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Financial Analysis

9-41 Part 2 Business Analysis and Valuation Tools

The Home Depot, Inc.”Abridged Annual Report for Fiscal Year 1985

A Letter to Our Shareholders:
Fiscal 1985 was a year of rapid expansion and con- ber, The Home Depot replaced a prior $100 million
tinued growth for The Home Depot. Feeling the time bank credit line with an eight-year decreasing
was ripe for us to enhance our share of the do-it- revolving credit agreement of $200 million. In addi-
yourself market, we seized the opportunity to make tion, we are pursuing sale-and-leaseback negotia-
a signi¬cant investment in our long-term future. At tions for an aggregate of approximately $50 million
the same time, we recognized that our short-term for ten of our stores. These sources of additional
The Home Depot

pro¬t growth would be affected. funds, along with internally generated cash ¬‚ow, will
provide us with an ample ¬nancial foundation to
The Home Depot intends to be the dominant factor
continue to underwrite our growth over the next sev-
in every market we serve. The key to our success has
eral years.
been that upon entering a new market, we make a
substantial commitment”opening multiple stores, We are also quite proud that The Home Depot
providing excellent customer service, creating highly achieved its substantial gain in sales and market
visible promotions, and growing the entire market. share in what turned out to be a very dif¬cult year
We turn the novice into a do-it-yourselfer and for our industry and retailing in general. The do-it-
enable the expert to do more for less money. yourself “warehouse” industry, which we pioneered
only a few short years ago, has recently attracted
From shortly before the end of ¬scal 1984 to the
many competitors, some of whom have already
close of ¬scal 1985, The Home Depot entered eight
fallen by the wayside, having mistaken our dramatic
new markets”Dallas, Houston, Jacksonville, San
success as a path towards easy pro¬ts. Now the
Diego, Los Angeles, Shreveport, Baton Rouge and
industry is faced with a situation when only the
Mobile”in a period of approximately 13 months. In
strongest and most capable will survive. As this pro-
that time, the number of Home Depot stores rose
cess continues, we expect to encounter additional
dramatically, from 22 to 50, including 9 stores
cost competition in the ¬ght for market dominance.
acquired in the Bowater acquisition which had not
However, with our strengths”both ¬nancial and our
been in our original plan. Twenty of these stores
successful ability to develop a loyal customer base”
were opened during the past ¬scal year alone. Dur-
we are con¬dent that The Home Depot will emerge
ing this time span, we have become the only
an even stronger company.
national warehouse retailing chain serving markets
across the Sunbelt. We have never doubted The Home Depot™s ability to
be a leader in our business. We have the market
This expansion program required a tremendous
dominance, the superior retailing concepts and the
investment of capital expenditures and inventory, as
necessary foundation of experienced management.
well as in personnel. As a result, our net earnings
Further, we have the determination to maintain our
declined from record levels achieved during the pre-
vious ¬scal year. In ¬scal 1985, The Home Depot
earned $8,219,000, or $.33 per share, as com- Looking at some of our markets individually, clearly
pared with $14,122,000, or $.56 per share, in ¬s- our most dif¬cult environment has been in Houston,
cal 1984. However, as The Home Depot engaged where the oil-related economy is undergoing painful
in this major thrust forward, it also increased its contractions combined with particularly ¬erce indus-
market share and market presence as revenues try competition. This has caused our newly-opened
rose 62% from $432,779,000 in ¬scal 1984 to stores to operate at a sub par level. In Dallas/Fort
$700,729,000 in ¬scal 1985. Worth, the stores we acquired at the end of ¬scal
Despite our signi¬cant investments, we still continue 1984 have not yet generated the pro¬ts we expect.
to be in a very strong ¬nancial condition. In Decem- Such dif¬cult market conditions demand a ¬‚exible
358 Financial Analysis

Financial Analysis

reaction both in merchandising and operations. When we open stores in existing markets, sharing
Recognizing the future potential of both of these advertising costs and operational expenses, we
markets, our management team is addressing the achieve a faster return than stores in new markets.
issues and feels con¬dent that the ¬nal outcome will With this in mind, in January 1986, we withdrew
be positive. from the Detroit market and delayed the opening of
stores in San Francisco. These stores were targeted
In the other markets entered this year, the situation
for a substantial initial loss in earnings that would
has been considerably more positive. There, our
have been necessary to achieve market dominance.
stores are experiencing growth much closer to our
From our standpoint, these new markets would have
historical patterns.
had the combined effect of diluting our personnel
In support of our California and Arizona operations, and negatively affecting our earnings.
a West Coast division was inaugurated to facilitate a
It has always been Home Depot™s philosophy to

The Home Depot
timely response to the demands of that marketplace.
maintain orderly growth and achieve market domi-
With management personnel in place, this division
nance as we expand to new markets. Indeed,
is now responsible for the merchandising and oper-
growth for growth™s sake has never been and never
ations of all stores in the western states.
will be our objective. We intend to invest prudently
Other highlights of the past year™s activities include and expand aggressively in our business and our
the progress we have made in expanding our man- markets only when such expenditures meet our crite-
agement team, and the computer systems we ria for long-term pro¬tability.
installed into our operations to enhance our ef¬-
We are quite optimistic about our company™s
future”both for ¬scal 1986 and for the years to fol-
During the year, we completed the store price look- low. Essential to this optimism is the fact that The
up phase of our management information system. Home Depot has consistently proven that we can
This facilitates tracking individual items™ sales grow the market in every geographical area we
through our registers, resulting in a more concise enter. Simply, this means that we do not have to take
method of inventory reorder and margin manage- business away from hardware stores and other exist-
ment with the information now available. ing home-improvement outlets, but rather, to create
new do-it-yourselfers out of those who have never
During the coming year we will be testing a perpet-
done their own home improvements.
ual inventory tie-in with our price look-up system,
eliminating pricing of our merchandise at the store Our philosophy is to educate our customers on how
level. The latter is being tested in several stores pres- to be do-it-yourselfers. Our customers have come to
ently and hopefully will be expanded to include all expect The Home Depot™s knowledgeable sales staff
of our stores by year end. This will have a signi¬cant to guide them through any project they care to
effect on labor productivity at the store level. undertake, whether it be installing kitchen cabinets,
constructing a deck, or building an entire house.
The Home Depot is always looking for ways in which
Our sales staff knows how to complete each project,
to do things better, priding ourselves on our ¬‚exibil-
what tools and material to include, and how to sell
ity and ability to innovate and to react to changing
our customers everything they need.
conditions. Whether it is a matter of developing
state-of-the-art computer systems, reevaluating our The Home Depot traditionally holds clinics for its
store layouts or adapting to fast-changing markets customers in such skills as electrical wiring, carpen-
and new types of merchandising, ¬‚exibility has try, and plumbing, to name a few. Upon the success-
always been a Home Depot characteristic. ful completion of such clinics, our customers are
con¬dent in themselves and in The Home Depot.
In ¬scal 1986, The Home Depot will continue to
This con¬dence allows them to attempt increasingly
expand, but at a much more moderate pace. We
advanced and complex home improvements.
plan to open nine new stores. These stores will be in
existing markets except for two locations in the new Concerning our facilities, Home Depot™s warehouse
market of San Jose, California. retailing concept allows us to carry a truly fantastic
Financial Analysis

9-43 Part 2 Business Analysis and Valuation Tools

selection of merchandise and offer it at the lowest value of their homes. We at The Home Depot have
possible prices. Each of our stores ranges from found that by successfully delivering this message,
about 65,000 to over 100,000 square feet of selling we have created loyal and satis¬ed customers. And
space, with an additional 4,000 to 10,000 square by maintaining leadership in our markets, we have
feet of outdoor selling area. In these large stores, we established a sound basis on which to build a future
are able to stock all the materials and tools needed of growth with pro¬tability.
to build a house from scratch, and to landscape its The Home Depot management and staff are dedi-
grounds. With each store functioning as its own cated to the proposition that we are”and will
warehouse, with a capacity of over 25,000 different remain”America™s leading do-it-yourself retailer.
items, we are able to keep our prices at a minimum
while providing the greatest selection of building Bernard Marcus
materials and name brand merchandise. Chairman and
The Home Depot

Chief Executive Of¬cer
For the majority of Americans, their home is their
most valuable asset. It is an asset that consistently
appreciates. It is also an asset in need of ongoing Arthur M. Blank
care and maintenance. By becoming do-it-yourself- President and
ers, homeowners can signi¬cantly enhance the Chief Operating Of¬cer
360 Financial Analysis

Financial Analysis


Fiscal Year Ended
February 2, 1986 February 3, 1985 January 29, 1984
(52 weeks) (53 weeks) (52 weeks)

Net Sales (note 2) $700,729,000 $432,779,000 $256,184,000
Cost of Merchandise Sold 519,272,000 318,460,000 186,170,000
Gross Pro¬t 181,457,000 114,319,000 70,014,000
Operating Expenses:
Selling and store operating expenses 134,354,000 74,447,000 43,514,000

The Home Depot
Preopening expenses 7,521,000 1,917,000 2,456,000
General and administrative expenses 20,555,000 12,817,000 7,376,000
Total Operating Expenses 162,430,000 89,181,000 53,346,000
Operating Income 19,027,000 25,138,000 16,668,000
Other Income (Expense):
Net gain on disposition of property and
equipment (note 7) 1,317,000 ” ”
Interest income 1,481,000 5,236,000 2,422,000
Interest expense (note 3) (10,206,000) (4,122,000) (104,000)
(7,408,000) 1,114,000 2,318,000
Earnings Before Income Taxes 11,619,000 26,252,000 18,986,000
Income Taxes (note 4) 3,400,000 12,130,000 8,725,000
Net Earnings $ 8,219,000 $ 14,122,000 $ 10,261,000

Earnings per Common and Common
Equivalent Share (note 5) $ .33 $ .56 $ .41

Weighted Average Number of Common
and Common Equivalent Shares 25,247,000 25,302,000 24,834,000
Financial Analysis

9-45 Part 2 Business Analysis and Valuation Tools

February 3, 1985
February 2, 1986

Current Assets:
Cash, including time deposits of $43,374,000 in 1985 $ 9,671,000 $ 52,062,000
Accounts receivable, net (note 7) 21,505,000 9,365,000
Refundable income taxes 3,659,000 ”
Merchandise inventories 152,700,000 84,046,000
Prepaid expenses 2,526,000 1,939,000
Total current assets 190,061,000 147,412,000
The Home Depot


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