羅斯百貨 (ROST) 2012 Q2 法說會逐字稿

Good morning, and welcome to the Ross Stores second quarter 2012 earnings release conference call.

The call will begin with prepared comments by Management, followed by a question-and-answer session.

(Operator Instructions)

Before we get started, on behalf of Ross Stores, I would like to note that the comments made on this call will contain forward-looking statements regarding expectations about future growth and financial results, including sales and earnings forecasts and other matters that are based on the Company's current forecast of aspects of its future business.

These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from historical performance or current expectations.

Risk factors are included in today's press release and the Company's fiscal 2011 Form 10-K and fiscal 2012 Form 10-Q and 8-Ks on file with the SEC.

Now I would like to turn the call over to Michael Balmuth, Vice Chairman and Chief Executive Officer.

Good morning.

Joining me on our call today are Norman Ferber, Chairman of the Board; Michael O'Sullivan, President and Chief Operating Officer; Gary Cribb, Executive Vice President, Stores and Loss Prevention; John Call, our Group Senior Vice President and Chief Financial Officer; and Bobbi Chaville, Senior Director, Investor Relations.

Before we review our financial results, I would like to briefly discuss our recent announcement of an updated CEO succession plan approved by our Board of Directors.

As part of this plan and at my request, the Board and I have reached an agreement where I will remain with the Company at least through May of 2016.

My CEO role will be unchanged until June of 2014.

I will then become Executive Chairman, and the Board will elect a new CEO from our strong bench of very talented and skilled senior executives.

The new CEO will report directly to the Board and take on responsibility for most areas of the Company.

As Executive Chairman, I will remain actively involved in the business, with property development and dd's DISCOUNTS continuing to report to me.

Our Chairman, Norman Ferber, will become Chairman Emeritus, with his current consulting role to remain unchanged.

The Board and I firmly believe this type of long-term succession plan will allow us to remain focused on executing the strategies that have driven our outstanding financial results over the past several years.

We are also confident this plan will help us continue to maximize future stockholder returns.

In a couple of years, I will partner with the new CEO to effect a smooth leadership transition.

I was able to benefit from this type of mentoring relationship with Norman Ferber, who handed the CEO reins to me 16 years ago.

To ensure our ongoing success over the long term, I will continue to stay very engaged with the entire senior management team in setting strategy and direction for the Company.

I have been privileged to work with outstanding people at Ross Stores for 23 years and look forward to continuing to do so for many years to come.

Now turning to earnings.

We'll begin with a brief review of our second quarter performance, followed by our outlook for the remainder of the year.

Afterwards, we will be happy to respond to any questions you may have.

We are pleased with our better than expected performance in the second quarter and first six months of 2012.

Our strong sales and earnings growth for both periods continues to be driven by our ability to deliver compelling name brand bargains to today's value-focused consumers while strictly controlling both inventories and expenses.

Earnings per share for the 13 weeks ended July 28, 2012, increased 27% to $0.81 from $0.64.

These results are on top of a 20% gain in the same period last year.

Net earnings for the quarter grew 23% to $182 million.

Sales rose 12% to $2.341 billion, with comparable store sales up 7% on top of 5% growth in the second quarter of 2011.

For the six months ended July 28, 2012, earnings per share were $1.74, up from $1.38.

These results represent a 26% increase on top of a 23% gain in the first half of 2011.

Net earnings for the period rose 22% to $390.6 million, up from $321.2 million last year.

Sales for the first six months of 2012 increased 13% to $4.698 billion, with comparable store sales up 8%, which was on top of a 4% gain in the prior year period.

Merchandise and geographic trends were broad based for the second quarter and the first six months.

For both periods, juniors and shoes were the best performing categories, while Florida showed the most geographic strength.

Earnings before interest and taxes in the 2012 second quarter grew to a record 12.8% of sales, up from 11.7% in the prior year.

The drivers were higher gross margin and leverage on selling, general, and administrative expenses from the strong gain in same-store sales.

John will provide additional color on these operating margin trends in a few minutes.

As we ended the second quarter, total consolidated inventories increased 2% versus the prior year, while packaway levels were 48% of total inventories, compared to 49% at this time last year.

More importantly, average in-store inventories declined 5%.

As a reminder, we are planning selling store inventories to be down in the mid-single digit range for the back half of the year.

Now let's turn to dd's DISCOUNTS.

dd's generated solid results in the second quarter, with above planned sales in gross margin.

Like Ross, dd's is also benefiting from our ability to flow a larger percentage of fresh product to our stores by operating on lower inventory levels.

We continue to expect dd's to generate improved growth in pre-tax earnings for 2012 compared to last year.

With respect to our store expansion program, we remain on track to open a total of 31 new Ross and dd's DISCOUNTS locations in the third quarter and about 80 stores for the full year.

This growth includes our ongoing expansion into the Midwest, where we expect to operate 36 Ross Stores by the end of the year.

Now John will provide further color on our second quarter results and details on our guidance for the balance of the year.

Thank you, Michael.

Our 7% comparable store sales gain in the second quarter was driven by mid-single-digit growth in the number of transactions, combined with a low single-digit increase in the size of the average basket.

Operating margin grew by about 110 basis points in the quarter to 12.8%.

The 80 basis point improvement in gross margin was driven by a 65 basis point increase in merchandise margin, which includes 10 basis points from a lower shrink accrual and lower distribution and occupancy costs, which contributed about 50 and 25 basis points, respectively.

These favorable trends more than offset 55 basis points of higher buying costs, due in part to one-time severance-related expenses and modestly higher freight costs.

Leverage on the robust 7% comparable store sales gain drove a 30-basis point reduction in selling, general, and administrative expenses, primarily due to lower store costs as a percent of sales.

During the second quarter, we repurchased 1.7 million shares for a total purchase price of $113 million.

We remain on track to buy back a total of $450 million in common stock during fiscal 2012 to complete the two-year $900 million program authorized in early 2011.

Let's turn now to our guidance for the back half of the year.

For the 13 weeks ending October 27, 2012, we are targeting total sales to grow about 8% to 9%, driven by a combination of new store growth and same-store sales that are forecast to be up 3% to 4%.

Comparable store sales are forecast to increase 4% to 5% in August, 2% to 3% in September, and 3% to 4% in October.

This compares to last year, when they rose 4% in August and 5% in both September and October.

As Michael mentioned, we plan to open 31 net new stores during the period, including 25 Ross Dress for Less and 6 dd's DISCOUNTS.

Third quarter earnings per share are forecast to be in the range of $0.63 to $0.66, compared to $0.63 in the prior year.

Last year's third quarter benefited from much better than expected shortage results and a lower tax rate, due to favorable tax audit settlements.

Together, these items increased third quarter 2011 EPS by about $0.06 per share.

We are targeting operating margin of 10.4% to 10.6% for the 2012 third quarter.

As I just mentioned, higher projected shortage this year, compared to the very favorable prior year shrink results, is expected to more than offset significant leverage on selling, general, and administrative expenses and improvement in merchandise gross margins in this year's third quarter.

Net interest expense is planned to be approximately $2 million, and our tax rate is expected to be about 37%, up from 35% in the prior year period.

We also estimate weighted average diluted shares outstanding of about $223 million.

For the fourth quarter, we are targeting same-store sales for the 13 weeks ending January 26, 2013, to increase 1% to 2% on top of strong 7% gain last year.

For the 14 weeks ending February 2, 2013, we are targeting earnings per share to be in the range of $0.99 to $1.04, up from last year's $0.85.

Without the estimated per-share benefit of about $0.08 to $0.09 from the 53rd week, fourth quarter EPS is projected to grow about 6% to 12%.

Now I'll turn the call back to Michael.

Thank you, John.

As noted in today's press release, we are raising our 2012 guidance with earnings per share for the 53 weeks ending February 2, 2013, now forecast to be in the range of $3.36 to $3.44, including the previously mentioned $0.08 to $0.09 benefit from the extra week.

This compares to our prior guidance of $3.26 to $3.37 and represents projected earnings per share growth of 14% to 17% on a 52-week basis over earnings per share of $2.86 in fiscal 2011.

Looking ahead, we recognize that there are still a number of headwinds in today's macroeconomic and retail environment that could have a negative impact on consumer spending.

As a result, while we hope to do better, we believe it is prudent to plan our business conservatively.

That said, we remain very liquid and are open to buy, and our merchants continue to find plenty of competitively-priced name brand fashions for the family and the home.

In addition, we are very well positioned as a value retailer in the current climate.

By efficiently executing our off-price business model, we believe we can continue to benefit from consumers' ongoing preference for bargains.

To accomplish that, we plan to stay focused on the same strategies that have driven our successful growth over the past several years, namely, offering our customers fresh and exciting assortments of compelling name brand merchandise while strictly controlling both inventories and expenses.

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

(Operator Instructions)

Your first question comes from the line of Brian Tunick with JPMorgan.

Your line is now open.

Thanks, and congrats, everyone.

First question -- just trying to understand a little more as we think about -- I know last quarter you raised your overall store target plans.

Any learning so far from the Midwest and the Chicago market, whether it be the micro-merchandising or how you're flowing inventory into the stores, that can give you more confidence about either accelerating or holding your square footage growth rate here going forward?

And then the second question -- on the shrink, I know it comes up on a lot of the calls -- but besides having, obviously, lower inventory per foot, are there other things you guys have done in the past three or four years in the stores on the employee side where you think that can continue to improve the shrink rate?

Okay.

Brian, on the first piece of that, the new markets -- as you know, we opened 14 stores in new markets in October of last year.

So it's still very early to get any kind of read.

What I would say is that the early signs have been very positive.

The customer reception and the customer feedback we've gotten have been very good.

That has kind of reinforced, happily, that we are going to be very successful in those markets long term.

Any major learnings -- I think that's the question you really asked -- nothing major.

I think we have made some tweaks along the way, some minor improvements here and there to assortments and to operations, but nothing major.

So overall, we are feeling very good about the new markets.

This is Gary.

I will answer the question around shrink.

So we, over the past number of years, have implemented a significant number of shortage initiatives.

To name a few -- we have increased our physical personnel in stores, designed to prevent shortage; we have done a number of technology advances that we use; we have implemented hard tagging throughout the store, again, designed at shortage prevention.

And we believe that through consistent execution that we can get better over time.

Your next question comes from the line of Rick Patel with Bank of America.

Your line is now open.

Thank you.

Good morning, everyone.

It looks like you had a pretty decent ramp-up in pack-away inventories on a dollar basis from 1Q to 2Q.

Can you help us think about that?

Is this a function of ramping up for the holidays?

Or have you seen an uptick in the number of great buying opportunities in the marketplace?

And then secondly, how should we think about pack-away inventories ramping in the back half, and what are the gross margin implications of that?

The uptick is a function of us finding what we consider terrific bargains, branded bargains.

And thinking about our pack-away levels going forward, it's going to be a function of what we find.

If it continues to be a very good buyer's market, it would ramp.

That remains to be seen.

So far, we've been seeing some very good buying opportunities out there, very good.

Third, the gross margin on it -- the gross margin on it is favorable.

But you match up gross margin to the parent business that it comes from.

So, better product has, obviously, lower margin than moderate product.

But the pack-away product of each is higher than if we were buying goods regularly on closeouts.

Okay.

And then, can you update us on your marketing strategy for the back half?

I am curious if you are planning marketing dollars to be up versus last year, and how much of a change you're expecting in impressions, given the different channels that you are using for marketing this year.

Yes.

Rick, there is really no change in our marketing strategy in the back half.

Our marketing spending will be in line with last year as a percentage of sales, and our marketing mix in terms of dd's and other channels will be comparable to last year.

All right.

Great.

Thank you very much.

Your next question comes from the line of Jaime Katz with Morningstar.

Your line is now open.

Good morning.

Thanks for taking my call.

Are there any new ways that you have thought of increasing traffic, maybe through some sort of targeted marketing in certain regions?

Obviously, you called out Florida as a strong region.

But are there some regions that are coming in a little bit weaker that you guys have changed the way you have targeted the audience there?

Let me take that question in two parts.

First of all, in terms of the regions, our sales performance has been pretty broad-based.

I know Michael mentioned in his remarks that Florida has been the strongest, but actually, we have been strong across all regions.

There haven't been any weak regions in our chain.

In terms of any special targeting, any special marketing -- no, not really.

I mean, our style has always been -- our strategy has always been to use marketing as a way to remind the customer to keep coming to Ross.

But the real hook is the bargains that they find in the store.

So our focus is really to make sure that we have great merchandise, great bargains, and that's what keeps the customer coming back.

Marketing is just to remind them of that.

We are not trying any gimmicks with our marketing program.

We are not doing anything different.

Thank you.

Your next question comes from the line of Jeff Stein with Northcoast Research.

Your line is now open.

Couple questions -- first of all, a question for John.

Wondering, at the high end of your guidance range for the third quarter -- in other words, if you do a 4% comp, would you leverage SG&A at that level?

Yes, we would.

Okay.

Great.

And then, next question -- wondering, your Home Business seems to have lagged the Apparel Business for some time.

I'm wondering if there is any strategy in mind to kind of maybe reenergize that Business and try to ramp up the growth rate a little bit more?

Well, we think in Home, in the more recent period, we have had some execution issues, and we think we're in the process of cleaning all that up.

We would expect Home to be back on track based on that.

Okay.

And should we expect to see that in the back half of this year, or is that more of a calendar 2013 initiative?

I think -- oh, no.

It's an initiative that's ongoing.

We'd expect to see some improvement in Q4 and more so as we move into the spring.

Okay.

And just finally -- CapEx.

Can you talk at all about spending levels beyond the current fiscal year?

Should they begin to abate somewhat, or will they remain at these levels?

As far as CapEx goes this year, we've updated our view around that.

We think we'll spend between $465 million and $475 million.

Principally, the increases there relate to distribution centers that we're building.

That will continue into 2013.

And then after that, it'll abate back to more historical levels.

Got it.

Thank you.

Your next question comes from the line of Kimberly Greenberger from Morgan Stanley.

Your line is open.

Great.

Thank you.

And congratulations on a really terrific result here.

I wanted to ask about the second quarter transaction metrics.

John, if you could break those down for us between the transaction count versus average dollar sale and averaging retail price?

As I recall, it's primarily been an increase in traffic and an increase in transactions that have driven your comps so far this year, and I'm wondering if you have any insight into the drivers of that surge in traffic?

As I think about your business over the last 10 or 12 years, I don't remember a year where I think traffic has been as robust as this year.

So maybe just any insight you could offer there.

And secondarily -- if you have a similarly low shrink result this year when you do your physical inventory in September as you did last year, would that be neutral to third quarter EPS?

Or what's imbedded in your third quarter guidance?

Thanks.

Sure.

As far as the transaction trends in the second quarter -- the number of transactions, as you mentioned, was up mid-single-digit rate, so the driver of the comp was the transaction volume.

We did see a low single-digit increase in the size of the average basket.

But as we've seen over the last several years, it's been traffic that has really driven the comp.

And last year, we had similar levels of mid-single-digit increase in traffic, and that has been a recurring thing.

As far as shrink is concerned -- we have not dialed any benefit into positive shrink results above and beyond our accrual this year.

I'll remind you that over the past, probably two or three years, the results have benefited the third quarter by probably $0.04 to $0.055 over a three-year period.

We don't think it's prudent to expect that again -- continue to expect that, because we are at historically low levels, and we think it's just prudent not to dial that in.

And I don't think it's realistic that we'll receive the 4% to 5% benefit.

Having said that, as Gary mentioned, we are still very bullish on our shrink work.

We continue to invest in those initiatives.

But we are down to a level of whoever have already picked the high-hanging fruit.

Great.

Thanks, John.

Your next question comes from the line of David Mann with Johnson Rice.

Your line is now open.

Thank you, good morning.

John, can you talk a little bit about the components of gross margin -- how we should think about those in the third quarter?

And then also, could you give us a sense of how big that one-time severance expense was?

Yes.

In the third quarter, the theme will continue for the year, which is the lower inventory levels have increased turn, which have reduced our markdown levels.

And that should continue into the third and the fourth quarters, as we anticipate inventories will be down in the mid-singles.

And as far as the kind of one-time severance piece, it was worth about 20 BPs.

Okay.

And then in terms of the distribution number of the benefit that you have had in the current quarter, the second quarter -- can you talk a little bit about what was going on there?

Sure.

We did have, at a gross level, the distribution centers did perform better on the higher volumes.

So we did have some leverage there.

There is also a piece of pack-away timing embedded in that 50 basis points of improvement in distribution.

Okay.

And one last question -- in terms of dd's, you are delivering, it sounds like much improved performance or continued improved performance there.

Can you give us a sense, in terms of your guidance, what kind of improved bottom-line performance dd's is likely to contribute this year?

Well, overall, David, you're right -- dd's continued to perform well for the second quarter.

Actually, for the first half of the year, it beat itself in margin plans.

Over the last few years, it's benefited from the same approach that we have taken at Ross in terms of reducing our inventory levels, which has improved the freshness of the product, which has driven sales and has also sped up turns, which has improved the margins.

So, we are pretty happy with that, with dd's' performance.

I think we had mentioned earlier in the year, we expected dd's to be accretive to earnings -- not really material; it's a relatively small part of our overall business.

But it's on track to be pretty accretive to earnings this year.

The only thing I would add to that is that we are pleased with the dd's store contribution levels, which have pretty much mimicked those at Ross Stores currently.

Great.

Thank you very much.

Your next question comes from the line of Richard Jaffe from Stifel Nicolaus.

Your line is now open.

Thanks very much, guys.

Just a follow-on with dd's -- how much of your Ross Stores expertise in the market is helping dd's?

How much does one team provide a helping hand to the other in terms of great product or pack-away or excess product?

Or are they run as really silos, very independent?

They are separate buying organizations that work closely together when it's appropriate.

Thank you.

Your next question comes from the line of Laura Champine from Canaccord.

Your line is now open.

This is Jason Smith on the line for Laura.

I just had a quick question about your Q3 guidance.

Is there something that you are seeing in August that's making you a little more conservative, given the recent traffic in sales trends?

So for August, we are guiding 4% to 5%, which we're guiding that the highest month of the quarter.

It's up against a lower comp.

Other than that, I think I'd remain silent on it, in that we don't comment on inter-month sales.

Okay.

And I mean, where is a conservatism coming, given recent trends?

We hope to do better, okay?

And we think it's better to run our business in a very conservative model.

And it's worked well for us doing that for a number of years, and we'll continue to do that.

Okay.

Thank you very much.

Your next question comes from the line of Omar Saad from ISI Group.

Your line is open.

Thank you.

I was wondering if you could give us a little bit of an update on the buying organization -- what size you're at, at this point?

Have you seen a lot of growth there?

What's the talent availability like as the business continues to grow?

Are you seeing turnover?

What are your long-term goals?

Or do you feel you have the organization in place on the buying side for what you're looking for, for the business, long term?

Okay.

I would say we have a very well-developed buying organization that we grow close to 10% a year.

That's our plan, our medium-range plan.

We have a very aggressive program developing our own.

And certainly, the talent availability outside of our Company -- to your question, with what's going on in the retail industry over the last few years, there is some good talent out there, too.

But we prefer to grow our own when we can.

Got you.

And then if I could ask just a quick question on the landscape, the competitive dynamics out there, some dislocation happening at various department stores.

Do you see changes in the way consumers are shopping?

And can you see in your data new customers coming into your stores, whether it's the Ross Stores or the dd's stores, that are fleeing some of these other channels?

Yes.

I guess a couple of thoughts in response to that, Omar.

First of all, with an 8% comp sales growth in the first half of the year, to say that we are growing customers from somewhere.

Actually, that's been true for the last few years.

Our comp sales is have been very strong.

So obviously, we are taking share of the apparel market.

We do, do a lot of research to understand where our customers are coming from, and we have gained a lot of new customers over the last few years.

And what the research tells us is that there are a number of factors and there are a number places that our customers come from.

So, partly it's dislocation in the department store channel, but also, it's the general economy.

And perhaps most importantly, the number one thing that causes customers to come to Ross and do business with us is that we are offering them great deals.

So, it's a combination of all those factors.

The most important one is the bargains.

Thanks, guys.

Great job.

Thank you.

Your next question comes from the line of Evren Kopelman with Wells Fargo.

Your line is open.

Thanks.

Good morning.

I wanted to ask about your micro-merchandising initiatives -- where we are in terms of the benefits you expect to see from that?

And maybe some of the surprises that you have seen that -- relative to your expectations that the systems have allowed you to do?

Thanks.

So Evren, as you know, we rolled out micro-merchandising about two years ago.

It has actually been several years in development, so we spent a lot of time thinking about it before we put it in place and designing it.

But it's really been in place for about two years across the chain.

And we think it has helped our business in terms of making sure that we have the right product going to the right store at the right time.

And it's been a major contributor to us being able to continue to cut our inventory levels, which in turn has improved freshness of the merchandise and helped to drive turns.

In terms of big surprises -- I don't think there have been any.

I think it's kind of done what we expected it to do.

Each store now has a much more customized assortment, based the upon the micro-merchandising planning and trending that we have done.

But that's kind of what we intended it to do.

So, no big surprises to report.

Your next question comes from the line of Pamela Quintiliano from Oppenheimer.

Your line is open.

Good morning.

It's Dan Giacomi filling in for Pamela.

Congratulations on the quarter.

I had a quick question on Ross versus dd's.

Can you help us think about the traffic and conversion levels at those two, given that they reflect different demographics?

And earlier this week, a competitor that caters to a more constrained consumer had suggested that the macro is beginning to weigh more heavily.

Any insights would be greatly appreciated.

Thanks.

In terms of the composition of comps among both companies -- very similar traffic is driving both of those increases, and we haven't seen a large disparity among the two.

And on conversion, both Ross and dd's have pretty healthy conversion rates.

Typically, what we find is, when a customer visits a Ross or when a customer visits a dd's, more often or not, they are going to find something that they like.

So, the conversion rates are pretty high for the chain.

Great.

Thank you.

Your next question comes from the line of Roxanne Meyer from UBS.

Your line is open.

Thanks.

Let me add my congratulations on a terrific quarter.

First, I just wanted to follow up on your comments regarding new customers and where you are getting them from.

I am wondering if you could share anecdotally any insights as to -- are you seeing a wider customer demographic?

I know one of your competitors talked about seeing a younger customer increasingly shopping their stores.

And then, secondly, given that so many retailers are talking about lower sourcing costs trickling through in the back half, wondering if you have any update as to what that impact could be on your business as well?

Thanks.

So, Roxanne, on the customer question -- yes, we've certainly done research on the new customers that we have attracted.

And, by and large, they are drawing from the same demographic groups as our existing customer base.

You mentioned younger customers.

We have always done particularly well with younger customers.

I think that's a combination of they are attracted to the great values that we offer and the assortment that we offer, and we see that again in our research on new customers.

We see that continuing, that we do particularly well with younger customers.

Relevant to cost and impact on our business, we price our merchandise off of a branded product that's in department stores.

So we will be watching how they price their product.

We have been watching, and we will be pricing accordingly to keep a proper distance from their retails to our retails.

And the cost for us is really a function of the existing supply lines in the market, regardless of what they are paying for product.

Your next question comes from the line of Alex Fuhrman from Piper Jaffray.

Your line is now open.

Great.

Thanks, guys.

I would like to talk a little bit about the composition of your pack-away inventory.

Given that it's been building based on opportunistic buys, I would assume the quality is very high.

If you could comment on the quality of the brands in your pack-away inventory -- how you feel that sits versus last year?

And then, given the strength you have had in the juniors business in the last 11 months -- and I know it's a little bit harder to pack that merchandise away, because it's a little more of a fickle customer in terms of stash in -- has the composition of your pack-away inventory by merchandise category changed at all as juniors have become a more prominent part of the business?

We actually feel very good about the quality of the brands in our pack away.

And that's the reason why the number has been climbing.

Our junior business is not a big participant in the pack-away business.

It's a much more trendy business.

It happens.

There are -- there is really one classification in particular where we might pack away a little more.

But for the most part, in juniors, it's a buy and sell business.

Great.

That's really helpful.

Thanks and good luck, guys.

Thank you.

Your next question comes from the line of Daniel Hofkin from William Blair & Co.

Your line is now open.

Good morning, guys.

Great quarter.

Just following up on the earlier question on the department stores, specifically JCPenney.

Can you say qualitatively in trade areas versus non-trade areas of JCPenney -- are you seeing a measurable difference in the comp over the last -- since earlier this year?

And then, is that also helping you on the dislocation among some of your department store competitors -- helping you in terms of incremental product availability?

In terms of the sales impact, Daniel, 95% of our stores are within 10 miles of a JCPenney.

We have sliced and diced stores based upon proximity, and we don't see a pattern.

So analystically, what I can tell you is, we don't see that the stores near a JCPenneys are comping better than stores that are further away.

All the stores, whether they're near or far from JCPenney, are doing well.

With that said, I will go back to the point we talked about earlier.

With an 8% comp in the first half, it's clear that we're taking share from somewhere and customers are coming from somewhere.

I think our conclusion is that they're coming from a lot of different places.

This is only one factor.

There are many other factors driving our comp performance.

And in terms of seeing product as it relates to specifically one retailer -- I would say the mid-tiers has struggled a little more in total.

And although we don't often know exactly where the product is coming from as them to sell it to us, our suspicion is that we are getting product from a few of the key mid-tier players.

I am sorry -- I was going to say if I could ask one follow-up, which is -- what is the current thought about the drop-through rate on an incremental comp point?

I know you guys budget your business for a low comp.

Our drop-through rate is around 25% for incremental sales above plan, and that's about what we're running.

That's about the operating margin on the incremental sales?

That's about the operating margin.

On an annual basis, a one-point comp is probably worth about $0.06 to $0.07.

Great.

Thanks very much.

Your next question comes from the line of Mark Montagna from Avondale Partners.

Your line is now open.

I just wanted to get a little more clarity in terms of customers -- there was a prior question on this -- are you seeing a broadening of your age range, by any chance?

Are you seeing a broadening of the income demographic -- perhaps a higher income demographic?

Our customers have a pretty broad set of demographics to begin with.

Our existing customers are drawn from different income groups, different age groups, and so forth.

So, no, we haven't seen any major change in that profile, in that demographic breakdown.

Just lastly -- regarding inventory shrink, sounds like you are guiding to flat.

If your inventory is going to be down mid-single-digits, we should expect some less shrink, just simply because you have less inventory out there?

Is the question, we should expect lower shrink levels because we have lower inventories?

Yes, because clearly, you are executing well in a lot of the other disciplines to prevent shrink.

Just seems logical that there would be that much less to be --

I'd say we hope so.

We're optimistic about that.

Not only lower levels of inventory, but the programs we put in place and we keep investing in that area of the business.

Okay.

Thank you.

Your next question comes from the line of David Glick with Buckingham Research.

Your line is open.

Good morning.

Thank you.

Two quick questions -- first, on the SG&A leverage in the second quarter, clearly a very strong operating margin performance.

I was curious why the leverage wasn't as great as previous quarters.

I am assuming perhaps it was a higher incentive comp accrual or maybe a catch-up accrual.

I was wondering if you could give some color on that?

And then I have a follow-up on your expansion strategy for Ross.

Sure, David, I think that's right.

There is always timing issues between quarters.

We did have some pretty good leverage in G&A, but we did take our bonus accrual up in the quarter as well.

So, I'd say good leverage; there is some timing issues in there, but overall, we're pretty pleased with the results.

Okay.

Thank you.

That's helpful.

In terms of your expansion strategy for the Ross Stores -- you opened in Chicago a year ago.

How do we think about how you fill in the white space as you move across a vast area where you don't have stores?

Is your strategy to be expanding into more contiguous markets?

Or could you leapfrog around to various parts of that white space?

You know, that's something we look at all the time in terms of real estate availability and new markets to move into.

Right now, our focus is on the new markets we've moved into, such as Chicago, and building our scale in those markets.

I'd rather not comment in terms of the next markets that we would go to after that.

Okay.

Great.

Thanks.

Good luck on the second half.

Thank you.

Your next question comes from the line of Marni Shapiro with The Retail Tracker.

Your line is open.

Hey, guys, congratulations.

And, Michael, congratulations.

I think you moved to Chairman shortly after I stopped selling Ross Stores about 100 years ago.

So, congratulations.

It's been a long time.

I have two very quick questions.

On dd's -- as you open stores, should we expect to see a similar growth regionally as the way you rolled out Ross Stores -- still with the cluster approach across the Southern tier before you would hit someplace like the Midwest?

Yes.

Well, I'd say a couple of things.

One thing for sure is that, that approach that we took at Ross historically was a fairly targeted approach.

We picked one market, and then we moved to another market, and then we moved to another market, rather than sort of a shotgun, sort of a scattergun kind of approach.

We've always tried to be much more focused and build scale into the markets we are in before we move on.

I think you can certainly expect the same thing in terms of dd's.

Excellent.

And then, following on the heels of the last question -- is there any thought over a longer period of time of moving into either Canada, or secondary or not obvious markets like maybe outlet malls?

On your first question about other countries, internationally -- no, not right now.

Our priority right now is domestic moves in the United States.

We are only in just around about 30 states.

So until we've expanded into a greater number of states within the US, I don't think we are really going to look internationally.

And relative to outlet malls, I don't have the number with me, but we are in several outlet malls.

Okay.

Fantastic.

I didn't realize that.

Congratulations, guys, and best of luck with the fall season.

Thanks.

Your next question comes from the line of Dana Telsey with Telsey Advisory Group.

Your line is now open.

Good morning, afternoon, everyone.

And congratulations, Michael.

It certainly has been a long time.

As you think about new markets, how do you see the performance in new markets?

Anything being done differently in terms of size of store, time frame for return, logistics in getting those stores accepted in a quicker manner?

And lastly, with the strength of the comp that you have been having lately, any way to track how much of the business or the traffic is from new customers, how much is from existing customers?

Thank you.

Thank you.

On the first thing, markets -- we put a lot of work into preparing for our entry into new markets.

And we certainly went back and looked at what we learned from previous new markets that we entered.

I think there are a number of things that we were able to incorporate into our entry into the Chicago market last year.

Those things included just how we set about setting up an operating team, how we think about marketing.

Obviously, we've talked a lot in the past about micro-merchandising and making sure we have better tools to come up with the right assortment as we enter new markets.

So, I think there are a whole host of things that went into preparing for the new market entry.

On the second part of your question -- new customers versus existing customers -- we know from our own research, we do know that our comp growth has been driven by a combination of new customers and existing customers spending more or coming to the store more often.

So, it's really a combination of both of those.

Thank you.

(Operator Instructions)

Your next question comes from the line of Paul Lejuez from Nomura.

Your line is now open.

Thanks, guys.

I was just wondering about the pack-away strategy at dd's -- how does that compare to Ross Stores?

Is it a larger or smaller percentage of the total inventory at any given time?

Thanks.

It's smaller.

Thanks.

I'm showing there are no further questions on the line.

I'll turn the call back to Mr. Balmuth.

Thank you for joining us today and for your interest in Ross Stores.

Have a great day.

And ladies and gentlemen, this concludes today's conference call.

You may now disconnect.