Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Ross Stores, Inc. (NASDAQ:ROST)

F4Q06 Earnings Call

March 21, 2007 11:00 am ET

Executives

Michael A. Balmuth - Vice Chairman of the Board, President, Chief Executive Officer

John G. Call - Chief Financial Officer, Senior Vice President, Secretary

Michael O’Sullivan - Executive Vice President, Chief Administrative Officer

Analysts

Tim Geyer - Piper Jaffray

Jeff Black - Lehman Brothers

Brian Tunick - J.P. Morgan

Paul Lejuez - Credit Suisse

Kimberly Greenberger - Citigroup

David Mann - Johnson Rice & Company

Mark Montagna - C.L. King & Associates

Margaret Mager - Goldman Sachs

Patrick McKeever - Avondale Partners

Rob Wilson - Tiburon Research Group

Dana Telsey - Telsey Advisory Group

Rob Schwartz - JL Advisors

Richard Jaffe - Stifel Nicolaus

TRANSCRIPT SPONSOR
Better Than AdSense

Operator

Good morning. Welcome to the Ross Stores fourth quarter and fiscal 2006 earnings release conference call. The call will begin with prepared comments by Michael Balmuth, Vice Chairman, President, and Chief Executive Officer, followed by a question-and-answer session.

(Operator Instructions)

At this time, I would like to turn the call over to Michael Balmuth, Vice Chairman, President, and Chief Executive Officer.

Michael A. Balmuth

Good morning. Joining me on the call today are Norman Ferber, Chairman of the Board; Gary Cribb, Executive Vice President and Chief Operations Officer; Michael O’Sullivan, Executive Vice President and Chief Administrative Officer; John Call, Senior Vice President and Chief Financial Officer; and Katie Loughnot, Vice President of Investor Relations.

We will begin our call today with a review of our fourth quarter and year-to-date performance followed by our outlook for the 2007 fiscal year. Afterwards, we will be happy to respond to any questions you may have.

Before we begin, I want to note that our comments in this call will contain forward-looking statements regarding expectations about future growth and financial results and other matters that are based on management’s current forecast of aspects of the company’s future business.

These forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from historical results or current expectations. These risk factors are detailed in today’s press release and our fiscal 2005 Form 10-K and fiscal 2006 Form 8-K’s and 10-Q’s on file with the SEC.

Today we reported that fourth quarter 2006 earnings per share grew 35% to $0.66, from $0.49 in the fourth quarter of 2005. Net earnings for the quarter totaled $93.1 million, compared to $71 million in the prior year period.

For the 53 weeks ended February 3, 2007, earnings per share grew 25% to $1.70 from $1.36 for the 52 weeks ended January 28, 2006. Net earnings for fiscal 2006 were a record $241.6 million, compared to $199.6 million in fiscal 2005.

We estimate that the 53rd week in fiscal 2006 added approximately $88 million in sales and $0.07 in earnings per share to both our fourth quarter and fiscal year results.

In addition, we recognized expenses related to the adoption of FAS-123R equivalent to about $0.01 per share for the fourth quarter and $0.06 per share for the 2006 fiscal year. Adjusting for both the extra week and stock option related costs, earnings per share increased about 22% in the fourth quarter and 24% for the full year.

TRANSCRIPT SPONSOR

Better Than AdSense

What if there was a way to promote your company to a perfectly targeted group of potential customers, partners, acquirers and investors? What if you could tailor your pitch to them at the moment of maximum interest? And what if you could do this for a no-brainer price?

This is exactly what Seeking Alpha is offering with transcript sponsorships.

Seven types of companies are sponsoring earnings transcripts on Seeking Alpha:

1. Company sponsors its own earnings call transcript (example).

2. Company sponsors partner's transcript (example).

3. Company sponsors competitor's transcript (example).

4. Issuer-sponsored research firm sponsors client's transcript (example).

5. Investment newsletter sponsors transcripts of successful stock picks (example).

6. IR firm sponsors transcript of micro-cap company (example).

7. Consulting company sponsors company's transcript in sector of interest (example).

Your company's name and promotion could have been on this transcript! Learn more, or email Zack Miller for details.

Fourth quarter sales increased 14% to $1.6 billion. Our comparable store sales gain of 1% was in line with expectations and on top of a 6% increase in the prior year. Sales during the quarter were in line with our expectations.

Our operating margin grew by about 115 basis points in the quarter, driven by a total gross margin increase of 60 basis points and a decline in selling, general and administrative costs of about 55 basis points.

Gross margin benefited from a combination of improvements in distribution center costs, mark-downs, shortage accrual, and leverage from the extra week, partially offset by higher freight costs and stock option related expenses.

As a percent of sales, selling, general and administrative costs for the quarter benefited mainly from lower workers’ compensation costs and leverage on the extra week, partially offset by increases in store payroll and stock option related expenses.

For the full year, sales rose 13% to $5.570 billion, with same-store sales up 4% on top of a 6% gain in 2005.

We ended 2006 with 797 stores, including 771 Ross Dress for Less and 26 dd's DISCOUNTS locations for about 9% unit growth compared to the prior year.

For both the fourth quarter and the fiscal year, the Southwest and the Mid-Atlantic were two of the strongest regions and the best performing merchandise businesses were home and shoes.

Fiscal 2006 operating margin grew about 40 basis points, all due to improvement on the gross margin line. Lower mark-downs, distribution costs and shortage accrual as a percent of sales more than offset higher freight and stock option related costs.

Selling, general and administrative expenses as a percent of sales were flat to the prior year, mainly due to leverage from the extra week that offset the impact of stock option related expenses.

Our balance sheet and cash flows as we ended the fiscal year remain healthy. In 2006, cash flows from operations funded $224 million in capital expenditures to open 63 net new stores and to make ongoing infrastructure investments in systems and distribution, including $87 million to acquire our Fort Mills, South Carolina distribution center from the lessor. We also repaid a $50 million term loan that we used to finance equipment and systems at our Paris, California distribution center.

We continued our long-term practice of returning capital to shareholders through both our stock repurchase and dividend programs. During 2006, we repurchased 7.1 million shares of common stock for an aggregate of $200 million as part of the two-year, $400 million program authorized by our Board of Directors in the fourth quarter of 2005. We ended the fiscal year with 139.4 million shares of common stock issued and outstanding.

As we began 2007, $200 million remained available under the current stock repurchase authorization, which we expect to complete by the end of fiscal year 2007.

Our Board also approved in January 2007 a 25% increase to our quarterly cash dividend to $0.075 per share, our 13th consecutive annual dividend increase.

Looking ahead to 2007, we plan to open about 90 net new stores, including 63 Ross Dress for Less and 27 dd's DISCOUNTS. This accelerated unit growth is driven primarily by the opportunistic real estate acquisition we made in the latter part of 2006 of a number of former Albertson sites. Approximately 40 of these sites will open in 2007, all in established, top-performing sunbelt markets, including California, Florida, Texas, Arizona, Colorado, and Oklahoma. About half will be Ross Dress for Less and half dd's DISCOUNTS stores.

We are pleased with our better-than-expected fiscal 2006 sales and profit trends at dd's DISCOUNTS. The Albertson real estate opportunity gives us the ability to accelerate the growth of this promising concept into additional new markets that, like California, feature a range of demographics that we believe are favorable for both Ross Dress for Less and dd's DISCOUNTS.

On a four wall, pretax basis, our dd's DISCOUNTS stores are contributing to earnings. However, with only 26 locations today, their buying and distribution costs are still creating some earnings drag, about 25 basis points in 2006. We estimate that the dd's can break even when the business reaches 80 to 100 locations.

We believe that our stronger-than-expected operating performance to date at dd's confirms that we have identified a customer demographic that we were not reaching with our core Ross concept. These results gave us the confidence to take advantage of the Albertsons real estate opportunity to accelerate dd's growth and more than double the size of this chain in 2007, including entry into new markets in Florida, Texas and Arizona.

Now I would like to turn to our earnings guidance for the 2007 first quarter and full year. At the beginning of February, we stated our targets for a 1% to 2% increase in same-store sales for the first quarter on top of a strong 6% gain in the prior year. We also communicated monthly comparable store sales targets of 1% to 2% for February, 4% to 5% for March, and down 2% to 3% for April, reflecting the Easter calendar shift.

Because the holiday is two weeks earlier in 2007, it shifts all of our Easter related sales into fiscal March. Same-store sales for March and April combined are planned to be up 1% to 2%, in line with our forecast for the quarter.

In early March, we reported that February same-store sales increased 1% on top of a 6% gain in the prior year. For the first quarter ending May 5, 2007, we continue to project that earnings per share will be in the range of $0.46 to $0.48, compared to $0.41 in the prior year. We are adding 33 net new stores during the quarter, consisting of about 25 Ross and eight dd's DISCOUNTS, including the first two new dd's in Florida.

Our earnings per share target of $1.85 to $1.95 for the 2007 fiscal year ending February 2, 2008, also remains unchanged. On a 52-week basis, this range is in line with our long-term goal of 15% to 20% annual EPS growth. Underlying assumptions for 2007 include store growth of 11% to 12%, and comparable store sales gains of 2% to 3%.

Operating margin is forecast to increase by 10 to 30 basis points on a 52 to 53-week basis, or more importantly, 30 to 50 basis points on a 52-week basis, which is again in line with our long-term goal.

To sum up, we believe our 2006 financial results confirm that we are moving in the right direction. We continue to deliver attractive off-price bargains to our customers and to make progress on the initiatives we have put in place to improve our operating profitability. These include ongoing inventory controls to reduce mark-downs, the rollout of engineered standards to improve productivity and lower costs in our distribution centers, and implementation of shortage control initiatives to reduce shortage expenses.

During 2006, these efforts showed solid results in the form of double-digit sales gains, a 40 basis point improvement in operating margin, and 25% growth in earnings per share.

As we look ahead, we see considerable opportunity for further expansion in operating margin. We seek to achieve that by continuing to work on the recent initiative that resulted in reductions in mark-downs, distribution and shortage costs in 2006.

In addition, over the next couple of years, we will be developing new capabilities and system enhancements with the goal of getting closer to our customers at a more local level. We believe all of these efforts will contribute to incremental operating margin gains of 30 to 50 basis points annually over the next few years.

This rate of improvement, combined with our plans for 9% to 10% annual unit growth, a 2% to 3% increase in comparable store sales each year, and our ongoing stock repurchase program, support our long-term growth objective of 15% to 20% earnings per share growth over the next several years.

Now, we would like to open up the call and respond to any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question is coming from Tim [Geyer] with Piper Jaffray. Please go ahead.

Tim Geyer - Piper Jaffray

Good morning and congratulations on a solid quarter. Just a couple of questions for you. First of all, I was wondering if you could give us anymore color on the content of your current pack away inventory, in terms of what percent is spring versus fall merchandise? Also, do you see any key categories within that inventory that could help position you in the upcoming season, or is there more of a branded focus within that inventory content?

Michael A. Balmuth

Our balance of spring to fall pack away, candidly I do not have that number on me but it is consistent with where it has been over the past several years. We have been taking advantage of opportunities as we see fit in the market. Could you give me question number two again, please?

Tim Geyer - Piper Jaffray

I was just wondering if there are any key categories that you are seeing that you were able to build up on previously that you think could help position you for these upcoming seasons.

Michael A. Balmuth

Actually, what I would say is it has been broad-based and it has been a very good buyer’s market.

Tim Geyer - Piper Jaffray

Great, and then one follow-up; I was wondering, have you explored the opportunity to bring in some exclusive brands, as many other retailers have done recently, given industry consolidation has improved the availability of some of these brands?

Michael A. Balmuth

Actually, we still believe our business has brands that are traded in department/specialty stores and we have not gone forward on a proprietary brand.

Tim Geyer - Piper Jaffray

Great. Thank you very much.

Operator

Thank you. Our next question is coming from Jeff Black with Lehman Brothers. Please go ahead.

Jeff Black - Lehman Brothers

Great, just a couple of questions. First, for I guess John Call, the lower workers’ comp that impacted the expense rate, can you just explain or remind us why that is occurring and how much we see that benefit going forward?

Second, for Michael, this year we are upping the unit growth rate, the 11% range or square footage, rather. What does it look like beyond ’07? It sounds to us like dd's gets more stores. I just was not certain when dd's hits that 80 to 100 mark. The overall question is are we continuing to see above 10% unit growth beyond ’07 when you have not made an acquisition of stores? Thank you.

John G. Call

This is John addressing the workers’ comp question. There are three main drivers of the benefit there. First, we have experienced a reduction in the frequency of accidents and also in the severity of accidents, both in our distribution centers and our stores, based on programs that we put in place 24 to 36 months ago.

Additionally, we have had the benefit of a favorable impact of California legislation on work comp, so all combined, the actuaries have dialed that in to their actuarial assumptions which drive out a lower work comp expense. We believe that those expenses are sustainable and have been actually included in our guidance that was issued for ’07.

Michael A. Balmuth

Relative to our unit growth rate after ’07, where we took advantage of this opportunistic acquisition, we would expect to go back to a 9% to 10% unit growth rate.

Jeff Black - Lehman Brothers

Mike, when might we see the 80 to 100 stores for dd's and reach profitability on the dd's side? Is that an ’08-09 timeframe?

Michael A. Balmuth

It will be the next few years. We are putting that together. That is a moving target on stores right now but we are putting that together. The next few years I think would be safe.

Jeff Black - Lehman Brothers

Okay, thanks. Good luck.

Operator

Thank you. Our next question is coming from Brian Tunick with J.P. Morgan. Please go ahead.

Brian Tunick - J.P. Morgan

Thanks. Two questions; I am just trying to understand, are you raising your EBIT margin goal here? It sounded like you said 10 to 30 bps I thought a year, and now it sounds like you are saying 30 to 50 bps a year. We were just curious, given where your SG&A is now, is there anymore SG&A opportunity to cut?

The second question on the new markets, what is happening with the store productivity and four wall returns versus your mature stores? Maybe just those two questions. Thank you.

John G. Call

Brian, this is John. On the operating margin, both answers are actually correct. It is actually 10 to 30 basis points if we compare a 53-week year to our upcoming 52-week year. On a sustained basis, 52 weeks to 52 weeks, it is 30 to 50 basis points and that is our target and that is what we achieved this year.

Brian Tunick - J.P. Morgan

Is all that coming on the SG&A line?

John G. Call

Not all of it. Not all of it. In fact, this year it came out of the margin line where we had improvements in mark-downs, distribution center strength, et cetera.

Brian Tunick - J.P. Morgan

Okay.

Michael O’Sullivan

Brian, it’s Michael O’Sullivan. I will answer your second question about new markets. I think we are happy with some of the progress we have made in the new markets. In 2006, the Southeast comped at the same level as the chains. The Mid-Atlantic actually did better than the chain, so we are pleased with that but as we have said in the past, we would like the productivity of new stores in those markets to be better. We believe fundamentally the customers in those markets are the same as off-price customers elsewhere -- they want bargains.

So we think we can do more, particularly in terms of assortment, to drive more business in those markets. But we were happy with the progress we made in ’06.

Brian Tunick - J.P. Morgan

And you have those assortment planning tools now?

Michael O’Sullivan

We are building them, and actually it is a combination of two things. One is we are continuing to back-fill in those markets, which naturally will help raise our awareness and our customer traffic. Secondly, we are making improvements to assortments over time.

There are some tools that are going to take frankly a few years for us to roll out, to build and roll out, so we do not have the full toolset yet but we are trying to make improvements over time.

Brian Tunick - J.P. Morgan

Terrific. Thanks and good luck, guys.

Operator

Thank you. Our next question is coming from Paul Lejuez with Credit Suisse. Please go ahead.

Paul Lejuez - Credit Suisse

What can you tell us about -- we are hearing a lot about the sub-prime issue in the market. How do you think that could impact your customers? I do not know any kind of data that you might be able to share in terms of any changes in patterns that you are seeing, and customers that pay cash versus credit -- do you know what percentage of your customers own homes? I’m thinking about some of the macro data, trying to link it back to you guys.

Michael O’Sullivan

Paul, we look at that kind of thing all the time, looking at what is happening in the macro economy. The truth is our business is sufficiently diverse and sufficiently complex that it is almost impossible to isolate a single variable. So obviously we are watching what is happening in the sub-prime market but I cannot see -- we have not seen any drop-off in our business that we can track back and say that is what drove it.

I will say in the off-price, it is even doubly difficult to predict because on the one hand, something like that could affect your customers and therefore your sales but it could also affect your supply in a positive way. So it is almost impossible for us to parse through that and figure out what effect it will have.

Paul Lejuez - Credit Suisse

Just to follow-up, inventory, it looked like it was up per square foot overall. What is the plan going forward?

Michael A. Balmuth

Inventory was up as we ended the year. There were a couple things going on; we had more in transit into our DCs to get ready for the Easter holiday. We also had a calendar shift in terms of when the year ended. So those two things drove inventories up at year-end.

We will have a calendar shift going forward, so it may be slightly different than it was last year but overall, we are planning in-store inventories flat.

Paul Lejuez - Credit Suisse

Thanks, and good luck.

Operator

Thank you. Our next question is coming from Kimberly Greenberger with Citigroup. Please go ahead.

Kimberly Greenberger - Citigroup

This is Meg for Kimberly. Just a couple of questions. First, can you provide us with more detail on the gross margin line, and maybe quantify how each component contributed to the 60 basis points increase in the quarter?

Secondly, can you remind us when exactly you began to see efficiencies in your supply chain that allowed you to go get product into stores more quickly last year?

Just lastly, can you give us end of quarter square footage? Thank you.

Michael A. Balmuth

Let me dissect the margin elements. Merchant margin increased about 20 basis points. That is inclusive of shrink and freight. Distribution levered by between 40 and 50 basis points, and stock options included in gross margin cost us about 10 basis points. So if you add that up, that is the 60 basis point improvement in the quarter in G&A.

What was your follow-on to that, Meg?

Michael O’Sullivan

I think it was around supply chain. The short answer is it was about in the spring of last year when we saw the supply chain improvement, so we are coming up on the anniversary of that now.

Michael A. Balmuth

I think the third piece was selling square footage. As we ended the year, it was about 18.6 million feet.

Kimberly Greenberger - Citigroup

Thank you.

Operator

Thank you. Our next question is coming from David Mann with Johnson Rice. Please go ahead.

David Mann - Johnson Rice & Company

Yes, thank you. Good morning. Just on that last question, in terms of the distribution efficiencies, can you give us a sense on how much more of the recovery there you have over the next couple of years in terms of gross margin improvement?

Michael A. Balmuth

Relative to gross margin, again in the quarter we got 40 or 50 basis points. On the year, we got about 35 basis points. We are looking at that. We think in ’07 the improvement will be more incremental than that. In other words, not as much as that as we keep our foot on the pedal in terms of productivity. So we think there is more that could come over the next coming years. I would hate to put a cap on it.

David Mann - Johnson Rice & Company

In terms of shrink, have you been able to take cycle counts to get a sense on how you are doing relative to -- I guess it is what, about a 10 basis point accrual lower than last year?

Michael A. Balmuth

We do not really take cycle counts. We will take our full physical in the September-October timeframe. We do have a feeling that the shortage initiatives that we put in place have taken hold and are contributing to the improvement that we saw last year and anticipate that we will see continued improvement going forward as well.

David Mann - Johnson Rice & Company

Okay, and then one other balance sheet question. The accrued liabilities jumped a lot. Is there anything to parse out there or is that just the timing issues tied to inventory?

Michael A. Balmuth

Most of that is in payables. Our payables leverage was 66% this year versus 51% last year, so it is timing relative to working capital and the inventory build.

David Mann - Johnson Rice & Company

Great. Thank you.

Operator

Thank you. Our next question is coming from Mark Montagna with C.L. King.

Mark Montagna - C.L. King & Associates

I just wanted to narrow the results for the Southeast and Mid-Atlantic. I was wondering if you could tell us what percent of the chain’s productivity those two regions are operating at? I guess last year you said that they were at about 75% at the beginning of 2006. I am wondering where they ended up by the end of the year.

Michael O’Sullivan

It is about that. Like I said last year, one of those regions was in line with the chain. The Southeast was in line with the chain. The Mid-Atlantic was slightly better, so they stayed around about the mid-70s.

Mark Montagna - C.L. King & Associates

Could you tell us what your year-end cash target is and what your free cash flow projection is?

Michael A. Balmuth

If we look at where we ended the year and comment about payables contributing to that cash balance, you probably would have to take $140 million off of that balance relative to the payables leverage we achieved. It is not sustainable. We are thinking about $290 million in CapEx, so you roll that out. Relative to our cash target going into next year, we have not really talked about that -- something more in line with more normal levels, more nominal levels.

Mark Montagna - C.L. King & Associates

Okay, and then for your store openings for this year, are they all slated for existing markets or are you going to expand into some new markets at all?

Michael O’Sullivan

For Ross, all of the openings will be in existing markets. For dd's, obviously we have talked about we are opening in Florida, Texas, Arizona, so those are new markets for dd's, although not new markets for the corporation.

Mark Montagna - C.L. King & Associates

Okay. That’s all I needed. Thanks.

Operator

Thank you. Our next question is coming from Margaret Mager with Goldman Sachs. Please go ahead.

Margaret Mager - Goldman Sachs

I would like to get a little bit more color on the success that you are seeing in your home area. What are the important factors driving that, especially in light of the situation, it seems a little bit surprising. If you could just talk about the home category broadly, that would be interesting.

Also, I just wanted to make sure I understood clearly the complexion of same-store sales in March-April; March, up I think 4% to 5% and then April is what and the combined is up 1% to 2%, and that is because of the Easter shift, if I’m reading it correctly from you. Is there anything that you would say at all regarding the economy or the weather or the impact on business to date in the month of March? Thanks.

Michael A. Balmuth

Margaret, I got the second part of the question clearly. The first part, there was some noise on the phone. If you could repeat the first part about home again.

Margaret Mager - Goldman Sachs

I just wanted to get a little bit more color on what is happening in the home area, where you are finding success, how you are going to continue to drive that business, and why do you think it is doing well in the context of the housing market having its challenges at the moment? Thanks.

Michael A. Balmuth

Our home business, we really have not added new classifications. We have not gone into any new categories. We have really strengthened areas within our buying team that actually has really improved execution, is how we have been getting our growth there. There have been reasonable opportunities in the market which supports our -- the home business is a little more up-front driven than the rest of the company, but there have been no opportunities to take advantage as the home business has been not quite as good around the horn. That is really the key of what has been happening. It has just been improved execution, improved opportunities for us to purchase.

Margaret Mager - Goldman Sachs

Okay, so when you say it is a bit more of an up-front business, normally you are buying out farther on home? Is that interpreted correctly?

Michael A. Balmuth

We and I think everyone else buys out further. There is importing there in the home business, so it has been a very good buyer’s market based on difficulties other home retailers have had.

Margaret Mager - Goldman Sachs

Interesting, thanks. And then on the same-store sales, just understanding that and to date, how is March going? I do not know if you look at retail traffic data at all, but it is showing some declining trends in retail traffic for mall and retail broadly. I am just wondering what you are seeing. Thanks.

Michael A. Balmuth

We really are not choosing to comment mid-month on how our performance is, but relative to what is going on, we are not economists, you know, we were -- running as we said along the lines of our plan. In these kinds of things, our business might not be an interesting barometer. Some customers in a difficult economy will trade down to off-price, so we are not really the bellwether I think on it.

Margaret Mager - Goldman Sachs

Okay. Thanks.

Operator

Thank you. Our next question is coming from Patrick McKeever with Avondale Partners. Please go ahead.

Patrick McKeever - Avondale Partners

Thanks. Good morning, everyone. On dd's, as you accelerate the growth of that business, I am just wondering if you have made any refinements or significant changes to the store prototype.

Michael A. Balmuth

I would say that we continue to make small changes, tweaks in the prototype, nothing that is dramatic or extremely different from what we initially went to market with. But as we have done with Ross, we will continue to refine it over time.

Patrick McKeever - Avondale Partners

So the prototype will be pretty similar to some of the first -- I’m sorry, the new stores will be pretty similar to some of the first stores that you opened in the San Francisco Bay area then?

Michael A. Balmuth

They might be a drop smaller, but that is about it.

Patrick McKeever - Avondale Partners

And then, Michael, you said that it is a buyer’s market out there for your merchandise. I guess my question is a year ago, the big event for the off-price space, I guess the industry overall, the apparel industry was the merger of Federated and May and the divestitures that occurred and so forth. What is the big event out there right now as it relates to, and what is contributing to the good opportunities that are out there in the marketplace? Or is it just a bunch of different things? Is there any one specific event that is helping the supply right now?

Michael A. Balmuth

Always, it is a bunch of different things but I think the same thing that was the big driver a year ago, I think people are growing into that, the change in the retail landscape, and that creates supply imbalances, and that is where we come in.

Patrick McKeever - Avondale Partners

Last question, just back to the new stores and new markets, so those continue -- there has not been a big change in the way those stores are performing relative to the overall, or relative to the stores in your existing markets? The productivity metric is still around 75% -- is that right?

Michael O’Sullivan

Yes, there has not been a change. Our expectation, like we said a little bit earlier, we believe we can drive performance in those markets but we believe it is going to take some time.

Patrick McKeever - Avondale Partners

And a lot of it still is tied to implementing more micro-merchandising and just merchandising the stores differently -- is that correct?

Michael O’Sullivan

Yes, it is a combination of things. Certainly the assortments are a big piece of it. We are working on that. That is going to take -- frankly, that is going to take a few years. But also building awareness, building presence in those markets, which is why we continue to back-fill. So it is a combination of things, but certainly assortments is the biggest.

Patrick McKeever - Avondale Partners

Okay. Thank you so much.

Operator

Thank you. Our next question is coming from Rob Wilson with Tiburon Research. Please go ahead.

Rob Wilson - Tiburon Research Group

Thank you. Could you go over the comp store sales components in Q4, transaction versus average transaction size?

John G. Call

Sure. In Q4, the transaction size was pretty flat. The comp was driven by traffic.

Rob Wilson - Tiburon Research Group

You mentioned earlier that your merchandise margin was up 20 basis points in Q4 but you also mentioned that a couple of those components were shrink and freight, if I am not mistaken.

John G. Call

That is correct.

Rob Wilson - Tiburon Research Group

Could you break out those three components?

John G. Call

Merchandise margin overall was up 20. That is all the goods related items. Shrink was up 15-ish -- excuse me, shrink was better by 15-ish and freight offset that completely.

Rob Wilson - Tiburon Research Group

Are you willing to give us an earnings per share drag on dd's in FY06?

John G. Call

I think what we have said is dd's was a drag of about 25 basis points in ’06, about $0.06, so it was about the same as options.

Rob Wilson - Tiburon Research Group

So it was about a $0.06 drag?

John G. Call

Yes.

Rob Wilson - Tiburon Research Group

One final question; last year in Q1, you said the west coast had a cold and wet Q1. Are you seeing higher comps in California this year versus last year and versus maybe the rest of the chain?

John G. Call

California was wet and cold last year and California is sunny and warm this year, so at the beginning of the month, what we said is we are going to align our comp guidance and sales reporting to month-end levels. I think we will leave it at that.

Rob Wilson - Tiburon Research Group

No comment on February, California?

Michael A. Balmuth

February in California, the weather, we didn’t think was a big deal year over year.

Rob Wilson - Tiburon Research Group

Fair enough. Thank you. Thanks for taking my call.

Operator

Thank you. Our next question is coming from Dana Telsey with Telsey Advisory Group. Please go ahead.

Dana Telsey - Telsey Advisory Group

Good afternoon, everyone. Can you please talk a little bit about minimum wage and any potential impact that changes there might have just on the expense structure? I noticed the merchant organization always continues to be refined. What spaces do you see needing to be filled for dd's or for Ross and are there any new categories that you are looking into for merchants in either area? Thank you.

John G. Call

On the minimum wage, we did experience some of that pressure this year and we have it dialed in to our estimates for next year, so it does have some impact to us and we think we have it appropriately calibrated.

Michael A. Balmuth

Dana, I believe your second question related to areas within merchandising that we would be looking for new merchants.

Dana Telsey - Telsey Advisory Group

Yes, exactly.

Michael A. Balmuth

It is really not something I would talk about in a forum like this, for internal reasons and external reasons.

Dana Telsey - Telsey Advisory Group

In terms of categories, what do you think -- you had mentioned the home. What are you seeing in footwear and juniors? And is the landscape changing at all?

Michael A. Balmuth

I do not see dramatic changes in the landscape. There are certainly trend changes in juniors going on but no dramatic change in the landscape that we are seeing.

Dana Telsey - Telsey Advisory Group

Thank you.

Operator

Thank you. Our next question is coming from Rob Schwartz with JL Advisors. Please go ahead.

Rob Schwartz - JL Advisors

Congratulations on a strong finish to the year. I have two questions. First, regarding dd’s margins over time. As it starts to mature, do you think margins should approach those of Ross?

Secondly, over the long-term, do you think your past peak margins of 9.5% are achievable again?

John G. Call

Relative to dd’s margin, as we look at how dd’s is doing, what the sales levels are in that box, and we look at the results we expect out of that box over time, they are very similar to the Ross margins that we achieve over time.

Relative to your second question on margin expansion, we believe that there is room for margin expansion for the next couple of years. We are targeting 30 to 50 basis points. We feel pretty good about that. Clearly the biggest impact on margin, or the upside to margin could be top line growth. That is where we are with that.

Operator

Thank you. Our next question is coming from Richard Jaffe with Stifel. Please go ahead.

Richard Jaffe - Stifel Nicolaus

Thanks very much guys, and a good end to the quarter, or good end to the year, rather. Just a follow-on with dd's DISCOUNTS, could you compare dd’s to Ross in terms of inventory investment, sales per store, dollars and units per transaction?

Michael O’Sullivan

It is a little bit difficult to make apples-to-apples comparison between dd’s and Ross, partly because the dd’s we have opened so far are all in California, dd's is a new chain, Ross is 25 years old. I would stay away from making comparisons between the two businesses for all those reasons. It is hard to come up with any meaningful comparison.

Richard Jaffe - Stifel Nicolaus

Well, just trying to gauge the level of dollar investment a store would require in terms of inventory, and perhaps you have answered the question in your expectations for sales per square foot would be comparable to Ross over time. Is that fair to say?

Michael O’Sullivan

On sales per square foot, yes, over time.

Richard Jaffe - Stifel Nicolaus

I guess the inventory commitment in terms of the cost of a dd’s versus the cost of a new Ross, inventory plus build-out?

Michael O’Sullivan

For the same volume store, comparable, yes. But that is my point. Because Ross is in 27 states and dd’s is currently in one, it is hard to make that direct comparison because you have to pick a store that looks exactly like dd’s to make the comparison. But if it is the same volume store, then the inventory investment would be similar.

John G. Call

I would also say on the build-out costs, where we are to date is they look a lot more like Ross stores that we take in our own construction, so there is a little bit higher cash up-front commitment that will, the return on that cash takes a little bit longer if you look over the life of that lease, which is typically 10 years. It looks very similar to Ross on the construction.

Richard Jaffe - Stifel Nicolaus

That is very helpful. Thank you. Just a quick question on the debt. Obviously incurred some debt on the balance sheet and if I understand, eliminated some of the off balance sheet liabilities. Is that complete? There is no off balance sheet liabilities related to the DCs, or for any other reason at this point and the debt has covered all of that?

John G. Call

We have put on $150 million of long-term notes. We took that down in December. Earlier in the year, we paid off a synthetic lease of $87 million and we also paid off a short-term note for $50 million, so that debt basically replaced a piece of the off balance sheet debt and a piece of the on balance sheet debt. We still have $70 million of off balance sheet liability related to our Southwest DC.

Richard Jaffe - Stifel Nicolaus

Is there any intention to do a similar transaction to eliminate that?

John G. Call

No, that is long-term. I think that is ten-year money.

Richard Jaffe - Stifel Nicolaus

It is as we see it now. Okay. Thanks very much.

Operator

(Operator Instructions)

There appears to be no further questions. I will turn the floor back over to you for any further or final remarks.

Michael A. Balmuth

Thank you all for attending and have a very good day.

Operator

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.

TRANSCRIPT SPONSOR

Better Than AdSense

What if there was a way to promote your company to a perfectly targeted group of potential customers, partners, acquirers and investors? What if you could tailor your pitch to them at the moment of maximum interest? And what if you could do this for a no-brainer price?

This is exactly what Seeking Alpha is offering with transcript sponsorships.

Six types of companies are sponsoring earnings transcripts on Seeking Alpha:

1. Company sponsors its own earnings call transcript (example).

2. Company sponsors partner's transcript (example).

3. Company sponsors competitor's transcript (example).

4. Issuer-sponsored research firm sponsors client's transcript (example).

5. Investment newsletter sponsors transcripts of successful stock picks (example).

6. IR firm sponsors transcript of micro-cap company (example).

7. Consulting company sponsors company's transcript in sector of interest (example).

Your company's name and promotion could have been on this transcript! Learn more, or email Zack Miller for details.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Ross Stores F4Q06 (Qtr End 2/3/07) Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts