ROSS STORES, INC. annual report, FY2015

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Ross Stores, Inc. — FY2015 Form 10-K

Business context and reporting period. Ross Stores operates Ross Dress for Less and dd’s DISCOUNTS off-price apparel and home-fashion chains. The fiscal year ended January 30, 2016, comprised 52 weeks; comparative fiscal 2014 also comprised 52 weeks. At year-end, the company operated 1,446 stores: 1,274 Ross and 172 dd’s DISCOUNTS locations. The filing is annual, with quarterly data including the fourth quarter.

Financial performance

  • Annual results: Sales were $11.940 billion, up 8.1% from $11.042 billion. Comparable-store sales increased 4%, versus 3% in FY2014.
  • Profit and margins: Net earnings were $1.021 billion, up 10.4%; diluted EPS was $2.51, up 13.6% from $2.21. Gross margin was 28.2% (cost of goods sold 71.8% of sales), versus 28.1%; SG&A was 14.6% of sales in both years. Pretax margin was 13.5% in both years; net margin rose to 8.5% from 8.4%.
  • Fourth quarter: Sales were $3.251 billion versus $3.033 billion a year earlier; net earnings were $264.2 million versus $248.5 million; diluted EPS was $0.66 versus $0.60.
  • Cash flow and investment: Operating cash flow was $1.326 billion, down from $1.373 billion. Capital expenditures were $367.0 million versus $646.7 million; operating cash flow less capital expenditures was approximately $959 million, compared with $726 million. Cash and cash equivalents ended the year at $761.6 million.
  • Debt and liquidity: Long-term debt carrying value was $396.0 million (approximately $400 million principal). The company had no borrowings under its $600 million revolving facility, which expires in June 2017, and reported a 1.5:1 current ratio. It stated available cash, operating cash flow, bank lines and trade credit should cover operating needs, planned investment, repurchases and dividends for at least 12 months.

Material changes versus FY2014

  • Sales growth accelerated slightly, from 7.9% to 8.1%, and comparable-store sales growth increased from 3% to 4%. The store base expanded by 84 net locations to 1,446.
  • Merchandise gross margin improved 45 basis points, partly offset by 35 basis points of higher distribution costs and 10 basis points of higher freight costs. Overall cost of goods sold improved about five basis points as a share of sales.
  • Net interest expense increased to $12.6 million from $3.0 million, primarily reflecting the 3.375% senior notes issued in 2014 and reduced capitalized interest.
  • Operating cash flow decreased, mainly due to packaway inventory levels and timing of receipts and payments. Packaway represented 47% of inventory at year-end, up from 45%.
  • Capital expenditures declined following major 2014 investments in the New York buying office and distribution centers. The company repurchased $700 million of shares and paid $192.3 million in dividends during FY2015.

Outlook, risks and contingencies

  • Management forecast approximately $425 million of FY2016 capital expenditures and an effective tax rate of 37%–38%. It gave no specific FY2016 sales or earnings guidance in the provided filing text.
  • Management’s strategy emphasizes continued off-price execution, store growth primarily in existing markets, and expansion in newer markets. It cited value-conscious customers and off-price market-share gains as supportive factors, while cautioning that continued sales growth and earnings increases are not assured.
  • Key risks include intense retail and e-commerce competition; changes in consumer demand, macroeconomic conditions and weather; sourcing and inventory execution, including packaway markdown exposure; supply-chain, information-system and cybersecurity disruptions; labor costs and retention; and the availability and economics of new store sites.
  • Pending class actions, primarily in California, include wage-and-hour and consumer-protection claims. Management believed pending litigation and other proceedings would not have a material adverse effect; outcomes remain uncertain. Unrecognized tax benefits, including interest and penalties, totaled $94.2 million; management said certain matters could reduce tax expense by up to $3.7 million within 12 months.
  • Significant commitments include $3.416 billion of future minimum lease payments and $1.721 billion of purchase obligations. The company also had $400 million principal of senior notes and a $1.4 billion two-year stock repurchase authorization for FY2015–FY2016.

Important facts for investors to verify

  • Whether comparable-store sales, merchandise margins and inventory turnover remain resilient as the store base grows and packaway inventory stays elevated.
  • How distribution and freight costs, wage increases and other operating expenses affect margins and cash generation.
  • Actual FY2016 capital spending, store openings, share repurchases and dividend funding relative to management’s plans and liquidity assessment.
  • Lease and purchase commitments, the 2017 revolving-credit-facility renewal, and compliance with debt covenants.
  • Developments in California class actions, tax audits and the $94.2 million unrecognized-tax-benefit liability.

The independent auditor issued an unqualified opinion on the financial statements and concluded that internal control over financial reporting was effective as of January 30, 2016.