Good afternoon, and welcome to the Ross Stores First Quarter 2017 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 2016 Form 10-K and fiscal 2017 Form 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.

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

As mentioned in our press release, we achieved respectable growth in both sales and earnings during the first quarter, despite the uncertainty and volatility in the external environment. Earnings per share for the period were $0.82, up from $0.73 in the prior year. Net earnings were $321 million, up from $291 million last year.

First quarter sales increased 7% to $3.3 billion with comparable store sales up 3%. .

Sales gains at Ross were broad-based across most merchandise categories and geographic region. First quarter operating margin of 15.2% exceeded our expectations due to above planned sales and merchandise margins.

As we ended the first quarter, total consolidated inventories were up 6% versus the prior year with average in-store inventory down slightly. Packaway as a percent of total inventories was 46%, similar to last year.

Despite challenging multi-year comparison, dd's DISCOUNTS also saw continued solid growth in same-store sales and operating profits in the first quarter. Our store expansion program remains on track with the addition of 23 new Ross and 5 dd's DISCOUNTS stores in the first quarter.

We are planning a total of 90 new locations in 2017, comprised of approximately 70 Ross and 20 dd's DISCOUNTS. As usual, these numbers do not reflect our plans to close or relocate about 10 older stores during the year. .

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

Thank you, Barbara. Our 3% comparable store sales gain was driven by higher traffic as well as an increase in the size of the average basket. While first quarter operating margin of 15.2% decreased relative to last year's 15.4%, it exceeded our expectations. .

Cost of goods sold was flat for the quarter. Merchandise margins improved by 15 basis points while distribution and occupancy costs declined by 15 and 5 basis points, respectively. These improvements were offset by a 35 basis point increase in freight expenses.

Selling, general and administrative expenses during the period increased by 20 basis points mainly due to higher wages. Earnings per share for the quarter also benefited by $0.01 due to favorable expense timing that is expected to reverse in subsequent quarters. During the first quarter, we repurchased 3.3 million shares for a total of $215 million.

We remain on track to buy back as planned a total of $875 million in stock for the year under the new 2-year $1.75 billion program authorized by our Board of Directors in February of this year. .

Let's turn now to our second quarter guidance. For the second quarter ending July 29, 2017, we are forecasting same-store sales to be up 1% to 2% on top of a 4% gain last year with earnings per share of $0.73 to $0.76 compared to $0.71 last year. Our guidance for the second quarter is based on the following assumptions.

Total sales are projected to increase 4% to 5%. We expect to open 28 new stores during the period, including 21 Ross and 7 dd's DISCOUNTS locations. Second quarter operating margin is projected to be 13.9% to 14.1%, down slightly from last year's 14.4%, reflecting our forecast for higher freight costs and wage costs. .

In addition, net interest expense for the quarter is estimated to be about $3 million. Our tax rate is expected to be approximately 37% to 38% and weighted average diluted shares outstanding are projected to be about 387 million.

Based on our first quarter results and second quarter guidance, we now project earnings per share for the 53 weeks ending February 3, 2018, to be in the range of $3.07 to $3.17 compared to $2.83 last year. As a reminder, our forecasted EPS for 2017 includes an approximate benefit of $0.08 per share from the 53rd week. .

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

Thank you, Michael. As I said earlier, we had a solid first quarter, despite the challenging external environment. Looking ahead, we have plenty of liquidity and are open-to-buy to take advantage of the terrific opportunities in the marketplace and offer shoppers the best bargains possible.

That said, we also face our own increasingly difficult prior year comparisons, along with political macroeconomic and retail climate that are likely to remain uncertain. So while we hope to do better, we are maintaining a somewhat cautious outlook for the balance of the year.

Over the longer term, we are confident the off-price sector will remain a strong performing segment of retail as consumers continue to seek value. In addition, we believe our operating strategies and ongoing investments in people, processes and systems should enable us to drive respectable growth in both sales and earnings in 2017 and beyond. .

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

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

Last year, in the first quarter, you had some challenges with the women's apparel business.

Can you talk a little bit about how that performed and perhaps your learnings from last year and how you've made changes? And then, lastly, what opportunities you see for the second quarter in that division?.

Okay. Ladies' comparable sales for the first quarter were positive. We feel that the changes we made, we no longer have those lingering execution issues that we had last year on the challenges. We feel that those are behind us. We've made the appropriate changes. A lot of those issues were around seasonality in color and execution.

So we feel that, that – that we made progress during '16, that we've made additional progress in Q1 and that we're going to continue to move forward. And there are opportunities as we improve our assortments in the second quarter. .

The next question is from Oliver Chen from Cowen. .

The in-store inventories are really attractively down. It really seems like there could be opportunities for you to explore optimization space within your stores, whether that be new categories or continuing to enhance the cash [ drop ].

Could you speak to some guardrails or framework you're thinking about as you embark on just making sure you maximize the real estate space that you have? Or what you'll think about square footage to maximize ROIC given that there could be some opportunities there?.

Sure. Oliver, it's Michael O'Sullivan. It's a good question because, as you know, over the last several years, we've reduced average inventory in store by about 40%. So this is a question we've actually been working on for some time. And we've been using the extra space that we've created, if you like, in stores to really look at 3 things.

One is make the stores easier to shop just by organizing the store in an easier to shop way; secondly, expanding into faster growing or new categories; and then thirdly, when it comes to new stores, be more flexible in terms of the store size, the new store openings.

So I would say we're actually pursuing a mix of all 3 in terms of, as you say, optimizing how we're using the space. .

Your next question is from Marni Shapiro from Retail Tracker. .

As you guys are looking out, you're one of the few opening stores still and there are a lot of people who are closing stores. Can you talk a little bit about what you're seeing on the rent? And I guess, even the relief side beyond 2017 and I suppose even part of 2018 for your stores. .

Sure, Marni. We're very happy with the availability of the real estate locations that we're seeing. And as you'll appreciate, typically, the real estate locations we're seeing now really feed the pipeline for the next 2, 3 years. So we're pretty happy with that outlook.

There aren't -- as you say, there aren't many retailers out there who are opening 18 to 19 new stores a year. So therefore, landlords are pretty happy to see us. We have a great real estate team, a great network and they've done a nice job finding new locations.

In terms of rent and occupancy costs, we're certainly taking opportunities where they exist to negotiate and renegotiate those. But I would say that for the most part, rents and occupancy are fairly stable at this point. .

The next question is from Lindsay Drucker Mann from Goldman Sachs. .

Coming off of the first quarter was especially challenging for a number of large retailers, department stores, specifically with that negative traffic and tough comps.

Barbara, can you talk about how that affects your business, what you're seeing in the marketplace or in your business that might be a spillover related to the broader macro?.

Sure. What we're seeing in the marketplace is there's a lot of availability. It's pretty broad based and as you know, availability is often the result of department stores not making their plan and their forecast, so that's the one thing we would see in the immediate.

In the future, obviously, it gives us an opportunity, I guess, the department store business is challenging to gain more market share. .

Okay. And if I could follow up, I think as we started -- as we exited 4Q and you were looking at 1Q, you had a cautious tone given what seem to be a slower start to the quarter.

Could you talk a bit about how the quarter played out and ultimately, allowed you to beat your initial targets?.

Sure, Lindsay. In terms of trends during the quarter, certainly, like you saw and I think across the retail landscape, sale strengthened as we move through the quarter. .

The next question is from Kimberly Greenberger from Morgan Stanley. .

I was wondering, looking back to February, did you have any sort of impact on your business from the delay in tax refunds? And I wasn't sure if you might have had an opportunity to quantify that or not.

And then Barbara, on -- you talked about sales gains were relatively broad based across most merchandise categories and regions here in the first quarter.

Were there areas where you saw some, let's say, improving momentum in your business where you see opportunity to really maximize in any of those categories as we go through the rest of the year?.

Sure, Kimberly. It's Michael Hartshorn. The delay in tax refunds, it certainly wasn't a positive for the quarter. The volatility made it a little bit more challenging to plan and operate the business. It's hard to say though if there was a negative impact to the overall quarter from the refunds.

I'll give you some stats on -- also on regional performance. For us, Southeast Florida and the Midwest were the top-performing regions. The Midwest continues to be very strong region for us, it's been a top-performing region for over 3 years. I call on other major markets.

California was slightly below the chain average given the unfavorable weather with the storms during the quarter. Texas performed in line with the chain, and that's an improvement from the second half of 2016 when it was below the chain average. .

And then, Kimberly, in terms of areas that are improving the momentum, sales really were pretty broad based throughout the company. Ladies continues to make progress.

The Ladies business is always a challenging business since there's really no major sales trend, fashion trends out there unless you really have weather to drive it, particularly in Q1, Ladies continues to be a challenge. But we do feel like we are improving on our execution.

And so if we continue to do what we need to do, our expectation is that it would improve as we get into second quarter. But again, there is -- one of the real problems in Ladies is there is no real overriding fashion trend to drive it. .

The next question is from Bob Drbul from Guggenheim. .

I was just wondering, there's a lot of discussion around certain vendors that are trying to pull back from the off-price channel.

And are you seeing any of that in your discussions? And can you maybe just talk to any other new brand opportunities that you're seeing or categories that are becoming more available to you?.

Sure. Yes, I know there's been a lot of discussion about vendors wanting to pull back. Well, we haven't really seen that. We continue to see plenty of branded bargains in the marketplace. And quite frankly, vendors have strategies that have fluctuated over time.

And we do business with over 8,000 vendors, so we've been able to successfully navigate over the years through all of these changes. In terms of new brands, we really wouldn't talk about brands -- specific brands on the call, and same thing pretty much for new categories where we're testing. .

The next question is from Paul Lejuez from Citigroup. .

Can you talk about how wages impacted your earnings growth this quarter versus what you expect over the next several quarters and even looking out beyond '17?.

Sure, Paul. We expect wages to abate in the second half of the year as we anniversary the most recent wage increases that took place in last year's second quarter for us. So our guidance though still for the year assumes an SG&A leverage point at about 30%, which is in line with historical averages. .

Got you.

And then I think -- sorry?.

Well, I was just going to add, further out, I think you had asked beyond 2017, it's hard for us to be precise beyond the current year. But we've taken the view that wage pressure is probably going to be a reality for the next several years.

Certainly, in some of the major states that we're in, there's legislation that's already been passed that pushes up the minimum wage over the next several years. So we're expecting continued wage pressure, but it's hard to be precise about that. .

Got you. And I think you guys were looking for flattish merch margin for the year. Has the first quarter experience or buying environment changed that view at all? Just curious what your outlook is on merch margin specifically. .

No. We haven't changed our outlook, Paul, even though we exceeded merch margins by 15 basis points during the quarter. Though that was primarily driven by above plan sales, which allowed us to leverage markdowns and drive the business with closeouts. Just after 1 quarter, we wouldn't change our outlook for the year. .

The next question is from Matthew Boss from JPMorgan. .

So I guess, just to piggyback on that. As we think about the gross margin line longer term, you've taken the inventory down 40% as you outlined. Do you see further opportunity on the inventory front? And is it best to think about, at this level of comp, flattish gross margins as a whole? And then just one micro on the freight.

What is the headwind? What's the magnitude in the second quarter, because I know you outlined that?.

So we didn't say specifically on the basis point impact, though. We -- beginning in Q4, we did -- have seen a tightening of carrier rates as well as fuel costs that are up against some very low levels last year. Right now, we expect freight costs to be a headwind for the remainder of the year and that's reflected in our guidance. .

In terms of your question about the outlook for gross margin, there were really 3 things that have helped us drive our gross margin improvement over the past several years. The inventory reductions we've taken have obviously helped us to drive down markdowns, that's been important component.

Improvements in our shortage control, the investments we've made there, again, have helped to drive our gross margin. And then the third component has been ahead of plan sales, driving, obviously, ahead of plan terms.

As we look forward, of those 3, I think there's limited opportunity left in the first 2, the inventory reduction and the shortage control. We'll continue to manage those tightly. But I think, realistically, there's a limit to what more we can do.

So most of the growth on gross margin going forward is going to have to come from the sales line in terms of ahead of plan sales. .

The next question is from Adrienne Yih from Wolfe Research. .

My question is on the home category. I was wondering -- there's, obviously, some of your competitors are expanding into that category more aggressively and actually launching a secondary concept here in the United States.

So I was wondering what your plans are with your home sales? You obviously have a better quarter of your sales coming from there, if you can help us with the strategy there. .

Sure. Home is actually been one of our strongest categories over the last couple of years and we believe that there is further opportunity to grow the business. But for competitive reasons, we wouldn't disclose a specific target. .

The next question is from David Mann from Johnson Rice. .

Question about your distribution centers. You made a lot of investment, I guess, in the last couple of years, you're starting to see some benefit.

Where are you in terms of the opportunity to leverage those investments and improve productivity? How much longer do you think you can get gains there?.

Sure, David. So in the first quarter, DCs levered by about 15 basis points, and that was all due to both efficiencies in the DCs and also fixed cost leverage.

So we would, certainly, over the next couple of years expect to see -- have some ability to lever the fixed cost there as we don't expect additional significant investments in the next couple years. .

The next question is from Laura Champine from Roe Equity Research. .

In California where you got your highest density of stores, do you think that market is maturing? And along those lines, as we look at next year's store openings, will those be more focused in the Midwest or other lesser penetrated markets?.

In terms of California, we continue to see comps there, certainly, over the last couple years. I mean, we've obviously been in the market for 30 years and we continue to comp. So we continue to believe we have opportunity to comp stores there. .

In terms of the breakdown of our new store openings, I don't think that's going to change materially. I mean, from year-to-year, you could see a small adjustment, but I don't expect to see a material change.

So the way to think about it, is about 1/3 of our new stores, more or less, are in the Midwest, about 1/3 are in sort of existing, if you like, Ross markets outside the Midwest and then the remainder are dd's new openings. .

Your next question is from Brian Tunick from RBC. .

Was curious regarding your stores located near the liquidation areas of Macy's or Sears and Kmart.

Just any comments regarding how your stores performed in those areas? And have you thought about doing any kind of proactive marketing events with what JCPenney will be doing coming up in the second quarter?.

Sure, Brian. The closures were fairly recent and late in the quarter, so the impact would have been barely minor to the quarter. Over the long term though, fewer stores, fewer competitors certainly create more market share opportunities for us, which should be a positive factor for the business. .

The next question is from Ike Boruchow from Wells Fargo. .

Michael, just to close the loop on gross margin, I mean, the compares get a little bit more difficult as the year progresses.

How should we -- is there anything we should keep in mind in our models on the gross margin line? Do you expect flat to up, remainder of the year? And is there something embedded in your fiscal year guide just on the gross margin line? Just help us out. .

No. I wouldn't change anything that we said in our initial call, Ike, earlier in the year that we expect going into the year that we expected merchandise margins to be relatively flat and to call out, at this point, that we think freight will be a headwind to the remainder of the year. .

[Operator Instructions] Your next question is from Mike Baker from Deutsche Bank. .

I want to ask about online competition. And I think it's clear that you guys have taken share from department stores and online. May not be impacting you as you continue to comp.

But I guess, how do you -- how can you tell or how do you know that your customers wouldn't buy from you online? What have you done to ask your customers because perhaps you are losing some share or losing some sales on the table without the online.

But I know, economically, it doesn't work right for you but are your customers demanding it at all?.

We haven't had any -- we certainly haven't had any communication from customers that they're demanding e-commerce from Ross. I think that's mainly because of the type of business we run. I mean, it's important to keep in mind we're a moderate off-price retailer, a low averaging of retail around about $10.

So as you mentioned, Mike, the economics really don't work. We offer a very broad assortment which, again, is hard to replicate online. And a treasure hunt environment, which, again, is very difficult to replicate outside of the bricks-and-mortar format.

So overall, we feel like it's very difficult for an online retailer, even if that retailer was us to sort of compete with what we offer in our stores. That's not to say that it's not important for us to monitor what's going on online and to monitor online competitors. We do that all the time. .

Well, and I appreciate that. If I could just follow up, you said you haven't hadn't had communication with your customers.

But dare I ask, have you asked them? In what way would you ask your customers, if we did have an online site, is that something that would be attractive to you?.

I think it's hard to know how you would actually get at that question other than looking at our business.

And if we saw our business start to fall off, and we diagnosed that and found the customers were buying online rather than coming into our stores, buying online from other people rather than coming to our stores, I think that would be a clear indicator for us. Clearly, based upon the strength of our business, we're not seeing that trend. .

Your next question is from Simeon Siegel from Nomura Instinet. .

Has the concentration of your top vendors changed at all over the past year or so? Do you expect any shift in their percentage composition going forward? And then just to your point about the macro challenges and the tougher compares, any color on what you'd expect the comp cadence to look like in the back half?.

Well, on the comps front, on the concentration of top vendors, I would say probably similar year-over-year without having that exact number in front of me. The supply lines have been pretty broad based with all our vendors, so I would think that there aren't any real challenges there.

Could you just repeat the second part of the question on those macroeconomic piece -- macro?.

Yes. Just think what you expect the comp cadence to look like in the back half. I think at the end of your prepared remarks, I think you mentioned the tougher comparison and just macro environment for the rest of the year. .

So no, we'll give -- we'll update the back half comp when we give our release in August. I'd just point you to, when we started the year, we expected 1 to 2 so you can be pretty similar across the rest of the year. .

And the next question is from Dana Telsey from Telsey Advisory Group. .

As you're thinking about inventory, how do you think about the composition of packaways going forward and what your outlook is for it? And then when you think about real estate cost and new store openings, given the current real estate environment, is rental cost or lease expense at all more flexible today than it was in the past?.

I'll talk about packaway first. So in terms of packaway going forward, packaway are opportunistic purchases, so it's kind of hard to predict where the packaway will come from or what the composition will be.

What I would say is that the criteria for putting goods into packaway, the values that we want to put out later on in the year after we sell the goods is really the main criteria. So it's kind of really hard to predict the classification or the amount quite, frankly, it fluctuates. .

And then on the second question, Dana, on real estate. I would say, the truth is that store closures in the strip mall environment have been a feature for several years now, whether it's office supply retailers or sporting goods retailers or electronics retailers going out of businesses. So I would say that it's really more of the same right now.

I would say that rental costs and occupancy costs have stabilized. But I think a lot of the impact that you've seen from store closures has actually happened over the last few years. .

And just to add one thing about packaway. We feel very good about the content of our current packaway that we own today. .

And as you think about diversification of the merchandise mix, over the next few years, what do you -- how do you see the mix diversifying?.

Between the different types of products you mean, between Home, [indiscernible]?.

Yes, exactly. Yes, yes. .

Well, we feel good about Home. We feel that we have growth at Home, but past that I wouldn't talk about that on the call. What I would say is that we think there's opportunities broad based throughout the entire box. .

There are no further questions at this time. I will turn the call back 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..