Good afternoon, and welcome to the Ross Stores Third 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 10-Qs 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 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'll begin our call today with a review of our third 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 noted in today's press release, our third quarter sales and earnings outperformed our expectations despite being up against our toughest prior year comparison and 2 major hurricanes during the quarter. We are pleased with these results, which reflect our continued market share gains in a challenging retail environment. .

Earnings per share for the period were $0.72, up 16% from last year. These results include an approximate $0.01 benefit from favorable expense timing that's expected to reverse in the fourth quarter. .

Net earnings grew to $274 million compared to $204 million in the prior year. Sales for the third quarter rose 8% to $3.3 billion with comparable store sales up 4% on top of a robust 7% gains last year. .

Operating margin of 13.3% was better than expected, mainly due to a combination of higher merchandise margins and leverage on above-plan sales..

For the first 9 months of fiscal 2017, earnings per share were $2.36, up 15% on top of an 11% increase in the prior year. Net earnings were $912 million, up from $817 million last year. Sales year-to-date rose 8% to $10.1 billion with comparable store sales up 4% versus a 4% gain in the same period last year. .

By region, trends were fairly broad-based with the Midwest performing the strongest during the period. We estimate that the hurricanes in Texas and Florida had a minimal impact for the quarter as sales rebounded significantly following the storms. .

By merchandise category, children's was the best-performing area, benefiting from solid execution of our merchandising strategies. .

Similar to Ross, dd's DISCOUNTS continued to post better-than-expected gains in both sales and operating profit for the third quarter. As we ended the third quarter, total consolidated inventories were up 4%, with average in-store inventories flat compared to the prior year. Packaway as a percent of total inventories was 46% compared to 45% last year.

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Turning to our expansion programs, we opened 30 new Ross and 10 dd's DISCOUNT locations in third quarter, completing our 2017 store opening program. We expect to end the year with 1,408 Ross and 213 dd's DISCOUNTS stores, a net increase of 88 locations for fiscal 2017. .

Now Michael Hartshorn will provide further color on our third quarter results and details on our guidance for the remainder of the year. .

Thank you, Barbara. Let's start with our third quarter results. Our 4% comparable store sales gain was driven by increases in both traffic and the size of the average basket. As Barbara mentioned, third quarter operating margin outperformed our projections and increased 65 basis points to 13.3%. .

Cost of goods sold for the quarter improved 30 basis points, driven by a 25 basis point increase in merchandise margin and occupancy and buying costs that were lower by 20 basis points each.

These gains were partially offset by 30 basis point increase in freight cost, along with 5 basis points in higher distribution expenses due mainly to the timing of packaway-related costs. .

Selling, general and administrative expenses during the period were lower by 35 basis points as a result of leverage on our 4% comparable store sales gain and as we anniversaried nonrecurring cost in last year's third quarter. .

During the quarter, we repurchased 3.6 million shares of common stock for a total purchase price of $219 million. Year-to-date, we have bought back a total of 10.5 million shares for an aggregate price of $649 million.

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

Let's turn now to our fourth quarter outlook. As mentioned in our press release, we are raising our sales expectations for the fourth quarter. We now forecast comparable store sales to increase 2% to 3% on top of strong [Audio Gap] over the last several years.

We are projecting earnings per share to remain unchanged at $0.88 to $0.92, as the benefit from higher comparable store sales is expected to be offset by the aforementioned expense timing shift from the third to the fourth quarter.

As a reminder, our EPS guidance for both the fourth quarter and fiscal year includes an estimated benefit of $0.08 from the extra week. .

total sales are projected to grow 11% to 12%, which includes a benefit from this year's 53rd week; operating margin is projected to be in the range of 14.0% to 14.2% versus 13.6% in the prior year; net interest expense is estimated to be about $1.5 million; our tax rate is planned at approximately 37% to 38%; and we expect average diluted shares outstanding to be about 380 million.

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Based on our year-to-date results and projected fourth quarter guidance, we are now planning earnings per share for the full year on a 53-week basis to be in the range of $3.24 to $3.28. On a 52-week basis, this updated forecast for fiscal 2017 represents solid projected earnings per share growth of 12% to 13% on top of a 13% gain in 2016. .

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

Thank you, Michael. Again, we are pleased with the better-than-expected results we achieved in the third quarter despite facing our toughest prior year comparisons and 2 major hurricanes. .

As we enter the fourth quarter, we are encouraged by our above-plan sales and earnings year-to-date. In addition, our merchants have done an excellent job of acquiring exciting assortment of sharply priced name-brand fashions and guests to appeal to today's holiday shoppers.

While we're optimistic about our prospects for the fourth quarter, our guidance reflects an uncertain external environment and the likelihood of yet another very promotional holiday season. As Michael just mentioned, we also faced our own challenging multiyear comparisons.

Nonetheless, we believe that off-price will remain a strong performing segment in retail, driven by consumers' ongoing focus on value. .

Most importantly, we have a consistent track record of being able to deliver the compelling bargains that our customers desire. All of this makes us confident in our ability to achieve solid growth in sales and earnings over the long term. .

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

[Operator Instructions] Your first question is from Simeon Siegel with Nomura Instinet. .

So with most companies calling out hurricane and warm weather impacts, can you just share any thoughts as to why you to really didn't see those pressures? And then just any way to think about operating expenses into next year, whether it's wage, freight or just anything else to keep in mind. .

Sure, it's Michael Hartshorn. On the hurricane impact, so we estimate that the negative impact of the hurricanes in Texas and Florida was less than 50 basis points to comp sales for the quarter end. To be clear, that estimate includes both the initial store closures and a significant bounce back following the storms.

About 15% of our stores were closed at some point during the storms, but all stores have reopened and all stores remained in our comp base throughout the quarter. In terms of other weather trends outside the hurricane impacts, weather was relatively neutral for us during the quarter. .

Okay, great.

And then any thoughts on operating expenses?.

Yes. So on operating expenses for next year, we wouldn't comment at this point. But in our year-end call, we'll update our guidance for the year. .

Your next question is from Matthew Boss from JPMorgan. .

Can you talk about your increased top line confidence entering the fourth quarter and just anything you're seeing by category or execution opportunity versus last year? And if you drill down by region, could you just talk about new store performance in your Midwest builds and anything in Texas post the hurricanes. Any kind of color would be great. .

Sure. In terms of the updated guidance in the fourth quarter, as we mentioned in our comments, we're encouraged by our above-plan sales trends, not only in the third quarter, but certainly in the last six months. And our view that we're well positioned in terms of assortment and value offering for the holidays.

In terms of regional performance, as we mentioned, comments -- in our comments on the Midwest, it was the strongest performing region, and that's been the case since we entered the market in 2011. Among our other geographies, Texas actually performed above the chain average with the significant sales rebound following Harvey.

Obviously, that only impacted the Houston market or mainly impacted the Houston market. Florida was below the chain average with most of the state impacted by Irma, and California performed relatively in line with the chain average. Our new store credits -- go ahead. Sorry, Matt. .

No, no, go ahead. I was just going to ask about the new store productivity exactly. .

Yes, so new store productivity, we've mentioned this on our past calls, it's come down over the last couple of years, certainly with the entry into the Midwest and also our dd's expansion. But that said, Midwest continues to be one of the strongest comping markets for us.

Overall, Ross' new stores are in the neighborhood of 60% to 65% of the chain average, with no material change this year. .

Your next question is from Brian Tunick with RBC. .

I guess, I was curious, Barbara, when you think about the biggest opportunities versus holiday last year, when you think about marketing or gifting or flow of goods, what do you think there are a couple of opportunities are? And then maybe Michael can talk a little bit about the comp composition.

Should we expect at some point? Do you think AUR can start to flatten out? Or is the model really driven by increases in traffic and the basket size?.

Sure, Brian. In terms of a product this year versus last year, what I would say is that our business is performing -- our performance is pretty broad-based right now. So we feel good as we enter into the fourth quarter that both our apparel and non-apparel businesses are working well.

In terms of difference on the floor, what I would say is you'll see an expansion of gifts. And I think in terms of values on the floor, there's been a lot of availability in the market and we've had solid execution by the merchants all year, and that translates to good values in fashions on the floor for the fourth quarter. .

On the comp composition of the comp sales increase, Brian, as we mentioned in prepared remarks, the 4% comp was driven by traffic and the size of the average basket. That basket was driven by increase in the units per transaction with AUR down slightly. Your question specific to AUR, it's been relatively flat for a number of years.

It is down slightly, but that's driven by the mix of the business. .

Okay. And if I could just throw out one more.

On the market share gains you've been talking about, so far this year, any changes in how your marketing in those store clusters? Or anything you're doing differently to capture those customers?.

Brian, this is Michael O'Sullivan. The answer is no, not really. I mean, we are -- we continue to experiment in that marketing with new forms of marketing, but nothing that I would point to that really has driven our comp. What's been driving our comp is really the great values that are in the store.

The marketing is reporting that, but it isn't what's driving it. .

Your next question is from Kimberly Greenberger with Morgan Stanley. .

Michael, I wanted to ask about SG&A. Obviously, you delivered very nice SG&A leverage here in the third quarter. It sounded like there was a $0.01 benefit to the third quarter from a shift and you anniversaried, I think, some -- I think you said nonrecurring cost from last year.

So on a normal go-forward basis on a 4% comp, let's say, I know you don't guide to 4%, but in the third quarter, you delivered a 4%, what sort of normal leverage would we expect to see out of SG&A? And then I'm wondering if you can talk to us about how you're thinking about any future impacts on SG&A from wage headwinds and how we should think about Ross navigating those wage headwinds?.

Sure. As we mentioned, the impact to the quarter as a reminder, last year in the third quarter, we did a 7 comp, but only levered by 5 basis points. So that included a nonrecurring matter that helped our comparison this year. Going forward, the expectation would be for us to have some leverage at the 3% comp level, that's kind of the breakeven.

And looking into the fourth quarter, if we performed above the high end of the guidance, I think you should expect some leverage. In terms of wages, we're going through our budget right now and we'll provide an update at year-end. But as we've always done, we'll look to mitigate any impact from wages by being more efficient in the business.

Obviously, wages could also be positive for top line sales as well. So we'll update the group on our year-end call. .

Your next question is from Omar Saad with Evercore ISI. .

I wanted to ask you a question about fashion and the fashion quotient, how you think about the fashion quotient as you guys build inventory for holiday and into next year.

Are there trends in the marketplace that you see are applicable across categories that create consumer interest that you see opportunities? Just anything along those lines, how you're thinking about fashion in your product, that would be great. .

Sure. I would say that there weren't really any strong, strong fashion trends out there. I mean, there's some smaller trends, but something that would be -- would change the course of what you were doing going from a skinny jeans to a wide-legged pant. There's no major fashion trend.

So I think that's part of the issue as you go through, particularly in Ladies Apparel is that there aren't any real drivers out there. The trends that are out there, however, we have in our assortment. And because we've been able to execute at such a high level and have liquidity, we've been able to chase availability and get in-season goods.

And so we feel pretty good about our assortments as we enter into the fourth quarter, but I actually think a big part of the fashion quotient in the Ladies business is the lack of fashion to be honest. .

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

So fantastic that traffic was up in the basket. And I was curious if the basket, was it because of -- was it a mixed shift? Is she buying something different? Or is she buying more units? I'm curious what the complexion of it was. .

Sure, Marni. The basket was driven by more units. AUR was down slightly, and that's been our trend for some time now, certainly over the last year, 1.5 years. The comp has been driven by a combination of both traffic in basket. .

And are you planning AUR down? Or is it just better buys and -- or mixed shift that's causing AUR down?.

It's mixed shift, Marni. .

Your next question is from Paul Lejuez with Citi. .

Just curious about the performance of women's apparel, also the home category. And curious, as we think about fourth quarter, how are you planning merchandise margin? And also curious what's price or what's baked in from a packaway perspective.

Any impact that, that might have on your gross margin?.

Sure. In terms of performance, the Ladies business performed slightly behind the chain average and home performed slightly ahead of the chain average. And in Ladies, as you would expect, that's a difficult -- it's a difficult business in the outside world, so we were pleased with that performance and continue to work on that business.

In terms of Q4 merchandise margin... .

Margins are planned up. In our guidance, they're planned up a bit, Paul, for the fourth quarter. .

And what's driving that, Michael?.

Its trend and it's a combination of above-plan performance so far. At least year-to-date, it's been driven by availability and it's been driven by our ability to stay liquid and performing above plan. It forces us to chase the business with closeouts, and there is some leverage you get on markdowns if you turn [ classic ]. .

Got you. And then just have one other piece on the gross margins in terms of the packaway impact. .

Yes. We wouldn't talk about the margin impact of packaway. It's usually the best in terms of margin impact, packaway. We see it as a sales driver versus a margin driver. .

[indiscernible] as far as how things flow in and out of the DC timing there?.

No change from last year. .

Your next question is from Oliver Chen with Cowen. .

We had a question related to the merchandise margins and the dynamics between mark ons versus markdowns and what you've been seeing in relation to mark ons. It sounds like it's been encouraging. The other question is about the non-apparel product mix.

What's your framework for thinking about how to best utilize your square footage? You've done a really good job managing inventories, but it feels like there's a nice opportunity ahead as you evaluate what customers would want to buy from you in categories other than apparel. .

Oliver, in terms of the complexion of merchandise margin, it's been a mix of both the [ pioneer ] or mark on and turning faster, and that's been true all year and it was fairly true in the third quarter. .

Sure. And in terms of non-apparel in the product mix as it relates to the store, first, we've decided what businesses we want to drive and what trends we want to drive. In terms of utilizing square footage, since we cut our inventory 40% over the last 6 years or so, that space is an issue in terms of maximizing that space.

We drive that base off of really what products we want to drive into -- and put in front of the customer. We don't necessarily, just say we want to fill the space to say what is it you really want and can we deliver compelling bargains, and then that's how we decide how we're going to expand the business. .

[indiscernible].

And do you have any thoughts just on mark-on trends going forward? Do you expect IMU to be a multiyear benefit? Just would love your thoughts on that. And then if you have any specificity about categories, you had incremental interest in which you don't -- which you could drive intensity in, that would be interesting. .

Oliver, on forward-looking margin components, that's not something we talk about on the call. .

In terms of businesses, you're asking me what businesses we'd like to expand go forward? I mean, we'll be really successful also on the call also. We're always trying to diversify the mix in the store. But giving specifics on the call, we wouldn't talk to. .

Your next question comes from Laura Champine with Roe Equity Research. .

I wanted to talk a little bit about the drivers. The UPT that's headed higher, are you doing a better job on cash wrap? Or do you have consumers buying a cross-category more than they did in the past? Or what's driving that? And then on the flip side, you said that AUR is lower because of mix shift.

Is that in any specific category? Are you seeing that trend across the store?.

Laura, on UPT, we think it's just a function of putting great values in front of the customer, and it's a product of the merchandise. So customers in, they're buying more per visit. And the second half of your question was on AUR. AUR is just down slightly and it's mixed within mixes of business. So it's not a fundamental change for us. .

And it's not focused in any one category more than others, is that true?.

It's not. Yes, it's not. .

Your next question comes from Bob Drbul with Guggenheim Securities. .

Just wondering if in terms of the comp performance, do you feel like you've had significant benefit from competitive store closures throughout retail? And on the children's business, can you just elaborate on what you saw in children's and what led that to be such a successful category this quarter?.

On the store closures, no, there's not a significant benefit. There's -- the number of stores is not only not material, it impacts about 10% of the chain. But the pickup post-liquidation is not meaningful to the overall comp. .

And in terms of the Kid's business, the performance is broad-based. So it was every segment, infant, boys, girls, and we've had really solid execution in there. And so we were able to chase a lot of that business and offer compelling bargains to the customer. .

Great.

And on dd's, are you seeing success in similar categories that you're seeing at Ross? Or is there a big difference from the merchandising mix there?.

Well, yes, as Barbara said in her remarks, dd's posted pretty good sales and operating profit in the quarter. I would say that, as you know, dd's has a somewhat different customer segment. But in many ways, the same factors that drove Ross' success, they're also at play at dd's.

That's the focus on value, the ability to offer great bargains through opportunistic buying, but very strong execution of our merchandising and operating strategies. Those same factors apply at dd's. But the specifics in terms of what are the merchandising strategies are different, obviously, between dd's and Ross.

But the overall drivers, I would say, are very similar. .

Your next question is from Roxanne Meyer with MKM Partners. .

My question is on your packaway business, it's been a fairly consistent percentage.

But I'm just wondering in light of the continued market availability and the trends that you've been seeing, the fact that you've been chasing business, I'm wondering if you're thinking longer term about scaling that business down or changing the way that you buy over time. .

Well, the way we think about packaway is if there's -- there's no definitive number we go out there thinking about it with. We really do it based off of what the merchandise has offered out there is for us. So if it's great deal, we buy it. And so that, oftentimes, builds to the number of that, that you get to.

You're trying to get to if we're chasing business for packaway because sometimes you're compelling bargains of seasonal goods. So if it's sweaters or outdoor or things like that, you want to pack that away because you can use those to open the season and to drive sales until you get more availability in the marketplace.

So we feel good about packaway, and we feel good -- very good about the contents of the packaway that we have right now. .

Your next question is from Jamie Merriman with Bernstein. .

My question is just a follow-up on sales productivity.

As you build awareness and market share in the Midwest, would your expectation be that, that new store productivity should start to come up over time? And can you just talk about for your more mature stores in the Midwest, are you seeing sales productivity at chain average levels?.

Sure. Certainly, we would see stores after they open given the comp that their average store volumes are increasing. Right now, we're planning the business as if the productivity would be lower in year 1 and then comp faster in the first couple years. It's unlikely that it would reach the chain average.

We have been in regions for 30 years in California, which are our most productive stores. But we would expect them to continue to grow over time for sure. .

Your next question is from Mike Baker with Deutsche Bank. .

Maybe a two-part question.

One on dd's, is it yet -- or at what point does it become big enough to impact the comp? In other words, does the Ross-only stores comp reflects the total company comp? Or at some point, is dd's sort of dragging up the entire comp as it becomes bigger?.

Yes. So Mike, at this point, dd's represents less than 10% of the business. So just mathematically, the key driver of the corporation's comp is Ross' comp. .

Understood. But if at 10% of the business, if it were less mature in comping up 500 basis points better, that could sort of lift total comps by 50 basis points and be the difference between the way you guys report a whole number.

So in other words, just trying to see if the core stores are comping in line with what you're reporting for the total company. And I guess, it sounds like they are.

Maybe a follow-up question, is there any big differential based on the maturity of stores? I guess, you said California, which I presume are the most mature stores are in line with the chain average.

But maybe if you look at 5-year-old stores versus 10-year-old stores versus 15-year-old stores, et cetera, do the comps fall off as you go out further?.

Yes, I'd say the differential on comp is really in the first 5 years. After 5 years, there's not a meaningful break. Again, I used California as an example. We've been in there for 30 years. And the vast majority of those stores we've been in, 10, 15 years, and there's no break and there's no lack of confidence in the stores.

So the real differential is the first 5 years. .

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

I had a follow-up question for Michael on your comment that inventory has been turning faster all year and that's helped your merchandise margin. I was curious what the key driver was of that accelerated inventory turn, whether it's related to maybe new systems or processes or a product mix.

What explains it? And is there more left to go there for next year where we can expect inventory turns to be faster again?.

Sure, Lindsay. So first, inventories have been down over 40% over a number of years. This year, it's strictly a function of how we're executing the business in open-to-buy. We go into the year with a 1 to 2 comp. We plan inventories at that level. If we can exceed that comp, you're able to chase the business and you turn faster.

So this year is really a function of how we manage the business, and I think that's going to be the opportunity going forward as well in terms of when we look into next year and beyond. .

Got it. And one for Barbara, you highlighted in your opening remarks that you're braced for a very promotional holiday. Holidays are often very promotional.

I'm curious if you think there's anything different about sort of how you think this holiday season might play out or dynamics that you think might allow it to shape up differently than other kind of promotional seasons in the past. .

Well, it's been promotional all year. What I really think is that it will be more promotional. It's already started to be more promotional. We are starting earlier, and then that last-minute push at the very end, our expectation is that it will be more promotional than it was last year as far as that is to believe, but I do believe that.

And so we're trying to posture ourselves, understanding that that's what that looks like. .

There are no further questions at this time. I will turn the call back over to Barbara Rentler for closing remarks. .

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..