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Ross Stores, Inc.Q1 2008 Earnings Call Transcript 2 comments

May 21, 2008 | about: ROST

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Ross Stores, Inc. (ROST)

Q1 2008 Earnings Call

May 21, 2008, 11:00 am, ET

Executives

Norman A. Ferber – Chairman of the Board

Michael Balmuth – Vice Chairman, President, Chief Executive Officer

Gary L. Cribb – Executive Vice President, Chief Operations Officer

Michael B. O’Sullivan – Executive Vice President, Chief Administrative Officer

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

Katie Loughnot – Vice President of Investor Relations

Analysts

Mark Montagna – C. L. King & Associates

Kimberly Greenberger – Citigroup

Paul Lejuez – Credit Suisse

David Mann – Johnson Rice & Company

Brian Tunick – J. P. Morgan

Jeff Black – Lehman Brothers

Patrick McKeever – MKM Partners

Jeffrey Klinefelter – Piper Jaffray

Richard Jaffe – Stifel Nicolaus and Company

Dana Telsey – Telsey Advisory Group

Rodney Shapiro – Retail Tracker

Presentation

Operator

Good morning. Welcome to the Ross Stores first quarter 2008 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). As a reminder, ladies and gentlemen, this call is being recorded today, Wednesday, May 21^st. At this time I would like to turn the call over to Michael Balmuth.

Michael Balmuth

Good morning. Thank you for joining us today. Also 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; John Call, Senior Vice President and Chief Financial Officer; and Katie Loughnot, Vice President of Investor Relations.

We’ll begin with a brief review of our first quarter performance followed by our outlook for the balance of the 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 our 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 2007 Form 10K and 2008 Form 8Ks on file with the SEC.

Today we reported that earnings per share for the 13 weeks ended May 3^rd, 2008, grew 25% to $0.60 from $0.48 per share for the 13 weeks ended May 5^th, 2007. As noted in today’s press release, our first quarter 2008 results include a real estate settlement that added income equivalent to about $0.02 per share during the period.

Net earnings for the quarter were $79.5 million compared to $67 million for the prior year period.

Sales for the 13 weeks ended May 3^rd, 2008, increased 10% to $1.556 billion with comparable stores sales up a solid 3% over the prior year and ahead of our original forecast.

Our ongoing focus on expanding and strengthening the brand content of our assortments throughout the store while improving the fashion content in our core apparel businesses contributed to the healthy sales gains in the quarter. Dresses and shoes remained the top performing merchandise categories with strong double-digit same-store sales gains. We also are seeing positive results in home and accessories where comparable store sales rose in the mid to high single digits. We believe that our other core apparel businesses in ladies and mens are moving in the right direction with gradual improvement expected as the year progresses.

The mid-Atlantic and Texas were the strongest geographic regions with comparable store sales up in the high single digits. California same store sales rose a respectable 2% during the quarter.

We are pleased that we were able to leverage our solid sales gains into healthy profit growth in the quarter. Strong execution of our merchandising strategies combined with strict inventory and expense management were the main drivers of our ahead-of-planned earnings for the period.

As a result, we were able to realize larger than planned increases in operating margin, which grew about 45 basis points to 8.2%. Profit margins benefited mainly from better than expected improvement in merchandise margins, lower distribution costs as a percent of sales, leverage on corporate expenses, and income from a real estate settlement related to a store closure.

As we entered the first quarter total consolidated inventories were down about 7%, which was slightly lower than planned.

We continue to operate our business with leaner inventory levels compared to prior years, promoting faster in-store turns and lower markdowns. This contributed to considerably lower clearance levels, clearance inventory at the end of April versus last year, which bodes well for merchandise margin in the second quarter.

Average selling store inventories were down about 13% as we ended the quarter. Pass away was about 36% of total inventories, which was flat compared to last year’s first quarter.

As expected, we opened 28 new stores in the first quarter; 26 Ross Dress for Less and 2 dd’s DISCOUNTS.

First quarter overall sales trends at dd’s DISCOUNTS were in line with forecasts, but the performance was mixed. While our comparable dd’s stores posted increases over the prior year they were somewhat less than planned. This was offset, however, by the new dd’s stores that we opened in 2007 which performed slightly better than projected.

We continue to conduct research to better understand the dd’s customer and the demographic differences between regions. Over the next several months we believe this work will provide us with a better insight into the key drivers of this business.

Now let’s talk about our financial condition. We are pleased to report that both our balance sheet and cash flows remain healthy. We ended the period with $308 million of cash and short-term investments. Our cash position is benefiting from reduced working capital needs as we operate the business on lower inventories.

During the first three months of 2008 we repurchased 2.5 million shares of common stock for an aggregate purchase price of $77 million. We remain on track to complete half of our new two-year, $600 million buy-back program for a total of $300 million this year. In addition, we expect to complete this full two-year buy-back without taking on any incremental long-term debt.

Now our CFO John Call will provide some additional colour on our first quarter results and details on our guidance for the second quarter.

John G. Call

Thank you, Michael. As discussed, the operating margin improved by about 45 basis points driven by a 40 basis point decline in selling, general and administrative costs and a five basis point improvement in gross margin.

Merchandise to margin increased to about 15 basis points in the quarter. Our comparison versus the prior year was impacted by timing issues related to markdowns taken in the first quarter of 2007 that sold during last year’s second quarter. Because we are on the cost method of accounting, markdowns do not reduce gross margin until they sell. So we are forecasting even stronger merchandise margin gains in this year’s second quarter compared to the higher-than-planned markdown activity in the prior year period.

In the first quarter higher freight costs related to fuel surcharges were offset by lower distribution costs which improved about 10 basis points. Both occupancy and buying costs experienced a slight increase of about five basis points over the prior year.

Selling, general and administrative costs in total declined about 40 basis points compared to last year’s first quarter. The real estate settlement benefitted the period by about 30 basis points. Slight deleveraging in store cost was more than offset by lower corporate expenses as a percent of sales in the quarter.

Store costs in the first half of 2008 are being pressured by the large number of new stores we opened in 2007, including 26 new dd’s DISCOUNTS.

Interest income of $1.6 million in the quarter also was better than planned, benefitting mainly from higher cash balances resulting from the progress we’ve made in inventory management that is driving fast returns, fresh receipts, and higher accounts payable leverage.

As planned, earnings also benefited from a slightly lower tax rate in the quarter. With the adoption of FIN 48, there is now more variability in our quarterly tax rates. We continue to forecast our tax rate for the year to be relatively flat to 2007 at about 39%.

Finally, our buy-back program drove a 4.5% reduction in shares outstanding, leveraging earnings per share growth in the quarter.

Let’s turn now to our second quarter guidance for the 13 weeks ending August 2^nd, 2008.

Although we remain cautious regarding the macro-environment, we are now projecting second quarter same store sales to increase 1% to 3% and earnings per share to grow16% to 27% for a targeted range of $0.43 to $0.47 compared to $0.37 in the prior year. The assumptions that support these projections include: total sales are expected to grow about 8% to 10% driven by a combination of new store growth and, as mentioned, a 1% to 3% increase in same store sales.

We are forecasting about 25 net new stores to open during the period, including 24 Ross Dress for Less locations and one dd’s DISCOUNT.

We are planning comparable store sales in May to increase 4% to 5%. This guidance reflects favourable weather across many of our markets and an easier comparison versus May of 2007 when same store sales rose 1%.

For June we are targeting comparable store sales to grow 1% to 3% on top of a strong 4% gain in the prior year.

With inventory management driving fast returns and lower markdowns we expect to end the quarter with less clearance than last year. So because July is typically a transitional clearance driven period, we have planned same store sales that month to be flattish to the prior year.

Operating margin is expected to increase about 20 to 60 basis points for a forecasted range of 6% to 6.4% compared to 5.8% last year.

As previously mentioned, we are planning even stronger gains in gross margin during the second quarter, though we expect that to be partially offset by an increase in selling, general and administrative costs as a percent of sales.

Our 2007 second quarter results included income from insurance proceeds related to a store loss and a lower than planned settlement for a legal matter that combined added about 25 basis points to last year’s second quarter operating margin. Interest income for the second quarter of 2008 is planned to be approximately $500,000 and our tax rate is expected to be about 39%.

We also estimate weighted average diluted shares outstanding of about $132 million.

Now I’ll turn the call back to Michael for some closing comments.

Michael Balmuth

Thank you, John. Based on our second quarter guidance and our above plan results in the first quarter we are now projecting earnings per share for fiscal 2008 to be in the range of $2.19 to $2.29 for a forecasted growth of 15% to 21% over $1.90 in fiscal 2007.

Again, to sum up our comments today, we are pleased with our solid ahead of plan sales and earnings results in the first quarter that were achieved despite the difficult retail environment. We believe this reflects the resilience of our off-price business model.

Our history shows that we have been able to manage successfully in many types of business climates with less volatility in our financial results than a comparable full-price retailer.

During these times we benefit from an increased supply of great brands at strong discounts. This makes our stores attractive destinations for customers seeking compelling bargains for their family and their home as shown by our solid performance in the last two quarters.

In addition, because we can buy even closer to need today we can be more defensive and operate our stores with leaner inventory levels. This in turn increases our open to buy capacity, giving us even more flexibility to take advantage of the great close outs available on the market. As a result, we can realize fast returns and lower mark downs with a more rapid flow of fresh and exciting bargains to our stores which we have done and continue to do.

Looking ahead, we remain confident that solid execution of our merchandise strategies, all with the key ingredient for success in this business, along with continued strict inventory and expense controls, will enable us to maximize our prospects for sales and earnings growth over the balance of 2008 and beyond.

At this point we would like to open up the call and respond to any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is from Jeff Black with Lehman Brothers.

Jeff Black – Lehman Brothers

Congratulations, guys. Just a couple of questions, I guess, for Michael. Where specifically are we seeing some improvement or better traction in the ladies business? Can you update us on Juniors? I don’t think you called that out, but I think that’s been tough in the past. Have we seen a light at the end of the tunnel there?

For John, on the inventory, that came in a lot lower than we would have thought. Can we expect to see you build a little bit more inventory in the second quarter and in the back half of the year? Just an overall update on what to think about in terms of inventory per square foot. Thanks.

Michael Balmuth

This is Michael. We’re starting to see traction in the Misses. We certainly have performed very well in dresses. There’s a national trend in dresses and we’re, I think, capturing more than the average in that. We’re very pleased with that. We’re seeing movement in our assortments and costs probably in our business, both in Misses and Special Sizes. It’s moving. It’s a slow move, but getting better.

Juniors, we planned conservatively and the results have been pretty much in line with our conservative plans and on a comparable basis are considerably down. But that was our strategy going in.

John G. Call

Jeff, on inventory levels we ended the quarter slightly below where we had planned the quarter. As we look forward, inventory levels are planned to be down high singles to low double digits and moderate more to kind of the high, high singles levels in the back half.

Jeff Black – Lehman Brothers

Great. Thanks for the clarity. Good luck.

Operator

Your next question is from Brian Tunick with J. P. Morgan.

Brian Tunick – J. P. Morgan

Hi. Thanks, guys. I guess my question, Michael, for you is with the May comp guidance and maybe with your outlook to June, any thoughts of the stimulus cheques that everyone’s going to be getting? Historically do you expect your business and have seen the pickup from that historically? And then the second question is, maybe update us on the micro merchandising roll out or the systems initiative that we’re expecting to see in the second half.

Michael B. O’Sullivan

Actually, I’ll take that, Brian. It’s Michael O’Sullivan. First of all, on the rebate cheques, the truth is we just don’t know. There are so many things that affect our business – supply, weather, gas prices, rebate cheques – it’s hard for us to pull that out. Having said that, we are students of our business so we have gone back and looked at previous occasions where there have been similar rebate cheques.

So in 2001, for example, there were 90 million rebate cheques issued between July and September. The back half of 2001 your ad comps did pretty well, but I warn you that was off a pretty soft prior period in 2000 and, frankly, 9-11 was right in the middle of that. So it’s very hard to sort of parse that out and figure out what exactly the impact was. So we think it’s going to be good, but it’s hard for us to quantify. That’s the rebate cheque side.

Your second question I think was about micro-merchandising. Right now we’re about to launch the pilot business in the micro-merchandising. There are two businesses that we’re piloting the tools and processes with which represent about 15% of our business. We’ll then move to some other major businesses in 2009 which would represent about 50% of our business, and then the balance of the businesses would be in 2010.

Operator

The next question is from Kimberly Greenberger with Citigroup.

Kimberly Greenberger - Citigroup

Congratulations on a nice quarter. I was hoping you could give us transaction metrics for Q1? On the lower clearance inventory year-over-year, Michael, is there any way to quantify that? Either give us clearance inventories or percentage of total this year or last year? Any way to quantify that decline?

Secondarily, I just wanted to confirm that your updated annual EPS guidance of $2.19 to $2.29 includes the $0.60 from Q1, that’s the basis that you are using here for Q1?

Lastly, the CapEx numbers have been somewhat elevated here ‘06/‘07, and that’s what we’re modeling here for ‘08. When do you think, longer term, we might be able to see that CapEx number decline back below the $200 million mark? Thanks.

John G. Call

Kimberly, on the transaction metrics, our price per item was relatively flat for the quarter; our transaction size was relatively flat. It really was volume that took the comps up.

Relative to the question about whether or not the annual guidance includes the $0.02 from the real estate transaction, the answer is yes, it does.

Michael B. O’Sullivan

Kimberly, I think your third question was around capital expenditure. One of the big drivers of our CapEx in the last couple of years has been DC capacity, so distribution capacity, and building out new distribution centers. This year’s CapEx includes a chunk of spending to expand one of our distribution centers in Southern California, the Moreno Valley distribution center. We expect that expansion to be completed by early ‘09.

As we look forward as to how much DC capacity we are going to need in the next couple of years, we are not anticipating another major processing center in the next couple of years. We might need to add a storage facility, but that will be less expensive. We expect at least from a DC CapEx perspective, for spending to ramp down a little bit over the next couple of years.

John G. Call

I think your final question was on clearance levels. Kimberly, clearance levels are slightly down for us in the chain as we accelerate inventory levels and bring the total inventory level down, which is helping us manage the markdown line as well.

Kimberly Greenberger - Citigroup

Any way to quantify that change, John?

John G. Call

I’d say slightly down.

Operator

The next question is from Paul Lejuez - Credit Suisse.

Paul Lejuez - Credit Suisse

I just want to dig into California a little bit. Are you seeing anything different in that market in terms of transactions versus ticket? Also just wondering what you’re seeing there in terms of shopping by existing customers versus attracting a new tradedown customer?

Michael B. O’Sullivan

I will take the second piece on the tradedown customer. It would be speculative, we don’t really know. We do pretty regular research on our customers and that allows us to look out over a longer time horizon where our customers are coming from. We know that historically our customers have come from everywhere. Our customers typically shop at every store, pretty much. They’re only really loyal to one thing and that’s a bargain, which is kind of what we try and focus on, that we can get a bigger share of their wallet if we put bargains in front of them.

That research tells us that much and tells us over a longer period of time where customers are coming from disproportionately, but it’s not really sensitive enough to figure out on a short time horizon whether it’s a tradedown customer or a trade-up customer. It’s probably both; we don’t know.

Paul Lejuez - Credit Suisse

Are you able to track sales from existing customers?

Michael B. O’Sullivan

Not really, no. We know we have a pretty loyal core customer base, but we don’t really have that level of detail to figure that out.

Paul Lejuez - Credit Suisse

How about in the transaction versus ticket, the average ticket in California?

John G. Call

We estimate that those levels would be similar to the rest of the chain.

Paul Lejuez - Credit Suisse

Last, product availability at dd’s versus Ross, are you seeing anything different in the dd’s market?

Michael Balmuth

Not really. It’s a good time to be an off-price buyer.

Operator

The next question is from David Mann - Johnson Rice.

David Mann - Johnson Rice

In terms of the corporate expense leverage, was that all due to the comp or were there some areas where you had some unusual cost savings or control?

John G. Call

There are some timing issues in the quarter related to self-funded health-care plans, etcetera, that gave us some leverage in the quarter. Actually, when we looked at the second quarter, SG&A will be up slightly given that we’re up against 25 basis points of income we had last year. If we look at that across the first half, G&A is relatively flat.

David Mann - Johnson Rice

Michael, I think in the last couple of calls you have talked about perhaps doing a little bit better in the Southeast markets. Can you give an update on how some of those underperforming stores might be doing?

Michael B. O’Sullivan

Actually the Southeast, at least in the first quarter, was actually a little bit behind the chain. Not materially from a comp basis, but a little bit behind the chain. The mid-Atlantic, which is another region we have called out in the past was actually well ahead of the chain so it’s hard for us to draw any sort of long-term sustainable conclusions from that.

John G. Call

Also, Kimberly, let me give some more clarity around where clearance levels are. I said slightly. They are probably down on a per-store basis; probably down low double-digits as a percentage term.

Operator

Your next question is from Jeff Klinefelter - Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

On the dd’s comment that ‘07 stores were slightly better than expected, can you just remind us where those stores opened and any other insights in helping to describe their better performance and what are you gleaning from that going forward with store openings?

Michael, in terms of product, at this point going into the fall season you and your buying organization, what are you sensing, what are you seeing out there in terms of product availabilities? Is it as good or better than last year going into the second half?

Lastly on second half guidance, John maybe I missed this, but the gross margin versus SG&A leverage potential, second half versus first half?

Michael B. O’Sullivan

I’ll take the first part of that regarding dd’s new stores. Last year we doubled the size of the dd’s chain so we added 26 stores. The vast majority of those were actually outside of California which is the first time we had opened dd’s outside of California. As we’ve said on previous calls, we were disappointed with their performance. They didn’t perform anything like as well as the initial 26 stores had performed.

As we came into ’07 -- the first quarter at least -- they performed better and we’re happy with that, but it’s one quarter so we don’t know if it’s sustainable. We’ve certainly made some adjustments to the assortments. We think that has helped but as I said, we don’t really know how that will play out in the remaining quarters of the year.

In terms of plans to dd’s going forward, again because we doubled the size of the chain in ‘07, as we said earlier this year we’re really using ‘08 to sort of take a little bit of a breather to make sure that we bed those stores in, really make sure we understand what’s driving their performance and then we’ll make a decision from there in terms of how many dd’s stores to open up over the next few years.

Michael Balmuth

The product availability versus a year ago, what we’ve seen so far through the first four-and-a-half months of the year is it’s considerably better than a year ago. How long it will stay like that, no one knows but my instinct would say that we’ve got a good ways to go based on how mainstream retailers are performing. My instinct would say we’ll have a good buying opportunity for a bit more time ahead of us.

John G. Call

On guidance, we haven’t given guidance on the second half specifically, what was given was the annual earnings per share guidance. Coming closer into the second quarter we expect about, as I said, 20 to 60 basis points of improvement in EBIT margin. That’s up against 25 basis points of income we had last year. Most of that leverage will come from the gross margin line. SG&A will actually be pressured a bit, we think, in the second quarter.

Operator

Your next question is from Mark Montagna - CL King.

Mark Montagna - CL King

A question about your pricing power. Typically you try to maintain a certain spread between your prices and the department stores. Considering the consumer is so price-driven right now, do you need to maintain that same spread or are you getting increasing pricing power that you can allow that spread to narrow?

Michael Balmuth

Allow the spread to narrow? No. At most in something like this we’d widen the spread, meaning the spread from department store pricing to our pricing. If we are able to take advantage of better pricing from the market, we usually will pass it on.

Operator

Our next question is from Patrick McKeever - MKM Partners.

Patrick McKeever - MKM Partners

Could you talk a little bit more about your shoe business, which has been comping very well? How big is that now as a percent of sales? What’s driving the business? That is a little counter to the broader trend in retail, which is weakness in shoes. What’s driving your shoe business? Are you adding SKUs? Are you adding new brands? Lastly, same basic question, how are the price points holding up in shoes?

Michael Balmuth

Our shoe business is approximately in the 10% range of our store. Why are we doing better in shoes? In off-price or in our business, we are executing better then we had before, and it boils down to that. Our SKU levels really are not a lot different. Our pricing has been very sharp. There have been a lot of opportunities based on the shoe conditions in the market.

What’s going to happen going forward in shoes in pricing, who knows. I know there is a price increase coming out in the Far East in shoes. What I think will happen then is there will be more opportunities because retail will rise and mainstream stores will create a backup, which hopefully we’ll be able to take advantage of.

I think a multiple of things have been going on; market condition and improved execution are really the drivers for us.

Patrick McKeever - MKM Partners

On the fuel surcharges that you mentioned in the quarter, is that the first time you have called that out as a material issue? What are you seeing there? Is it going to get worse here? What are you hearing?

Michael B. O’Sullivan

Actually on that second to last piece of the question, maybe you can tell us whether it’s going to get worse or will not. We certainly knew that fuel prices were going to be high coming into the year so we planned for that to some degree but we didn’t plan that it would be $130 a barrel. That’s why there has been some impact on Q1.

Having said that, Patrick, I would say 18 months, 24 months ago when we first saw fuel prices rise -- and at that point they were blowing through the $50 a barrel mark -- when we first saw them rise we actually took a step back and took a look at our transportation costs. We put a number of initiatives in place that are coming to fruition now that relate to how we flow goods into our distribution centers, how we pack goods onto trucks, that kind of thing.

So to some degree we were able to use those initiatives to offset some of the fuel increases in Q1 and that will help us in the remainder of the year as well. But it won’t be enough to offset it completely, as long as prices remain at the levels they’re at or if they increase further.

Operator

The next question is coming from Marni Shapiro - The Retail Tracker.

Marni Shapiro - The Retail Tracker

Could you just give me a little bit more insight into the inventory levels? They are planned down very conservatively. I was curious if that was a combination of units plan down as well as better prices from buying? And if it was planned down equally across the board or were there pockets of home or apparel, men’s versus women’s, accessories that are planned up where others are planned down more significantly?

John G. Call

Relative to inventory levels, it’s really a function of just taking the total levels down, not really a price function. So we just took absolute levels down to increase the turn and increase the freshness of the store.

Michael Balmuth

And on the inventory cut, whether it was across the board or selected areas, every area in the company was hit significantly. Certain areas were considerably more aggressive than that, though.

Marni Shapiro - The Retail Tracker

Is there anything that you’re planning up as you go into the next quarter?

Michael Balmuth

In inventory levels?

Marni Shapiro - The Retail Tracker

Besides the dresses, I assume. Any inventory that you’re planning up as you go into the second quarter and beyond?

Michael Balmuth

No.

Operator

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