ROST

Ross Stores, Inc. - Q2 2006 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended July 29, 2006, and the six-month period ended on the same date. Ross Stores, Inc. operates as the second-largest off-price apparel and home goods retailer in the United States, operating under the banners "Ross Dress for Less" and "dd's DISCOUNTS." As of the period end, the company operated 770 stores (744 Ross and 26 dd's DISCOUNTS) across 27 states and Guam.

Key Financial Metrics

Margins (as % of Sales): Net earnings margin was 3.5% for the quarter and 4.0% for the six-month period. Cost of goods sold (COGS) was 78.3% for the quarter and 77.4% for the six-month period.

Material Changes vs. Prior Period

• Revenue Growth: Sales increased 11.6% for the quarter and 13.2% for the six-month period compared to the prior year. This growth was driven by 75 net new stores opened since the prior year and comparable store sales growth of 4% (quarter) and 5% (six months).
• Profitability: Net earnings increased 7.3% for the quarter and 13.3% for the six-month period. Diluted EPS grew due to higher net earnings and a reduction in weighted average shares outstanding from stock repurchases.
• Accounting Changes: The company adopted SFAS No. 123(R) regarding stock-based compensation in fiscal 2006. This adoption decreased earnings before taxes by approximately $3.3 million for the quarter and $6.8 million for the six-month period. Additionally, certain compensation expenses were reclassified from SG&A to COGS.
• Liquidity: Cash and cash equivalents decreased by $132.4 million over the six-month period, primarily due to significant investing and financing activities, including the purchase of a distribution center and stock repurchases.

Guidance, Outlook, and Risks

• Capital Expenditures: The company forecasts approximately $265.0 million in capital expenditures for fiscal 2006. This includes $87.3 million for the purchase of the Fort Mill, South Carolina distribution center.
• Debt and Financing: The company repaid its $50.0 million term debt in March 2006. It has received expressions of interest to purchase $150 million of unregistered senior notes (12 and 15-year tranches) at a weighted average interest rate of 6.45%. Settlement is anticipated in the fourth quarter.
• Dividends: A cash dividend of $0.06 per share was declared in August 2006, payable in October 2006.
• Stock Repurchases: Under a $400 million program authorized in November 2005, the company repurchased approximately 3.6 million shares for $98.9 million during the six-month period.
• Risks: Key risks include competitive pressures, consumer spending trends, supply chain disruptions, and the impact of higher fuel costs. The company faces litigation regarding employee wage and hour claims, though management does not expect a material adverse effect.

Investor Verification Checklist

• Debt Refinancing: Verify the finalization and terms of the proposed $150 million senior notes issuance to replace the repaid term debt and fund the distribution center purchase.
• Comparable Store Sales: Monitor the sustainability of the 4-5% comparable store sales growth rate in a competitive off-price retail environment.
• Capital Allocation: Assess the impact of the $265 million capital expenditure forecast on future cash flows and liquidity, particularly given the recent $87.3 million cash outlay for the Fort Mill facility.
• Accounting Impact: Review the ongoing impact of SFAS No. 123(R) on reported earnings and the reclassification of compensation costs between COGS and SG&A.
• Legal Proceedings: Track the status of class action lawsuits regarding employee classification and wage claims in California.