HOME DEPOT, INC. (HD) FY 2022 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Our MD&A includes the following sections:

•Executive Summary

•Results of Operations

•Liquidity and Capital Resources

•Critical Accounting Policies

Executive Summary

The following table presents highlights of our annual financial performance:

We reported net sales of $151.2 billion in fiscal 2021. Net earnings were $16.4 billion, or $15.53 per diluted share. We opened five new stores in the U.S. and two new stores in Mexico during fiscal 2021, resulting in a total store count of 2,317 at January 30, 2022, which includes 14 stores in the U.S. from a small acquisition completed during the second quarter of fiscal 2021. At the end of fiscal 2021, a total of 311 of our stores, or 13.4%, were located in Canada and Mexico. Total sales per retail square foot were $604.74 in fiscal 2021. Our inventory turnover ratio was 5.2 times at the end of fiscal 2021, compared to 5.8 times at the end of fiscal 2020. The decrease in our inventory turnover ratio was primarily driven by an increase in average inventory levels during fiscal 2021 to support the demand environment.

We generated $16.6 billion of cash flow from operations, issued $3.0 billion of long-term debt, net of discounts, and received $1.0 billion of net proceeds from short-term debt during fiscal 2021. This cash flow, together with cash on hand, was used to fund cash payments of $14.8 billion for share repurchases, pay $7.0 billion of dividends, fund $2.6 billion in capital expenditures, and repay an aggregate of $1.5 billion of long-term debt. In February 2022, we announced a 15% increase in our quarterly cash dividend to $1.90 per share.

Our ROIC was 44.7% for fiscal 2021 and 40.8% for fiscal 2020. See the “Non-GAAP Financial Measures” section below for our definition and calculation of ROIC, as well as a reconciliation of NOPAT, a non-GAAP financial measure, to net earnings (the most comparable GAAP financial measure).

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Results of Operations

The tables and discussion below should be read in conjunction with our consolidated financial statements and related notes included in this report. The following table presents the percentage relationship between net sales and major categories in our consolidated statements of earnings:

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Note: Certain percentages may not sum to totals due to rounding.

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(1)Does not include results for HD Supply, including the legacy Interline Brands business, which was integrated into HD Supply during the fourth quarter of fiscal 2021.

(2)Average ticket represents the average price paid per transaction and is used by management to monitor the performance of the Company, as it represents a primary driver in measuring sales performance.

(3)Sales per retail square foot represents sales divided by retail store square footage. Sales per retail square foot is a measure of the efficiency of sales based on the total square footage of our stores and is used by management to monitor the performance of the Company’s retail operations as an indicator of the productivity of owned and leased square footage for these retail operations.

Fiscal 2021 Compared to Fiscal 2020

Sales. We assess our sales performance by evaluating both net sales and comparable sales.

Net Sales. Net sales for fiscal 2021 increased $19.0 billion, or 14.4%, to $151.2 billion. The increase in net sales for fiscal 2021 primarily reflected the impact of positive comparable sales driven by an increase in comparable average ticket, as well as sales from HD Supply, which was acquired in the fourth quarter of fiscal 2020. In fiscal 2021, we saw continued elevated home improvement demand, which began at the end of the first quarter of fiscal 2020, with strong performance across our departments as customers continued to focus on home improvement projects and repairs. A weaker U.S. dollar positively impacted sales growth by $760 million in fiscal 2021.

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Online sales, which consist of sales generated online through our websites for products picked up in our stores or delivered to customer locations, represented 13.7% of net sales and grew by 9.4% during fiscal 2021 compared to fiscal 2020. The increase in online sales in fiscal 2021 was driven by customers continuing to leverage our digital platforms for their shopping needs.

Comparable Sales. Comparable sales is a measure that highlights the performance of our existing locations and websites by measuring the change in net sales for a period over the comparable prior-period of equivalent length. Comparable sales includes sales at all locations, physical and online, open greater than 52 weeks (including remodels and relocations) and excludes closed stores. Retail stores become comparable on the Monday following their 52nd week of operation. Acquisitions are typically included in comparable sales after they have been owned for more than 52 weeks. Comparable sales is intended only as supplemental information and is not a substitute for net sales presented in accordance with GAAP.

Total comparable sales increased 11.4% in fiscal 2021, reflecting an 11.7% increase in comparable average ticket and nearly flat comparable customer transactions when compared to fiscal 2020. The increase in comparable sales reflected a number of factors, including strong home improvement demand and benefits from our strategic efforts to drive an enhanced interconnected experience in both the physical and digital worlds, as well as inflation. The increase in comparable average ticket was primarily driven by inflation, an increase in big-ticket transactions, elevated project demand, and strong demand for new and innovative products.

During fiscal 2021, all of our merchandising departments posted positive comparable sales and 10 of our 14 merchandising departments posted double-digit positive comparable sales led by Kitchen and Bath and Lumber when compared to fiscal 2020. Our Outdoor Garden, Hardware, Indoor Garden, and Paint departments had single-digit positive comparable sales when compared to fiscal 2020.

Gross Profit. Gross profit increased $6.0 billion, or 13.3%, to $50.8 billion in fiscal 2021. Gross profit as a percent of net sales, or gross profit margin, was 33.6% in fiscal 2021 compared to 34.0% in fiscal 2020. The decrease in gross profit margin reflected pressure from product mix, investments in our supply chain network, and higher product and transportation costs offset by the benefit from higher retail prices.

Operating Expenses. Our operating expenses are composed of SG&A and depreciation and amortization.

Selling, General & Administrative. SG&A increased $1.0 billion, or 3.9%, to $25.4 billion in fiscal 2021. As a percent of net sales, SG&A was 16.8% for fiscal 2021 compared to 18.5% for fiscal 2020. The decrease in SG&A as a percent of net sales for fiscal 2021 was primarily driven by leverage resulting from a positive comparable sales environment along with cycling total COVID-19-related expenses of $2.1 billion and transaction-related expenses associated with the acquisition of HD Supply of $110 million incurred during fiscal 2020. These benefits were partially offset by an increase in hourly payroll-related costs in fiscal 2021, primarily driven by wage investments we made in the latter part of fiscal 2020 and throughout fiscal 2021. Total COVID-19-related expenses incurred during fiscal 2021 were $262 million.

Depreciation and Amortization. Depreciation and amortization increased $258 million, or 12.1%, to $2.4 billion in fiscal 2021. As a percent of net sales, depreciation and amortization was 1.6% for both fiscal 2021 and fiscal 2020, primarily reflecting leverage resulting from a positive comparable sales environment, offset by increased depreciation expense from strategic investments in the business as well as higher intangible asset amortization expense.

Interest and Other, net. Interest and other, net, was $1.3 billion for both fiscal 2021 and fiscal 2020. Interest and other, net, as a percent of net sales was 0.9% for fiscal 2021 compared to 1.0% for fiscal 2020, primarily reflecting leverage resulting from a positive comparable sales environment.

Provision for Income Taxes. Our combined effective income tax rate was 24.4% for fiscal 2021 compared to 24.2% for fiscal 2020.

Diluted Earnings per Share. Diluted earnings per share were $15.53 for fiscal 2021 compared to $11.94 for fiscal 2020. The increase in diluted earnings per share for fiscal 2021 was primarily driven by the factors discussed above, as well as share repurchases.

Fiscal 2020 Compared to Fiscal 2019

For a comparison of our results of operations for fiscal 2020 to fiscal 2019, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Form 10-K for fiscal 2020.

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Non-GAAP Financial Measures

To provide clarity about our operating performance, we supplement our reporting with certain non-GAAP financial measures. However, this supplemental information should not be considered in isolation or as a substitute for the related GAAP measures. Non-GAAP financial measures presented herein may differ from similar measures used by other companies.

Return on Invested Capital. We believe ROIC is meaningful for investors and management because it measures how effectively we deploy our capital base. We define ROIC as NOPAT, a non-GAAP financial measure, for the most recent twelve-month period, divided by average debt and equity. We define average debt and equity as the average of beginning and ending long-term debt (including current installments) and equity for the most recent twelve-month period.

The following table presents the calculation of ROIC, together with a reconciliation of NOPAT to net earnings (the most comparable GAAP measure):

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(1)Income tax adjustment is defined as operating income multiplied by our effective tax rate for the trailing twelve months.

(2)The beginning balance of equity for fiscal 2019 was adjusted to reflect an immaterial opening balance sheet adjustment due to the adoption of Accounting Standards Codification Topic 842, Leases, in fiscal 2019.

Liquidity and Capital Resources

At January 30, 2022, we had $2.3 billion in cash and cash equivalents, of which $1.3 billion was held by our foreign subsidiaries. We believe that our current cash position, cash flow generated from operations, funds available from our commercial paper programs, and access to the long-term debt capital markets should be sufficient not only for our operating requirements but also to enable us to invest in the business through capital expenditures, fund dividend payments, fund any share repurchases, make any required debt payments, and satisfy other contractual obligations through the next several fiscal years. In addition, we believe we have the ability to obtain alternative sources of financing, if necessary.

Our material cash requirements include contractual and other obligations arising in the normal course of business. These obligations primarily include long-term debt and related interest payments, operating and finance lease obligations, and purchase obligations. See below for additional details regarding these material cash requirements.

In addition to our cash requirements, we follow a disciplined approach to capital allocation. This approach first prioritizes investing in the business, with the intent of then returning excess cash to shareholders in the form of dividends and share repurchases. For fiscal 2022, we plan to invest approximately $3 billion back into our business in the form of capital expenditures, in line with our expectation of approximately two percent of net sales on an annual basis, compared to $2.6 billion in fiscal 2021. However, we may adjust our capital expenditures to support the operations of the business, to enhance long-term strategic positioning, or in response to the economic environment, as necessary or appropriate.

During fiscal 2021, we paid cash dividends of $7.0 billion to shareholders. In February 2022, we also announced a 15% increase in our quarterly cash dividend from $1.65 to $1.90 per share. We intend to pay a dividend in the future; however, any future dividend is subject to declaration by the Board of Directors based on our earnings, capital requirements, financial condition, and other factors considered relevant by our Board of Directors.

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In May 2021, our Board of Directors approved a $20.0 billion share repurchase authorization, of which $9.6 billion remained available as of January 30, 2022. This new authorization replaced the previous authorization of $15.0 billion, which was approved in February 2019, and does not have a prescribed expiration date. During fiscal 2021, we had cash payments of $14.8 billion for repurchases of our common stock through open market purchases. The amount and continuation of our share repurchases will be influenced by the evolving economic environment and business conditions.

Debt

At January 30, 2022, we had commercial paper programs that allowed for borrowings up to $3.0 billion. In connection with these programs, we had back-up credit facilities with a consortium of banks for borrowings up to $3.0 billion at January 30, 2022, which consisted of a five-year $2.0 billion credit facility scheduled to expire in December 2023 and a 364-day $1.0 billion credit facility scheduled to expire in December 2022. In December 2021, we completed the renewal of our 364-day $1.0 billion credit facility, extending the maturity from December 2021 to December 2022. At January 30, 2022, there were $1.0 billion of outstanding borrowings under our commercial paper programs, and we were in compliance with all of the covenants contained in our credit facilities, none of which are expected to impact our liquidity or capital resources.

We also issue senior notes from time to time as part of our capital management strategy. In September 2021, we issued $3.0 billion of senior notes, and the net proceeds were used for general corporate purposes, including repurchases of shares of our common stock. We also repaid $1.35 billion of senior notes during fiscal 2021. At January 30, 2022, we had an aggregate principal amount of senior notes outstanding of $36.4 billion, with $2.3 billion payable within 12 months. Future interest payments associated with these senior notes total $20.9 billion, with $1.2 billion payable within 12 months, based on current interest rates, which include the impact of our active interest rate swap agreements.

The indentures governing our senior notes do not generally limit our ability to incur additional indebtedness or require us to maintain financial ratios or specified levels of net worth or liquidity. The indentures governing the notes contain various customary covenants; however, none are expected to impact our liquidity or capital resources. See Note 4 to our consolidated financial statements for further discussion of our debt arrangements.

Leases

We use operating and finance leases to fund a portion of our real estate, including our stores, distribution centers, and store support centers. At January 30, 2022, we had aggregate lease obligations of $12.6 billion, with $1.3 billion payable within 12 months. Aggregate lease obligations include $1.3 billion of obligations related to leases not yet commenced. See Note 3 to our consolidated financial statements for further discussion of our operating and finance leases.

Purchase Obligations and Other

Purchase obligations include all legally binding contracts such as firm commitments for inventory purchases, media and sponsorship spend, software acquisitions, license commitments, and legally binding service contracts. We issue inventory purchase orders in the ordinary course of business, which are typically cancellable by their terms, therefore we do not consider purchase orders that are cancellable to be firm inventory commitments. At January 30, 2022, we had aggregate purchase obligations of $2.1 billion, with $1.2 billion payable within 12 months.

At January 30, 2022, we had aggregate liabilities for unrecognized tax benefits totaling $570 million, none of which are expected to be paid in the next 12 months. The timing of payment, if any, associated with our long-term unrecognized tax benefit liabilities is unknown. See Note 5 to our consolidated financial statements for further discussion of our unrecognized tax benefits.

We have no material off-balance sheet arrangements.

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Cash Flows Summary

Operating Activities. Cash flow generated from operations provides us with a significant source of liquidity. Our operating cash flows result primarily from cash received from our customers, offset by cash payments we make for products and services, associate compensation, operations, occupancy costs, and income taxes.

Cash provided by or used in operating activities is also subject to changes in working capital. Working capital at any point in time is subject to many variables, including seasonality, inventory management and category expansion, the timing of cash receipts and payments, vendor payment terms, and fluctuations in foreign exchange rates.

Net cash provided by operating activities decreased by $2.3 billion in fiscal 2021 compared to fiscal 2020 and was primarily driven by changes in working capital, partially offset by an increase in net earnings. Working capital was impacted by higher merchandise inventories resulting from our efforts to continue to meet the demand environment and from higher product and transportation costs, along with timing of vendor payments.

Investing Activities. Cash used in investing activities decreased by $7.2 billion in fiscal 2021 compared to fiscal 2020, primarily due to $7.8 billion of net consideration paid to acquire HD Supply in fiscal 2020, partially offset by increased capital expenditures.

Financing Activities. Cash used in financing activities in fiscal 2021 primarily reflected $14.8 billion of share repurchases, $7.0 billion of cash dividends paid, and $1.5 billion of repayments of long-term debt, partially offset by $3.0 billion of net proceeds from long-term debt and $1.0 billion of net proceeds from short-term debt.

Cash used in financing activities in fiscal 2020 primarily reflected $6.5 billion of cash dividends paid, $2.9 billion of repayments of long-term debt, $974 million of net repayments of short-term debt, and $791 million for share repurchases prior to our suspension of share repurchases in March 2020, partially offset by $7.9 billion of net proceeds from long-term debt.

Critical Accounting Policies

Our significant accounting policies are disclosed in Note 1 to our consolidated financial statements. The following discussion addresses our most critical accounting policies, which are those that are both important to the representation of our financial condition and results of operations, and that require significant judgment or use of significant assumptions or complex estimates.

Merchandise Inventories

We value the majority of our inventory under the retail inventory method, using the first-in, first-out method, with the remainder of our inventories valued under a cost method. Under the retail inventory method, inventories are stated at cost, which is determined by applying a cost-to-retail ratio to the retail value of inventories.

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The retail value of our inventory is adjusted as needed to reflect current market conditions. Because these adjustments are based on current prevailing market conditions, the value of our inventory approximates the lower of cost or market. The valuation under the retail inventory method is based on a number of factors such as markups, markdowns, and inventory losses (or shrink). As such, there exists an inherent uncertainty in the final determination of inventory cost and gross profit. We determine markups and markdowns based on the consideration of a variety of factors such as current and anticipated demand, customer preferences and buying trends, age of the merchandise, and weather conditions.

We calculate shrink based on actual inventory losses identified as a result of physical inventory counts during each fiscal period and estimated inventory losses between physical inventory counts. The estimate for shrink occurring in the interim period between physical inventory counts is calculated on a store-specific basis and is primarily based on recent shrink results. A 10% increase in the shrink rate used to estimate our inventory shrink reserve would have increased cost of sales by approximately $100 million for fiscal 2021. Historically, the difference between estimated shrink and actual inventory losses has not been material to our annual financial results.

Due to changes in operating conditions during fiscal 2020 as a result of the COVID-19 pandemic, we used the results from a sample of stores that were able to conduct physical inventories as a basis for estimating shrink for those stores at which physical inventory counts were temporarily suspended during fiscal 2020. We believe the sample of stores that were selected for inventory counts in fiscal 2020 provided a reasonable basis for estimating shrink where a physical inventory count was not performed in fiscal 2020. During fiscal 2021, we performed all regularly scheduled physical inventory counts, including store locations where physical inventory counts were suspended during fiscal 2020, and the difference between estimated shrink and actual inventory losses was not material.

We do not believe there is a reasonable likelihood for a material change in the estimates or assumptions we use to value our inventory under the retail inventory method. We believe that the retail inventory method provides an inventory valuation which approximates cost and results in valuing our inventory at the lower of cost or market.

Impairment of Long-Lived Assets

We evaluate our long-lived assets each quarter for indicators of potential impairment. Indicators of impairment include current period losses combined with a history of losses, our decision to relocate or close a store or other location before the end of its previously estimated useful life, or when changes in other circumstances indicate the carrying amount of an asset may not be recoverable. The evaluation for long-lived assets is performed at the lowest level of identifiable cash flows, which is generally the individual store level. The assets of a store with indicators of impairment are evaluated for recoverability by comparing their undiscounted future cash flows with their carrying value. Our cash flow projections look several years into the future and include assumptions of variables such as future sales and operating margin growth rates, economic conditions, market competition, and inflation.

If the carrying value is greater than the undiscounted future cash flows, we then measure the asset’s fair value to determine whether an impairment loss should be recognized. If the resulting fair value is less than the carrying value, an impairment loss is recognized. For locations identified for closure or relocation, we generally base our estimates of fair market value on market appraisals of owned locations and estimates of the amount of potential sublease income and the time required to sublease for leased locations. For operating locations, we generally base our fair value estimates on future cash flow projections, as described above, and an appropriate discount rate to determine the present value of those future cash flows. Impairments of long-lived assets were not material to our consolidated financial statements in fiscal 2021, fiscal 2020 or fiscal 2019.

Uncertain Tax Positions

We are subject to income taxes in the United States and in multiple jurisdictions across our global operations. Thus, the determination of our provision for income taxes requires significant judgment, the use of estimates, and the interpretations and application of complex tax law. Our provision for income taxes could be affected by many factors, including changes in business operations, changes in tax law, outcomes of income tax audits, changes in our assessment of certain tax contingencies, the impact of discrete tax items, and the mix of earnings among our U.S. and foreign operations.

The calculation of our tax liabilities involves complexity and thus, there are many transactions and calculations for which the ultimate tax determination is uncertain. The assessment of uncertain tax positions requires the use of significant judgment in evaluating our tax positions and assessing the timing and amounts of deductible and taxable items. We record the benefits of uncertain tax positions in our financial statements only after determining a more likely than not probability that the uncertain tax positions will be sustained.

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Business Combinations

We account for business combinations using the acquisition method of accounting, which requires that once control is obtained, all the assets acquired and liabilities assumed are recorded at their respective fair values at the date of acquisition. The determination of fair values of identifiable assets and liabilities requires estimates and the use of valuation techniques when market value is not readily available and requires a significant amount of management judgment. For the valuation of intangible assets acquired in a business combination, we typically use an income approach. Significant estimates in valuing certain intangible assets include, but are not limited to, the amount and timing of future cash flows, growth rates, customer attrition rates, discount rates and useful lives. The excess of the purchase price over fair values of identifiable assets acquired and liabilities assumed is recorded as goodwill. During the measurement period, which is up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.

Additional Information

For information on accounting pronouncements that have impacted or are expected to materially impact our financial condition, results of operations, or cash flows, see Note 1 to our consolidated financial statements.