羅斯百貨 (ROST) 2006 Q1 法說會逐字稿

Good morning.

Welcome to the Ross Stores first-quarter 2006 earnings release conference call.

The call will begin with prepared comment by Michael Balmuth, Vice Chairman, President, and Chief Executive Officer, followed by a question-and-answer session.

After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) At this time done I would like to turn the call over to Michael Balmuth, Vice Chairman, President, and Chief Executive Officer.

Good morning.

Joining me on the call today are Norman Ferber, Chairman of the Board;

Gary Cribb, Executive Vice President and Chief Operating 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 brief review of our first-quarter performance, followed by our outlook and guidance for the second quarter and back half of 2006.

We will also discuss our longer-range plans and objectives.

Afterwards, we will 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 2005 Form 10-K on file with the SEC.

Today we reported 2006 first-quarter earnings per share of $0.41, up 21% over the $0.34 earned in the first quarter of 2005.

Net earnings for the first quarter of 2006 were $59.2 million compared to $50.1 million in the prior year.

Our first-quarter 2006 results are after a $3.5 million or an equivalent of about $0.015 per share in stock option-related expenses in connection with the adoption of FAS 123(R), Share Based Payments.

Sales for the first quarter increased 15% to $1,292,000,000, with comparable store sales up 6% over the prior year.

Strength across many geographic markets and merchandise categories drove our healthy sales gains during the first quarter.

The strongest regions during the period were the Southwest and Texas, both of which posted double-digit gains in same store sales.

The best performing merchandise categories continued to be shoes, juniors, and home, which generated solid double-digit gains and comparable store sales as well.

We also realized better-than-expected sales gains at dd's DISCOUNTS.

First-quarter consolidated operating margins, before the effect of about 25 basis points in stock option-related expenses, expanded by about 40 basis points to 7.7%.

Our improved profitability was driven mainly by a decline in distribution costs as a percent of sales and leverage on other expenses from our solid sales performance, partially offset by higher shrinkage accruals and increases in both freight and incentive compensation costs as a percent of revenue.

As noted in today's press release, we adopted FAS number 123(R), the new accounting rules related to stock option expensing, effective with our first-quarter 2006 results.

The portion of these new non-cash compensation charges that relates to our associates in the merchandising and distribution organizations is included in cost of goods sold.

The balance of these non-cash charges is included in selling, general, and administrative expenses.

The Company's operating results for the first quarter of fiscal 2006 also reflect comparable classification of the Company's cash bonus payments and restricted stock compensation costs.

In prior periods, all of these expenses were included in selling, general, and administrative expenses.

For consistent presentation with the first quarter of 2006, we are reclassifying a portion of the bonus and restricted stock expenses for prior periods, including the first quarter of 2005.

The reclassification for prior periods has no impact on previously reported total cost and expenses, net earnings, or earnings per share.

We are making corresponding adjustments to reflect these line item classifications to our previously reported quarterly operating statements for 2004 and 2005, and they are now available on the press release page of our website, located at www.rossstores.com.

As we ended the first quarter, total consolidated inventories were up about 2% driven mainly by the growth in new stores, partially offset by the lower in-store levels.

Pack-away was about 36% of total inventories at the end of April compared to 34% at the same time last year.

Average in-store inventories at quarter end were down about 8% on top of a 9% increase in the prior year, when we boosted inventory levels in preparation for our datacenter move.

Our in-store inventory number includes inventory wanted as allocated as the distribution centers until it sells through.

With the recent improvement in distribution center productivity, we have realized a larger than expected reduction in in-transit time to stores, which we believe led to higher than planned in-store inventory levels.

This situation combined with the later Easter holiday led to more aggressive markdowns of first-quarter receipts in April.

Moving forward, we believe that these supply chain efficiencies are sustainable, and that we can operate our business on slightly lower levels of in-store inventories.

As a result, over the balance of the year, we are planning in-store inventory levels to be down about 4% to 6% versus comparable levels in 2005.

We believe the trend of lower inventory levels in our business will contribute to a faster and fresher flow of bargains throughout our stores.

Earlier this month, we reiterated our guidance for same store sales to increased 3% to 4% in the second quarter of 2006, and for earnings per share to be in the range of $0.30 to $0.32, after projected stock option-related expenses, equivalent to about $0.01 to $0.02 per share.

The financial assumptions that support these projections are as follows.

Sales are expected to grow about 10% to 11% for the second quarter of 2006 compared to the prior-year period.

We are forecasting a net addition of about 25 new stores during the second quarter, including 19 Ross locations and six dd's stores.

Same store sales are forecasted to increase 3% to 4% for the quarter.

Month to date in May we are slightly ahead of our forecast for a 3% to 4% gain in comparable store sales.

For the balance of the quarter we are forecasting same store sales to be up 3% to 4% in June, followed by a 4% to 5% increase in July.

Including the impact of about 25 basis points in stock option-related expenses, operating margin is expected to be flat to down 40 basis points compared to 5.9% in the second quarter of 2005.

Modest improvement in merchandise gross margin and distribution and buying costs are forecast to be offset by a higher shrink accrual and increases in freight, occupancy, and store expense.

As a reminder, we had expected continued pressure on operating margin and earnings during the first half of 2006, from the higher year-over-year shrink accrual and higher freight costs, until we anniversary the charge for shortage that we took in the third quarter of 2005.

We still plan to take our next full physical inventory in September 2006 and are hopeful that our shortage control initiative will allow us to show some improvement in our shrink results when we announce third-quarter 2006 earnings.

We are forecasting interest to be neutral to earnings in the second quarter.

Our tax rate is expected to remain unchanged at about 39%.

We estimate weighted average diluted shares outstanding of about 144 million.

For the second half of 2006, we continue to plan same store sales gains of 3% to 4% in the third quarter and 2% to 3% in the fourth quarter.

Third-quarter 2006 earnings per share after stock option-related expenses equivalent to about $0.01 to $0.02 per share are projected to be in the range of about $0.27 to $0.29 compared to $0.25 in EPS for the third quarter of 2005.

Expected operating margin improvement from lower shortage and related accounts payable expense versus the prior year is projected to be partially offset mainly by higher freight, occupancy, and store expense.

For the fourth quarter, which has 14 weeks this year, earnings per share are projected to be in the range of $0.60 to $0.64, inclusive of stock option-related expenses equivalent about $0.01 to $0.02 per share.

This 14-week forecast compares to reported earnings per share of $0.49 for the 13-week fourth quarter of 2005.

We estimate that the 53rd week in 2006 will add about $80 million in revenue and approximately $0.06 to $0.07 in earnings per share, which is included in our guidance.

As a result, for the full 53-week 2006 year, we now project that earnings per share will increase 16% to 22% to a forecasted range of $1.58 to $1.66, inclusive of stock option-related expenses equivalent to about $0.06 per share related to the adoption of FAS 123(R).

We are pleased to report that both our balance sheet and cash flows remain strong and healthy.

We ended the period with $145 million in cash and no debt, after repaying the $50 million term loan for the Southwest distribution center equipment.

Subsequent to the end of the quarter, we also utilized available cash in early May to pay down our obligation of $87 million on the Southeast distribution center lease.

We are currently exploring long-term financing alternatives for these capital investments.

We continue to return capital to stockholders through both our stock repurchase and dividend programs.

During the first three months of 2006, we repurchased 1.7 million shares of common stock for an aggregate of $48.9 million under the two-year $400 million program authorized by our Board of Directors in the fourth quarter of 2005.

We ended the first quarter with 143 million shares of common stock issued and outstanding.

Looking ahead, as always our major focus is on executing our off-price strategy of continuing to secure the best branded bargains to satisfy our customers; expectations.

In addition, over the next 18 to 24 months, we will continue to work on developing new micromerchandising initiatives to address customer wants and needs at a more local level without compromising our ability to offer our customers a wide assortment of branded bargains.

Our primary objective is to strengthen the performance in newer regions like the Southeast as well as in below average markets such as the Mid-Atlantic.

This initiative should also be of benefit when we begin to grow again into new geographies in the future.

We are pleased with the progress we have made over the last few quarters, as evidenced by our recent trends of solid gains in comparable store sales.

In addition, as expected, we are beginning to see gradual improvement in operating profitability.

For the balance of 2006, we will remain very focused on delivering fresh and exciting name brand bargains every day, while also continuing our new micromerchandising efforts, which we anticipate will allow us over time to get closer to our customers at a more local level.

We also continue to work on improving distribution productivity and expense trends, and on staying diligent in our efforts to get shortage results back to more normal levels.

These actions are projected to contribute to a gradual improvement over time in store sales productivity and operating profitability, enhancing our prospects for achieving our target of 15% to 20% annual earnings per share growth over the next several years.

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

(OPERATOR INSTRUCTIONS) Brian Tunick of JPMorgan.

Michael, two questions for you.

I guess first one, since the comp store sales trends have been pretty strong, we were wondering how the new store productivity differs versus mature stores.

How much of the deleveraging of occupancy are we seeing?

Where are the new stores per foot versus the mature stores?

The second question is, does your second-half guidance already assume the higher shrink reserves?

Thanks very much.

The first question was new stores, and productivity versus comps?

Yes, just trying to understand, since your same store sales have been strong, but you're occupancy deleveraging, we are assuming it's the new store productivity that has been dragging it down.

Can you just talk about some of the gaps between maybe the new store (multiple speakers)?

Relative to occupancy, there's a couple things going on.

First is that the average store volumes aren't keeping pace with the comps, which -- and that is due to the newer stores and newer regions coming in over the last couple of years.

But how significant is that gap?

You know, we have said before that those new stores are kind of 70-ish, in that range.

That is what we reported before and that is pretty consistent.

But we also had a change in accounting that put some pressure on occupancies, where we now expense the preopening lease costs based on new accounting guidance.

We also this year are coming up against some lease renewals for some of the older stores that are putting some pressure on occupancy.

Okay.

Then the second question on -- does the second-half guidance you're issuing include the higher shrink reserves?

Yes, it does.

Okay, thanks very much.

Tim Dyer of Piper Jaffray.

Just a couple questions for you.

First of all, I believe last year in Q2 Florida was a very strong region in terms of sales.

I was wondering how this region will be impacted this year, given the profitability issues you have previously addressed in those newer markets.

Then regarding those issues, is it primarily a mix issue related to the region?

So Florida, actually, as you talk about the Southeast Florida is not included in that.

Our Florida stores have done very well historically, and we believe will continue to do well.

So it is not included in the Southeast markets that we talk about.

Okay.

I'm sorry.

Relative to your question relative to mix, we believe it's an assortment issue that has many components to it, and mix is certainly part of it.

Okay.

Then also, with recent consolidation at Federated May, have you been impacted at all by the clearance activity related to the store closures?

Then do you expect, going forward, there will be any increased availability of product for you?

You know, it is hard to measure.

We know exactly where the stores were that went out of business, obviously.

But we had a reasonable comp performance for the quarter.

So we think we were impacted when they first started the sales, and it became less and less as they went on.

Your second part of the question was?

Just going forward, do you expect -- is there going to be any more availability of product due to these closures?

Hard to say, but you know product availability has been pretty good, and the dynamics in the industry are changing based on the consolidation.

I do think the consolidation ultimately is a plus for off-price for availability.

All right.

Then lastly if you could give us any update on the initiatives you have used to correct the shrink issue.

Sure.

There's a number of different in-store initiatives that we have focused on.

We focused on increased electronic surveillance.

We are tagging more than we have historically tagged in the past.

In our worst stores we are utilizing extra security personnel in those stores, to address both internal and external theft.

We are hopeful that we are going to see much improved results when we take our physical inventory in September.

Great, thank you.

Jeff Black of Lehman Brothers.

I had a couple questions.

First, can we get some color on how much freight weighted on the gross margins in the first quarter?

As we move into the second quarter, we were trying to determine why there would not be a little more upside in the gross margin?

We gave up 130 basis points on the markdown side last year.

How much of that do you think we get back?

If the answer is that you took some extra markdowns in the back half of the quarter in Q1, we're just trying to get a sense of comps accelerated over the quarter; it looks like inventories were taken down pretty far and that you managed inventory well.

So I just want to get a sense of why there would not be a little more upside in the gross margin.

Thanks.

On freight for the first quarter, it hurt us by about 20 basis points.

We don't see that trend changing throughout the year, with where gas prices are.

The second question was regarding inventory levels at the end of the first quarter?

Yes.

Regarding inventory levels, and while we would not see -- you gave up 130 basis points on the markdown side in the second quarter last year.

How much of that do you think you really get back, given that inventory levels are in a lot better shape as we see it heading into the second quarter this year?

Inventories levels as we ended the first quarter, although they appeared low at down 8.

We actually were against an up 9 last year relative to our data center move.

We actually believe that our inventory levels as we ended the quarter were a little higher than where we would like them to be, which is going to put some pressure on markdowns in the second quarter, we believe.

So you know with somewhat higher inventory levels, as we go forward we're going to take those down to around 4% to 6%.

You should be seeing that, which will allow us, we believe, quicker turn and fresher merchandise in the stores, which will go out to chase the business.

So although inventories may appear lower, our view is that they're still a little bit too high.

Do you have any color on what categories or where we have seen these imbalances, and why you are getting them?

You made some comments in the April sales release about the economy being or consumers (multiple speakers)?

Our inventory levels were higher than we wanted in the second quarter.

In the first quarter, okay?

Essentially we made errors in planning our inventory.

They were too high.

You know, as we went back and looked at this, we really planned our business up against two years of distorted inventories, because of the implementation of core merchandising where we had to upload our inventory at a portion of the first quarter in '04.

And our data center move in '05, we had to upload inventory yet again.

So we’re really in many ways planning inventories versus '03, which is not a good thing for a retailer to be doing in '06.

So with that, we think that also contributed to what we would say are inventory planning mistakes.

Okay?

But we do believe we have now got it under control for the rest of the year.

With our DC efficiencies, we think the fact that we can run lower inventories is a very good thing for an off-price company to be doing, and we are very pleased that we now have building efficiencies that put us in a position to do that.

Okay, fair enough.

Thanks a lot.

Kimberly Greenberger of Citigroup.

I am wondering if you could talk about the 195 basis points that we lost last year in the third quarter on shrinkage, and the (indiscernible) adjustments.

Approximately what percentage of that loss are you assuming you can get back in the third quarter, based on your guidance?

Does your guidance assume a favorable shrink result?

Secondarily, could you just give us a bit more clarity on the different components and how much they were moving in basis points in the gross margin line and the SG&A?

That would be helpful.

Thanks.

To the first part of your question, Kimberly, so the third quarter does not assume any improvement in shrink.

We assume -- the guidance assumes the same accrual rate that we're using in the first half.

Having said that, in the third quarter we do get the biggest piece of that back.

I think it's important to remember, also, that third quarter last year comps were up 9; and without the inventory and accounts payable issues, earnings would have been up 33%.

So we are up against a pretty tough quarter from that perspective.

And the second part of your question?

The second part was just if you could give us some granularity on the basis point movement of DC costs, incentive compensation, and just some additional detail on the gross margin and the SG&A line within the first quarter.

Thanks.

In the first quarter?

Yes.

So DC costs were actually favorable by about 100 basis points, offset by shrink and freight.

Shrink was about 40, freight was about 20.

So a pretty good DC performance.

Again we have a headwind on shrink and freight.

In terms of G&A, option expense was about 15 basis points and the incentive plan accrual increase was about 15 basis points as well.

And the occupancy piece within the gross margin line?

So the occupancy piece, because of the 6% comp, you know, about broke even.

Because we were able to almost leverage that, where in other quarters we're planning lower comps and have not planned to get that leverage.

If we do better in sales, obviously, we will.

Great.

Lastly on the 6% comp increase in the quarter, if you could just tell us how that breaks down from an average dollar sale versus the number of transactions, that would be great.

Thanks.

Sure.

So the 6% comp was driven half by number of transactions, and the other half by the size of the basket.

Actually, the average retail stayed about flat, but we are getting slightly more units in the basket than last year.

Great.

Thank you.

Paul Lejuez of Credit Suisse.

Last month, you made a couple of cautionary comments.

Just wondering what is it that you are seeing perhaps out in the field?

What are your buyers telling you that makes you a bit more cautious?

Gasoline, is that weighing on any particular region of the country?

Just trying to dig in a little bit more on those cautionary comments.

The cautionary comments were really not based on anything our buyers are seeing.

Buyers tend usually to be optimistic, okay?

So it has nothing to do with merchandise that is available, which is very plentiful.

It has to do with that in prior years, when there's been gas hikes of a significant nature, we have seen a slowdown of consumer spending.

Okay?

That was simply really what -- where our caution was and still is.

Any particular regions that you're already seeing that?

Because it didn't seem that you really ran into that last year when gas was spiking.

Yes, you really can't go -- when we look at it, we have looked at it over longer horizons and one period.

It is hard to tell, even last year, if we might have been impacted, we might have done even better.

But in other years, we certainly had definitive correlations.

Right now, we don't see it in a particular region.

But as you move into the year and get into the winter months, it becomes harder and harder.

Okay.

Thanks, guys.

Good luck.

Dana Telsey out of TAG.

Can you talk a little bit about some of the go-forward systems initiatives that you had in terms of more micromerchandising, in terms of the next evolution?

When do you think some of it starts to get hold?

What is the cost and what do you see the benefit being?

Thank you.

This is Michael O'Sullivan, I will answer that.

Right now, we're looking at a number of different things that we can do in terms of process changes and systems enhancements.

We're still pretty much at the sort of evaluation stage.

There's a number of different things we could do; we are trying to figure out which would be the most effective for the business.

And frankly, we haven't yet made that determination.

In terms of time frame, I would guess that it will be 2008 before we see any meaningful impact from any of the changes we're going to make.

Will that help your new store productivity in some of those other regions?

Yes, that is one of the primary goals is to improve our assortment in new markets; and (indiscernible) effect of that should be improve sales productivity.

John, how much will that cost, and how much is in CapEx this year and next year?

(indiscernible) CapEx.

Again we're still in the formative stages in trying to plan exactly what the system requirements will be and exactly what we're going to do.

So we haven't actually put a bow around what the costs will be at this point.

Thank you.

Margaret Mager of Goldman Sachs.

One of the things, just observing your Company over the past couple years, is that there has just been a very long series of ongoing disappointments.

I am sure that you're disappointed too that things just aren't coming together the way the market would hope or investors would hope.

When do you think all the noise is behind you and you can really say that you are on the right footing and heading in a very firm direction forward?

Is this the second half of '06.

Is it a 2007 time frame?

Like when does all the noise stop in the Ross story?

This is Michael Balmuth.

We are actually pleased with how we're doing, okay?

We have said this is going to be a transition.

We have said that we are going to make progress on certain issues.

And we have been marching along making progress in top line.

We're now making progress in distribution.

We're seeing progress in our new markets.

This is not a big bang, go from where we were to an instant success.

Okay?

We see that we're moving in the right direction, and that is what we have been articulating that we were going to do.

We're very pleased with where we sit.

Given where things, where our performance has been, the fact that this year we are going to show a 16% to 22% EPS growth, and that on our key initiatives we're making progress on each and every one of them, we are actually feeling fairly good about the direction the Company is going in at this time.

Okay.

I thought I heard you say that you were working your inventory decisions based on 2003 data, and this wasn't a great thing for a retailer to be doing.

So I can't imagine that you would consider that not a disappointment or a frustration and whatnot.

That is the essence of the question.

When do you really get to a place where you are kind of in the clear as far as decision-making with appropriate historical numbers, that you can feel really good that you are making the right decisions?

You know, we are at that spot now, and also we're not the first retailer to have a slight inventory problem in the quarter, despite any kind of systems issue.

We just basically gave it to you the way we saw it.

Okay.

It has been kind of a series of challenges managing the inventory as far as I can see.

With regard to your comments again on the macroenvironment, how do you reconcile that with the fact that you're running above plan in May?

Is your caution regarding the consumer and gas prices just something to be aware of?

Or is it really something that is happening right now?

Well, we're not economists, okay?

We do have historical records that show it does impact retail performance.

It has impacted our performance in the past.

We're doing better than we have expected.

We're happy about that.

We attribute that to probably better execution, very good availability of product in the market.

But there is something looming out over us and all retailers, and we are just calling it out as a caution.

Okay, thank you.

(OPERATOR INSTRUCTIONS) Patrick McKeever of Avondale Partners.

I have a question on the efficiencies at the distribution centers.

Just wondering if you could share a little bit on that one, and talk about where the efficiencies are coming.

Is it primarily in labor?

Is it pretty evenly spread or are they pretty evenly spread across your distribution centers?

Can you see more improvement there over the next several quarters?

This is Gary, Patrick.

I think as most people are aware, we finished our implementation of the standards, our standards and engineering project, in Q1 of this year.

As we anticipated and as we planned, we have seen and will continue to see gradual improvement in productivity.

To answer the question about where we are seeing it, we're seeing it across our network.

It is in line, actually slightly exceeding expectations based on our plan.

We believe that we will continue to see similar improvements as we move forward.

I would also add that the first-quarter number I gave of 100 basis points was up against a softer number than last year.

As we head through the back half of the year I don't expect to see -- we expect to see gradual improvements, but not to the extent we did the first quarter.

We are also bringing on balance sheet and beginning to depreciate our Southeast DC, which will [offset] some of the benefit.

So as Gary said, gradual improvement is what we expect.

So now it's really reached the implementation phase, and all of the engineered standards project itself was wrapped up in the first quarter, and now it is just a matter of implementing all the standards.

That's correct.

So really the standards are implemented now.

It is really a matter of them continuing to gain traction.

As people perform and execute consistently, they improve with time; and we will see over time gradual improvements accordingly.

You mentioned that you were getting some -- I guess the deliveries are making their way to the store more quickly than you had anticipated.

Maybe you could share a little color on that one.

I think one of the added benefits of getting better means we get the goods through our DCs quicker and in turn get them to the stores in a faster period of time.

I think that if anything, we are watching that; we're anticipating that we are going to get there quicker, and we exceeded our expectation slightly.

Relative to quantifying that amount, I will give that to John.

So part of the issue in the first quarter was we were just quicker to the store, which we have -- if you piece out that piece of the supply chain from the DC to the store quicker, meaning more goods in the store, it gives us the opportunity to take inventories down in the back half of the year in the store.

All right.

Thank you very much.

[Ken Gowe] of Pioneer Investments.

First of all, thank you for releasing your press release a little earlier this morning.

I think that helped out some of us a bit, so thanks.

I may have misheard earlier in the call;

I am just wondering if you could clarify again when you expect to get the inventories kind of to your targeted level.

We think we are in reasonable position now, and it will be gradually moving down through the next quarter.

So I would say in another 30 days we will be exactly where we want; and we should be able to maintain that through the remainder of the year.

Okay, great.

So that really should not be an issue going forward at all.

Not at all.

Your sales were great for the quarter.

I am just wondering if you could comment a little bit on the impact of weather on the West Coast, because presumably that actually had a negative impact.

Well, we would say it was a negative.

California was certainly -- it certainly trailed the Company.

So it was cold and wet, and it is certainly not a positive to our key market.

Okay, great.

Thank you very much.

Kimberly Greenberger of Citigroup.

This question is for Michael O'Sullivan.

What functionalities have you started to utilize in your new system, and what functionality do you think you will have an opportunity to utilize in the future?

The functionality we have in our system right now is basically providing all the information that different parts of the business need; and actually providing that in quite a flexible form.

What I mean by that is being able to slice and dice the data in numerous different ways.

So that is kind of what we have.

In terms of where we would like to go, the platform that we now have, the systems platform, actually captures a lot more information than our older systems used to.

So we have the potential to do a lot more, to take that information and use it to generate more sophisticated plans or more sophisticated forecasts.

We are looking at how we can utilize that, what process changes would be required, what systems enhancements might be required.

That is kind of the direction that we're headed.

Are you using it yet to look at markdown optimization, or brand, size, color, store-level assortment planning?

Both of those areas are things that we're looking at in terms of potential for the future.

So they are part of the sort of consideration set of things that we would look at.

Yes, we did not turn -- we have not turned those on yet.

Okay, great.

Thanks.

David Mann of Johnson Rice.

I just want to clarify a couple things.

On the shrink issue, I think you said you're hopeful and expect to yield much better results after September.

Have you taken any cycle counts thus far to support that?

This is Gary, David.

We recently, literally recently, just completed some individual store inventories.

Really those inventories were designed to ensure that the initiatives that we have in place are appropriate and are having the desired impact.

And results, from a results perspective it is really too early to tell.

As far as the impact on the total Company, it would be inconsequential to the total Company.

We're really using them just to ensure we're doing the right things.

We will know the results for sure when we complete our full physical in September.

Okay.

Then John, on an earlier question about new store productivity I think you talked about 70% of I guess an average store volume.

Can you reconcile with, I believe, the comment you made on the last call about the Southeastern stores being at 75% to 80%?

Are you talking about the same things?

I am.

So the comment related to new market stores, new stores in new markets.

I didn't say 70;

I said in the 70s.

Okay.

So it is not a change in the performance?

No.

Okay.

Then one last question on the gas price caution issue that you have out there, or that you have some concern about.

Is that an issue that is somewhat applicable for all markets equally?

Or do you think that you have seen historically more impact in California?

It is probably where -- it is probably a hard thing for me to say market by market.

Our model is resilient in the sense that a certain amount of customers trade down when these things happen.

But there sometimes is a bump in road, and we don't know exactly where that bump is.

Will we get resistance when we hit the bump?

We are able to reprice our product by buying opportunistically, so we can get ourselves in line to what the customer is expecting and reacting to how other retailers are promoting.

Probably you would have to say markets that rely more on driving, okay, or in the winter months, our colder markets, would be hit harder.

Okay, but not necessarily an obvious bigger material bump in California?

No, no.

Okay, great.

Thank you.

Mike Whitfield of Hahn Capital.

I wanted to ask about the gross margins.

You have mentioned some of the items that you have been working on.

If we were to get through a number of these items, shrink, getting the merchandise systems up and running where we want them, is gross margin -- can it approach what it did in earlier this decade, 2002, 2003 fiscal years?

So relative to the issues that we have, there's a couple things going on in gross margin, not only merchandise margin.

I think from a merchandise margin perspective, I think obviously sales and accelerating sales at the markdown line.

That is one aspect of margin.

The other costs kind of embedded in margin are the DC costs, which we have spoken about.

We anticipate gradual improvement.

And the shrink issue that we are working on.

So to your question, can we get back to kind of historical levels in let's just call it operating margin?

We think over a period of time.

We not put a time frame around that, but we're making gradual improvement.

As Michael said, we are very pleased with where we are.

We are hitting the initiatives we need to hit.

We're seeing incremental improvement in operating margin.

Based on the earnings guidance that we have out there, indicate improvement in operating margin.

So we are pleased with where we are.

Can you restate or repeat what you said earlier about the impact of last year's accruals for shrink and what was the impact there in terms of (multiple speakers)?

The impact in the third quarter was a catch-up when we actually took our physical.

It was 195 basis points to that quarter.

From that point in time we have been accruing 35 to 40 basis points more in shrink.

As we get through the third quarter we will look to see how much traction the initiatives got and what our shrink will be.

At that point in time we will be able to report what that performance has been.

As Gary indicated we're making progress in shrink, and the initiatives looks like they are taking hold from an execution standpoint.

We will know when we take physical.

Thank you.

(OPERATOR INSTRUCTIONS) There appear to be no questions at this time.

Okay, thank you all and have a very good day.

Thank you.

This does conclude today's Ross Stores conference call.

You may disconnect your lines at this time and have a wonderful day.