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 and Non-GAAP Measures

*    Liquidity and Capital Resources

*    Critical Accounting Policies

Executive Summary
Highlights of our annual financial performance follow:

Note: Fiscal 2019 and fiscal 2017 include 52 weeks. Fiscal 2018 includes 53 weeks.
We reported net sales of $110.2 billion in fiscal 2019 . Net earnings were $11.2 billion , or $10.25 per diluted share. We opened one net new store in Mexico and three net new stores in the U.S. during fiscal 2019 , for a total store count of 2,291 at February 2, 2020 . At the end of fiscal 2019 , a total of 307 of our stores, or 13.4% , were located in Canada and Mexico. Total sales per retail square foot were $454.82 in fiscal 2019 , and our inventory turnover ratio was 4.9 times at the end of fiscal 2019 .
We generated $13.7 billion of cash flow from operations during fiscal 2019 and issued $3.4 billion of long-term debt, net of discounts and premiums. These funds, together with cash on hand, were used to pay $6.0 billion of dividends, fund cash payments of $7.0 billion for share repurchases, repay $365 million of net short-term borrowings, fund $2.7 billion in capital expenditures, and repay $1.0 billion of senior notes that matured in June 2019.
During fiscal 2019 , we repurchased $7.0 billion of our common stock through open market transactions and an ASR agreement. In February 2020, we announced a 10% increase in our quarterly cash dividend to $1.50 per share.

The recent outbreak of the novel coronavirus COVID-19, which was declared a pandemic by the World Health Organization on March 11, 2020, has led to adverse impacts on the U.S. and global economies and created uncertainty regarding potential impacts to our supply chain, operations, and customer demand. The pandemic has impacted and could further impact our operations and the operations of our suppliers and vendors as a result of quarantines, facility closures, and travel and logistics restrictions. As a result of COVID-19, we have reduced store operating hours, expanded our paid time off policy for associates, and shifted certain store support operations to remote or virtual, and we may face additional labor-related costs. We are also taking steps in our stores to manage foot traffic to better protect our customers and associates. In addition, in certain jurisdictions, we have had to cease sales of or delay commencement of work on certain services deemed "non-life-sustaining."
We continue to actively monitor the situation and may take further actions that alter our operations as may be required by federal, state or local authorities or that we determine are in the best interests of our associates, customers, suppliers, vendors and shareholders. While the disruption is currently expected to be temporary, there is

uncertainty regarding its duration. Therefore, while we expect the pandemic to impact our business, results of operations, financial position, and liquidity, we cannot reasonably estimate the impact at this time.
Results of Operations and Non-GAAP Measures
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 displays the percentage relationship between net sales and major categories in our consolidated statements of earnings, as well as the percentage change in the associated dollar amounts:

Operating expenses:

Interest and other (income) expense:

Note: Fiscal 2019 and fiscal 2017 include 52 weeks. Fiscal 2018 includes 53 weeks. Certain percentages may not sum to totals due to rounding.

% Change

(1)    Fiscal 2019 compares the 52 week period in fiscal 2019 to weeks 2 through 53 in fiscal 2018. Fiscal 2018 calculations do not include results from the 53 rd week of fiscal 2018 and compare weeks 1 through 52 in fiscal 2018 to the 52 week period in fiscal 2017.

(2)    Comparable sales for fiscal 2017 do not include results for Interline.

(3)    The calculations do not include results for Interline.

(4)    The 53 rd week of fiscal 2018 increased customer transactions by 24.5 million, added $0.01 to average ticket, and increased sales per retail square foot by $6.87.

(5)    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.

(6)    Sales per retail square foot represents sales divided by the 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 as an indicator of the productivity of owned and leased square footage for retail operations.

Fiscal 2019 Compared to Fiscal 2018
Sales. We assess our sales performance by evaluating both net sales and comparable sales.
Net Sales . Fiscal 2019 consisted of 52 weeks compared to 53 weeks in fiscal 2018 . Net sales for fiscal 2019 increased $2.0 billion , or 1.9% , to $110.2 billion . The increase in net sales in fiscal 2019 primarily reflected the impact of positive comparable sales driven by an increase in comparable average ticket growth and comparable customer transactions, offset by $1.7 billion of net sales attributable to the additional week in fiscal 2018. Online sales, which consist of sales generated online through our websites for products picked up in our stores or delivered to customer locations, represented 9.3% of net sales and grew 19.4% during fiscal 2019 .
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 52 nd week of operation. Acquisitions, digital or otherwise, are included in comparable sales after they have been owned for more than 52 weeks. Our comparable sales results for fiscal 2019 compare the 52-week period reported for fiscal 2019 to weeks 2 through 53 in fiscal 2018. 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 3.5% in fiscal 2019 . The increase in comparable sales reflected a number of factors, including traffic growth across a number of our core categories and the execution of our strategic efforts to drive an enhanced interconnected experience in both the physical and digital worlds. All of our merchandising departments posted positive comparable sales in fiscal 2019 except for Lumber , which was negative primarily due to commodity price deflation. For fiscal 2019 , comparable sales for our Appliances, Indoor Garden, Decor/Storage, Tools, Hardware, and Outdoor Garden merchandising departments were above the Company average. Our comparable average ticket increased 2.5% in fiscal 2019 while comparable customer transactions increased 1.1% during fiscal 2019 . The increase in comparable average ticket was due in large part to strong sales in big ticket purchases in certain categories, such as appliances and vinyl plank flooring.
Gross Profit. Gross profit increased $412 million , or 1.1% , to $37.6 billion in fiscal 2019 . Gross profit as a percent of net sales, or gross profit margin, was 34.1% in fiscal 2019 compared to 34.3% in fiscal 2018 . The decrease in gross profit margin for fiscal 2019 was primarily driven by higher shrink and changes in product mix.
Operating Expenses. Our operating expenses are composed of SG&A, depreciation and amortization, and impairment loss.
Selling, General & Administrative . SG&A increased $227 million , or 1.2% , to $19.7 billion in fiscal 2019 . As a percent of net sales, SG&A was 17.9% for fiscal 2019 compared to 18.0% for fiscal 2018 . The decrease in SG&A as

a percent of net sales for fiscal 2019 was primarily driven by expense leverage resulting from positive comparable sales and continued expense control, partially offset by expenses related to strategic investments in the business.
Depreciation and Amortization . Depreciation and amortization increased $119 million , or 6.4% , in fiscal 2019 . As a percent of net sales, depreciation and amortization was 1.8% for fiscal 2019 compared to 1.7% in fiscal 2018 . The increase in depreciation and amortization as a percent of net sales reflects incremental depreciation stemming from investments in the business, partially offset by leverage resulting from positive comparable sales and timing of asset additions. The additional week in fiscal 2018 did not result in incremental expense because we recognize depreciation and amortization expense on a monthly basis.
Impairment Loss . There were no material impairment losses recognized in fiscal 2019 . We recognized a $247 million impairment loss in fiscal 2018 related to certain trade names associated with Interline. See Note 1 to our consolidated financial statements for further discussion.
Interest and Other, net. Interest and other, net, was $1.1 billion for fiscal 2019 compared to $974 million for fiscal 2018 . Interest and other, net, as a percent of net sales increased to 1.0% in fiscal 2019 from 0.9% in fiscal 2018 , primarily due to higher interest expense resulting from higher debt balances in fiscal 2019 .
Provision for Income Taxes. Our combined effective income tax rate was 23.6% for both fiscal 2019 and fiscal 2018 . The provision for income taxes in fiscal 2019 reflects a benefit from stock-based compensation and other discrete tax items. The effective income tax rate for fiscal 2018 primarily reflected the enactment of the Tax Act. See Note 5 to our consolidated financial statements for further discussion.
Diluted Earnings per Share. Diluted earnings per share were $10.25 for fiscal 2019 compared to $9.73 for fiscal 2018 . Diluted earnings per share for fiscal 2019 reflected a tax-related benefit of $0.17 per share resulting from stock-based compensation and other discrete tax items.
Diluted earnings per share for fiscal 2018 reflected a benefit of $1.48 per share resulting from the enactment of the Tax Act, a benefit of $0.21 per share for the 53 rd week, and a decrease of $0.16 per share due to the impairment loss related to certain trade names associated with Interline.
Fiscal 2018 Compared to Fiscal 2017
For a comparison of our results of operations for fiscal 2018 to fiscal 2017 , see " Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations " of our Form 10-K for the fiscal year ended February 3, 2019, filed with the SEC on March 28, 2019.

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

Note: Fiscal 2019 and fiscal 2017 include 52 weeks. Fiscal 2018 includes 53 weeks.

(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 has been adjusted to reflect an immaterial opening balance sheet adjustment due to the adoption of ASU No. 2016-02, Leases, in fiscal 2019.The beginning balance of equity for fiscal 2018 has been adjusted to reflect an opening balance sheet adjustment of $75 million due to the adoption of ASU No. 2014-09, Revenue from Contracts with Customers, in fiscal 2018.

Liquidity and Capital Resources
Cash and Cash Equivalents at End of Year
At February 2, 2020 , we had $2.1 billion in cash and cash equivalents, of which $1.8 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 for our operating requirements and to enable us to fund our capital expenditures, dividend payments, and any required long-term debt payments through the next several fiscal years. In addition, we believe we have the ability to obtain alternative sources of financing. We expect capital expenditures of approximately $2.8 billion in fiscal 2020. Given the current uncertainty related to the COVID-19 pandemic, we may adjust our capital expenditures as necessary or appropriate to support the operations of the business.
Debt and Derivatives
At February 2, 2020, we had commercial paper programs with an aggregate borrowing capacity of $3.0 billion . All of our short-term borrowings in fiscal 2019 and fiscal 2018 were under these commercial paper programs. In connection with these programs, we have back-up credit facilities with a consortium of banks for borrowings up to $3.0 billion , which consist of a five-year $2.0 billion credit facility, which expires in December 2022, and a 364-day

$1.0 billion credit facility. In December 2019, we completed the renewal of our 364-day $1.0 billion credit facility, extending the maturity from December 2019 to December 2020. At February 2, 2020 , we were in compliance with all of the covenants contained in the credit facilities, none of which are expected to impact our liquidity or capital resources. At February 2, 2020 , there were $974 million of borrowings outstanding under these commercial paper programs compared to $1.3 billion at February 3, 2019 .
In March 2020, we expanded our commercial paper programs from $3.0 billion to $6.0 billion. We also entered into an additional 364-day $3.5 billion credit facility in March 2020, which together with the two credit facilities mentioned above backs up our expanded commercial paper programs. We may enter into additional credit facilities or other debt financing.
We also issue senior notes from time to time and use derivative financial instruments in the management of our exposure to fluctuations in foreign currencies and interest rates on certain long-term debt. See Note 4 and Note 7 to our consolidated financial statements for further discussion of our debt and derivative agreements.
Leases
We use operating and finance leases to fund a portion of our real estate, including our stores, distribution centers, and store support centers. See Note 3 to our consolidated financial statements for further discussion of our operating and finance leases.
Share Repurchases
In February 2019, our Board of Directors authorized a new $15.0 billion share repurchase program, of which approximately $8.3 billion remained at the end of fiscal 2019 . During fiscal 2019 , we had cash payments of $7.0 billion for repurchases of our common stock through open market purchases and an ASR agreement. See Note 6 to our consolidated financial statements for further discussion of our share repurchases. In March 2020, we suspended our share repurchases until such time as we deem appropriate.
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, employee compensation, operations, and occupancy costs.
Cash provided by or used in operating activities is also subject to changes in working capital. Working capital at any specific 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 in fiscal 2019 was $13.7 billion driven primarily by net earnings of $11.2 billion and non-cash adjustments to net earnings of $2.7 billion, consisting of depreciation and amortization, stock-

based compensation expense and changes in deferred income taxes, offset by working capital outflows driven primarily by timing of inventory purchases and collection of receivables.
Net cash provided by operating activities in fiscal 2018 was $13.0 billion driven primarily by net earnings of $11.1 billion and non-cash adjustments to net earnings of $2.7 billion, consisting of depreciation and amortization, stock-based compensation, impairment loss and changes in deferred income taxes, partially offset by net cash outflows associated with changes in working capital driven primarily by timing of inventory purchases.
Investing Activities. Cash used in investing activities primarily reflected $2.7 billion and $2.4 billion of capital expenditures for investments in our business in fiscal 2019 and fiscal 2018 , respectively.
Financing Activities. Cash used in financing activities in fiscal 2019 primarily reflected $7.0 billion of share repurchases and $6.0 billion of cash dividends paid, partially offset by $2.0 billion of net proceeds from short- and long-term debt.
Cash used in financing activities in fiscal 2018 primarily reflected $10.0 billion of share repurchases and $4.7 billion of cash dividends paid, partially offset by $2.0 billion of net proceeds from short- and long-term debt.
Contractual Obligations
Our significant contractual obligations at February 2, 2020 were as follows:

Payments Due by Period

(1)    Excludes finance lease obligations.

(2)    Interest payments are calculated at current interest rates, including the impact of active interest rate swaps.

(3)    Includes finance and operating lease imputed interest of $608 million and $786 million , respectively.

(4)    Purchase obligations include all legally binding contracts such as firm commitments for inventory purchases, utility purchases, capital expenditures, software acquisitions and license commitments, and legally binding service contracts. Purchase orders that are not binding agreements are excluded from the table above.

(5)    Excludes $448 million of noncurrent unrecognized tax benefits due to uncertainty regarding the timing of future cash tax payments.

Off-Balance Sheet Arrangements
We have no material off-balance sheet arrangements.
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 substantial 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.
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 determined as a result of physical inventory counts during each fiscal period and estimated inventory losses which occur between physical inventory counts. The estimate for shrink in the interim period between physical inventory counts is calculated on a store-specific basis based on recent shrink results and current trends in the business. 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 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. 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. Impairments and lease obligation costs on closings and relocations were not material to our consolidated financial statements in fiscal 2019 , fiscal 2018 or fiscal 2017.
Self-Insurance
We have established liabilities for certain losses related to general liability (including product liability), workers' compensation, employee group medical, and automobile claims for which we are self-insured. Our self-insured retention or deductible, as applicable, for each claim involving general liability, workers' compensation, and automobile liability is limited to $25 million, $1 million, and $1 million, respectively. We have no stop loss limits for self-insured employee group medical claims. Our liabilities represent estimates of the ultimate cost for claims incurred at the balance sheet date. The estimated liabilities are not discounted and are established based upon analysis of historical data and actuarial estimates. The liabilities are reviewed by management and third-party actuaries to ensure that they are appropriate. While we believe these estimates are reasonable based on the information currently available, if actual trends, including the severity or frequency of claims, medical cost inflation or fluctuations in premiums, differ from our estimates, our results of operations could be impacted. Actual results related to these types of claims did not vary materially from estimated amounts for fiscal 2019 , fiscal 2018 or fiscal 2017.
Vendor Allowances
Vendor allowances primarily consist of volume rebates that are earned as a result of attaining certain purchase levels and co-op advertising allowances for the promotion of vendors' products that are typically based on

guaranteed minimum amounts with additional amounts being earned for attaining certain purchase levels. These vendor allowances are accrued as earned, with those allowances received as a result of attaining certain purchase levels accrued over the incentive period based on estimates of purchases. We believe that our estimate of vendor allowances earned based on expected volume of purchases over the incentive period is an accurate reflection of the ultimate allowance to be received from our vendors.
Volume rebates and certain co-op advertising allowances reduce the carrying cost of inventory and are recognized in cost of sales when the related inventory is sold. Certain other co-op advertising allowances that are reimbursements of specific, incremental and identifiable costs incurred to promote vendors' products are recorded as an offset against advertising expense in SG&A.
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 dealing with 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.
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.