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Ross Stores 10-Q 2005

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

(Mark one)

 

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended July 30, 2005

 

 

or

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the transition period from _______ to _______

 

 

 

Commission file number:  0-14678


ROSS STORES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware

 

94-1390387

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

4440 Rosewood Drive, Pleasanton, California

 

94588-3050

(Address of principal executive offices)

 

(Zip Code)

 

 

 

Registrant’s telephone number, including area code     (925) 965-4400

 

 

 

Former name, former address and former fiscal year, if
changed since last report.

 

N/A

 

 

 

          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes   x

No   o

          Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes   x

No   o

          Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):

Yes   o

No   x

          The number of shares of Common Stock, with $.01 par value, outstanding on August 18, 2005 was 146,106,238.



PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

($000, except stores and per share data, unaudited)

 

July 30,
2005

 

July 31,
2004

 

July 30,
2005

 

July 31,
2004

 


 


 


 


 


 

 

 

 

 

 

(As Restated,
see Note B)

 

 

 

 

(As Restated,
see Note B)

 

SALES

 

$

1,171,862

 

$

1,008,600

 

$

2,295,799

 

$

2,000,492

 

COSTS AND EXPENSES

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold, including related buying, distribution and occupancy costs

 

 

916,214

 

 

773,716

 

 

1,775,530

 

 

1,524,882

 

Selling, general and administrative

 

 

186,604

 

 

163,651

 

 

369,340

 

 

325,147

 

Impairment of long-lived assets

 

 

—  

 

 

18,000

 

 

—  

 

 

18,000

 

Interest (income) expense, net

 

 

(580

)

 

336

 

 

(878

)

 

506

 

 

 



 



 



 



 

Total costs and expenses

 

 

1,102,238

 

 

955,703

 

 

2,143,992

 

 

1,868,535

 

Earnings before taxes

 

 

69,624

 

 

52,897

 

 

151,807

 

 

131,957

 

Provision for taxes on earnings

 

 

27,345

 

 

20,683

 

 

59,478

 

 

51,596

 

 

 



 



 



 



 

Net earnings

 

$

42,279

 

$

32,214

 

$

92,329

 

$

80,361

 

EARNINGS PER SHARE

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

.29

 

$

.22

 

$

.63

 

$

.54

 

Diluted

 

$

.29

 

$

.21

 

$

.62

 

$

.53

 

WEIGHTED AVERAGE SHARES OUTSTANDING (000)

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

145,102

 

 

148,106

 

 

145,555

 

 

148,998

 

Diluted

 

 

147,321

 

 

150,903

 

 

147,894

 

 

152,148

 

DIVIDENDS PER SHARE

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per share

 

$

.05

 

$

.04

 

$

.05

 

$

.04

 

Stores open at end of period

 

 

695

 

 

616

 

 

695

 

 

616

 

See notes to condensed consolidated financial statements.

2


CONDENSED CONSOLIDATED BALANCE SHEETS

($000, unaudited)

 

July 30,
2005

 

January 29,
2005

 

July 31,
2004

 


 


 


 


 

 

 

 

 

(Note A)

 

(As Restated,
see Note B)

 

ASSETS

 

 

 

 

 

 

 

 

 

 

CURRENT ASSETS

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

119,397

 

$

115,331

 

$

64,353

 

Short-term investments

 

 

25,800

 

 

67,400

 

 

44,000

 

Accounts receivable

 

 

35,371

 

 

31,154

 

 

27,876

 

Merchandise inventory

 

 

975,846

 

 

853,112

 

 

897,542

 

Prepaid expenses and other

 

 

51,060

 

 

46,756

 

 

53,711

 

Deferred income taxes

 

 

8,968

 

 

8,968

 

 

25,047

 

 

 



 



 



 

Total current assets

 

 

1,216,442

 

 

1,122,721

 

 

1,112,529

 

PROPERTY AND EQUIPMENT

 

 

 

 

 

 

 

 

 

 

Land and buildings

 

 

70,029

 

 

28,572

 

 

28,759

 

Fixtures and equipment

 

 

686,680

 

 

652,882

 

 

589,728

 

Leasehold improvements

 

 

350,311

 

 

345,195

 

 

316,760

 

Construction-in-progress

 

 

28,298

 

 

17,860

 

 

20,012

 

 

 



 



 



 

 

 

 

1,135,318

 

 

1,044,509

 

 

955,259

 

Less accumulated depreciation and amortization

 

 

526,444

 

 

488,331

 

 

445,578

 

 

 



 



 



 

Property and equipment, net

 

 

608,874

 

 

556,178

 

 

509,681

 

Other long-term assets

 

 

53,025

 

 

57,100

 

 

58,007

 

 

 



 



 



 

Total assets

 

$

1,878,341

 

$

1,735,999

 

$

1,680,217

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

CURRENT LIABILITIES

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

534,253

 

$

451,861

 

$

471,651

 

Accrued expenses and other

 

 

160,527

 

 

154,017

 

 

152,382

 

Accrued payroll and benefits

 

 

112,455

 

 

105,683

 

 

103,056

 

Income taxes payable

 

 

—  

 

 

—  

 

 

(2,248

)

 

 



 



 



 

Total current liabilities

 

 

807,235

 

 

711,561

 

 

724,841

 

Long-term debt

 

 

50,000

 

 

50,000

 

 

50,000

 

Other long-term liabilities

 

 

115,127

 

 

116,668

 

 

110,023

 

Deferred income taxes

 

 

96,767

 

 

92,201

 

 

75,006

 

 

 



 



 



 

Total liabilities

 

 

1,069,129

 

 

970,430

 

 

959,870

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

Common stock

 

 

1,469

 

 

1,472

 

 

1,478

 

Additional paid-in capital

 

 

507,443

 

 

449,524

 

 

424,664

 

Treasury stock

 

 

(17,578

)

 

(11,618

)

 

(8,447

)

Deferred compensation

 

 

(37,114

)

 

(25,266

)

 

(26,005

)

Retained earnings

 

 

354,992

 

 

351,457

 

 

328,657

 

 

 



 



 



 

Total stockholders’ equity

 

 

809,212

 

 

765,569

 

 

720,347

 

 

 



 



 



 

Total liabilities and stockholders’ equity

 

$

1,878,341

 

$

1,735,999

 

$

1,680,217

 

See notes to condensed consolidated financial statements.

3


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

Six Months Ended

 

 

 


 

($000, unaudited)

 

July 30,
2005

 

July 31,
2004

 


 


 


 

 

 

 

 

(As Restated,
see Note B)

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

Net earnings

 

$

92,329

 

$

80,361

 

Adjustments to reconcile net earnings to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

52,764

 

 

45,619

 

Deferred income taxes

 

 

4,566

 

 

(5,173

)

Tax benefit from equity issuance

 

 

17,430

 

 

7,473

 

Impairment of long-lived assets

 

 

—  

 

 

18,000

 

Change in assets and liabilities:

 

 

 

 

 

 

 

Merchandise inventory

 

 

(122,734

)

 

(56,051

)

Other current assets, net

 

 

(8,521

)

 

(26,827

)

Accounts payable

 

 

89,727

 

 

30,033

 

Other current liabilities

 

 

13,283

 

 

(11,633

)

Other long-term, net

 

 

1,147

 

 

18,967

 

 

 



 



 

Net cash provided by operating activities

 

 

139,991

 

 

100,769

 

CASH FLOWS USED IN INVESTING ACTIVITIES

 

 

 

 

 

 

 

Additions to property and equipment

 

 

(96,200

)

 

(60,118

)

Sales (purchases) of short-term investments, net

 

 

41,600

 

 

(44,000

)

 

 



 



 

Net cash used in investing activities

 

 

(54,600

)

 

(104,118

)

CASH FLOWS USED IN FINANCING ACTIVITIES

 

 

 

 

 

 

 

Issuance of common stock related to stock plans

 

 

28,391

 

 

11,218

 

Treasury stock purchased

 

 

(5,960

)

 

(8,447

)

Repurchase of common stock

 

 

(89,009

)

 

(123,847

)

Dividends paid

 

 

(14,747

)

 

(12,768

)

 

 



 



 

Net cash used in financing activities

 

 

(81,325

)

 

(133,844

)

 

 



 



 

Net increase (decrease) in cash and cash equivalents

 

 

4,066

 

 

(137,193

)

Cash and cash equivalents:

 

 

 

 

 

 

 

Beginning of period

 

 

115,331

 

 

201,546

 

 

 



 



 

End of period

 

$

119,397

 

$

64,353

 

NON-CASH INVESTING ACTIVITIES

 

 

 

 

 

 

 

Straight-line rent capitalization in build-out period

 

$

1,608

 

$

3,439

 

See notes to condensed consolidated financial statements.

4


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three and Six Months Ended July 30, 2005 and July 31, 2004
(Unaudited)

Note A: Summary of Significant Accounting Policies

Basis of Presentation.  The accompanying unaudited condensed consolidated financial statements have been prepared from the records of the Company without audit and, in the opinion of management, include all adjustments (consisting of only normal, recurring adjustments) necessary to present fairly the financial position at July 30, 2005 and July 31, 2004; the results of operations for the three and six months ended July 30, 2005 and July 31, 2004; and cash flows for the six months ended July 30, 2005 and July 31, 2004.  The balance sheet at January 29, 2005, presented herein, has been derived from the audited consolidated financial statements of the Company as of the fiscal year then ended.

Accounting policies followed by the Company are described in Note A to the audited consolidated financial statements for the fiscal year ended January 29, 2005.  Certain information and disclosures normally included in the notes to annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted for purposes of the interim condensed consolidated financial statements.  The interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements, including notes thereto, contained in the Company’s Annual Report on Form 10-K for the year ended January 29, 2005.

The results of operations for the three and six-month periods herein presented are not necessarily indicative of the results to be expected for the full year.

Reclassifications.  Certain reclassifications have been made in the 2004 condensed consolidated financial statements to conform to the current presentation.  These reclassifications include presenting deferred compensation and treasury stock as separate components of stockholders’ equity.

Provision for litigation expense and other legal proceedings.  The Company is party to various legal proceedings arising from normal business activities.  Actions filed against the Company include commercial, customer, and labor and employment related claims, including lawsuits in which plaintiffs allege that the Company violated state and/or federal wage and hour and related laws.  Actions against the Company are in various procedural stages.  Many of these proceedings raise factual and legal issues and are subject to uncertainties.  In the opinion of management, resolution of these matters is not expected to have a material adverse effect on the Company’s financial condition or results of operations.

Like many California retailers, the Company has been named in class action lawsuits concerning claims regarding employee payroll and wage claims.  Recently, the Orange County Superior Court certified a class in a case involving whether the Company’s Assistant Store Managers in California are correctly classified as exempt managers under California Wage Orders.  This is a procedural ruling and does not address the merits of the case.  In the opinion of management, resolution of this matter is not expected to have a material adverse effect on the Company’s financial condition or results of operations.

Stock-Based Compensation.  The Company accounts for stock-based awards to employees using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.”  Because the Company grants stock option awards with exercise prices equal to fair market value, no compensation expense is recorded at issuance.  Compensation expense for restricted stock awards is based on the market value of the shares awarded at the date of grant and is amortized on a straight-line basis over the vesting period.  The disclosure requirements of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123” are set forth below.

5


Had compensation costs for the Company’s stock option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the methods of SFAS No. 123, the Company’s net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

 


 


 

($000, except per share data)

 

July 30,
2005

 

July 31,
2004

 

July 30,
2005

 

July 31,
2004

 


 


 


 


 


 

 

 

 

 

 

(As Restated,
see Note B)

 

 

 

 

(As Restated,
see Note B)

 

Net earnings

As reported

 

$

42,279

 

$

32,214

 

$

92,329

 

$

80,361

 

Add: Stock-based employee compensation expense included in reported net earnings, net of tax

 

 

2,376

 

 

2,295

 

 

4,788

 

 

4,488

 

Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of tax

 

 

(4,571

)

 

(4,716

)

 

(10,025

)

 

(9,149

)

 

 

 



 



 



 



 

Net earnings

Pro forma

 

$

40,084

 

$

29,793

 

$

87,092

 

$

75,700

 

 

 

 



 



 



 



 

Basic earnings per share

As reported

 

$

.29

 

$

.22

 

$

.63

 

$

.54

 

 

Pro forma

 

$

.28

 

$

.20

 

$

.60

 

$

.51

 

Diluted earnings per share

As reported

 

$

.29

 

$

.21

 

$

.62

 

$

.53

 

 

Pro forma

 

$

.27

 

$

.20

 

$

.59

 

$

.50

 

At July 30, 2005, the Company had two stock-based compensation plans. SFAS No. 123 establishes a fair value method of accounting for stock options and other equity instruments.  For determining pro forma earnings per share, the fair value of the stock options and employees’ purchase rights were estimated using the Black-Scholes option pricing model using the following assumptions:

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

July 30,
2005

 

July 31,
2004

 

July 30,
2005

 

July 31,
2004

 

 

 


 


 


 


 

Stock Options

 

 

 

 

 

 

 

 

 

 

 

 

 

Expected life from grant date (years)

 

 

3.3

 

 

3.1

 

 

3.4

 

 

3.1

 

Expected volatility

 

 

33.7

%

 

39.0

%

 

33.8

%

 

37.0

%

Risk-free interest rate

 

 

4.1

%

 

3.2

%

 

3.8

%

 

2.8

%

Dividend yield

 

 

0.8

%

 

0.6

%

 

0.7

%

 

0.6

%


 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

July 30,
2005

 

July 31,
2004

 

July 30,
2005

 

July 31,
2004

 

 

 


 


 


 


 

Employee Stock Purchase Plan

 

 

 

 

 

 

 

 

 

 

 

 

 

Expected life from grant date (years)

 

 

1.0

 

 

1.0

 

 

1.0

 

 

1.0

 

Expected volatility

 

 

30.9

%

 

28.3

%

 

30.9

%

 

28.3

%

Risk-free interest rate

 

 

2.9

%

 

1.3

%

 

2.9

%

 

1.3

%

Dividend yield

 

 

0.7

%

 

0.5

%

 

0.7

%

 

0.5

%

The weighted average fair values per share of stock options granted for the three-month periods ended July 30, 2005 and July 31, 2004, were $7.67 and $7.48, and for the six-month periods ended July 30, 2005 and July 31, 2004, were $7.81 and $7.92, respectively.  The weighted average fair values per share of employee stock purchase awards for the three-month periods ended July 30, 2005 and July 31, 2004, were $7.61 and $6.81, and for the six-month periods ended July 30, 2005 and July 31, 2004, were $7.61 and $6.81, respectively.

6


Note B: Restatement of Prior Year Consolidated Financial Statements

On February 7, 2005, the Office of the Chief Accountant of the Securities and Exchange Commission (“SEC”) issued a letter to the American Institute of Certified Public Accountants expressing its views regarding certain operating lease accounting issues and their treatment under generally accepted accounting principles in the United States of America (“GAAP”).  In response to this letter, the Company initiated a review of its lease-related accounting and determined that the Company’s method of accounting for landlord incentives or allowances under operating leases (tenant improvement allowances) and the Company’s method of accounting for “rent holidays” were not consistent with this guidance.

The Company historically accounted for tenant improvement allowances as reductions of fixed assets on the consolidated balance sheets and as reductions of capital expenditures in investing activities in the consolidated statements of cash flows.  The Company historically amortized leasehold improvements over the original lease term, typically 10 years.  The Company determined that the appropriate interpretation of Financial Accounting Standards Board (“FASB”) Technical Bulletin No. 88–1, “Issues Relating to Accounting for Leases,” requires these allowances to be recorded as deferred rent liabilities on the consolidated balance sheets, amortized over the lease term, and included as a component of operating activities in the consolidated statements of cash flows.

The Company historically amortized rent holiday periods on a straight–line basis over the lease term based on the store opening date, which excluded the build-out period for its stores from the term over which it expensed rent.  The Company considered FASB Technical Bulletin No. 85–3, “Accounting for Operating Leases with Scheduled Rent Increases,” and determined that the lease term should commence on the date the Company takes possession of the leased space for construction purposes, which is generally one to four months prior to the opening date. 

In addition, the Company historically capitalized rent during the construction period for its distribution and headquarter facilities.  The Company considered interpretive guidance based on analogies to FASB Statement No. 34, “Capitalization of Interest Cost,” and FASB Statement No. 67, “Accounting for the Costs and Initial Rental Operations of Real Estate Projects” regarding capitalization of rent during the period of time a lessee is performing construction activities.  The Company concluded that its historical policy of capitalizing rent during the build-out period is appropriate and corrected its accounting to apply the policy to the build-out period for all facilities, including its stores.  See Note E for a new FASB Staff Position regarding the capitalization of rent during a build-out period.

In addition, the tax benefit from equity issuance is now presented as an operating activity rather than a financing activity in the condensed consolidated statements of cash flows.

The Company’s short-term investments, totaling $44 million at July 31, 2004, comprised of state and other government obligations with original contractual maturities of ten years or more; however are highly liquid and have a short-term auction feature resulting in an effective maturity of 15 to 30 days.  Previously, these investments were classified as cash equivalents.  The Company restated these as short-term investments on the condensed consolidated balance sheet and the corresponding investment in short-term investments in the condensed consolidated statement of cash flows.

As a result, the Company restated its condensed consolidated financial statements as of and for the three months and six months ended July 31, 2004.

7


The following is a summary of the effects of the restatement on the Company’s condensed consolidated statements of earnings for the three months and six months ended July 31, 2004, condensed consolidated balance sheet as of July 31, 2004, and cash flows for the six months ended July 31, 2004:

 

 

Condensed Consolidated Statements of Earnings

 

 

 


 

($000, except per share data)
Three months ended July 31, 2004

 

As Previously
Reported1

 

Adjustments

 

As Restated2

 


 


 


 


 

Cost of goods sold, including related buying, distribution and occupancy costs

 

$

772,743

 

$

973

 

$

773,716

 

Selling, general and administrative

 

 

164,032

 

 

(381

)

 

163,651

 

Earnings before taxes

 

 

53,489

 

 

(592

)

 

52,897

 

Provision for taxes on earnings

 

 

20,914

 

 

(231

)

 

20,683

 

Net earnings

 

 

32,575

 

 

(361

)

 

32,214

 

Earnings per share — basic

 

$

.22

 

$

.00

 

$

.22

 

Earnings per share — diluted

 

$

.22

 

$

(.01

)

$

.21

 


 

 

Condensed Consolidated Statements of Earnings

 

 

 


 

($000, except per share data)
Six months ended July 31, 2004

 

As Previously
Reported1

 

Adjustments

 

As Restated2

 


 


 


 


 

Cost of goods sold, including related buying, distribution and occupancy costs

 

$

1,523,365

 

$

1,517

 

$

1,524,882

 

Selling, general and administrative

 

 

325,463

 

 

(316

)

 

325,147

 

Earnings before taxes

 

 

133,158

 

 

(1,201

)

 

131,957

 

Provision for taxes on earnings

 

 

52,065

 

 

(469

)

 

51,596

 

Net earnings

 

 

81,093

 

 

(732

)

 

80,361

 

Earnings per share — basic

 

$

.54

 

$

.00

 

$

.54

 

Earnings per share — diluted

 

$

.53

 

$

.00

 

$

.53

 


 

 

Condensed Consolidated Balance Sheet

 

 

 


 

($000, except per share data)
As of July 31, 2004

 

As Previously
Reported1

 

Adjustments

 

As Restated

 


 


 


 


 

Prepaid expenses and other

 

$

53,978

 

$

(267

)

$

53,711

 

Deferred income taxes (asset)

 

 

22,742

 

 

2,305

 

 

25,047

 

Fixtures and equipment

 

 

570,833

 

 

18,895

 

 

589,728

 

Leasehold improvements

 

 

268,104

 

 

48,656

 

 

316,760

 

Accumulated depreciation

 

 

415,195

 

 

30,383

 

 

445,578

 

Accrued expenses and other

 

 

151,359

 

 

1,023

 

 

152,382

 

Other long-term liabilities

 

 

68,251

 

 

41,772

 

 

110,023

 

Retained earnings

 

 

332,246

 

 

(3,589

)

 

328,657

 

8


 

 

Condensed Consolidated Statements of Cash Flows

 

 

 


 

($000, except per share data)
Six months ended July 31, 2004

 

As Previously
Reported1

 

Adjustments

 

As Restated

 


 


 


 


 

Net cash provided by operating activities3

 

$

89,644

 

$

11,125

 

$

100,769

 

Net cash used in investing activities

 

 

(56,466

)

 

(47,652

)

 

(104,118

)

Net cash used in financing activities3

 

 

(126,371

)

 

(7,473

)

 

(133,844

)

Net decrease in cash and cash equivalents4

 

 

(93,193

)

 

(44,000

)

 

(137,193

)



1 As previously stated in the Form 10-Q filed for the quarter ended July 31, 2004.

2 See Note J in the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended January 29, 2005.

3 The tax benefit from equity issuance was restated as an operating activity in the condensed consolidated statements of cash flows.

4 Short-term investments were restated from cash and cash equivalents in the condensed consolidated balance sheet.

Note C:  Earnings Per Share (“EPS”)

SFAS No. 128, “Earnings Per Share,” requires earnings per share to be computed and reported as both basic EPS and diluted EPS.  Basic EPS is computed by dividing net earnings by the weighted average number of common shares outstanding for the period.  Diluted EPS is computed by dividing net earnings by the sum of the weighted average number of common shares and dilutive common stock equivalents outstanding during the period.  Dilutive EPS reflects the potential dilution that could occur if options to issue common stock were exercised into common stock.

For the three months ended July 30, 2005 and July 31, 2004, there were approximately 2,519,600 and 1,437,500 shares, and for the six months ended July 30, 2005 and July 31, 2004, there were approximately 2,001,700 and 618,900 shares, respectively, that could potentially dilute basic EPS in the future that were excluded from the calculation of diluted EPS because their effect would have been anti-dilutive (option exercise price exceeds average stock price) in the periods presented.

The following is a reconciliation of the number of shares (denominator) used in the basic and diluted EPS computations (shares in thousands):

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

Basic
EPS

 

Effect of Dilutive
Common Stock
Equivalents

 

Diluted
EPS

 

Basic
EPS

 

Effect of Dilutive
Common Stock
Equivalents

 

Diluted
EPS

 

 

 


 


 


 


 


 


 

July 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares

 

 

145,102

 

 

2,219

 

 

147,321

 

 

145,555

 

 

2,339

 

 

147,894

 

Amount

 

$

.29

 

$

.00

 

$

.29

 

$

.63

 

$

(.01

)

$

.62

 

July 31, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares

 

 

148,106

 

 

2,797

 

 

150,903

 

 

148,998

 

 

3,150

 

 

152,148

 

Amount

 

$

.22

 

$

(.01

)

$

.21

 

$

.54

 

$

(.01

)

$

.53

 

Note D:  Impairment of Long-Lived Assets

During the second quarter of 2004, the Company relocated its corporate headquarters from Newark, California to Pleasanton, California and decided to pursue a sale of its Newark facility. In accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company recognized a non-cash impairment charge of $18 million before taxes in the second quarter of 2004 to write-down the carrying value of its Newark facility from a net book value of approximately $33 million to the estimated fair value of approximately $15 million.  The $18 million loss was subsequently reduced to $15 million in the third quarter of 2004 when the Company sold the Newark facility.  The fair value of the Newark facility assets held for sale of approximately $15 million is included in “Prepaid expenses and other” in the accompanying condensed consolidated balance sheets as of July 31, 2004.

9


Note E:  Recently Issued Accounting Standards

In November 2004, the FASB issued the revised SFAS No. 151, “Inventory Costs,” which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe that the adoption of SFAS No. 151 will have a material impact on the Company’s operating results or financial position.

In December 2004, the FASB issued the revised SFAS No. 123(R), “Share-Based Payment,” which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS No. 123(R) requires recognition of stock-based compensation expense in the consolidated financial statements over the period during which an employee is required to provide service in exchange for the award.  SFAS No. 123(R) is effective for the fiscal year beginning after June 15, 2005. The Company will implement the requirements of the standard as of the beginning of its fiscal year 2006.  The impact of adopting SFAS No. 123(R) will be dependent on numerous factors including, but not limited to, the valuation model chosen by the Company to value stock-based awards; the assumed award forfeiture rate; the accounting policies adopted concerning the method of recognizing the fair value of awards over the requisite service period; and the transition method chosen for adopting SFAS No. 123(R).  The Company has not yet quantified the effects of the adoption of SFAS No. 123(R).

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” which requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The Company does not expect the adoption of SFAS No. 154, which is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, to have a material impact on the consolidated financial statements.

10


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
Ross Stores, Inc.
Pleasanton, California

We have reviewed the accompanying condensed consolidated balance sheets of Ross Stores, Inc. and subsidiaries (the “Company”) as of July 30, 2005 and July 31, 2004, and the related condensed consolidated statements of earnings for the three and six-month periods then ended and of cash flows for the six-month periods then ended. These condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to such condensed consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Ross Stores, Inc. as of January 29, 2005, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated April 13, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of January 29, 2005 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Deloitte & Touche LLP

 

 

San Francisco, California

 

 

 

 

 

September 7, 2005

 

 

11


ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

This section and other parts of this Form 10-Q contain forward-looking statements that involve risks and uncertainties.  The Company’s 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 the subsection below entitled “Forward-Looking Statements and Factors Affecting Future Performance.”  The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and the consolidated financial statements and notes thereto in the Company’s 2004 Form 10-K.  All information is based on the Company’s fiscal calendar.

Restatement of Prior Year Condensed Consolidated Financial Statements

The condensed consolidated financial statements for the prior period have been restated.  See Note B of the condensed consolidated financial statements for additional discussion.  This discussion and analysis gives effect to such restatement.

Overview

Ross Stores, Inc. (the “Company”) is the second largest off-price apparel and home goods retailer in the United States, with 682 Ross Dress for Less® stores in 26 states and Guam and 13 dd’s DISCOUNTS® store locations in California at July 30, 2005.  Ross Stores offers first-quality, in-season, name brand and designer apparel, accessories, footwear and home fashions at everyday savings of 20 to 60 percent off department and specialty store regular prices.  dd’s DISCOUNTS® features a more moderately-priced assortment of first-quality, in-season, name brand apparel, accessories, footwear and home fashions at everyday savings of 20 to 70 percent off moderate department and discount store regular prices. 

The Company’s primary strategy has been a continued focus on pursuing and refining its existing off-price business, and steadily expanding its store base.  In establishing growth objectives for the business, the Company closely monitors market share trends for the off-price industry.  According to data from the NPD Group, which provides global sales and marketing information on the retail industry, the off-price share of total apparel sales in 2004 grew to 8.5% from 7.6% in 2003, reflecting the ongoing importance of value to consumers.  Full-priced department stores and mass merchandise retailers experienced a decline in apparel market share over the same period.  The Company’s strategies are designed to take advantage of these growth trends and continued customer demand for name-brand fashions for the family and the home at competitive everyday discounts.

12


Results of Operations

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

July 30,
2005

 

July 31,
2004

 

July 30,
2005

 

July 31,
2004

 

 

 


 


 


 


 

 

 

 

 

 

 

(As Restated,
see Note B)

 

 

 

 

 

(As Restated,
Note B)

 

SALES

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales (millions)

 

$

1,172

 

$

1,009

 

$

2,296

 

$

2,000

 

Sales growth

 

 

16.2

%

 

4.4

%

 

14.8

%

 

8.4

%

Comparable store sales growth

 

 

7

%

 

(3

)%

 

5

%

 

0

%

COSTS AND EXPENSES (as a percent of sales)

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold, including related buying, distribution and occupancy costs

 

 

78.2

%

 

76.7

%

 

77.3

%

 

76.2

%

Selling, general and administrative

 

 

15.9

%

 

16.2

%

 

16.1

%

 

16.3

%

Impairment of long-lived assets

 

 

0

%

 

1.8

%

 

0

%

 

0.9

%

EARNINGS BEFORE TAXES

 

 

5.9

%

 

5.3

%

 

6.6

%

 

6.6

%

NET EARNINGS

 

 

3.6

%

 

3.2

%

 

4.0

%

 

4.0

%

Stores.     The Company’s operating strategy is to open additional stores in new and existing markets based on local market penetration, the ability to leverage overhead expenses, local demographic characteristics including population, and competition. Management continually evaluates opportunistic real estate acquisitions and opportunities for potential new store locations. The Company also evaluates its current store locations and determines store closures based on similar criteria.

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

July 30,
2005

 

July 31,
2004

 

July 30,
2005

 

July 31,
2004

 

 

 


 


 


 


 

Stores at the beginning of the period

 

 

673

 

 

599

 

 

649

 

 

568

 

Stores opened in the period

 

 

22

 

 

17

 

 

46

 

 

48

 

Stores closed in the period

 

 

—  

 

 

—  

 

 

—  

 

 

—  

 

 

 



 



 



 



 

Stores at the end of the period

 

 

695

 

 

616

 

 

695

 

 

616

 

 

 



 



 



 



 

Sales.     The 16% total sales increase for the three months ended July 30, 2005 over the prior year reflects the opening of 79 net new stores between July 31, 2004 and July 30, 2005, and a 7% increase in sales from “comparable” stores (defined as stores that have been open for more than 14 complete months).  The 15% total sales increase for the six months ended July 30, 2005 over the same period in the prior year reflects the opening of 79 net new stores between July 31, 2004 and July 30, 2005, and a 5% increase in sales from comparable stores.

13


The Company’s sales mix for the three and six months ended July 30, 2005 and July 31, 2004 was as follows:

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

July 30,
2005

 

July 31,
2004

 

July 30,
2005

 

July 31,
2004

 

 

 


 


 


 


 

Ladies

 

 

35

%

 

36

%

 

36

%

 

36

%

Home accents and bed and bath

 

 

20

%

 

20

%

 

20

%

 

19

%

Men’s

 

 

16

%

 

17

%

 

16

%

 

17

%

Fine jewelry, accessories, lingerie and fragrances

 

 

11

%

 

12

%

 

11

%

 

11

%

Children’s

 

 

8

%

 

6

%

 

8

%

 

8

%

Shoes

 

 

10

%

 

9

%

 

9

%

 

9

%

 

 



 



 



 



 

Total

 

 

100

%

 

100

%

 

100

%

 

100

%

 

 



 



 



 



 

Management expects to address the competitive climate for apparel and home goods off-price retailers by pursuing and refining the Company’s existing strategies and by continuing to strengthen its organization, to diversify the merchandise mix, and to more fully develop the organization and systems to strengthen regional merchandise offerings.  Although the Company’s strategies and store expansion program contributed to sales gains for the three and six-month periods ended July 30, 2005, there can be no assurance that these will result in a continuation of revenue or profit growth. 

Cost of Goods Sold.     Cost of goods sold increased $142.5 million for the three months ended July 30, 2005 compared to the same period in the prior year, mainly due to increased sales from the opening of 79 net new stores between July 31, 2004 and July 30, 2005, and increased distribution and logistics costs. 

Cost of goods sold as a percentage of sales for the three months ended July 30, 2005 increased approximately 150 basis points compared with the same period in the prior year.  This increase is largely attributable to lower merchandise gross margin and higher distribution and logistics costs during the quarter.  Higher markdowns primarily contributed to an approximate 130 basis point increase in merchandise cost of goods sold as a percentage of sales.  Distribution and logistics costs as a percentage of sales increased by approximately 50 basis points.  This was partially offset by a 30 basis point decrease in store occupancy and depreciation costs as a percentage of sales, which benefited from leverage on the 7% increase in comparable store sales.

Cost of goods sold increased $250.6 million for the six months ended July 30, 2005 compared to the same period in the prior year, mainly due to increased sales from the opening of 79 net new stores between July 31, 2004 and July 30, 2005, and increased distribution and logistics costs. 

Cost of goods sold as a percentage of sales for the six months ended July 30, 2005 increased approximately 110 basis points compared with the same period in the prior year.  This increase is largely attributable to lower merchandise gross margin and higher distribution and logistics costs.  Higher markdowns contributed to an approximate 80 basis point increase in merchandise cost of goods sold as a percentage of sales.  Distribution and logistics costs as a percentage of sales increased by approximately 45 basis points.  This was partially offset by a 15 basis point decrease in store occupancy and depreciation costs as a percentage of sales.

There can be no assurance that the gross profit margins realized for the three and six-month periods ended July 30, 2005 will continue in the future.

Selling, General and Administrative Expenses.     Selling, general, and administrative expenses increased $23.0 million for the three months ended July 30, 2005 compared to the same period in the prior year, primarily due to increased store operating costs reflecting the opening of 79 net new stores between July 31, 2004 and July 30, 2005, and increased information technology costs and related depreciation. 

For the three months ended July 30, 2005, selling, general and administrative expenses as a percentage of sales decreased approximately 30 basis points compared to the same period in the prior year, primarily due to leverage from the 7% increase in sales from comparable stores.  As a percentage of sales, store operating costs decreased approximately 40 basis points.

14


This was partially offset by an increase in information technology and related depreciation costs and an approximate 10 basis point increase in other occupancy costs primarily due to the move into the new corporate headquarters.

Selling, general, and administrative expenses increased $44.2 million for the six months ended July 30, 2005 compared to the same period in the prior year, primarily due to increased store operating costs reflecting the opening of 79 net new stores between July 31, 2004 and July 30, 2005, and increased information technology costs and related depreciation. 

For the six months ended July 30, 2005, selling, general and administrative expenses as a percentage of sales decreased approximately 15 basis points compared to the same period in the prior year.  As a percentage of sales, advertising and store operating costs decreased approximately 30 basis points, primarily due to leverage from the 5% increase in sales from comparable stores partially offset by an approximate 15 basis point increase primarily due to increased information technology costs and related depreciation.

Impairment of Long-Lived Assets.     During the second quarter of 2004, the Company relocated its corporate headquarters from Newark, California to Pleasanton, California and decided to pursue a sale of its Newark facility.  In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company recognized a non-cash impairment charge of $18 million before taxes in the second quarter of 2004 to write-down the carrying value of its Newark facility from a net book value of approximately $33 million to the estimated fair value of approximately $15 million.  The $18 million loss was subsequently reduced to $15 million in the third quarter of 2004 when the Company sold the Newark facility.  The fair value of the Newark facility assets held for sale of approximately $15 million is included in “Prepaid expenses and other” in the accompanying condensed consolidated balance sheets as of July 31, 2004. 

Taxes on Earnings.     The Company’s effective tax rate for the three and six months ended July 30, 2005 and July 31, 2004 was approximately 39%, which represents the applicable Federal and State statutory rates reduced by the Federal benefit received for State taxes.  The effective rate is affected by changes in law, location of new stores, level of earnings and the result of tax audits.  The Company anticipates that its effective tax rate for fiscal 2005 will be approximately 38% to 40%.

Net Earnings.     The increase in net earnings as a percentage of sales for the three months ended July 30, 2005, compared to the same period in the prior year, is primarily due to lower selling, general and administrative expenses as a percentage of sales and the effect of the prior year impairment charge.  Diluted earnings per share increased to $.29 from $.21 in the prior year as a result of an increase in net earnings and a decrease in weighted average diluted shares outstanding, which was largely attributable to the acquisition of common stock under the Company’s stock repurchase program.

Net earnings as a percentage of sales for the six months ended July 30, 2005, compared to the same period in the prior year, remained flat primarily due to lower selling, general and administrative expenses as a percentage of sales offset by the effect of the prior year impairment charge.  Diluted earnings per share increased to $.62 from $.53 in the prior year as a result of an increase in net earnings and a decrease in weighted average diluted shares outstanding, which was largely attributable to the acquisition of common stock under the Company’s stock repurchase program.

15


Financial Condition

Liquidity and Capital Resources

The Company’s primary sources of funds for its business activities are cash flows from operations and short-term trade credit. The Company’s primary ongoing cash requirements are for seasonal and new store merchandise inventory purchases and capital expenditures in connection with new stores, and investments in information systems and infrastructure.  The Company also uses cash to repurchase stock under its stock repurchase program and to pay dividends.

 

 

Six Months Ended

 

 

 


 

($000)

 

July 30,
2005

 

July 31,
2004

 


 


 


 

 

 

 

 

 

 

(As Restated
 See Note B)

 

Cash flows from operating activities

 

$

139,991

 

$

100,769

 

Cash flows used in investing activities

 

 

(54,600

)

 

(104,118

)

Cash flows used in financing activities

 

 

(81,325

)

 

(133,844

)

 

 



 



 

Net increase (decrease) in cash and cash equivalents

 

$

4,066

 

$

(137,193

)

 

 



 



 

Operating Activities

Net cash provided by operating activities was $140.0 million for the six months ended July 30, 2005, and $100.8 million for the six months ended July 31, 2004.  The primary source of cash from operations for the six months ended July 30, 2005 was net earnings plus non-cash expenses for depreciation and amortization, partially offset by cash used to purchase merchandise inventory, net of trade payables. The increase in cash flows from operations for the six months ended July 30, 2005 is primarily due to an increase of accounts payable leverage (defined as accounts payable divided by merchandise inventory) from 53% at July 31, 2004 to 55% at July 30, 2005.  Working capital (defined as current assets less current liabilities) was $409 million as of July 30, 2005, compared to $388 million as of July 31, 2004. The Company’s primary source of liquidity is the sale of its merchandise inventory.  Management regularly reviews the age and condition of the merchandise and is able to maintain current merchandise inventory in its stores through replenishment processes and liquidation of slower-moving merchandise through clearance markdowns.

Investing Activities

During the six-month periods ended July 30, 2005 and July 31, 2004, the Company spent approximately $96.2 million and $60.1 million, respectively, for capital expenditures (excluding leased equipment) for fixtures and leasehold improvements to open new stores, implement management information systems, install and implement materials handling equipment and related distribution center systems, and various other expenditures related to existing stores, buying offices, corporate offices and the purchase of a warehouse in Moreno Valley, California (“Moreno Valley warehouse”).  The Company opened 46 and 48 net new stores during the six months ended July 30, 2005 and July 31, 2004, respectively.  In addition, the Company sold $41.6 million and purchased $44.0 million, net, in short-term investments during the six months ended July 30, 2005 and July 31, 2004, respectively.

The Company is forecasting approximately $185 million in capital expenditures for fiscal 2005 to fund fixtures and leasehold improvements to open both new Ross stores and dd’s DISCOUNTS® stores.  In addition, these capital expenditures are expected to cover the relocation, or remodel of existing stores, and investments in store and merchandising systems, distribution center land, buildings, equipment and systems, and various central office expenditures.  The Company expects to fund these expenditures out of cash flows from operations, and existing bank and credit facilities.

16


Financing Activities

During the six-month periods ended July 30, 2005 and July 31, 2004, liquidity and capital requirements were provided by cash flows from operations, and trade credit.  Substantially all of the Company’s store sites, buying offices, its headquarters, and certain distribution centers are leased and, except for certain leasehold improvements and equipment, do not represent long-term capital investments.  The Company owns its distribution centers in Carlisle, Pennsylvania and Moreno Valley, California.

The Company repurchased 3.2 million and 4.5 million shares of common stock for an aggregate purchase price of approximately $89.0 million and $123.8 million during the periods ended July 30, 2005 and July 31, 2004, respectively. These stock repurchases were funded by cash flows from operations.

Short-term trade credit represents a significant source of financing for investments in merchandise inventory.  Trade credit arises from customary payment terms and trade practices with the Company’s vendors.  Management regularly reviews the adequacy of credit available to the Company from all sources and has been able to maintain adequate lines to meet the capital and liquidity requirements of the Company.

The table below presents significant contractual payment obligations of the Company as of July 30, 2005:

($000)
Contractual Obligations

 

Less
than 1
Year

 

1 – 3
Years

 

4 – 5
Years

 

After 5
Years

 

Total

 


 


 


 


 


 


 

Long-term debt

 

$

2,505

 

$

51,044

 

$

—  

 

$

—  

 

$

53,549

 

Operating leases

 

 

224,065

 

 

400,201

 

 

306,214

 

 

381,463

 

 

1,311,943

 

Other financings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Synthetic leases

 

 

10,086

 

 

8,819

 

 

8,182

 

 

12,272

 

 

39,359

 

Other synthetic lease obligations

 

 

84,205

 

 

2,004

 

 

—  

 

 

56,000

 

 

142,209

 

Purchase obligations

 

 

835,253

 

 

9,167

 

 

2,256

 

 

—  

 

 

846,676

 

 

 



 



 



 



 



 

Total contractual obligations

 

$

1,156,114

 

$

471,235

 

$

316,652

 

$

449,735

 

$

2,393,736

 

 

 



 



 



 



 



 

Long-Term Debt.     The Company has a $50 million senior unsecured term loan agreement to finance the equipment and information systems for its Perris, California distribution center.  Total borrowings under the term loan were $50 million as of July 30, 2005.  The Company has estimated interest on long-term debt of $3.5 million during the term of the loan, which is calculated based upon prevailing interest rates (LIBOR plus 150 basis points) and is included in “Long-term debt” in the table above.  Interest is payable no less than quarterly at the bank’s applicable prime rate or at LIBOR plus an applicable margin (currently 150 basis points) which resulted in an effective interest rate of 5.01% at July 30, 2005.  All amounts outstanding under the term loan will be due and payable in December 2006.  Borrowings under this term loan are subject to certain operating and financial covenants including maintaining certain interest coverage and leverage ratios. 

Off-Balance Sheet Arrangements

Operating Leases.     Substantially all of the Company’s store sites, certain distribution centers, and the Company’s buying offices and corporate headquarters are leased and, except for certain leasehold improvements and equipment, do not represent long-term capital investments.  The Company owns its distribution centers in Carlisle, Pennsylvania and Moreno Valley, California.

17


The Company has lease arrangements for certain equipment in its stores for its point-of-sale (“POS”) hardware and software systems.  These leases are accounted for as operating leases for financial reporting purposes.  The initial terms of these leases are two years and the Company typically has options to renew the leases for two to three one-year periods.  Alternatively, the Company may purchase or return the equipment at the end of the initial or each renewal term.  The Company has guaranteed the value of the equipment at the end of the respective initial lease terms of $12.0 million, which is included in “Other synthetic lease obligations” in the table above.

In January 2004, the Company commenced its lease on its corporate headquarters in Pleasanton, California. The lease has an initial term of 10.5 years with three five-year renewal options.

In October 2004, the Company entered into a lease arrangement to use a portion of its previously sold Newark, California distribution center (“Newark Facility”) to support distribution activities for dd’s DISCOUNTS® for an initial lease term of two years, with a one-year renewal option, a minor part of its remaining useful life. 

Other Financings.     The Company leases a 1.3 million square foot distribution center in Fort Mill, South Carolina. This distribution center, including equipment and systems, is being financed under an $87.3 million, five-year operating lease, commonly referred to as a synthetic lease, which expires in May 2006.  Monthly rent expense is currently payable at 90 basis points over LIBOR on the lease balance of $87.3 million.  The Company has estimated rent expense on the lease which is calculated based upon prevailing interest rates (LIBOR plus 90 basis points) and is included in “Synthetic leases” in the contractual obligations table above.  At the end of the lease term, the Company must refinance the $87.3 million synthetic lease facility, purchase the distribution center at the amount of the then-outstanding lease balance, or arrange a sale of the distribution center to a third party.  The Company has agreed under a residual value guarantee to pay the lessor up to 85% of the lease balance.  The Company’s obligation under this residual value guarantee of $74.2 million is included in “Other synthetic lease obligations” in the contractual obligations table above.

The Company also leases a 1.3 million square foot distribution center in Perris, California.  This distribution center is being financed under a $70 million ten-year synthetic lease facility that expires in July 2013.  Rent expense on this center is payable monthly at a fixed annual rate of 5.8% on the lease balance of $70 million.  At the end of the lease term, the Company must refinance the $70 million synthetic lease facility, purchase the distribution center at the amount of the then-outstanding lease balance, or arrange a sale of the distribution center to a third party.  If the distribution center is sold to a third party for less than $70 million, the Company has agreed under a residual value guarantee to pay the lessor the shortfall below $70 million not to exceed $56 million. The Company’s contractual obligation of $56 million is included in “Other synthetic lease obligations” in the above table. The $50 million financing of equipment and systems for the Perris, California center is included in “Long-term debt” in the table above.

In accordance with Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” the Company has recognized a liability and corresponding asset for the fair value of the residual value guarantee in the amount of $8.3 million for the Perris, California distribution center and $1.5 million for the POS lease.  These residual value guarantees are being amortized on a straight-line basis over the original terms of the leases. The current portion of the related asset and liability is recorded in “Prepaid expenses and other” and “Accrued expenses and other,” respectively, and the long-term portion of the related assets and liabilities is recorded in “Other long-term assets” and “Other long-term liabilities,” respectively, in the accompanying condensed consolidated balance sheets. 

In addition, the Company leases two separate warehouse facilities for packaway storage in Carlisle, Pennsylvania with operating leases expiring through 2011.  In January 2004, the Company entered into a two-year lease with two one-year options for a warehouse facility in Fort Mill, South Carolina. These three leased facilities are being used primarily to store packaway merchandise.

The synthetic lease facilities described above, as well as the Company’s long-term debt and revolving credit facility, have covenant restrictions requiring the Company to maintain certain interest coverage and leverage ratios.  In addition, the interest rates under these agreements may vary depending on the Company’s actual interest coverage ratios.  As of July 30, 2005, the Company was in compliance with these covenants. 

In December 2003, the FASB issued the revised FIN No. 46(R), “Consolidation of Variable Interest Entities,” which addresses consolidation by business enterprises of entities that are not controllable through voting interests or in which the equity investors do not bear the residual economic risks and rewards.  FIN No. 46(R) explains how to identify variable interest entities and how an enterprise should assess its interest in an entity to decide whether to consolidate that entity. 

18


The Company was not required under FIN No. 46(R) to consolidate its synthetic leases since the lessors/owners are not variable interest entities. 

Purchase Obligations.     As of July 30, 2005, the Company had purchase obligations of $846.7 million.  These purchase obligations primarily consist of merchandise inventory purchase orders, commitments related to store fixtures, supplies, and information technology service and maintenance contracts.  Total merchandise inventory purchase orders of $799.4 million are all purchase obligations of less than one year as of July 30, 2005.

Commercial Credit Facilities

The table below presents significant commercial credit facilities available to the Company as of July 30, 2005:

 

 

Amount of Commitment Expiration Per Period

 

 

 

 

 

 


 

Total
Amount
Committed

 

($000)
Commercial Credit Commitments

 

Less than
1 Year

 

1 - 3
Years

 

4 - 5
Years

 

Over 5
Years

 

 


 


 


 


 


 


 

Revolving credit facility1

 

$

—  

 

$

—  

 

$

600,000

 

$

—  

 

$

600,000

 

 

 



 



 



 



 



 

Total commercial commitments

 

$

—  

 

$

—  

 

$

600,000

 

$

—  

 

$

600,000

 

 

 



 



 



 



 



 



1

Contains a $200 million sublimit for issuances of letters of credit, of which $62.8 million is outstanding and $137.2 million is available as of July 30, 2005.

Revolving Credit Facility.     In 2004, the Company entered into a $600 million revolving credit facility with its banks, which contains a $200 million sublimit for issuances of letters of credit of which $137.2 million was available at July 30, 2005.  Interest is LIBOR-based plus an applicable margin (currently 75 basis points) and is payable upon borrowing maturity but no less than quarterly.  Borrowing under this credit facility is subject to the Company maintaining certain interest coverage and leverage ratios.  The Company has had no borrowings under this facility.  This revolving credit facility is scheduled to expire in March 2009.

Standby Letters of Credit.     The Company uses standby letters of credit to collateralize certain obligations related to its self-insured workers’ compensation and general liability claims.  The Company had $62.8 million and $65.2 million in standby letters of credit outstanding at July 30, 2005 and July 31, 2004, respectively.

Trade Letters of Credit.     The Company had $21.7 million and $27.1 million in trade letters of credit outstanding at July 30, 2005 and July 31, 2004, respectively.

Dividends.     In May 2005, a quarterly cash dividend payment of $.05 per common share was declared by the Company’s Board of Directors, and was paid on July 1, 2005.  In August 2005, a quarterly cash dividend of $.05 per common share was declared by the Company’s Board of Directors, payable on or about September 30, 2005.

Stock Repurchase Program.     In January 2004, the Company announced that the Board of Directors authorized a stock repurchase program of up to $350 million for 2004 and 2005.  During the six months ended July 30, 2005, the Company repurchased approximately 3.2 million shares for an aggregate purchase price of approximately $89.0 million. 

The Company estimates that cash flows from operations, bank credit lines and trade credit are adequate to meet operating cash needs, fund its planned capital investments, repurchase common stock and make quarterly dividend payments for at least the next twelve months.

19


Critical Accounting Policies

The preparation of the Company’s consolidated financial statements requires management of the Company 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.  The Company believes the following critical accounting policies describe the more significant judgments and estimates used in the preparation of its consolidated financial statements:

Merchandise Inventory.  The Company’s merchandise inventory is stated at the lower of cost or market with cost determined on a weighted average cost method.  The Company purchases manufacturer overruns and canceled orders both during and at the end of a season which are referred to as “packaway” inventory.  Packaway inventory is purchased with the intent that it will be stored in the Company’s warehouses until a later date, which may even be the beginning of the same selling season in the following year.  Included in the carrying value of the Company’s merchandise inventory is a provision for shrinkage.  The shrinkage reserve is based on historical shrinkage rates as evaluated through the Company’s physical merchandise inventory counts and cycle counts.  If actual market conditions, markdowns, or shrinkage are less favorable than those projected by management, or if sales of the merchandise inventory are more difficult than anticipated, additional merchandise inventory write-downs may be required.

Long-lived Assets.  The Company records a long-lived asset impairment charge when events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable based on estimated future cash flows.  An impairment loss would be recognized if analysis of the undiscounted cash flow of an asset group was less than the carrying value of the asset group. During the second quarter of 2004, the Company relocated its corporate headquarters from Newark, California to Pleasanton, California and decided to pursue a sale of its Newark facility.  The Company recognized a non-cash impairment charge of $18 million before taxes in the second quarter of 2004 to write-down the carrying value of its Newark facility from its net book value of approximately $33 million to the estimated fair value of approximately $15 million.  The fair value of the Newark facility assets held for sale of approximately $15 million is included in “Prepaid expenses and other” in the accompanying condensed consolidated balance sheets as of July 31, 2004.

Self-Insurance.  The Company self insures certain of its workers’ compensation and general liability risks as well as certain of its health insurance plans. The Company’s self-insurance liability is determined actuarially, based on claims filed and an estimate of claims incurred but not reported.  Should a greater amount of claims occur compared to what is estimated or the costs of medical care and state statutory requirements increase beyond what was anticipated, reserves recorded may not be sufficient and additional charges could be required.

The above listing is not intended to be a comprehensive list of all of the Company’s accounting policies.  In many cases, the accounting treatment of a particular transaction is specifically dictated by Generally Accepted Accounting Principles, with no need for management’s judgment in their application.

New Accounting Pronouncements

In November 2004, the FASB issued the revised SFAS No. 151, “Inventory Costs,” which clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe that the adoption of SFAS No. 151 will have a material impact on the Company’s operating results or financial position.

In December 2004, the FASB issued the revised SFAS No. 123(R), “Share-Based Payment,” which establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS No. 123(R) requires recognition of stock-based compensation expense in the consolidated financial statements over the period during which an employee is required to provide service in exchange for the award. SFAS No. 123(R) is effective for the fiscal year beginning after June 15, 2005. The Company will implement the requirements of the standard as of the beginning of its fiscal year 2006.  The impact of adopting SFAS No. 123(R) will be dependent on numerous factors including, but not limited to, the valuation

20


model chosen by the Company to value stock-based awards; the assumed award forfeiture rate; the accounting policies adopted concerning the method of recognizing the fair value of awards over the requisite service period; and the transition method chosen for adopting SFAS No. 123(R).  The Company has not yet quantified the effects of the adoption of SFAS No. 123(R).

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” which requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The Company does not expect the adoption of SFAS No. 154, which is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, to have a material impact on the consolidated financial statements.

dd’s DISCOUNTS®

The Company operates 13 dd’s DISCOUNTS® stores, its off-price concept targeted to serve the needs of lower-income households, which it believes to be one of the fastest growing demographic markets in the country.  dd’s DISCOUNTS® features a moderately-priced assortment of first-quality, in-season, name brand apparel, accessories, footwear and home fashions at everyday savings of 20 to 70 percent off moderate department and discount store regular prices.  The Company opened ten initial stores at locations in California during the second half of 2004 and three stores during the first half of 2005.  This new business generally has similar merchandise departments and categories to those of Ross, but features a different mix of brands, consisting mostly of moderate department store and discount store labels at lower average price points.  The average dd’s DISCOUNTS® store is approximately 26,000 gross square feet and is located in an established strip shopping center in densely populated urban and suburban neighborhoods.  The dd’s DISCOUNTS® and Ross merchant, store and distribution organizations are separate and distinct; however, dd’s DISCOUNTS® shares other certain corporate and support services with Ross.

Moreno Valley Warehouse Acquisition

On May 20, 2005, the Company acquired a warehouse property consisting of land and building in Moreno Valley, California for $38.3 million.  The Company funded the acquisition with its existing cash balances and is currently using the warehouse for storing packaway inventory. 

Forward-Looking Statements and Factors Affecting Future Performance

This report includes certain forward-looking statements regarding forecasted capital expenditures, and expected sales and earnings levels, which reflect the Company’s current beliefs, projections and estimates with respect to future events and the Company’s future financial performance, operations and competitive position. The words “expect,” “anticipate,” “estimate,” “believe,” “looking ahead,” “forecast,” “guidance,” “plan,”  “projected,” and similar expressions identify forward-looking statements.  These forward looking statements are subject to risks and uncertainties that could cause the Company’s actual results to differ materially from historical results or current expectations.

Risks and uncertainties that apply to both Ross and dd’s DISCOUNTS® stores include, without limitation, the Company’s ability to effectively operate and integrate various new supply chain and core merchandising systems, including generation of all necessary information in a timely and cost effective manner; achieving and maintaining targeted levels of productivity and efficiency in its distribution centers; obtaining acceptable new store locations; competitive pressures in the apparel industry; changes in the level of consumer spending on or preferences for apparel or home-related merchandise;  changes in geopolitical and general economic conditions; unseasonable weather trends; disruptions in supply chain; lower than planned gross margin, higher than planned markdowns, higher than expected inventory shortage, and greater than planned operating costs; the Company’s ability to continue to purchase attractive brand-name merchandise at desirable discounts, the Company’s ability to identify and successfully enter new geographic markets, and the Company’s ability to attract and retain personnel with the retail talent necessary to execute its strategies.  

21


The Company’s corporate headquarters, certain of its distribution centers and 29% of its stores are located in California.  Therefore, a downturn in the California economy or a major California natural disaster could significantly affect the Company’s operating results and financial condition. 

The Company’s continued success depends, in part, upon its ability to increase sales at existing locations, and to open new stores and to operate stores on a profitable basis.  There can be no assurance that the Company’s existing strategies and store expansion program will result in a continuation of revenue growth or profit growth. 

Future economic and industry trends that could potentially impact revenue and profitability remain difficult to predict.  The factors underlying the Company’s forecasts are dynamic and subject to change.  As a result, any forecasts speak only as of the date they are given and do not necessarily reflect the Company’s outlook at any other point in time.  The Company disclaims any obligation to update or revise these forward-looking statements.

Other risk factors are detailed in the Company’s Form 10-K for fiscal 2004.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to market risks, which primarily include changes in interest rates.  The Company does not engage in financial transactions for trading or speculative purposes. 

Interest that is payable on the Company’s revolving credit facilities and long-term debt is based on variable interest rates and is, therefore, affected by changes in market interest rates.  In addition, lease payments under certain of the Company’s synthetic lease agreements are determined based on variable interest rates and are, therefore, affected by changes in market interest rates.  As of July 30, 2005, the Company had no borrowings outstanding under its revolving credit facilities and had $50 million of long-term debt outstanding which accrues interest at LIBOR plus 150 basis points.

A hypothetical 100 basis point increase in prevailing market interest rates would not have materially impacted the Company’s consolidated financial position, results of operations, or cash flows as of and for the three and six-month periods ended July 30, 2005. The Company does not consider the potential losses in future earnings and cash flows from reasonably possible near term changes in interest rates to be material. 

The Company occasionally uses forward contracts to hedge against fluctuations in foreign currency prices. The Company had no outstanding forward contracts at July 30, 2005.

ITEM 4.  CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Management, with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the Company’s “disclosure controls and procedures” (as defined in Exchange Act Rule 13a-15(e)) as of the end of the quarterly period covered by this report.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report. 

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met.  In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events.

22


Quarterly Evaluation of Changes in Internal Control Over Financial Reporting

Management, with the participation of the Chief Executive Officer and Chief Financial Officer, also conducted an evaluation of the Company’s internal control over financial reporting to determine whether any change occurred during the second fiscal quarter of 2005 that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.  Based on that evaluation, management has concluded that there was no such change during the second fiscal quarter.

23


PART II – OTHER INFORMATION

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Information regarding shares of common stock repurchased by the Company during the second quarter of 2005 is as follows:

Period

 

Total
Number of
Shares (or
Units)
Purchased1

 

Average
Price Paid
per Share
(or Unit)

 

Total Number of
Shares (or
Units) Purchased as Part
of Publicly
Announced Plans or
Programs

 

Maximum Number (or
Approximate Dollar
Value) of Shares (or
Units) that May Yet Be
Purchased Under the
Plans or Programs
($000)

 


 



 



 



 



 

May (5/1/2005-5/28/2005)

 

 

424,400

 

$

26.78

 

 

424,400

 

$

121,000

 

June (5/29/2005-7/2/2005)

 

 

683,127

 

$

29.44

 

 

679,582

 

$

101,000

 

July (7/3/2005-7/30/2005)

 

 

555,275

 

$

27.06

 

 

554,909

 

$

86,000

 

 

 



 

 

 

 



 

 

 

 

Total

 

 

1,662,802

 

$

27.96

 

 

1,658,891

 

$

86,000

 

 

 



 

 

 

 



 

 

 

 



1     The Company acquired 3,911 shares for the quarter ended July 30, 2005 related to income tax withholdings for restricted stock.  All remaining shares were repurchased under the two-year $350 million stock repurchase program publicly announced on February 5, 2004.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the Annual Meeting of Stockholders, held on May 19, 2005 (the “2005 Annual Meeting”), the stockholders of the company voted on and approved the following proposals:

Proposal 1: To elect three Class III directors (Stuart G. Moldaw, George P. Orban and Donald H. Seiler) for a three-year term.

Proposal 2: To ratify the appointment of Deloitte & Touche LLP as the Company’s independent auditors for the fiscal year ending January 28, 2006.

2004 ANNUAL MEETING ELECTION RESULTS

PROPOSAL 1:  ELECTION OF DIRECTORS

DIRECTOR

 

IN FAVOR

 

WITHHELD

 

TERM EXPIRES

 


 



 



 


 

Stuart G. Moldaw

 

 

130,077,676

 

 

7,523,555

 

2008

 

George P. Orban

 

 

133,135,532

 

 

4,465,699

 

2008

 

Donald H. Seiler

 

 

120,300,871

 

 

17,300,360

 

2008

 

24


PROPOSAL 2:  RATIFICATION OF THE APPOINTMENT OF DELOITTE & TOUCHE LLP AS INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS FOR THE FISCAL YEAR ENDING JANUARY 28, 2006

FOR

 

AGAINST

 

ABSTAIN


 


 


115,950,758

 

21,609,049

 

41,424

ITEM 6.  EXHIBITS

Incorporated herein by reference to the list of Exhibits contained in the Exhibit Index within this Report.

25


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

 

ROSS STORES, INC.

 


 

(Registrant)

 

 

Date:  September 8, 2005

By:

/s/ J. Call

 

 

John G. Call

 

 

Senior Vice President, Chief Financial Officer,

 

 

Principal Accounting Officer and Corporate Secretary

26


INDEX TO EXHIBITS

Exhibit
Number

 

Exhibit


 


 

3.1

 

Amendment of Certificate of Incorporation dated May 21, 2004 and Amendment of Certificate of Incorporation dated June 5, 2002 and Corrected First Restated Certificate of Incorporation incorporated by reference to Exhibit 3.1 to the Form 10-Q filed by Ross Stores for its quarter ended July 31, 2004.

 

 

 

 

 

3.2

 

Amended By-laws, dated August 25, 1994, incorporated by reference to Exhibit 3.2 to the Form 10-Q filed by Ross Stores for its quarter ended July 30, 1994.

 

 

 

 

 

10.1

 

Second Amendment to the Employment Agreement effective May 18, 2005 between Michael Balmuth and Ross Stores, Inc.

 

 

 

 

 

10.2

 

First Amendment to the Ross Stores, Inc. 2004 Equity Incentive Plan, effective May 17, 2005.

 

 

 

 

 

10.3

 

Form of Stock Option Agreement for Non-Employee Directors for options granted pursuant to Ross Stores, Inc. 2004 Equity Incentive Plan.

 

 

 

 

 

15

 

Letter re: Unaudited Interim Financial Information from Deloitte & Touche dated September 7, 2005.

 

 

 

 

 

31.1

 

Certification of Chief Executive Officer Pursuant to Sarbanes-Oxley Act Section 302(a).

 

 

 

 

 

31.2

 

Certification of Chief Financial Officer Pursuant to Sarbanes-Oxley Act Section 302(a).

 

 

 

 

 

32.1

 

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350.

 

 

 

 

 

32.2

 

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.

27

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