Ross Stores, Inc.

Good afternoon and welcome to the Ross Source Fourth Quarter and Fiscal Year 2021 Earnings Release Conference Call. The call will begin with prepared comments by management, followed by a question and answer session. At this time, all participants are in listen-only mode. To ask the question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. Please be advised that today's call is being recorded. Before we get started, on behalf of Ross Source, 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, new store openings, COVID-related costs, 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 2020 Form 10-K and fiscal 2021 Form 10-Qs and 8-Ks on file for the SEC. Now, I would like to turn the call over to Barbara Rundler, Chief Executive Officer.

Good afternoon. Good afternoon. Joining me on our call today are Michael Hartram, Group President and Chief Operating Officer, Adam Orbus, Executive Vice President and Chief Financial Officer, and Betty Chen, Vice President, Investor Relations. We will begin our call today with a review of our fourth quarter and 2021 performance, followed by our outlook for 2022 and the longer term. Afterwards, we'll be happy to respond to any questions you may have. As noted in today's press release, we achieved strong sales results in the fourth quarter despite the negative impact from both the surge in Omicron cases during the peak holiday selling period and continued supply chain congestion. Earnings per share for the 13 weeks ended January 29, 2022 were $1.04 on net income of $367 million. This compared to $1.28 per share on net earnings of $456 million for the 13 weeks ended February 1, 2020. Total sales for the fourth quarter were $5 billion, with comparable store sales up 9% versus the same period in 2019. For the 2021 fiscal year, earnings per share were $4.87, a net income of $1,723,000,000, up from $4.60 per share on net earnings of $1,661,000,000 in 2019. Total sales for 2021 rose 18% to $18.9 billion, with comparable store sales up 13%. Now let's turn to additional details on our fourth quarter results. For the holiday selling period, the best performing larger merchandise areas were children's and men's, while the Midwest and Southeast were the strongest regions. Similar to Ross, DD's discount trends remained solid during the period. However, their profitability was also negatively impacted by cost pressures related to freight, wages, and COVID. At quarter end, total consolidated inventories were up 23% versus 2019, mainly from an increase in in-transit merchandise due to longer lead times from the industry-wide supply chain bottlenecks. Average store inventories were down slightly versus 2019, while pack-away merchandise represented 40% of total inventories versus 46% two years ago. As noted in today's release, we are pleased to report that our board recently authorized a new two-year program to repurchase up to $1.9 billion of our common stock through fiscal 2023. This authorization replaces the $850 million remaining under the prior buyback we announced in May of last year. A total of $650 million of common stock was repurchased under the previous program in fiscal 2021. The Board also increased our quarterly cash dividend by 9% to 31 cents per share to be payable on March 31st, 2022 to stockholders of record as of March 15th, 2022. The increases to our stock repurchase and dividend programs reflect our ongoing commitment to enhancing stockholder value and returns, as well as our confidence in the strength of our balance sheet and projected future cash flows. Now, Adam will provide further details on our fourth quarter results and additional color on our outlook for fiscal 2022.

Thank you, Barbara. As previously mentioned, our comparable store sales increased 9% for the quarter. This gain was driven by growth in the size of the average basket, partially offset by a decline in transactions. Fourth quarter operating margin of 9.8% was down 350 basis points from 13.3% in 2019, mainly due to ongoing expense headwinds. Cost of goods sold increased 210 basis points due to a combination of factors. Domestic freight rose 100 basis points, and distribution costs increased 70 basis points, primarily due to the previously mentioned supply chain challenges in addition to higher wages. Merchandise margin declined 50 basis points due to higher ocean freight costs, while buying expenses grew 20 basis points. Occupancy levered 30 basis points on higher sales volume. SG&A for the period rose 140 basis points, again, due to pressure from the holiday-related pay incentives plus higher wages and COVID costs. Total net COVID-related expenses for the quarter were approximately 35 basis points, with a higher impact to SG&A than cost of goods sold. Now let's discuss our outlook for fiscal 2022. As Barbara noted in our press release, 2022 is a difficult year to predict for numerous reasons. We are up against last year's record government stimulus and the lifting of COVID restrictions that led to unprecedented consumer demand, which fueled extraordinary sales gains in the spring of 2021. In addition, we continue to face industry-wide supply chain headwinds, as well as external risks from the effects of inflation, both on consumer demand and on costs within our business. As a result, comparable store sales for the 52 weeks ending January 28th, 2023 are planned to be flat to up 3% versus a 13% gain in 2021. Earnings per share for 2022 are projected to be $4.71 to $5.12 compared to $4.87 in 2021. This reflects our expectation for sales and profitability to improve as we move through the year, given the substantial cost increases we incurred in the fall of 2021. Our guidance assumptions for the 2022 year include total sales are forecast to grow by two to 6%, we plan to return to our more normal opening cadence of 100 new locations in 2022, comprised of about 75 ROS and 25 DDs discounts. As usual, we expect to close about 10 older stores. Operating margin for the full year is planned to be in the 11.6 to 12.1 percent range, down slightly from 2021 due to deleveraging on lower same-store sales gains and again, ongoing expense headwinds, especially in the first half of 2022. Net interest expense is estimated to be $70 million. Depreciation and amortization expense, inclusive of stock-based amortization, is forecast to be about $560 million for the year. The tax rate is projected to be about 24% to 25%. and diluted shares outstanding are expected to be approximately $348 million. In addition, capital expenditures for 2022 are planned to be approximately $800 million. This outlay will fund further investments in our supply chain to support long-term growth and in technology to increase efficiencies throughout the business in order to maximize our prospects to capture profitable market share going forward. Let's now turn to our guidance for the first quarter. In addition to the aforementioned stimulus benefits and strong pent-up demand early last year, we also faced larger headwinds from higher freight and wage costs early in the year. As a result, we are forecasting comparable store sales for the 13 weeks ending April 30th, 2022 to be down two to down 4% on top of a 13% gain for the 13 weeks ended May 1st, 2021. Earnings per share for the 2022 first quarter are projected to be $0.93 to $0.99 versus $1.34 in the prior year period. The operating statement assumptions that support our first quarter guidance includes the following. Total sales are forecast to be down 2% to up 1% versus last year's first quarter. We plan to add 30 new stores consisting of 22 Ross and eight DDs discounts during the period. We project first quarter operating margin to be 10.2 to 10.6% compared to 14.2% last year. The expected decline reflects the deleveraging effect from the negative same store sales assumption as well as ongoing expense pressure from freight and wage costs early in the year. Net interest expense is estimated to be $19 million. Our tax rate is expected to be approximately 25%, and diluted shares are forecast to be about $350 million. Now I will turn the call back to Barbara Rentler for closing comments.

Thank you, Adam. As mentioned in our press release, given consumers' increased focus on value and convenience, We have seen favorable sales trends in both our new and infill market stores. As a result, along with the large number of retail closures and bankruptcies over the last several years, we now believe that Ross Dress for Less can expand to about 2,900 locations, up from our prior target of 2,400, and that Dee Dee's discounts can eventually become a chain of approximately 700 stores versus our previous projection of 600. This represents an overall 20% increase in our forecasted potential to 3,600 stores, providing substantial runway for expansion relative to our year-end store count of 1,923 locations. We operate an attractive sector of retail, and our mission continues to be delivering the best bargains possible to leverage our favorable market position. Looking at 2023 and beyond, we are targeting a return to double-digit earnings per growth driven by a combination of same-store sales gains, operating margin improvement, accelerated new store openings, and our ongoing stock repurchase program. In closing, we especially want to thank our approximately 100,000 talented associates throughout the company, whose dedication has enabled us to successfully navigate through the unprecedented challenges of the past two years. We believe their continued efforts will enable us to capitalize on our opportunities for future sales and earnings growth while also delivering strong returns to stockholders over the coming years. At this point, we'd like to open up the call and respond to any questions you may have.

As a reminder, if you have a question at this time, please press a star 1 on your telephone keypad. If your question has been answered or you wish to remove yourself from the queue, press the pound key. We kindly request that you limit your question to one only. Thank you. Once again, that's star one to ask a question. Your first question comes from the line at Kimberly Greenberger with Morgan Stanley. Please go ahead.

Okay, great. Thank you so much. I wanted to just ask about the guidance here for Q1. And if you have seen perhaps a better start to the quarter but are expecting something deceleration as we get through the stimulus lap. I'm just wondering, you know, how you're planning the quarter. And then if I could just sneak one more in, I just wanted to ask Barbara about what you're seeing in terms of inventory availability in the market and whether you have been able to capitalize on perhaps some of the supply chain volatility that's causing, you know, late deliveries elsewhere. Thanks so much.

Kimberly, hi. I'll start with the first quarter guidance. It's Michael Hartshorn. The first quarter last year, we saw a significant acceleration in March and April last year. As a reminder, the government stimulus hit and started being dispersed to taxpayers in the third week. We're planning around that with our guidance. We had a slower start to the year last year and then had a significant acceleration as we moved through the quarter.

And then as it pertains, Kimberly, to availability, there is definitely availability, but what I would say is it's not consistent across all merchandise departments and classifications. As goods come in from the supply chain congestion and there's issues, it's not always as broad-based in every business. But with that, yes, I would say we've been able to capitalize on the volatility in the supply chain, just given our increase in pack-away, how much it's gone up in the last few months. And we see more potential opportunities in front of us from closeouts. There's a lot of that merchandise that vendors are still moving is not necessarily even in the country.

Great. Thank you so much.

Thank you. Your next question comes from the line of Mark Altrager with Baird. Please go ahead.

Good afternoon. Thanks for taking my question. So with the inflationary backdrop getting tougher, I was hoping you could give us some perspective on how your customer has responded to the inflation in the past. And as you're planning for the spring season, how are you thinking about the share gain opportunity as consumers seek value? versus the risk of a near-term pullback in spending as consumers digest some of the price hikes in essentials categories? Thanks.

Hi. Obviously, we don't have – it's been 40 years since the U.S. has seen this type of inflation, so we don't have a ton of experience on how the customer will react. So I'd be speculating as inflation appears – at this point, to be with us for a while. In general, I'd say the consumer seems to be healthy coming into the year, given higher wages and savings, but obviously with this level of inflation throughout the economy, they're going to have to make choices how and where they spend their money, and it's highly likely the consumer will be seeking value, and that would be positive for us.

Thank you. Your next question comes from the line of Matthew Boss with J.P. Morgan. Please go ahead.

Great, thanks, and congrats on the next quarter. So, Barbara, maybe could you elaborate on the behavioral changes that you cited tied to value and convenience, you know, when you saw this potentially accelerate, how you think the model's positioned? And then just on the profitability front, as you cited in 2023 and moving forward, operating margin improvement, Help us to think about the drivers of that as we think about the return to double-digit earnings growth annually going forward.

Matthew, let me... Go ahead, Michael. You go first.

Go ahead. On the way we're thinking about this year, I'll just go through the components of expenses and then talk through the long-term model. Overall, like everyone in the U.S. economy, we're seeing cost inflation throughout the business. For us, it's most acutely felt in transportation, both domestic and ocean freight markets, and also on the wage front. In those three areas, we have a very good line of sight on ocean freight, and we know that they will remain elevated through 2022. On the domestic freight, we don't expect the same type of headwinds on core domestic freight, although we do expect, especially with the current geopolitics, we do expect volatility in fuel-related costs. And then on wages, with low unemployment rates, the overall labor market continues to be very tight, although the warehousing labor market has been the most competitive over the last year. All that said, we believe we're well positioned to start the year, especially given the wage actions we took in the back half of 2021. On the long-term model, given our market share opportunity with the consumers heightened focused on value and convenience, and given the fact that we're facing less brick-and-mortar competition, we believe we have a market share opportunity going forward. So looking into 2023, As you mentioned, we're targeting double-digit earnings per share growth, and the model or the formula looks very similar to what it looked like prior to the pandemic, and that's a combination of new store growth around 5%, comp sales of 3% to 4% with EBIT margin expansion at the high end of that range, and with the stock repurchase program, that adds up to the double-digit EPS growth.

Thank you. Your next question comes from the line of Chuck Grom with Gordon Haskins. Please go ahead.

Hey, thank you very much. Earlier today, Cole spoke to an improving traffic picture in the month of February and also noted that they've begun to see some trade down in certain categories, suggesting that the focus on value that you guys are suggesting has actually already started to be gone. So I'm just curious if you've seen that thus far and how it bodes for the balance of the year.

We wouldn't comment on inter-quarter trends for us. Obviously, the latest information we could talk about is in January. What we did see during the quarter as Omicron spiked surged right before Christmas. We did see a fall off on traffic, but the customer with their fewer trips bought more per transaction as we progressed through the remainder of the quarter.

And the focus on value. You know, our customer has always been focused on value. But, you know, as the world is evolving and there's inflation, we actually feel we have an opportunity to gain a trade-down customer at the same time. So, you know, value has always been critical for us and is something the merchants are constantly watching and evaluating, especially as retails have gone up in the outside world, understanding where our price-value relationship is with everything. So... Value is critical to us always and it'll just be more important to go forward.

Thank you. Thank you. Your next question comes from the lineup, Lorraine Hutchinson with Bank of America. Please go ahead.

Thanks. Good afternoon. Just following up on that, you had discussed last quarter some limited pricing actions in certain categories. Can you update us on the success of that and if you plan to continue to broaden that out for more of the store?

Sure. We have put in a strategic process where we actually go in and the buyers are constantly assessing the market to understand pricing and where there were potentially opportunities to increase that pricing. And we started that last quarter and it continued through this quarter. And the average price per SKU was up somewhat during the quarter. You know, the way we're looking at it is we've had successes in many areas now compared to where we were, and we are watching it and evaluating it. And, you know, I would say being cautious about moving the needle, you know, based off of where we sit in the food chain. So we're evolving and testing in certain commodities, not even testing, buying it in certain commodities where it's been successful. But I think the most important thing for us to remember is that, you know, value to our customer, you know, that real definition for her is the appropriate separation of price between ourselves and mainstream retail. So we'll continue to do that, and we'll watch things as they evolve and move on from there.

Thank you.

Thank you. Our next question comes from the line of Michael Benetti with Credit Suisse. Please go ahead.

Hey guys, thanks for all the information here. Just to follow that a little bit, I mean, it does seem like, you know, I know at first you were fairly resistant to talking about AUR increases, but I guess, you know, two quarters has gone by now and the rest of the world is going to be taking some pretty meaningful price increases. I mean, do you see the opportunity improving versus where you were one and two quarters ago as far as the ability to take price? And I guess also as you look through the store, are you starting to see Any evidence of a new customer coming in that would point to evidence to you of a trade down? I know during the Great Recession, it was a long time ago now, but I know you guys benefited from a lot of customers coming in from channels like department store and specialty apparel. I'm wondering if you've seen any evidence like that among the new customers coming in.

Well, Michael, first let's talk about the pricing. So, right, for the last two quarters, we've really been watching it. We've got a process in place. We are watching the – Retails move in our competition and all types of competition because the merchants are studying that. And where we think we have that opportunity and we can still offer unbelievable value to the customer, we're taking it. If we don't feel like we can offer that value to her at this point, we're not taking it. What I would also say is it's kind of hard to predict where mainstream retails will be in the future and what they're going to do because you know, prices can go up and go up and go up, and they might go up until they don't work at some point. And a traditional retailer can POS at any moment in time. So we're trying to really manage our way through giving the customer great value, increasing the AUR where it's appropriate, and really making sure that we balance through where the future could go in terms of, you know, potential POSing at some point in time. So there's a lot of variables, which is why we have which is why we have processes in place and we're doing it strategically. But where we have done it strategically and continue to offer values to the customer, great values, it is working. And in terms of understanding the trade-down customer, I think it's kind of hard to see if you're asking from specific types of products or retails. I wouldn't say we've seen anything specific along those lines. to say that we're getting a trade down customer at this point. But with inflation continuing, one would think that that would be a logical conclusion that over time that we could potentially pick up additional market share.

Thanks a lot. Thank you. Your next question comes from the line of Marnie Shapiro with Retail Tracker. Please go ahead.

Hey, guys. I have just a quick follow-up on the pricing question again. I'm sorry. But are you able to take prices up at Didi's? I know those prices tend to be a little bit lower and the customer a little bit more sensitive. And then if you could also just talk about past this year, kind of longer term, you said there's a change out there in bricks and mortar, fewer competitors, potentially meaning a healthier retail environment in general. So is there an opportunity for you guys to push up the food chain a little bit with some better brands and some changes to the assortment just a little bit, especially at Ross Stores?

Okay, so two things. So at DeeDee's, you know, we have the customer is absolutely price sensitive and has lower price points. But in DeeDee's, we're running the same process we're doing at Ross. We're studying it. The merchants are understanding it. They're understanding values because, again, A lot of the competition for DeeDee's is mass market, and a lot of those retails have gone up. And so, you know, we're running the same process in both companies to make sure that we have real sides around it, we can understand it, and make the right decisions. And DeeDee's has also had success in some areas where they have tried it. So I would say both companies, it's kind of, you know, it's an ongoing process, and it will be the same process that will, you know, continue. In terms of longer, you're saying an assortment strategy, could we trade up into more better brands? And I think, you know, our better brand strategy that we have, we're comfortable with. We continue to test and try better brands, see what the customer responds to. So I would think we would continue to do that and then, you know, give her and offer her what she wants. But as it stands today, you know, you know, when it comes to brands and supply, as you know, it can also peak in value, right? So especially on better brands, it can, you know, there can be a lot and it can temper, they can come back up. So I think we're always looking to try to increase our brand strategy and try to offer the customer the best possible products and values that we can. So that process would continue if over time there were more opportunities and the customer was responding, we would continue to to shift the assortment based on the customer's response.

Great. That makes a lot of sense. Best of luck for the spring season.

Thank you.

Thank you. Your next question comes from the line of Beth Reed with Truist Securities. Please go ahead.

Hi. Good afternoon. I wanted to ask about the lower income consumer. Have you seen any changes in purchasing patterns related to this specific customer cohort or any call-out in trends at Roth versus DD? Thank you.

I wouldn't make any call-outs Ross versus Deedee's. Deedee's performance has been in line to Ross, actually performed better with government stimulus earlier in the year, but has maintained levels that are similar. And then in terms of changes, there are just so many factors that... are happening with the consumer, whether it's COVID-related, whether it's inflation, whether it's all the other things we're seeing, it would be hard to parse that specifically out on their behavior related to income factors.

Thank you. Your next question comes from the line of Dana Telsey with Telsey Advisory Group. Please go ahead.

Hi. Good afternoon, everyone. As you think about the expanded opportunity for new store openings at both businesses, any adjustments in size that you're making, how are you thinking about the regions where you're going to and expanding into, and any framework this past fourth quarter of what you saw by region and how it was different by brand? Thank you.

On region performance, what we saw in the fourth quarter, as we said in the commentary, the top performing regions included the Southeast and the Midwest, and then our largest regions, California, Florida, and Texas. Texas was above the chain average, and California and Florida were slightly below. But in terms of how we're thinking about long-term store potential, what gives us confidence in that is, as we do every year, we look at research on the store potential. And there's a couple factors that are important. First of all, more broadly, the consumers focus on value and convenience and then the brick-and-mortar retail closures, but also the change. changing traffic patterns for evolving customer behavior post-COVID, our ability to cluster stores together in high density and high volume trade areas. We've had success in our smaller markets. And then last but not least, we have a favorable growth trends in our targeted demographics. So those are the changes. that gives us confidence to increase the store count potential, the 3600 location.

Thank you.

Thank you. Your next question comes from the line of Laura Champagne with Loop Capital. Please go ahead.

Thanks for taking my question. It's about the long-term growth algorithm that you're laying out. today and it's more philosophical like why is now we're going into our third year where the comparables aren't exactly likely to live up to their name why is now the right time to lay out this long term growth algorithm and what gives you the confidence that you can put up sustainable comp growth what kind of a macro do you need to hit your goals well I'd say number one uh

Laura, is what we've talked about, is given the customer's continued focus on value and convenience, we're in the right sector of retail and we think we have a large market share opportunity ahead of us. I think this is the first time, 2022 is a difficult year to predict, but we think we can grow market share and we think we have the strategies in place to be able to do that.

if I can get a quick follow on, will the growth, I think what I heard was store growth of about 5%. Would that push your CapEx in the out years up to more like 4% or 5% of sales compared to the 3%, 3.5% you have been running historically?

There's a couple of factors that go into the CapEx. Certainly one of the most important is new store growth, but it can get choppy with our distribution center capital as we're As last year, we added a new distribution center that is opening early this year, so it can get a bit choppy. But going forward, I think it remains at these levels, maybe slightly up in future years based on distribution center capacity growth.

Got it. Thank you.

Thank you. Your next question comes from the line of John Kernan with Cowen. Please go ahead.

Good afternoon. Thanks for taking my question. You know, freight inflation and wage inflation isn't the only cost inflation out there, product costs are higher. What's the outlook for merchandise margin this year and long term?

Yeah, John, I'll jump in on that. you know, consistent with the prior quarters in 2021, merchandise margin was strong. Without ocean freight, it improved every quarter versus LY versus 2019. So while we expect ocean freight costs to remain elevated through 2022, you know, we're going to anniversary that initial spike in ocean freight costs in the fall. So as we look forward into 2022, again, without the impact of ocean freight, we feel like it's healthy and will continue to be strong and grow in 2022, obviously dependent on sales and inventory turns, but feel strong about that.

Got it. Thanks. Just maybe one quick follow-up. Where are we in the wage inflation cycle at Ross Stores? You seem to imply that you've taken wages up both in stores and DCs. We've heard quite a bit from some of your big-box clients competitors out there about where they're taking wages. Where are we in the wage inflation cycle here? Do you feel comfortable where you are now in both DCs and stores?

Yeah, I would say after the year, we feel good about the changes we made last year. But our approach has been to look at wages on a market-by-market basis versus a blanket approach. But I would also add there are statutory increases. There's minimum wage increases. California has large bumps year to year, and there's other large states for us that have minimum wage increases. So we're keeping up with those, and then we're making decisions on a market-by-market basis to make sure we can hire great talent across the chain. Got it. Thank you. Best of luck.

Thank you. Your next question concerned the line of Aiki Buricho with Wells Fargo. Please go ahead.

Hey, everyone. Just on freight, I think you gave on a double L-Y basis, it was 100 basis point headwind in Q4. Can you say what that was year over year just to give some context? And then if there's any way you could explain what's embedded? I think you said the cost should get much better as you move through next fiscal year. But what is the year over year headwind that you're currently anticipating, whether it's first half, full year, anything to be helpful would be great.

Yeah. Ike, we wouldn't give specifics on the due leverage. We usually would do that after the fact. But as I explained, the back half of last year is when we started seeing significant increases in ocean freight as lead times extended and we had to pay more in the spot rate market. So we're up against that. We'll be up against that next year, so it will be less of a headwind this year. Overall, we expect, though, that ocean freights will stay elevated all the way through the year and perhaps a bit higher. But the vast headwind...

uh will be uh in the first half of the year versus the second half of the year if that makes sense okay thanks and uh we have no further question at this time i will now turn the call over back to barbara rentler for closing remarks thank you for joining us today and for your interest in raw stores and this concludes today's conference call you may now disconnect