Ross Stores F1Q07 (Qtr End 5/5/07) Earnings Call Transcript

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Ross Stores, Inc. (ROST)
F1Q07 Earnings Call
May 23, 2007 11:00 am ET

Executives

Michael Balmuth - Vice Chairman, President and CEO
John Call - CFO
Gary Cribb - COO
Michael O'Sullivan - CAO

Analysts

Michelle Clark - Morgan Stanley
Jeff Black - Lehman Brothers
Ryan Tunick - JPMorgan
Tracy Kogan - Credit Suisse
Jeff Klinefelter - Piper Jaffray
Patrick McKeever - Avondale Partners, LLC
Marni Shapiro - The Retail Tracker
Rob Wilson - Tiburon Research Group
Dana Telsey - Telsey Advisory Group
Ted Grace - Goldman Sachs
Mark Montagna - C.L. King & Associates
David Mann - Johnson Rice & Company

Presentation

Operator

Good morning, and welcome to the Ross Stores first quarter 2007 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 Balmuth

Good morning and thank you for joining us today. Unfortunately, I have laryngitis, so John Call, our Senior Vice President and Chief Financial Officer, will be delivering our prepared remarks so that I can save my voice for responses to questions.

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John Call

Thank you, Michael. Also joining us today on our call 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; and Katie Loughnot, Vice President of Investor Relations.

We'll begin our call today with a brief review of our first quarter performance, followed by our outlook and guidance for the second quarter and fiscal year. Afterwards, we'll be happy to respond to any questions you may have.

Before we begin, I want to note that our comments on 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 2006 Form 10-K, on file with the SEC.

Today, we reported earnings per share for the 13-weeks ended May 5, 2007 of $0.48, compared to $0.41 for the 13-weeks ended April 29, 2006. Net earnings for the quarter were $67 million, compared to $59.2 million for the prior year period. Sales for the 13-weeks ended May 5, 2007 were $1.4 billion, up 9% versus the first quarter in fiscal 2006. Comparable store sales for the 13-weeks ended May 5, 2007 were flat compared to the 13-weeks ended May 6, 2006. For the 13-weeks ended April 29, 2006, comparable store sales rose 6%.

Our first quarter results were driven by a combination of top line growth and expansion in operating margin. Same-store sales for the quarter were slightly below our projection of 1% to 2% increase due to our sales shortfall in April. We believe April was affected by a larger than expected impact from the Easter calendar shift and unseasonable weather during the first two weeks. Geographic and merchandise trends during the quarter were broad based.

The strongest markets were on the West Coast with California comparable store sales up 2%. Home and dresses were the best performing merchandise category. Similar to Ross, dd's DISCOUNTS sales for the quarter were also somewhat lower than planned due to the sales shortfall in April.

Operating margin for the period grew about 30 basis points to 7.7%, as a 60 basis point gain in gross margin was partially offset by a 30 basis point increase in selling, general and administrative costs.

Cost of goods sold benefited mainly from higher merchandise gross margins and reductions as a percent of sales and distribution and buying costs. These improvements were partially offset by higher freight and occupancy expense as a percent of sales.

The primary driver of the increase in SG&A expenses as a percent of sales during the quarter was higher store operating costs, mostly due to the deleveraging effect of flat comparable store sales. This was partially offset by leveraging our corporate costs over a larger store base.

As we ended the first quarter, total consolidated inventories were up about 12%, driven mainly by the growth in new stores, partially offset by lower in-store levels that were in line with plan and down on average about 5%. Pack away was about 36% of total inventory, compared to 35% at the end of last year's first quarter. As planned, we opened 33 new stores in mid to late March; 25 Ross Dress for Less; and eight dd's DISCOUNTS.

We are pleased to report that both our balance sheet and cash flows remain strong and healthy. We ended the period with $206 million in cash and short-term investments and $150 million in long-term debt.

We continue to return capital to stockholders through both our repurchase and dividend program. During the first three months of 2007, we repurchased 1.5 million shares of common stock, for an aggregate of $51 million. By the end of 2007, we expect to complete the remaining $149 million authorization under our two-year $400 million program authorized by our board of directors in the fourth quarter of 2005. We ended the first quarter with 138.7 million shares of common stock issued and outstanding.

Now, let's talk about our guidance for the second quarter. For the 13-weeks ending August 4, 2007 we are projecting same-store sales to increase 1% to 2% over the prior year and earnings per share in the range of $0.35 to $0.37.

The assumptions that support these projections include: total sales are expected to grow about 10% to 11% for the second quarter of 2007 compared to the second quarter ended July 29, 2006;

We are forecasting about 32 net new stores during the second quarter, including 21 Ross Dress for Less locations and 11 dd's DISCOUNTS;

By month, we are planning comparable store sales on a day-for-day basis versus the prior year for both May and June to be flat to up 1% and for July to be up 3% to 4%. For the second quarter ended July 29, 2006, same-store sales in May and June grew 5%, while July rose only 1%.

Operating margin is expected to be in the range of 5.7% to 5.9%, compared to 5.6% in the prior year period.

This guidance includes forecasted markdown pressure equivalent to about $0.01 per share resulting from the sales shortfall in April.

Interest expense should be offset by interest income. Our tax rate is expected to remain unchanged at about 39%. And we estimate weighted average diluted shares outstanding of about 139.5 million.

Let's turn to our outlook for the balance of the year. Throughout the fall season, we've planned to reinvigorate our core missy's and men's businesses with a younger, fresher focus, while strengthening their overall assortments with a wider range of highly recognizable brands. We see opportunities as well to improve merchandise offerings in our accessories department and to roll out fine jewelry to 36 additional locations for an updated total of 265 Ross Stores in the chain with this merchandise. This is consistent with our focus this year on increasing assortments of gift giving merchandise for holiday.

In addition, home -- which is an important driver of traffic, especially in the fourth quarter -- continues to post solid gains. In setting our targets for the second half of the year, we also took into consideration prior year sales comparisons that start to ease beginning in July and particularly in the fourth quarter. As a result, even though we are somewhat cautious concerning the external environment, we expect top line trends to strengthen in the back half as a result of our previously mentioned merchandise improvement and the easier prior year sales comparisons. So, we still believe that our original plan of 3% to 4% gains in same-store sales during the back half of the year is both realistic and doable.

For the fiscal year, our projected earnings per share also remained within the range of our initial guidance of $1.85 to $1.95 for the 52-weeks ending February 2, 2008. Compared to 2006 on a 52-week basis, this range is consistent with our target for annual earnings per share growth of 15% to 20% over the next few years.

To sum up, although there may be volatility in monthly trends, we believe that over the longer term, our business will continue to be resilient because bargains will always remain in fashion. Our core strategy and focus is consistently delivering a constant flow of fresh and exciting name brand assortments at great values to our customers. This is a key to our past, present and future success.

At this moment, we would like to open the call and respond to questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Michelle Clark - Morgan Stanley.

Michelle Clark - Morgan Stanley

Can you first provide with us more detail on the gross margin line, specifically quantifying each component's contribution to the 60 basis point increase during the quarter?

Second, if you could comment on what you're seeing in terms of the overall strength of the consumer?

Then specifically what you're seeing in Florida? It's been called out by other retailers as a spot of weakness, giving what is going on in the housing market there, if you're seeing weakness in the consumer there?

Third, on the second quarter comp guidance, it was a little bit lighter than I had been expecting. Are there any calendar shifts that are impacting second quarter comp growth? Thank you.

John Call

Regarding gross margin and what the components of that margin are, as mentioned, we leveraged 60 basis points in the quarter. 65 basis points of leverage was due to higher merchandise margin, principally as a result of lower markdowns in the quarter and a lower shrink accrual. Additionally, we had reductions in DC processing costs of about 10 basis points and that's on 100 basis point gain in the prior year. We also had about 20 basis points of leverage on buying costs. That was offset by increases in freight costs of about 20 basis points and also the deleveraging impact on flat comps on occupancy about 15 basis points.

Gary Cribb

Florida did underperform the chain. We're not economists, though. We tend to focus on what we control and we will do whatever we can internally to look at operations and look at merchandising to drive sales appropriately there.

Michelle Clark - Morgan Stanley

Just the overall strength of the consumer in addition to what you're seeing in Florida?

Michael O’Sullivan

You mean on a national basis rather than just Florida?

Michelle Clark - Morgan Stanley

Yes, that's correct.

Michael O’Sullivan

Yes. It's a good question. It's something we've looked at in terms of gas prices and subprime mortgages, et cetera. There were just too many things that affect our business for us to be able to pick apart individual consumer items. Our only response when we hear stories of subprime mortgage programs or gas prices going up is to focus really on two things: one is making sure that we're putting bargains in front of the customer and the second is making sure that we have liquidity so we can turn any slowdown into an opportunity.

So we're always cautious. But I can't really say that we've noticed a particular slowdown with the customer that's affected our business at this point.

Michelle Clark - Morgan Stanley

My last question was on second quarter comp guidance. It came in a little bit below where I'm currently forecasting. I'm just trying to get a sense of, are there any calendar shifts that are impacting second quarter comp growth, or do you feel like you're being cautious here, given the macro-environment, or is it something else going?

John Call

We were actually up 5%, as we mentioned in the comments, in May and June last year. So we're rolling over a 5% comp. Relative to the calendar, we're comparing day for day.

Michelle Clark - Morgan Stanley

So it has more to do with comparisons than with any weakness in the consumer?

John Call

That's right.

Operator

Thank you. Your next question is from Jeff Black - Lehman Brothers.

Jeff Black - Lehman Brothers

John, could you talk about the decrease in working capital from payables and what caused that? Is that similar trend we could see going forward? Michael, did we talk about how May started off thus far, as we sometimes do during these calls? Thanks.

John Call

Jeff, relative to working capital, we ended the fourth quarter and our payables leverage was 66%, which is a lot higher than typically would see due to the difference in our fiscal calendar versus our suppliers' calendar. So, we're a bit off calendar. That came down in the first quarter to more normal levels of about 55%, which was similar to the prior year. So it was just a timing shift in terms of when we paid cash on the inventory.

Jeff Black - Lehman Brothers

So, we don't expect similar drops in 2Q or 3Q?

John Call

No, I would expect it to be consistent from a payables leverage standpoint to inventory, that we've experienced historically.

Jeff Black - Lehman Brothers

On the May sales, Michael, any comment on how we're doing thus far?

Michael O’Sullivan

We're pretty comfortable with that guidance of flat to up 1% for May.

Operator

Your next question is from Ryan Tunick with JPMorgan.

Ryan Tunick - JP Morgan

As usual, I'll ask the productivity of the new stores and the new markets question to see if there's been any progress there? As you think about next year's footage growth, are we going to be backfilling?

The second question is on the dd's drag. I think you said last year it was about a 6% drag to earnings. Any updated expectation for 2007 as far as drag or contributions?

Michael O’Sullivan

I'll take the first question on productivity of new stores. We opened 33 stores in March, 25 Ross, eight dd's. Frankly, after ten weeks, it's just too early to tell how those stores are doing. We did make some adjustments to how we plan those stores and we'll make further adjustments to other of our groups this year. But frankly, it will be end of year before we know how those adjustments worked and whether they helped drive improvement in performance.

Ryan Tunick - JP Morgan

Even the last 12 months, are you seeing any change in those new markets?

Michael O’Sullivan

No. As we said on the call at the end of '06, we were happy with the progress we made in the southeast and the Mid-Atlantic, but not a dramatic improvement in new store performance in those markets.

John Call

Brian, on the dd's drag, last year the drag was about 25 basis points. Given that we'll double the size of that chain this year, we're anticipating that the drag this year will be about 35 basis points.

Operator

Your next question is from Tracy Kogan - Credit Suisse.

Tracy Kogan - Credit Suisse

If you could talk about the current buying environment and the availability of good product? Secondly, when was the last time you can remember a poor buying environment and what was the cause? Thanks.

Michael Balmuth

The current buying environment is actually very strong. The last time I can remember a poor buying environment, I can't get precise on that. There are better times than others. If you manage a business with a lot of liquidity, most buying times are reasonable, but we're in one that's beyond reasonable right now.

Operator

Your next question is from Jeff Klinefelter - Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

As you look in the second half of the year in terms of your current pack away situation, where are you most encouraged in terms of your opportunities to see sales acceleration as it relates to your opportunistic buys last year?

Secondly, in terms of the market pricing, as the retail industry is consolidating and a lot of doors are closing in some formats and opening in others; Are you able to do any, or are you doing any regional analysis in looking at your competitive positioning and pricing, market by market? And if so, are you making any adjustments or what are you learning from that?

Michael Balmuth

Pack away position, we're real pleased with what we own but it's fairly broad based and it really wouldn't be a unique situation by business. The unique and specific opportunities that a brand has that we took advantage of; we look at it more that way. We feel pretty good about how we're positioned in our pack away inventories going forward.

Our regional pricing, it's not something we really manage our business to. We run a global pricing situation.

Jeff Klinefelter - Piper Jaffray

Lastly, in terms of brand opportunities, a lot of moderate-priced department stores now are getting into exclusive brand situations. Is this something that you could look at more going forward as an opportunity for your differentiation in the market?

Michael Balmuth

For us to open exclusive brands for ourselves?

Jeff Klinefelter - Piper Jaffray

Yes.

Michael Balmuth

It's not our business model. Our business model is to have brands that are out in department stores and specialty stores. The more brands they open or the more brands they ask vendors to open for them creates more labels that are available to our vendors.

Operator

Your next question is from Patrick McKeever - Avondale Partners.

Patrick McKeever

I'm just wondering if you could elaborate a little on some of the merchandising initiatives that you're planning in missy and in misses for the back half of the year?

Michael Balmuth

Basically, what we saw when we looked at our assortments last year is we were too basic in our offerings and we see opportunities to get more fashion into our mix and based on the buying environment, we've certainly been able to penetrate key brands to a much higher degree than we have before. Both of those things are a good thing.

Additionally, throughout the store, we don't think we were as prepared on a gift basis last year in fourth quarter and so we've put a strong initiative in to focus on that and we see opportunities because we haven't done that, to the degree that we are planning to this year, in the past.

Patrick McKeever

So just generally speaking, more aggressive buying on gifts?

Michael Balmuth

Well, it's funding certain classifications that are gift-related at the appropriate time. We also saw opportunities in many of these classes coming out of last fall. So we were able to take advantage of things, interesting opportunities within some of these classes today.

Patrick McKeever

Within women's apparel, what is strong right now and what is weak? Do dresses continue to be weak?

Michael Balmuth

No, dresses is actually a terrific business right now. Nationally, certainly it's terrific for us but right now, that's the strongest business, I think, for anyone in apparel.

Patrick McKeever

But that turned relatively recently, right?

Michael Balmuth

Relatively recently, we've started to see coming out of fall into spring. So, if that's relatively recently, yes.

Operator

Your next question comes from Marni Shapiro - The Retail Tracker.

Marni Shapiro - The Retail Tracker

Glad to hear you're taking advantage of this environment. My question is actually on that. When you talk about the younger, fresher merchandise, are we to read into that that's the contemporary market as opposed to the junior market?

Are the opportunities more specific to segments, like denim or dresses, or is it expanding the brands within the store and buying into some of the brands in that market that are now available?

Michael Balmuth

Okay. It's not juniors in our thinking. It really is updating our missy assortment. Some of it's contemporary. Some of it is every label you can buy, you can buy it with an updated slant or a more traditional, predictable basic slant. We were buying things a little bit to the latter slant. So we are skewing things that way, in addition to taking advantage of the contemporary market that we might not have before. That was phase one of the question.

Marni Shapiro - The Retail Tracker

Is it segment, so building areas like denim and dresses, or is it more the brand and the way you're buying it?

Michael Balmuth

It's actually the brand and the way we're buying it and there are some funding shifts additionally. The brands and the way we're buying it is the more dominant piece.

Marni Shapiro - The Retail Tracker

And will you also take this philosophy of buying into accessories, say handbags, for example, and even bedding to a degree?

Michael Balmuth

We expect to see it across all of apparel.

Operator

Your next question is from Rob Wilson -Tiburon Research Group.

Rob Wilson - Tiburon Research Group

Could you provide some detail maybe on the comp sales metrics, maybe average transaction size or transactions? And are there any changes planned in marketing? Have you implemented anything new recently?

John Call

On the average transaction for the first quarter, actually our basket was slightly up, offset by the transaction count, which was slightly down. Retail per SKU was flat.

Michael O’Sullivan

On your question about marketing, we're always looking at and evaluating where we're spending our marketing money, shifting it between markets to get the best bang for the buck. That's the main thing we're doing. We've always been pretty consistent in our message, the focus on branded bargains and that hasn't changed. I don't expect that will change. So, I wouldn't expect any major change in our marketing program.

Operator

Your next question is from Dana Telsey - Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

Can you please give us a little bit of an update on engineered standards and how that's working, how it's benefiting you currently?

Also, I think in the fourth quarter call, you had mentioned getting closer to the customer on a more local level. What initiatives are going on there and how is that progressing?

John Call

I'll speak to the engineered standards. We're at a fairly mature stage in the process. I think as you remember, we had a 35 basis point improvement in DC's last year. We showed a 10 basis point improvement this quarter on top of 100 basis points from a year ago. We continue to see and believe that we'll experience gradual productivity over time.

Michael O’Sullivan

Dana, on your question about getting closer to the customer on a more local level. That's an initiative we've had underway for several months. We're really trying to plan our business down at the store class level, so to a much more detailed level than we have historically and trained our business at that detailed level as well.

2007 is really the year where we're sort of building those capabilities and putting in place those new processes. I would say 2008, we would start piloting those capabilities in a couple of businesses. Then over the remaining couple of years we would roll them out across the business. So, we think this is an important initiative but it's one that's going take a few years to really have an impact.

Operator

Your next question is from Ted Grace - Goldman Sachs.

Ted Grace - Goldman Sachs

Could you just update us on management's philosophy on returning excess cash or capital to shareholders? Obviously, the $400 million buyback has been quite substantial and you've commented there's another $150 million or more to go this year. But beyond that what we could look for? Obviously, the track record of increasing the dividend has been great but how we should think about potential increases going forward, if it's in line with the earnings growth or some other metric cash flow? That would be great. Thank you.

Michael Balmuth

As far as a buyback is concerned, we'll plan our business and the excess cash we're not using in the business we'll typically return to shareholders in terms of a buyback. That's been our history over the past decade. We would adopt that going forward.

Also, as far as the dividend is concerned, we did take it up this year and actually we've taken it up every year going forward. But I would say that our philosophy would be in terms of the total amount returned to shareholders, I think last year was $234 million. That percentage of dividend to buyback will remain pretty constant.

Operator

Your next question is from Mark Montagna - C.L. King.

Mark Montagna - C.L. King & Associates

Hi. I was curious what comp you need this year to leverage expenses? Is it different for the second quarter versus the second half?

John Call

Mark, last year our EBIT margin increased around 50 basis points or so on a 52-week basis. This year we're calling for an increase of 30 to 50 basis points. Most of that leverage is coming out of the gross margin line. In fact, we'll delever expenses given the headwinds we have from a store cost standpoint, driven by minimum wage and other factors.

Mark Montagna - C.L. King & Associates

So, for the full year you expect to delever this year?

John Call

That's correct.

Mark Montagna - C.L. King & Associates

What would it take to actually leverage the expenses?

John Call

Probably north of a 4% comp.

Operator

Your next question is from Ryan Tunick -JP Morgan.

Ryan Tunick - JP Morgan

Any surprises so far with the Albertsons store conversion? Would you be more open to making more real estate acquisitions like that?

When is the next physical inventory that you guys will be taking to maybe update us on your shrink reserves?

Michael Balmuth

So no surprises with Albertsons. We are on track to our plan and we are open to deals like that. Just as a reminder, we've had two in our 25-year history that look similar to that.

Our next physical inventory is in September. We'll conclude that in the third quarter.

Ryan Tunick - JP Morgan

Can I just add, how many dd's do you need to break even from a scale perspective?

Michael Balmuth

From a scale perspective, we're thinking it's between 80 and 100 stores.

Operator

Your next question is from David Mann -Johnson Rice.

David Mann - Johnson Rice

In terms of your in-store inventories, can you give us a sense on how you expect them to trend over the next several quarters?

John Call

In terms of in-store, we're down 5% at the end of this quarter. We're going to be anniversarying some of the supply chain efficiencies in the second quarter, so we would expect the in-store amount to be flattish.

David Mann - Johnson Rice

Is that relatively consistent across different markets, in terms of the level declines?

John Call

Depending on the area, it tends to be lower. We would like to see it lower by area and we've planned certain areas lower than others.

David Mann - Johnson Rice

In which markets might they be lower?

John Call

We're not prepared to give that level of detail, David.

Operator

There are no further questions. I would like to hand the floor over to Michael Balmuth for my closing comments.

Michael Balmuth

I just want to thank everyone for attending and have a great day.

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