Why did earnings grow strongly when comparable-store sales were flat?

Growth came mainly from new store openings (203 in fiscal 2002) and a 120 basis point improvement in operating margin, which rose to 10.0% of sales. Gross margin improved to 31.1% from 30.2% due to centralized purchasing, rationalized vendor and SKU assortments, lower inventory shrink, and greater direct-import penetration. Operating expenses grew more slowly than gross profit as a share of sales, though selling and store operating expense rose to 19.2% of sales.

Why did operating cash flow decline in fiscal 2002?

Operating cash flow fell to $4.8 billion from $6.0 billion mainly because inventory increased to improve in-stock positions, with average inventory per store up 7.9%. This was partially offset by a jump in accounts payable, as days payable outstanding rose to 42 from 34 after the company moved payment terms closer to industry averages.

How much is Home Depot spending on capital expenditures and share buybacks going forward?

Fiscal 2002 capital expenditures were $2.7 billion, and fiscal 2003 capex is expected to be about $4.0 billion, reflecting higher spending on store remodeling, technology, and other initiatives. Share repurchases totaled $2 billion in fiscal 2002 under a program approved in July 2002. The filing does not state a specific repurchase target for fiscal 2003.

Is Home Depot's debt load a concern for investors?

On the reported balance sheet, debt is modest. Long-term debt was about $1.3 billion, with a long-term debt-to-equity ratio of 6.7%, against $2.3 billion in cash and short-term investments. Including the net present value of operating and off-balance-sheet leases, the ratio would be 28.5%. Those leases include three off-balance-sheet structured financing arrangements with $799 million in residual value guarantees.

What risks did management highlight that could affect future performance?

Management cited competition, sensitivity to the U.S. economy, store cannibalization (21% of existing stores affected, reducing comparable sales by about 4%), and execution risk around in-store initiatives such as SPI, which caused some out-of-stock positions in spring and early summer. The company also noted that expensing stock options starting in fiscal 2003 would reduce diluted EPS by roughly $0.02.

HD 10-K FY2003 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed April 21, 2003. Cited figures are marked; the original filing is the authoritative source.

The Home Depot's fiscal 2002 (52 weeks ended February 2, 2003) showed solid profitability growth despite flat comparable-store sales.

Net sales rose 8.8% to $58.2 billion^a, driven by 203 new stores opened during the year, while comparable-store sales were flat at 0%. Gross margin expanded 90 basis points to 31.1%, helped by centralized purchasing, lower shrink, and higher direct-import penetration (8% vs. 6%). Operating income grew 18.2% to $5.83 billion (10.0% of sales), and diluted EPS increased 20.9% to $1.56, with net earnings up 20.4% to $3.66 billion.

Weighted average weekly sales per store fell 4.9% to $772,000,^b reflecting cannibalization of about 21% of existing stores, which management estimates reduced comparable sales by roughly 4%. Cash flow and capital allocation shifted meaningfully. Operating cash flow declined to $4.8 billion from $6.0 billion, mainly because merchandise inventory rose 7.9% per store to improve in-stock positions.

The company offset part of this with stronger payables, with days payable outstanding rising to 42 from 34. Capital expenditures fell to $2.7 billion^c from $3.4 billion on timing shifts, and management guided fiscal 2003 capex to roughly $4.0 billion. The company also repurchased about 68.6 million shares for $2 billion under a July 2002 program, pushing financing outflows to $2.2 billion.

Balance sheet strength remains evident, with $2.3 billion^d in cash and short-term investments, total long-term debt of only about $1.3 billion, and a long-term debt-to-equity ratio of 6.7%, though this rises to 28.5% when operating and off-balance-sheet leases are capitalized. For investors, the key takeaways are margin-driven earnings growth achieved without comparable-sales growth, a planned step-up in fiscal 2003 investment, and rising sensitivity to inventory and working-capital management.

Management plans 206 new store openings in fiscal 2003 and expects the diluted EPS impact of expensing stock options to be about $0.02. Legal proceedings are not expected to be material.

02—Key points

Key Highlights

Net sales up 8.8% to $58.2 billion; 203 new stores opened, but comparable-store sales were flat (0%) and weekly sales per store fell 4.9% to $772,000.
Gross margin expanded to 31.1% from 30.2%, driven by centralized purchasing, lower shrink, and direct-import penetration rising to 8% from 6%.
Operating income rose 18.2% to $5.83 billion; net earnings grew 20.4% to $3.66 billion and diluted EPS rose 20.9% to $1.56.
Operating cash flow fell to $4.8 billion from $6.0 billion as inventory per store rose 7.9%; days payable outstanding increased to 42 from 34.
Capital expenditures declined to $2.7 billion from $3.4 billion, but fiscal 2003 capex is planned at about $4.0 billion with 206 planned store openings.
Repurchased about 68.6 million shares for $2 billion in fiscal 2002; year-end cash and short-term investments were $2.3 billion.
Long-term debt-to-equity is a modest 6.7%, but rises to 28.5% including capitalized operating and off-balance-sheet leases; about 21% of existing stores were cannibalized by new openings.

03—Questions

Frequently Asked Questions

Why did earnings grow strongly when comparable-store sales were flat?
Growth came mainly from new store openings (203 in fiscal 2002) and a 120 basis point improvement in operating margin, which rose to 10.0% of sales. Gross margin improved to 31.1% from 30.2% due to centralized purchasing, rationalized vendor and SKU assortments, lower inventory shrink, and greater direct-import penetration. Operating expenses grew more slowly than gross profit as a share of sales, though selling and store operating expense rose to 19.2% of sales.
Why did operating cash flow decline in fiscal 2002?
Operating cash flow fell to $4.8 billion from $6.0 billion mainly because inventory increased to improve in-stock positions, with average inventory per store up 7.9%. This was partially offset by a jump in accounts payable, as days payable outstanding rose to 42 from 34 after the company moved payment terms closer to industry averages.
How much is Home Depot spending on capital expenditures and share buybacks going forward?
Fiscal 2002 capital expenditures were $2.7 billion, and fiscal 2003 capex is expected to be about $4.0 billion, reflecting higher spending on store remodeling, technology, and other initiatives. Share repurchases totaled $2 billion in fiscal 2002 under a program approved in July 2002. The filing does not state a specific repurchase target for fiscal 2003.
Is Home Depot's debt load a concern for investors?
On the reported balance sheet, debt is modest. Long-term debt was about $1.3 billion, with a long-term debt-to-equity ratio of 6.7%, against $2.3 billion in cash and short-term investments. Including the net present value of operating and off-balance-sheet leases, the ratio would be 28.5%. Those leases include three off-balance-sheet structured financing arrangements with $799 million in residual value guarantees.
What risks did management highlight that could affect future performance?
Management cited competition, sensitivity to the U.S. economy, store cannibalization (21% of existing stores affected, reducing comparable sales by about 4%), and execution risk around in-store initiatives such as SPI, which caused some out-of-stock positions in spring and early summer. The company also noted that expensing stock options starting in fiscal 2003 would reduce diluted EPS by roughly $0.02.

04—Continue

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