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The growth is attributable to several factors. First, the Company opened 20 new stores
during 1985 and closed one store. Second, second-year sales increases were realized
366 Financial Analysis




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Financial Analysis




from the three new stores opened in 1984 and from the nine former Bowater Home Cen-
ter stores acquired during 1984. Third, comparable store sales increases of 2.3% were
achieved despite comparing the 52-week 1985 ¬scal year to the sales of the 53-week
1984 ¬scal year, due in part to the number of customer transactions increasing by 64%.
Finally, the weighted average weekly sales per operating store declined 6% in 1985 due
to the signi¬cant increase in the ratio of the number of new stores to total stores in opera-
tion”new stores have a lower sales rate than mature stores until they establish market
share.
Gross pro¬t in 1985 increased 59% from $114,319,000 to $181,457,000. This
increase was due to the increased sales and was partially offset by a reduction in the
gross pro¬t margin from 26.4% to 25.9%. The reduction is primarily due to lower mar-
gins achieved while establishing market presence in new markets.




The Home Depot
Cost and expenses increased 93% during 1985 and, as a percent of sales, increased
from 20.3% to 24.2%. The increase in selling and store operating, preopening expenses
and net interest expense is due to the opening of 20 new stores, the costs associated with
the former Bowater Home Center stores, and the related cost of building market share.
The large percentage of new stores which have lower sales but ¬xed occupancy and cer-
tain minimum operating expenses tends to cause the percentage of selling and store
operating costs to increase as a percentage of sales. The net gain on disposition of prop-
erty and equipment is discussed fully in note 7 to the ¬nancial statements.
Earnings before income taxes decreased 56% from $26,252,000 to $11,619,000
resulting from the increase in operating expenses to support the Company™s expansion
program. The Company™s effective income tax rate declined from 46.2% to 29.3% result-
ing from an increase in investment and other tax credits as a percentage of the total tax
provision. As a percentage of sales, earnings decreased from 3.3% in 1984 to 1.2% in
1985 due to the increase in operating expenses as discussed above.

Fiscal Year Ended February 3, 1985 Compared to January 29, 1984
Net sales in ¬scal 1984 increased 69% from $256,184,000 to $432,779,000. The
growth was attributable to several factors. First, the company opened three new stores
during ¬scal 1984. Second, the Company had sales of $9,755,000 from the nine former
Bowater Home Center stores acquired on December 3, 1984. Third, second-year sales
increases were realized from the nine stores opened during ¬scal 1983. Fourth, compa-
rable store sales increases of 14% were due in part to 53 weeks in ¬scal 1984 compared
to 52 weeks in ¬scal 1983 and in part to the number of customer transactions increasing
by 63%. Finally, excluding the sales of the former Bowater Home Center stores, the
weighted average weekly sales per operating store increased 6% to $383,500 in ¬scal
1984.
Gross pro¬t in ¬scal 1984 increased 63% from $70,014,000 to $114,319,000. This
net increase was due to the increased sales and was partially offset by a reduction in the
gross pro¬t margin from 27.3% to 26.4%. The reduction in the gross pro¬t percentage is
largely the result of the purchase of a high proportion of promoted merchandise by cus-
tomers in the second quarter.
Costs and expenses increased 73% during ¬scal 1984. As a percent of sales, costs and
expenses increased from 19.9% to 20.3% due to increased selling, store operating, gen-
eral and administrative expenses. This planned increase was in preparation of the
Company™s future expansion. Interest expense increased signi¬cantly as a result of the
367
Financial Analysis




9-51 Part 2 Business Analysis and Valuation Tools




issuance of substantial debt during ¬scal 1984 to fund the Company™s expansion. These
increases were partially offset by reduced preopening expenses and increased interest
income resulting from temporary investment of the proceeds of the debt ¬nancing.
Earnings before income taxes increased 38% from $18,986,000 to $26,252,000
resulting from the factors discussed above. Such pretax earnings, however, were reduced
by a loss from the Bowater stores of approximately $1,900,000 from date of acquisition
(December 1984) to year end. The Company™s effective income tax rate increased slightly
from 46.0% to 46.2% resulting principally from less investment and other tax credits as a
percentage of the total tax provision. As a percentage of sales, earnings decreased from
4.0% in ¬scal 1983 to 3.3% in ¬scal 1984. The decline is a result of the company™s
reduced gross pro¬t percentage and increases in the operating expenses discussed
above.
The Home Depot




Impact of In¬‚ation and Changing Prices
Although the Company cannot accurately determine the precise effect of in¬‚ation on its
operations, it does not believe in¬‚ation has had a material effect on sales or results of
operations. The Company has complied with the reporting requirements of the Financial
Accounting Standards Board Statement No. 33 in note 10 to the ¬nancial statements.
Due to the experimental techniques, subjective estimates and assumptions, and the
incomplete presentation required by this accounting pronouncement, the Company ques-
tions the value of the required reporting.

Liquidity and Capital Resources
Cash ¬‚ow generated from existing store operations provided the Company with a sig-
ni¬cant source of liquidity since sales are on a cash-and-carry basis. In addition, a signif-
icant portion of the Company™s inventory is ¬nanced under vendor credit terms. The
Company has supplemented its operating cash ¬‚ow from time to time with bank credit
and equity and debt ¬nancing. During ¬scal 1985, $88,000,000 of working capital was
provided by the revolving bank credit line, $4,400,000 from industrial revenue bonds,
and approximately $15,707,000 from operations. In addition, during ¬scal 1985, the
Company entered into a new credit agreement for a $200,000,000 revolving credit facil-
ity with a group of banks.
The Company has announced plans to open nine new stores during ¬scal 1986, two in
the new market of northern California and the balance in existing markets. The cost of
this store expansion program will depend upon, among other factors, the extent to which
the Company is able to lease second-use store space as opposed to acquiring leases or
sites and having stores constructed to its own speci¬cations. The Company estimates that
approximately $6,600,000 per store will be required to acquire sites and construct facili-
ties to the Company™s speci¬cations and that approximately $1,700,000 will be required
to open a store in leased space plus any additional costs of acquiring the lease. These
estimates include costs for site acquisition, construction expenditures, ¬xtures and equip-
ment, and in-store minicomputers and point-of-sale terminals. In addition, each new
store will require approximately $1,800,000 to ¬nance inventories, net of vendor ¬nan-
cing. The Company believes it has the ability to ¬nance these expenditures through exist-
ing cash resources, current bank lines of credit which include a $200,000,000 eight-year
revolving credit agreement, funds generated from operations, and other forms of ¬nan-
cing, including but not limited to various forms of real estate ¬nancing and unsecured
borrowings.
368 Financial Analysis




9-52
Financial Analysis




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies
Fiscal Year
The Company™s ¬scal year ends on the Sunday closest to the last day of January and
usually consists of 52 weeks. Every ¬ve or six years, however, there is a 53-week year. The
¬scal year ended February 2, 1986 (1985) consisted of 52 weeks, the year ended Febru-
ary 3, 1985 (1984) consisted of 53 weeks and the year ended January 29, 1984 (1983)
consisted of 52 weeks.

Principles of Consolidation




The Home Depot
The consolidated ¬nancial statements include the accounts of the Company and its
wholly owned subsidiary. All signi¬cant intercompany transactions have been eliminated
in consolidation. Certain reclassi¬cations were made to the 1984 balance sheet to con-
form to current year presentation.

Merchandise Inventories
Inventories are stated at the lower of cost (¬rst-in, ¬rst-out) or market, as determined by
the retail inventory method.

Depreciation and Amortization
The Company™s buildings, furniture, ¬xtures, and equipment are depreciated using the
straight-line method over the estimated useful lives of the assets. Improvements to leased
premises are amortized on the straight-line method over the life of the lease or the useful
life of the improvement, whichever is shorter.

Investment Tax Credit
Investment tax credits are recorded as a reduction of Federal income taxes in the year
the credits are realized.

Store Preopening Costs
Non-capital expenditures associated with opening new stores are charged to expense
as incurred.

Earnings Per Common and Common Equivalent Share
Earnings per common and common equivalent share are based on the weighted aver-
age number of shares and equivalents outstanding. Common equivalent shares used in
the calculation of earnings per share represent shares granted under the Company™s
employee stock option plan and employee stock purchase plan.
Shares issuable upon conversion of the 81„2% convertible subordinated debentures are
also common stock equivalents. Shares issuable upon conversion of the 9% convertible
subordinated debentures would only be included in the computation of fully diluted earn-
ings per share. However, neither shares issuable upon conversion of the 81„2% nor the 9%
convertible debentures were dilutive in any year presented, and thus neither were consid-
ered in the earnings per share computations.
369
Financial Analysis




9-53 Part 2 Business Analysis and Valuation Tools




2. Acquisition
On December 3, 1984 the Company acquired the outstanding capital stock of Bowater
Home Center, Inc. (Bowater) for approximately $38,420,000 including costs incurred in
connection with the acquisition. Bowater operated nine retail home center stores primarily
in the Dallas, Texas metropolitan area. The acquisition was accounted for by the purchase
method and, accordingly, results of operations have been included with those of the
Company from the date of acquisition. Cost in excess of the fair value of net assets
acquired amounted to approximately $25,291,000, which is being amortized over forty
years from date of acquisition using the straight-line method.

The following table summarizes, on a pro forma, unaudited basis, the estimated com-
The Home Depot




bined results of operations of the Company and Bowater for the years ended February 3,
1985 and January 29, 1984, as though the acquisition were made at the beginning of
¬scal year 1983. This pro forma information does not purport to be indicative of the
results of operations which would have actually been obtained if the acquisition had been
effective on the dates indicated.
Fiscal Year Ended
February 3, 1985 January 29, 1984*
(Unaudited)
Net sales $482,752,000 $274,660,000
Net earnings 9,009,000 6,913,000
Earnings per common and common
equivalent share .36 .28

*Includes the operations and pro forma adjustments from the date of inception of Bowater™s operations in August,
1983.



3. Long-Term Debt and Lines of Credit
Long-term debt consists of the following:
February 2, 1986 February 3, 1985
81„2% convertible subordinated debentures, due July 1, 2009,
convertible into shares of common stock of the Company at a
conversion price of $26.50 per share. The debentures are
redeemable by the Company at a premium from July 1, 1986
to July 1, 1995, will retire 70% of the issue prior to maturity.
Interest is payable semi-annually. $86,250,000 $86,250,000
9% convertible subordinated debentures, due December 15,
1999, convertible into shares of common stock of the Com-
pany at a conversion price of $16.90 per share. The deben-
tures are redeemable by the Company at a premium from
December 15, 1986 to December 15, 1994. An annual man-
datory sinking fund of $2,000,000 per year is required from
1994 to 1998. Interest is payable semi-annually. 14,000,000 14,000,000
Total convertible subordinated debentures 100,250,000 100,250,000
370 Financial Analysis




9-54
Financial Analysis




February 2, 1986 February 3, 1985
Revolving credit agreement. Interest may be ¬xed for any portion
outstanding for up to 180 days, at the Company™s option,
based on a CD rate plus 3„4%, the LIBOR rate plus 1„2% or at the
prime rate. 88,000,000 ”
*Variable Rate Industrial Revenue Bond (see note 7) 10,100,000 10,100,000
*Variable Rate Industrial Revenue Bond, secured by a letter of
credit, payable in sinking fund installments from December 1,

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