Why did TJX's profit margin decline in fiscal 2005 despite strong sales growth?

The pre-tax margin fell from 8.0% to 7.2%, mainly because cost of sales, including buying and occupancy costs, rose to 76.3% of sales from 75.6%. Contributing factors were a $30.7 million non-cash lease accounting charge (about 0.2 points), the absence of the favorable 53rd week in fiscal 2004 (about 0.2 points), and higher markdowns at divisions other than Marmaxx, particularly Winners/HomeSense, HomeGoods, and A.J. Wright. Marmaxx actually improved its own merchandise margin.

What was the impact of the one-time lease accounting charge?

TJX recorded a cumulative, non-cash pre-tax charge of $30.7 million ($19.3 million after tax, or $0.04 per share) in the fourth quarter of fiscal 2005. It conformed rent expense timing to GAAP, so rent is now recognized when the company takes possession of a store, 30 to 60 days before opening. Going forward, this accelerates pre-opening rent expense but reduces monthly rent expense over the lease term. Management excludes this charge when presenting comparable earnings.

How is TJX returning capital to shareholders, and what is the outlook?

In fiscal 2005 TJX repurchased 25.1 million shares for $588 million and paid $83.4 million in dividends. Dividends per share rose to $0.18 from $0.14. The company completed a $1 billion buyback in May 2004 and started a new $1 billion program, of which $406.6 million had been used as of January 29, 2005. Management plans roughly $600 million in repurchases in fiscal 2006. The company had no borrowings outstanding under its credit facilities at year end.

Which TJX businesses are growing and which are struggling?

Marmaxx (T.J. Maxx and Marshalls) is the core engine, with 4% same-store sales growth, a 9.8% segment margin, and 50 net new stores in fiscal 2005. T.K. Maxx grew sales 31% to $1.3 billion, although its margin fell to 5.4%. Winners and HomeSense grew sales 19% but saw margin fall to 8.5% after excess inventory led to markdowns. HomeGoods' same-store sales grew only 1%, and its segment profit fell by more than half. A.J. Wright had a segment loss of $15.0 million after rapid expansion and weaker moderate-income demand, and Bob's Stores lost $17.3 million as it refines its concept.

What risks should investors monitor based on this filing?

Key watch items include: (1) margin pressure from markdowns and rising occupancy and distribution costs, especially outside Marmaxx; (2) inventory growth of 21% to $2.35 billion against 1% growth in per-store inventory, which raises markdown risk if demand softens; (3) execution risk in the rapid store expansion, which management acknowledged may have been too aggressive for A.J. Wright; (4) the EITF 04-08 accounting change, which dilutes diluted EPS by about $0.04 because the 16.9 million shares underlying the convertible notes are now included in the calculation; (5) potential cash needs if the zero-coupon convertible notes are put in fiscal 2008 (about $392 million); and (6) the American Jobs Creation Act repatriation provision, which could reduce tax costs on foreign earnings starting in fiscal 2006.

TJX 10-K FY2005 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 30, 2005. Cited figures are marked; the original filing is the authoritative source.

TJX Companies' fiscal 2005 (52 weeks ended January 29, 2005) was a year of strong top-line growth with margin pressure.

Net sales rose 12% to $14.9 billion^a, driven by roughly 6 points from new stores, 5 points from same-store sales growth (4% at Marmaxx), and 2 points from the full-year contribution of Bob's Stores, partly offset by the absence of the 53rd week in the prior year. Store count grew 8% to 2,224 and selling square footage grew 8%. Diluted EPS was $1.30, up from $1.25, but this figure includes a one-time, non-cash $0.04 lease accounting charge and an adverse $0.04 effect from the newly adopted EITF 04-08 treatment of convertible debt.

Excluding the lease charge, EPS was $1.34^b versus a restated $1.20 for fiscal 2004 (adjusted for the 53rd week), a 12% increase. Profitability was the key concern. The pre-tax margin fell from 8.0% to 7.2%, mainly because cost of sales, including buying and occupancy costs, rose 0.7 points.

Causes included the lease charge, the lapping of the 53rd week, and markdowns at divisions other than Marmaxx. Segment results diverged sharply: Marmaxx (T.J. Maxx and Marshalls) improved its segment margin to 9.8%^c, while HomeGoods' margin fell to 2.3%, A.J.

Wright posted a segment loss of $15.0 million^d, and Bob's Stores lost $17.3 million. Winners and HomeSense margin fell to 8.5% on markdowns tied to excess inventory, and T.K. Maxx margin fell to 5.4%.

Cash generation and capital return remained strong. Operating cash flow was $1.08 billion and capital expenditures were $429 million. TJX repurchased 25.1 million shares for $588 million, paid $83 million in dividends, and plans roughly $600 million in buybacks for fiscal 2006.

Management guided to 161 net new stores in fiscal 2006 (about 7% growth), roughly 8% selling square footage growth, and capex of about $530 million. Balance sheet metrics stayed healthy, with total debt at 29.7% of capitalization and no borrowings outstanding under credit facilities at year end. Inventory rose 21% to $2.35 billion, a point investors should watch alongside the markdown pressure.

02—Key points

Key Highlights

Net sales grew 12% to $14.9 billion, with 5% consolidated same-store sales growth and 8% growth in store count to 2,224 stores.
Diluted EPS was $1.30 (up from $1.25), or $1.34 excluding a one-time $0.04 non-cash lease accounting charge; this compares with $1.20 on a comparable basis in fiscal 2004.
Pre-tax margin declined to 7.2% from 8.0%, driven by cost of sales (including buying and occupancy costs) rising to 76.3% of sales from 75.6%.
Marmaxx (T.J. Maxx and Marshalls) was the standout, with 4% same-store sales growth, a 9.8% segment margin, and $10.5 billion in sales (70% of the total).
Weaker divisions: A.J. Wright posted a $15.0 million segment loss, Bob's Stores lost $17.3 million, and HomeGoods' segment margin fell to 2.3% from 5.7%.
Strong cash returns: $1.08 billion operating cash flow, $588 million in share repurchases (25.1 million shares), and $83 million in dividends; fiscal 2006 buyback plan is about $600 million.
Fiscal 2006 outlook calls for 161 net new stores (about 7% growth), roughly 8% selling square footage growth, and capital expenditures of about $530 million.

03—Questions

Frequently Asked Questions

Why did TJX's profit margin decline in fiscal 2005 despite strong sales growth?
The pre-tax margin fell from 8.0% to 7.2%, mainly because cost of sales, including buying and occupancy costs, rose to 76.3% of sales from 75.6%. Contributing factors were a $30.7 million non-cash lease accounting charge (about 0.2 points), the absence of the favorable 53rd week in fiscal 2004 (about 0.2 points), and higher markdowns at divisions other than Marmaxx, particularly Winners/HomeSense, HomeGoods, and A.J. Wright. Marmaxx actually improved its own merchandise margin.
What was the impact of the one-time lease accounting charge?
TJX recorded a cumulative, non-cash pre-tax charge of $30.7 million ($19.3 million after tax, or $0.04 per share) in the fourth quarter of fiscal 2005. It conformed rent expense timing to GAAP, so rent is now recognized when the company takes possession of a store, 30 to 60 days before opening. Going forward, this accelerates pre-opening rent expense but reduces monthly rent expense over the lease term. Management excludes this charge when presenting comparable earnings.
How is TJX returning capital to shareholders, and what is the outlook?
In fiscal 2005 TJX repurchased 25.1 million shares for $588 million and paid $83.4 million in dividends. Dividends per share rose to $0.18 from $0.14. The company completed a $1 billion buyback in May 2004 and started a new $1 billion program, of which $406.6 million had been used as of January 29, 2005. Management plans roughly $600 million in repurchases in fiscal 2006. The company had no borrowings outstanding under its credit facilities at year end.
Which TJX businesses are growing and which are struggling?
Marmaxx (T.J. Maxx and Marshalls) is the core engine, with 4% same-store sales growth, a 9.8% segment margin, and 50 net new stores in fiscal 2005. T.K. Maxx grew sales 31% to $1.3 billion, although its margin fell to 5.4%. Winners and HomeSense grew sales 19% but saw margin fall to 8.5% after excess inventory led to markdowns. HomeGoods' same-store sales grew only 1%, and its segment profit fell by more than half. A.J. Wright had a segment loss of $15.0 million after rapid expansion and weaker moderate-income demand, and Bob's Stores lost $17.3 million as it refines its concept.
What risks should investors monitor based on this filing?
Key watch items include: (1) margin pressure from markdowns and rising occupancy and distribution costs, especially outside Marmaxx; (2) inventory growth of 21% to $2.35 billion against 1% growth in per-store inventory, which raises markdown risk if demand softens; (3) execution risk in the rapid store expansion, which management acknowledged may have been too aggressive for A.J. Wright; (4) the EITF 04-08 accounting change, which dilutes diluted EPS by about $0.04 because the 16.9 million shares underlying the convertible notes are now included in the calculation; (5) potential cash needs if the zero-coupon convertible notes are put in fiscal 2008 (about $392 million); and (6) the American Jobs Creation Act repatriation provision, which could reduce tax costs on foreign earnings starting in fiscal 2006.

04—Continue

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