us to be in that Sunday paper. We've added some incremental promotional events where we felt it was appropriate in the marketplace to compete, of course, in the Sunday paper. You've seen us with some specific supplier partnerships events, whether it be a Procter & Gamble brandSAVER event, et cetera, you've seen those, in addition to in the Sunday newspaper. So we're responding. We feel good about our marketing plan for '13 and certainly heading into the holiday season. And as I mentioned in my remarks, we think the holiday season will be a competitive environment, so -- but we feel good about it.

Daniel T. Binder - Jefferies & Company, Inc., Research Division

And my second question was around the acceleration that you've talked about. Your plan for 5% to 7% comps recently, you've seen sort of build up towards the lower end of that. I know Q4 was sequentially a little bit better. I'm just curious, where -- what do you think the biggest deviation from your sort of expectations were between achieving the sort of lower end of that range versus the upper end? And is the HBA program at this point where you thought it would be when you had rolled it out?

Howard R. Levine

Dan, I think the biggest variation on our sales has been related to our discretionary businesses, as we talked about. The consumer is focused on what they need every day and not so much on some of the other discretionary categories, so that was the biggest delta. In terms of why we went from 5% to 7% to 4% to 6%, candidly as we talked about, it's a midpoint of 5%. It's a very tough, uncertain environment out there with the elections, the economy, et cetera, and we just thought it would be proper to land in that kind of area. Mike, you want to take the HBA?

Michael R. Bloom

Yes. No, I mean, as far as HBA goes, it's -- as I mentioned, HBA is performing well. I think you could argue better than we may have expected, ramping up a little quicker than we expected, so again, good news and we feel good about the trajectory of HBA.

Operator

Our next question is from Matt Boss with JPMorgan Chase.

We'll move onto the next question. The next question is from Scot Ciccarelli with RBC Capital.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Given the acceleration that you guys saw in the Consumable sales this particular quarter, can you help us size the impact that tobacco had on the quarter? Back of the envelope suggests it was in the $30 million to $50 million range, but just wondering if our math is at least in the ballpark there.

Howard R. Levine

We're not really giving color to sales trends specific to categories, Scot. Tobacco has obviously gotten a lot of great traction. We're very pleased with the way our stores are controlling shrink in the categories and the way our customers have responded. But we're not going to break out individual categories at this point.

Michael R. Bloom

And we're -- Scot, we're also very pleased with the attachment rate on tobacco purchases.

Scot Ciccarelli - RBC Capital Markets, LLC, Research Division

Got it. Okay. And then one other question. You guys have added a lot of branded products, especially with McLane coming in, et cetera. But it also sounds like you're still driving greater penetration of private label in the store. And I guess I'm wondering, can you give us any color on how that nets out? Is that a function of customers seeking lower price point items? Or would you attribute that to something else?

Michael R. Bloom

Yes, so as far as private brands go, I -- it's one of the areas I'm actually most excited about. We've -- as I mentioned, we added about 400 SKUs last year, we're going to add about 500 SKUs this year, Consumables growing, I think it's in the neighborhood of 16% in private brands this year. We're improving our quality. We've improved our packaging. We've got new leadership in private brands. Tammy DeBoer just came onboard. Again, just all upside, very excited, we've got the pricing model. We feel pretty good about our pricing model in private brands today. So again, all good news and increased penetration. You saw that in our food category, our private brands outpaced our national brands, so all good news.

Operator

Our next question is from Meredith Adler with Barclays Capital.

Meredith Adler - Barclays Capital, Research Division

Maybe this might be a question for Mike. But you talked a fair amount about what the focus next year is in terms of store-level execution, improving inventory productivity, and just making things easier for the store staff. And clearly, if you're going to keep growing fastest-turning inventory, those things are important. Could just talk about maybe more specifically what some of the initiatives are and how long it takes to kind of improve -- get to the point where you want to be?

Michael R. Bloom

Yes. So Meredith, let me try and add a little bit of color. I mean, so we're store operators. I'm a store operator. It's my background. What we're going to do is we're -- our goal is to make it easier across every aspect. That could be everything from -- I can give you -- here's a couple of examples. Think about how we ship products to stores and the displays that they're in. So the store can just open a box and put the display on the shelf. Or think about pre-priced, or think about when items hang up on pegboard, we send it already tabbed so the peg's on it. So there's so much we can do to make it easier for our stores. It's everything from putting -- from the time the truck hits the back door to the time the delivery gets onto the shelf. It's from the time the customer walks to the checkout to the time -- speed of checkout and how we can improve speed of checkout, and that's design of checkout and that's all -- there's so many components there. As far as the time frame goes, it's what we do, and it's what we do really well. I think we proved in 2012 that our operators respond very well. Think about the initiatives that we executed, and I've said in my view, almost flawlessly. So I anticipate this is going to go just as smooth. This is music to their ears. We've worked them pretty hard in 2012, and it's our responsibility to make it easier on them and we plan to do that. So it will be our focus this year.

Meredith Adler - Barclays Capital, Research Division

Great. And then just another question, perhaps related about inventory and inventory productivity. Do you have some kind of a goal for this year of where you think inventory per store should get to or the growth in inventory per store in '13 versus '12?

Howard R. Levine

Sure, Meredith. I think no question that we've added a lot to our inventory levels over the last several quarters. And frankly, that was part of our game plan to do so. When we evaluated our assortment across the competitive landscape, we had a much lower level of inventory, which means that we had a much smaller assortment. So we felt we needed to go through this step to add SKUs to the inventory, to enhance the assortment, to be more competitive. And the good news is we're getting some good traction. Not every item is performing as well as we'd like. There's plenty of opportunities to improve upon that. And that's what the focus will be this year is looking to SKU optimize, evaluate SKUs that did not perform, replace them with better performing SKUs, and that's across private brand, as well as national brand. And our goal is – I mean, I think I said this last time, is -- and frankly, the end of August, we're pretty much where we thought we would be. But going into fiscal '13, I'm hoping by the end of this year, we're going to start to see some inventory productivity. We haven't forgot what that means. I shake up some of our guys every once in a while to make sure that they understand what that word means. And they've assured me that they do, and it will be a focus. But again, it's part of the plan. We needed to add the SKUs. We needed to improve the assortment. We're getting that, and now we're going to focus on the productivity side of things. So we're definitely working on it.

Operator

Our next question is from Matt Boss with JPMorgan Chase.

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

You spoke to accelerating trends as the quarter progressed. Can you talk about new brand introductions in the quarter, how you think the incremental targeted $40,000 to $70,000 income household customer is responding to some of the marketing and assortment changes to the best you can?

Howard R. Levine

Matt, when we look at that higher-income customer, I think we continue to believe that's a great opportunity for Family Dollar. We're still in the early innings there in terms of making our stores more appealing to that type of customer. But when I think about what we've done with our renovation program, the way we've grown our assortment, importantly, our focus on improving the quality, our private brand merchandise, when you see Family Gourmet -- in fact, I'm having a Family Gourmet water today as we speak. It's fantastic merchandise. It tastes good. It looks good. All those things are critically important, not only to our core customer and that we're not losing focus on, but particularly this higher-income customer and how we can capture more per wallet. But I think we're well positioned. We've got it on our radar to continue to work on that. And a lot of it is driven by location too. I will be candid with you, not every one of our locations is in a position for that trade-down customer, but a lot are. And there's certainly plenty of real estate available in some of those markets to also take advantage of. But we're taking it slow. We're making sure that we don't lose focus on the core customer but still expand the focus on a better-income customer. And while it doesn't speak very well to what's going on in our country, I think there's going to be more and more people looking for value and convenience that we offer. And I think we're going to be very satisfied when we look back over the next few years in terms of what that might be. Mike, do you have something to add to that?

Michael R. Bloom

Yes, Matt, just as far, you mentioned some of the national brand introductions. I would tell you, when you look -- when you think about our Consumables business trends that we mentioned, I would applaud our supplier partners for stepping up. And we've built great relationships. We continue to enhance those relationships. They stepped up there. We're having great partnership meetings with them, and it's a win-win for both of us, so we look forward to continuing that.

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

That's great. And then from a gross margin perspective, you spoke to recent signs of progress on the sourcing front. Where are you today? You spoke to the 13% longer-term 2015 target on direct buys. And what are you seeing overseas that gives you the confidence that this is progressing and on plan?

Howard R. Levine

Yes. So again, if I think about the areas that I'm excited about, global sourcing, private brands. What I'm most excited about with our global sourcing is, one, we've mentioned we've moved our direct sourcing to 4%. We've hired some great talent overseas. We've got great leadership both here in Matthews and over in Shenzhen. In fact, they're over there now, getting ready to open this office in Shanghai. We continue to attract really, really strong talent with a lot of experience in sourcing from – that have done sourcing for major retailers in the marketplace. We're finding the factories. We're building relationships. So again, it's why we continue to expand our global sourcing or our global presence over there. We continue to see opportunity. It's moving. It's right on pace. We're on pace to hit that 13% direct to factory by 2015. And again, if you think about quality and packaging, everything's headed in the right direction and just feel really good about it.

Operator

Our final question today is from Joseph Parkhill with Morgan Stanley.

Joseph Parkhill - Morgan Stanley, Research Division

I appreciate your commentary on planning conservatively for Apparel in the short term. I was wondering if you could also just talk about how you're approaching your buys for the holiday season overall?

Howard R. Levine

Joe, it really varies across category. But specifically in terms of Apparel, as I stated earlier, conservatively, we bought down, think that we're well positioned there. But other categories, we were more aggressive on, it just depends on what we're talking about. I don't want to go into all the specifics of how we decided to merchandise and buy each category. But we picked our spots. I think what Mike talked about, there's going to be a lot of new things in Family Dollar during this holiday that we haven't had before, which I think is going to create some additional excitement, along with our core strengths in toy, the toy category, the trim-a-tree category, the gift-giving category. So we think we've got a great holiday assortment. As we said in our comments, we think it's going to be a very competitive holiday season, and we planned accordingly.

Joseph Parkhill - Morgan Stanley, Research Division

Okay. And then I guess just finally, if you could just update us on your thoughts around California, how the stores are progressing thus far and how many of your new stores for next year are planned for that state.

Michael R. Bloom

Yes, I'll take that. I'll start and maybe, Howard, jump in. But I tell you, I continue to be really excited about what's going on in California. The consumer has accepted us very well. It's early. I think we've got in the neighborhood of 50-some stores in California. I think we'll have about 50 stores in this fiscal year '13 that we'll open in California. I'll tell you what's -- what we like -- what I like about California and is encouraging is the discretionary business is stronger in California than it is in the rest of the chain. So the mix is favorable for us in California. So again, all good news, customer loves us out there, and we team members doing a great job executing, so.

Operator

I will now turn the call over to Ms. Rawlins for a final comment.

Kiley F. Rawlins

Thank you, Wendy. So it's the top of the hour, and unfortunately, we did not get to everyone in the queue today. As always, Kevin and I will be available after the call to take your questions. Thank you for your continued interest in Family Dollar, and have a great day.

Operator

Thank you. This does conclude today's conference. Thank you very much for joining. You may disconnect at this time.

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