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Ross Stores 10-Q 2006

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 29, 2006

 

 

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

 

N/A

changed since last report.

 

 

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer           x

Accelerated filer           o

Non-accelerated filer           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 17, 2006 was 141,106,256.



PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Condensed Consolidated Statements of Earnings

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

($000, except per share data, unaudited)

 

July 29,
2006

 

July 30,
2005

 

July 29,
2006

 

July 30,
2005

 


 



 



 



 



 

Sales

 

$

1,308,052

 

$

1,171,862

 

$

2,599,728

 

$

2,295,799

 

Costs and expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

 

1,024,130

 

 

919,166

 

 

2,012,966

 

 

1,784,165

 

Selling, general and administrative

 

 

210,635

 

 

183,652

 

 

417,802

 

 

360,705

 

Interest income, net

 

 

(1,554

)

 

(580

)

 

(3,438

)

 

(878

)

 

 



 



 



 



 

Total costs and expenses

 

 

1,233,211

 

 

1,102,238

 

 

2,427,330

 

 

2,143,992

 

Earnings before taxes

 

 

74,841

 

 

69,624

 

 

172,398

 

 

151,807

 

Provision for taxes on earnings

 

 

29,464

 

 

27,345

 

 

67,804

 

 

59,478

 

 

 



 



 



 



 

Net earnings

 

$

45,377

 

$

42,279

 

$

104,594

 

$

92,329

 

Earnings per share

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

.32

 

$

.29

 

$

.74

 

$

.63

 

Diluted

 

$

.32

 

$

.29

 

$

.73

 

$

.62

 

Weighted average shares outstanding (000)

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

140,348

 

 

145,102

 

 

140,991

 

 

145,555

 

Diluted

 

 

142,698

 

 

147,321

 

 

143,454

 

 

147,894

 

Dividends per share

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per share

 

$

.06

 

$

.05

 

$

.06

 

$

.05

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stores open at end of period

 

 

770

 

 

695

 

 

770

 

 

695

 

See notes to condensed consolidated financial statements.

2


Condensed Consolidated Balance Sheets

($000, unaudited)

 

July 29,
2006

 

January 28,
2006

 

July 30,
2005

 


 



 



 



 

 

 

 

 

 

(Note A)

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

59,351

 

$

191,767

 

$

119,397

 

Short-term investments

 

 

7,417

 

 

12,763

 

 

25,800

 

Accounts receivable

 

 

33,904

 

 

29,122

 

 

35,371

 

Merchandise inventory

 

 

959,792

 

 

938,091

 

 

975,846

 

Prepaid expenses and other

 

 

50,567

 

 

37,090

 

 

51,060

 

Deferred income taxes

 

 

20,014

 

 

20,014

 

 

8,968

 

 

 



 



 



 

Total current assets

 

 

1,131,045

 

 

1,228,847

 

 

1,216,442

 

Property and equipment

 

 

 

 

 

 

 

 

 

 

Land and buildings

 

 

138,036

 

 

74,298

 

 

70,029

 

Fixtures and equipment

 

 

794,591

 

 

740,540

 

 

686,680

 

Leasehold improvements

 

 

386,320

 

 

376,411

 

 

350,311

 

Construction-in-progress

 

 

33,185

 

 

21,266

 

 

28,298

 

 

 



 



 



 

 

 

 

1,352,132

 

 

1,212,515

 

 

1,135,318

 

Less accumulated depreciation and amortization

 

 

618,227

 

 

572,663

 

 

526,444

 

 

 



 



 



 

Property and equipment, net

 

 

733,905

 

 

639,852

 

 

608,874

 

Other long-term assets

 

 

58,057

 

 

58,837

 

 

53,025

 

Long-term investments

 

 

13,140

 

 

11,202

 

 

—  

 

 

 



 



 



 

Total assets

 

$

1,936,147

 

$

1,938,738

 

$

1,878,341

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

537,928

 

$

474,614

 

$

534,253

 

Accrued expenses and other

 

 

191,581

 

 

200,723

 

 

160,527

 

Accrued payroll and benefits

 

 

131,082

 

 

128,060

 

 

112,455

 

Income taxes payable

 

 

—  

 

 

25,586

 

 

—  

 

Short-term debt

 

 

—  

 

 

50,000

 

 

—  

 

 

 



 



 



 

Total current liabilities

 

 

860,591

 

 

878,983

 

 

807,235

 

Long-term debt

 

 

—  

 

 

—  

 

 

50,000

 

Other long-term liabilities

 

 

123,760

 

 

122,926

 

 

115,127

 

Deferred income taxes

 

 

94,747

 

 

100,657

 

 

96,767

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

 

 

 

Common stock

 

 

1,421

 

 

1,448

 

 

1,469

 

Additional paid-in capital

 

 

510,143

 

 

522,566

 

 

507,443

 

Treasury stock

 

 

(20,596

)

 

(18,244

)

 

(17,578

)

Deferred compensation

 

 

—  

 

 

(29,375

)

 

(37,114

)

Accumulated other comprehensive (loss) income

 

 

(173

)

 

20

 

 

—  

 

Retained earnings

 

 

366,254

 

 

359,757

 

 

354,992

 

 

 



 



 



 

Total stockholders’ equity

 

 

857,049

 

 

836,172

 

 

809,212

 

 

 



 



 



 

Total liabilities and stockholders’ equity

 

$

1,936,147

 

$

1,938,738

 

$

1,878,341

 

See notes to condensed consolidated financial statements.

3


Condensed Consolidated Statements of Cash Flows

 

 

Six Months Ended

 

 

 


 

($000, unaudited)

 

July 29,
2006

 

July 30,
2005

 


 



 



 

Cash Flows from Operating Activities

 

 

 

 

 

 

 

Net earnings

 

$

104,594

 

$

92,329

 

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

 

 

 

 

 

 

 

Depreciation and amortization

 

 

50,915

 

 

44,891

 

Stock-based compensation

 

 

13,621

 

 

7,873

 

Deferred income taxes

 

 

(3,092

)

 

4,566

 

Tax benefit from equity issuance

 

 

6,280

 

 

17,430

 

Excess tax benefits from stock-based compensation

 

 

(1,243

)

 

—  

 

Change in assets and liabilities:

 

 

 

 

 

 

 

Merchandise inventory

 

 

(21,701

)

 

(122,734

)

Other current assets, net

 

 

(18,259

)

 

(8,521

)

Accounts payable

 

 

71,954

 

 

89,727

 

Other current liabilities

 

 

(36,743

)

 

13,283

 

Other long-term, net

 

 

2,770

 

 

1,147

 

 

 



 



 

Net cash provided by operating activities

 

 

169,096

 

 

139,991

 

 

 

 

 

 

 

 

 

Cash Flows Used in Investing Activities

 

 

 

 

 

 

 

Purchase of assets under lease

 

 

(87,329

)

 

—  

 

Other additions to property and equipment

 

 

(58,794

)

 

(96,200

)

Sales of investments, net

 

 

3,215

 

 

41,600

 

 

 



 



 

Net cash used in investing activities

 

 

(142,908

)

 

(54,600

)

 

 

 

 

 

 

 

 

Cash Flows Used in Financing Activities

 

 

 

 

 

 

 

Repayment of term debt

 

 

(50,000

)

 

—  

 

Issuance of common stock related to stock plans

 

 

8,550

 

 

28,391

 

Excess tax benefits from stock-based compensation

 

 

1,243

 

 

—  

 

Treasury stock purchased

 

 

(2,352

)

 

(5,960

)

Repurchase of common stock

 

 

(98,867

)

 

(89,009

)

Dividends paid

 

 

(17,178

)

 

(14,747

)

 

 



 



 

Net cash used in financing activities

 

 

(158,604

)

 

(81,325

)

 

 



 



 

Net (decrease) increase in cash and cash equivalents

 

 

(132,416

)

 

4,066

 

Cash and cash equivalents:

 

 

 

 

 

 

 

Beginning of period

 

 

191,767

 

 

115,331

 

 

 



 



 

End of period

 

$

59,351

 

$

119,397

 

 

 



 



 

Non-Cash Investing Activities

 

 

 

 

 

 

 

Straight-line rent capitalization in build-out period

 

$

—  

 

$

1,608

 

Change in fair value of investment securities

 

$

(192

)

$

—  

 

See notes to condensed consolidated financial statements.

4


Notes to Interim Condensed Consolidated Financial Statements

Three and Six Months Ended July 29, 2006 and July 30, 2005
(Unaudited)

Note A:  Summary of Significant Accounting Policies

Basis of Presentation.  The accompanying unaudited interim condensed consolidated financial statements have been prepared from the records of Ross Stores, Inc. and subsidiaries (the “Company”) without audit and, in the opinion of management, include all adjustments (consisting of only normal, recurring adjustments except as described below) necessary to present fairly the Company’s financial position as of July 29, 2006 and July 30, 2005; the results of operations for the three and six months ended July 29, 2006 and July 30, 2005; and cash flows for the six months ended July 29, 2006 and July 30, 2005.  The Condensed Consolidated Balance Sheet as of January 28, 2006, presented herein, has been derived from the Company’s audited consolidated financial statements for 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 28, 2006.  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 28, 2006.

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.

Stock-based compensation.  Effective in fiscal year 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” and elected to adopt the standard using the modified prospective transition method.  SFAS No. 123(R) replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.”  This new accounting standard requires recognition of compensation expense based upon the grant date fair value of all stock-based awards, typically over the vesting period.  Prior periods were not revised for comparative purposes.

Reclassifications.  In prior periods, stock-based compensation expense and incentive compensation expense were included in Selling, general and administrative expenses.  In accordance with SEC Staff Accounting Bulletin (“SAB”) No. 107, which provides guidance on implementation of SFAS No. 123(R), all compensation-related expenses should be recorded in a manner similar to other employee payroll costs.  Therefore, for prior periods, the Company has reclassified the portion of stock-based compensation and incentive compensation that relates to personnel in the merchandising and distribution organizations from Selling, general and administrative expense to Cost of goods sold.  Beginning in fiscal year 2006, the portion of stock option and employee stock purchase plan (“ESPP”) expenses included in stock-based compensation expense for personnel in the merchandising and distribution organizations is included in Cost of goods sold. 

Under the provisions of SFAS No. 123(R), Deferred compensation previously reported as a contra-equity amount and representing the amount of unamortized value of restricted stock issued is no longer reported separately.  Accordingly, Deferred compensation in the Condensed Consolidated Balance Sheet as of July 29, 2006 was reclassified to Additional paid-in capital.  In addition, amortization of deferred compensation related to restricted stock is now reported as Stock-based compensation in the Condensed Consolidated Statements of Cash Flows, rather than as Depreciation and amortization. 

See Note B for more information on the Company’s stock-based compensation plans and implementation of SFAS No. 123(R).

Lease accounting.  The Company has adopted the Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) 13-1, “Accounting for Rental Costs Incurred During a Construction Period,” which requires that rental costs incurred during a construction period be expensed, not capitalized, beginning in the first quarter of 2006.

5


Implementation of this new standard did not have a significant impact on the Company’s financial results for the three and six-month periods ended July 29, 2006.  When a lease contains “rent holidays” or requires fixed escalations of the minimum lease payments, the Company records rental expense on a straight-line basis over the term of the lease and the difference between the average rental amount charged to expense and the amount payable under the lease is recorded as deferred rent.  The Company amortizes deferred rent on a straight-line basis over the lease term commencing on the date the leased space is ready for its intended use.  Tenant improvement allowances are included in Other long-term liabilities and are amortized over the lease term.  Tenant improvement allowances are included as a component of operating cash flows in the Condensed Consolidated Statements of Cash Flows.

Provision for litigation expense and other legal proceedings.  The Company is party to various legal proceedings arising in the normal course of business.  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 regarding employee payroll and wage claims.  The Orange County Superior Court has 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.

Note B:  Stock-Based Compensation

Stock options and restricted stock.  The Company has one equity incentive compensation plan, the 2004 Equity Incentive Plan (the “2004 Plan”).  The 2004 Plan provides for various types of incentive awards, which may potentially include the grant of non-qualified and incentive stock options, stock appreciation rights, restricted stock purchase rights, restricted stock shares, restricted stock units, performance shares, performance units and deferred stock units.  The 2004 Plan also provides for the automatic grant of stock options to each non-employee director at pre-established times and at a predetermined value.  To date, the Company has granted stock options and restricted stock shares under the 2004 Plan.  Under the 2004 Plan, stock options are granted at exercise prices not less than the fair market value on the date the option is granted, expire not more than ten years from the date of grant, and normally vest over a period not exceeding four years from the date of grant.  The Company grants restricted shares to officers and key employees.  The fair value of these shares at the date of grant is amortized as an expense on a straight-line basis over the vesting period of generally two to four years.

Employee Stock Purchase Plan.  Under the ESPP, eligible full-time employees participating in the offering period can choose to have up to the lesser of 10% or $21,250 of their annual base earnings withheld to purchase the Company’s common stock.  The purchase price of the stock is the lower of 85% of the market price at the beginning of the offering period, or end of the offering period.

Stock-based compensation.  The Company adopted the provisions of SFAS No. 123(R) on January 29, 2006, the beginning of its 2006 fiscal year, using the modified prospective method.  Under SFAS No. 123(R), compensation expense is recognized based on the grant date fair value of stock-based compensation awards granted in fiscal 2006 and later, and based on the unvested portion of awards that were outstanding as of January 28, 2006 from prior year grants.  Stock-based awards are valued using the Black-Scholes option pricing model, consistent with the Company’s prior pro forma disclosures under SFAS No. 123.  Compensation expense for unvested awards outstanding at the effective date is recognized over the remaining vesting period using the compensation cost calculated for purposes of the prior pro forma disclosures.  For awards granted after the adoption date, the Company recognizes expense based on the fair value of the award on a straight-line basis over the applicable vesting term. 

6


For the three and six-month periods ended July 29, 2006 and July 30, 2005, the Company recognized the following expense related to stock-based compensation (in $000):

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

July 29,
2006

 

July 30,
2005

 

July 29,
2006

 

July 30,
2005

 

 

 



 



 



 



 

Stock option and ESPP related expenses

 

$

3,308

 

$

—  

 

$

6,772

 

$

—  

 

Restricted stock amortization

 

 

3,408

 

 

3,912

 

 

6,849

 

 

7,873

 

 

 



 



 



 



 

Total stock-based compensation expense

 

$

6,716

 

$

3,912

 

$

13,621

 

$

7,873

 

 

 



 



 



 



 

Capitalized stock-based compensation cost was not significant.

The determination of the fair value of stock options and ESPP shares, using the Black-Scholes model, is affected by the Company’s stock price as well as assumptions as to the Company’s expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behavior, the risk-free interest rate, and expected dividends.

The Company estimates the expected term of options granted taking into account historical and expected future exercise, cancellation and forfeiture behavior.  The Company estimates the volatility of the common stock by using historical volatility over a period equal to the award’s expected term.  The risk-free interest rates that are used in the valuation models are based upon yields of U.S. Treasury issues with remaining terms similar to the expected term on the options.  Dividend yield has been estimated based on the Company’s expectation of future dividend payouts. 

SFAS No. 123(R) requires companies to estimate future expected forfeitures at the date of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates.  In previous fiscal years, the Company had recognized the impact of forfeitures as they occurred.  Now, the Company uses historical data to estimate pre-vesting forfeiture rates in determining the amount of stock-based compensation expense to recognize.  All stock-based compensation awards are amortized on a straight-line basis over the requisite service periods of the awards.

The fair value of the stock options and ESPP rights granted during the respective periods were estimated using the Black-Scholes option pricing model and the following weighted average assumptions: 

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

Stock Options

 

July 29,
2006

 

July 30,
2005

 

July 29,
2006

 

July 30,
2005

 


 



 



 



 



 

Expected life from grant date (years)

 

 

3.9

 

 

3.3

 

 

4.2

 

 

3.4

 

Expected volatility

 

 

31.4

%

 

33.7

%

 

32.7

%

 

33.8

%

Risk-free interest rate

 

 

4.9

%

 

4.1

%

 

4.5

%

 

3.8

%

Dividend yield

 

 

0.8

%

 

0.8

%

 

0.8

%

 

0.7

%


 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

Employee Stock Purchase Plan

 

July 29,
2006

 

July 30,
2005

 

July 29,
2006

 

July 30,
2005

 


 



 



 



 



 

Expected life from grant date (years)

 

 

1.0

 

 

1.0

 

 

1.0

 

 

1.0

 

Expected volatility

 

 

26.6

%

 

30.9

%

 

26.6

%

 

30.9

%

Risk-free interest rate

 

 

4.5

%

 

2.9

%

 

4.5

%

 

2.9

%

Dividend yield

 

 

0.8

%

 

0.7

%

 

0.8

%

 

0.7

%

7


Total stock-based compensation recognized in the Company’s Condensed Consolidated Statements of Earnings for the periods ended July 29, 2006 and July 30, 2005 is as follows (in $000):

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

Statements of Earnings Classification

 

July 29,
2006

 

July 30,
2005

 

July 29,
2006

 

July 30,
2005

 


 



 



 



 



 

Cost of goods sold

 

$

2,919

 

$

1,874

 

$

5,872

 

$

3,771

 

Selling, general and administrative

 

 

3,797

 

 

2,038

 

 

7,749

 

 

4,102

 

 

 



 



 



 



 

Total

 

$

6,716

 

$

3,912

 

$

13,621

 

$

7,873

 

 

 



 



 



 



 

Prior to fiscal 2006, the Company had accounted for share-based compensation costs in accordance with APB No. 25, as permitted by SFAS No. 123.  Had compensation costs for the Company’s equity 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 for the periods ended July 30, 2005 would have been reduced to the pro forma amounts indicated below:

($000, except per share data)

 

Three Months
Ended
July 30, 2005

 

Six Months
Ended
July 30, 2005

 


 



 



 

Net earnings

 

As reported

 

$

42,279

 

$

92,329

 

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

 

 

2,376

 

 

4,788

 

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

 

 

(4,571

)

 

(10,025

)

 

 

 

 



 



 

Net earnings

 

Pro forma

 

$

40,084

 

$

87,092

 

 

 

 

 



 



 

Basic earnings per share

 

As reported

 

$

.29

 

$

.63

 

 

 

Pro forma

 

$

.28

 

$

.60

 

Diluted earnings per share

 

As reported

 

$

.29

 

$

.62

 

 

 

Pro forma

 

$

.27

 

$

.59

 

The weighted average fair values per share of stock options granted for the three-month periods ended July 29, 2006 and July 30, 2005, were $8.37 and $7.67, and for the six-month periods ended July 29, 2006 and July 30, 2005, were $8.66 and $7.81, respectively.  The weighted average fair values per share of employee stock purchase awards for the three-month periods ended July 29, 2006 and July 30, 2005, were $7.70 and $7.61, and for the six-month periods ended July 29, 2006 and July 30, 2005, were $7.70 and $7.61, respectively.

8


Stock option activity.  The following table summarizes stock option activity for the six months ended July 29, 2006:

 

 

Number of shares (in thousands)

 

Weighted average exercise price

 

 

 



 



 

Outstanding at January 28, 2006

 

 

8,665

 

$

20.51

 

Granted

 

 

728

 

 

27.92

 

Exercised

 

 

(576

)

 

14.80

 

Forfeited

 

 

(188

)

 

26.95

 

 

 



 



 

Outstanding at July 29, 2006

 

 

8,629

 

$

21.37

 

 

 



 



 

The following table summarizes information about the weighted average remaining contractual life (in years) and the weighted average exercise prices for stock options both outstanding and exercisable as of July 29, 2006 (number of shares in thousands):

 

 

 

Options outstanding

 

Options exercisable

 

 

 

 


 


 

Exercise price range

 

 

Number of
shares

 

Remaining
life

 

Exercise
price

 

Number of
shares

 

Exercise
price

 



 


 


 


 


 


 

$

4.50

 

to

 

$

11.03

 

 

 

2,068

 

 

2.98

 

$

9.99

 

 

2,068

 

$

9.99

 

 

11.06

 

to

 

 

20.90

 

 

 

1,810

 

 

5.98

 

 

18.15

 

 

1,433

 

 

17.86

 

 

20.90

 

to

 

 

27.81

 

 

 

2,152

 

 

8.43

 

 

26.04

 

 

758

 

 

25.01

 

 

27.84

 

to

 

 

28.69

 

 

 

1,931

 

 

8.49

 

 

28.51

 

 

421

 

 

28.41

 

$

28.71

 

to

 

$

32.85

 

 

 

668

 

 

8.10

 

 

29.67

 

 

270

 

 

29.79

 

 

 

 

 

 

 

 

 

 



 



 



 



 



 

 

Totals

 

 

 

 

 

 

 

 

8,629

 

 

6.60

 

$

21.37

 

 

4,950

 

$

17.21

 

 

 

 

 

 

 

 

 

 



 



 



 



 



 

The aggregate intrinsic value (the difference between the market price and the option’s exercise price) of options outstanding and options exercisable as of July 29, 2006 was $44.1 million and $41.6 million, respectively.

Restricted stock activity.  During the six-month period ended July 29, 2006, restricted stock awards totaling 267,000 shares were issued and awards totaling 32,000 shares were forfeited.  The unamortized compensation expense at July 29, 2006 was $29.1 million.  During the period, shares withheld for tax withholding totaled 84,000 shares, and are considered treasury shares which are available for reissuance.  As of July 29, 2006, total shares subject to repurchase related to unvested restricted stock were 2.2 million shares.  A total of 3.6 million shares were available for new restricted stock awards under the 2004 Plan at the end of the period.

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 outstanding options to issue common stock were exercised into common stock.

For the three and six months ended July 29, 2006, there were approximately 3,857,600 and 3,641,500 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 in the periods presented.  For the three and six months ended July 30, 2005, there were approximately 2,519,600 and 2,001,700 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 in the periods presented.

9


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 29, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares

 

 

140,348

 

 

2,350

 

 

142,698

 

 

140,991

 

 

2,463

 

 

143,454

 

Amount

 

$

.32

 

$

.00

 

$

.32

 

$

.74

 

$

(.01

)

$

.73

 

July 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shares

 

 

145,102

 

 

2,219

 

 

147,321

 

 

145,555

 

 

2,339

 

 

147,894

 

Amount

 

$

.29

 

$

.00

 

$

.29

 

$

.63

 

$

(.01

)

$

.62

 

Note D: Debt and Revolving Credit

In March 2006, the Company repaid its $50.0 million term debt in full.  The borrowing was made in 2002 to finance the equipment and information systems for the Perris, California distribution center.

In July 2006, the Company amended its existing $600.0 million revolving credit facility, extending the expiration date to July 2011, and changing the interest pricing to LIBOR plus 45 basis points.

The Company has received expressions of interest to purchase an aggregate of $150 million of unregistered senior notes issuable in 12 and 15 year tranches at a weighted average interest rate of 6.45%.  Completion of any transaction remains subject to the purchasers’ due diligence and to finalization and execution of definitive agreements, which is expected to occur in the third quarter.  The settlement of the transaction is anticipated to occur in the fourth quarter.

Note E: Distribution Center Purchase

In May 2006, the Company exercised its option to purchase its Fort Mill, South Carolina distribution center and paid cash in the amount of $87.3 million to acquire the facility from the lessor.  The Company estimated the fair value of the components of the facility and the related equipment using various valuation techniques, including appraisals, market prices, and cost data.  Amounts recorded for each component are based on these fair value estimates.

Note F:  Recently Issued Accounting Standards

In July 2006, the FASB issued Interpretation Number 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”), effective for fiscal years beginning after December 15, 2006.  Under FIN No. 48, companies are required to disclose uncertainties in their income tax positions, including information as to tax benefits included in returns and not recognized for financial statement purposes.  The Company has not yet quantified the effects of adopting FIN No. 48.

10


Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of

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 29, 2006 and July 30, 2005, and the related condensed consolidated statements of earnings for the three and six-month periods ended July 29, 2006 and July 30, 2005, and of cash flows for the six-month periods ended July 29, 2006 and July 30, 2005.  These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the 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 the 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 reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim 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 the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Ross Stores, Inc. and subsidiaries as of January 28, 2006, 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 4, 2006, 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 28, 2006, 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 5, 2006

 

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.  Our actual results may differ materially from the results discussed in the forward-looking statements.  Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A (Risk Factors) below.  The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and the consolidated financial statements and notes thereto in our 2005 Form 10-K.  All information is based on our fiscal calendar.

Overview

We are the second largest off-price apparel and home goods retailer in the United States, with 744 Ross Dress for Less® (“Ross”) stores in 27 states and Guam, and 26 dd’s DISCOUNTS® store locations in California at July 29, 2006.  Ross offers first-quality, in-season, name brand and designer apparel, accessories, footwear and home fashions at everyday savings of 20% to 60% 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% off moderate department and discount store regular prices. 

Our primary strategy is to pursue and refine our existing off-price business, and steadily expand our store base.  In establishing growth objectives for our business, we closely monitor market share trends for the off-price industry.  Sales for the off-price sector grew by 11.3% during 2005, which is significantly faster than total national apparel sales, which grew by 3.6%, according to data from the NPD Group, which provides global sales and marketing information on the retail industry.  Our 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.

Results of Operations

Reclassifications.  In prior periods, stock-based compensation expense related to restricted stock grants and incentive compensation expense were included in Selling, general and administrative expenses.  In accordance with SEC Staff Accounting Bulletin (“SAB”) No. 107, which provides guidance on implementation of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” all compensation-related expenses should be recorded in a manner similar to other employee payroll costs.  Therefore, for prior periods, we have reclassified the portion of stock-based compensation and incentive compensation that relates to personnel in the merchandising and distribution organizations from Selling, general and administrative expense to Cost of goods sold.  Beginning in fiscal year 2006, the portion of stock option and employee stock purchase plan (“ESPP”) expenses included in stock-based compensation expense for personnel in the merchandising and distribution organizations is also included in Cost of goods sold.

12


The following table summarizes the results of operations for the three and six month periods ended July 29, 2006 and July 30, 2005:

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

July 29,
2006

 

July 30,
2005

 

July 29,
2006

 

July 30,
2005

 

 

 



 



 



 



 

Sales

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales (millions)

 

$

1,308

 

$

1,172

 

$

2,600

 

$

2,296

 

Sales growth

 

 

11.6

%

 

16.2

%

 

13.2

%

 

14.8

%

Comparable store sales growth

 

 

4

%

 

7

%

 

5

%

 

5

%

Costs and expenses (as a percent of sales)

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

 

78.3

%

 

78.4

%

 

77.4

%

 

77.7

%

Selling, general and administrative

 

 

16.1

%

 

15.7

%

 

16.1

%

 

15.7

%

Interest income

 

 

(0.1

)%

 

0.0

%

 

(0.1

)%

 

0.0

%

Earnings before taxes

 

 

5.7

%

 

5.9

%

 

6.6

%

 

6.6

%

Net earnings

 

 

3.5

%

 

3.6

%

 

4.0

%

 

4.0

%

Stores.  Our operating strategy is to open additional stores based on local market penetration, the ability to leverage overhead expenses, local demographic characteristics including population, and competition.  We continually evaluate opportunistic real estate acquisitions and opportunities for potential new store locations.  We also evaluate our current store locations and determine store closures based on similar criteria.

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

July 29,
2006

 

July 30,
2005

 

July 29,
2006

 

July 30,
2005

 

 

 



 



 



 



 

Stores at the beginning of the period

 

 

746

 

 

673

 

 

734

 

 

649

 

Stores opened in the period

 

 

25

 

 

22

 

 

37

 

 

46

 

Stores closed in the period

 

 

(1

)

 

—  

 

 

(1

)

 

—  

 

 

 



 



 



 



 

Stores at the end of the period

 

 

770

 

 

695

 

 

770

 

 

695

 

 

 



 



 



 



 

Sales.  Sales for the three months ended July 29, 2006 increased $136.2 million, or 11.6%, compared to the same period in the prior year due to the impact of the 75 net new stores opened between July 30, 2005 and July 29, 2006, and a 4% increase in sales from “comparable” stores (defined as stores that have been open for more than 14 complete months).  Sales for the six months ended July 29, 2006 increased $303.9 million, or 13.2%, compared to the same period in the prior year due to the impact of the 75 net new stores opened between July 30, 2005 and July 29, 2006, and a 5% increase in sales from comparable stores.

Our sales mix is shown below for the three and six-month periods ended July 29, 2006 and July 30, 2005:

 

 

Three Months Ended

 

Six Months Ended

 

 

 


 


 

 

 

July 29,
2006

 

July 30,
2005

 

July 29,
2006

 

July 30,
2005

 

 

 



 



 



 



 

Ladies

 

 

35

%

 

35

%

 

35

%

 

36

%

Home accents and bed and bath

 

 

20

%

 

20

%

 

20

%

 

20

%

Men’s

 

 

16

%

 

16

%

 

15

%

 

16

%

Fine jewelry, accessories, lingerie and fragrances

 

 

11

%

 

11

%

 

11

%

 

11

%

Children’s

 

 

8

%

 

8

%

 

9

%

 

8

%

Shoes

 

 

10

%

 

10

%

 

10

%

 

9

%

 

 



 



 



 



 

Total

 

 

100

%

 

100

%

 

100

%

 

100

%

 

 



 



 



 



 



13


We expect to address the competitive climate for apparel and home goods off-price retailers by pursuing and refining our existing strategies and by continuing to strengthen our organization, to diversify the merchandise mix, and to more fully develop the organization and systems to strengthen regional and local merchandise offerings.  Although our strategies and store expansion program contributed to sales gains for the three and six-month periods ended July 29, 2006, we cannot be sure that they will result in a continuation of revenue or profit growth.

Stock-based compensation.  Effective in fiscal year 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” and elected to adopt the standard using the modified prospective transition method.  This new accounting standard requires recognition of compensation expense based on the grant date fair value of all stock-based awards, typically amortized over the vesting period.  The impact on second quarter results was to decrease earnings before taxes by approximately $3.3 million, and net income by approximately $2.0 million.  The impact on results for the six- month period ended July 29, 2006 was to decrease earnings before taxes by approximately $6.8 million, and net income by approximately $4.1 million.  Prior periods were not revised for comparative purposes. 

See Notes A and B to the Notes to the Condensed Consolidated Financial Statements for more information on our implementation of SFAS No. 123(R) and stock-based compensation plans.

Cost of goods sold.  Cost of goods sold for the three months ended July 29, 2006 increased $105.0 million compared to the same period in the prior year mainly due to increased sales from the opening of 75 net new stores between July 30, 2005 and July 29, 2006, a 4% increase in sales from “comparable” stores, and additional stock compensation expenses recognized pursuant to SFAS No. 123(R).

Cost of goods sold as a percentage of sales for the three months ended July 29, 2006 decreased approximately 15 basis points compared with the same period in the prior year.  This decrease was mainly driven by a 25 basis point improvement in distribution and logistics costs and a 25 basis point improvement in buying expenses.  These favorable trends were partially offset by a 20 basis point increase in occupancy costs and a 15 basis point increase in compensation expenses recognized pursuant to SFAS No. 123(R).

Cost of goods sold for the six months ended July 29, 2006 increased $228.8 million compared to the same period in the prior year mainly due to increased sales from the opening of 75 net new stores between July 30, 2005 and July 29, 2006, a 5% increase in sales from comparable stores, and additional stock compensation expenses recognized pursuant to SFAS No. 123(R).

Cost of goods sold as a percentage of sales for the six months ended July 29, 2006 decreased approximately 30 basis points compared with the same period in the prior year.  This decrease was mainly driven by a 60 basis point improvement in distribution and logistics costs and a 10 basis point improvement in buying expenses.  These favorable trends were partially offset by a 20 basis point decline in merchandise margin primarily due to a higher shortage provision, a 10 basis point increase in compensation expenses recognized pursuant to SFAS No. 123(R), and a 10 basis point increase in occupancy costs.

We cannot be sure that the gross profit margins realized for the three and six-month periods ended July 29, 2006 will continue in the future.

Selling, general and administrative expenses.  For the three months ended July 29, 2006, Selling, general and administrative expenses increased $27.0 million compared to the same period in the prior year, mainly due to increased store operating costs reflecting the opening of 75 net new stores between July 30, 2005 and July 29, 2006.

Selling, general and administrative expenses as a percentage of sales for the three months ended July 29, 2006 increased approximately 45 basis points compared to the same period in the prior year.  This increase is primarily due to a 20 basis point increase in compensation expenses recognized pursuant to SFAS No. 123(R), a 15 basis point increase in store operating costs, and a 10 basis point increase in other general and administrative costs.

14


For the six months ended July 29, 2006, Selling, general and administrative expenses increased $57.1 million compared to the same period in the prior year, mainly due to increased store operating costs reflecting the opening of 75 net new stores between July 30, 2005 and July 29, 2006.

Selling, general and administrative expenses as a percentage of sales for the six months ended July 29, 2006 increased approximately 35 basis points compared to the same period in the prior year.  This increase is primarily due to an approximate 15 basis point increase in compensation expenses recognized pursuant to SFAS No. 123(R), a 10 basis point increase in store operating costs and a 10 basis point increase in other general and administrative costs.

Taxes on earnings.  Our effective tax rate for the three and six-month periods ended July 29, 2006 and July 30, 2005 was approximately 39%, which represents the applicable combined federal and state statutory rates reduced by the federal benefit of state taxes deductible on federal returns.  The effective rate is affected by changes in law, location of new stores, level of earnings and the result of tax audits.  We anticipate that our effective tax rate for fiscal 2006 will be approximately 38% to 40%.

Net earnings.  The decrease in net earnings as a percentage of sales for the three months ended July 29, 2006, compared to the same period in the prior year, is primarily due to higher Selling, general and administrative expenses and a slightly higher tax rate, which is partially offset by higher interest income as a percentage of sales.  Net earnings as a percentage of sales for the six months ended July 29, 2006 is the same as the prior year, which is primarily due to lower Cost of goods sold and higher interest income, offset by higher Selling, general and administrative expenses as a percentage of sales.

Earnings per share.  Diluted earnings per share increased to $.32 for the three months ended July 29, 2006 from $.29 in the prior year period, and $.73 for the six-month period ended July 29, 2006 from $.62 in the prior year period, as a result of an increase in net earnings and a decrease in weighted average diluted shares outstanding, which was largely attributable to the repurchase of common stock under the Company’s stock repurchase program.

Financial Condition

Liquidity and Capital Resources

Our primary sources of funds for our business activities are cash flows from operations and short-term trade credit.  Our primary ongoing cash requirements are for seasonal and new store merchandise inventory purchases, capital expenditures in connection with opening new stores, and investments in distribution centers, information systems and infrastructure.  We also use cash to repay debt, repurchase stock under our stock repurchase program and to pay dividends.

 

 

Six Months Ended

 

 

 


 

($000)

 

July 29,
2006

 

July 30,
2005

 


 


 


 

Cash flows from operating activities

 

$

169,096

 

$

139,991

 

Cash flows used in investing activities

 

 

(142,908

)

 

(54,600

)

Cash flows used in financing activities

 

 

(158,604

)

 

(81,325

)

 

 



 



 

Net (decrease) increase in cash and cash equivalents

 

$

(132,416

)

$

4,066

 

 

 



 



 

Operating Activities

Net cash provided by operating activities was $169.1 million and $140.0 million for the six months ended July 29, 2006 and July 30, 2005, respectively.  The primary source of cash from operations for the six months ended July 29, 2006 and July 30, 2005 was net earnings plus non-cash expenses for depreciation and amortization and increased trade credit, partially offset by cash used to finance merchandise inventory.

15


The increase in cash flows from operations for the six months ended July 29, 2006 is primarily due to a net increase in trade credit financed merchandise inventory.  Working capital (defined as current assets less current liabilities) was $270.5 million as of July 29, 2006, compared to $409.2 million as of July 30, 2005.  Our primary source of liquidity is the sale of our merchandise inventory.  We regularly review the age and condition of our merchandise and are able to maintain current merchandise inventory in our stores through replenishment processes and liquidation of slower-moving merchandise through clearance markdowns.

Investing Activities

During the six-month periods ended July 29, 2006 and July 30, 2005, we spent approximately $146.1 million and $96.2 million, respectively, for capital expenditures (excluding leased equipment) for fixtures and leasehold improvements to open new stores, implement information technology systems, install and implement materials handling equipment and related distribution center systems, and various other expenditures related to existing stores, buying offices and corporate offices.  For the period ended July 29, 2006, such amounts included the purchase of assets under a lease of $87.3 million.  We opened 37 and 46 new stores during the six months ended July 29, 2006 and July 30, 2005, respectively.  In addition, we received net proceeds from sales of investments of $3.2 million and $41.6 million during the six months ended July 29, 2006 and July 30, 2005, respectively.

We are forecasting approximately $265.0 million in capital expenditures for 2006 to fund fixtures and leasehold improvements to open both new Ross and dd’s DISCOUNTS stores, to fund the relocation, or fixture and cosmetic upgrades of existing stores, and to fund investments in store and merchandising systems, distribution center land, buildings, equipment and systems, and various central office expenditures.  This $265.0 million forecast includes $87.3 million related to our purchase in May 2006 of the leased assets at our Fort Mill, South Carolina distribution center.  We expect to fund remaining 2006 capital expenditures out of cash flows from operations, and existing bank credit facilities and potential new debt placement.

Financing Activities

During the six-month periods ended July 29, 2006 and July 30, 2005, our liquidity and capital requirements were provided by cash flows from operations, bank credit facilities and trade credit.  Substantially all of our store locations, buying offices, our corporate headquarters, and one distribution center are leased and, except for certain leasehold improvements and equipment, do not represent long-term capital investments.  We own our distribution centers in Carlisle, Pennsylvania, Moreno Valley, California, and Fort Mill, South Carolina. 

In March 2006, we repaid our $50.0 million term debt outstanding as of January 28, 2006 in full.  In May 2006, we exercised our option to purchase our Fort Mill, South Carolina distribution center for $87.3 million. 

We repurchased 3.6 million and 3.2 million shares of common stock for an aggregate purchase price of approximately $98.9 million and $89.0 million during the six-month periods ended July 29, 2006 and July 30, 2005, respectively.  These 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 our vendors.  We regularly review the adequacy of credit available to us from all sources and expect to be able to maintain adequate trade, bank and other credit lines to meet our capital and liquidity requirements, including lease obligations in 2006.

We are evaluating alternative sources of financing for the $50.0 million term debt and the $87.3 million Fort Mill, South Carolina distribution center.  We have received expressions of interest to purchase an aggregate of $150 million of unregistered senior notes issuable in 12 and 15 year tranches at a weighted average interest rate of 6.45%.  Completion of any transaction remains subject to the purchasers’ due diligence and to finalization and execution of definitive agreements, which is expected to occur in our third quarter.  The settlement of the transaction is anticipated to occur in our fourth quarter.

16


The table below presents our significant contractual payment obligations as of July 29, 2006:

($000)
Contractual Obligations

 

Less than
1 year

 

1 – 3 years

 

3 – 5 years

 

After 5 years

 

Total

 


 


 


 


 


 


 

Operating leases

 

$

267,439

 

$

492,039

 

$

387,531

 

$

461,617

 

$

1,608,626

 

Other financings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Synthetic leases

 

 

9,848

 

 

10,130

 

 

8,182

 

 

8,181

 

 

36,341

 

Other synthetic lease obligations

 

 

3,001

 

 

6,375

 

 

—  

 

 

56,000

 

 

65,376

 

Purchase obligations

 

 

838,974

 

 

15,986

 

 

1,189

 

 

—  

 

 

856,149

 

 

 



 



 



 



 



 

Total contractual obligations

 

$

1,119,262

 

$

524,530

 

$

396,902

 

$

525,798

 

$

2,566,492

 

 

 



 



 



 



 



 

Off-Balance Sheet Arrangements

Operating leases.  Substantially all of our store sites, one of our distribution centers, and our buying offices and corporate headquarters are leased and, except for certain leasehold improvements and equipment, do not represent long-term capital investments.

We have lease arrangements for certain equipment in our stores for our 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 we typically have options to renew the leases for two to three one-year periods.  Alternatively, we may purchase or return the equipment at the end of the initial or each renewal term.  We have guaranteed the value of the equipment, of $9.4 million, at the end of the respective initial lease terms, which is included in Other synthetic lease obligations in the table above.

Other financings.  We lease a 1.3 million square foot distribution center in Perris, California.  The land and building for this distribution center is being financed under a $70.0 million ten-year synthetic lease 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 $70.0 million.  At the end of the lease term, we have the option to either refinance the $70.0 million synthetic lease facility, purchase the distribution center at the amount of the then-outstanding lease obligation, 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 $70.0 million, we have agreed under a residual value guarantee to pay the lessor the shortfall below $70.0 million not to exceed $56.0 million.  Our contractual obligation of $56.0 million is included in Other synthetic lease obligations in the above table.

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,” we have 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 $1.8 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, we lease two separate warehouse facilities for packaway storage in Carlisle, Pennsylvania with operating leases expiring through 2011.  In January 2004, we entered into a two-year lease with two one-year options for a warehouse facility in Fort Mill, South Carolina, the first option of which has been exercised extending the term to February 1, 2007.  These three leased facilities are being used primarily to store packaway merchandise.

17


The synthetic lease facilities described above, as well as our revolving credit facility, have covenant restrictions requiring us to maintain certain interest coverage and leverage ratios.  In addition, the interest rates under these agreements may vary depending on our actual interest coverage ratios.  As of July 29, 2006, we were in compliance with these covenants. 

Distribution center purchase.  In May 2006, we exercised our option to purchase our Fort Mill, South Carolina distribution center and paid cash in the amount of $87.3 million to acquire the facility from the lessor.  We estimated the fair value of the components of the facility and the related equipment using various valuation techniques, including appraisals, market prices, and cost data.  Amounts recorded for each component are based on these fair value estimates.

Purchase obligations.  As of July 29, 2006 we had purchase obligations of $856.1 million.  These purchase obligations primarily consist of merchandise inventory purchase orders, commitments related to store fixtures and supplies, and information technology service and maintenance contracts.  Merchandise inventory purchase orders of $810.2 million represent purchase obligations of less than one year as of July 29, 2006.

Commercial Credit Facilities

The table below presents our significant available commercial credit facilities at July 29, 2006:

 

 

Amount of Commitment Expiration Per Period

 

 

 

 

 


 

Total
amount
committed

 

($000)
Commercial Credit Commitments

 

Less than
1 year

 

1 - 3 years

 

3 - 5 years

 

After 5 years

 

 


 


 


 


 


 


 

Revolving credit facility

 

$

—  

 

$

—  

 

$

600,000

 

$

—  

 

$

600,000

 

 

 



 



 



 



 



 

Total commercial commitments

 

$

—  

 

$

—  

 

$

600,000

 

$

—  

 

$

600,000

 

 

 



 



 



 



 



 

Revolving credit facility.  We have available a $600.0 million revolving credit facility with our banks, which contains a $300.0 million sublimit for issuances of standby letters of credit, of which $236.5 million was available at July 29, 2006.  In July 2006 we amended this facility to change the expiration date and interest pricing.  Interest is LIBOR-based plus an applicable margin (currently 45 basis points) and is payable upon borrowing maturity but no less than quarterly.  Our borrowing ability under this credit facility is subject to our maintaining certain interest coverage and leverage ratios.  We have had no borrowings under this facility, which expires in March 2011.

Standby letters of credit.  We use standby letters of credit to collateralize certain obligations related to our self-insured workers’ compensation and general liability claims.  We had $63.5 million and $62.8 million in standby letters of credit outstanding at July 29, 2006 and July 30, 2005, respectively.

Trade letters of credit.  We had $28.7 million and $21.7 million in trade letters of credit outstanding at July 29, 2006 and July 30, 2005, respectively.

Dividends.  In August 2006, our Board of Directors declared a cash dividend payment of $.06 per common share, payable on or about October 2, 2006.  Our Board of Directors declared quarterly cash dividends of $.06 per common share in May 2006, January 2006 and November 2005, and $.05 per common share in January, May and August 2005.

Stock repurchase programs.  In November 2005, we announced that our Board of Directors authorized a new two-year stock repurchase program of up to $400.0 million for 2006 and 2007.  We repurchased 3.6 million and 3.2 million shares of common stock for aggregate purchase prices of approximately $98.9 million and $89.0 million for the six months ended July 29, 2006 and July 30, 2005, respectively.

18


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

Critical Accounting Policies

The preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements.  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.  We believe the following critical accounting policies describe the more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.

Merchandise inventory.  Our merchandise inventory is stated at the lower of cost or market, with cost determined on a weighted average cost method.  We purchase 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 our 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 our merchandise inventory is a provision for shortage.  The shortage reserve is based on historical shortage rates as evaluated through our periodic physical merchandise inventory counts and cycle counts.  If actual market conditions, markdowns, or shortage are less favorable than those projected by us, or if sales of the merchandise inventory are more difficult than anticipated, additional merchandise inventory write-downs may be required.

Long-lived assets.  We record 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.  If our actual results differ materially from projected results, an impairment charge may be required in the future.  In the course of performing this analysis, we determined that no long-lived asset impairment charge was required for the three and six months ended July 29, 2006 and July 30, 2005.

Depreciation and amortization expense.  Property and equipment are stated at cost, less accumulated depreciation and amortization.  Depreciation is calculated using the straight-line method over the estimated useful life of the asset, typically ranging from five to twelve years for equipment and 20 to 40 years for real property.  The cost of leasehold improvements is amortized over the useful life of the asset or the applicable lease term, whichever is less. 

Lease accounting.  We have adopted FASB Staff Position (“FSP”) 13-1, “Accounting for Rental Costs Incurred During a Construction Period,” which requires that rental costs incurred during a construction period be expensed, not capitalized, beginning in the first quarter of 2006.  When a lease contains “rent holidays” or requires fixed escalations of the minimum lease payments, we record rental expense on a straight-line basis and the difference between the average rental amount charged to expense and the amount payable under the lease is recorded as deferred rent.  We amortize deferred rent on a straight-line basis over the lease term commencing on the date the leased space is ready for its intended use.  Tenant improvement allowances are included in Other long-term liabilities and are amortized over the lease term.  Changes in tenant improvement allowances are included as a component of operating activities in the Condensed Consolidated Statements of Cash Flows.

Self-insurance.  We self insure certain of our workers’ compensation and general liability risks as well as certain of our health plans.  Our 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, our recorded reserves may not be sufficient and additional charges could be required.

Stock-based compensation.  We now account for stock-based compensation under the provisions of SFAS No. 123(R).  Under SFAS No. 123(R) compensation expense is recognized for the grant date fair value of new awards granted in fiscal 2006 and later, and for the unvested portion of awards that were outstanding as of January 28, 2006 from prior year grants.  Stock-based awards are valued using the Black-Scholes option pricing model, consistent with our prior pro forma disclosures under SFAS No. 123. 

19


Compensation expense for awards outstanding at the effective date is recognized over the remaining vesting period using the compensation cost calculated for purposes of the prior pro forma disclosures.  For awards granted after the adoption date, we recognize expense for the fair value of the award on a straight-line basis over the applicable vesting term. 

The determination of the fair value of stock options and ESPP shares, using the Black-Scholes model, is affected by our stock price as well as assumptions as to our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behavior, the risk-free interest rate and expected dividends.

SFAS No. 123(R) requires companies to estimate future expected forfeitures at the date of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates.  In previous fiscal years, we had recognized the impact of forfeitures as they occurred.  Now we use historical data to estimate pre-vesting forfeitures and to recognize stock-based compensation expense.  All stock-based compensation awards are amortized on a straight-line basis over the requisite service periods of the awards.

These critical accounting policies noted above are not intended to be a comprehensive list of all of our accounting policies.  In many cases, the accounting treatment of a particular transaction is specifically dictated by Generally Accepted Accounting Principles (“GAAP”), with no need for management’s judgment in their application.  There are also areas in which management’s judgment in selecting one alternative accounting principle over another would not produce a materially different result.

New Accounting Pronouncements

In July 2006, the FASB issued Interpretation Number 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”), effective for fiscal years beginning after December 15, 2006.  Under FIN No. 48, companies are required to disclose uncertainties in their income tax positions, including information as to tax benefits included in returns and not recognized for financial statement purposes.  We have not yet quantified the effects of adopting FIN No. 48.

Forward-Looking Statements

This report may contain a number of forward-looking statements regarding, without limitation, planned store growth, new markets, expected sales, projected earnings levels, capital expenditures and other matters.  These forward-looking statements reflect our then current beliefs, projections and estimates with respect to future events and our projected financial performance, operations and competitive position.  The words “plan,” “expect,” “anticipate,” “estimate,” “believe,” “forecast,” “projected,” “guidance,” “looking ahead” and similar expressions identify forward-looking statements.  

Future economic and industry trends that could potentially impact revenue, profitability, and growth remain difficult to predict.  As a result, our forward-looking statements are subject to risks and uncertainties which could cause our actual results to differ materially from those forward-looking statements and our previous expectations and projections.  Refer to Part II, Item 1A in this quarterly report on Form 10-Q for a more complete discussion of risk factors for Ross and dd’s DISCOUNTS.  The factors underlying our forecasts are dynamic and subject to change.  As a result, any forecasts or forward-looking statements speak only as of the date they are given and do not necessarily reflect our outlook at any other point in time.  We disclaim any obligation to update or revise these forward-looking statements.

Other risk factors are detailed in the Company’s Securities and Exchange Commission filings including, without limitation, our annual report on Form 10-K for 2005.

20


Item 3.  Quantitative and Qualitative Disclosures about Market Risk

We are exposed to market risks, which primarily include changes in interest rates.  We do not engage in financial transactions for trading or speculative purposes. 

We occasionally use forward contracts to hedge against fluctuations in foreign currency prices. We had no outstanding forward contracts at July 29, 2006.

Interest that is payable on our revolving credit facilities is based on variable interest rates and is, therefore, affected by changes in market interest rates.  As of July 29, 2006, we had no borrowings outstanding under our revolving credit facilities.  In addition, lease payments under certain of our synthetic lease agreements are determined based on variable interest rates and are, therefore, affected by changes in market interest rates. 

A hypothetical 100 basis point increase in prevailing market interest rates would not have materially impacted our consolidated financial position, results of operations, or cash flows as of and for the three and six-month periods ended July 29, 2006.  We do not consider the potential losses in future earnings and cash flows from reasonably possible, near term changes in interest rates to be material. 

Item 4.  Controls and Procedures

Disclosure Controls and Procedures

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

Quarterly Evaluation of Changes in Internal Control Over Financial Reporting

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, also conducted an evaluation of our internal control over financial reporting to determine whether any change occurred during the second fiscal quarter of 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.  Based on that evaluation, our management concluded that there was no such change during the second fiscal quarter.

PART II – OTHER INFORMATION

Item 1.  Legal Proceedings

The two paragraphs under the caption “Provision for litigation expense and other legal proceedings” in Note A of Notes to Condensed Consolidated Financial Statements are incorporated herein by reference.

21


Item 1A.  Risk Factors

Our quarterly report on Form 10-Q for our second fiscal quarter 2006, and information we provide in our press releases, telephonic reports and other investor communications, including those on our website, may contain a number of forward-looking statements with respect to anticipated future events and our projected financial performance, operations and competitive position that are subject to risk factors that could cause our actual results to differ materially from those forward-looking statements and our prior expectations and projections.  Refer to Management’s Discussion and Analysis for a more complete identification and discussion of “Forward-Looking Statements.”

Our financial condition, results of operations, cash flows and the performance of our common stock may be adversely affected by a number of risk factors.  Risks and uncertainties that apply to both Ross and dd’s DISCOUNTS include, without limitation, the following:

We are subject to the economic and industry risks that affect large United States retailers.

Our business is exposed to the risks of a large, multi-store retailer, which must continually and efficiently obtain and distribute a supply of fresh merchandise throughout a large and growing network of stores.  These risks include a number of factors, including:

An increase in the level of competitive pressures in the retail apparel or home-related merchandise industry.

Potential changes in the level of consumer spending on or preferences for apparel or home-related merchandise, including the potential impact from higher gas prices on consumer spending.

Potential changes in geopolitical and/or general economic conditions that could affect the availability of product and/or the level of consumer spending.

Unseasonable weather trends that could affect consumer demand for seasonal apparel and apparel-related products.

A change in the availability, quantity or quality of attractive brand-name merchandise at desirable discounts that could impact our ability to purchase product and continue to offer customers a wide assortment of competitive bargains.

Potential disruptions in supply chain that could impact our ability to deliver product to our stores in a timely and cost-effective manner.

A change in the availability, quality or cost of new store real estate locations.

A downturn in the economy or a natural disaster in California or in another region where we have a concentration of stores, or a distribution center.  Our corporate headquarters, two distribution centers and 28% of our stores are located in California.  As a result, these risks could significantly affect the Company’s operating results and financial condition.

Potential pressure on freight costs from higher-than-expected fuel surcharges.

We are subject to operating risks as we attempt to execute on our merchandising and growth strategies.

The continued success of our business depends, in part, upon our ability to increase sales at our existing store locations, and to open new stores and to operate stores on a profitable basis.  Our existing strategies and store expansion programs may not result in a continuation of our anticipated revenue growth or profit growth.  In executing our off-price retail strategies and working to improve our efficiency, expand our store network, and reduce our costs, we face a number of operational risks, including:

Our ability to attract and retain personnel with the retail talent necessary to execute our strategies.

Our ability to effectively implement and operate our various supply chain, core merchandising and other information systems, including generation of all necessary data and reports for merchants, allocators and other business users in a timely and cost-effective manner.

Our ability in 2006 and 2007 to successfully implement new processes and systems enhancements that are expected to improve our micro-merchandising capabilities with the goal of being able to plan, buy and allocate product at a more local versus regional level.

Our ability to improve new store sales and profitability, especially in newer regions and markets.

Our ability to achieve and maintain targeted levels of productivity and efficiency in our distribution centers.

22


Our ability to continue to obtain acceptable new store locations.

Our ability to identify and to successfully enter new geographic markets.

Lower than planned gross margin, including higher than planned markdowns, inventory shortage or freight costs.

Greater than planned operating costs including, among other factors, increases in occupancy costs, advertising costs, and wage and benefit costs, including as a result of changes in labor laws or as a result of class action or other lawsuits relating to wage and hour claims and other labor-related matters.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

Information regarding shares of common stock we repurchased during the second quarter of 2006 is as follows:

Period

 

Total
number of
shares
purchased1

 

Average
price paid
per share

 

Total number of
shares purchased
as part of publicly
announced plans or
programs

 

Maximum approximate
dollar value of shares
that may yet be
purchased under the
plans or programs
($000)

 


 



 



 



 



 

May (4/30/2006-5/27/2006)

 

 

389,671

 

$

28.75

 

 

388,600

 

$

340,000

 

June (5/28/2006-7/1/2006)

 

 

819,314

 

$

27.32

 

 

817,899

 

$

318,000

 

July (7/2/2006-7/29/2006)

 

 

656,017

 

$

25.24

 

 

652,430

 

$

301,000

 

 

 



 

 

 

 



 

 

 

 

Total

 

 

1,865,002

 

$

26.89

 

 

1,858,929

 

 

 

 

 

 



 

 

 

 



 

 

 

 



1 We acquired 6,073 shares during the quarter ended July 29, 2006 related to income tax withholdings for restricted stock.  All remaining shares were repurchased under the two-year $400.0 million stock repurchase program publicly announced in November 2005.

Item 4. Submission of Matters to a Vote of Security Holders

At our Annual Meeting of Stockholders, held on May 18, 2006 (the “2006 Annual Meeting”), our stockholders voted on and approved the following proposals:

Proposal 1: To elect three Class II directors (Michael Balmuth, K. Gunnar Bjorklund and Sharon D. Garrett) for a three-year term.

Proposal 2: To approve the Company’s Second Amended and Restated Incentive Compensation Plan.

Proposal 3: To ratify the appointment of Deloitte & Touche LLP as the Company’s independent registered public accounting firm for the fiscal year ending February 3, 2007.

2006 Annual Meeting Election Results

Proposal 1: Election of directors

 

Director

 

In favor

 

Withheld

 

Term expires

 

 


 


 


 


 

 

Michael Balmuth

 

119,877,775

 

13,141,757

 

2009

 

 

K. Gunnar Bjorklund

 

120,485,092

 

12,534,440

 

2009

 

 

Sharon D. Garrett

 

125,258,108

 

7,761,424

 

2009

 

23


Proposal 2: Approval of the Company’s Second Amended and Restated Incentive Compensation Plan.

 

For

 

Against

 

Abstain

 

 


 


 


 

 

127,528,275

 

5,424,053

 

67,204

 

Proposal 3: Ratification of the appointment of Deloitte & Touche LLP as the Company’s independent registered public accounting firm for the fiscal year ending February 3, 2007.

 

For

 

Against

 

Abstain

 

 


 


 


 

 

131,568,616

 

1,428,419

 

22,497

 

Item 6.  Exhibits

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

24


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 6, 2006

By:

/s/ J. Call

 

 

 

John G. Call

 

 

 

Senior Vice President, Chief Financial Officer,

 

 

 

Principal Accounting Officer and Corporate Secretary

25


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

 

First Amendment to the Employment Agreement between Barbara Levy and Ross Stores, Inc. effective May 1, 2006.

 

 

 

10.2

 

Ross Stores, Inc. Second Amended and Restated Incentive Compensation Plan, incorporated by reference to the appendix to the Definitive Proxy Statement on Schedule 14A filed by Ross Stores, Inc. on April 12, 2006.

 

 

 

15

 

Letter re: Unaudited Interim Financial Information from Deloitte & Touche LLP dated September 5, 2006.

 

 

 

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.

26

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