Ross Stores Q2 2021 Earnings Results & Report

Ross Stores EPS Results

• Actual EPS: $1.39
• Consensus EPS: $1.00
• Beat/Miss: Beat by +$0.39
• One Year Ago EPS: $0.06
• EPS Beat Rate: 8 of last 8 quarters

Ross Stores Revenue Results

• Actual Revenue: $4.80 billion
• Expected Revenue: $4.56 billion
• Beat/Miss: Beat by +$247.90 million
• YoY Revenue Growth: N/A

Ross Stores (NASDAQ:ROST) is an off-price apparel and home fashion retailer headquartered in Dublin, California. The company operates primarily through its Ross Dress for Less stores, which offer branded and designer apparel, accessories, footwear, and home merchandise at discounts to regular department and specialty store prices.

Ross Stores also operates dd’s DISCOUNTS, a chain focused on value-oriented apparel, accessories, footwear, and home products. Both retail formats generally purchase merchandise opportunistically from manufacturers, department stores, and other suppliers, allowing the company to offer changing assortments and discounted prices.

Founded in 1950, Ross Stores serves customers across the United States through its store network and e-commerce presence. Ross Dress for Less locations operate in numerous states, the District of Columbia, and Guam, while dd’s DISCOUNTS stores serve selected U.S. markets.

Ross Stores Q2 2021 Earnings Call Transcript

Key Takeaways

• Ross delivered a 15% comparable-store-sales gain in Q2, driving total sales up 21% to $4.8 billion and EPS up 22% to $1.39 versus 2019.
• For Q3, the company expects comparable-store-sales growth of 5–7%, sales up 9–12% and EPS of $0.61–$0.69, reflecting headwinds from higher freight, distribution and COVID-related costs.
• Inventory at quarter-end was down 5% versus 2019, with packaway inventory at 30% of total, as the company manages supply-chain congestion and receipt delays.
• Ross plans to open about 65 new stores in fiscal 2021 (45 Ross and 20 dd’s discounts, net of closures) and return to ~100 annual openings in 2022.
• Despite uncertainties around stimulus and COVID variants, management remains confident in its value-retail positioning and sees opportunity to gain market share amid industry closures.

Presentation

[Operator]

Good afternoon, and welcome to the Ross Stores second quarter 2021 earnings release conference call. The call will begin with prepared comments by management, followed by a question-and-answer session. 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, 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.

[Operator]

Risk factors are included in today's press release and the company's fiscal 2020 Form 10-K and fiscal 2021 Form 10-Q and 8-Ks on file with the SEC. Now, I'd like to turn the call over to Barbara Rentler, chief executive officer.

[Barbara Rentler, CEO at Ross Stores]

Good afternoon. Joining me on our call today are Michael Hartshorn, Group President, Chief Operating Officer, and Connie Kao, Group Vice President, Investor Relations. We'll begin our call today with a review of our second quarter performance, followed by our outlook for the third quarter and fiscal year. Afterwards, we'll be happy to respond to any questions you may have. As noted in today's press release, we are pleased that both second quarter sales and earnings substantially exceeded our expectations. Sales benefited from customers' positive response to our broad assortment of great bargains. In addition, our results were bolstered by a number of external factors, including ongoing government stimulus, increasing vaccination rates, and diminishing COVID restrictions. Earnings per share for the 13 weeks ended July 31st, 2021, grew 22% to $1.39 on net income of $494 million.

[Barbara Rentler, CEO at Ross Stores]

This compares to $1.14 per share on net earnings of $413 million for the 13 weeks ended August 3rd, 2019. Total sales for the quarter rose 21% to $4.8 billion, with comparable store sales up a robust 15%. For the first six months, earnings per share were $2.73 on net earnings of $971 million, up from $2.29 per share on net income of $834 million for the same period in 2019. Sales for the first half of 2021 rose 20% to $9.3 billion, with comparable store sales up 14%. For the second quarter, Ross's sales trends across merchandise areas and regions were fairly broad-based, with children's and the Midwest performing the best. Additionally, dd's DISCOUNTS trends remained robust during the period as both sales and operating profit gains significantly exceeded our expectations.

[Barbara Rentler, CEO at Ross Stores]

At quarter end, total consolidated inventories were down 5%, while average selling store inventories were up 3% versus 2019. Packaway levels ended at 30% of the total compared to 43% for the same period in 2019, as we used a substantial amount of packaway merchandise to support ahead of planned sales. There were receipt delays due to supply chain congestion. Turning to store growth, we now expect to open approximately 65 total locations this year, comprised of about 45 Ross and 20 DD's DISCOUNTS. As usual, these numbers do not reflect our plans to close or relocate about 10 stores. As mentioned in last quarter's call, in 2022, we expect to return to our normal annual opening program of approximately 100 new stores. Now, Michael Hartshorn will provide further details on our second quarter results, third quarter guidance, and updated outlook for the year.

[Michael Hartshorn, Group President and COO at Ross Stores]

Thank you, Barbara. As we previously stated, comparable store sales increased 15% in the quarter, mainly driven by a larger average basket with traffic up slightly versus 2019. Operating margin was well above plan and up versus 2019 at 14.1%. Cost of goods sold decreased by 45 basis points in the quarter. Merchandise margin and occupancy improved by 80 basis points each, while buying costs declined by 10 basis points. Partially offsetting these items were higher distribution expenses, which grew 40 basis points, primarily from wage increases, while worsening industry-wide supply chain congestion drove higher freight costs of 85 basis points. SGA for the period rose five basis points as leverage from strong sales gains was offset by COVID expenses and higher incentives given our better-than-expected second quarter results.

[Michael Hartshorn, Group President and COO at Ross Stores]

Total net COVID-related expenses for the period were approximately 45 basis points, the vast majority of which impacted SG&A. During the quarter, we repurchased 1.4 million shares of common stock for a total purchase price of $176 million. We remain on track to buy back a total of $650 million in stock for the year. Now let's discuss our third quarter guidance. As a reminder, our projections compared to the same period in 2019. Looking ahead, there remains much uncertainty on the sustainability of the positive external factors that benefited our first-half results, as well as the potential risks we could face from the spread of COVID variants and worsening industry-wide supply chain congestion. As a result, we are forecasting comparable store sales to be up 5%-7% for the third quarter, with earnings per share projected to be in the range of $0.61-$0.69.

[Michael Hartshorn, Group President and COO at Ross Stores]

The operating statement assumptions that support our third quarter guidance include the following. Total sales are projected to grow 9%-12%. We expect operating margins to be 7.3%-7.9%. This forecast reflects significant escalation of freight costs, as well as higher distribution expenses. In addition, ongoing COVID-related costs are projected to negatively impact EBIT margins by approximately 45 basis points in the period. We plan to open 28 stores during the third quarter, consisting of 18 Ross and 10 DD's DISCOUNTS. Net interest expense is estimated to be about $19 million. Our tax rate is expected to be approximately 24%-25%, and weighted average diluted shares outstanding are projected to be about 354 million.

[Michael Hartshorn, Group President and COO at Ross Stores]

Based on our first-half results and third-quarter guidance, we now project full-year comparable store sales gains of 10% to 11% and earnings per share to be in the range of $4.20 to $4.38, compared to $4.60 in 2019. I'll turn the call back to Barbara for closing comments.

[Barbara Rentler, CEO at Ross Stores]

Thank you, Michael. While we're pleased by the better-than-expected results we reported today, as Michael noted, there's a high level of uncertainty on a number of external factors and how they may affect our business over the balance of the year. That said, we believe we are well-positioned as a value retailer and remain confident in our ability to continue to deliver great branded bargains. Moving forward, we remain optimistic about our prospects for continued growth in both sales and profitability over the longer term, especially given consumers' increasing focus on value and convenience. Moreover, the significant number of retail closures and bankruptcies in recent years further enhances our ability to gain additional market share in the future. At this point, we'd like to open up the call and respond to any questions you might have.

[Operator]

Your first question is from the line of Lorraine Hutchinson from Bank of America. Your line is open.

[Lorraine Hutchinson, Analyst at Bank of America]

Thanks. Good afternoon. It's quite a different tone with the 2Q beat versus the 3Q guidance. I was just curious: how much of these sales and margin pressures are you seeing today versus how much are you baking in just in case things get worse?

[Michael Hartshorn, Group President and COO at Ross Stores]

Kimberly, it's Michael. On the sales front, the guidance is really based on the high level of uncertainty and risk that could happen in the third and fourth quarters, and it's really based on the risk that the external factors that benefited the first half, how sustainable those are. Also, with the Delta variant and supply chain congestion, what other risks exist. That said, we hope to do better than the guidance, as we have year-to-date thus far.

[Operator]

Your next question is from Mark Altschwager from Baird. Your line is open.

[Mark Altschwager, Analyst at Baird]

Good afternoon. Thanks for taking my question. A lot of focus out there on kind of the cost side of the current kind of supply chain backdrop. I was hoping you could speak to some of the opportunities this is creating or expected to create in the months and quarters ahead, just with canceled orders, late deliveries, inventory trapped in nodes kind of throughout the system. Just how do you see this really playing out from an inventory availability standpoint in the coming quarters? Thank you.

[Barbara Rentler, CEO at Ross Stores]

Well, listen, obviously, the supply chain congestion is causing all kinds of receipt delays right now. We expect those actually to worsen as the year goes on. At some point in time, those goods will back up, and we will see those as potentially an opportunity either for packaway or to flow, depending upon business or what the types of products are. At this moment, you would think that that would happen probably either late in the year or the beginning of next year, if I had to pick a timeframe.

[Operator]

Your next question is from the line of Paul Lejuez from TD Cowen. Your line is open.

[Paul Lejuez, Analyst at TD Cowen]

Thanks, guys. Can you maybe talk about performance by state? Curious, your three big states, how different the performance was in the second quarter. Also curious if there are any states in particular where you might be seeing some sort of change in trend in the third quarter to date that's kind of guiding how you are thinking about comps in Q3. Was also curious if you could just talk about home versus apparel performance in the quarter. Thanks.

[Michael Hartshorn, Group President and COO at Ross Stores]

On the regional performance, Texas, Florida, California, they make up about 50% of our sales. What we saw during the quarter, Texas and California were relatively in line with the chain. Florida, which trailed in the first quarter, saw a significant improvement as tourism increased, though still a bit below the chain in the second quarter. We wouldn't comment on current quarter trends at this point.

[Barbara Rentler, CEO at Ross Stores]

Home versus apparel. Home continues to be one of our top-performing merchandise areas, similar to trends that we've seen throughout the entire pandemic. Apparel, however, continued to accelerate from Q1 to Q2. I think what we're seeing in apparel is, pre-COVID, there was already a shift towards casual wear and then activewear. What's happening now is that more traditional sportswear classifications have also improved. That's starting to build the sales from one quarter to the other.

[Paul Lejuez, Analyst at TD Cowen]

Barbara, are you seeing the supply chain disruption impact certain categories more than others? Anything you can share there?

[Barbara Rentler, CEO at Ross Stores]

Look, overall, there's plenty of supply. It's not consistent, to your point, across merchandise departments. In reality, what's happening is that merchandise deliveries are sliding. It could slide two weeks, 30 days; they're sliding. What the merchants are really doing is they are constantly flexing based off of what they're seeing in the market, the availability, and they're chasing into classifications that they need. It's a little bit of a moving target, but overall, there's plenty of supply.

[Paul Lejuez, Analyst at TD Cowen]

Okay. Thank you. Good luck.

[Operator]

Again, in order to allow everyone time for questions, we ask that you please limit yourselves to one question. Your next question is from the line of Kimberly Greenberger from Morgan Stanley. Your line is open.

[Kimberly Greenberger, Analyst at Morgan Stanley]

Okay, great. Thank you. I wanted to hear if you'd given any further thought to potentially some price actions just to help absorb some of the higher costs, even if it's just a little bit here or there or sort of surgically done based on what comparison prices you're seeing in the marketplace. I just wanted to see if you had thought about that any differently as compared to your comments back in May. Then could I just get a clarification on the full-year 10%-11% comp guidance? What does that embed for the fourth quarter? Thank you so much.

[Barbara Rentler, CEO at Ross Stores]

Okay. In terms of pricing, Kimberly, we still strongly believe that price value is critical to our customers. As you know, we've over the years talked about how the merchants comp shop regularly, and they really understand that our target shopper is really price-savvy. If she's not getting the best deal out there, she knows it. The higher prices at traditional retailers could increase the pricing gap that we offer and strengthen the values that we provide to our shoppers. Quite frankly, the merchants are constantly making those price value assessments of their assortments all the time.

[Barbara Rentler, CEO at Ross Stores]

They're prioritizing, as we'll always prioritize, really having sharply priced assortments for our entire store. At this point, I wouldn't talk anything more about it for competitive reasons, but the one comment that I would say is we won't be the leader in terms of raising prices. The merchants will do their job, and they'll assess it, and they'll price it the way they see it.

[Michael Hartshorn, Group President and COO at Ross Stores]

Kimberly, on comp guidance, the fourth quarter looks very similar to the Q3 at the 5%-7%.

[Kimberly Greenberger, Analyst at Morgan Stanley]

Thank you.

[Operator]

Your next question is from Chuck Grom from Gordon Haskett. Your line is open.

[Chuck Grom, Analyst at Gordon Haskett]

Hey, thank you very much. Good quarter. Just wondering if you guys could speak to the magnitude of the DC and freight costs that you're anticipating in the third quarter. It looks like over the past couple of quarters, it's been about 100 basis point 125 basis point drag. Just wondering if you could speak to how big of a drag you're expecting here in this quarter. Thank you.

[Michael Hartshorn, Group President and COO at Ross Stores]

We didn't give specific guidance. In the second quarter, obviously, DCs were 40 basis points of drag, and freight was 85 basis points. We would expect both the DCs and the freight costs to worsen in the back half. Some of that's driven by the leverage on comp, but we raised wages further in the DCs, and we're seeing specifically ocean freight costs significantly escalate in the back half. Those expectations for worsening are built into the guidance that we give.

[Operator]

Your next question is from the line of Matthew Boss from JP Morgan. Your line is open.

[Matthew Boss, Analyst at JPMorgan]

Great. Thanks, and congrats on a nice quarter. Barbara, any early thoughts on overall back-to-school trends, maybe what you've seen so far in August in some of the states that have gone back earlier? Michael, on gross margin, have you embedded any change in the external promotional or pricing backdrop for the third quarter relative to what we saw in the front half of the year, just in your merchandise margin outlook?

[Barbara Rentler, CEO at Ross Stores]

Matt, the back-to-school trends, look, we've been pleased with our younger businesses' performances for a while, and so that obviously bodes well for back to school. In terms of classifications, I would say the customer is still buying wear now but has started to make that conversion to go forward in a more traditional back-to-school fashion that we might have seen from a product perspective in, let's say, 2019. We feel good about those businesses because obviously our younger businesses are doing well; therefore, back to school, we feel pretty good about.

[Michael Hartshorn, Group President and COO at Ross Stores]

Matthew, on margin, obviously we have built in what we can see today with our current on-order. I think our big opportunity, as it was in the second quarter, is if we can exceed these sales plans; there should be a benefit as we turn faster and take lower margins.

[Operator]

Your next question is from Janine Stichter from Jefferies. Your line is open.

[Janine Stichter, Analyst at Jefferies]

Hi. Thanks for taking my question. Wanted to ask about the COVID cost, if you had any thoughts about the timeline for potentially starting to moderate the expense you're putting into the cleaning and sanitation aspect in the stores. Thank you.

[Michael Hartshorn, Group President and COO at Ross Stores]

Sure. I think that's changed over time. Obviously, if you would've asked me that two months ago, it would've been sooner than later. Right now, we have the cleaning aspect built in throughout the rest of the year, which we think is appropriate given the variant spread.

[Janine Stichter, Analyst at Jefferies]

Got it. Thank you.

[Operator]

Your next question is from Michael Binetti from Credit Suisse. Your line is open.

[Michael Binetti, Analyst at Credit Suisse]

Hey, guys. Thanks for taking our questions here. Michael, I'm curious; what do you think are the biggest opportunities to get the business if we try to look beyond a lot of the noise in the margin right now to get the business back to that kind of 14% plus operating margin that you guys saw a few years back? It sounds like, I guess, when you look at the pricing commentary in the softlines group, you seem to think that there's no real emergency here to move towards it, maybe that implies you're thinking that some of these costs we're seeing are quite transitory. If that's right, what do you think are the best ways for this business to get back to that 14+ operating margin in the past from here?

[Michael Hartshorn, Group President and COO at Ross Stores]

Sure, Michael. As you mentioned, obviously we have transitory costs in the business right now, whether it's COVID. At some point, there'll be some equilibrium in the freight world, especially with ocean freight that we expect to be an opportunity going forward. I would say the return to 2019 margin levels will be highly dependent on strong sales performance over time. Given we're in a very vibrant sector of retail, there's market share up for grab with store closures and bankruptcies and a customer who's focused on value and convenience. We feel good about our opportunities. Now, that is not to say that we don't have a lot of work going on in the business to find places to be more efficient to offset some of these costs. I think it's dependent on how long some of this inflation lasts and, then certainly, on top-line growth.

[Michael Binetti, Analyst at Credit Suisse]

Thank you.

[Operator]

Your next question is from John Kernan from Cowen. Your line is open.

[John Kernan, Analyst at Cowen]

Excellent. Thanks for taking my question. Just curious on the quantification of freight and distribution headwinds into next year. Is this the impact that you're guiding to in the back half of the year? Is that ballpark how we should think about it for the first half of next year?

[Michael Hartshorn, Group President and COO at Ross Stores]

I wouldn't comment on next year at this point. In the DCs, the wages that we've made are permanent. That said, we do have productivity initiatives that we'll build into our budgets and plans for next year. On the freight cost, I'd say it's hard to say at this point. If I gave you my view at this point, I think some of the ocean and congestion will bleed into the first part of next year.

[John Kernan, Analyst at Cowen]

Got it. One quick follow-up, just as we stay on the theme of supply chain here, are you concerned at all about deliveries into the holidays and early part of next year, given some of the things we're seeing at ports, et cetera?

[Barbara Rentler, CEO at Ross Stores]

Well, I think, look, we all know there's the supply chain problems and it's backed up, and all the issues with COVID overseas, which kind of made all of the, not all, but a large majority of goods coming out of China slide. I think the issues are real, and I think they'll continue for a while. What we have to do is really make sure that we're paying attention to what it is and that the merchants are adjusting and flexing based off of what they're seeing and what's happening around them. The majority of our business is closeouts. So a lot of these things are a timing issue of how goods will slide. What goods might be late that might be available for us to buy in season? It's like a moving target.

[Barbara Rentler, CEO at Ross Stores]

I think the challenge as you go into Q1 is that Chinese New Year's is a couple of weeks earlier. Those two things are going to collide, I think, a little bit in terms of deliveries and the kind of goods that have to get out of China in particular. I think the answer is we're going to watch it, we're going to adjust as we go, and we're in a flexible business model, so as long as we can offer a treasure hunt and a broad assortment, that's what we're going to do.

[John Kernan, Analyst at Cowen]

Excellent. Thank you.

[Operator]

In order to allow everyone time for questions, we ask that you please limit yourself to one question. Your next question is from Adrienne Yih from Barclays. Your line is open.

[Adrienne Yih, Analyst at Barclays]

Thank you very much. Barbara, I was wondering if you had seen any changes in basket or ATV this quarter versus first quarter, and then toward the end of the quarter, were you seeing any impact in particularly Texas and Florida, of maybe the Delta variant on late July trends? I know that for a quarter, they seem to be fine. Any trailing off at the end of the quarter? Thank you very much.

[Michael Hartshorn, Group President and COO at Ross Stores]

Adrienne, on the components of comp, it was mainly driven by the size of the basket. Traffic was up slightly, and the basket was driven. AUR was up slightly, but it was basically driven by units per transaction, and that was a consistent trend with comp throughout the quarter. We wouldn't say specifically the sequential trend other than to say it was fairly robust throughout the quarter. May was slightly higher than the other months in terms of absolute comp.

[Adrienne Yih, Analyst at Barclays]

Thank you very much, and best of luck. Congrats.

[Operator]

Your next question is from the line of Marni Shapiro from Retail Tracker. Your line is open.

[Marni Shapiro, Analyst at The Retail Tracker]

Hey, guys. Congrats on a great quarter. I just want to clarify one thing, Michael, that you said. You said Texas, California, and Florida made up what % of your sales? You guys used to talk about this in the past. I just want to clarify the number that I heard.

[Michael Hartshorn, Group President and COO at Ross Stores]

It's about 30% of our business.

[Marni Shapiro, Analyst at The Retail Tracker]

That's what I thought. Could we talk just a little bit about marketing? I know it's not a big, ambitious push for you guys like it is for other retailers, but I'm curious: just through COVID, coming into this year, where was your marketing spend? Has it ticked up through this year as the stores have all now, for the most part, been opened? Have you been spending against that, or has demand been so strong that you haven't ticked up the marketing? What should we think about in the back half of the year? If you could just talk a little bit about that.

[Michael Hartshorn, Group President and COO at Ross Stores]

In terms of marketing, for competitive reasons, we wouldn't provide the details there, Marni, but we have made strategic investments. We've made channel shifts, and we have put more money into places like digital versus broadcast. We have made some shifts during COVID, and we'll continue to find what works best for us going forward.

[Marni Shapiro, Analyst at The Retail Tracker]

Has it picked up now that the stores are open compared to a year ago when, say, the first half of the year for sure stores were.

[Michael Hartshorn, Group President and COO at Ross Stores]

Yeah, Marni. No doubt about it. When the stores were closed, we obviously took it as an opportunity to not spend when the stores were closed. It certainly has picked up versus last year.

[Marni Shapiro, Analyst at The Retail Tracker]

That's all rolled back in here. Okay. It should be about your usual levels then from here out with all the stores opened.

[Michael Hartshorn, Group President and COO at Ross Stores]

Correct.

[Marni Shapiro, Analyst at The Retail Tracker]

Okay, fantastic. Thank you. Best of luck with the rest of fall season.

[Michael Hartshorn, Group President and COO at Ross Stores]

Thank you.

[Barbara Rentler, CEO at Ross Stores]

Thanks.

[Operator]

Your next question is from Laura Champine from Loop Capital. Your line is open.

[Laura Champine, Analyst at Loop Capital]

Thanks for taking my question. Still trying to get my head around the significant decline, almost 50% sequentially, in EBIT margins that you're sort of looking to in Q3. I certainly heard the 45 basis points of COVID costs, but are you expecting a big reversal in merchandise margin, or what are some of the assumptions embedded within that EBIT margin assumption?

[Michael Hartshorn, Group President and COO at Ross Stores]

On the EBIT margin in between Q2 and Q3, for instance, obviously, the 5%-7% comp is lower than our year-to-date performance at 15% or 15% in Q2. That drives a significant portion of it. As I mentioned, ocean freight costs; we've embedded the assumption that that will significantly escalate over Q2, and then we expect higher wages in the DC to drive a bit more deleverage than we had year to date.

[Laura Champine, Analyst at Loop Capital]

Got it. Can you give me total logistics costs as a percentage of sales, sort of normally and where it's tracking now?

[Michael Hartshorn, Group President and COO at Ross Stores]

That's not something we provide. Laura.

[Laura Champine, Analyst at Loop Capital]

Got it. Thank you.

[Michael Hartshorn, Group President and COO at Ross Stores]

The best guidance I can give you at this point is, again, freight was 85 basis points worse in the second quarter, and we've embedded significant escalation from that. On the DCs, as I mentioned, it was 40 basis points, and we expect additional deleverage because of higher wages.

[Laura Champine, Analyst at Loop Capital]

Got it.

[Operator]

Your next question is from Dana Telsey from Telsey Advisory. Your line is open.

[Dana Telsey, Analyst at Telsey Advisory]

Good afternoon. It seems like for a couple of quarters in a row now, DD's has had terrific performance. Anything to note there, and any changes to their plans in terms of what's driving that, or is it the child tax credits and stimulus? Secondly, just on packaway, I think it's 30% this quarter. I think it was 34% in the first quarter. How are you thinking about packaway for the balance of the year and the rate it would be at? Thank you.

[Michael Hartshorn, Group President and COO at Ross Stores]

Sure, Dana. On DDs, as we mentioned, DDs continue to have a robust sales trend and Ross EBITDA margin improvement. I'd say relative to Ross, it's been fairly consistent throughout the pandemic. Obviously, the external stimulus has impacted the DD's customer but also helped the Ross customer as well. The one thing they have in common, though, is that that customer is very focused on value, and they've been attracted to what we've had in the store. No changes that I would note in the second quarter. On inventory levels, as you mentioned, packaway was at 30% of our total inventory. With ahead-of-plan sales, we obviously used some of that inventory to fuel some of the sales growth. It was also impacted by delayed receipts. Within the inventory number, we have a higher level of in-transit than we had had historically.

[Michael Hartshorn, Group President and COO at Ross Stores]

The return, we would expect to return to historical levels over time, but that's going to be somewhat dependent on how we perform on the top line and whether we beat the plan and then also what supply chain congestion looks like at the end of the year.

[Operator]

Your next question is from Simeon Siegel from BMO Capital Markets. Your line is open.

[Dirk Lincicome, Analyst at BMO Capital Markets]

Hi, this is Dirk Lincicome for Simeon. I'm just wondering if we could get some color potentially on where you're seeing the most opportunity to capture that share, if that's with new customers or with expanding the current customer wallet within the current DD's and Ross customers, and what you're thinking about that going forward.

[Michael Hartshorn, Group President and COO at Ross Stores]

I would say what we've seen during the pandemic is we've seen a younger customer. Part of that early on in the pandemic was driven by the older customer with restrictions and hesitancy to shop. As we moved along, we've seen in the customers that older shopper is actually returning back to the store. I think we have an opportunity across our customer base to the extent that we can provide them the bargains that they've come to expect.

[Dirk Lincicome, Analyst at BMO Capital Markets]

Great. Thank you.

[Operator]

Your next question is from Jay Sole from UBS. Your line is open.

[Jay Sole, Analyst at UBS]

Great. Thank you. Michael, is it possible to quantify for us the magnitude of the worsening of the inflationary pressures that you called out between Q2 and Q3?

[Michael Hartshorn, Group President and COO at Ross Stores]

I would only just point to the overall EBIT margin. It's a significant de-escalation right now. The 7.3%-7.9% is 450-510 versus 2019 of deleverage. The main drivers out of that are obviously the comp difference between Q2 and Q3. The higher ocean freight is a significant portion of that, and then, as I mentioned, the higher distribution costs. I'd say the largest single deleverage is coming from ocean freight.

[Operator]

Our last question is from Roxanne Meyer from MKM Partners. Your line is open.

[Roxanne Meyer, Analyst at MKM Partners]

Great. Thanks, congratulations on a solid 2Q. My question is on the merchandise margin. You delivered a very robust gain there on top of a sizable gain in the first quarter, really on top of a significant increase in merch margin last year. Where is that coming from? Is that being helped by just utilizing packaway? How should we think about merchandise margin going forward?

[Michael Hartshorn, Group President and COO at Ross Stores]

In the quarter, really the upside versus our original expectations and again versus last year is we've been able to operate with inventory very close to need. We've operated with lower inventories in stores. We've been able to chase the business. That has driven faster turns and lower markdowns. What we've done throughout the pandemic is tried to operate very close to need. We think that we can do that not only during the pandemic, but post-pandemic, which will benefit margin in the future. The lower markdowns and faster turns was the main driver of the margin improvement in the second quarter.

[Operator]

There are no further questions at this time. I would now like to turn the call over to Barbara Rentler for her closing remarks.

[Barbara Rentler, CEO at Ross Stores]

Thank you for joining us today and for your interest in Ross Stores.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.

Participants

Executives

• Barbara Rentler, CEO

Analysts

• Adrienne Yih, Analyst at Barclays
• Chuck Grom, Analyst at Gordon Haskett
• Dana Telsey, Analyst at Telsey Advisory
• Dirk Lincicome, Analyst at BMO Capital Markets
• Janine Stichter, Analyst at Jefferies
• Jay Sole, Analyst at UBS
• John Kernan, Analyst at Cowen
• Kimberly Greenberger, Analyst at Morgan Stanley
• Laura Champine, Analyst at Loop Capital
• Lorraine Hutchinson, Analyst at Bank of America
• Mark Altschwager, Analyst at Baird
• Marni Shapiro, Analyst at The Retail Tracker
• Matthew Boss, Analyst at JPMorgan
• Michael Binetti, Analyst at Credit Suisse
• Michael Hartshorn, Group President and COO at Ross Stores
• Paul Lejuez, Analyst at TD Cowen
• Roxanne Meyer, Analyst at MKM Partners