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Item 7. Management’s Discussion and Analysis

2024-03-13 compared with 2023-03-15 · 60 added, 71 removed, 157 unchanged (45% of the section changed)

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The discussion in this Form 10-K generally focuses on fiscal 2023 compared to fiscal 2022.

A discussion of our results of operations and changes in financial condition for fiscal 2021 compared to fiscal 2020 has been excluded from this report, but can be found in Part II, Item 7.

A discussion of our results of operations and changes in financial condition for fiscal 2022 compared to fiscal 2021 has been omitted from this report, but can be found in Part II, Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Form 10-K for fiscal 2022.

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EXECUTIVE SUMMARY

The following table presents highlights of our annual financial results:

dollars in millions, except per share data Fiscal Fiscal Fiscal

2022 2021 2020

Net sales $ 157,403 $ 151,157 $ 132,110

Net earnings 17,105 16,433 12,866

Diluted earnings per share $ 16.69 $ 15.53 $ 11.94

Net cash provided by operating activities $ 14,615 $ 16,571 $ 18,839

Payments for businesses acquired, net — 421 7,780

Proceeds from long-term debt, net of discounts 6,942 2,979 7,933

Repayments of long-term debt 2,491 1,532 2,872

We reported net sales of $152.7 billion in fiscal 2023.

Net earnings were $15.1 billion, or $15.11 per diluted share.

During fiscal 2022, we opened two new stores in the U.S.

and four new stores in Mexico, and we lost one store in the U.S.

due to a fire, resulting in a total store count of 2,322 at January 29, 2023.

During fiscal 2023, we opened eight new stores in the U.S.

and five new stores in Mexico, resulting in a total store count of 2,335 at January 28, 2024.

At the end of fiscal 2023, a total of 320 of our stores, or 13.7% of our total store count, were located in Canada and Mexico.

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Our inventory turnover ratio was 4.3 times at the end of fiscal 2023, compared to 4.2 times at the end of fiscal 2022.

The decrease in our inventory turnover ratio was driven by an increase in average inventory levels during fiscal 2022 resulting from strategic investments to promote higher in-stock levels and pull forward merchandise in response to ongoing global supply chain disruption, as well as continued investment in our new supply chain facilities and carryover of some spring seasonal inventory.

We generated $21.2 billion of cash flow from operations and issued $2.0 billion of long-term debt, net of discounts, during fiscal 2023.

This cash flow, together with cash on hand, was used to fund cash payments of $8.4 billion for dividends and $8.0 billion for share repurchases.

In addition, we repaid $2.5 billion of long-term debt and $1.0 billion of net short-term debt and funded $3.1 billion in capital expenditures during fiscal 2022.

In addition, we invested $3.2 billion in capital expenditures and $1.5 billion in acquisitions, and we repaid $1.3 billion of long-term debt during fiscal 2023.

In February 2024, we announced a 7.7% increase in our quarterly cash dividend to $2.25 per share.

Our ROIC was 36.7% for fiscal 2023 and 44.6% for fiscal 2022.

The decrease in ROIC was primarily driven by lower operating income along with an increase in average long-term debt over the respective periods.

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).

Fiscal 2022 Form 10-K 26

RESULTS OF OPERATIONS

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Diluted earnings per share $15.11 $16.69 $15.53 (9.5) % 7.5 %

(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.

Fiscal 2023 Form 10-K

(1) Does not include results for HD Supply.

(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.

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

Net sales for fiscal 2022 increased $6.2 billion, or 4.1%, to $157.4 billion .

The increase in net s ales for fiscal 2022 primarily reflected the impact of positive comparable sales driven by an increase in comparable average ticket, partially offset by a decrease in comparable customer transactions.

A stronger U.S.

dollar negatively impacted net sales by $339 million in fiscal 2022.

Fiscal 2022 Form 10-K 27

Online sales, which consist of sales generated online through our websites and mobile applications for products picked up at our stores or delivered to customer locations, represented 14.2% of net sales and grew by 7.4% during fiscal 2022 compared to fiscal 2021.

The increase in online sales in fiscal 2022 was a result of customers continuing to leverage our digital platforms and reflects our ongoing investments to enhance these platforms and related fulfillment capabilities, which support our interconnected retail strategy.

Net sales for fiscal 2023 decreased $4.7 billion, or 3.0%, to $152.7 billion.

The decrease in net s ales for fiscal 2023 primarily reflects the impact of a negative comparable sales environment, primarily driven by a decrease in comparable customer transactions as well as the impact from lumber price deflation.

Online sales, which consist of sales generated online through our websites and mobile applications for products picked up at our stores or delivered to customer locations, represented 14.8% of net sales and increased by 1.1% during fiscal 2023 compared to fiscal 2022.

A weaker U.S.

dollar positively impacted net sales by $276 million in fiscal 2023.

Comparable Sales.

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Comparable sales is intended only as supplemental information and is not a substitute for net sales presented in accordance with GAAP.

Total comparab le sales increased 3.1% in fiscal 2022, reflecting an 8.8% increase in com parable average ticket, partially offset by a 5.4% decrease in comparable customer transactions compared to fiscal 2021.

The increase in comparable average ticket was primarily driven by inflation, as well as demand for new and innovative products.

The decrease in comparable customer transactions reflects the impact of macroeconomic factors during fiscal 2022, including indications of price sensitivity to the broader inflationary environment and a gradual shift in consumer spending from goods back to services, resulting in transactions trending towards fiscal 2019, pre-COVID-19 pandemic levels.

For fiscal 2022, 10 of our 14 merchandising departments posted positive comparable sales, led by Building Materials, P lumbing, Millwork, Paint, Hardware, and Kitchen and Bath, which posted comparable sales above the Company average.

Our Indoor Garden, Outdoor Garden, Appliances, and Flooring departments posted negative comparable sales.

Gross profit increased $1.9 billion, or 3.8%, to $52.8 billion in fiscal 2022.

Total comparable sales decreased 3.2% in fiscal 2023, reflecting a 2.9% decrease in comparable customer transactions and a 0.3% decrease in com parable average ticket compared to fiscal 2022.

The decrease in comparable customer transactions reflects the impact of macroeconomic factors, including the continued shift in consumer consumption trends away from goods and towards services and the impact of a higher interest rate environment, pressuring home improvement demand.

The decrease in comparable average ticket reflects U.S.

commodity price deflation, which negatively impacted average ticket by approximately 145 basis points, driven primarily by lumber.

This was partially offset by inflation across several product categories, which slowed relative to prior years, along with demand for new and innovative products.

For fiscal 2023, four of our 14 merchandising departments—Building Materials, Outdoor Garden, Hardware, and Plumbing—posted positive comparable sales compared to fiscal 2022.

All of our other merchandising departments posted negative comparable sales during fiscal 2023 compared to fiscal 2022, with our Lumber department posting a double-digit comparable sales decline primarily resulting from lumber price deflation, partially offset by higher unit sales.

Gross profit decreased $1.8 billion, or 3.4%, to $51.0 billion in fiscal 2023.

Gross profit as a percent of net sales, or gross profit margin, was 33.4% in fiscal 2023 compared to 33.5% in fiscal 2022.

The decrease in gross profit margin was primarily driven by higher product and transportation costs, pressure from shrink during the second half of the year, and investments in our supply chain network, offset by the benefit from higher retail prices, along with favorable product mix.

The decrease in gross profit margin primarily reflects price stabilization as well as reduction and optimization of our inventory position, partially offset by lower supply chain costs.

While we continue to experience shrink above historical averages, year-over-year pressure to gross profit margin from shrink decreased as we moved through fiscal 2023.

As a result, shrink did not have a significant impact on our gross profit margin in fiscal 2023 compared to fiscal 2022.

Operating Expenses

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

Fiscal 2023 Form 10-K

Selling, General & Administrative.

SG&A increased $314 million, or 1.2%, to $26.6 billion in fiscal 2023.

As a percent of net sales, SG&A was 16.7% in fiscal 2022 compared to 16.8% in fiscal 2021, primarily reflecting leverage from a positive comparable sales environment and lower incentive compensation, partially offset by wage investments for hourly associates and increased operational costs, including planned investmen ts designed to drive efficiencies in our stores .

As a percent of net sales, SG&A was 17.4% in fiscal 2023 compared to 16.7% in fiscal 2022, primarily reflecting deleverage from a negative comparable sales environment along with previously executed wage investments for hourly associates, partially offset by the one-time benefit from the favorable settlement of litigation with a vendor as well as lower incentive compensation.

Depreciation and Amortization.

Depreciation and amortiz ation increased $69 million, or 2.9%, to $2.5 billion in fiscal 2022.

As a percent of net sales, depreciation and amortization was 1.6% in both fiscal 2022 and fiscal 2021 , reflecting leverage from a positive comparable sales environment, offset by increased depreciation expense from strategic investments in the business.

Depreciation and amortiz ati on increased $218 million, or 8.9%, to $2.7 billion in fiscal 2023.

As a percent of net sales, depreciation and amortization was 1.8% in fiscal 2023 compared to 1.6% in fiscal 2022 , primarily reflecting increased depreciation expense from ongoing investments in the business and deleverage from a negative comparable sales environment.

Interest and Other, net

Interest and other, net increased $203 million, or 13.0%, to $1.8 billion in fiscal 2023.

As a percent of net sales, interest and other, net, was 1.0% in fiscal 2022 compared to 0.9% in fiscal 2021 , primarily reflecting higher interest expense due to higher debt balances and increased variable rate interest on floating rate debt resulting from interest rate swaps, partially offset by leverage from a positive comparable sales environment.

As a percent of net sales, interest and other, net, was 1.2% in fiscal 2023 compared to 1.0% in fiscal 2022 , primarily due to increased variable rate interest on floating-rate debt resulting from interest rate swaps, higher average debt balances, and deleverage from a negative comparable sales environment, partially offset by higher interest income.

Provision for Income Taxes

Our combined effective income tax rate was 24.0% in fiscal 2023 compared to 23.9% in fiscal 2022.

The decrease in our effective income tax rate in fiscal 2022 was driven by certain discrete tax benefits recognized in fiscal 2022.

Fiscal 2022 Form 10-K 28

Diluted Earnings per Share

Diluted earnings per share were $15.11 in fiscal 2023 compared to $16.69 in fiscal 2022.

The increase in diluted earnings per share for fiscal 2022 was primarily driven by higher net earnings during fiscal 2022, as well as lower diluted shares due to share repurchases.

The decrease in diluted earnings per share for fiscal 2023 was primarily driven by lower net earnings during fiscal 2023, partially offset by lower diluted shares due to share repurchases.

NON-GAAP FINANCIAL MEASURES

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

Fiscal 2023 Form 10-K

LIQUIDITY AND CAPITAL RESOURCES

At January 29, 2023, we had $2.8 billion in cash and cash equivalents, of which $825 million was held by our foreign subsidiaries.

At January 28, 2024, we had $3.8 billion in cash and cash equivalents, of which $1.0 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 program, and access to the long-term debt capital markets should be sufficient not only for our operating requirements, any required debt payments, and satisfaction of other contractual obligations, but also to enable us to invest in the business, fund dividend payments, and fund any share repurchases through the next several fiscal years.

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This approach first prioritizes investing in the business, followed by paying dividends, with the intent of then returning excess cash to shareholders in the form of share repurchases.

For fiscal 2023, 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.

During fiscal 2023, we invested approximately $3.2 billion back into our business in the form of capital expenditures.

Additionally, we invested approximately $1.5 billion on three acquisitions during fiscal 2023, accelerating our strategic initiatives and providing us with better capabilities to serve our customers.

For fiscal 2024, in line with our expectation of approximately two percent of net sales on an annual basis, we plan to invest approximately $3.0 billion to $3.5 billion back into our business in the form of capital expenditures, with investments focused on new stores and improving the customer experience, including through technology and development of other differentiated capabilities.

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.

Capital expenditures were $3.1 billion in fiscal 2022.

Fiscal 2022 Form 10-K 29

During fiscal 2023, we paid cash dividends of $8.4 billion to shareholders.

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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.

In August 2022, our Board of Directors approved a $15.0 billion share repurchase authorization that replaced the previous authorization of $20.0 billion, which was approved in May 2021.

This new authorization does not have a prescribed expiration date.

In August 2023, our Board of Directors approved a $15.0 billion share repurchase authorization that replaced the previous authorization of $15.0 billion, which was approved in August 2022.

The August 2023 authorization does not have a prescribed expiration date.

As of January 28, 2024, approximately $12.3 billion of the $15.0 billion share repurchase authorization remained available.

During fiscal 2023, we had cash payments of $8.0 billion for repurchases of our common stock through open market purchases.

In July 2022, we expanded our commercial paper program from $3.0 billion to $5.0 billion to further enhance our financial flexibility.

All of our short-term borrowings in fiscal 2022 were under our commercial paper program, and the maximum amount outstanding at any time was $2.7 billion.

In connection with our program, we have back-up credit facilities with a consortium of banks.

In July 2022, we also expanded the borrowing capacity under these back-up facilities from $3.0 billion to $5.0 billion by entering into a five-year $3.5 billion credit facility scheduled to expire in July 2027 and a 364-day $1.5 billion credit facility scheduled to expire in July 2023.

These facilities replaced our previously existing five-year $2.0 billion credit facility, which was scheduled to expire in December 2023, and our 364-day $1.0 billion credit facility, which was scheduled to expire in December 2022.

At January 29, 2023, there were no borrowings outstanding under our commercial paper program, 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 have a commercial paper program that allows for borrowings up to $5.0 billion.

In connection with our program, we have back-up credit facilities with a consortium of banks for borrowings up to $5.0 billion, which consist of a five-year $3.5 billion credit facility scheduled to expire in July 2027 and a 364-day $1.5 billion credit facility scheduled to expire in July 2024.

In July 2023, we completed the renewal of our 364-day $1.5 billion credit facility, extending the maturity from July 2023 to July 2024.

All of our short-term borrowings during fiscal 2023 were under our commercial paper program, and the maximum amount outstanding at any time was $1.5 billion.

At January 28, 2024, we had no outstanding borrowings under this program, 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 March 2022, we issued $4.0 billion of senior notes.

The net proceeds from this issuance were used for general corporate purposes, including repayment of outstanding indebtedness and repurchases of shares of our common stock.

In September 2022, we issued an additional $3.0 billion of senior notes.

The net proceeds from this issuance were used for general corporate purposes, including repurchases of shares of our common stock.

During fiscal 2022, we repaid $2.25 billion of senior notes.

In November 2023, we issued $2.0 billion of senior notes.

The net proceeds were used for general corporate purposes, including the repayment of our 3.75% senior notes due February 15, 2024 and repurchases of shares of our common stock.

In April 2023, we repaid $1.0 billion of senior notes at maturity.

At January 28, 2024, we had an aggregate principal amount of senior notes outstanding of $42.2 billion, with $1.1 billion payable within 12 months.

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See Note 5 to our consolidated financial statements for further discussion of our debt arrangements.

We use operating and finance leases largely to fund a portion of our real estate, including our stores, distribution centers, and store support centers.

At January 29, 2023, we had aggregate lease obligations of $14.7 billion, with $1.5 billion payable within 12 months.

Aggregate lease obligations include $2.1 billion of obligations related to leases not yet commenced.

Fiscal 2023 Form 10-K

We use operating and finance leases largely to obtain a portion of our real estate, including our stores, distribution centers, and store support centers.

At January 28, 2024, we had aggregate remaining lease payment obligations of $14.6 billion, with $1.7 billion payable within 12 months.

Aggregate lease obligations include approximately $450 million 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.

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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 29, 2023, we had aggregate purchase obligations of $1.8 billion, with $947 million payable within 12 months.

At January 29, 2023, we had aggregate liabilities for unrecognized tax benefits totaling $643 million, none of which are expected to be paid in the next 12 months.

At January 28, 2024, we had aggregate purchase obligations of $2.5 billion, with $1.0 billion paya ble within 12 months.

At January 28, 2024, we had aggregate liabilities for unrecognized tax benefits totaling $689 million, of which approximately $25 million 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.

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We have no material off-balance sheet arrangements.

Fiscal 2022 Form 10-K 30

CASH FLOWS SUMMARY

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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 $2.0 billion in fiscal 2022 compared to fiscal 2021, primarily driven by changes in working capital, slightly offset by an increase in net earnings.

Changes in working capital were driven by inventory management actions and the related timing of vendor payments.

These inventory management actions, which began in fiscal 2021 and moderated during the second half of fiscal 2022, reflect strategic investments in inventory to support the demand environment, promote higher in-stock levels, and pull forward merchandise for seasonal events in response to global supply chain disruption, as well as investments in our new supply chain facilities.

Net cash provided by operating activities increased by $6.6 billion in fiscal 2023 compared to fiscal 2022, primarily driven by changes in working capital, partially offset by a decrease in net earnings.

Changes in working capital were primarily driven by lower inventory purchases in fiscal 2023 relative to fiscal 2022, as well as timing of vendor payments.

Inventory levels normalized in fiscal 2023 as we adjusted purchasing activity to align with demand and continued to sell through existing inventory.

Fiscal 2023 Form 10-K

Investing Activities

Cash used in investing activities increased by $171 million in fiscal 2022 compared to fiscal 2021, primarily resulting from increased capital expenditures, partially offset by cash paid for an acquired business during fiscal 2021.

Net cash used in investing activities increased by $1.6 billion in fiscal 2023 compared to fiscal 2022, primarily resulting from cash paid for acquired businesses as well as increased capital expenditures primarily due to investments in new store growth.

See Note 1 3 to our consolidated financial statements for further discussion of acquisitions.

Financing Activities

Net cash used in financing activities in fiscal 2023 primarily reflected $8.4 billion of cash dividends paid, $8.0 billion of share repurchases, and $1.3 billion of repayments of long-term debt, partially offset by $2.0 billion of net proceeds from long-term debt.

Cash used in financing activities in fiscal 2022 primarily reflected $7.8 billion of cash dividends paid, $6.7 billion of share repurchases, $2.5 billion of repayments of long-term debt, and $1.0 billion of net repayments of short-term debt, partially offset by $6.9 billion of net proceeds from long-term debt.

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.

Fiscal 2021 reflected elevated share repurchase activity following the temporary suspension of repurchases during fiscal 2020 in order to enhance our liquidity position at the onset of the COVID-19 pandemic.

Fiscal 2022 Form 10-K 31

CRITICAL ACCOUNTING ESTIMATES

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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.

We value the majority of our inventory under the retail inventory method, with the remainder of our inventories valued under a cost method, primarily the first-in, first-out 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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Historically, the difference between estimated shrink and actual inventory losses has not been material to our annual financial results.

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 do not believe there is a reasonable likelihood of 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.

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For information on our accounting policies and 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.

Fiscal 2023 Form 10-K

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis