Good afternoon, and welcome to the Ross Stores Second Quarter 2015 Earnings Release Conference Call. [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 2014 Form 10-K and fiscal 2015 Form 10-Q and 8-Ks on the 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, Senior Director of Investor Relations..

We'll 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'll be happy to respond to any questions you may have..

As a reminder, all earnings per share results and forecasts for both the current and prior year reflect our recent 2-for-1 stock split that became effective June 11, 2015..

As noted in today's press release, we are pleased with our solid sales and earnings growth for both the second quarter and first 6 months. These results reflect that our assortments of compelling name-brand bargains continue to resonate with today's value-focused customers..

Earnings per share for the second quarter increased 11% to $0.63, up from $0.57 in the prior year. Net earnings for the quarter grew to $259 million compared to $240 million for the same period last year. Sales rose 9% for the quarter to $2,968,000,000 with comparable store sales up 4% over the prior year..

While second quarter operating margin of 13.9% was down from last year, it was slightly better than expected. The quarter benefited from higher merchandise margin and tight expense control that partially offset a planned increase in distribution costs related to recent infrastructure investment..

For the first 6 months of fiscal 2015, earnings per share increased 15% to $1.32, up from $1.15 in the prior year. Net earnings were $541 million, up 12% from $583 million (sic) [ $483 million ] last year. Sales for the year-to-date period rose 9% to $5,906,000,000 and comparable store sales increased 5%..

Similar to Ross, dd's posted better-than-expected gains in sales and profits for the quarter and year-to-date period as customers also responded positively to their value offering. .

The strength in merchandise and geographic sales trends for Ross during the second quarter were relatively broad-based. Juniors and Home were the best-performing departments while the Midwest continued to be the strongest region. .

As we ended the second quarter, total consolidated inventories were up 20% over the prior year with packaway levels at 46% of total inventory compared to 43% last year.

Average in-store inventories at quarter end were down slightly versus last year while total inventories were higher as we have taken advantage of increased closeout availability in the marketplace..

Now let's turn to our expansion program. Store growth remains on track with 19 new Ross and 8 dd's DISCOUNTS opening in the second quarter. For fiscal 2015, we continue to plan for about 70 new Ross and 20 dd's DISCOUNT locations. As usual, these numbers do not reflect our plan 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, and let's start with our second quarter results. Our 4% comparable store sales gain was driven mainly by an increase in the size of the average basket with the number of transactions up slightly from last year.

As mentioned earlier, while second quarter operating margin of 13.9% declined 35 basis points from last year, it was better than expected. .

Cost of goods sold increased 20 basis points, mainly from a 40 basis point increase in distribution expenses that were impacted by the opening of a new distribution center during the second quarter. Freight and buying costs also increased 10 and 5 basis points, respectively.

These unfavorable items were partially offset by a 25 basis point increase in merchandise margin and occupancy leverage of 10 basis points..

Selling, general and administrative expenses during the period increased by about 15 basis points. Last year's second quarter included a onetime benefit of about 20 basis points from the resolution of a legal matter. This prior year comparison more than offset the expense leverage we realized from the 4% comparable store sales increase..

During the quarter, we repurchased 3.5 million shares of common stock for a total purchase price of $176 million. Year-to-date, we have bought back a total of 6.9 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 under the 2-year $1.4 billion stock repurchase program approved by the Board of Directors in February 2015..

Let's turn now to our second half guidance. For the third quarter ending October 31, 2015, same-store sales are forecast to increase 1% to 2% on top of a 4% gain last year with earnings per share projected to be in a range of $0.48 to $0.50, up from $0.46 in the 2014 third quarter..

For the fourth quarter ending January 30, 2016, we are planning same-store sales to be flat to up 1% on top of a 6% gain last year with earnings per share projected to be $0.60 to $0.63 compared to $0.60 last year..

Now I'll provide some additional operating statement assumptions for our third quarter EPS target. Total sales are projected to grow 5% to 6% on the previously mentioned comparable store sales forecast of up 1% to 2%. We're planning to add 19 new Ross and 7 dd's DISCOUNTS locations during the period.

Operating margin is projected to be 11.3% to 11.5% versus 11.8% in the prior year. We are forecasting merchandise margins for this year's third quarter to be relatively flat while distribution costs are expected to remain elevated over the prior year.

The higher distribution costs reflect the recent infrastructure investments and unfavorable timing of packaway-related expenses..

Net interest expense is estimated to be about $4 million. .

Our tax rate is planned at approximately 35%. .

And we expect average diluted shares outstanding to be about 406 million..

Based on our results for the first 6 months and second half forecast, we are now projecting earnings per share for the full year to be in the range of $2.40 to $2.45, up 9% to 11% over $2.21 in fiscal 2014..

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

Thank you, Michael. While we are pleased by our better-than-expected results for the first half, we face more challenging sales and earnings comparisons over the balance of the year.

In addition, the macroeconomic environment remains uncertain and we expect the retail landscape to be highly promotional during the fall season, especially given the recent results from other retailers.

Based on these factors, while we hope to do better, we believe it is prudent to remain cautious in our forecasting our business for the second half of 2015. .

offering customers the best bargains possible on a wide assortment of fresh and exciting name-brand fashion for the family and the home. This will be the key of delivering respectable growth in sales and earnings both now and in the future..

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

[Operator Instructions] Your first question comes from the line of Lorraine Hutchinson from Bank of America Merrill Lynch. .

Can you discuss any regional differences that you saw during the quarter and if you felt an impact from either the back-to-school tax shifts or the later Labor Day?.

Sure, Lorraine. It's Michael. On the -- across regionally, the results were actually fairly good from a broad-based perspective. We mentioned the Midwest continues to be our strongest region, which had been true over the last 1.5 years. In terms of back-to-school markets, like all other retailers, we're impacted by later sales tax holiday events.

But overall, that did not have a big impact for us for the quarter. .

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

Just wanted to understand kind of the traffic-versus-ticket dynamic, a little bit different than one of your competitors. Just curious whether you feel like, going forward, pricing is a lever that you might choose to pull a little bit more even if it means sacrificing some ticket to drive more traffic.

And just obviously, you have harder comparisons in the second half, but the 1% to 2% guidance versus the 2% to 3% initial guidance going into this quarter, is it based on seeing a slower kind of underlying trend? Or are you just being conservative given the tougher compares that you have?.

Dan, on your first piece, as we mentioned in the remarks, the 4% comp was driven by a combination of a larger basket and a slight increase in the transactions. The basket was primarily driven by an increase in the unit per transaction and AUR was up slightly.

In terms of overall traffic, I mean, the way we think about our sales is we focus on overall sales and it comes down to merchandising. So based on that, we'll continue to do what's best and that is we'll try to deliver the most compelling bargains to our customers. .

And Daniel, on AUR, I think your question was would we sacrifice AUR to drive sales. I think we do that all the time. I think our pricing has always intended to be very sharp and I think that's driven our performance over the long term. We're all about offering great prices and great bargains. So our AUR is always an area of focus for us.

In terms of the guidance, the 1% to 2% in the back half versus the 2% to 3%, we've been very pleased with our performance the last couple of quarters, but there are a couple of reasons to be conservative in our guidance.

There's ongoing uncertainty in the macroeconomic and retail environment and you get a sense of that in some of the recent retailers' results, particularly from some of the department stores. And then the second reason to be conservative is we're up against some pretty tough multiyear comparisons in the back half.

Last year's third quarter was a 4% comp, last year's fourth quarter was a 6% comp so we're going up against those numbers. So putting all that to the side, you and others who followed us for a while will know that this is sort of a -- this is very much from our playbook.

We tend to manage the business relatively conservatively, but we hope to do better. And certainly, if the sales trend is there, we'll chase it. So that's kind of the outlook. .

Your next question comes from the line of Marni Shapiro from The Retail Tractor (sic) [ The Retail Tracker ]. .

It sounds like there's, as always, a lot of inventory in the market and a lot that you've packed away.

I'm just curious if there was any -- were there any segments that you found were tougher out there and there's just really exceptional deals? And are they segments that have done well in your stores that maybe weren't doing well in other stores?.

Actually, I think the deals are pretty broad based.

I mean, are you talking about which classifications of business?.

Yes. .

Actually, the deals have been pretty broad based. I mean, the supply lines have been in almost every business that we touch. So our assortments are broad in the stores, the availabilities for it, so that's why we've been able to maximize a lot of deals in the market. .

Fantastic.

And are you guys doing anything differently in the back half marketing-wise to maybe further boost traffic or drive home the values?.

Marni, not really. Our marketing strategy and message is pretty consistent. The message is always that we offer the best values. So there's really nothing new there. I mean, the focus really in terms of driving traffic is really to have the best bargains in the store. .

Your next question comes from the line of Oliver Chen from Cowen and Company. .

We're just curious about the back half and how you're thinking about inventory planning. Your inventories have been managed quite tightly and you've done a good job keeping your open-to-buy pretty open. Also, I wanted to just ask you about your comments on the uncertain environment and the highly promotional landscape.

Just because at some of the more broadline retailers, we've seen some really good momentum in apparel, so I was curious about how there's mixed messages out there in the marketplace. .

Sure. So on the second part of your question on the uncertain environment, I would say the results have been fairly mixed, some good, some not so good.

And certainly, when we're out in the market looking for the goods, it seems like there's plenty of supply, which, again, reinforces for us that there is some uncertainty in terms of the economic environment.

On inventory planning -- just repeat your question, Oliver, on inventory planning, what were you looking for there?.

Just curious about how you're planning in the holiday season and if you can continue to kind of grow at a lot less than sales. And if there's anything we should know about the timing of which you'll do gifting or floor sets relative to last year. .

Sure. In terms of how we're planning inventory, I think in Barbara's remarks, she said that in-store inventory levels were down slightly and that's kind of how we're planning them going forward.

In terms of timing, I don't know that there's any different there, Barbara, on, yes?.

No, in terms of the floor sets and the gift setups, no, the timing is similar -- will be similar to last year. In terms of the promotional landscape, Oliver, the promotional landscape in Q2, it was aggressive in certain segments of the market. So we were planning on being aggressive, it was aggressive.

I think when back-to-school comes to an end, we're going to see that, that was very aggressive and that we're going to see that continue going into the fall season, especially if some retailers are going into fall with high inventory levels. So that was the inventories. .

Okay, that's helpful. Just lastly, as we look at the weather, do you have any differentiation in terms of how you're thinking about certain categories in light of the forecast? I was just curious about outerwear and any read-throughs there about categories as it relates to weather as we approach the back half. .

Nothing that we'd call out that this point, Oliver. No, nothing at that detailed level. .

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

Just a follow-on. So the inventory build-up we should assume is in packaway and you've been able to take advantage of some of the disruptions in the ports to buy opportunistically.

Is that the correct assumption?.

Yes, Richard, that's right. As Barbara said, total inventories were up and that was entirely packaway. .

That's great. And I know there's been an open job at dd's. I'm wondering if there's a change in your thoughts about filling that job or just changing the reporting structure and operate without a president.

Can you comment on that?.

No changes in how we're thinking about that. We're still thinking about it in terms of replacing that position. That said, the dd's business has been doing pretty well over the last couple of quarters. We have a strong team in place. But no changes in terms of how we're thinking about the long-term leadership structure. .

Okay.

And you'll call us when El Niño hits and you'll get it first on the West Coast, right, so you'll just give us the heads-up?.

We will. .

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

Anyway, so -- okay. Excellent quarter, nicely done.

Can you just remind us what the packaway inventory was doing? How first quarter ended in terms of packaway? What percentage of inventory? So -- in other words, did you see a nice kind of sequential acceleration in the second quarter in packaway? And I'm wondering if you can tell if the goods you're getting were sort of dislocated goods from the ports? Or is it really quite difficult to tell actually how the goods are getting to you?.

In terms of overall levels, Kimberly, they're very similar to where we ended the first quarter. .

In terms of trying to understand where the goods came from, I would say at this point it's really difficult to tell. I mean, department store business was difficult and so some goods are clearly coming from that market.

And at this point, it's much more homogenized than the beginning when we saw huge amounts coming everywhere in every business from the port. .

So Barbara, do you think it's just the additional availability that you're seeing it's just sort of a function of a tough environment with vendors really trying to find a home for goods just given the disappointing numbers we're seeing out of department store space? Is that your read of the situation?.

At this point, yes. .

Your next question comes from the line of Laura Champine from Cantor Fitzgerald. .

This is Jason Smith on for Laura.

I was just wondering if you can give a sense as to how your competitor going down market may impact you guys going forward?.

What I would say about that it we're clearly operating in a very promotional and competitive environment and that's really true across the entire retail landscape, including our biggest competitor. But our focus really is on our own business.

So our top priority really remains providing the best compelling bargains possible to the customers and that's really not going to change. So that's really what our focus is, how we feel about it. .

Your next question comes from the line of Anne-Charlotte Windal from Bernstein. .

Two questions, if I may. The first one, I was wondering if you had any update to share with us on the potential impact from the wage increases and your ability to absorb costs from that. And my second question is one of your big competitors is talking a lot about the strength of their global sourcing capabilities.

I was wondering if you'd give us a little bit of an update on how global, I mean, you are at this point from a sourcing standpoint.

So I know thinking about your buying teams, I mean, where do you have active buying offices internationally?.

Sure. So on the first part of your question, wage increases. As we mentioned on the call in May, we've taken up our minimum entry-level wage to $9 an hour. That adjustment, together with any offsets, is built into the earnings guidance for the rest of the year.

In terms of further increases, we think the labor market is fairly dynamic and we like to sort of follow the labor trends before making decisions on any future moves. But I think, in general, we think if the economy improves over the next couple of years, it's likely that there'll be additional wage pressures out there. .

And in terms of the global sourcing availability, we buy from a lot of different sources around the world, so we feel that we have a wide assortment from a variety of countries and it's pretty widespread. .

Your next question comes from the line of Matthew Boss from JPMorgan. .

So as we think about gross margins, can you walk through the drivers of the merchandise margin expansion this quarter? And how should we think about the margin opportunity in the second half and on a multiyear basis from here?.

Matthew, it's Michael Hartshorn. So in terms of margin -- merchandise margin for the quarter, it's actually a mix.

We continue to operate the business with lower in-store inventory, which is what we ended the quarter at down -- slightly down 1%, so that helps drive faster terms and lower markdowns and it also included better buying, so a little bit on total margin. .

In terms of margin on a multiyear basis, Matthew, I think, as you know, we've taken a number of steps that have helped to drive margin over the last several years in terms of very significant reductions to inventory, very significant improvements to shrink.

Now look, we've been chipping away at those, but I think on a go-forward basis, I think any improvement in margin -- EBIT margin is likely to come from ahead-of-plan sales. .

Okay, great. And just a quick follow-up. On the uncertain retail landscape commentary, I mean, can this provide opportunity for your model? Or does a more promotional environment actually condense the value spread? Just curious kind of the puts and takes on some of those the larger-picture commentary and how it relates to your model. .

Well, there's a couple of things. From the pricing and value perspective, it goes to our being prudent about how we plan the back half because as the department stores promote and they have a lot of inventory, the values move. So we chase our business back, so we understand what's going on there and where our values need to be.

As it pertains to supply, when business is uncertain and difficult, it creates supply. Any disruption in business creates supply.

So you would think ultimately that there would be a bubble of good that results from, let's say, if back-to-school turns out to be more difficult than people anticipated that there would be good that are the results of that. So you kind of get it on both sides. .

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

Just a quick question on your Home performance, wondering how it performed relative to the rest of the store. And then if you could distinguish between hard home and soft home. .

Okay. Well, Home performed about the chain average. And actually, both segments of Home were good. I would say the decorative piece was even better than the bed and bath piece. .

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

A couple of quick questions. First, I want to make sure I understood. It sounded like part of the reasons behind your conservatism in the back half was the -- sounds like you're seeing a pretty fairly promotional environment out there.

I want to understand a little bit more what's driving that and why you think that affects your business -- or you consider that it might affect your business. And then I have one follow-up, please. .

So Omar, yes, I think really 2 key reasons to be -- well, I guess, 3 key reasons to be conservative in our outlook. One is the multiyear comparisons that I mentioned. Secondly, in our business, we can always chase good news.

We can always chase a good trend, so it makes sense to manage conservatively, so we keep expenses and inventory in check and then ultimately we can chase. And then the third piece, which is what you're getting at, which is sort of the outlook, I think a combination of things.

I think mixed results and -- actually weak results among department stores causes us to think that the environment, which is already fairly promotional, will continue to be pretty promotional in the back half. And how that affects us is we're all about price differentiation.

The difference between the value at Ross and the value elsewhere and to the extent that other stores, department stores, et cetera, promote that obviously eats into that price differentiation. So that's what's built into the conservatism. .

That's very helpful. And then kind of along a similar vein, if I look at your merch margin, it's been up, I think, 50 to 60 bps the last couple of quarters and slowed a little bit this quarter, up 20 or 30 bps. But the packaway percentage is still up year-over-year.

Is it the promotional environment that's kind of causing that differential? With the packaway up, I guess, I'd expect to see -- still see some more merchandise gains like you were seeing the last couple of quarters.

Or am I being too cute here, reading too much into it?.

No, so there was a differential in the first versus the second quarter. In addition, entering 2015, we had lower clearance levels, so that's actually helped us this year versus last year. And our comp was a little higher over planned in the first quarter versus the second quarter.

So both of those factors resulted in more favorable margin in Q1 versus the second quarter. .

Your next question comes from the line of Jill Nelson from Johnson Rice. .

Just given the energy crisis, what we're hearing about the oil and gas market, could you talk about maybe your performance in Texas and if you felt any pressure there?.

Texas, overall, has consistently been a good performer for us. In the second quarter and year-to-date, it's performed above the chain average for us. So it continues to be one of our best-performing regions. .

And Jill, we don't know whether that's -- it could be that consumers are trading down from more expensive retailers in that region. We don't really know what's driving that. .

Okay. And then I know you said dd's comp outperformed.

Could you just give a little bit more clarity on how its performance was in the second quarter?.

Sure. So as Barbara mentioned in her remarks, dd's posted better-than-expected gains in sales and profits in the quarter and that's actually been the pattern over the last several quarters.

We've been doing a number of things the last couple of years at dd's to drive sales and actually to drive profitability, particularly more tightly controlling inventories and expenses, so we feel good about how that's gone. In terms of longer term, we're very confident in the dd's' business model.

Last year, we opened about 20 dd's stores and we're on track to do about the same. So we're pretty happy with that business. .

Your next question comes from the line of Stephen Grambling from Goldman Sachs. .

One of the other differentials impacting gross margin, I think, was the step-up and the deleverage on the DC.

Can you give us a little bit sense for how that line item should progress over the year? And could you actually see some leverage as you move into next year and lap some of those costs?.

Stephen, it's Michael Hartshorn. Yes, so in the first quarter, we actually got a benefit in distributions and we actually expect that to turn around in the back half.

So distribution centers are going to be impacted both by the packaway-related timing costs and the fact that we just opened a new distribution center in Central Valley, California during the second quarter.

As you move into next year, you'll still have a hangover from the additional DC in the first half of the year and then you should be able to leverage in the back half. .

Your next question comes from the line of Bob Drbul from Nomura. .

I guess, the question that I have is as you progress throughout the second quarter and as you look into fall, have you had to make price adjustments on any of your merchandise given the competitive landscape that you're seeing out there?.

No, we haven't had to take price adjustments. We chase a big part of our business as we go, which is one of the reasons why we run usually with a conservative plan so that we can watch the promotional activity and understand where we need to be in relation to department stores. As Michael said, it's a value game, department stores to off-prices. .

And I guess, the second question that I have is with packaway being up, does it at all hinder your ability to buy sort of very close to need? Or are you making the investment in inventory now? Will that change the way you approach the business going forward? Or you have complete flexibility around it?.

It doesn't hinder anything. We have complete flexibility around it. .

[Operator Instructions] Your next question comes from the line of Patrick McKeever from MKM Partners. .

Just on the wage increase, I don't know if you've quantified the impact on margins, what kind of headwind, I guess, that amounted to in the quarter, but if -- I would like to know that. And if not, I mean, maybe some broad parameters around the wage increase, percent of employees that got it, that sort of thing.

And how are you measuring the impact with Walmart there combining the wage increase with training and more flexible scheduling and some other things, just hoping to improve the in-store experience for customers.

So I guess my thought is -- or my question is what's the ultimate objective there with you?.

So let me start with the last piece. I mean, our ultimate objective is to continue to attract and retain great associates and we've been very pleased with our ability to do that over the last several years. The reason to take up wage rates this year was to ensure that we could continue to do that going forward.

Now the impact on margin in the second quarter, there really wasn't one because we were able to find offsets in the business to neutralize the impact of the wage rate increase and that we were able to do that for the back half of the year, too. So as a result, it didn't really have an impact overall.

In terms of more broadly looking at how we manage our resources, our labor, our associates, we're always looking for ways to improve how we do that. I'm not familiar with some of the examples that you just described, but we're always looking at other ways to improve both our customer experience and actually also our associate retention at Ross. .

Okay.

So Michael then, you're saying for the back half of the year, it's more -- this is going to continue to be more of a neutral factor as it relates to margins?.

That's right. So it's in our guidance for the back half, that's right. .

And this concludes our Q&A session. I now turn the call back over for closing remarks. .

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

And this concludes today's conference. You may now disconnect..