Why all the fuss over Family Dollar?

Dollar Tree and Dollar General shareholders may be wondering why the boards of their respective companies are so intent on acquiring Family Dollar after seeing the takeover target’s first quarter results.

Family Dollar did not have a good Christmas. The company mustered a 1.2 percent same store sales increase in December, even though the disposable income of its price sensitive core customers surged when gasoline prices fell further and faster than anyone expected. Total sales during Family Dollar’s first quarter ended Nov. 29, 2014 increased 2.3 percent to $2.56 billion. However, the gain was driven by the addition of 59 new stores – well below the 179 units opened during the comparable period the prior year – as same store sales declined 0.4 percent due to a decline in customer traffic and transaction size.

Margins declined to 33.4 percent of sales from 34.3 percent and expenses increased to 30.3 percent of sales from 29.5 percent of sales. Per store inventory grew by three percent as the company’s assortment of food and tobacco expanded.

It wasn’t a good combination for profitability. Net income fell to $41.4 million from $78 million and even if merger related expenses are excluded profits fell to $50.2 million. Earnings per share declined 36 cents from 68 cents, or 44 cents if merger expenses are excluded.

“As expected, the first quarter of fiscal 2015 was very challenging, as we continued our transition from a very promotional merchandising strategy to a more everyday low price strategy,” said Family Dollar chairman and CEO Howard Levine. “During the quarter, gross margin continued to be pressured by the impact of our pricing investments, as well as strong growth of lower-margin consumable categories, including food and tobacco.”

Sales of consumable s increased 3.5% and now account for 75.8 percent sales last year. Meanwhile, sales of more profitable discretionary categories, such as apparel and accessories, home products, seasonal and electronics, declined 1.3 percent and now represent 24.2 percent of total company sales versus 25.1 percent last year.

“Our team did a good job of controlling expenses, however, ongoing topline challenges and continued margin pressures impacted our net profitability,” Levine said. “As we look to the rest of fiscal 2015, we are focused on driving more profitable sales growth, and the second quarter is off to a solid start.”

Levine characterized the 1.2 percent December comp increase as strong and said the company had fewer in season promotional markdowns and customer traffic increased.

“In fiscal 2014, we implemented a number of initiatives designed to drive sales and reposition our cost structure. We invested $50 million, on an annualized basis, to reduce prices in key areas; we closed 377 underperforming stores; and we took actions to reduce corporate overhead and re-align key organizational functions to reduce our infrastructure costs,” Levine said. Making no mention of the pending merger with Dollar Tree and Dollar General’s hostile counter efforts, Levine added,“While we are still in the early stages of our turnaround plan, we are beginning to see some stabilization in key areas, and we continue to believe that the strategic actions we have taken will position the company for better long-term performance.”