Business context and reporting period
Ross Stores, Inc. operates Ross Dress for Less and dd’s DISCOUNTS, off-price apparel and home goods retailers. This 10-Q covers the three months ended May 1, 2010, compared with the three months ended May 2, 2009; despite the request metadata stating “2009 Q1,” the filing reports fiscal 2010 Q1. At quarter-end, Ross operated 1,021 stores: 967 Ross locations and 54 dd’s DISCOUNTS stores. The interim financial statements were reviewed, not audited.
Financial performance and position
| Metric | Q1 2010 | Q1 2009 |
|---|---|---|
| Sales | $1,934.8 million | $1,691.6 million |
| Comparable-store sales growth | 10% | 3% |
| Net earnings | $142.3 million | $91.4 million |
| Diluted EPS | $1.16 | $0.72 |
| Operating cash flow | $189.2 million | $240.7 million |
Sales rose 14.4% and net earnings approximately 56% year over year. Cost of goods sold improved to 72.7% of sales from 75.0%; SG&A improved to 15.2% from 16.1%. Earnings before taxes were 12.0% of sales versus 8.8%, and net margin was 7.4% versus 5.4%. The effective tax rate was approximately 39% in both periods.
Cash and cash equivalents were $823.7 million at May 1, 2010, versus $459.3 million a year earlier and $768.3 million at January 30, 2010. Current assets were $1,859.7 million and current liabilities $1,229.6 million. Inventory was $908.1 million. Long-term debt was $150 million; the company had no borrowings under its $600 million revolving facility. The facility expires July 2011, and $216.7 million of its $300 million standby-letter-of-credit sublimit remained available. The company reported compliance with debt covenants.
Operating cash flow decreased $51.6 million year over year, primarily reflecting less accounts-payable leverage and incentive and store-bonus payments. Investing used $34.7 million, including $35.5 million of property and equipment additions. Financing used $99.2 million, including $94.3 million of common-stock repurchases and $19.6 million of dividends paid. Cash increased $55.3 million during the quarter.
Material changes versus the prior comparable period
- Sales growth reflected 10% comparable-store growth and 47 net additional stores year over year; the company opened 17 and closed one store during the quarter.
- Cost of goods sold as a percentage of sales improved about 230 basis points: merchandise gross margin contributed 130 basis points (including a 25-basis-point benefit from a lower shortage accrual), occupancy leverage about 70 basis points, and lower distribution costs about 40 basis points; higher freight costs offset about 10 basis points.
- SG&A as a percentage of sales declined about 90 basis points on leverage from stronger comparable sales. Net interest expense increased about $0.7 million, mainly because of lower capitalized construction interest and lower investment yields.
- Diluted EPS increased about 61%, reflecting higher earnings and a 3% reduction in weighted-average diluted shares, largely from repurchases.
- Investments totaled $17.8 million at fair value, down from $34.4 million a year earlier. Auction-rate securities of $0.9 million were valued using Level 3 inputs; management considered investment losses temporary.
Outlook, risks, contingencies and unusual items
Management forecast approximately $215 million of fiscal 2010 capital expenditures, funded from available cash and operating cash flows, and an effective tax rate of 38%–39%. The filing provides no specific sales or EPS guidance. Management said cash flows, bank credit lines, and trade credit should be adequate for operating needs, planned investments, repurchases, and quarterly dividends for at least the next 12 months, while cautioning that recent sales and margins may not continue.
The board authorized a two-year $750 million repurchase program for fiscal 2010 and 2011; approximately $94.3 million was spent on repurchases during the quarter. A May 2010 dividend of $0.16 per share was declared, payable June 30, 2010. Contractual obligations totaled $3.764 billion, including $2.019 billion of rent obligations and $1.422 billion of purchase obligations. Merchandise purchase orders accounted for $1.374 billion of purchase obligations due within one year. The company also disclosed a $56 million maximum residual-value guarantee related to its Perris, California synthetic lease.
Pending wage-and-hour class actions and other ordinary-course litigation were not expected by management to materially adversely affect financial condition, results, or cash flows. Unrecognized tax benefits were $35.4 million, including related interest; up to $1.4 million could reduce tax expense if certain statutes of limitations lapse within 12 months. Key risks cited include retail competition and consumer demand, merchandise sourcing and supply-chain disruption, weather and economic conditions, store expansion and execution, inventory/markdown/shrink management, and geographic concentration: 26% of stores and several facilities were in California.
Important facts for investors to verify
- Whether the 10% comparable-store growth and margin improvement persisted after the quarter; management explicitly warned they may not continue.
- How operating cash flow develops given the year-over-year decline and reliance on vendor credit and accounts-payable leverage.
- Progress and cash needs for the $215 million capital-spending plan and the $750 million repurchase authorization.
- Exposure to lease, purchase, and other commitments, including the $56 million synthetic-lease guarantee and near-term merchandise purchase obligations.
- Developments in wage-and-hour litigation, tax audits and unrecognized tax benefits, and the valuation of Level 3 auction-rate securities.