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 1,546 locations in 39 states, the District of Columbia, and Guam, as of February 1, 2020. 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 259 dd’s DISCOUNTS stores in 19 states as of February 1, 2020 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. In establishing appropriate growth targets for our business, we closely monitor market share trends for the off-price industry and believe our share gains over the past few years were driven mainly by continued focus on value by consumers. Our sales and earnings gains in 2019 continued to benefit from efficient execution of our off-price model throughout all areas of our business. Our merchandise and operational strategies are designed to take advantage of the expanding market share of the off-price industry as well as the ongoing customer demand for name brand fashions for the family and home at compelling discounts every day.

We refer to our fiscal years ended February 1, 2020, February 2, 2019, and February 3, 2018 as fiscal 2019, fiscal 2018, and fiscal 2017, respectively. Fiscal 2017 was a 53-week year. Fiscal 2019 and 2018 were each 52-week years.

Current Material Development – the COVID-19 Pandemic is Disrupting Our Business

The United States and other countries are experiencing a major global health pandemic related to the outbreak of a novel strain of coronavirus, COVID-19. Governmental authorities in affected regions are taking increasingly dramatic action in an effort to slow down the spread of the disease. As part of a growing number of retailers across the country, we have temporarily closed all store locations effective March 20, 2020 through April 3, 2020. We have closed our buying and corporate offices, and our distribution centers, for the same period, and we have instituted “work from home” measures for many of our associates. We are monitoring the situation and will reopen stores as conditions permit; however, extended or further closures may be required nationally, regionally, or in specific locations. Given the unprecedented uncertainty of this situation, including the unknown duration and severity of the pandemic and the unknown overall impact on consumer demand, we are unable to forecast the full impact on our business; however, we now expect that impacts from the COVID-19 pandemic and the related economic disruption will have a material adverse impact on our consolidated results of operations, consolidated financial position, and consolidated cash flows in fiscal 2020.

To preserve our financial liquidity, and out of an abundance of caution, we are temporarily suspending our stock repurchase program, and in mid-March 2020 we borrowed $800 million from our revolving credit facility, which bears interest at LIBOR plus 0.75% (currently 1.61%), to add to our cash balances. In addition, we are reducing our expense, inventory receipts, and capital expenditure plans.

Results of Operations

The following table summarizes the financial results for fiscal 2019, 2018, and 2017:

						2019						2018						2017
Sales
Sales (millions)						$	16,039					$	14,984					$	14,135
Sales growth						7.0		%				6.0		%				9.9		%
Comparable store sales growth (52-week basis)						3		%				4		%				4		%
Costs and expenses (as a percent of sales)
Cost of goods sold						71.9		%				71.6		%				71.0		%
Selling, general and administrative						14.7		%				14.8		%				14.5		%
Interest (income) expense, net						(0.1)		%				(0.1)		%				0.1		%
Earnings before taxes (as a percent of sales)						13.5		%				13.7		%				14.4		%
Net earnings (as a percent of sales)						10.4		%				10.6		%				9.6		%

Stores. Total stores open at the end of fiscal 2019, 2018, and 2017 were 1,805, 1,717, and 1,622, respectively. The number of stores at the end of fiscal 2019, 2018, and 2017 increased by 5%, 6%, and 6% from the respective prior years. Our expansion 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.

			Store Count			2019						2018						2017
			Beginning of the period			1,717						1,622						1,533
			Opened in the period			98						99						96
			Closed in the period			(10)			1			(4)						(7)
			End of the period			1,805						1,717						1,622
			Selling square footage at the end of the period (000)			37,900						36,300						34,700
			1 Includes the temporary closure of a store impacted by a weather event.

Sales. Sales for fiscal 2019 increased $1.1 billion, or 7.0%, compared to the prior year due to the opening of 88 net new stores during 2019 and a 3% increase in comparable store sales (defined as stores that have been open for more than 14 complete months). Sales for fiscal 2018 increased $0.8 billion, or 6.0%, compared to the prior year due to the opening of 95 net new stores during 2018 and a 4% increase in sales from comparable stores.

Our sales mix is shown below for fiscal 2019, 2018, and 2017:

						2019						2018						2017
Ladies						26		%				26		%				27		%
Home Accents and Bed and Bath						25		%				26		%				26		%
Men’s						14		%				14		%				13		%
Accessories, Lingerie, Fine Jewelry, and Fragrances						13		%				13		%				13		%
Shoes						13		%				13		%				13		%
Children’s						9		%				8		%				8		%
Total						100		%				100		%				100		%

We intend to address the competitive climate for off-price apparel and home goods by pursuing and refining our existing strategies and by continuing to strengthen our merchant organization, diversify our merchandise mix, and more fully develop our systems to improve our merchandise offerings. Although our strategies and store expansion program contributed to sales gains in fiscal 2019, 2018, and 2017, we cannot be sure that they will result in a continuation of sales growth or in an increase in net earnings.

As part of a growing number of retailers across the country, we have temporarily closed all store locations effective March 20, 2020 through April 3, 2020, in response to the COVID-19 pandemic. We have closed our buying and corporate offices, and our distribution centers, for the same period, and we have instituted “work from home” measures for many of our associates. Given the unprecedented uncertainty of this situation, including the unknown duration and severity of the pandemic, which may require extended and further store closures nationally, regionally, or in specific locations, and the unknown overall impact on consumer demand, we are unable to forecast the full impact on our business; however, we now expect that impacts from the COVID-19 pandemic and the related economic disruption will have a material adverse impact on our consolidated results of operations, consolidated financial position, and consolidated cash flows in fiscal 2020.

Cost of goods sold. Cost of goods sold in fiscal 2019 increased $809.9 million compared to the prior year mainly due to increased sales from the opening of 88 net new stores during the year and a 3% increase in sales from comparable stores.

Cost of goods sold as a percentage of sales for fiscal 2019 increased approximately 35 basis points from the prior year primarily due to a 35 basis point increase in distribution expenses and a 15 basis point increase in freight costs. These increases were partially offset by a 10 basis point improvement in merchandise gross margin and a five basis point reduction in buying costs.

Cost of goods sold in fiscal 2018 increased $683.6 million compared to the prior year mainly due to increased sales from the opening of 95 net new stores during the year and a 4% increase in sales from comparable stores.

Cost of goods sold as a percentage of sales for fiscal 2018 increased approximately 55 basis points from the prior year primarily due to a 40 basis point increase in freight costs, a 15 basis point increase in distribution expenses, higher buying costs of 10 basis points, and higher occupancy costs of five basis points. These increases were partially offset by an increase of 15 basis points in merchandise gross margin.

We cannot be sure that the gross profit margins realized in fiscal 2019, 2018, and 2017 will continue in future years.

Selling, general and administrative expenses. For fiscal 2019, selling, general and administrative expenses (“SG&A”) increased $140.2 million compared to the prior year, mainly due to increased store operating costs reflecting the opening of 88 net new stores during the year. SG&A as a percentage of sales for fiscal 2019 decreased by approximately 10 basis points compared to the prior year primarily due to leverage on higher sales.

For fiscal 2018, SG&A increased $172.9 million compared to the prior year, mainly due to increased store operating costs reflecting the opening of 95 net new stores during the year. SG&A as a percentage of sales for fiscal 2018 increased by approximately 30 basis points compared to the prior year primarily due to higher wages.

Interest (income) expense, net. In fiscal 2019, net interest income improved by $7.9 million compared to 2018 primarily due to lower interest expense on long-term debt due to the repayment of the Series A 6.38% unsecured Senior Notes in December 2018 and higher capitalized interest primarily related to the construction of our Brookshire, Texas distribution center. In fiscal 2018, net interest income improved by $17.8 million compared to 2017 primarily due to an increase in interest income and higher capitalized interest on information systems projects.

The table below shows the components of interest expense and income for fiscal 2019, 2018, and 2017:

			($000)						2019						2018						2017
			Interest expense on long-term debt						$	13,139					$	17,900					$	18,578
			Other interest expense						968						1,004						979
			Capitalized interest						(4,367)						(2,497)						(710)
			Interest income						(27,846)						(26,569)						(11,171)
			Interest (income) expense, net						$	(18,106)					$	(10,162)					$	7,676

Taxes on earnings. Our effective tax rates for fiscal 2019, 2018, and 2017 were approximately 23%, 23% and 33%, respectively. The effective tax rate 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 impacted by changes in tax law and accounting guidance, location of new stores, level of earnings, tax effects associated with share-based compensation, and the resolution of tax positions with various tax authorities. We anticipate that our effective tax rate for fiscal 2020 will be approximately 24%.

In November 2019, we resolved uncertain tax positions with a state tax authority. As a result, we recognized a tax benefit of approximately $10.0 million in the Consolidated Statement of Earnings. In fiscal 2018, we resolved uncertain federal tax positions related to fiscal 2015 with the Internal Revenue Service. As a result, we recognized a tax benefit of approximately $26.0 million in the Consolidated Statement of Earnings.

In fiscal 2017, the Tax Cuts and Jobs Act (the “Tax Act” or "tax reform") was signed into law. The Tax Act made significant changes to U.S. corporate taxation including reducing the U.S. federal corporate income tax rate from 35% to 21% effective January 1, 2018, the last month of fiscal 2017. U.S. GAAP requires that the impact of tax legislation be recognized in the period in which the law was enacted. We applied a U.S. federal income tax rate of 21% for fiscal 2018 and a blended U.S. federal income tax rate of approximately 34% for fiscal 2017. This reduced tax rate resulted in a benefit of $24.9 million in fiscal 2017. We recorded an additional tax benefit of $55.2 million due to the remeasurement of our deferred tax assets and liabilities in fiscal 2017.

Net earnings. Net earnings as a percentage of sales for fiscal 2019 were lower than in fiscal 2018, primarily due to higher cost of goods sold, partially offset by lower SG&A expenses and higher interest income. Net earnings as a percentage of sales for fiscal 2018 were higher compared to fiscal 2017, primarily due to lower taxes as a result of tax reform, and higher interest income, partially offset by higher cost of goods sold and higher SG&A expenses.

Earnings per share. Diluted earnings per share in fiscal 2019 was $4.60, which included a per share benefit of approximately $0.02 primarily related to the favorable resolution of a tax matter, compared to $4.26 in the prior year, which included a per share benefit of approximately $0.07 from the favorable resolution of a tax matter. The 8% increase in diluted earnings per share is attributable to an increase of approximately 5% in net earnings and 3% from the reduction in weighted-average diluted shares outstanding, largely due to the repurchase of common stock under our stock repurchase program.

Diluted earnings per share in fiscal 2018 was $4.26, which included a per share benefit of approximately $0.70 from tax reform and $0.07 from the favorable resolution of a tax matter, compared to $3.55 in the prior year, which included a per share benefit of approximately $0.21 from tax reform and a $0.10 benefit from the 53rd week. The 20% increase in diluted earnings per share was attributable to an increase of approximately 16% in net earnings (which included a 14% impact from tax reform and a 2% impact from the favorable resolution of a tax matter) and 4% from the reduction in weighted-average diluted shares outstanding, largely due to the repurchase of common stock under our stock repurchase program.

Financial Condition

Liquidity and Capital Resources

As previously noted, the United States and other countries are experiencing the COVID-19 pandemic and related economic disruptions. Governmental authorities in affected regions are taking increasingly dramatic action in an effort to slow down the spread of the disease. As part of a growing number of retailers across the country, we have temporarily closed all store locations effective March 20, 2020 through April 3, 2020. We have closed our buying and corporate offices, and our distribution centers, for the same period, and we have instituted “work from home” measures for many of our associates. We are monitoring the situation and will reopen stores as conditions permit; however, extended or further closures may be required nationally, regionally, or in specific locations. Given the unprecedented uncertainty of this situation, including the unknown duration and severity of the pandemic and the overall impact on consumer demand, we are unable to forecast the full impact on our business; however, this represents a known area of uncertainty and we now expect that impacts from the COVID-19 pandemic and the related economic disruption will have a material adverse impact on our business. This uncertainty includes the potential need for significant additional capital resources to maintain our operations during a period of declining revenue from sales. We began fiscal 2020 with $1.4 billion in cash and cash equivalents. To preserve our financial liquidity, we are temporarily suspending our stock repurchase program, and in mid-March 2020 we borrowed $800 million from our revolving credit facility, which bears interest at LIBOR plus 0.75% (currently 1.61%), to add to our cash balances. In addition, we are reducing our expense, inventory receipts, and capital expenditure plans. We plan to continue to monitor the rapidly developing situation and to take further action to reduce our expenses and preserve our financial flexibility, as necessary.

In normal times and historically, 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 merchandise inventory purchases, payroll, operating and variable lease costs, taxes, and 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 our stock repurchase program and to pay dividends, and we may use cash for the repayment of debt as it becomes due. Due to the COVID-19 pandemic and related economic disruptions, and with the temporary closure of all store locations effective March 20, 2020 through April 3, 2020, (and with extended or further closures possibly necessary), we anticipate that we will be required to rely far more heavily on our cash reserves and lines of credit, and we expect to carefully monitor and manage our cash position in light of ongoing conditions and levels of operations.

($ millions)			2019						2018						2017 1
Cash provided by operating activities			$	2,171.5					$	2,066.7					$	1,681.3
Cash used in investing activities			(555.0)						(410.4)						(354.8)
Cash used in financing activities			(1,683.2)						$	(1,531.5)					(1,149.4)
Net (decrease) increase in cash, cash equivalents, and restricted cash and cash equivalents			$	(66.7)					$	124.8					$	177.1
1 As the result of the adoption of ASU 2016-18, Statement of Cash Flow (Topic 230): Restricted Cash, in fiscal 2018, the prior year amounts were retrospectively adjusted. See Note A in Notes to Consolidated Financial Statements.

Operating Activities

Net cash provided by operating activities was $2,171.5 million, $2,066.7 million, and $1,681.3 million in fiscal 2019, 2018, and 2017, respectively, and was primarily driven by net earnings excluding non-cash expenses for depreciation and amortization and for deferred taxes. Our primary source of operating cash flow 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.

The increase in cash flow from operating activities in 2019 compared to fiscal 2018 was primarily driven by higher earnings and the timing of merchandise receipts and related payments versus last year. The timing of merchandise receipts and related payments versus last year resulted in accounts payable leverage (defined as accounts payable divided by merchandise inventory) of 71%, 67%, and 65% as of February 1, 2020, February 2, 2019, and February 3, 2018, respectively.

The increase in cash flow from operating activities in fiscal 2018 compared to fiscal 2017 was primarily driven by higher earnings, the timing of merchandise receipts and related payments versus last year, and lower income tax payments.

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. 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 in normal times and historically, 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 2019, packaway inventory was 46% of total inventory compared to 46% and 49% at the end of fiscal 2018 and 2017, respectively.

Investing Activities

Net cash used in investing activities was $555.0 million, $410.4 million, and $354.8 million in fiscal 2019, 2018, and 2017, respectively. The increase in cash used for investing activities in fiscal 2019 compared to fiscal 2018 and fiscal 2017 was primarily due to an increase in our capital expenditures.

In fiscal 2019, 2018, and 2017, our capital expenditures were $555.5 million, $413.9 million, and $371.4 million, respectively. 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, buying, and corporate offices. The increase in capital expenditures in fiscal 2019 compared to fiscal 2018 was primarily due to investments in our distribution centers, and information technology infrastructure investments for our stores, buying, corporate offices, and transportation. The increase in capital expenditures in fiscal 2018 compared to fiscal 2017 was primarily due to investments in our distribution centers, and information technology infrastructure investments for our stores, buying, corporate offices, and transportation. We opened 98, 99, and 96 new stores in fiscal 2019, 2018, and 2017, respectively.

In November 2017, we entered into a sale-leaseback transaction for one of our previously owned stores and received net cash proceeds of $16.0 million, recognized a gain on sale of $6.3 million, and deferred the residual $7.5 million gain over the remaining ten-year lease term. As of February 3, 2019, the effective date of the adoption of Financial Accounting Standards Board issued Accounting Standards Update 2016-02, Leases (Accounting Standards Codification "ASC" 842), we wrote-off the remaining $6.5 million deferred gain on the sale-leaseback transaction that met the sale definition under ASC 842 to beginning retained earnings.

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

($ millions)						2019						2018						2017
New stores						$	137.4					$	134.5					$	137.1
Existing stores						125.3						130.5						126.0
Information systems, corporate, and other						91.8						84.9						66.4
Distribution and transportation						201.0						64.0						41.9
Total capital expenditures						$	555.5					$	413.9					$	371.4

As previously noted, due to the COVID-19 pandemic and related economic disruptions, and to preserve our financial liquidity, we are reviewing and reducing our capital expenditure plans for fiscal 2020. Our capital expenditures would be to fund commitments related to the construction of our Brookshire, Texas distribution center, costs for fixtures and leasehold improvements to open planned new Ross and dd’s DISCOUNTS stores, investments in certain information technology systems, and for various other needed expenditures related to our stores, distribution centers, buying, and corporate offices. We expect to fund capital expenditures with available cash, including cash we obtained by drawing from our revolving credit facility, and cash flows from operations.

Financing Activities

Net cash used in financing activities was $1,683.2 million, $1,531.5 million, and $1,149.4 million in fiscal 2019, 2018, and 2017, respectively. During fiscal 2019, 2018, and 2017, our liquidity and capital requirements were provided by available cash and cash flows from operations.

In March 2019, our Board of Directors approved a two-year $2.55 billion stock repurchase program through fiscal 2020. As of the end of fiscal 2019, we have $1.275 billion remaining under the stock repurchase program. Due to the current economic uncertainty stemming from the severe impact of the COVID-19 pandemic, we are temporarily suspending our stock repurchase program.

In February 2017, our Board of Directors approved a two-year $1.75 billion stock repurchase program through fiscal 2018. In March 2018, our Board of Directors approved an increase in the stock repurchase authorization for fiscal 2018 by $200 million to $1.075 billion, up from the previously available $875 million.

We repurchased 12.3 million, 12.5 million, and 13.5 million shares of common stock for aggregate purchase prices of approximately $1,275 million, $1,075 million, and $875 million in fiscal 2019, 2018, and 2017, respectively. We also acquired 0.6 million, 0.7 million, and 0.7 million shares in fiscal 2019, 2018, and 2017, respectively, of treasury stock from our employee stock equity compensation programs, for aggregate purchase prices of approximately $60.7 million, $54.4 million, and $45.4 million during fiscal 2019, 2018, and 2017, respectively.

On March 3, 2020, our Board of Directors declared a quarterly cash dividend of $0.285 per common share, payable on March 31, 2020. Our Board of Directors declared cash dividends of $0.255 per common share in March, May, August, and November 2019, cash dividends of $0.225 per common share in March, May, August, and November 2018, and cash dividends of $0.160 per common share in February, May, August, and November 2017.

During fiscal 2019, 2018, and 2017, we paid dividends of $369.8 million, $337.2 million, and $247.5 million, respectively.

On December 13, 2018, we repaid at maturity the $85 million principal amount of the Series A 6.38% unsecured Senior Notes.

Short-term trade credit normally 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. Due to the COVID-19 pandemic and related economic disruptions, we face uncertainty about the levels of trade credit we can maintain and liquidity available from sales of merchandise. As noted below, we have drawn from our available bank lines to add to our current cash balance.

In July 2019, we entered into a new $800 million unsecured revolving credit facility, which replaced our previous $600 million unsecured revolving credit facility. This new credit facility expires in July 2024, and contains a $300 million sublimit for issuance of standby letters of credit. The facility also contains an option allowing us to increase the size of our revolving credit facility by up to an additional $300 million, with the agreement of the lenders. Interest on borrowings under this facility is based on LIBOR (or an alternate benchmark rate, if LIBOR is no longer available) plus an applicable margin (currently 75 basis points) and is payable quarterly and upon maturity. The revolving credit facility may be extended, at our option, for up to two additional one-year periods, subject to customary conditions. As of February 1, 2020, we had no borrowings or standby letters of credit outstanding on this facility and our $800 million credit facility remained in place and available.

Subsequent to year end, in March 2020, we borrowed $800 million from our revolving credit facility, which bears interest at LIBOR plus 0.75% (currently 1.61%), to add to our cash balances in order to provide enhanced financial flexibility due to uncertain market conditions arising from the impact of the COVID-19 pandemic.

The revolving credit facility is subject to a financial leverage ratio covenant. As of February 1, 2020, we were in compliance with this covenant.

The COVID-19 pandemic and related economic disruptions, including the temporary closure of all of our store locations effective March 20, 2020 through April 3, 2020, (and with extended or further closures possibly necessary), are creating significant uncertainty and challenges. We believe that existing cash balances, cash flows

from operations, bank credit lines, and trade credit are adequate to meet our near-term operating cash needs and capital investments; further prolonged and extensive temporary store closures may require access to additional corporate credit markets.

Contractual Obligations and Off-Balance Sheet Arrangements

The table below presents our significant contractual obligations as of February 1, 2020:

			Less than 1 year						1 - 3 years						3 - 5 years						After 5 years						Total¹
($000)
Recorded contractual obligations:
Senior notes			$	—					$	65,000					$	250,000					$	—					$	315,000
Operating leases			601,607						1,178,104						814,134						665,649						3,259,494
New York buying office ground lease²			5,883						13,226						14,178						947,527						980,814
Unrecorded contractual obligations:
Real estate obligations3			13,410						49,035						49,993						154,400						266,838
Interest payment obligations			12,682						21,120						16,875						—						50,677
Purchase obligations4			2,655,629						49,554						3,998						—						2,709,181
Total contractual obligations			$	3,289,211					$	1,376,039					$	1,149,178					$	1,767,576					$	7,582,004
1 We have a $66.0 million liability for unrecognized tax benefits that is included in Other long-term liabilities on our Consolidated Balance Sheets. This liability is excluded from the schedule above as the timing of payments cannot be reasonably estimated.
² Our New York buying office building is subject to a 99-year ground lease.
3 Minimum lease payments for operating leases signed that have not yet commenced.
4 Purchase obligations primarily consist of merchandise inventory purchase orders, commitments related to construction projects, store fixtures and supplies, and information technology services, transportation, and maintenance contracts.

Other than the unrecorded contractual obligations noted above, we do not have any material off-balance sheet arrangements as of February 1, 2020.

Senior notes. As of February 1, 2020, we had outstanding unsecured 3.375% Senior Notes due September 2024 with an aggregate principal amount of $250 million. Interest on the 2024 Notes is payable semi-annually.

As of February 1, 2020, we also had outstanding Series B unsecured Senior Notes in the aggregate principal amount of $65 million, held by various institutional investors. The Series B notes are due in December 2021 and bear interest at a rate of 6.53%. Borrowings under these Senior Notes are subject to certain financial covenants, including interest coverage and other financial ratios. As of February 1, 2020, we were in compliance with those covenants.

The 2024 Notes, and Series B Senior Notes are subject to prepayment penalties for early payment of principal.

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 our insurance obligations. As of February 1, 2020 and February 2, 2019, we had $4.2 million and $7.3 million, respectively, in standby letters of credit outstanding and $56.0 million and $58.3 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 $11.2 million and $13.3 million in trade letters of credit outstanding at February 1, 2020 and February 2, 2019, respectively.

Effects of inflation or deflation. We do not consider the effects of inflation or deflation to be material to our financial position and results of operations.

Other

Critical Accounting Policies

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 policies 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 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. See our audited consolidated financial statements and notes thereto under Item 8 in this Annual Report on Form 10-K, which contain descriptions of our accounting policies and other disclosures required by GAAP.

Merchandise inventory. Our merchandise inventory is stated at the lower of cost (determined using a weighted-average basis) or net realizable value. We purchase inventory that can either be shipped to stores or processed as packaway merchandise with the intent that it will be warehoused and released to stores at 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 the Company’s 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. Packaway inventory accounted for approximately 46%, 46%, and 49% of total inventories as of February 1, 2020, February 2, 2019, and February 3, 2018, respectively. Merchandise inventory includes acquisition, 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 evaluated through our annual 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 review our long-lived assets for a potential 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 undiscounted future cash flows. If analysis of the undiscounted cash flow of an asset group was less than the carrying value of the asset group, an impairment loss would be recognized to write the asset group down to its fair value. If our actual results differ materially from projected results, an impairment charge may be required in the future. For stores that are closed, we record an impairment charge, if appropriate, or accelerate depreciation over the revised useful life of the asset. In the course of performing our annual analysis, we determined that no long-lived asset impairment charge was required for fiscal 2019, 2018, or 2017.

Lease accounting. As our leases generally do not provide an implicit discount rate; we use the estimated collateralized incremental borrowing rate based on information available at the lease commencement date in determining the present value of lease payments for use in the calculation of the operating lease liabilities and right-of-use assets. This rate is determined using a portfolio approach based on the risk-adjusted rate of interest and requires estimates and assumptions including credit rating, credit spread, and adjustments for the impact of collateral. We believe that this is the rate we would have to pay to borrow an amount equal to the lease payments on a collateralized basis over a similar lease term. Operating lease liabilities and corresponding right-of-use assets include options to extend lease terms that are reasonably certain of being exercised. We do not record a lease liability and corresponding right-of-use asset for leases with terms of 12 months or less, and account for lease and non-lease components as a single lease component. Our lease portfolio is comprised of operating leases with the lease cost recorded on a straight-line basis over the lease term.

Prior to our adoption of Accounting Standards Codification ("ASC") 842 in the beginning of fiscal 2019, when a lease contained “rent holidays” or required fixed escalations of the minimum lease payments, we recorded rental expense on a straight-line basis over the term of the lease and the difference between the average rental amount was charged to expense and the amount payable under the lease was recorded as deferred rent. We began recording

rent expense on the lease possession date. Tenant improvement allowances were amortized over the lease term. Changes in deferred rent and tenant improvement allowances were included as a component of operating activities in the Consolidated Statements of Cash Flows. See "Recently adopted accounting standards" below.

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.

Income taxes. We account for our uncertain tax positions in accordance with ASC 740. We are required to make assumptions and judgments regarding our income tax exposures. Our policy is to recognize interest and/or penalties related to all tax positions in income tax expense. To the extent that accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision in the period that such determination is made.

Recently issued accounting standards. We consider the applicability and impact of all Accounting Standards Updates (“ASU”) issued by the Financial Accounting Standards Board (“FASB”). ASUs not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on our consolidated financial results.

Recently adopted accounting standards. In February 2016, the FASB issued ASU 2016-02, Leases (ASC 842), which along with subsequent amendments, supersedes the lease accounting requirements in ASC 840, Leases. The updated guidance requires balance sheet recognition for all leases with lease terms greater than one year including a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

We adopted ASC 842 as of February 3, 2019 (the "effective date"), using the optional transition method on a modified retrospective basis. We did not elect the transitional package of practical expedients or the use of hindsight upon adoption of the ASC. We elected to not record a lease liability and corresponding right-of-use asset for leases with terms of 12 months or less, and to account for lease and non-lease components as a single lease component. Upon adoption, we recorded lease liabilities based on the present value of the remaining minimum rental payments, using incremental borrowing rates as of the effective date, of $2.9 billion, and the corresponding right-of-use assets of $2.9 billion. We also recorded a cumulative-effect adjustment to decrease beginning retained earnings of $19.6 million, primarily related to the write-off of previously capitalized initial direct costs that are no longer capitalized under ASC 842, partially offset by the write-off of the deferred gain on a previous sale-leaseback transaction that meets the sale definition under ASC 842. Reporting periods beginning on or after February 3, 2019 are presented under ASC 842, while prior period amounts and disclosures were not adjusted and continue to be reported under ASC 840. Adoption of ASC 842 did not have a significant impact to the Company’s consolidated statements of earnings or to the consolidated statements of cash flows.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (ASC 606) which, along with subsequent amendments, supersedes the revenue recognition requirements in “Revenue Recognition (ASC 605).” This guidance provides a five-step analysis of transactions to determine when and how revenue is recognized and requires entities to recognize revenue when the customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. We adopted ASC 606 as of February 4, 2018, using the modified retrospective method. Results for reporting periods beginning on or after February 4, 2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with ASC 605. Upon adoption of ASC 606, we recorded a cumulative-effect adjustment to increase beginning retained earnings by $20 million as of February 4, 2018, primarily due to the change in the timing of the recognition of stored value card breakage. The impact of applying ASC 606 was not material to our consolidated financial statements for the year ended February 2, 2019.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. ASU 2016-18 requires restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts on the statement of cash flows. The standard also requires companies who report cash and restricted cash separately on the balance sheet to reconcile those amounts to the statement of cash flows. We adopted ASU 2016-18 as of February 4, 2018, using the retrospective method.

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 provides for changes to accounting for stock compensation including 1) excess tax benefits and tax deficiencies related to share-based payment awards will be recognized as income tax benefit or expense in the reporting period in which they occur (previously such amounts were recognized in additional paid-in capital); 2) excess tax benefits will be classified as an operating activity in the statement of cash flows; and 3) the option to elect to estimate forfeitures or account for them when they occur. The impact of recording excess tax benefits in income taxes in our consolidated statement of earnings may be material, depending upon our future stock price on vest date in relation to the fair value of awards on grant date and our future grants of stock-based compensation.

We adopted ASU 2016-09 in the first quarter of fiscal 2017, and elected to apply this adoption prospectively, except for forfeitures which we adopted on a modified retrospective basis. Accordingly, prior periods have not been adjusted. As a result of adoption, for the fiscal year ended February 3, 2018, we recognized $16.3 million of excess tax benefits related to stock-based payments as a reduction to our provision for income taxes. These items were historically recorded in additional paid-in capital. We also presented cash flows related to excess tax benefits as an operating activity in the Consolidated Statement of Cash Flows and elected to account for forfeitures as incurred beginning on January 29, 2017. The impact of this accounting policy election for forfeitures was a cumulative-effect adjustment to decrease retained earnings by $1.1 million as of January 29, 2017.

Forward-Looking Statements

Our Annual Report on Form 10-K for fiscal 2019, 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, the rapidly developing challenges and our plans and responses to the COVID-19 pandemic and related economic disruptions, 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,” “target,” “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. 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 Item 1A 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 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.