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

•	Liquidity and Capital Resources

•	Critical Accounting Policies

Executive Summary

Highlights of our annual financial performance follow.

dollars in millions, except per share data	Fiscal				Fiscal				Fiscal
2017				2016				2015
Net sales	$	100,904			$	94,595			$	88,519
Net earnings	8,630				7,957				7,009
Diluted earnings per share	7.29				6.45				5.46
Net cash provided by operating activities	$	12,031			$	9,783			$	9,373
Proceeds from long-term debt, net of discounts	2,991				4,959				3,991
Repayments of long-term debt	543				3,045				39
Repurchases of common stock	8,000				6,880				7,000

We reported net sales of $100.9 billion in fiscal 2017. Net earnings were $8.6 billion, or $7.29 per diluted share, and reflected the following:

•

In the third quarter of fiscal 2017, three hurricanes impacted our operations in the continental U.S., Puerto Rico, and the U.S. Virgin Islands. Hurricane-related sales contributed approximately $662 million to net sales in the second half of fiscal 2017. The gross profit on these hurricane-related sales was considerably less than the Company average. We also incurred approximately $170 million of hurricane-related expenses in the second half of fiscal 2017.

•	In the fourth quarter of fiscal 2017, we paid a one-time cash bonus to our U.S. hourly associates, which negatively impacted net earnings by $72 million and reduced diluted earnings per share by approximately $0.06.

•

On December 22, 2017, the U.S. government enacted the Tax Act, which included a reduction in the U.S. federal statutory tax rate from 35% to 21% and a transition to a modified territorial system. As a result of the enactment of the Tax Act, we recorded a net $127 million charge in the fourth quarter of fiscal 2017. This charge resulted in a $0.11 reduction to diluted earnings per share in fiscal 2017 (see Note 5 to the Consolidated Financial Statements for further discussion).

•	Results for fiscal 2017 also reflected a benefit of $106 million to our provision for income taxes for share-based payment awards resulting from the adoption of ASU No. 2016-09, "Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" in the first quarter of fiscal 2017. This benefit contributed $0.09 to diluted earnings per share in fiscal 2017.

We opened three new stores in the U.S. and three new stores in Mexico during fiscal 2017, for a total store count of 2,284 at January 28, 2018. At the end of fiscal 2017, a total of 304 of our stores, or 13.3%, were located in Canada and Mexico. Total sales per square foot were $417.02 in fiscal 2017, and our inventory turnover ratio was 5.1 times at the end of fiscal 2017.

In February 2017, our Board of Directors increased our targeted dividend payout ratio to 55% of prior-year diluted earnings per share. Also in February 2017, our Board of Directors authorized a $15.0 billion share repurchase program that replaced the previous authorization. In December 2017, our Board of Directors authorized a new $15.0 billion share repurchase program that replaced the February 2017 authorization. During fiscal 2017, we repurchased a total of 49.5 million shares of our common stock for $8.0 billion through ASR agreements and open market transactions. In February 2018, we announced a 15.7% increase in our quarterly cash dividend to $1.03 per share.

We generated $12.0 billion of cash flow from operations during fiscal 2017. This cash flow, along with $3.0 billion of long-term debt and $850 million of net short-term borrowings in fiscal 2017, was used to repay $500 million of floating rate senior notes that matured in September 2017, fund cash payments of $8.0 billion for share repurchases, pay $4.2 billion of cash dividends, fund $1.9 billion in capital expenditures, and acquire Compact Power and The Company Store.

Our ROIC was 34.2% for fiscal 2017. We define ROIC as NOPAT, a non-GAAP financial measure, for the most recent twelve-month period, divided by the average of beginning and ending long-term debt (including current

installments) and equity for the most recent twelve-month period. For a reconciliation of NOPAT to net earnings, the most comparable GAAP financial measure, and our calculation of ROIC, see the "Non-GAAP Financial Measures" section below.

Results of Operations

The tables and discussion below should be read in conjunction with our consolidated financial statements and related notes included in this report. We believe 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, are relevant to an evaluation of our business.

	Fiscal							Fiscal							Fiscal
	2017							2016							2015
dollars in millions	$				% of Net Sales			$				% of Net Sales			$				% of Net Sales
Net sales	$	100,904						$	94,595						$	88,519
Gross profit	34,356				34.0	%		32,313				34.2	%		30,265				34.2	%
Operating expenses:
Selling, general and administrative	17,864				17.7			17,132				18.1			16,801				19.0
Depreciation and amortization	1,811				1.8			1,754				1.9			1,690				1.9
Total operating expenses	19,675				19.5			18,886				20.0			18,491				20.9
Operating income	14,681				14.5			13,427				14.2			11,774				13.3
Interest and other (income) expense:
Interest and investment income	(74		)		(0.1	)		(36		)		—			(166		)		(0.2	)
Interest expense	1,057				1.0			972				1.0			919				1.0
Interest and other, net	983				1.0			936				1.0			753				0.9
Earnings before provision for income taxes	13,698				13.6			12,491				13.2			11,021				12.5
Provision for income taxes	5,068				5.0			4,534				4.8			4,012				4.5
Net earnings	$	8,630			8.6	%		$	7,957			8.4	%		$	7,009			7.9	%

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Note: Certain percentages may not sum to totals due to rounding.

										% Change
	Fiscal			Fiscal			Fiscal			Fiscal			Fiscal
2017			2016			2015			2017 vs. 2016			2016 vs. 2015
Selected financial and sales data:
Comparable sales increase (%) (1)	6.8	%		5.6	%		5.6	%		N/A			N/A
Comparable customer transactions increase (%) (1)	2.2	%		2.8	%		4.0	%		N/A			N/A
Comparable average ticket increase (%) (1)	4.5	%		2.7	%		1.6	%		N/A			N/A
Customer transactions (in millions) (1)	1,578.6			1,544.0			1,500.8			2.2	%		2.9	%
Average ticket (1)	$63.06			$60.35			$58.77			4.5	%		2.7	%
Sales per square foot (1)	$417.02			$390.78			$370.55			6.7	%		5.5	%
Diluted earnings per share	$7.29			$6.45			$5.46			13.0	%		18.1	%

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(1)	Does not include results for Interline, which was acquired in the third quarter of fiscal 2015.

Fiscal 2017 Compared to Fiscal 2016

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

Net Sales. Net sales for fiscal 2017 increased $6.3 billion, or 6.7%, to $100.9 billion. The increase in net sales in fiscal 2017 primarily reflected the impact of positive comparable sales driven by increased customer transactions and average ticket growth. Hurricane-related sales contributed approximately $662 million to net sales in the second half of fiscal 2017.

Comparable Sales. Comparable sales is a measure that highlights the performance of our existing locations and websites by measuring the change in 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 excluding closed stores. Retail stores become comparable on the Monday following their 365th day of operation. Acquisitions, digital or otherwise, are included after we own them for greater than 52 weeks (with the exception of Interline which is excluded from comparable sales). 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 6.8% in fiscal 2017. The increase in comparable sales reflected a number of factors, including the execution of our strategy and broad-based growth across our stores and online. Online sales, which consist of sales generated online through our websites for products picked up in our stores or delivered to customer locations, represented 6.7% of net sales and grew 21.5% during fiscal 2017. All of our merchandising departments posted positive comparable sales except for one, which was flat in fiscal 2017. Comparable sales for our Lumber, Electrical, Tools, Appliances, Flooring, Building Materials, and Indoor Garden merchandising departments were above the Company average during fiscal 2017. Our comparable customer transactions increased 2.2% during fiscal 2017. Further, our comparable average ticket increased 4.5% in fiscal 2017, due in part to strong sales in big ticket purchases in certain merchandising departments, such as Appliances and Flooring.

Gross Profit. Gross profit increased $2.0 billion, or 6.3%, to $34.4 billion in fiscal 2017. Gross profit as a percent of net sales, or gross profit margin, was 34.0% in fiscal 2017 compared to 34.2% in fiscal 2016. The modest decline in gross profit margin for fiscal 2017 reflected the impact of lower margin hurricane-related sales and higher shrink, partially offset by benefits from our supply chain.

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

Selling, General & Administrative. SG&A increased $732 million, or 4.3%, to $17.9 billion in fiscal 2017 and included approximately $170 million of hurricane-related expenses. As a percent of net sales, SG&A was 17.7% for fiscal 2017 compared to 18.1% for fiscal 2016. The decrease in SG&A as a percent of net sales for fiscal 2017 reflected expense leverage resulting from the positive comparable sales environment and continued expense control.

Depreciation and Amortization. Depreciation and amortization increased $57 million, or 3.2%, in fiscal 2017. The decrease in depreciation and amortization as a percent of net sales to 1.8% in fiscal 2017 from 1.9% in fiscal 2016 reflected expense leverage resulting from the positive comparable sales environment.

Interest and Other, net. Interest and other, net, was $983 million for fiscal 2017 compared to $936 million for fiscal 2016. Interest and other, net, as a percent of net sales was 1.0% for both fiscal 2017 and 2016 and reflected additional interest expense in fiscal 2017 resulting from higher long-term debt balances in fiscal 2017, offset by higher interest income in fiscal 2017 compared to fiscal 2016.

Provision for Income Taxes. Our combined effective income tax rate was 37.0% for fiscal 2017 compared to 36.3% for fiscal 2016. The effective income tax rate for fiscal 2017 reflected a net $127 million charge resulting from the enactment of the Tax Act. The effective income tax rate for fiscal 2017 also reflected a $106 million benefit to our provision for income taxes for share-based payment awards as a result of our adoption of ASU No. 2016-09 (see Note 1 and Note 5 to our consolidated financial statements for further discussion).

Diluted Earnings per Share. Diluted earnings per share were $7.29 for fiscal 2017 compared to $6.45 for fiscal 2016. Diluted earnings per share for fiscal 2017 included a benefit of $0.09 per share as a result of the adoption of ASU No. 2016-09, as well as decreases of $0.11 per share due to the net tax charge recorded in connection with the enactment of the Tax Act and $0.06 per share due to the one-time bonus payment to hourly associates made as a result of the Tax Act.

Fiscal 2016 Compared to Fiscal 2015

Sales.

Net Sales. Net sales for fiscal 2016 increased $6.1 billion, or 6.9%, to $94.6 billion. The increase in net sales for fiscal 2016 primarily reflected the impact of positive comparable sales driven by increased customer transactions and average ticket growth, as well as sales from Interline, which was acquired in the third quarter of fiscal 2015.

The increase in net sales was partially offset by pressure from a stronger U.S. dollar, which negatively impacted total sales growth by $549 million in fiscal 2016.

Comparable Sales. Total comparable sales increased 5.6% for fiscal 2016, which reflected a number of factors, including the execution of our strategy, improved strength across our business, and an improved U.S. home improvement market. Online sales represented 5.9% of net sales and grew 19.3% during fiscal 2016. All of our merchandising departments posted positive comparable sales for fiscal 2016. Comparable sales for our Appliances, Tools, Lumber, Lighting, Décor, Building Materials, and Indoor Garden merchandising departments were above the Company average for fiscal 2016. Further, our comparable customer transactions increased 2.8% for fiscal 2016 and comparable average ticket increased 2.7% for fiscal 2016, due in part to strong sales in big ticket purchases in merchandising departments such as Appliances, Flooring, and Roofing, offset in part by a stronger U.S. dollar.

Gross Profit. Gross profit for fiscal 2016 increased $2.0 billion, or 6.8%, to $32.3 billion. Gross profit as a percent of net sales, or gross profit margin, was 34.2% for both fiscal 2016 and 2015. Gross profit margin for fiscal 2016 reflected the impact of product mix changes, offset by benefits from our supply chain driven by increased productivity, and benefits from reaching higher levels of co-op allowances and rebates in certain category classes.

Operating Expenses.

Selling, General & Administrative. SG&A for fiscal 2016 increased $331 million, or 2.0%, to $17.1 billion. SG&A included Data Breach-related pretax expenses of $37 million in fiscal 2016 compared to $128 million of pretax net expenses in fiscal 2015. As a percent of net sales, SG&A was 18.1% for fiscal 2016 compared to 19.0% for fiscal 2015. The decrease in SG&A as a percent of net sales for fiscal 2016 reflected expense leverage resulting from the positive comparable sales environment and strong expense control.

Depreciation and Amortization. Depreciation and amortization for fiscal 2016 increased $64 million, or 3.8%, to $1.8 billion. Depreciation and amortization as a percent of net sales was 1.9% for both fiscal 2016 and 2015. Depreciation and amortization as a percent of net sales for fiscal 2016 reflected minor expense leverage resulting from the positive comparable sales environment.

Interest and Other, net. In fiscal 2016, we recognized $936 million of interest and other, net, compared to $753 million for fiscal 2015. Interest and other, net, for fiscal 2015 included a $144 million pretax gain related to the sale of our remaining equity ownership in HD Supply. Interest and other, net, as a percent of net sales was 1.0% for fiscal 2016 compared to 0.9% for fiscal 2015 due primarily to the HD Supply pretax gain in fiscal 2015 noted above and higher long-term debt balances in fiscal 2016.

Provision for Income Taxes. Our combined effective income tax rate was 36.3% for fiscal 2016 and 36.4% for fiscal 2015.

Diluted Earnings per Share. Diluted earnings per share were $6.45 for fiscal 2016 compared to $5.46 for fiscal 2015. Expenses related to the Data Breach resulted in decreases of $0.02 and $0.06 to diluted earnings per share for fiscal 2016 and 2015, respectively. The gain on the sale of our remaining equity ownership in HD Supply contributed a benefit of $0.07 to diluted earnings per share for fiscal 2015.

Non-GAAP Financial Measures

To provide clarity, internally and externally, 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.

	Fiscal				Fiscal				Fiscal
dollars in millions	2017				2016				2015
Net earnings	$	8,630			$	7,957			$	7,009
Interest and other, net	983				936				753
Provision for income taxes	5,068				4,534				4,012
Operating income	14,681				13,427				11,774
Income tax adjustment (1)	(5,432		)		(4,874		)		(4,286		)
NOPAT	$	9,249			$	8,553			$	7,488
Average debt and equity	$	27,074			$	27,203			$	26,663
ROIC	34.2		%		31.4		%		28.1		%

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(1)	Income tax adjustment is defined as operating income multiplied by our effective tax rate.

Additional Information

For information on accounting pronouncements that have impacted or are expected to materially impact our consolidated financial condition, results of operations, or cash flows, see Note 1 to our consolidated financial statements.

Liquidity and Capital Resources

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.

Net cash provided by operating activities increased $2.2 billion in fiscal 2017 and increased $410 million in fiscal 2016, and primarily reflected an increase in net earnings, excluding changes in working capital and non-cash items from operations. The increase in earnings resulted from higher comparable sales and expense leverage in both fiscal years.

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.

Investing Activities. Cash used in investing activities primarily reflected:

•	$1.9 billion of capital expenditures for investments in our business and $374 million cash paid in connection with the acquisitions of Compact Power and The Company Store in fiscal 2017;

•	$1.6 billion of capital expenditures for investments in our business in fiscal 2016; and

•	$1.7 billion paid in connection with the acquisition of Interline and $1.5 billion of capital expenditures for investments in our business in fiscal 2015.

Financing Activities. Cash used in financing activities primarily reflected:

•	$8.0 billion of share repurchases and $4.2 billion of cash dividends paid, partially offset by $3.3 billion of net proceeds from short- and long-term borrowings in fiscal 2017;

•	$6.9 billion of share repurchases and $3.4 billion of cash dividends paid, partially offset by $2.3 billion of net proceeds from short- and long-term borrowings in fiscal 2016; and

•	$7.0 billion of share repurchases and $3.0 billion of cash dividends paid, partially offset by $4.0 billion of net proceeds from short- and long-term borrowings in fiscal 2015.

Cash and Cash Equivalents at End of Year. At January 28, 2018, we had $3.6 billion in cash and cash equivalents, of which $3.2 billion was held by our foreign subsidiaries. We believe that our current cash position, access to the long-term debt capital markets, and cash flow generated from operations should be sufficient not only for our operating requirements but also to enable us to complete our capital expenditure programs and fund dividend payments, share repurchases, and any required long-term debt payments through the next several fiscal years. In addition, we have funds available from our commercial paper programs and the ability to obtain alternative sources of financing.

Debt and Derivatives

In December 2017, we increased the borrowing capacity of our commercial paper programs from $2.0 billion to $3.0 billion. All of our short-term borrowings in fiscal 2017 and fiscal 2016 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. In December 2017, we replaced our five-year $2.0 billion credit facility that was scheduled to expire in December 2019, with a new, substantially identical five-year $2.0 billion credit facility that expires in December 2022. In addition, we added a separate 364-day $1.0 billion credit facility that expires in December 2018. At January 28, 2018, we were in compliance with all of the covenants contained in the credit facilities, and none are expected to impact our liquidity or capital resources. At January 28, 2018 and January 29, 2017, there were $1.6 billion and $710 million, respectively, of borrowings outstanding under the commercial paper programs. We also issue senior notes from time to time.

We 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 capital and operating leases to finance a portion of our real estate, including our stores, distribution centers, and store support centers. See Note 3 and Note 4 to our consolidated financial statements for further discussion of our capital and operating leases.

Share Repurchases

In fiscal 2017, we repurchased 49.5 million shares of our common stock for $8.0 billion through ASR agreements and open market transactions. In February 2017, our Board of Directors authorized a $15.0 billion share repurchase program that replaced the previous authorization. In December 2017, our Board of Directors authorized a new $15.0 billion share repurchase program that replaced the February 2017 authorization. See Note 6 to our consolidated financial statements for further discussion of our share repurchases.

Contractual Obligations

Our significant contractual obligations at January 28, 2018 were as follows:

	Payments Due by Period
in millions	Total				Less than 1 Year				1 to 3 Years				3 to 5 Years				More Than 5 Years
Short-term debt	$	1,559			$	1,559			$	—			$	—			$	—
Long-term debt – principal payments (1)	24,750				1,150				2,750				3,600				17,250
Long-term debt – interest payments (2)	15,167				914				1,739				1,526				10,988
Capital lease obligations (3)	1,753				147				298				264				1,044
Operating lease obligations	7,138				921				1,655				1,276				3,286
Purchase obligations (4)	1,634				1,123				269				110				132
Unrecognized tax benefits (5)	187				187				—				—				—
Total	$	52,188			$	6,001			$	6,711			$	6,776			$	32,700

—————

(1)	Excludes capital lease obligations.

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

(3)	Includes $769 million of imputed interest.

(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 $450 million of noncurrent unrecognized tax benefits due to uncertainty regarding the timing of future cash tax payments.

Off-Balance Sheet Arrangements

We have operating leases for a portion of our real estate and other assets that are not reflected in our consolidated balance sheets.

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 portrayal 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.

As the valuation under the retail inventory method is based on estimates such as markups, markdowns, and inventory losses (or shrink), there exists an inherent uncertainty in the final determination of inventory cost and gross profit. 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 its undiscounted future cash flows with its carrying value. Our cash flow projections look several years into the future and include assumptions on 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 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 on a regular basis 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 2017, 2016 or 2015.

Revenues

We recognize revenue, net of estimated returns and sales tax, at the time the customer takes possession of merchandise or when a service is performed. We estimate the liability for sales returns, including the estimated gross profit impact, based on our historical return levels and believe that our estimate for sales returns is a reasonable reflection of future returns.

We defer revenue and the related gross profit for payments received from customers for which the customer has not yet taken possession of merchandise or we have not yet performed the service for the customer. This amount is recorded as deferred revenue. We estimate the gross profit related to deferred revenue using historical rates, which we believe to be a reasonable reflection of future rates. If these estimates significantly differ from actual amounts, our net sales and gross profit could be adversely impacted.

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 earned are initially recorded as a reduction in merchandise inventories and a subsequent reduction in cost of sales when the related product is sold. Certain 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.