Ross Stores Inc (ROST) — Q4 2018 Earnings Call Transcript

Good afternoon. Joining me on our call today are Michael O'Sullivan, President and Chief Operating Officer; Gary Cribb, Group Executive Vice President, Stores and Loss Prevention; John Call, Executive Vice President, Finance and Legal; Michael Hartshorn, Executive Vice President and Chief Financial Officer; and Connie Kao, Vice President, Investor Relations. We'll begin our call today with a review of our fourth quarter and 2018 performance followed by our outlook for 2019. Afterwards, we'll be happy to respond to any questions you may have. Let me first start the discussion of today's financial results by noting that our 2018 fourth quarter and fiscal year were 13- and 52-week periods, respectively, while our 2017 fourth quarter and fiscal year were 14- and 53-week periods. The 53rd week added approximately $219 million in sales and $0.10 in earnings per share to 2017's fourth quarter and fiscal year. Further, the extra week added about 70 and 20 basis points, respectively, to operating margin in last year's fourth quarter and full year. Now let's turn to today's results. As noted in today's press release, sales and earnings for both the fourth quarter and fiscal year outperformed our expectations. As we also mentioned, we achieved these results despite our own challenging multiyear comparisons and weakness in our Ladies apparel business during the holiday season. Earnings per share for the 13 weeks ended February 2, 2019, were $1.20 versus $1.19 in the 14 weeks ended February 3, 2018. Net earnings for the 2018 fourth quarter were $442 million versus $451 million in the prior year. For the 52 weeks ended February 2, 2019, earnings per share grew to $4.26 compared to $3.55 in the 53 weeks ended February 3, 2018. Fiscal 2018 net earnings were $1.6 billion, up from $1 billion in fiscal 2017. Now let's turn to our recent sales results. For the 13 weeks ended February 2, 2019, total sales were $4.1 billion. Comparable store sales for the period rose 4% over a strong 5% gain in last year's fourth quarter. For the 52 weeks ended February 2, 2019, sales increased 6% to $15 billion with comparable store sales up 4% on top of 4% gains in each of the 3 prior years. For the fourth quarter, men's was the best-performing area, and as I said, Ladies underperformed. Geographically, the Southeast and the Midwest were the strongest regions. dd’s DISCOUNTS customers continued to respond positively to its merchandise assortments, leading to another quarter and year of solid gains in both sales and operating profit. As we ended 2018, total consolidated inventories were up 7% over the prior year with packaway levels at 46% of the total compared to 49% last year. Average in-store inventories were down slightly versus last year. As noted in today's release, our board authorized a new program to repurchase $2.55 billion of common stock over the next 2 fiscal years. Our recent stock prices with the new repurchase program represent about 8% of the company's total market share and a 31% increase over the prior 2-year $1.95 billion authorization that was completed in January 2019. The board also approved an increase in the quarterly cash dividend to $0.255 per share, up 13% over the prior year. The increases to our shareholder payouts for 2019 reflect the current strength of our balance sheet and our ongoing ability to generate significant amounts of cash to fund growth and other capital needs of the business. We have repurchased stock as planned every year since 1993 and raised our cash dividend annually since its inception in 1994. This consistent record also reflects our continuing commitment to enhance shareholder value and returns. Now Michael Hartshorn will provide further details on our 2018 results and insights into our 2019 full year and first quarter guidance.

Thank you, Barbara. As Barbara mentioned earlier, earnings per share for the fourth quarter and fiscal 2018 were $1.20 and $4.26, respectively. These results compared to fourth quarter 2017 earnings per share of $1.19 and $3.55 for the year. Our earnings per share results reflect a one-time noncash gain of $0.07 related to the favorable resolution of a tax matter, as well as a $0.19 benefit from tax reform legislation in the fourth quarter and $0.70 for the year. In addition to the $0.10 earnings per share benefit from last year's 53rd week, our 2017 fourth quarter and fiscal year EPS results also included a $0.21 benefit from the adoption of tax reform legislation consisting of a one-time $0.14 gain due to a revaluation of deferred taxes and $0.07 from a lower tax rate. Now I'll discuss further details on our fourth quarter results. Our 4% comparable store sales gain in the quarter was driven by a combination of higher traffic and an increase in the size of the average basket. A better-than-expected operating margin of 13.2% for the period was down from last year. The 135 basis points decline was primarily due to the approximate 70 basis points benefit in the 2017 fourth quarter from the 53rd week and, as expected, higher freight and wage costs. For the full year, operating margin declined 85 basis points to 13.6%, due in part to last year's 20 basis points benefit from the 53rd week. Cost of goods sold for the year increased 55 basis points, consisting of 40 basis points of higher freight costs, a 15 basis point increase in distribution expenses, and a 10 and 5 basis point rise in buying and occupancy cost, respectively. These expense pressures were partially offset by a 15 basis point increase in merchandise gross margin. SG&A for the year rose 30 basis points, driven by higher wages. During the quarter, we repurchased 3.1 million shares of common stock for a total purchase price of $268 million. For the full year, we repurchased 12.5 million shares for an aggregate price of $1.075 billion. Now let's discuss our outlook for 2019. For the 52 weeks ending February 1, 2020, we are forecasting earnings per share to be $4.30 to $4.50, up from $4.26 for fiscal 2018. Our guidance reflects the adoption of the new lease accounting standard, which is not expected to have a significant impact on our earnings results. The operating statement assumptions for fiscal 2019 include the following: Total sales are projected to grow 5% to 6% for the 52 weeks ending February 1, 2020 compared to the 52 weeks ending February 2, 2019. Comparable store sales are expected to increase 1% to 2% on top of multiple years of strong gains. We plan to add about 100 new stores this year, consisting of approximately 75 Ross and 25 dd’s DISCOUNTS locations. As usual, these numbers do not reflect our plans to close or relocate about 10 older stores. We project that operating margin for 2019 will be in the range of 13.2% to 13.4% compared to 13.6% in 2018. The forecasted decline reflects our plans for relatively flat gross margin and some deleveraging of expenses if same-store sales increase 1% to 2%. Net interest income is estimated to be $17.6 million. Our tax rate is projected to be approximately 24%. We expect average diluted shares outstanding to be about 362 million. Capital expenditures in 2019 are projected to be approximately $600 million, which includes the initial investment for our next distribution center. And depreciation and amortization expense inclusive of stock-based amortization is forecast to be about $450 million. Let's move now to our first quarter guidance. Given the recent underperformance in Ladies apparel, a business that becomes more important in the first quarter, we are forecasting comparable store sales to be flat to up 2%. Earnings per share are projected to be $1.05 to $1.11 versus $1.11 for the first quarter ended May 5, 2018. Other assumptions that support our first quarter guidance include the following: Total sales are planned to increase 3% to 6%. We expect to open 22 new Ross and 6 dd’s DISCOUNTS locations during the quarter. First quarter operating margin is projected to be 13.4% to 13.8% versus last year's 15.1%. This forecasted decline includes expectations for a negative impact from the timing of packaway-related expenses that benefited last year's first quarter and ongoing headwinds from higher freight and wage costs in the first half of 2019. Net interest income for the quarter is estimated to be about $4.9 million. Our tax rate is expected to be approximately 23%. Finally, weighted average diluted shares outstanding are projected to be around 367 million.

Thank you, Michael. Again, we delivered better-than-expected sales and earnings gains for both the fourth quarter and fiscal year. Looking ahead, while we hope to do better, we continue to take a prudent approach to forecasting our business for 2019. Although we remain favorably positioned as an off-price retailer, we are facing our own difficult multiyear comparisons, a very competitive retail landscape, and an uncertain macroeconomic and political environment. Longer-term though, we remain confident in our ability to achieve ongoing profitable market share gains by consistently offering customers outstanding values throughout our store. As long as we remain focused on the careful execution of our proven off-price strategies, we believe we can continue to deliver solid growth in both sales and earnings. Before we begin the question-and-answer session, I'd like to thank John Call for his leadership and the numerous contributions he has made over more than 2 decades at Ross, including previously serving as CFO for 16 years. John begins his planned transition to an advisory role at the end of this month. At this point, we'd like to open up the call and respond to any questions you may have.

Congrats on a nice quarter. So, I guess, maybe my question is just on Ladies apparel, maybe on the weakness. Could you just elaborate on the drivers maybe how best to think about the timeframe to work through any excess inventory? And larger picture, what drove that and the time frame to correct it?

Okay. First of all, the Ladies apparel business got off course because we didn't have the right balance of our assortments in certain categories within the total apparel business. So as a result, we left some money on the table in seasonal areas of the business. In terms of excess inventories or residual inventory left in stores, we don't have any excess issues that we need to deal with or go through. In terms of correcting the merchandise miscues, what I would say is, obviously, we'll course correct as quickly as possible, but we expect gradual improvement as we rebalance the assortment throughout the year.

Sure, Matthew. On expenses, SG&A this year the leverage point is about 3%, which is in line with our historical averages pre-2018. We would expect more deleverage in the front half. As a reminder, we increased our national minimum wage in the second quarter of last year, so we have to round that in the first and a little bit of the second quarter. In addition, in overall operating margin freight costs escalated as we moved through the year last year. So those will be more of a drag in the first half versus the second half.

Could you quantify the freight headwinds that you're seeing? And then, also maybe comment on some of the contracts that are coming this year? Are you seeing some relief in the rates versus this time last year?

Sure, Lorraine. In terms of the impact of freight. So as we expected, first on the fourth quarter. So the fourth quarter there was a 135 basis point drag. 70 basis points of the decline was due to the 53rd week. The remaining 65 basis points was a combination of higher freight and wage costs. For the fiscal year, freights we had a 40 basis point drag for the full year. As we move into 2018, the drag was obviously higher in the third and fourth quarter. So we'd expect a continued drag in the first and second quarter and then be somewhat neutral later in the year. Our contracts, if you compare against the spot rates, actually in many cases are lower than the spot rates. So as we go through contract renewal this year, we would expect rates there to normalize somewhat. In my commentary, the gross margin was intended to be merchant margin so we expect merchant margin to be relatively flat for the year and we didn't provide additional guidance on distribution costs. Like the rest of the business, we would expect some wage headwinds in the distribution centers in the first half of the year more than the second half.

I understand that this was a misstep, and while I wish I could assure you it won’t happen again, I can't make that promise. It's unrealistic for anyone to claim that about any business. I don’t believe the challenge is with the off-price model itself; rather, the problems we faced were internal and self-inflicted. We need to reevaluate the assortment we've created for our customers. This issue is not related to our pricing strategy or future possibilities. Our focus now should be on making the necessary corrections. Ladies' apparel is a significant segment for us, both in off-price and other areas, making it crucial to address this. I believe our issues stemmed from missteps in merchandise that we must rectify, and we plan to do so throughout 2019.

I had a question about the relocation strategy. So it looks like the plan is for relocations and somewhat consistent with the number that you've done in prior years. And it was noticed some competitors in the retail space, who have been ramping up the number of relocations they're doing as more opportunities come up as you see closures across the market. How are you looking at opportunities here? And could that be more opportunities to ramp up relocations as those opportunities present themselves?

Sure. We open about 100 new stores each year, which includes some relocations. I don't anticipate that this number will change significantly in the next couple of years. We always consider additional opportunities as they arise, but I don't expect a substantial shift in our strategy.

Just following up on Alex's question. On the new stores, can you talk about new store productivity and performance? And as you continue to do like the 100 stores a year in terms of new real estate, any changes to the real estate availability or cost that you're seeing versus the past few years?

In terms of new store productivity it's actually been fairly stable over the last 5 years since we've entered the Midwest. So on average, a new store is about 60% to 65% of an average comp store in the chain, and then in the first few years, it ramps faster than the chain average.

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