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ROSS STORES INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This section and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A (Risk Factors) below. The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the consolidated financial statements and notes thereto in our Annual Report on Form 10-K for 2013. All information is based on our fiscal calendar. Overview Ross Stores, Inc. operates two brands of off-price retail apparel and home fashion stores -- Ross Dress for Less® ("Ross") and dd's DISCOUNTS®. Ross is the largest off-price apparel and home fashion chain in the United States with 1,172 locations in 33 states, the District of Columbia and Guam as of May 3, 2014. Ross offers first-quality, in-season, name brand and designer apparel, accessories, footwear, and home fashions for the entire family at everyday savings of 20% to 60% off department and specialty store regular prices. We also operate 137 dd's DISCOUNTS stores in 10 states that feature a more moderately-priced assortment of first-quality, in-season, name brand apparel, accessories, footwear, and home fashions for the entire family at everyday savings of 20% to 70% off moderate department and discount store regular prices as of May 3, 2014. Results of Operations The following table summarizes the financial results for the three month periods ended May 3, 2014 and May 4, 2013: Three Months Ended May 3, 2014 May 4, 2013 Sales Sales (millions) $ 2,681 $ 2,540 Sales growth 5.5 % 7.8 % Comparable store sales growth 1 % 3 % Costs and expenses (as a percent of sales) Cost of goods sold 71.2 % 70.8 % Selling, general and administrative 14.2 % 14.3 % Interest (income) expense, net 0.0 % 0.0 % Earnings before taxes (as a percent of sales) 14.6 % 14.9 % Net earnings (as a percent of sales) 9.1 % 9.2 % 13-------------------------------------------------------------------------------- Stores. Our expansion strategy is to open additional stores based on market penetration, local demographic characteristics, competition, expected store profitability, and the ability to leverage overhead expenses. We continually evaluate opportunistic real estate acquisitions and opportunities for potential new store locations. We also evaluate our current store locations and determine store closures based on similar criteria. Three Months Ended Store Count May 3, 2014 May 4, 2013 Beginning of the period 1,276 1,199 Opened in the period 37 28 Closed in the period (4 ) - End of the period 1,309 1,227 Sales. Sales for the three month period ended May 3, 2014 increased $140.7 million, or 6%, compared to the three month period ended May 4, 2013, due to the opening of 82 net new stores between May 4, 2013 and May 3, 2014 and a 1% increase in "comparable" store sales (defined as stores that have been open for more than 14 complete months). Our sales mix for the three month periods ended May 3, 2014 and May 4, 2013 is shown below: Three Months Ended May 3, 2014 May 4, 2013 Ladies 31 % 31 % Home Accents and Bed and Bath 23 % 22 % Shoes 13 % 14 % Accessories, Lingerie, Fine Jewelry, and Fragrances 13 % 13 % Men's 12 % 12 % Children's 8 % 8 % Total 100 % 100 % We intend to address the competitive climate for off-price apparel and home goods by pursuing and refining our existing strategies and by continuing to strengthen our organization, diversify our merchandise mix, and more fully develop our systems to improve regional and local merchandise offerings. Although our strategies and store expansion program contributed to sales gains for the three month period ended May 3, 2014, we cannot be sure that they will result in a continuation of sales growth or in an increase in net earnings. Cost of goods sold. Cost of goods sold for the three month period ended May 3, 2014 increased $109 million compared to the same period in the prior year, mainly due to increased sales from the opening of 82 net new stores between May 4, 2013 and May 3, 2014 and a 1% increase in comparable store sales. Cost of goods sold as a percentage of sales for the three month period ended May 3, 2014 increased approximately 35 basis points from the same period in the prior year. This was primarily driven by deleverage from the 1% increase in comparable store sales on occupancy and buying costs, which increased 20 and 10 basis points, respectively, and from a decline of about 10 basis points in merchandise margin. These expenses were partially offset by distribution costs which improved by approximately 5 basis points versus the same period in 2013. We cannot be sure that the gross profit margins realized for the three month period ended May 3, 2014 will continue in the future. Selling, general and administrative expenses. For the three month period ended May 3, 2014, selling, general and administrative expenses ("SG&A") increased $18 million compared to the same period in the prior year mainly due to increased store operating costs reflecting the opening of 82 net new stores between May 4, 2013 and May 3, 2014. 14-------------------------------------------------------------------------------- Selling, general and administrative expenses as a percentage of sales for the three month period ended May 3, 2014 declined 10 basis points compared to the same period in the prior year. Interest (income) expense, net. Net interest income as a percentage of sales remained relatively unchanged for the three month period ended May 3, 2014 compared to the same period in the prior year. Taxes on earnings. Our effective tax rate for both of the three month periods ended May 3, 2014 and May 4, 2013 was approximately 38%, which represents the applicable combined federal and state statutory rates reduced by the federal benefit of state taxes deductible on federal returns. The effective rate is impacted by changes in law, location of new stores, level of earnings, and the resolution of tax positions with various taxing authorities. We anticipate that our effective tax rate for fiscal 2014 will be approximately 38%. Net earnings. Net earnings as a percentage of sales for the three month period ended May 3, 2014 declined compared to the same period in the prior year primarily due to the increase in cost of goods sold. Earnings per share. Diluted earnings per share for the three month period ended May 3, 2014 was $1.15 compared to $1.07 in the prior year period. The 7% increase in diluted earnings per share is attributable to a 4% increase in net earnings and a 3% reduction in weighted average diluted shares outstanding due to the stock repurchase program. Financial Condition Liquidity and Capital Resources Our primary sources of funds for our business activities are cash flows from operations and short-term trade credit. Our primary ongoing cash requirements are for merchandise inventory purchases, payroll, rent, taxes, and capital expenditures in connection with new and existing stores, and investments in distribution centers, information systems, and buying and corporate offices. We also use cash to repurchase stock under our stock repurchase program and to pay dividends. Three Months Ended ($000) May 3, 2014 May 4, 2013Cash provided by operating activities $ 504,577 $ 352,859 Cash used in investing activities (143,658 ) (109,699 ) Cash used in financing activities (188,137 ) (175,747 ) Net increase in cash and cash equivalents $ 172,782 $ 67,413 Operating Activities Net cash provided by operating activities was $504.6 million and $352.9 million for the three month periods ended May 3, 2014 and May 4, 2013, respectively, and was primarily driven by net earnings excluding non-cash expenses for depreciation and amortization. Our primary source of operating cash flow is the sale of our merchandise inventory. We regularly review the age and condition of our merchandise and are able to maintain current merchandise inventory in our stores through replenishment processes and liquidation of slower-moving merchandise through clearance markdowns. The increase in cash flow from operating activities for the three month period ended May 3, 2014, compared to the same period in the prior year was primarily due to higher net earnings, an increase in accounts payable leverage (defined as accounts payable divided by merchandise inventory) and the timing of payments of certain expenses. The change in total merchandise inventory, net of the change in accounts payable, resulted in a source of cash of approximately $164 million for the three months ended May 3, 2014, compared to a source of cash of approximately $72 million for the three months ended May 4, 2013. Accounts payable leverage was 74%, 62%, and 70% as of May 3, 2014, February 1, 2014, and May 4, 2013, respectively. Changes in accounts payable leverage are primarily driven by the timing of receipts and payments. As a regular part of our business, packaway inventory levels will vary over time based on availability of compelling opportunities in the marketplace. Packaway merchandise is purchased with the intent that it will be stored in our 15 -------------------------------------------------------------------------------- warehouses until a later date. The timing of the release of packaway inventory to our stores is principally driven by the product mix and seasonality of the merchandise, and its relation to our store merchandise assortment plans. As such, the aging of packaway varies by merchandise category and seasonality of purchase, but typically packaway remains in storage less than six months. We expect to continue to take advantage of packaway inventory opportunities to deliver bargains to our customers. Changes in packaway inventory levels impact our operating cash flow. As of May 3, 2014, packaway inventory was 45% of total inventory compared to 49% at the end of fiscal 2013. At the end of the first quarter for fiscal 2013, packaway inventory was 45% of total inventory compared to 47% at the end of fiscal 2012. Investing Activities Net cash used in investing activities was $143.7 million and $109.7 million for the three month periods ended May 3, 2014 and May 4, 2013, respectively. The increase in cash used for investing activities for the three month period ended May 3, 2014, compared to the three month period ended May 4, 2013 was primarily due to an increase in our capital expenditures. Our capital expenditures were $148.7 million and $97.6 million for the three month periods ended May 3, 2014 and May 4, 2013, respectively. Our capital expenditures include costs to build or expand distribution centers, open new stores and improve existing stores, and for various other expenditures related to our information technology systems, buying, and corporate offices. In October 2013, we entered into a Sale-Purchase Agreement under which we have the right to purchase the office building where our New York buying office is located for $222 million. The building is subject to a 99 year ground lease through June 2111. The Sale-Purchase Agreement contemplates completion of the sale and purchase of the building on or before September 20, 2014, subject to satisfaction of various closing conditions. Under the Sale-Purchase Agreement, we provided a deposit of 10% of the purchase price. In the event we are unable or choose not to complete the purchase of the building, we would forfeit the deposit but have no further liability to the seller or obligation to complete the purchase. In September 2013, we deposited $11.1 million and provided an $11.1 million standby letter of credit to meet the 10% deposit obligation. Subsequent to the initial deposit, we made additional cash deposits in escrow totaling $8.9 million. In connection with these additional cash deposits we have reduced the standby letter of credit to $2.2 million. We plan to finance the purchase of the building in 2014. We are forecasting approximately $800 million in capital expenditures for fiscal year 2014, up from $551 million in fiscal 2013. In addition to funding costs for fixtures and leasehold improvements to open new Ross and dd's DISCOUNTS stores, the upgrade or relocation of existing stores, investments in information technology systems, and for various other expenditures related to our stores, distribution centers, buying and corporate offices, this increase in capital spending is primarily driven by the expected purchase of our New York buying office and continued construction of our two new distribution centers. We expect to fund the capital expenditures primarily with available cash and cash flows from operations and with proceeds from our planned financing of the purchase of our New York buying office. We had no purchases of investments for the three month periods ended May 3, 2014 and May 4, 2013. We had proceeds from investments of $12.0 million and $0.1 million for the three month periods ended May 3, 2014 and May 4, 2013, respectively. Financing Activities Net cash used in financing activities was $188.1 million and $175.7 million for the three month periods ended May 3, 2014 and May 4, 2013, respectively. For the three month periods ended May 3, 2014 and May 4, 2013, our liquidity and capital requirements were provided by available cash and cash flows from operations. In January 2013, our Board of Directors approved a two-year $1.1 billion stock repurchase program for fiscal 2013 and 2014. We repurchased 2.0 million and 2.3 million shares of common stock for aggregate purchase prices of approximately $138.7 million and $138.3 million during the three month periods ended May 3, 2014, and May 4, 2013, respectively. We also acquired $0.5 million and $0.4 million shares of treasury stock from our employee stock equity compensation programs, for aggregate purchase prices of approximately $35.5 million and $25.8 million during the three month periods ended May 3, 2014 and May 4, 2013, respectively. 16 --------------------------------------------------------------------------------For the three month periods ended May 3, 2014 and May 4, 2013, we paid dividends of $42.6 million and $37.5 million, respectively. Short-term trade credit represents a significant source of financing for merchandise inventory. Trade credit arises from customary payment terms and trade practices with our vendors. We regularly review the adequacy of credit available to us from all sources and expect to be able to maintain adequate trade, bank, and other credit lines to meet our capital and liquidity requirements, including lease payment obligations in 2014. Our existing $600 million unsecured revolving credit facility expires in June 2017 and contains a $300 million sublimit for issuance of standby letters of credit. Interest on this facility is based on LIBOR plus an applicable margin (currently 100 basis points) and is payable quarterly and upon maturity. As of May 3, 2014 we had no borrowings or standby letters of credit outstanding on this facility and our $600 million credit facility remains in place and available. We estimate that existing cash balances, cash flows from operations, bank credit lines, and trade credit are adequate to meet our operating cash needs and to fund our planned capital investments, common stock repurchases, and quarterly dividend payments for at least the next twelve months. Contractual Obligations The table below presents our significant contractual obligations as of May 3, 2014: Less than 1 - 3 3 - 5 After 5 ($000) one year years years years Total¹ Senior notes $ - $ - $ 85,000 $ 65,000 $ 150,000 Interest payment obligations 9,668 19,335 18,657 12,203 59,863 Operating leases (rent obligations) 419,674 807,430 568,096 519,453 2,314,653 Purchase obligations 2,032,673 67,983 - - 2,100,656 Total contractual obligations $ 2,462,015 $ 894,748 $ 671,753 $ 596,656 $ 4,625,172 1We have a $96.7 million liability for unrecognized tax benefits that is included in Other long-term liabilities on our interim Condensed Consolidated Balance Sheet. This liability is excluded from the schedule above as the timing of payments cannot be reasonably estimated. Senior notes. We have issued two series of unsecured senior notes in the aggregate principal amount of $150 million, held by various institutional investors. The Series A notes totaling $85 million are due in December 2018 and bear interest at a rate of 6.38%. The Series B notes totaling $65 million are due in December 2021 and bear interest at a rate of 6.53%. Interest on these notes is included in Interest payment obligations in the table above. These notes are subject to prepayment penalties for early payment of principal. Borrowings under these notes are subject to certain operating and financial covenants, including interest coverage and other financial ratios. As of May 3, 2014, we were in compliance with these covenants. Off-Balance Sheet Arrangements Operating leases. We currently lease our buying offices, three warehouse facilities, our former corporate headquarters, all but three of our store locations, and two truck and trailer parking facilities. Except for certain leasehold improvements and equipment, these leased locations do not represent long-term capital investments. We lease three warehouses. Two of the warehouses are in Carlisle, Pennsylvania with leases expiring in 2016 and 2017. The third warehouse is in Fort Mill, South Carolina, with a lease expiring in 2016. The leases for all three warehouses contain renewal provisions. We lease a 10-acre parcel for trailer parking adjacent to our Perris, California distribution center that expires in 2017 and a 20-acre facility located in Moreno Valley, California primarily for ancillary truck and trailer parking that expires in 2015. Both of these leases contain renewal provisions. 17 -------------------------------------------------------------------------------- We lease approximately 192,000 square feet of office space for our former corporate headquarters in Pleasanton, California, under several facility leases. The term for the majority of these leases expires in June 2014. The lease term for the remaining space of approximately 11,000 square feet expires in March 2015. We do not plan to renew any of these leases. We currently lease approximately 411,000 and 52,000 square feet of office space for our New York City and Los Angeles buying offices, respectively. The lease terms for these facilities expire in 2022 and 2017, respectively, and contain renewal provisions. We plan to purchase our New York buying office in 2014. Purchase obligations. As of May 3, 2014 we had purchase obligations of approximately $2,101 million. These purchase obligations primarily consist of merchandise inventory purchase orders, commitments related to construction projects, store fixtures and supplies, and information technology service and maintenance contracts. Commercial Credit Facilities The table below presents our significant available commercial credit facilities at May 3, 2014: Amount of Commitment Expiration Per Period Less than 1 Total amount ($000) year 1 - 3 years 3 - 5 years After 5 years committed Revolving credit facility $ - $ - $ 600,000 $ - $ 600,000 Total commercial commitments $ - $ - $ 600,000 $ - $ 600,000 For additional information relating to this credit facility, refer to Note E of Notes to Condensed Consolidated Financial Statements. Revolving credit facility. Our existing $600 million unsecured revolving credit facility expires in June 2017 and contains a $300 million sublimit for issuance of standby letters of credit. Interest on this facility is based on LIBOR plus an applicable margin (currently 100 basis points) and is payable quarterly and upon maturity. As of May 3, 2014 we had no borrowings outstanding or standby letters of credit issued under this facility and were in compliance with the covenants. Our revolving credit facility and senior notes have covenant restrictions requiring us to maintain certain interest coverage and other financial ratios. In addition, the interest rates under the revolving credit facility may vary depending on actual interest coverage ratios achieved. As of May 3, 2014 we were in compliance with these covenants. Standby letters of credit and collateral trust. We use standby letters of credit outside of our revolving credit facility in addition to a funded trust to collateralize our insurance obligations. As of May 3, 2014 and May 4, 2013, we had $24.3 million and $33.8 million, respectively, in standby letters of credit outstanding and $54.2 million and $47.2 million, respectively, in a collateral trust. The standby letters of credit are collateralized by restricted cash and the collateral trust consists of restricted cash, cash equivalents, and investments. As of May 3, 2014, we also had a $2.2 million standby letter of credit in connection with our New York buying office Sale-Purchase Agreement. Trade letters of credit. We had $31.6 million and $41.7 million in trade letters of credit outstanding at May 3, 2014 and May 4, 2013, respectively. Dividends. In May 2014, our Board of Directors declared a cash dividend of $0.20 per common share, payable on June 30, 2014. Effects of inflation or deflation. We do not consider the effects of inflation or deflation to be material to our financial position and results of operations. 18 --------------------------------------------------------------------------------Critical Accounting Policies Management's Discussion and Analysis of Financial Condition and Results of Operations is based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our condensed consolidated financial statements requires our management to make estimates and assumptions that affect the reported amounts. These estimates and assumptions are evaluated on an ongoing basis and are based on historical experience and on various other factors that management believes to be reasonable. Actual results may differ significantly from these estimates. During the first quarter of fiscal 2014, there have been no significant changes to the policies discussed in our Annual Report on Form 10-K for the year ended February 1, 2014. Forward-Looking Statements This report may contain a number of forward-looking statements regarding, without limitation, planned store growth, new markets, expected sales, projected earnings levels, capital expenditures, and other matters. These forward-looking statements reflect our then current beliefs, projections, and estimates with respect to future events and our projected financial performance, operations, and competitive position. The words "plan," "expect," "target," "anticipate," "estimate," "believe," "forecast," "projected," "guidance," "looking ahead" and similar expressions identify forward-looking statements. Future economic and industry trends that could potentially impact revenue, profitability, and growth remain difficult to predict. As a result, our forward-looking statements are subject to risks and uncertainties which could cause our actual results to differ materially from those forward-looking statements and our previous expectations and projections. Refer to Part II, Item 1A in this Quarterly Report on Form 10-Q for a more complete discussion of risk factors for Ross and dd's DISCOUNTS. The factors underlying our forecasts are dynamic and subject to change. As a result, any forecasts or forward-looking statements speak only as of the date they are given and do not necessarily reflect our outlook at any other point in time. We disclaim any obligation to update or revise these forward-looking statements. Other risk factors are detailed in our filings with the Securities and Exchange Commission including, without limitation, our Annual Report on Form 10-K for 2013. |