ROSS STORES, INC. (ROST) FY 2023 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Ross Stores, Inc. operates two brands of off-price retail apparel and home fashion stores—Ross Dress for Less® (“Ross”) and dd’s DISCOUNTS®. Ross is the largest off-price apparel and home fashion chain in the United States, with 1,693 locations in 40 states, the District of Columbia, and Guam, as of January 28, 2023. Ross offers first-quality, in-season, name brand and designer apparel, accessories, footwear, and home fashions for the entire family at savings of 20% to 60% off department and specialty store regular prices every day. We also operate 322 dd’s DISCOUNTS stores in 21 states as of January 28, 2023 that feature a more moderately-priced assortment of first-quality, in-season, name brand apparel, accessories, footwear, and home fashions for the entire family at savings of 20% to 70% off moderate department and discount store regular prices every day.

Our primary objective is to pursue and refine our existing off-price strategies to maintain and improve both profitability and financial returns over the long term. Over the past three years, we have faced a series of unprecedented challenges from the COVID-19 pandemic, subsequent supply chain disruptions and their related cost pressures, and ongoing inflationary headwinds. These conditions have had significant impacts not only on our own business operations and costs but also on our customers’ household budgets and in turn their shopping behaviors. As a result, our customers are seeking even stronger values when visiting our stores. We are closely monitoring market share trends for the off-price industry and we believe our share gains will continue to grow through continued focus on bringing value and convenience to our consumers.

We believe our merchandising and operational strategies enable us to deliver the most competitive bargains available to meet our customers’ ongoing demand for name brand fashions for the family and home at compelling discounts every day. We believe our continued focus on these strategies will enable us to maximize our potential for both sales and profit growth in fiscal 2023 and beyond.

The fiscal years ended January 28, 2023, January 29, 2022, and January 30, 2021 are referred to as fiscal 2022, fiscal 2021, and fiscal 2020, respectively, and were 52-week years.

In our fiscal 2021 Annual Report on Form 10-K, we compared our results of operations and financial condition to fiscal 2020 and also to the fiscal year ended February 1, 2020 (“fiscal 2019”). We believe the extended closure of our operations in the spring of 2020, and the significant disruptions caused by the COVID-19 pandemic throughout fiscal 2020, made fiscal 2019 a more useful and relevant basis for comparison to our fiscal 2021 performance. For comparisons of fiscal 2021 to both fiscal 2019 and fiscal 2020, refer to our Annual Report on Form 10-K for fiscal 2021.

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Results of Operations

The following table summarizes the financial results for fiscal 2022, 2021, and 2020:

Stores. Total stores open at the end of fiscal 2022, 2021, and 2020 were 2,015, 1,923, and 1,859, respectively. The number of stores at the end of fiscal 2022, 2021, and 2020 increased by 5%, 3%, and 3% from the respective prior years. In fiscal 2022, we opened 99 new stores. Looking forward to 2023, we expect to open approximately 100 new stores. We remain confident in our ability to expand in both new and existing regional markets over time. We continue to believe that consumers’ increased focus on value and convenience and the significant number of brick-and-mortar retail closures and bankruptcies over the last several years, provides opportunities for us to gain market share. Our longer term strategy is to open additional stores based on market penetration, local demographic characteristics, competition, expected store profitability, and the ability to leverage overhead expenses. 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.

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The total selling square footage as of January 28, 2023, January 29, 2022, and January 30, 2021 was 41.4 million, 39.9 million, and 38.8 million, respectively.

Sales. Sales for fiscal 2022 decreased $0.2 billion, or 1.2%, compared to the prior year. This was primarily due to a 4% decline in comparable store sales driven by escalating inflationary pressures that reduced customer demand during the fiscal year combined with the benefit in the prior year from government stimulus, as well as pent-up customer demand as COVID-19 restrictions eased. The sales decline was partially offset by the opening of 92 net new stores during fiscal 2022.

Sales for fiscal 2021 increased $6.4 billion, or 50.9%, compared to fiscal 2020. This was primarily due to all store locations remaining open throughout fiscal 2021, compared to the negative impact from the COVID-19 related closures of all of our stores during a significant portion of the March 2020 to June 2020 period. Sales for fiscal 2021 also benefited from a combination of government stimulus payments, increasing vaccination rates, diminishing COVID-19 restrictions on operations, pent-up consumer demand, and strong execution of our merchandising strategies. Sales also increased due to the opening of 64 net new stores during fiscal 2021.

Our sales mix is shown below for fiscal 2022, 2021, and 2020:

There remains significant uncertainty in the current macroeconomic environment, driven by inflation, increasing interest rates, the continuing impacts from the Russia-Ukraine conflict, concerns of a possible recession, and the COVID-19 pandemic. We expect these factors to continue impacting both our customers and our business in fiscal 2023. We intend to address the uncertain and competitive conditions within the retail climate for apparel and home goods by pursuing and refining our existing strategies, continuing to strengthen our merchant organization, diversifying our merchandise mix, and further developing our systems to improve our merchandise offerings. We cannot be sure our strategies and store expansion program will result in sales growth or an increase in net earnings.

Cost of goods sold. Cost of goods sold in fiscal 2022 increased $0.2 billion compared to the prior year mainly due to higher ocean and domestic freight costs, increased distribution costs, and higher merchandise markdowns, partially offset by lower comparable store sales and lower buying costs. Cost of goods also increased due to the opening of 92 net new stores during fiscal 2022.

Cost of goods sold in fiscal 2021 increased $3.9 billion compared to fiscal 2020 mainly due to higher sales, given that all our stores were open throughout fiscal 2021, compared to the negative impact from the COVID-19 related closures of all of our stores during a significant portion of the March 2020 to June 2020 period. Cost of goods also increased due to the opening of 64 net new stores during fiscal 2021.

Cost of goods sold as a percentage of sales for fiscal 2022 increased approximately 210 basis points from fiscal 2021 primarily due to a 130 basis point decline in merchandise margin primarily due to higher ocean freight costs and increased markdowns, an 85 basis point increase in distribution expenses primarily due to the timing of packaway inventory carrying costs and the deleveraging effect from the opening of our Brookshire, Texas distribution center, a 30 basis point deleverage in occupancy costs, and a 25 basis point increase in domestic freight costs primarily due to higher fuel costs. These increases were partially offset by a 60 basis point decrease in buying costs primarily due to lower incentive compensation expenses.

We expect incentive compensation expenses to return to target levels in fiscal 2023 and for domestic and ocean freight costs to decrease.

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Selling, general and administrative expenses. For fiscal 2022, selling, general and administrative expenses (“SG&A”) decreased $115.2 million compared to the prior year. The decrease was primarily due to lower incentive compensation expenses and lower COVID-19 costs, partially offset by the opening of 92 net new stores during fiscal 2022.

For fiscal 2021, SG&A increased $371.2 million compared to fiscal 2020. The increase was primarily due to all our stores remaining open throughout fiscal 2021 compared to the impact from the COVID-19 related closures of all of our stores during a significant portion of the March 2020 to June 2020 period, and to the opening of 64 net new stores during fiscal 2021, partially offset by approximately $240 million in long-term debt refinancing costs incurred in fiscal 2020.

SG&A as a percentage of sales for fiscal 2022 decreased by approximately 45 basis points compared to fiscal 2021 primarily due to lower incentive compensation expenses and lower COVID-19 costs, partially offset by higher wages and the deleveraging effect of the 4% comparable store sales decline.

We expect SG&A in fiscal 2023 to increase as a result of incentive compensation expenses returning to target levels.

Interest expense, net. In fiscal 2022, net interest expense decreased by $71.5 million compared to fiscal 2021 primarily due to increased interest income from higher interest rates and lower interest expense on long-term debt due to the repayment of the principal on the $65.0 million notes in fiscal 2021, partially offset by lower capitalized interest.

In fiscal 2021, net interest expense decreased by $9.1 million compared to fiscal 2020 primarily due to the elimination of interest expense on short-term debt due to the repayment of our $800 million revolving credit facility in October 2020 and higher capitalized interest primarily related to the construction of our Brookshire, Texas distribution center, partially offset by lower interest income primarily due to lower interest rates.

The table below shows the components of interest expense, net for fiscal 2022, 2021, and 2020:

Taxes on earnings. Our effective tax rate for fiscal 2022 and 2021 was approximately 24%. Our effective tax rate for fiscal 2020 was 20%. The increase in effective tax rate of 4% for fiscal 2021 compared to fiscal 2020 was primarily due to the impact of hiring tax credits on lower pre-tax earnings in fiscal 2020.

Our effective tax rate represents the applicable combined federal and state statutory rates reduced by the federal benefit of state taxes deductible on federal returns. Our effective tax rate is impacted by changes in tax law and accounting guidance, location of new stores, level of earnings, tax effects associated with stock-based compensation, and the resolution of tax positions with various tax authorities.

In fiscal 2022, the Inflation Reduction Act (“IRA”) was signed into law. The IRA made several changes to business tax provisions including a one percent excise tax on stock repurchases made after December 31, 2022. The one percent excise tax does not impact our effective tax rate.

In fiscal 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law. The CARES Act made several significant changes to business tax provisions including modifications for net operating losses, employee retention credits, and deferral of employer payroll tax payments. The Consolidated Appropriations

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Act of 2021 (“CAA”) was signed into law during fiscal 2020. The CAA made several changes to business tax provisions including extending certain employment-related tax credits through December 31, 2025.

Net earnings. Net earnings as a percentage of sales for fiscal 2022 were lower than in fiscal 2021 primarily due to higher cost of goods sold, partially offset by lower SG&A expenses and lower interest expense. Net earnings as a percentage of sales for fiscal 2021 were higher compared to fiscal 2020 primarily due to lower cost of goods sold, lower SG&A expenses, and lower interest expense, partially offset by higher taxes on earnings.

Earnings per share. Diluted earnings per share in fiscal 2022 was $4.38 compared to $4.87 in the prior year. The lower diluted earnings per share in fiscal 2022 was primarily attributable to a 12% decrease in net earnings, partially offset by the 2% reduction in weighted-average diluted shares outstanding, largely due to stock repurchases under our stock repurchase program.

Diluted earnings per share in fiscal 2021 was $4.87 compared to $0.24 in fiscal 2020. The higher diluted earnings per share in fiscal 2021 was primarily attributable to all our store locations remaining open throughout fiscal 2021, compared to the negative impact from the COVID-19 related closures of all of our stores during a significant portion of the March 2020 to June 2020 period.

Financial Condition

Liquidity and Capital Resources

The 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 merchandise inventory purchases, payroll, operating and variable lease costs, taxes, capital expenditures in connection with new and existing stores, and investments in distribution centers, information systems, and buying and corporate offices. We also use cash to repurchase stock under active stock repurchase programs, pay dividends, and repay debt as it becomes due.

Operating Activities

Net cash provided by operating activities was $1.7 billion in fiscal 2022. This was primarily driven by net earnings excluding non-cash expenses for depreciation, amortization, and stock-based compensation, and an increase in deferred income taxes, partially offset by merchandise inventory payments and payment of fiscal 2021 incentive bonuses. Net cash provided by operating activities was $1.7 billion in fiscal 2021. This was primarily driven by net earnings excluding non-cash expenses for depreciation, amortization, and stock-based compensation, partially offset by higher merchandise inventory receipts net of accounts payable. Net cash provided by operating activities was $2.2 billion in fiscal 2020. This was primarily driven by higher accounts payable due to longer payment terms, lower merchandise receipts as we closely managed inventory levels and used packaway inventory to replenish our stores, and net earnings excluding non-cash expenses for depreciation, amortization, and stock-based compensation.

The decrease in cash flow from operating activities in fiscal 2022 compared to fiscal 2021 was primarily driven by payment of fiscal 2021 incentive bonuses and lower net earnings, partially offset by lower merchandise inventory receipts net of accounts payable, higher income taxes payable, and higher deferred income taxes.

The decrease in cash flow from operating activities in fiscal 2021 compared to fiscal 2020 was primarily driven by lower accounts payable leverage (defined as accounts payable divided by merchandise inventory), partially offset by higher net earnings in the year.

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Accounts payable leverage was 99%, 105%, and 150% as of January 28, 2023, January 29, 2022, and January 30, 2021, respectively. The decrease in accounts payable leverage in fiscal 2022 compared to fiscal 2021 was primarily driven by shorter payment terms. The decrease in accounts payable leverage in fiscal 2021 compared to fiscal 2020 was primarily driven by higher merchandise receipts to support higher sales and to replenish our packaway inventory.

As a regular part of our business, packaway inventory levels will vary over time based on availability of compelling merchandise purchase opportunities in the marketplace and our decisions on the timing for release of that inventory. Packaway merchandise is purchased with the intent that it will be stored in our warehouses until a later date. The timing of the release of packaway inventory to our stores is principally driven by the product mix and seasonality of the merchandise, and its relation to our store merchandise assortment plans. As such, the aging of packaway varies by merchandise category and seasonality of purchase, but typically packaway remains in storage less than six months. We expect to continue to take advantage of packaway inventory opportunities to maximize our ability to deliver bargains to our customers.

Changes in packaway inventory levels impact our operating cash flow. At the end of fiscal 2022, packaway inventory was 40% of total inventory compared to 40% and 38% at the end of fiscal 2021 and 2020, respectively.

Investing Activities

Net cash used in investing activities was $654.1 million, $557.8 million, and $405.4 million in fiscal 2022, 2021, and 2020, respectively, and was related to capital expenditures. Our capital expenditures include costs to build, expand, and improve distribution centers, open new stores and improve existing stores, and for various other expenditures related to our information technology systems and buying and corporate offices.

The increase in cash used for investing activities in fiscal 2022 compared to fiscal 2021 was primarily due to higher capital expenditures related to the construction of 99 new stores compared to 65 in the prior year, the refresh and enhancement of our existing stores, the construction of our Buckeye, Arizona distribution center, and the investments in various information technology systems, partially offset by the lower expenditures related to our Brookshire, Texas distribution center which opened in the first quarter of fiscal 2022. The increase in cash used for investing activities in fiscal 2021 compared to fiscal 2020 was primarily due to an increase in our capital expenditures as a result of the resumption of capital projects deferred during fiscal 2020.

Our capital expenditures over the last three years are set forth in the table below:

Capital expenditures for fiscal 2023 are projected to be approximately $810 million. Our planned capital expenditures for fiscal 2023 are for investments in our supply chain to support long-term growth, including construction of our next distribution centers, costs for fixtures and leasehold improvements to open new Ross and dd’s DISCOUNTS stores, investments in information technology systems, and for various other expenditures related to our stores, distribution centers, and buying and corporate offices. We expect to fund capital expenditures with available cash. The increase in our planned capital expenditures for fiscal 2023 compared to fiscal 2022 is primarily driven by investments in our next distribution centers, existing store improvements, information technology systems, and various expenditures related to distribution centers, and buying and corporate offices.

Financing Activities

Net cash used in financing activities was $1.4 billion and $1.2 billion in fiscal 2022 and 2021, respectively. Net cash provided by financing activities was $1.7 billion in fiscal 2020. The increase in cash used in financing activities for fiscal 2022 compared to fiscal 2021 was primarily due to stock repurchases under our current $1.9 billion stock repurchase program. The decrease in cash flows from financing activities for fiscal 2021 compared to fiscal 2020

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was primarily due to the completion of our public debt offerings, net of refinancing costs in fiscal 2020, the resumption of our stock repurchases in the second quarter of fiscal 2021, the resumption of cash dividend payments in the first quarter of fiscal 2021, and the repayment of our Series B unsecured Senior Notes.

Revolving credit facilities. In February 2022, we entered into a new, $1.3 billion senior unsecured revolving credit agreement (the “2022 Credit Facility”), which replaced our previous $800 million unsecured revolving credit facility. As of January 28, 2023, we had no borrowings or standby letters of credit outstanding under the 2022 Credit Facility, the $1.3 billion credit facility remained in place and available, and we were in compliance with the financial covenant. Refer to Note D: Debt in the Notes to Consolidated Financial Statements for additional information.

Senior notes. As of January 28, 2023, we had approximately $2.5 billion of outstanding unsecured Senior Notes. Refer to Note D: Debt in the Notes to Consolidated Financial Statements for additional information.

Other financing activities. In March 2019, our Board of Directors approved a two-year $2.55 billion stock repurchase program through fiscal 2020. Due to the economic uncertainty stemming from the severe impact of the COVID-19 pandemic, we suspended that stock repurchase program as of March 2020, at which time we had repurchased $1.407 billion under the $2.55 billion stock repurchase program.

In May 2021, our Board of Directors authorized a program to repurchase up to $1.5 billion of our common stock through fiscal 2022.

In March 2022, our Board of Directors approved a new two-year program to repurchase up to $1.9 billion of our common stock through fiscal 2023. This new program replaced the previous $1.5 billion stock repurchase program, effective at the end of fiscal 2021 (at which time we had repurchased $650 million under the previous $1.5 billion program).

We repurchased 10.3 million, 5.7 million, and 1.2 million shares of common stock for aggregate purchase prices of approximately $950 million, $650 million, and $132 million in fiscal 2022, 2021, and 2020, respectively. During fiscal 2022, 2021, and 2020, we also acquired 0.5 million shares in each year of treasury stock from our employee equity incentive plans, for aggregate purchase prices of approximately $48.9 million, $57.3 million, and $45.2 million, respectively.

On February 28, 2023, our Board of Directors declared a quarterly cash dividend of $0.335 per common share, payable on March 31, 2023. Our Board of Directors declared a cash dividend of $0.310 per common share in March, May, August, and November 2022 and a cash dividend of $0.285 per common share in March, May, August, and November 2021. Prior to fiscal 2021, our most recent quarterly dividend was a quarterly cash dividend of $0.285 per common share declared by our Board of Directors in March 2020. In May 2020, we temporarily suspended our quarterly dividends due to the economic uncertainty stemming from the COVID-19 pandemic.

During fiscal 2022, 2021, and 2020, we paid dividends of $431.3 million, $405.1 million, and $101.4 million, respectively.

Short-term trade credit represents a significant source of financing for our 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 credit, bank credit facility, and other credit sources to meet our capital and liquidity requirements, including for lease and interest payment obligations.

During fiscal 2022 and fiscal 2021, our liquidity and capital requirements were provided by available cash and cash flows from operations. During fiscal 2020, our liquidity and capital requirements were provided by available cash and cash flows from operations and by our long-term debt financing.

We ended fiscal 2022 with $4.6 billion of unrestricted cash balances, which were held primarily in overnight money market funds invested in U.S. treasury and government instruments across a highly diversified set of banks and other financial institutions. We also have $1.3 billion available under our senior unsecured revolving credit facility. We estimate that existing cash and cash equivalent balances, cash flows from operations, bank credit facility, and trade credit are adequate to meet our operating cash needs and to fund our planned capital investments, common stock repurchases, and quarterly dividend payments for at least the next 12 months.

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Contractual Obligations

The table below presents our significant contractual obligations as of January 28, 2023:

Supply chain finance program. We facilitate a voluntary supply chain finance program (the “program”) to provide certain suppliers with the opportunity to sell receivables due from us to a participating financial institution at the sole discretion of both the suppliers and the financial institution. A third party administers the program; our responsibility is limited to making payment on the terms originally negotiated with the supplier, regardless of whether the supplier sells its receivable to a financial institution. We do not enter into financial agreements with the participating financial institution in connection with the program. The range of payment terms we negotiate with our suppliers is consistent, irrespective of whether a supplier participates in the program.

All outstanding payments owed under the program are recorded within Accounts payable in the Consolidated Balance Sheets. The amounts owed to a participating financial institution under the program and included in Accounts payable were $119.2 million and $272.7 million at January 28, 2023 and January 29, 2022, respectively. We account for all payments made under the program as a reduction to operating cash flows in Accounts payable within the Consolidated Statements of Cash Flows. The amounts settled through the program and paid to the participating financial institution were $777.5 million and $430.1 million during fiscal 2022 and 2021, respectively.

Standby letters of credit and collateral trust. We use standby letters of credit outside of our revolving credit facility in addition to a funded trust to collateralize some of our insurance obligations. We also use standby letters of credit outside of our revolving credit facility to collateralize some of our trade payable obligations. As of January 28, 2023 and January 29, 2022, we had $2.6 million and $3.3 million, respectively, in standby letters of credit outstanding and $57.8 million and $56.7 million, respectively, in a collateral trust. The standby letters of credit are collateralized by restricted cash and the collateral trust consists of restricted cash, cash equivalents, and investments.

Trade letters of credit. We had $7.6 million and $19.3 million in trade letters of credit outstanding at January 28, 2023 and January 29, 2022, respectively.

Other than the unrecorded contractual obligations noted above, we do not have any material off-balance sheet arrangements as of January 28, 2023.

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Other

Critical Accounting Estimates

The preparation of our consolidated financial statements requires our management 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. We believe the following critical accounting estimates describe the more significant judgments and estimates used in the preparation of our consolidated financial statements and are not intended to be a comprehensive list of all of our accounting estimates.

Merchandise inventory. Our merchandise inventory is stated at the lower of cost (determined using a weighted-average basis) or net realizable value. Merchandise inventory includes acquisition, transportation, processing, and storage costs related to packaway inventory. Included in the carrying value of our merchandise inventory is a provision for shortage. The shortage reserve is based on historical shortage rates as determined through our annual physical merchandise inventory counts and cycle counts. Historically, our actual physical inventory count results have shown our provision for shortage to be reliable. As a measure of sensitivity, a five percent change in shortage rates as of January 28, 2023 would not have materially impacted our cost of goods sold in fiscal 2022.

Insurance obligations. We use a combination of insurance and self-insurance for a number of risk management activities, including workers’ compensation, general liability, and employee-related health care benefits. Our self-insurance and deductible 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 increase beyond what was anticipated, our recorded reserves may not be sufficient and additional charges could be required. A five percent increase or decrease in our insurance reserves would not have materially impacted our net earnings in fiscal 2022.

Recent Accounting Pronouncements

Refer to Note A: Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements for a discussion of recent accounting pronouncements and their impact to our Consolidated Financial Statements.

Forward-Looking Statements

Our Annual Report on Form 10-K for fiscal 2022, and information we provide in our Annual Report to Stockholders, press releases, and other investor communications including those on our corporate website, may contain a number of forward-looking statements regarding, without limitation, projected sales, costs and earnings, planned new store growth, capital expenditures, the continuing challenges from the COVID-19 pandemic and related economic disruptions and our plans and responses to them, sustainability and carbon reduction targets, and other matters. These forward-looking statements reflect our then-current beliefs, plans, and estimates with respect to future events and our projected financial performance, operations, and competitive position. The words “plan,” “expect,” “target,” “anticipate,” “estimate,” “believe,” “forecast,” “projected,” “guidance,” “looking ahead,” and similar expressions identify forward-looking statements.

Future impact from inflation, interest rate increases, ongoing military conflicts and economic sanctions, the COVID-19 pandemic, climate change, and other economic, regulatory, and industry trends that could potentially impact revenue, profitability, operating conditions, and growth are difficult to predict. 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, plans, and projections. Refer to ITEM 1A. RISK FACTORS in this Annual Report on Form 10-K for a more complete discussion of risk factors for Ross and dd’s DISCOUNTS. The factors underlying our forecasts and plans 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.

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