ROSS STORES, INC. (ROST) FY 2024 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 1,764 locations in 43 states, the District of Columbia, and Guam, as of February 3, 2024. 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 345 dd’s DISCOUNTS stores in 22 states as of February 3, 2024 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. Although inflation has moderated during the past year, the cost of essentials remains elevated and continues to pressure our low-to-moderate income customers’ discretionary spending. 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 customers, despite the ongoing uncertainty in the current macroeconomic and geopolitical environments.

We believe our merchandising and operational strategies enable us to deliver the most competitive bargains available to meet our customers’ ongoing demand for quality branded goods for the family and home at compelling discounts every day. Our merchandising strategies include offering a wide assortment of quality branded bargains for our customers. We believe staying diligently focused on executing our merchandising strategies is an important driver of our ability to gain market share in fiscal 2024 and the long term.

The fiscal year ended February 3, 2024 is referred to as fiscal 2023 and was a 53-week year. The fiscal years ended January 28, 2023 and January 29, 2022 are referred to as fiscal 2022 and fiscal 2021, respectively, and were 52-week years.

The discussion that follows relates to fiscal 2023 and fiscal 2022. Discussion of fiscal 2021 items and year-to-year comparisons between fiscal 2022 and fiscal 2021 that are not included in this Annual Report on Form 10-K can be found in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for fiscal 2022.

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Results of Operations

The following table summarizes our financial results for fiscal 2023, 2022, and 2021:

Stores. Our long-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.

Total stores open at the end of fiscal 2023, 2022, and 2021 were 2,109, 2,015, and 1,923, respectively. The number of stores at the end of fiscal 2023, 2022, and 2021 increased by 5%, 5%, and 3% from the respective prior years. In fiscal 2023, we opened 97 new stores. Looking forward to 2024, we expect to open approximately 90 new stores. 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 provide opportunities for us to gain market share.

The following table summarizes the stores opened and closed during fiscal 2023, 2022, and 2021:

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The total selling square footage as of February 3, 2024, January 28, 2023, and January 29, 2022 was 42.8 million, 41.4 million, and 39.9 million, respectively.

Sales. Sales for fiscal 2023 increased $1.7 billion, or 9.0%, compared to the prior year. This was primarily due to the 5% increase in comparable store sales, the opening of 94 net new stores during fiscal 2023, and the impact of the 53rd week.

Our sales mix is shown below for fiscal 2023, 2022, and 2021:

Cost of goods sold. Cost of goods sold in fiscal 2023 increased $0.9 billion compared to the prior year mainly due to the 5% comparable store sales increase, higher sales from the opening of 94 net new stores during fiscal 2023, higher incentive compensation expense, and the impact of the 53rd week, partially offset by lower ocean and domestic freight costs.

Cost of goods sold as a percentage of sales for fiscal 2023 decreased approximately 195 basis points from fiscal 2022 primarily due to a 160 basis point increase in merchandise margin mainly due to lower ocean freight costs, a 60 basis point decrease in domestic freight costs, 25 basis points of leverage in occupancy costs, and a 20 basis point decrease in distribution costs primarily due to the timing of packaway inventory carrying costs. Partially offsetting these items was a 70 basis point increase in buying costs primarily due to higher incentive compensation expense.

We expect lower merchandise margin as a percentage of sales in fiscal 2024 as we plan to offer more brands that are sharply priced throughout our stores. We expect this impact will be partially offset by lower incentive compensation expense, which is expected to return to target levels.

Selling, general and administrative expenses. For fiscal 2023, selling, general and administrative expenses (“SG&A”) increased $508.4 million compared to the prior year. The increase was primarily due to higher incentive compensation expense, higher store wages, the opening of 94 net new stores during fiscal 2023, and the impact of the 53rd week.

SG&A as a percentage of sales for fiscal 2023 increased by approximately 125 basis points compared to fiscal 2022 primarily due to higher incentive compensation expense and higher store wages.

We expect lower incentive compensation expense in fiscal 2024, which is expected to return to target levels.

Interest (income) expense, net. In fiscal 2023, interest (income) expense, net improved by $167.0 million compared to fiscal 2022 primarily due to increased interest income from higher interest rates.

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The table below shows the components of interest (income) expense, net for fiscal 2023, 2022, and 2021:

Taxes on earnings. Our effective tax rate for fiscal 2023, 2022, and 2021 was approximately 24%. 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.

Net earnings. Net earnings as a percentage of sales for fiscal 2023 was higher than in fiscal 2022 primarily due to lower cost of goods sold and higher interest income, partially offset by higher SG&A expenses.

Earnings per share. Diluted earnings per share in fiscal 2023 was $5.56 compared to $4.38 in the prior year. Fiscal 2023 includes a per share benefit of approximately $0.20 from the 53rd week. The $1.18 increase in diluted earnings per share in fiscal 2023 was primarily attributable to a 24% increase in net earnings (which included a 4% impact from the 53rd week) and a 3% reduction in weighted-average diluted shares outstanding, primarily due to stock repurchases under our stock repurchase program.

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 related to our new and existing stores, and investments in distribution centers, information systems, and buying and corporate offices. We also use cash to repurchase stock under our stock repurchase programs, pay dividends, and repay debt as it becomes due.

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Operating Activities

Net cash provided by operating activities was $2.5 billion in fiscal 2023. This was primarily driven by net earnings excluding non-cash expenses for depreciation, amortization, and stock-based compensation. 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.

The increase in cash flow from operating activities in fiscal 2023 compared to fiscal 2022 was primarily driven by higher current year incentive compensation accruals combined with lower incentive compensation payments and higher net earnings, partially offset by lower accounts payable leverage (defined as accounts payable divided by merchandise inventory).

Accounts payable leverage was 89% and 99% as of February 3, 2024 and January 28, 2023, respectively. The decrease in accounts payable leverage in fiscal 2023 compared to fiscal 2022 was primarily driven by timing of inventory receipts and related payments versus last year.

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. Packaway inventory was 40% of total inventory at the end of fiscal 2023 and 2022.

Investing Activities

Net cash used in investing activities was $762.8 million, $654.1 million, and $557.8 million in fiscal 2023, 2022, and 2021, respectively, and was related to our 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 2023 compared to fiscal 2022 was primarily due to higher capital expenditures related to the construction and build-out of new stores, the construction of distribution centers, including capital expenditures related to our new Buckeye, Arizona distribution center, and various information technology projects.

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

Capital expenditures for fiscal 2024 are projected to be approximately $840 million. Our planned capital expenditures for fiscal 2024 are for investments in our supply chain to support long-term growth, including construction of our next distribution centers, investments in our information technology systems, costs for fixtures and leasehold improvements to open new Ross and dd’s DISCOUNTS stores, 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 2024 compared to fiscal 2023 is primarily driven by investments in our next distribution centers, information technology systems, existing store improvements, and various expenditures related to distribution centers, and buying and corporate offices.

Financing Activities

Net cash used in financing activities was $1.4 billion, $1.4 billion, and $1.2 billion in fiscal 2023, 2022, and 2021, respectively, primarily resulting from stock repurchases under our stock repurchase programs and dividend payments.

Revolving credit facilities. We have a $1.3 billion senior unsecured revolving credit facility (“Credit Facility”). As of February 3, 2024, we had no borrowings or standby letters of credit outstanding under the 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 February 3, 2024, 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 May 2021, our Board of Directors authorized a program to repurchase up to $1.5 billion of the Company’s common stock through fiscal 2022.

In March 2022, our Board of Directors approved a two-year program to repurchase up to $1.9 billion of the Company’s common stock through fiscal 2023. This program replaced the previously approved $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).

In March 2024, our Board of Directors approved a new two-year program to repurchase up to $2.1 billion of the Company’s common stock through fiscal 2025.

The following table summarizes our stock repurchase activity in fiscal 2023, 2022, and 2021:

During fiscal 2023, 2022, and 2021, we also acquired 0.5 million shares of treasury stock in each year from our employee equity incentive plans for aggregate purchase prices of approximately $48.6 million, $48.9 million, and $57.3 million, respectively.

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On March 5, 2024, our Board of Directors declared a quarterly cash dividend of $0.3675 per common share, payable on March 29, 2024.

Our Board of Directors declared a cash dividend of $0.3350 per common share in February, May, August, and November 2023. Our Board of Directors declared a cash dividend of $0.3100 per common share in March, May, August, and November 2022 and a cash dividend of $0.2850 per common share in March, May, August, and November 2021.

During fiscal 2023, 2022, and 2021, we paid dividends of $454.8 million, $431.3 million, and $405.1 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.

During fiscal 2023, fiscal 2022, and fiscal 2021, our liquidity and capital requirements were provided by available cash and cash flows from operations.

We ended fiscal 2023 with $4.9 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, debt repayments, common stock repurchases, and quarterly dividend payments for at least the next 12 months.

Contractual Obligations

The table below presents our significant contractual obligations as of February 3, 2024:

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Supply chain finance program. We facilitate a voluntary supply chain finance program (the “program”) to provide certain suppliers with the opportunity to sell their receivables due from us to participating financial institutions at the sole discretion of both the suppliers and the financial institutions. 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 institutions 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 participating financial institutions under the program and included in Accounts payable were $146.9 million and $119.2 million at February 3, 2024 and January 28, 2023, 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.

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. As of February 3, 2024 and January 28, 2023, we had $2.2 million and $2.6 million, respectively, in standby letters of credit outstanding and $60.8 million and $57.8 million, respectively, in a collateral trust. The standby letters of credit are collateralized by restricted cash and the collateral trust consists of restricted cash and cash equivalents.

Other than the unrecorded contractual obligations noted above, we did not have any material off-balance sheet arrangements as of February 3, 2024.

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. A five percent change in shortage rates as of February 3, 2024 would not have materially impacted our cost of goods sold in fiscal 2023.

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 2023.

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.

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Forward-Looking Statements

Our Annual Report on Form 10-K for fiscal 2023, 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, earnings, planned new store growth, capital expenditures, 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,” “outlook,” “looking ahead,” and similar expressions identify forward-looking statements.

Future impact from inflation, high interest rates and interest rate increases, ongoing military conflicts and economic sanctions, public health crises, climate change, and other economic, regulatory, and industry trends that could potentially impact our 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.