羅斯百貨 (ROST) 2008 Q2 法說會逐字稿

Good morning.

Welcome to the Ross Stores second-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, this call is being recorded.

At this time, I would like to turn the call over to Mr.

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 from investor relations, Katie Loughnot and Bobbi Chaville.

I will begin with a brief review of our second quarter and first half performance, followed by our outlook for the balance of the year.

John Call, our CFO, will provide more details on our second-quarter results and guidance for the back half of the year.

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 of our future growth and financial results and other matters that are based on management's current forecasts 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 10-K and 2008 Form 10-Q and 8-Ks on file with the SEC.

We are pleased to report that strong sales earnings growth for both the second quarter and year-to-date periods.

Earnings per share for the 13 weeks ended August 2, 2008 grew 46% to $0.54 from $0.37 per share for the 13 weeks ended August 4, 2007.

Net earnings for the second quarter of 2008 rose 40% to a record $71.3 million compared to $50.9 million in the second half of 2007.

Sales in the second quarter grew 14% to $1.640 billion with comparable store sales up 6% from the prior year period.

For the six months ended August 2, 2008, earnings per share grew 33% to $1.13, up from $0.85 in the first half of 2007.

Net earnings for the first six months of 2008 grew 28% to a record $150.8 million compared to $117.9 million for the same year-to-date period in 2007.

Sales for the first six months of 2008 increased 12% to $3.197 billion with comparable store sales up 5%.

We believe that our solid financial results were driven mainly by our ability to offer compelling bargains on fresh and exciting name brand fashions for the family and the home.

The tax rebate checks and favorable weather also benefited sales during the quarter.

Dresses, accessories, and shoes were the strongest merchandise categories, all posting double-digit increases in comparable store sales during the quarter.

The best performing markets were Texas and the mid-Atlantic, with same-store sales percentage gains in the low double digits to mid teens.

California comparable store sales grew 4% in the quarter.

We are pleased that we were able to leverage these solid sales gains into strong earnings growth.

Operating margin in the second quarter increased by about 130 basis points to 7.1% as a 180 basis point gain in gross margin was partially offset by a 50 basis point increase in selling, general, and administrative expenses.

John Call will provide additional details on these margin trends in a few minutes.

As we ended the second quarter, total consolidated inventories were down about 5% with in-store inventories down on average about 14%.

Packaway levels on average per store basis were down about 7% from the prior year.

As expected, we opened 26 new stores in the second quarter, 25 Ross Dress for Less and one dd's DISCOUNTS.

Year-to-date, we have added 51 Ross and three dd's and we ended the quarter with a total of 943 locations.

Our second-quarter sales trends at dd's DISCOUNTS were in line with our forecast but continued to have mixed results.

Comparable stores posted positive gains that were slightly lower than expected while the newer stores performed somewhat better than planned.

We continue to closely monitor dd's performance as we examine the target customer of this young chain and where and how to best position its growth.

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 $312 million of cash and short-term investments.

Our cash position is benefiting from higher earnings and reduced working capital needs as we operate the business on lower inventories.

During the second quarter, we repurchased 2 million shares of common stock for an aggregate purchase price of $75 million.

Year-to-date, we have bought back a total of 4.6 million shares for an aggregate price of $153 million.

We remain on track to complete half of our current two-year $600 million buyback program or about $300 million this year.

In addition, we expect to complete this full two-year buyback without taking on any incremental long-term debt.

Now John Call will provide some additional details on our second-quarter results and guidance for the back half of the year.

Thank you, Michael.

As Michael discussed, second-quarter operating margin improved by about 130 basis points, driven by a 180 basis point increase in gross margin that was partially offset by a 50 basis point increase in selling, general, and administrative costs.

The improvement in gross margin during the second quarter was driven mainly by higher merchandise margin, which increased about 185 basis points.

Our merchandise margin comparison was affected 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.

Therefore, almost the entire improvement in markdown performance in the first half of 2008 is reflected in our second-quarter results.

This comparison is normalized when we look at our merchandise margin for the first half, which improved by almost 100 basis points.

This primarily reflects our tight inventory control that is driving faster turns and lower markdowns.

Gross margin in the quarter also benefited from lower distribution costs as a percentage of sales.

Partially offsetting these favorable trends were higher incentive plan accruals and an increase in freight expense versus the prior year.

As expected, we saw higher selling, general, and administrative costs as a percent of sales versus last year.

A portion of this increase was driven by the prior year comparison, which benefited about 25 basis points from insurance proceeds and lower legal settlement costs.

Our incentive plan accrual in the second quarter was also higher due to the strong ahead of plan earnings in the period.

Finally versus the prior year, both our second-quarter and first-half results benefited from a favorable interest comparison, a slightly lower tax rate, and a reduction in diluted shares outstanding from our buyback.

Let's now turn to our third-quarter guidance for the 13 weeks ending November 1, 2008.

As noted in today's press release, we believe it is prudent to remain defensively positioned as we enter the second half of the year based on the uncertain macro environment and the uncertain retail environment which no longer have the benefit of a tax rebate check.

As a result, we are maintaining our original target of comparable stores sales gains of 2% to 3% for both the third and fourth quarters.

Based on these second-half sales assumptions, earnings per share are projected to increase 17% to 22% to a range of $0.42 to $0.44 for the 13 weeks ending November 1, 2008, up from $0.36 in the prior year.

For the 13 weeks ending January 31, 2009, earnings per share are forecast to increase 11% to 16% for a range of $0.78 to $0.81, up from $0.70 in the prior year.

Our growth rate for the fourth quarter takes into consideration the risk of a highly promotional holiday period.

In addition, we starts to anniversary the improvement that began in the fourth quarter of 2007 when our tight inventory control started to drive faster turns and better gross margins.

The assumptions that support our third-quarter earnings per share projections are as follows.

Total sales are expected to grow about 8% to 9%, driven by a combination of new store growth and as mentioned, a 2% to 3% increase in same-store sales for the quarter.

Same-store sales for each month of the quarter are also planned up 2% to 3%.

We are forecasting about 23 net new stores to open during the period, including 21 Ross Dress for Less locations and two dd's DISCOUNTS.

Operating margin is expected to increase about 30 to 50 basis points for a forecasted range of 5.7% to 5.9% compared to 5.4% last year.

This projected operating margin increase assumes strong gross margin gains driven mainly by higher merchandise margins and lower distribution costs.

These improvements are projected to be partially offset by an increase in selling, general, and administrative costs as a percentage of sales.

Expenses in our third quarter are expected to be pressured by our prior year comparison and other quarterly timing issues.

In the third quarter of 2007, SG&A benefited by about 25 basis points due to income from a construction related settlement at one of our distribution facilities.

We are forecasting no interest income or expense for the third quarter compared to the first half, which realized a benefit from higher interest income versus the prior year.

While we still expect our tax rate for the fiscal year to be relatively flat to 2007 at approximately 39%, we now have more variability in our quarterly tax rate since adopting FIN 48.

Our first two quarters benefited from a slightly lower tax rate versus the prior year while the third quarter rate is expected to increase to about 39%, up from 38% last year.

Diluted shares are now targeted to be about 131.5 million in the third quarter and 132 million for fiscal 2008.

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

Thank you, John.

As we enter the fall season, we remain very pleased with the resilience of our off-price business model in today's tough retail climate.

We believe that our ability to deliver compelling name brand bargains throughout our stores was the main driver of our solid performance in the first half of the year.

Our year-to-date performance and longer-term history both show that we can manage successfully in many types of business climates with less volatility in our financial results than a comparable full priced retailer.

During these times we benefit from the increased supply of great brands at significant discounts, like we continue to see today.

This makes our stores attractive destinations for customers seeking great values for their family and their home as shown by our solid year-to-date sales performance.

In addition, our strong inventory management has enabled us to buy even closer to need today and operate our stores with leaner inventory levels.

This in turn has increased our open to buy capacity, giving us even more flexibility to take advantage of the great closeouts available in the market.

As a result, we have realized faster turns and lower markdowns with a more rapid flow of fresh and exciting bargains to our stores.

Based on our first six months results and second-half guidance, fiscal 2008 earnings per share are now projected to increase 23% to 25% to $2.33 to $2.38, up from $1.90 in fiscal 2007.

In closing, we remain confident that the solid execution of our merchandising strategies always the key ingredient for success in this business along with continued tight 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.

(Operator Instructions) Adrianne Shapira.

Thank you, very impressive on the inventory control.

We were just wondering if you could shed some light in terms of the level of markdowns in that inventory.

Because to your point about the cost method of accounting, how we should think about gross margins going forward?

So as I mentioned for the first half, gross margin was up by about 100 basis points.

Going forward, if we continue our focus, which we plan to do on keeping our inventory tight, the experience around gross margins should continue to some extent -- I would say not to the extent that we experienced in the first half because in the fourth quarter of last year we began to anniversary some of that tighter inventory performance.

Right, but can you give us a sense of the percentage of markdowns within the inventory today, the currency of the inventory?

Sure, we'll look at clearance levels are down kind of low double digits right now, low teens.

Great, that's helpful.

Then just on the regional, you called out California up 4%.

Can you just give us a sense of how that has been trending and then perhaps also talk about the regional performance and perhaps some of the other markets like Florida and Nevada, sort of home-inflicted markets?

Sure, as we said in the announcement that California for the quarter was up 4.

Our strongest markets outside of California were Texas which is up 14.

We experienced up 12% in the mid Atlantic and then had various regions that were high single digits.

And second question was Florida, so Florida for the quarter was up 4%.

Thank you.

Brian Tunick.

I guess a couple of questions.

First it is pretty impressive to hear these mid-Atlantic stores are the second-best performing region.

Maybe just talk about what's happening there.

Obviously that's been a region that struggles for you guys and we haven't seen any micro-merchandising rollout yet, is that correct?

Then the second question is on the 2% to 3% comp guidance for the back half, can you guys get operating leverage on the SG&A side on that number?

Okay, Brian, it's Michael O'Sullivan.

I will take the first question on the mid-Atlantic.

The comp in the mid-Atlantic, the comp growth has run well above average both in the first quarter and the second quarter.

We are obviously happy with that and we've made some changes to the assortment, more better goods which we think have helped.

But I think we need to see a more sustained improvement over multiple quarters before we declare victory.

I think we are happy at this point, but we need a few more quarters before we will take away a strong trend from it.

On the second part of your question was about are we using any micromerchandising tools in that market?

At this point, the answer is no, not yet.

Brian, on the other part of your question related to SG&A leverage in the back half, our expectation would be third quarter would look somewhat similar to this quarter relative to expense levels.

I would say for the year we should be kind of flattish in-store operating costs and depending on how the year tracks, we could have a little bit of deleverage from increased incentive comps.

Sean Naughton.

Just a couple of quick questions.

One is as we start to see some of these retailers get into some trouble here in California and then potentially this Florida market, have you guys seen any impact to your business year to date on some of those businesses that are potentially having inventory liquidation sales, etc.?

We haven't seen any impact that would quantify historically what would happen on something like this.

As they go through the liquidation events we might see some slight negative and then as the store closes we see a pick up in the business.

But nothing material today.

Okay, then secondly, you guys mentioned before that operating margins could return to 8% to 8.5% potentially someday three to five years down the road.

What is potentially holding that back from any sort of acceleration in increasing the operating margin gains?

So, we have said that we believe over a period of time we can get back to kind of the mid-8% level.

Clearly we are on track this year with operating margins up 130 basis points from the second quarter and as we look to the year, operating margins probably have been in the 60 basis point range, we are tracking to those levels.

We think the key driver is to return those levels of EBIT margin would be store productivity, which would be probably the easiest driver to get there.

And obviously looking to managing our expense line.

Okay, then final question is there any change in the mix of brands that you are seeing that's available?

Is there any change from a better assortment of brands that you are seeing out there in the marketplace today?

Slight.

There is -- it is a very -- been very good buyers market and slight change in the availability of brands, but it is really more quality goods available from the normal restore structure.

Okay, thank you very much.

Kimberly Greenberger.

Thank you and congratulations on a great quarter.

I was wondering, John, if you could specifically comment on the increased incentive plan compensation this quarter.

Can you give us the basis points associated with that?

And did you have an opportunity to --?

I don't know if I want to use the word over accrue, but maybe get a little bit more aggressive on your accrual here in the second quarter because you had some room to do so?

Then secondarily on the merchandise margin, do you look at that -- at the new level of merchandise margin you achieved here in the second quarter as a sustainable level or is there a risk of some give back next year in the second quarter?

Thanks.

Your first question related to kind of our incentive plan cost relative to the deleveraging G&A.

It was about half of that, half of that number, and we accrue incentive plan costs based on what our expected earnings will be and clearly if you look at the year, we had a higher proportion of those earnings in the second quarter based on its performance.

Commenting on the sustainability of gross margin, as we mentioned in the prepared comments, there were some timing issues around markdowns in '07 and we are up against those markdowns specifically in the second quarter of '07 from markdowns that were actually taken the first quarter and sold through during the second quarter.

We think if we continue to manage our inventory tightly, we think that certainly gross margin can be sustained.

Having said that, we will be up against those levels in the fourth quarter and into next year, but we are pleased with where we are today.

So John, are you saying that your fourth quarter '07, first quarter and second quarter '08 gross margin levels you would consider to be a normalized level and whether or not we are flat, up, or down against those numbers going forward will I guess depend on your ability to just continue to execute your strategy.

But you don't see any reason why you couldn't achieve those numbers?

I think obviously turn relates to the top line and if we can keep the top line relative, we can turn the inventories which will relate which will result in lower markdown levels.

Again with that, keeping our eye on inventories and make sure we are tight on inventory balance as well.

I would add that we are planning to run our inventories down and even against last year's levels in the high single digits in the back half of the year.

So we think we put ourselves in a position to sustain the gross margin improvements we have had in markdowns.

Thanks, Michael.

And I just had a quick follow-up for Michael O'Sullivan on the micromerchandising effort.

I think that you were saying that some of the first categories that you are testing on the micromerchandising are starting to hit stores here in August.

Are you still on track for that or is that being pushed out?

And do you --?

How is the early phase of that going if you are starting to deliver?

You are right, the first sort of pilot rollout of micromerchandising is scheduled for the fall, which obviously began August 1 in our calendar.

So yes, it started.

It is early days to give you any sort of conclusions on it.

The only thing I would say is what we said on previous calls is that this pilot phase is really a chance for us to sort of learn how to use the tools to make some adjustments so that when we roll out to other parts of the business in '09 and '10, those tools can be more effective.

So just as a reminder, this pilot really covers about 15% of the business in terms of product categories, so that is how we are thinking about it at this point.

Great.

Thanks and good luck here in the second half.

Paul Lejuez.

Just looking at the spread between California comps and the rest of the chain, it seems to be getting a little bit wider.

Just wondering what the plan is for the second half of the year in terms of California versus the overall chain?

And then if you could, maybe just give us an update on what you are seeing in terms of women's apparel and home products.

Thanks.

So Paul, relative to the comp guidance in the back half, we really don't split out state-by-state levels.

Let's say we are pleased with California based on what we read is going on elsewhere in California.

We are actually pretty pleased with our performance for the first half.

And relative to home product and women's product, with what's going on with a lot of home retailers across the country, there's more product available in home than is -- been normal in any type of business environment.

And apparel still continues to be as we would normally expect in this kind of environments to be a solid buying environment also.

Home is a bit of a surprise.

Jeff Black.

Let me add my congratulations.

I had a question on dd's.

To what extent is dd's still a drag on the overall margin?

Are we to take it, Michael, that you think that business has kind of stabilized given the new store improvements?

When do you think we see a real improvement in dd's?

Is that something we might see in '09 or is it too early to say?

It's Michael O'Sullivan, Jeff, I'll answer that question.

It is worth remembering that we doubled the size of the chain in '07.

So as we have said before, we are using a way to kind absorb that growth to make some adjustments to the business to monitor performance and we've done some additional research to understand the customer a bit better.

Some -- businesses hit plan this year but the performance within that has been a little bit mixed, as Michael described in his remarks.

So we really want to use the rest of the year to continue to look at performance of the business and to match that up against what we have seen from the customer research.

And based upon that, I think we will think about how to best position this business for growth where and how to position the business for growth.

Have we publicly discussed how much though that this is dragging if any on the overall operating margin?

Yes, we have said that dd's this year the drag to operating margin is about 30 to 35 basis points.

And we are saying that you are hitting that this year and then the business is performing within that range?

Yes, that's correct.

Okay, thank you.

Dana Telsey.

Good afternoon, everyone, and congratulations.

Can you talk a little bit about -- as you think about inventory and what's available out there, closeout goods versus off-price goods, is there more of a mix shift going on either between closeout and off-price and is that also a contributor to the margins?

Then also as you think about your sales growth, how much of the sales growth is from existing customers, how much from new customers?

And is your marketing taking advantage of any of that?

Thank you.

Okay, I'm a little confused with closeout versus off-price.

But I'm assuming you meant closeouts versus regular price?

Exactly, yes.

All right, so certainly in this kind of environment having more closeouts available of quality (inaudible) is an event.

So some of our margin improvement is from closeouts.

Our intent is to buy as many closeouts as we can and the idea of running tighter inventories gives us the ability long term, not just on a short-term basis, to be more actively pursuing closeouts in the market in a more aggressive way than perhaps we were -- not perhaps, for sure we were before.

So I think we are positioning going forward to take advantage of closeouts better than we were.

I don't know that we can quantify.

Michael, maybe you want to --?

I think it's a good question about is our ahead of sales business coming from new customers or existing customers.

Like Michael was about to say, I don't think we really know.

What I can tell you is we do research on our customers pretty regularly and the one thing we know for certain is that our customers shop a lot of stores.

They have plenty of choices.

There's a lot of cross shopping particularly within the apparel business.

And what really drives our sales and our success is if we are able to differentiate ourselves versus all those other retailers where they could buy goods and if we are able to put better goods in front of them, better bargains in front of them.

That is what really drives it.

Now whether that is driving it with customers who used to buy far less or never used to come to Ross at all versus other customers who always used to come to Ross and are just coming more often, I don't think we can really -- we can't really get a handle on that.

Relative to marketing, we really haven't done anything different than our normal game plan in marketing and that is how -- we don't think that's really changed the tone of our business right now.

We think we are satisfying our customers a little better.

Thank you very much.

Patrick McKeever.

Thank you.

I'm just wondering if you might make some general comments about back-to-school and what you are expecting.

I know you said that August is planned up to 2% to 3% in line with the quarter overall.

But I'm just wondering if you might add some color around the back-to-school?

TJX said that they thought the business would come later this year.

Wondering if you share that opinion?

Then on the quarterly -- on the monthly comps in the third quarter, you're saying 2% to 3% each month of the quarter.

There I am just wondering why we shouldn't expect some acceleration in comps in particularly in October, given the easy negative 1% comparison?

Thanks.

I will take the first part -- this is Michael -- on back-to-school.

On a general comment, whether it is going to be later or not, we plan the months fairly similarly, so we think it's going to be not that way.

It hasn't been the best, frankly, going -- the first half of the year hasn't been the best junior season around the country.

And so we think back-to-school will be okay.

We have some concerns because there's less disposable dollars in kid's pockets today, but we think it will be reasonable.

But for us, we haven't delineated a time frame that it will -- time frame different than a year ago for the trend of the business.

And Patrick, if you look at -- if we look at the layout of our comp for the quarter, we have to remember we had a sales tax issue in the state of Florida.

So if you normalize for that, the quarters are all fairly even -- the months are all fairly throughout period on a comparative basis.

John, you mean just Florida not doing the tax-free holiday this year?

Yes, that's correct.

Actually last year not this year, Pat.

Okay, then a question on categories, merchandise categories.

What are some of the weaker merchandise categories right now and has there been any change I guess in trend over the past few months?

Really there hasn't been any major change.

The weakest business in the company at this point is the junior business and it's been that way for a while.

We have a very developed junior business and -- but we have been able to get through it by offsetting it in the businesses.

Okay.

Thanks, Michael.

William Keller.

Thank you for taking my question.

Thinking about inventory and the way it has come down over the last few years, especially in this environment where it sounds like availability is quite good, how should we be thinking about go forward when perhaps the buying environment is not quite as robust as it is now?

Thinking about it, tell me where you would like me to go on this?

In terms of -- I guess can the inventory declines continue?

Can you continue to run at this level or at some point are things going to have to snap back a bit when availability perhaps gets a little less robust?

I can tell you this, it is not going to snap back.

We've learned to run our business on less inventory and we are not going to forget that lesson.

Okay, very good.

Last thing on working capital, which came down significantly in this quarter.

Is there something -- and you break out current assets in the release, but not so much current liabilities.

Is there anything of a one-time nature -- is that a sustainable change as well?

The biggest driver of the working capital increase is obviously inventory management and with inventory management, we have more -- and the faster turn, we have more accounts payable leverage.

So last year in the quarter, AP leverage was about 56%.

This year it's 67%.

We believe that level in the 60s is sustainable.

Excellent, thank you very much.

Richard Jaffe.

Thanks very much, guys, and I appreciate all the color.

I guess a question of -- you guys have been doing it for a while.

The environment seems very difficult.

You are managing through it very effectively with leaner inventories and taking advantage of some of the opportunities in the marketplace, but wondering how you see both the fall season and spring '09 unfolding as you compare it to your experience in other downturns, say 2001 at or even the late -- the early '90s, late '80s?

How we see it in terms of what, Richard?

How long the challenging environment will remain, how long the [crippled] buying opportunities will continue?

How you see the environment unfolding from a positive and a negative standpoint?

Obviously not being economists, it is difficult for us to predict, but you know what is going on an external retail is this -- other retail despite the economy is going to have an impact on that and certainly with the recent Chapter 11s, not knowing how many doors are going to fully get closed out of these things and what other Chapter 11s be forthcoming, the environment might be better than most of us think for the retailers who are surviving.

So it's hard for me to really answer the question beyond that.

Certainly we don't see -- who knows if post the election things are going to get better in the economy.

I don't think anyone is really forecasting that, so we continue to watch other retailers and run conservative inventories and try and take advantage of opportunities, do the best job that we can in this type of environment.

A follow-on with that.

In the past, department stores have been -- when under pressure been very promotional and it put pressure on your stores, they became price competitive with Ross.

Do you see that as a possibility for the fourth quarter or do you see the consolidation of department stores offsetting that somewhat?

I don't know if it ever offsets it but certainly we've positioned ourselves conservatively for the fourth quarter because we have some concerns based on history, as you are bringing up.

But we will see if they've managed their inventories effectively, it will be less promotional.

It won't be as bad as you are possibly alluding to.

We will see, then.

Thank you very much.

David Mann.

Thank you, congratulations as well.

On the earlier question on dd's, how much of the improvement of that operating drag is really necessary for you to get back to the mid-8% operating margin?

Give me that again.

You have an operating drag at dd's.

Is that an obstacle to you getting back to the mid-8% in operating margin?

So as we've looked at these, obviously we'd expect some pro forma questions.

Is it an obstacle?

I would say as we continue to improve that area of our company, it will certainly help.

I would not say it is necessarily an obstacle to get back to that level of mid-8%.

As we said right now, we are down 30, 35 basis points.

As we continue to improve that business, obviously that should lessen.

I think the biggest driver of getting back to the mid-8s is how we operate Ross.

Okay, on the SG&A, I think you said that the bonus was about half of the year-over-year increase.

If I remember correctly, your original plan for the quarter was about 10 basis point increase.

Can you just clarify what other SG&A offsets there might have been?

And on the corporate line, did you lever your corporate overhead?

Yes, so going through the G&A line again, about half of the deleverage came from call it a one-time occurrence in the quarter last year where we had recovery from some insurance proceeds instead of the legal matter less than we had accrued.

The other piece comes from as you mentioned the incentive plan comp.

We were able to lever back office comp during the quarter.

Having said that, store operating costs were relatively flat based on the reallocation of payroll from the fourth quarter into the second quarter based on some things we're doing to match our payroll dollars to the functional activity that takes place in the store as opposed to merely allocating those dollars based on sales.

Okay, great.

Then one last sort of housekeeping.

I think in past quarters you've talked about specifically how shrink changed in the quarter.

Can you also give us that as well as how much freight negatively hurt you?

So freight, the freight drag in the quarter was between 10 and 20 basis points and shrink pretty minimal.

Very good, thank you.

Marni Shapiro.

Congratulations on a great quarter.

One quick SG&A question.

You talked about some pressure in the third quarter.

I was curious if that would carry into the fourth quarter as well?

Then Michael, if you could just talk about the marketplace, are you able to test and try and play with a little bit some different categories, opportunities, price points, brands that maybe weren't available to Ross Stores or maybe you didn't think the Ross Stores customer would be interested in given the environment and all the availability out there?

I'll take the first part, Marni.

I did mention that in the third quarter we would expect some pressure from SG&A.

In the fourth quarter that reverses where we get a bit of leverage in the fourth quarter.

This is Michael, in this environment, I'm not even sure it's just based on the environment.

It is based on our more appetite to be testing price points and values really that represent higher price points.

We're doing a little more of that across the store in various categories in this time and we are somewhat encouraged because it really -- really reminds all of us that we are in a value business, not a price point business.

It helps us position our assortments better going forward.

So yes, in answer to your question, we are doing some of that.

Great, good luck with back-to-school, guys.

Mark Montagna.

Just a question regarding inventory.

It sounds like in the fourth quarter you are expecting the declines to moderate a bit.

When you get to the comparisons versus right now you're having the double-digit declines, can we expect you to still be able to reduce inventory by mid-single digits once you start anniversarying these tougher declines?

Yes.

Could it be high single digits?

It could be.

Okay, I'm assuming it probably can't be double digits, then.

We are not anticipating it.

Okay, then just housekeeping question regarding CapEx.

Can you tell us what your expected CapEx and D&A is for this year?

We're expecting CapEx, Mark, at probably around $240 million this year.

Okay, how about D&A?

In terms of absolute dollars?

Yes.

Just a second.

I would expect D&A of around probably between $150 million and $160 million.

Okay, thanks.

That's all I had.

Kimberly Greenberger.

Thanks, I just had a couple of quick follow-ups, John.

Could you take a look at the 6% comp in the quarter and give us the break out between the transaction count increase and the increase in the average dollar value of the transaction?

Then secondarily, could you just give us a little bit more color in the gross margin line, the basis points associated with occupancy leverage, the improvement of distribution centers and the offsets in the higher incentive comp accrual in that gross margin bucket?

That would be great.

Sure, for the quarter the 6% comp was driven principally by volume.

Our average transaction was relatively flat.

In terms of break out, on the -- in the gross margin line, gross margin -- merchandise margin was up 185 basis points, I think as we said in the prepared comments.

And from the other elements, we said freight was pressuring gross margin by between 10 and 20 basis points; distribution center actually better by around 50, 60 basis points.

About half of that was really related to some timing issues around capitalization, distribution comps, into our packaway inventory.

Then incentive plan comps and buying comps put pressure on by about 50 basis points.

So we get 180 basis point improvement during the quarter.

Did you mention occupancy in there, John?

Occupancy was relatively flat.

Great, thanks.

(Operator Instructions) Jeff Black.

Thanks, I just had a quick follow-up on the packaway side.

Michael, how do we feel just qualitatively about the content of what you have in packaway now?

And how might that benefit things going forward on the gross margin side if in fact we think we are getting better merchandise in packaway than we have had in prior years?

Just any color on that would be helpful, thanks.

Well, I would say we feel pretty good about what we have there, but I would say normally we do.

So that's why we put it there.

But reality of it is if in fact we bought it smart and we bought -- and our instincts when we bought it turn out to be correct when it hits the selling floor, I would say it probably would have more of an effect on topline than margin the way I look at it.

Because we are packing -- we are not necessarily packing away at the same price lines, moderate versus better as a year ago.

So it will be topline issue I think the way I would look at it.

Hopefully we have packed away wisely.

Great, thank you.

At this time, there are no further questions.

Thank you all and have a very good day.

This concludes today's conference call.

You may now disconnect.