羅斯百貨 (ROST) 2016 Q2 法說會逐字稿

Good afternoon and welcome to the Ross Stores second-quarter 2016 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 FY15 Form 10-K and FY16 Form 10-Q and 8-Ks on file with the SEC. Now I'd like to turn the call over to Barbara Rentler, Chief Executive Officer.

Good afternoon. Joining me on our call today are Michael Balmuth, Executive Chairman; Michael O'Sullivan, President and Chief Operating Officer; Gary Cribb, Executive Vice President - Stores and Loss Prevention; John Call, Executive Vice President Finance and Legal; Michael Hartshorn, Group Senior Vice President and Chief Financial Officer; and Connie Kao, Vice President - Investor Relations.

We will begin our call today with a review of our second-quarter and year-to-date performance followed by our outlook for the remainder of the year. Afterwards, we will be happy to respond to any questions you may have.

As noted in today's press release, both sales and earnings results in the second quarter were ahead of our forecast. Earnings per share for the period were $0.71, up 13% on top of an 11% increase in the prior year. These results include an approximate $0.01 benefit from favorable expense timing that is expected to reverse in the second half.

Net earnings for the second quarter grew to $282 million compared to $259 million for the same period last year. Sales rose 7% to $3.181 billion, with comparable store sales up 4% on top of a 4% gain in the prior year. Higher merchandise gross margin during the second quarter drove a 50-basis-point increase in operating margin to 14.4%. For the first six months of FY16, earnings per share were $1.44, up 9% on top of a 15% increase in the prior year.

Net earnings were $573 million, up from $541 million in last year's first half. Sales year to date rose 6% to $6.27 billion, with comparable store sales up 3% versus a 5% gain in the prior-year period. dd's DISCOUNTS again posted better-than-expected gains in both sales and profits for the quarter, as customers continued to respond positively to their merchandise offering. During the quarter, California and the Midwest were the strongest regions, while shoes and home were the best-performing merchandise categories at Ross.

We also made some progress improving the assortments in our ladies apparel businesses, where we struggled during the spring season. As we ended the second quarter, total consolidated inventories were up 3% compared to the prior year, with average in-store inventories down 1%. Packaway as a percent of total inventories was 47% compared to 46% at this time last year.

Turning to our expansion program, store growth remains on track, as 24 new Ross and 7 dd's DISCOUNTS opened in the second quarter. For the full year, we continue to plan for a total of 70 new Ross and 20 dd's DISCOUNTS locations. As usual, these numbers do not reflect our plans to close or relocate a handful of stores.

Now Michael Hartshorn will provide further color on our second-quarter results and details on our second-half guidance.

Thank you, Barbara. Let's start with our second-quarter results. Our 4% comparable store sales gain was driven by increases in both traffic and the size of the average basket. As mentioned earlier, second-quarter operating margin was better than expected, increasing 50 basis points from last year to 14.4%. Cost of goods sold improved 60 basis points in the quarter, driven by a 45-basis-point increase in merchandise margin and distribution and buying costs that were lower by 10 and 5 basis points, respectively.

Selling, general, and administrative expenses during the period increased by 10 basis points, due mainly to higher wages. During the quarter, we repurchased 3.1 million shares of common stock for a total purchase price of $176 million. Year to date, we have bought back a total of 6.2 million shares for an aggregate price of $352 million. As planned, we expect to buy back a total of $700 million in stock for the year to complete the two-year $1.4 billion stock repurchase program approved by our Board of Directors in February 2015.

Let's turn now to our second-half guidance. For the third quarter ending October 29, 2016, same-store sales are forecast to increase 1% to 2% on top of a 3% gain last year, with earnings per share projected to be in the range of $0.52 to $0.55 versus $0.53 in last year's third quarter.

For the fourth quarter ending January 28, 2017, we are also planning same-store sales to be up 1% to 2% on top of a 4% gain last year. With earnings per share projected to be $0.73 to $0.76 compared to $0.66 last year. The difference in earnings-per-share growth between the third and fourth quarters is mainly due to timing of packaway-related costs compared to the prior year.

Now I'll provide some additional operating statement assumptions for our third-quarter EPS targets. Total sales are projected to grow 4% to 5%. We're planning to add 25 new Ross and 9 dd's DISCOUNTS locations during the period. In addition to the previously mentioned timing of packaway-related costs, if same-store sales perform in line with our guidance, or a 1% to 2% gain, there would be some deleveraging on occupancy and other expenses. Thus, operating margin is projected to be 11.6% to 11.8% versus 12.1% in the prior year.

Net interest expense is estimated to be about $4.5 million. Our tax rate is planned at approximately 36% to 37%, and we expect average diluted shares outstanding to be about $394 million. As noted in today's press release, based on our results for the first six months and the second-half forecast, we are now projecting earnings per share for the full year to increase 7% to 10% to $2.69 to $2.75, on top of a 14% gain in FY15.

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

Thank you, Michael. To sum up, our sales and earnings growth improved from earlier in the year, with second-quarter results that were above our projections. As previously mentioned, we have made some progress improving the assortments in our ladies apparel businesses, where we struggled during the spring season. However, we know we still have more work to do in this very important area. So as we move into the second half and beyond, we will continue to place additional emphasis on further improving our merchandise offerings in this business.

We are well positioned with plenty of open to buy, in order to take advantage of the large availability of product in the marketplace today, not only in ladies apparel, but throughout the store. This flexibility will allow us to offer plenty of appealing fashions and compelling bargains to our customers.

That said, we still face an increasingly uncertain macroeconomic, political, and retail environment. So while we hope to do better, we believe it is prudent to manage our business conservatively over the balance of the year. At this point, we'd like to open up the call and respond to any questions you might have.

(Operator Instructions)

David Mann, Johnson Rice.

Yes, good afternoon and congratulations on a nice recovery after the first quarter -- or acceleration, I should say. My question is on the third quarter guidance. Can you talk about the comp guidance you're giving for the third quarter, why we should expect that to decelerate a little bit from what you saw in the second quarter? And how much is that packaway expense, the differential that you're talking about impacting Q3 versus Q4?

Thank you.

David, on the comp guidance, first of all. I think as Barbara said in her remarks, as we look at the back half, we think we continue to face an increasingly uncertain macroeconomic, political, and retail environment. I would say that the retail environment we are expecting is likely going to be promotional, given relatively poor performance levels that have been reported recently and also some store closure announcements that have been made. So in a way, all those factors together it makes sense for us to be relatively conservative in our guidance. We will do our best and certainly we hope to do better.

David, on the timing of pack away, as we noted in our comments, the difference between the third and fourth quarter is mainly due to the timing of pack-away-related costs. As a reminder, we saw benefits from the timing last year in Q3 and a significant negative impact in Q4. So while we hope to do better, Q3 and Q4, taken together, it implies a 5% to 10% EPS growth on a 1% to 2% comp versus the 9% increase in the first half of the year at the 3% comp.

Great, thank you.

Brian Tunick, Royal Bank of Canada.

Thanks. Good afternoon, very nice results.

Two questions. Just trying to understand, it sounds like a lot of retailers are calling out July being the strongest month of the second quarter. People talking about back-to-school off to a good start. I know you guys had fewer, I think tax-free days in Florida this year. So just curious, when you gave your third-quarter guidance, how you view those inputs.

And then if you could talk about the buckets of merchandise margin drivers. What still are the biggest opportunities ahead of the Company? Thanks very much.

Brian, it's Michael.

In terms of trends during the quarter, for us, similar it sounds like, to other retailers, July was slightly higher than May and June, and may and June were relatively similar. In terms of margin performance for the quarter, the higher margin merchandise margin was driven by above-plan sales and somewhat better execution. I'd say in the longer term, the best thing that we can do to drive sales is sales -- or drive margin is sales productivity.

Okay. And do you have an outlook on inventory per store decline goals? What do you think is left in the opportunity there?

Overall, since we started cutting inventory, we have inventories down over 40% in front of the customer. And I think going forward, we will try to operate the business with slightly lower inventories. But I think we're certainly in the ninth inning of reducing significant inventory in front of the customer.

Super. Thanks and good luck for the back half.

Oliver Chen, Cowen and Company.

Hi, congratulations on all the execution here.

Regarding the ladies business, it sounds like you've made some really nice progress here. If you could elaborate on your thoughts on what work is left to do and also how this has interacted with traffic. It feels like it's been on its way to being corrected, but I know that you're thinking that there's more opportunity. And it was very nice to see that momentum in traffic, which has been tough for retailers as a whole. So I'm curious about those two and how the interplay going forward.

Thanks.

So Oliver, I'll talk a little bit about the ladies, the improvement. We feel like we've improved slightly in Q2. The assortments I would say are moving in the right direction. But I would also say that we feel like we have a ways to go. We believe that we're addressing the correct issues in the assortments, but it takes time to completely address those merchandise issues. So although we've made some improvements, we know we still have a little bit of road ahead of us.

Go ahead, Oliver.

Well, on that topic, is weather something we should think and watch about? Because I know weather played a role and a risk factor in terms of properly assorting. So, if there is a way to think about that aspect - that axis of risk or not, it would be interesting to hear your thoughts.

The weather, I would say what really happened in terms of our assortment issues that we had in Q1, I don't think it directly related to the weather; I think it directly related to how we assorted the total assortment. Obviously, we were taking some considerations of news of El Nino into consideration, but the weather itself wasn't the main driver.

We really just had execution issues and the assortments got off course. We feel at this point like we've identified the issues. We're in the process of addressing and correcting those issues, but we still feel like we have improvements to make ahead of us.

Ike Boruchow, Wells Fargo.

Hi everyone. Good afternoon and congratulations on a nice quarter. Maybe Michael on the expense front: it seems like you have a little bit more flexibility on the SG&A line than maybe your larger peer. Right now, m My question is, it sounds like wage inflation should continue to be a headwind into next year, especially given your California exposure. Maybe just simplistically, would you expect next year to have a similar amount of headwinds that you're seeing this year or more or less? Just curious ballpark, how you think about that.

Sure, Ike. Clearly, labor cost will be in expense headwind for us, and frankly, the whole retail industry. We entered this year in 2016, and we've taken minimum wages up across the chain. And the impact of those adjustments are reflected in our full-year guidance, which is currently a 7% to 10% increase. So we have done a good job organizationally finding efficiencies throughout the business.

We will go through our 2017 planning process later this year, and like last year, do our best to find efficiencies throughout the business to attempt to mitigate further wage increases. And we'll be providing an update on that when we give guidance early next year.

Thanks.

Lindsay Drucker Mann, Goldman Sachs.

Thanks, good afternoon. I was hoping you could comment on whether when you have some of your larger big-box apparel retailers go out of business in a local market whether that impacts your business? And how you feel about occupying some of that space for -- especially if it's on mall.

Thanks.

Lindsay, I would say that there's a short-term impact and then more of a medium- long-term impact. The short-term impact is when a retailer goes out of business or when they close stores, that just adds to the promotional environment. And as Barbara mentioned in her earlier remarks, we're assuming that the back half of the year will be fairly promotional and those store closures will add to that.

In the medium to long term though, once those stores have closed, what we've found in the past is that when there's that competition, we have an opportunity to gain share. So longer term, there should be a benefit there.

On the third part of your question about is there an opportunity for space, it all depends on the particular store. As you know, we're a strip-mall retailer, and it all depends upon the size of the store that's being closed, is there an opportunity to chop that up, etc. And that is something that our real estate group is pretty expert at looking at.

So hard to answer that in terms of specific opportunities.

Great, thanks so much.

Mike Baker, Deutsche Bank.

Thanks. So, department store inventories came way down this quarter. They did a good job clearing a lot of product. I think their inventories were down on a year-over-year basis, as much as they've been about five or six years. How does that impact your business in the back half of the year?

On one hand, does it mean that there might be less excess inventory available? Are you that much more important to your vendors now that they are looking for someone to buy some product, and what does it do to the promotional atmosphere?

Thanks.

Mike, I think that's a few different things. As our inventory comes down, and in terms of having less excess inventory, the market is full of excess inventory now. There's a tremendous amount of availability in the market, more than there normally would be. So in terms of excess from now through the fall, I don't think there will be any inventory issue.

In terms of how promotional they get, I still believe that even with less inventory, there's so many uncertain factors out there, the macroeconomic environment, political environment, even though stores are positioned perhaps with less inventory than they had last year, that doesn't necessarily mean that sales will materialize. So that remains to be seen.

So the way we're viewing it the fourth quarter, to what Michael O'Sullivan said, that the fourth quarter will be highly promotional. And then, that will determine the additional excess supply that could be there beyond what we're seeing in the marketplace today.

Okay, thanks. If I could ask one more, you had said that the second quarter I think you said benefited from a timing expense that will reverse in the back half. But that's not the packaway that you're referring to, is it? Or is there something else?

No, it is packaway.

Okay. That's what you're referring to.

Yes.

Okay. Got you. Thank you.

Michael Binetti, UBS.

Hello. Good evening. Congratulations on a nice quarter. Let me just ask you about -- one of the questions earlier was related to labor for next year. And we're trying to figure out for the most part with the algorithms look like for next year in the space where we know you guys run a very tight box and you guys have done a nice job on inventory.

So you pointed to the 7% to 10% EPS growth this year. If labor is somewhat similarly incremental next year, can you help us think about maybe what the fixed versus floating is in the rest of SG&A? So to your point earlier that the best source of leverage from here will be store-level productivity.

Sure, Michael. When we talk about our long-term model, we've said that low double-digit EPS growth is our long-term model. And that's based on a comp between 3% to 4%. So that's really what the most important driver of achieving that low double-digit growth.

The other thing I'd say in terms of SG&A and occupancy, the leverage points for both of those have not changed. Currently, our guidance assumes SG&A for the year is about 3% and occupancy is about 4%.

Okay. And then would you mind just clarifying the comment earlier on the comps getting a lift from the average basket size? Was that UPT or average unit retail? What do you think was driving that with a little bit more color please, thank you?

Sure. As we mentioned in the remarks, the 4% comp was driven by both traffic and the size of the average basket. And the higher basket was driven mainly from higher units per transaction. So for us, that's always about the merchandise and the assortment we put in front of the customer, and that's what we think is driving it.

Thanks.

Omar Saad, Evercore ISI.

Hello. This is Warren Cheng on for Omar. I just had a follow up to Ike's question on the wage inflation. Can you just -- as you look ahead and look at wage inflation for next year and beyond, is this something that you look to proactively get ahead of based on the competitive environment? Is it more based -- is it more determined by legislation that passed? Can it vary by state? Just trying to get a little bit of a framework for how long this could last and how you think about this and how you make these decisions.

Sure. So Warren, just a little bit of a recap in terms of what we've done. Last year, we moved minimum entry wage rate to $9. And as we've mentioned on a previous call this year, we took our minimum hourly rate up to $10 for eligible store associates. But our expectation is that there's going to continue to be wage pressure in the general economy over the next several years.

We also know that in some states, some very important states like California, there is already legislation that's passed or close to being passed that's going to set up multiple years of minimum wage increases. So those are things that we're looking at. And as part of our budget and longer-term planning process, we will look for ways to offset some of those minimum wage increases.

It will get harder over time. I think we've done a good job so far, as Michael Hartshorn said, in absorbing those wage rate increases in the last couple of years. But there's probably a limit to how much we can absorb. So that's our expectation over the next few years.

Great, thank you.

Matthew Boss, JPMorgan.

Thanks, on your store growth, what's the maturity curve for new stores? Do you see 90 stores roughly as a good number of net adds the next few years? And just what have you seen from your latest Midwest builds?

Matthew, yes, I think that 90-store, give or take a few stores, is the level we have been running at for the last several years now, and it's a level we're pretty comfortable with in terms of availability of good sites and our operational capabilities in terms of being able to open stores in a high quality way. So yes, we feel good about that number.

In terms of the new region, the Midwest, we entered the Midwest four or five years ago now. I would say we're very pleased with how it's going. You'll have heard on these calls over the last couple of years, well certainly over the last year and a half, the Midwest has been one of our top-performing regions. So we are very good about the business we're building there.

Great, best of luck.

Paul Lejuez, Citigroup.

Thanks, it's Tracy filling in for Paul. Two things, I was wondering if you could tell us what the comp gap was between your better and your worst-performing regions. And then secondly, what impact did ladies apparel had on the comp or how much did it drag? Thanks.

Tracy, it's Michael.

I will answer that just telling you some general outline of the regional performance. The strength in comp was relatively broad-based. As we mentioned in our comments, the Midwest and California were our strongest regions. The Midwest, as Michael O'Sullivan just said, has been very strong over the last several years. California for us likely benefited from more seasonal weather during the quarter. And then of our larger markets, Florida and Texas were in line with the chain. In terms of absolute comp, on ladies, that's not something we would disclose on a call like this. But suffice it to say, ladies did underperform the chain, but that is somewhat of an improvement versus Q1.

So it was less of a drag than it was in first quarter?

Yes.

Thank you.

Lorraine Hutchinson, Bank of America Merrill Lynch.

Thank you, good afternoon. Barbara, when do you think you'll have the ladies apparel business fixed or aligned with where you'd like it to be? And then could you also talk about where you see the greatest opportunities for the holiday assortment?

Sure. The ladies business, it's a very big business, and at our size it's not the easiest business to turn around. I don't have -- we continually are making progress, but I don't have a definitive date of when I think it -- I could say at a certain period of time we're going to be 100% set. It's a work in progress, so we feel like we're correcting the right things. We think we've identified our issues. But that's a very big business and a very long haul, so I really couldn't give you a definitive timeframe.

In terms of holiday, we will have an emphasis on gift-giving, the way we did last year. It will be broad-based throughout the entire box. Obviously, the key classifications, the home businesses, which are traditionally good gift-giving businesses. But really we see that throughout the entire box everywhere.

Thank you.

Laura Champine, Roe Equity Research.

(Operator Instructions)

Good afternoon. In this holiday season, being an election year and another fiercely competitive year, are there any significant changes that you expect to make to your media spend or advertising plans?

Laura, no, the short answer is no. Our marketing strategy and message has been fairly consistent over the years. The message is pretty straightforward that we offer the best values in apparel and home fashions. That still the strategy, still the message. So no significant changes.

Got it. And then as we look forward into 2017, with everything we know today about changes in department store footprints, with the macro environment and the cost environment, would you see any significant step up or step back in your square footage growth?

Not at this point, no. No. We plan, as you'll appreciate, with the nature of retail real estate, we have a pipeline of stores that we plan to open. So at this point, our 2017 openings are fairly far along. And as I said in an earlier answer, or an answer to an earlier question, we're pretty happy with that 90 or so level of new store openings.

Great, thank you.

Roxanne Meyer, MKM Partners.

Great, thanks, and let me add my congratulations on a really strong quarter. First, I'm curious to get a little bit more color in the home category. Wondering what's driving performance there. Is there anything you're doing differently in execution or certain categories that are outperforming?

Well, the home business, our performance has been very broad-based. Obviously, the merchants are out there continually looking for better values and broader assortments, but in grand total, home it's very broad based.

Okay, great. And then as it relates to the issues in the women's business, I'm just wondering if there's anything that you're doing differently going forward to both correct the issues and prevent future ones in terms of whether it's change in processes or otherwise and anything you can describe.

What I would say about ladies is we've done a lot of drill-down, a lot of analysis to understand what issues need to be corrected. And obviously, when you do anything like that and you look within your four walls, you're really going in and saying -- reviewing everything from processes to total assortments. So I would say, no stone left unturned. Really, you're looking every component of it.

Okay, great. And then just last, your inventory ended cleanly. But I'm wondering within your composition of inventory if you have any clearance carry over within women's, or whether you were able to end the Q2 in a clean inventory position within the women's merchandise.

We ended pretty cleanly.

Okay, great. Thanks a lot and best of luck in the back half.

Kimberly Greenberger, Morgan Stanley.

Great, thank you so much. Barbara, it sounds like you've made progress in ladies, yet still have targeted additional work to do. I was surprised that the comp trend has reaccelerated so quickly to that 4% level, with ladies still being a drag. I'm wondering if there are other category that filled the gap there.

And then, Michael, just a clarification. Could you remind us the basis-point impact in 3Q and 4Q from that pack-away shift? And can we just simply use that as a guidepost this year? Or does it depend actually on your pack-away balances at the end of 3Q and 4Q and it's maybe somewhat difficult to forecast? Thank you.

Yes, the guidepost from last year, frankly, is going to change based on the volume this year. I think the best guidepost is to take the difference between EPS growth between Q3 and Q4 and the primary difference there is the timing of pack-away.

And Kimberly, in terms of filling the sales gap to get to the 4%, as we said in our comments, our home and our shoe business has been very strong.

And Barbara, was that an acceleration from the trends that you had seen in the first quarter and/or the fourth quarter? Or was there a different category maybe that you saw acceleration in?

No, there was acceleration in that trend and those businesses.

Great. Thank you so much.

I will now turn the call over to Barbara Rentler for closing comments.

Thank you for joining us today and for your interest in Ross Stores. Have a great day.

This concludes today's conference call. You may now disconnect.