Ross Stores, Inc. (ROST) Q2 2022 Earnings Call Transcript

Ross Stores, Inc. (NASDAQ: ROST) Q2 2022 earnings call dated Aug. 18, 2022

Corporate Participants:

Barbara Rentler — Vice Chair and Chief Executive Officer

Adam Orvos — Executive Vice President and Chief Financial Officer

Michael J. Hartshorn — Group President and Chief Operating Officer

Analysts:

Lorraine Hutchinson — Bank of America — Analyst

Paul Lejuez — Citigroup — Analyst

Kimberly Greenberger — Morgan Stanley — Analyst

Chuck Grom — Gordon Haskett — Analyst

Matthew Boss — JPMorgan — Analyst

Adrienne Yih — Barclays — Analyst

Mark Altschwager — Baird — Analyst

Brooke Roach — Goldman Sachs — Analyst

Michael Binetti — Credit Suisse — Analyst

Ike Boruchow — Wells Fargo — Analyst

Jay Sole — UBS — Analyst

Dana Telsey — Telsey Advisory Group — Analyst

Laura Champine — Loop Capital — Analyst

Aneesha Sherman — Bernstein — Analyst

Corey Tarlowe — Jefferies — Analyst

Simeon Siegel — BMO Capital Markets — Analyst

Marni Shapiro — Retail Tracker — Analyst

Presentation:

Operator

Good afternoon, and welcome to the Ross Stores Second Quarter 2022 Earnings Release Conference Call.

[Operator Instructions] Before we get started, on behalf of Ross Stores, I would like to note that 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 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 2021 Form 10-K and fiscal 2022 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 — Vice Chair and Chief Executive Officer

Good afternoon. Joining me on our call today are Michael Hartshorn, Group President and Chief Operating Officer; Adam Orvos, Executive Vice President and Chief Financial Officer; and Connie Kao, Group Vice President, Investor Relations. We’ll begin our call today with a review of our second quarter 2022 performance, followed by our updated outlook for the second half 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 disappointed with our sales results, which were impacted by the mounting inflationary pressures our customers faced as well as an increasingly promotional retail environment. Earnings came in above our guidance range, primarily due to lower incentive costs resulting from the below-plan top line performance. Total sales for the period were $4.6 billion versus $4.8 billion in the prior year period. Comparable store sales were down 7% compared to a robust 15% increase in last year’s second quarter, which was our strongest period of 2021.

Earnings per share for the 13 weeks ended July 30, 2022, were $1.11 on net income of $385 million. These results compared to $1.39 per share on net earnings of $494 million for last year’s second quarter. For the first six months, earnings per share were $2.08 on net income of $723 million. These results compared to earnings per share of $2.73 on net earnings of $971 million in the first half of 2021.

Sales for the 2022 year-to-date period were $8.9 billion with comparable sales down 7% versus a strong 14% gain in the first half of 2021. Shoes and men’s were the strongest merchandise areas during the quarter. Both Florida and Texas were the top-performing regions, mainly due to the outperformance of our border and tourist locations. We are making merchandising adjustments to meet changing customer demand. That said, the actions we have taken thus far were unable to offset the mounting financial pressures on our low- to moderate-income consumers and the impact on our business from an increasingly promotional retail environment.

Similar to the first quarter, dd’s DISCOUNTS performance in the second quarter continued to be well below Ross’s, mainly due to today’s escalating inflationary pressures that are having a larger impact on dd’s lower-income customers. At quarter end, total consolidated inventories were up 55% versus the same period in 2021. While average store inventory during the quarter were up 15% versus last year, we operated with very similar levels when compared to pre-pandemic.

Packaway merchandise represented 41% of total inventory versus 30% in the same period of the prior year when we used a substantial amount of packaways to meet robust consumer demand. Additionally, supply chain congestion continued to ease during the second quarter, resulting in above-plan early receipts of merchandise that we stored in packaway and will flow to stores throughout the fall season. Looking ahead, we expect these early receipts to wane and to have the appropriate inventory levels in the fourth quarter.

Turning to store growth. Our 2022 expansion program is on schedule with the addition of 21 new Ross and eight dd’s DISCOUNTS locations in the second quarter. We remain on track to open a total of approximately 100 locations this year comprised of about 75 Ross and 25 dd’s. As usual, these numbers do not reflect our plans to close or relocate about 10 stores. Now Adam will provide further details on our second quarter results and additional color on our updated outlook for the remainder of fiscal 2022.

Adam Orvos — Executive Vice President and Chief Financial Officer

Thank you, Barbara. As previously mentioned, our comparable store sales were down 7% for the quarter as a decline in the number of transactions versus the prior year was partially offset by an increase in the size of the average basket. Second quarter operating margin was 11.3% compared to 14.1% in 2021. This decline was due to a combination of deleveraging effect on expenses from the decrease in same-store sales, higher markdowns and ongoing headwinds from higher freight costs that did not begin to escalate until the second half of 2021. These expense pressures were partially offset by lower incentive costs that were much higher last year when we significantly outperformed our plans.

We also saw a decline in COVID expenses versus last year’s second quarter. Cost of goods sold during the period increased by 320 basis points. Merchandise margin declined 205 basis points due to both higher ocean freight costs and markdowns. Distribution costs increased 85 basis points due to a combination of unfavorable timing of packaway-related expenses and deleverage from our new distribution center, while occupancy and domestic freight rose by 55 and 35 basis points, respectively. Partially offsetting these higher costs were buying expenses that improved by 60 basis points, again due to lower incentives.

SG&A for the period levered by 40 basis points as deleverage from the lower comparable sales was more than offset by lower incentive and COVID costs. During the second quarter, we repurchased 2.9 million shares of common stock for an aggregate cost of $235 million. As previously announced, we expect to buy back $950 million of common stock during fiscal 2022 under our two-year $1.9 billion repurchase program that extends through fiscal 2023.

Now let’s discuss our outlook for the remainder of 2022. As Barbara noted in today’s press release, given our recent results as well as the increasingly unpredictable macroeconomic landscape in today’s more promotional retail environment, we believe it is prudent to adopt a more conservative outlook for the balance of the year. We are now forecasting comparable sales for the 13 weeks ending October 29, 2022, to decline 7% to 9% on top of a strong 14% gain last year. For the fourth quarter, same-store sales are planned to be down 4% to 7% versus a 9% increase in the last quarter of 2021.

As noted in our press release, if the second half performs in line with these updated sales assumptions, earnings per share for the third quarter is projected to be $0.72 to $0.83 versus $1.09 last year and $1.04 to $1.21 for the fourth quarter compared to $1.04 in 2021. Based on our first half results and second half guidance, earnings per share for fiscal 2022 are now planned to be in the range of $3.84 to $4.12 versus $4.87 last year.

Now let’s turn to our guidance assumptions for the third quarter of 2022. Total sales are forecasted to decline 4% to 7% versus the prior year. We expect to open 41 locations during the quarter, including 29 Ross and 12 dd’s DISCOUNTS locations. Operating margin for the third quarter is planned to be in the 7.8% to 8.7% range versus 11.4% in 2021, primarily reflecting the deleverage on the same-store sales decline. In addition, merchandise margin is forecast to be pressured by ongoing increases in ocean freight costs. We are also projecting higher markdowns to right-size our inventory levels given the lower revenue forecast and adjust pricing as we expect an increasingly promotional retail environment.

Lastly, third quarter operating margin also reflects unfavorable timing of packaway-related costs. Interest expense is estimated to be approximately $400,000. The tax rate is projected to be about 24% to 25% and diluted shares outstanding are expected to be approximately 345 million.

Finally, I want to emphasize that Ross continues to be in a strong financial position with significant resources to manage through today’s challenging economic and retail landscape. Our healthy balance sheet includes $5.2 billion in total liquidity with $3.9 billion in cash and $1.3 billion in untapped borrowing capacity. We also continue to return large amounts of cash to stockholders with a cumulative total of $1.4 billion expected to be paid out under our stock repurchase and dividend programs in 2022.

Now I will turn the call over to Barbara for closing comments.

Barbara Rentler — Vice Chair and Chief Executive Officer

Thank you, Adam. We are facing a very difficult and uncertain macroeconomic environment that we expect will continue to strain our customers’ discretionary spending. Though 2022 will likely remain a challenging year for our company, we believe our value-focused business model and our strong financial position will enable us to manage through these economic pressures and rebound over time. At this point, we’d like to open up the call and respond to any questions you may have.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Lorraine Hutchinson with Bank of America. Please proceed with your question.

Lorraine Hutchinson — Bank of America — Analyst

Thanks. Good afternoon. So you’ve included a better fourth quarter comp versus 3Q in your guidance. Can you talk about the areas of opportunity that you see in the fourth quarter? And also, what gives you confidence that things will improve?

Michael J. Hartshorn — Group President and Chief Operating Officer

Hi. It’s Michael Hartshorn. First, on the fourth quarter guidance alone, if you look at the multiyear compare, we did a 9% last year. So it’s one of the easiest compares, which is really the driver of the 4% to 7% comp this year in guidance.

Barbara Rentler — Vice Chair and Chief Executive Officer

So Lorraine, in terms of opportunities in terms of the fourth quarter, I think that would be around gifting — that we didn’t maximize some of our gifting areas last year.

Operator

Thank you. Our next question comes from the line of Paul Lejuez with Citigroup. Please proceed with your question.

Paul Lejuez — Citigroup — Analyst

Hey. Thanks, guys. Sorry if I missed it, but curious about the performance of home versus apparel and if there were any notable trends in those categories, how they trend throughout the quarter, get worse, get better. And I’m also curious if you think the comp shortfall was all macro driven or if you attribute any sort of execution issues that might have also factored in. Thanks.

Barbara Rentler — Vice Chair and Chief Executive Officer

Home sales are relatively in line with the chain average and the performance of home and apparel was pretty similar for the quarter. Both businesses had areas of business that were strong and areas of business that were weaker, so they were relatively in line.

Michael J. Hartshorn — Group President and Chief Operating Officer

Paul, on the macro, I mean, of course, there are things that we know we could have done better in the business. In terms of trends during the quarter, we outperformed earlier in the quarter, both on a single-year and a multiyear basis. And I think if you looked across retail, I think people weakened in the back half of the quarter. Obviously, fuel prices peaked in June so a portion of the performance is certainly driven by the macroeconomic environment.

Paul Lejuez — Citigroup — Analyst

I think some have also seen a little bit of an improvement at the end of July into August. Anything you can share on that front?

Michael J. Hartshorn — Group President and Chief Operating Officer

Yes. We wouldn’t comment on trends within this next quarter.

Paul Lejuez — Citigroup — Analyst

Okay. Thanks. Good luck.

Operator

Thank you. Our next question comes from the line of Kimberly Greenberger with Morgan Stanley. Please proceed with your question.

Kimberly Greenberger — Morgan Stanley — Analyst

Okay. Great. Thanks so much. Barbara, on the last call, you talked about the very significant shift you were seeing in the kinds of categories and the types of products that Ross shoppers were buying and how much that had changed by April and May compared to when we started the year. I know you were working here through the second quarter to reposition inventory and sort of pivot toward those categories. I’m wondering if you can just talk about where you are on that journey, the progress you made in the second quarter and what — where you sit today, what’s your evaluation of the progress? And is there still more to go in the second half of the year? Thanks.

Barbara Rentler — Vice Chair and Chief Executive Officer

Sure. The pivot was to take us out of casual product into more things that the customer wanted. So more wear-to-work in men’s and ladies, more social, more going out-type products, whether that would have been in shoes or ready-to-wear. That’s really where the main shift was on the apparel side. We’ve made some progress there, but we certainly have a longer way to go. But I feel much better about where we were — from where we were in Q1 to where we are now because we’ve really been able to expand some of those assortments when I felt like we were a little bit behind.

So — and then in terms of go forward, we’re going to meet whatever the customer demand is. So with everything that is so difficult out there, a highly promotional environment, we’re going to see where the customer tells us, where and when what she wants, and then we’ll make the shift from there. But we feel like we’re in a better state of balance between, let’s say, casual and more wear-to-work products in men’s and ladies.

Kimberly Greenberger — Morgan Stanley — Analyst

Fantastic. That’s really helpful, Barbara. And just one follow-up on the product. Are you starting to see new vendors come to Ross? Maybe vendors that you didn’t work with last year or in 2020? I’m just wondering if the more robust buying environment is yielding an opportunity to maybe work with additional vendors that you haven’t seen for the last year or two.

Barbara Rentler — Vice Chair and Chief Executive Officer

The answer to that is yes. Both new vendors or vendors that perhaps, we hadn’t seen availability from for an extended period of time, the availability out there is pretty broad-based right now in all products and a good — better basket. There’s just a lot of merchandise in the country. And so I think vendors themselves are looking to expand their business. And if they haven’t been doing business with us, at least it was an opportunity. So yes, I think that — and I think that probably will continue based on the amount of inventory that’s in the country.

Kimberly Greenberger — Morgan Stanley — Analyst

Terrific. Thanks so much.

Operator

Thank you. Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question.

Chuck Grom — Gordon Haskett — Analyst

Thanks very much. Good afternoon. Barbara, how do you balance taking advantage of the great deals in the marketplace today versus waiting for better deals down the road? Because I imagine the deals today look a lot better than they did a few months ago than those you’re getting today. And I guess as a follow-up, when should we expect those to start showing up in the P&L for you, guys? Is that a third and fourth quarter phenomenon? Or do we start to see that in ’23?

Barbara Rentler — Vice Chair and Chief Executive Officer

Okay. Just first, in terms of the deals, it was a good deal today just to get better as we go. The merchants are really out there in the market shopping to see what’s out there, shopping to see what the availability is. And to assess where the product is the best product — we use a lot of product out there. What you really want to do is get the best product at the best price, so the merchants are out there assessing what that looks like. And then you really want to get the most desirable product, right? So if it’s the best product and you think that’s a really sharp price and something you haven’t been able to really get or deployed. You’re going to pull the trigger and buy it. If there’s a lot of — if there’s products where there’s lots and lots of availability, you might buy some metered in, you might pack some away for the following year. I mean, it’s not just one kind of cookie-cutter answer here. I think that the key thing now for the merchants is really to be out there understanding the promotional environment, right? So when you’re buying goods now, what you really have to be attuned to is what is the right value.

So the buyers have to be very strategic in terms of buying the right merchandise at the appropriate value for customers, given the current inflationary environment. So I think it’s supply, and it’s really studying what’s going on in the outside world with so much inventory sitting in retail stores, with the inflated inventory and a more promotional environment, which I think we all believe is probably going to get more heightened in the fourth quarter. So there’s a variety of things that need to happen there, so I don’t think it’s quite the cookie-cutter. So to get to, I think we’ll see some for this year. I think there’ll be some packaway for spring, and there may even potentially be some packaway for fall. But we have to wait and see what that looks like.

Chuck Grom — Gordon Haskett — Analyst

Great. Thank you.

Operator

Thank you. Our next question comes from the line of Matthew Boss with JPMorgan. Please proceed with your question.

Matthew Boss — JPMorgan — Analyst

Great. Thanks. Barbara, so larger picture, on the mounting inflationary pressure that you cited on your customer, how does this affect the value and convenience elements of your model? Or is there anything that you’re seeing today that’s different than past times of consumer disruption where your model actually outperforms over time? And then Adam, while sales are below your target model today, are there any structural underlying changes to the models margin as we think about multiyear in your view?

Barbara Rentler — Vice Chair and Chief Executive Officer

So Matthew, in terms of mounting inflation, I think over the last few months, we had initially made strategic price increases. And I think with the slowing consumer demand and the escalating inflationary pressures, it all comes down to value. And so for us to be successful, we really need to make sure that we understand the value of what’s going on around us and get ourselves really highly focused on that because that really, in the end, is what will make us successful. Our customer is looking for branded bargains, great values every day. That’s what she’s come to expect for 40 years, and that’s what she expects from us now.

So I think that really comes down to the merchants being in the market, understanding the availability, understanding what’s going on and then knowing when to pull the trigger and to drive it because that’s what helped us from 2008 to 2009. And I think that, that will help — what will help us here also in getting ourselves in the right value when the customer is under so much pressure with all the macroeconomic issues that are out there.

Adam Orvos — Executive Vice President and Chief Financial Officer

And Matthew, this is Adam. So we don’t see anything structurally different in our model, still feel bullish about the environment, the retail environment in our model going forward. When we talk about multiyear and think about 2023, specifically, I think the key is we’re going to have to see how the inflationary aspects play out in the second half. That’s obviously a critical variable. How we plan sales next year, profitability will be highly dependent on that kind of top line assumption.

Michael J. Hartshorn — Group President and Chief Operating Officer

Matthew, just to add to that, obviously, since the pre-pandemic, the changes have been really around the cost in the business, and those are acutely in two different places with wages and transportation, whether domestically or on imports. I think what we expect to see is both the domestic and import costs to come down over time. We’re already starting to see some break in those costs here in the back half, especially on the import costs. So I think those will come down, which will be a benefit to us. On the wage front, I think the increases we saw during COVID are structural at the current levels and are at least at this level. What I’d say about the wage market right now is it’s still tight, but it is stable, which is much different from where we were last year when we were getting people back to work and there was frenzied demand in the U.S. So I think there is going to be some opportunity in cost as the transportation comes down with the lower demand in the U.S.

Matthew Boss — JPMorgan — Analyst

Great color. Best of luck.

Operator

Thank you. Our next question comes from the line of Adrienne Yih with Barclays. Please proceed with your question.

Adrienne Yih — Barclays — Analyst

Great. Thank you very much. Barbara, this is sort of more of an opinion question for you. I’m wondering if you believe that the aggressive discretionary promotions at Walmart and Target are maybe temporarily taking some market share away. And I guess in the past, when they aren’t as promotional, might that alleviate kind of some of the kind of market share shifts that are going on? So that’s my first question. And then for Michael, can you talk about any price pass-through attempts, if any? And I know that you guys have been very, very careful about that. And what does your average unit cost look like at this point kind of heading into holiday? Thank you very much.

Barbara Rentler — Vice Chair and Chief Executive Officer

Adrienne, as it pertains to Walmart, look, I think we look at everyone as a competitor, whether it’s Walmart, whether it’s the other off-pricers, whether it’s Macy’s. I think there’s a lot of opportunities for the consumer to buy bargains now and whether it’s Walmart or Target, whoever it is, and so it’s hard for us to measure that. I think the most important thing that we can do now is really, we need to understand value. And we need to understand where we need to be on the value equation with the customer. And that is a shift from where we were. So I think it’s very — it’s hard for us to measure that. But again, it’s more competition. And they have both been very aggressive in their pricing, as we all know, to move through some goods. So that’s our job to understand it.

Adrienne Yih — Barclays — Analyst

Helpful. Thank you.

Michael J. Hartshorn — Group President and Chief Operating Officer

On pricing, what we saw during the quarter on AUR, so AURs were up during the quarter. As we said in the commentary, the minus 7% comp was a function of lower traffic and higher basket. The basket was really driven by a higher AUR. What we’d expect for the fall season with us really trying to drive value and with our additional markdowns, we’d expect AURs to moderate versus the first half over the balance of the year.

Adrienne Yih — Barclays — Analyst

Thank you very much. Best of luck.

Operator

Thank you. Our next question comes from the line of Mark Altschwager with Baird. Please proceed with your question.

Mark Altschwager — Baird — Analyst

Great. Thank you for taking my question. I guess for Michael or Adam, the sales outlook is slightly better in Q4 versus Q3, though the magnitude of the implied margin inflection, I think, is fairly significant if I’m reading it all correctly. Is that primarily markdowns in Q3 that are expected to be kind of cleared through by Q4? Or are there kind of other things that are going on there? Thank you.

Michael J. Hartshorn — Group President and Chief Operating Officer

Just on Q4, as I mentioned in Lorraine’s question, that was our lowest comp last year, and that was a function of, one, with supply chain congestion, we didn’t get all the goods we wanted to in the stores before the holiday, and there was also an Omicron spike leading up to Christmas that dampened traffic a bit. So that should be a benefit versus last year. And then the fourth quarter was the peak of our cost increases, including incentives, and cost in the business, whether it was ocean freight or wage increases to staff in the store and the DCs for holiday. So we’re up against that, and that will be a benefit versus last year.

Adam Orvos — Executive Vice President and Chief Financial Officer

And Mark, this is Adam. Just to build on that, I think when you look at timing in third quarter versus fourth quarter, ocean freight probably is still headwinds as we move into third quarter just based on the comparison to LY and then probably some favorability, specifically in ocean freight in fourth quarter, and then probably a little bit more timing impact from our packaway cost in third quarter versus fourth quarter.

Mark Altschwager — Baird — Analyst

Very helpful. Thank you.

Michael J. Hartshorn — Group President and Chief Operating Officer

You bet.

Operator

Thank you. Our next question comes from the line of Brooke Roach with Goldman Sachs. Please proceed with your question.

Brooke Roach — Goldman Sachs — Analyst

Good afternoon and thank you for taking our question. Barbara, I’d like to ask you if you’re seeing any evidence of trade-down in your business. Are you seeing any new customer acquisition above and beyond traditional levels from customers that typically don’t shop Ross Stores? And then maybe as a follow-up, you commented on plans to adjust pricing and markdowns in the third quarter. Can you comment on the magnitude and the time line to achieve a more normalized markdown level and when you might be a little bit more clean? Thank you.

Michael J. Hartshorn — Group President and Chief Operating Officer

On the consumer, we’re not seeing any change, certainly. Since — if I take the first to the second quarter with our comps, they’ve been relatively consistent. The composition of comps have been relatively consistent. If I compare it to when we started to lap the stimulus from last year, and our customer surveys and our own performance would suggest that where we’re really seeing pressure is the lower-end consumer. But on the trade-down customer, there’s no indication that is in our data that would suggest that that’s happening.

Barbara Rentler — Vice Chair and Chief Executive Officer

But we do serve a wide range of customers. Today, we serve a wide range of customers. So we’re going to watch trends closely and then we’ll make merchandising adjustments accordingly. So it would probably take us some time to see because our range of customers is so broad.

Operator

Thank you. Our next question comes from the line of Michael Binetti with Credit Suisse. Please proceed with your question.

Michael Binetti — Credit Suisse — Analyst

Hey, guys. Thanks for help here. I just want to make sure I have — I understand. I’m thinking alongside you guys on the model. I think that as we look at like the three-year growth rate in third quarter — in the fourth quarter, take like a 2- to 3-point step down in the way that you’re guiding fourth quarter is — but you’re expecting markdowns to ramp, which I would assume are going to give you a good shot of bringing in a new customer. Is that deceleration? I’m curious what the deceleration is based on. Is that based on your insights for the industry slowing? Or Barb, you just mentioned you’re hopeful that trade-down can start to happen after some period of time. Do you not bake that in, in fourth quarter? Maybe some help on how you’re thinking about that deceleration.

Michael J. Hartshorn — Group President and Chief Operating Officer

Michael, it’s really a function — it’s our biggest quarter. It bodes — serves us well to be very cautious, especially after missing two quarters in a row on top line, so we are being cautious in the fourth quarter. And we do think it’s going to be a very promotional environment, so that’s what it’s based on.

Barbara Rentler — Vice Chair and Chief Executive Officer

Right. And also, based off the supply lines in the world, if, in fact, the trends line turns out to be better than we think it is, we’re going to be able to chase some of that.

Operator

Thank you. Our next question comes from the line of Ike Boruchow with Wells Fargo. Please proceed with your question.

Ike Boruchow — Wells Fargo — Analyst

Hey, guys. Just want to talk about the packaway inventory, up in year-over-year as a percent of inventory and in dollars, up pretty meaningfully. I know you’re not going to go into specifics. But just curiously, maybe at a high level, can you talk about the buying margins, the closeout margins you guys are basically seeing today versus, I don’t know, 12 months ago, 18 months ago? Are they starting to ramp up? Where — how does that look maybe versus, again, like I said, 12 months ago or maybe versus history? Just any kind of color at a high level would be interesting. Thanks.

Michael J. Hartshorn — Group President and Chief Operating Officer

Ike, first, on the — on what we have in packaway. We are up as a percentage of total inventory, but that is up against last year when we were using a lot of our packaway in the frenzied demand in the second quarter, which was our top comp for 2021. And then also, packaway right now includes early receipts of merchandise, and that’s mainly home product. And what happened there is that last year, we’re experiencing longer lead times. We were having difficulty getting products on time and on plan. So what we did this year is extended our lead times coming into the first quarter in our ordering cycle.

What we saw in the first quarter is those — surprisingly, lead times improved, but we kept the longer lead times in the second quarter because we were concerned about port labor negotiations in L.A. and also COVID — continuing COVID shutdowns in China. Neither of those risks played out and with lower demand in the U.S., lead times actually improved. So we have stored in packaway early receipts of home that will flow in the back half of the year.

Barbara Rentler — Vice Chair and Chief Executive Officer

In terms of margins on closeouts and upfront, it’s hard to compare one year to another based on — it’s hard to compare what I bought this year versus what I had historically, so it’s not necessarily quite as simple as just as going, here’s the pitch on it. So I think it remains to be seen on the closeout rates. We’ve seen what kind of values we need to put on the floor and what availability, when people want to move it. It’s a measured balance.

Ike Boruchow — Wells Fargo — Analyst

Understood. Thank you.

Operator

Thank you. Our next question comes from the line of Jay Sole with UBS. Please proceed with your question.

Jay Sole — UBS — Analyst

Great. Thank you so much. I just want to dig into the AUR strategy for the back half of the year. Are you saying that you’re going to use AUR as a lever to try to take share and alleviate some of the traffic issue that you’ve had recently?

Barbara Rentler — Vice Chair and Chief Executive Officer

Yes. Listen, we’re in the value business. And in the last couple of quarters, we’ve really — we’ve made some strategic price increases. And the customer, based on slowing demand and inflationary pressures, has voted that she doesn’t necessarily think the value is where it needs to be. So yes, if we could get — we want to get our AUR more in line, and we want to offer the customer more value. And the AUR can move around based off of mix, right, because it doesn’t necessarily mean depending upon what types of products you have on the floor, the AUR can move. I think the word we’re looking here is for value. And clearly, the more value we offer the customer, history would tell us that we would perform better. So that is our strategy. I mean based off of where she is and the pressure that the customer is under, that’s really what we need to do. We need to understand what the outside world is doing and we need to offer better value.

Jay Sole — UBS — Analyst

Okay. Thank you so much.

Operator

Thank you. Our next question comes from the line of Dana Telsey with Telsey Advisory Group. Please proceed with your question.

Dana Telsey — Telsey Advisory Group — Analyst

Good afternoon, everyone. As you see the differences between the Ross and the dd’s chain, what are the differences between the 2? And whether it’s traffic or whether it’s product sell-through and what you’re saying? And is your AUR strategy at all different with dd’s and Ross in terms of magnitude for the back half of the year? Thank you.

Michael J. Hartshorn — Group President and Chief Operating Officer

Hi, Dana. On dd’s, so similar to Q1, dd’s performance in Q2 continued to be well below Ross, although up against very robust comps last year. The inflationary pressure here has even a larger impact on the dd’s low-income customer. dd’s average household income is $40,000 to $45,000. Therefore, this customer is obviously more sensitive to the pressures in fuel and food costs and other inflationary purchases. I would say like Ross, our focus is on delivering the best bargains, but we need to even provide greater value to the dd’s customer. And like Ross, we built in higher markdowns in the back half of the year.

Dana Telsey — Telsey Advisory Group — Analyst

Thank you.

Operator

Thank you. Our next question comes from the line of Laura Champine with Loop Capital. Please proceed with your question.

Laura Champine — Loop Capital — Analyst

Thanks for taking my question. I’ve got a couple. So when do you think that logistics costs will start to ease? And then secondly, you mentioned more clearance activity in Q3. When do you think that inventories come more in line with sales trends, assuming that’s a goal given the packaway opportunities you see?

Michael J. Hartshorn — Group President and Chief Operating Officer

Laura, it’s Mike. On logistics cost, we’re already seeing them. They already seemed to have peaked and have started to come down. I think it’s different between domestic and ocean freight. I think ocean freight, there are a lot of long-term contracts that it may take some time to come down. But certainly, the current noncontract market is below the contract rate. So we’re starting to see some movement even on contract rates. Domestic, at least for us, we expect domestic costs to be relatively neutral in the back half because we started seeing them rising in the back half of last year. But I suspect over time, both of them will come down and maybe not to the levels that we saw pre-pandemic though.

Barbara Rentler — Vice Chair and Chief Executive Officer

And then in terms of the inventory level coming down, we see that moving as it goes throughout the fall. But with that, we have liquidity, and we’re comfortable with our liquidity. And so we have — open to buy to take advantage of opportunities. So it’s kind of two things going on at the same time.

Laura Champine — Loop Capital — Analyst

Got it. Thank you.

Operator

Thank you. Our next question comes from the line of Aneesha Sherman with Bernstein. Please proceed with your question.

Aneesha Sherman — Bernstein — Analyst

Thanks. So if I heard it right, the in-store inventory levels at the moment are about in line with what you saw pre-pandemic. So just trying to understand the rationale for the higher markdowns you’re doing now as well as into the second half. Is it about your product mix and you’re seeing slowing trends in certain categories in the rebalancing? Or is it more about benchmarking to the external environment that’s becoming more promotional? What’s the bigger driver of the markdowns you expect?

Barbara Rentler — Vice Chair and Chief Executive Officer

I think it’s a combination of both. But I think the promotional environment has gotten so aggressive in such a short period of time that we need to make the move on the goods. Otherwise, we’re not offering the customer the value that she wants and needs, and so that’s played a big part of it. And then there’s always — there always is. There’s always businesses that aren’t good or they need to take markdowns more aggressively. But that’s really — it’s the promotional cadence and just really watching where the AUR is in the outside world and being very, very conscious of that and understanding that. So getting — the faster we get to the value equation that she really wants, the better our performance will be.

Aneesha Sherman — Bernstein — Analyst

Thank you.

Operator

Thank you. Our next question comes from the line of Corey Tarlowe with Jefferies. Please proceed with your question.

Corey Tarlowe — Jefferies — Analyst

Hi. Good afternoon. Thanks for taking my que stion. Barbara, you mentioned realigning the value equation to where you think it needs to be. And with that, are there any cost savings initiatives that you have in place to help to kind of underpin the profitability and the profit goals that you have for the remainder of this year?

Michael J. Hartshorn — Group President and Chief Operating Officer

I would say from an expense structure standpoint, we absolutely have put in places, whether using technology in the stores or automation in our distribution centers, which is our big pockets of expense, we’ve continued to add new capabilities in stores and in the distribution centers to increase efficiency and reduce costs.

Corey Tarlowe — Jefferies — Analyst

Great. And then as it relates to the store opportunity and real estate and the rent structures and your lease renewals, are you seeing anything incrementally helpful on the expense side there as well?

Michael J. Hartshorn — Group President and Chief Operating Officer

I wouldn’t say there’s anything material in that renewal process, but we will continue to open stores. As we said in the comment, we’ll open 100 stores this year. And at this point, don’t see any changes in our expansion plans. But I would say overall on the renewals and the new rents, there’s nothing that I’d call out specifically.

Corey Tarlowe — Jefferies — Analyst

Great. Very helpful. Thank you very much and best of luck.

Operator

Thank you. Our next question comes from the line of Simeon Siegel with BMO Capital Markets. Please proceed with your question.

Simeon Siegel — BMO Capital Markets — Analyst

Thanks. Good afternoon. Did you or could you, I guess, qualify like-for-like AUR versus maybe the mix shifts-driven AUR? Just trying to align the AUR with the markdown color. And then sorry for what’s probably a dumb question, but just can you help parse out the comment, that earnings beat, because of the lower incentive cost on the lower sales? I guess — just trying to understand what it means that you made more money on the bottom line because sales missed plan and how to think about maybe what levers you have at your disposal if top line pressures get worse. Thank you.

Michael J. Hartshorn — Group President and Chief Operating Officer

On the comment on incentive costs, it was a function of lower earnings. If we would have been at this comp level, we would have been fairly close to the low end of the earnings range. In terms of cost structure, certainly, there are other things we can do in the cost structure if we saw a greater decline in sales. They probably wouldn’t be great decisions for the long term or going into 2023, but we could certainly get more stark with our expense structure.

Barbara Rentler — Vice Chair and Chief Executive Officer

And could you just repeat the first question about the AUR markdowns? Could you just say that again?

Simeon Siegel — BMO Capital Markets — Analyst

Yes, sure. So just within AUR, I guess, any way to think through like-for-like is tough given your product offering. But just if AUR — how much may have been driven by mix shift versus like-for-like?

Barbara Rentler — Vice Chair and Chief Executive Officer

Part of it was driven by mix shift because there were businesses that we didn’t maximize last year because of supply lines or, for example, things like shoes, which runs a higher AUR. So part of it comes from mix, where we couldn’t get the supply we needed last year fast enough to drive the sales higher. But the other part of it just comes from — strategically, we strategically increased some prices where we have other, potentially, assortment shifts within the mix. And so it’s kind of hard to really quantify that in saying because we’re comparing casual product to wear-to-work product now. Wear-to-work product has higher AURs than active wear.

So I would — all I could tell you really is it’s a mix. It’s really a mix of both. Certainly, apparel raises the AUR compared to casual. And definitely, shoes helped to raise the AUR because it’s just a different product base, and we couldn’t get the supply we needed last year. So those would be my two main call-outs on that.

Simeon Siegel — BMO Capital Markets — Analyst

Got it. Thanks a lot. Best of luck for the rest of the year.

Operator

Thank you. Our final question comes from the line of Marni Shapiro with Retail Tracker. Please proceed with your question.

Marni Shapiro — Retail Tracker — Analyst

Thanks, guys. Can you just give a quick update? Are there any changes on the store openings for this year? And then, Barbara, I have a bigger picture question just about the use of packaways in back-to-school. As kids are going back to school, do you think you are well set up in uniform and what they need for back-to-school? And are you seeing a difference in the way she’s shopping? Meaning is she buying what she needs and holding off on what she wants? Maybe the new fashion top, but her kids are getting her back-to-school clothing.

Michael J. Hartshorn — Group President and Chief Operating Officer

Marni, on real estate, no change. We expect to open 100 locations, and that’s 41 stores over the balance of the year.

Marni Shapiro — Retail Tracker — Analyst

Okay. Thank you.

Barbara Rentler — Vice Chair and Chief Executive Officer

And in terms of back-to-school, I would — she bought — she’s buying definitely the necessities. She is buying uniforms and backpacks and all of those products. I also think that part of what she bought for back-to-school was she might have bought her child shorts when people started taking markdowns on, let’s say, denim shorts earlier. So I think it’s kind of a mixed bag. But I think if we were historically talking about back-to-school over time, the customer has bought merchandise much closer to the time they go to school or immediately after they get in school. It’s hard to tell now with the pandemic, right? So that [Technical Issues] and so I think it’s a combination of both. But it’s been very hard to read without having two or three years of any real history on it, so.

Marni Shapiro — Retail Tracker — Analyst

Right. I guess that makes sense. It feels like it’s going to be a later back-to-school this year anyway with pressure on her. And so it feels like she’s buying what she needs, and everything else could kind of take a pause. And so maybe there’s a break in weather or whatever it is. And then just one last. On holiday traffic, last year, you had — your inventories were clean. But also, we had Omicron hit at some point in December. And so it feels like there’s a real opportunity even in just driving traffic to the stores for gifting and — during that period of time, assuming there’s not some, I don’t know, new variant, the gamma 5 variant or whatever it is.

Michael J. Hartshorn — Group President and Chief Operating Officer

You’re right, Marni. Last year, we were impacted, especially approaching Christmas with Omicron. And then within our own performance, we had difficulty getting good holiday goods through the supply chain.

Marni Shapiro — Retail Tracker — Analyst

Okay. I just wanted to confirm. Great. Best of luck, guys, with the rest of back-to-school and fall.

Barbara Rentler — Vice Chair and Chief Executive Officer

Thanks.

Michael J. Hartshorn — Group President and Chief Operating Officer

Thank you.

Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session. I will now turn the call back over to Barbara Rentler for closing remarks.

Barbara Rentler — Vice Chair and Chief Executive Officer

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

Operator

[Operator Closing Remarks]