EX-13 6 exhibit13.htm EXHIBIT 13 - PORTIONS OF LOWE'S 2008 ANNUAL REPORT TO SHAREHOLDERS exhibit13.htm

 
 
 




The following discussion and analysis summarizes the significant factors affecting our consolidated operating results, financial condition, liquidity and capital resources during the three-year period ended January 30, 2009 (our fiscal years 2008, 2007 and 2006).  Each of the fiscal years presented contains 52 weeks of operating results.  Unless otherwise noted, all references herein for the years 2008, 2007 and 2006 represent the fiscal years ended January 30, 2009, February 1, 2008, and February 2, 2007, respectively.  This discussion should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements included in this annual report that have been prepared in accordance with accounting principles generally accepted in the United States of America.

EXECUTIVE OVERVIEW

External Factors Impacting Our Business

We entered 2008 knowing a challenging sales environment would pressure our results, but the effects of declining home prices, rising unemployment and tightening credit markets were even greater than anticipated.  Highlighting the impact of the current economic environment on our business, comparable store sales declined 7.2% in 2008, while gross margin declined 43 basis points versus the prior year.  The economic pressures on consumers intensified in the fourth quarter as unemployment swelled, resulting in a further decline in consumer confidence and consumer spending.  In fact, consumer spending continued to contract at the fastest rate in over 25 years.  For the fourth quarter of 2008, comparable store sales declined 9.9%, while gross margin declined 115 basis points versus the fourth quarter of 2007.

During the fourth quarter 2008 holiday season, as consumer spending contracted substantially, we knew that competition for sales would be intense in certain categories where we compete with a broader group of retailers.  During one of the most promotional holiday seasons in memory, we chose to be proactive and move more quickly and deeply than originally planned with our seasonal merchandise markdowns.  We also accelerated our exit strategy for the majority of our wallpaper product group.  These more aggressive merchandise markdowns pressured gross margin in the fourth quarter of 2008, but improved our inventory position heading into 2009.  We expect our first quarter 2009 gross margin to recover and be down only slightly compared to the first quarter of 2008.

For the year, we estimate that the discretionary component of our sales declined to approximately one-third of total sales, down from approximately 45% in 2006, as the number and size of discretionary projects continued to decline.  This hesitancy to invest in larger discretionary projects led to a decline of 9% in comparable store sales for tickets above $500 during the year.  However, tickets below $50 experienced only a 2% decline in comparable store sales in 2008, evidence of the relative strength of smaller-ticket items.

The sales environment remains challenging, and the external pressures facing our industry will continue in 2009.  The potential for a recovery in demand during 2009 is primarily dependent on factors beyond our control, with stabilizing employment statistics being one of the most important in restoring consumer spending.  With the uncertainty in the current environment, we remain focused on effectively deploying capital, controlling expenses and capturing profitable market share.

Effectively Deploying Capital

We have looked critically at our capital plan for 2009 and have reduced our planned store openings to 60 to 70 stores, inclusive of approximately five store openings in Canada and two store openings in Mexico.  This is down from 115 store openings in 2008.  The reduction in store openings is in response to the challenging economic environment in markets across the U.S.  We are also rationalizing other capital spending, including our store remerchandising efforts, to ensure an appropriate return on our investment.  These changes have reduced our capital plan to $2.5 billion in 2009, a reduction of $1.1 billion compared to our capital spending in 2008.

Additionally, where appropriate, we have adjusted our store format in large and midsized markets as part of an overall effort to better leverage our invested capital.  Over the last few years, we have utilized a 103,000-square-foot (103K) store

 
 
 

 


format, which is approximately 12% smaller than our 117,000-square-foot format, in a number of size-constrained metropolitan locations.  This decrease in store size provided an average reduction in spending of $2 million per store and will provide an ongoing reduction in utility and maintenance costs.  In 2009, we will continue to increase the proportion of new stores utilizing the 103K store format, and in the future we plan to utilize the 103K store format for the majority of our projects.

Our centralized distribution network has always been fundamental to our success.  Our network consists of 14 regional distribution centers (RDCs); 15 flatbed distribution centers (FDCs); four facilities to support our import business, Special Order Sales, and internet fulfillment; and three transload facilities.  This network allows us to deliver the right products to the right stores at the right time.  We will continue to upgrade our logistics and distribution processes and systems to better integrate our planning and execution.  This allows us to continue to manage our inventory investment, drive efficiencies in our distribution network, and evolve the process that continues to be one of our competitive advantages.

Controlling Expenses

Our largest expense is payroll, and we strive to keep payroll hours in our stores proportionate to sales volumes and, even more specifically, to the sales volumes of individual departments within our stores.  Our goal is to manage our payroll expense without sacrificing customer service, which is accomplished with the staffing model we have built over many years.  The staffing model is reviewed regularly to incorporate improvements and efficiencies we have implemented that have allowed us to move non-selling hours to selling hours.  Examples of such improvements in 2008 include our Freight Flow initiative that took best practices from our receiving process and implemented them across the chain.  In addition, during 2008, we reduced store hours in some of our slower sales markets when Daylight Saving Time ended, which allowed us to reallocate hours in affected stores to the busier times of the day.  As a result of these improvements, we have updated our staffing model for 2009, reducing the required hours and reducing the base hours threshold without reducing customer facing hours.  We will continue to monitor our service levels closely throughout 2009 to ensure these changes to our staffing model do not negatively impact customer service.

We have also reviewed our physical inventory process to identify process improvements and cost savings.  The majority of our stores has historically had two physical inventories per year; however, during the past several years our inventory shrink control initiatives have yielded solid results.  As a result, we began a test of conducting one physical inventory in our better-performing stores.  Over the past four years, we have slowly increased the number of stores with one physical inventory and have experienced no noticeable increases in those stores’ shrink results.  Therefore, we are moving additional stores to one inventory per year in 2009, which will save approximately $10 million.

As we have further penetrated U.S. markets, our increased store density has allowed us to leverage our district and regional staff.  During the past two years, we have added 268 stores but only one region and 15 districts, increasing the average store count per district from eight to nine and the average store count per region from 66 to 75.  Additionally, we have expanded the coverage of our area operations and area loss prevention managers, increasing the average number of stores covered by each manager by more than three stores, rather than adding headcount in these positions.  We are confident that we will continue to have the oversight needed to ensure consistent and effective application of our policies and procedures, while reducing expenses.

Over the past three years, we have managed our corporate staffing, primarily through attrition, to match the slowing sales environment.  By filling only the most needed positions, we have effectively had a corporate-level hiring freeze for nearly two years.  As a result, we have frozen or left unfilled almost 400 positions at the corporate office in 2008.  As a measure of our efforts to ensure appropriate management of our corporate infrastructure, over the past two years our store count and selling square footage have each grown by over 19% while our corporate staff has grown by less than 5%.

Lastly, over the past two years, we have reduced our marketing spend by $84 million.  This was the result of significant reductions in mass media as the Lowe’s brand gained national awareness and market share, and more targeted advertising, including the USPS New Movers program and various multicultural programs.

 
 

 
 
Capturing Profitable Market Share
 
Our goal remains to drive profitable market share gains during these challenging times.  According to third-party estimates, we gained approximately 300 basis points of total store unit market share during the home improvement industry downturn which began three years ago.  This is evidence of our compelling product offering, commitment to customer service and our ability to capitalize on the evolving competitive landscape.

We continue to refine and improve our “Customer Focused” program, which measures each store’s performance relative to key components of customer satisfaction, including selling skills, delivery, Installed Sales and checkout experience.  Our customer service scores, measured by our quarterly Customer Focused process, have never been higher.  We know that the foundation of our success is our people, and this difficult economic environment has provided us the opportunity to both hire and retain great people.  Over the past two years, we have seen the average tenure of a Lowe’s store manager increase by almost eight months from an average of slightly over seven years to an average of almost eight years.  Additionally, the average tenure of the other members of the store management team has increased nearly nine months over that time period.  We are confident that we will continue to build a solid and experienced foundation to provide excellent service and drive sales today, and when the economic environment begins to improve.

OPERATIONS

The following table sets forth the percentage relationship to net sales of each line item of the consolidated statements of earnings, as well as the percentage change in dollar amounts from the prior year. This table should be read in conjunction with the following discussion and analysis and the consolidated financial statements, including the related notes to the consolidated financial statements.

                 
Basis Point Increase / (Decrease) in Percentage of Net Sales from Prior Year
     
Percentage Increase / (Decrease) in Dollar Amounts from Prior Year
 
 
2008
     
2007
     
2008 vs. 2007
     
2008 vs. 2007
 
Net sales
100.00
%
   
100.00
%
   
N/A
     
(0.1)%
 
Gross margin
34.21
     
34.64
     
(43)
     
(1.3)
 
Expenses:
                           
Selling, general and administrative
22.96
     
21.78
     
118
     
5.3
 
Store opening costs
0.21
     
0.29
     
(8)
     
(27.5)
 
Depreciation
3.19
     
2.83
     
36
     
12.7
 
Interest - net
0.58
     
0.40
     
18
     
44.3
 
Total expenses
26.94
     
25.30
     
164
     
6.4
 
Pre-tax earnings
7.27
     
9.34
     
(207)
     
(22.3)
 
Income tax provision
2.72
     
3.52
     
(80)
     
(23.0)
 
Net earnings
4.55
%
   
5.82
%
   
(127)
     
(21.8)%
 
                             
                 
Basis Point Increase / (Decrease) in Percentage of Net Sales from Prior Year
     
Percentage Increase / (Decrease) in Dollar Amounts from Prior Year
 
2007
     
2006
     
2007 vs. 2006
     
2007 vs. 2006
 
Net sales
100.00
%
   
100.00
%
   
N/A
     
2.9%
 
Gross margin
34.64
     
34.52
     
12
     
3.3
 
Expenses:
                           
Selling, general and administrative
21.78
     
20.75
     
103
     
8.0
 
Store opening costs
0.29
     
0.31
     
(2)
     
(3.9)
 
Depreciation
2.83
     
2.48
     
35
     
17.5
 
Interest - net
0.40
     
0.33
     
7
     
26.4
 
Total expenses
25.30
     
23.87
     
143
     
9.1
 
Pre-tax earnings
9.34
     
10.65
     
(131)
     
(9.7)
 
Income tax provision
3.52
     
4.03
     
(51)
     
(10.1)
 
Net earnings
5.82
%
   
6.62
%
   
(80)
     
(9.5)%
 
 

 
 

 


Other Metrics
   
2008
     
2007
     
2006
 
Comparable store sales (decrease)/increase 1
   
(7.2)%
     
(5.1)%
     
0.0%
 
Total customer transactions (in millions)
   
740
     
720
     
680
 
Average ticket 2
   
$65.15
     
$67.05
     
$68.98
 
                         
At end of year:
                       
Number of stores
   
1,649
     
1,534
     
1,385
 
Sales floor square feet (in millions)
   
187
     
174
     
157
 
Average store size selling square feet (in thousands) 3
   
113
     
113
     
113
 
                         
Return on average assets 4
   
6.8%
     
9.5%
     
11.7%
 
Return on average shareholders' equity 5
   
12.7%
     
17.7%
     
20.8%
 
 
1 We define a comparable store as a store that has been open longer than 13 months.  A store that is identified for relocation is no longer considered comparable one month prior to its relocation.  The relocated store must then remain open longer than 13 months to be considered comparable. The comparable store sales increase for 2006 included in the preceding table was calculated using sales for a comparable 52-week period, since fiscal year 2005 contained 53 weeks.
2 We define average ticket as net sales divided by the total number of customer transactions.
3 We define average store size selling square feet as sales floor square feet divided by the number of stores open at the end of the period.
4 Return on average assets is defined as net earnings divided by average total assets for the last five quarters.
5 Return on average shareholders’ equity is defined as net earnings divided by average shareholders’ equity for the last five quarters.

Fiscal 2008 Compared to Fiscal 2007

Net sales – Reflective of the challenging sales environment, net sales decreased 0.1% to $48.2 billion in 2008.  Comparable store sales declined 7.2% in 2008 compared to a decline of 5.1% in 2007.  Total customer transactions increased 2.8% compared to 2007, driven by our store expansion program.  However, average ticket decreased 2.8% to $65.15, as a result of fewer project sales.  Comparable store customer transactions declined 4.1%, and comparable store average ticket declined 3.1% compared to 2007.

The sales weakness we continued to experience was most pronounced in larger discretionary projects and was the result of dramatic reductions in consumer spending.  Certain of our project categories, including cabinets & countertops and millwork, had double-digit declines in comparable store sales for the year.  These two project categories together with flooring were approximately 17% of our total sales in 2008.  This is comparable to 2002 levels, after having peaked at nearly 18.5% in 2006.  We also experienced continued weakness in certain of our style categories, such as fashion plumbing, lighting and windows & walls.  These product categories are also typically more discretionary in nature and delivered double-digit declines in comparable store sales for the year.

Due to consumers’ hesitancy to take on larger discretionary projects, we experienced mixed results within Specialty Sales during the year.  Special Order Sales delivered a 9.5% decline in comparable store sales, due to continued weakness in cabinets & countertops, fashion plumbing, lighting and millwork.  Installed Sales performed above our average comparable store sales change with a decline of 6.0% for 2008.  However, we experienced low-double-digit declines in comparable store sales in the third and fourth quarters of 2008 as the economic environment worsened.  Commercial Business Customer sales have continued to deliver above-average comparable store sales throughout this industry downturn as a result of our targeted efforts to focus on the professional tradesperson, property maintenance professional and the repair/remodeler.

We experienced solid sales performance due to increased demand for hurricane-related products, which helped drive a comparable store sales increase in building materials and above-average comparable store sales changes in outdoor power equipment and hardware.  Favorable comparisons due to last year’s drought conditions contributed to above-average
 

 
 

 
 

comparable store sales changes in our lawn & landscape products and nursery categories.  The continued willingness of homeowners to take on smaller projects to improve their outdoor space and maintain their homes also contributed to the above-average comparable store sales change in our nursery category, as well as in paint and home environment.  Other categories that performed above our average comparable store sales change included appliances and rough plumbing, while flooring and seasonal living performed at approximately the overall corporate average.

From a geographic market perspective, we experienced a wide range of comparable store sales performance during the first three quarters of 2008.  Markets in the Western U.S. and Florida, which include some of the markets most pressured by the declining housing market, experienced double-digit declines in comparable store sales during each of the first three quarters of the year.  Contrasting those markets we saw solid sales results in our markets in Texas, Oklahoma, certain areas of the Northeast and parts of the upper Midwest and Ohio Valley during the same period.  However, in the fourth quarter of 2008, the economic pressures on consumers intensified as unemployment swelled, resulting in a further decline in consumer confidence and consumer spending.  This impacted all of our geographic markets, and resulted in a comparable store sales decline of 9.9% for the fourth quarter, compared to a decline of 7.2% for the year.

Gross margin - For 2008, gross margin of 34.21% represented a 43-basis-point decrease from 2007.  This decrease was primarily driven by carpet installation and other promotions, which negatively impacted gross margin by approximately 21 basis points.  We also saw a decline of approximately 14 basis points due to higher fuel prices during the first half of the year and de-leverage in distribution fixed costs.  Additionally, markdowns associated with our decision to exit wallpaper reduced gross margin by approximately three basis points.  The de-leverage from these factors was partially offset by a positive impact of approximately 12 basis points from lower inventory shrink and approximately four basis points attributable to the mix of products sold.

For the fourth quarter of 2008, gross margin of 33.73% represented a 115-basis-point decrease from the fourth quarter of 2007.  This decrease was driven by a number of factors.  We experienced elevated promotional activity in many product categories as competitors initiated inventory-clearing promotions in the quarter.  To protect our customer franchise and our price image, we matched various competitor offers during the quarter which negatively impacted gross margin by approximately 50 basis points.  In addition, our efforts to clear seasonal inventory in our seasonal living and tools categories impacted gross margin by approximately 30 and 20 basis points, respectively.  Also, markdowns associated with our decision to exit wallpaper reduced gross margin by approximately 15 basis points.  Higher fuel prices increased cost of goods sold and negatively impacted gross margin by approximately 10 basis points.  Slightly offsetting these items was a positive impact of 14 basis points from lower inventory shrink.

SG&A - The increase in SG&A as a percentage of sales from 2007 to 2008 was primarily driven by de-leverage of 70 basis points in store payroll. As sales per store declined, additional stores met the base staffing hours threshold, which increased the proportion of fixed-to-total payroll.  Although this created short-term pressure on earnings, in the long-term it ensures that we maintain the high service levels that customers have come to expect from Lowe’s.  The resulting de-leverage in store payroll was partially offset by leverage of 31 basis points of in-store service expense, due to the shifting of certain tasks from third-party, in-store service groups to store employees.  The offsetting impact of these two factors resulted in net de-leverage of 39 basis points.  We  experienced de-leverage of approximately 21 basis points in fixed expenses such as property taxes, utilities and rent during the year as a result of softer sales.  Additionally, we experienced 11 basis points of de-leverage associated with the write-off of new store projects that we are no longer pursuing and a long-lived asset impairment charge for open stores.  We also experienced de-leverage of approximately nine basis points in bonus expense attributable to higher achievement against performance targets this year, and de-leverage of seven basis points in retirement plan expenses due to changes in the 401(k) Plan that increased our matching contribution relative to the prior year.

Store opening costs - Store opening costs, which include payroll and supply costs incurred prior to store opening as well as grand opening advertising costs, totaled $102 million in 2008, compared to $141 million in 2007.  These costs are associated with the opening of 115 new stores in 2008, as compared with the opening of 153 stores in 2007 (149 new and four relocated).  Store opening costs for stores opened during the year averaged approximately $0.8 million and $0.9 million per store in 2008 and 2007, respectively.  Because store opening costs are expensed as incurred, the timing of expense recognition fluctuates based on the timing of store openings.
 

 
 

 


Depreciation - Depreciation de-leveraged 36 basis points as a percentage of sales in 2008.  This de-leverage was driven by the addition of 115 new stores in 2008 and the comparable store sales decline.  Property, less accumulated depreciation, increased to $22.7 billion at January 30, 2009, compared to $21.4 billion at February 1, 2008.  At January 30, 2009, we owned 88% of our stores, compared to 87% at February 1, 2008, which includes stores on leased land.

Interest - Net interest expense is comprised of the following:

(In millions)
 
2008
   
2007
 
Interest expense, net of amount capitalized
 
$
314    
$
230  
Amortization of original issue discount and loan costs
    6       9  
Interest income
    (40 )     (45 )
Interest - net
 
$
280    
$
194  

Interest expense increased primarily as a result of the September 2007 $1.3 billion debt issuance and lower capitalized interest associated with fewer stores under construction.

Income tax provision - Our effective income tax rate was 37.4% in 2008 versus 37.7% in 2007.  The decrease in the effective tax rate was due to an increase in federal and state tax credits as a percentage of taxable income in 2008 versus the prior year.

Fiscal 2007 Compared to Fiscal 2006

Net sales – Sales increased 2.9% to $48.3 billion in 2007.  The increase in sales was driven primarily by our store expansion program.  We opened 153 stores in 2007, including four relocations, and ended the year with 1,534 stores in the U.S. and Canada.  However, a challenging sales environment led to a decline in comparable store sales of 5.1% in 2007 versus flat comparable store sales in 2006.  Total customer transactions increased 5.9% compared to 2006, while average ticket decreased 2.8% to $67.05, a reflection of fewer project sales.  Comparable store customer transactions declined 1.8%, and comparable store average ticket declined 3.3% compared to 2006.

Comparable store sales declined 6.3%, 2.6%, 4.3% and 7.6% in the first, second, third and fourth quarters of 2007, respectively.  Our industry was pressured by the soft housing market, the tight mortgage market, continued deflationary pressures from lumber and plywood, and unseasonable weather, including the exceptional drought in certain areas of the U.S.  From a geographic market perspective, we continued to see dramatic differences in performance.  Our worst-performing markets included those areas that had been most impacted by the dynamics of the housing market, including California and Florida.  These areas and the Gulf Coast reduced our comparable store sales by approximately 250 basis points for the year.  Contrasting with those markets, we saw relatively better comparable store sales performance in our markets in the central U.S., which have had less impact from the housing market. Two of these markets, which include areas of Texas and Oklahoma, delivered positive comparable store sales in 2007 and had a positive impact on our comparable store sales of approximately 100 basis points for the year.

Reflective of the difficult sales environment, only two of our 19 product categories experienced comparable store sales increases in 2007.  The categories that performed above our average comparable store sales change included rough plumbing, lawn & landscape products, hardware, paint, lighting, nursery, fashion plumbing and appliances.  In addition, outdoor power equipment performed at approximately our average comparable store sales change in 2007.  Despite the difficult sales environment, we were able to gain unit market share of 80 basis points for the total store in calendar year 2007, according to third-party estimates.  Continued strong unit market share gains indicate that we are providing great service and value to customers.

Our Big 3 Specialty Sales initiatives had mixed results in 2007.  Growth in Installed Sales was 2.8% and growth in Special Order Sales was 0.5% in 2007, while comparable store sales declined 5.5% for Installed Sales and 8.1% for Special Order Sales as a result of the weakness in bigger-ticket and more complex projects.  For the year, Installed Sales was approximately 6% of our total sales and Special Order Sales was approximately 8%.  In contrast, total sales growth for Commercial Business Customers outpaced the company average.
 

 
 

 


Gross margin - For 2007, gross margin of 34.64% represented a 12-basis-point increase over 2006.  This increase as a percentage of sales was primarily driven by 13 basis points related to positive product mix shifts, 11 basis points related to increased penetration of imported goods and five basis points of improved inventory shrink results.  This leverage was partially offset by de-leverage of 13 basis points in transportation costs primarily attributable to rising fuel costs, and seven basis points as a result of start-up costs for new distribution facilities.

SG&A - The increase in SG&A as a percentage of sales from 2006 to 2007 was primarily driven by de-leverage of 67 basis points in store payroll as a result of the weak sales environment. As sales per store declined, stores were meeting our minimum staffing hours threshold which increased the proportion of fixed-to-total payroll.  In addition, we saw de-leverage of eight basis points in retirement plan expenses as a result of changes to the 401(k) Plan to replace the performance match program with an increased baseline match.  No performance match was earned in 2006.  We also had de-leverage in fixed expenses such as rent, utilities and property taxes as a result of softer sales.  These items were partially offset by leverage of 23 basis points in advertising expense, primarily attributable to reduced spending on tab production and distribution, and national television advertising.

Store opening costs - Store opening costs, which include payroll and supply costs incurred prior to store opening as well as grand opening advertising costs, totaled $141 million in 2007, compared to $146 million in 2006.  These costs are associated with the opening of 153 stores in 2007 (149 new and four relocated), as compared with the opening of 155 stores in 2006 (151 new and four relocated).  Store opening costs for stores opened during the year in the U.S. averaged approximately $0.8 million and $0.9 million per store in 2007 and 2006, respectively.  Store opening costs for stores opened during the year in Canada averaged approximately $2.4 million per store in 2007 as a result of additional expenses necessary to enter a new market.  Because store opening costs are expensed as incurred, the timing of expense recognition fluctuates based on the timing of store openings.

Depreciation - Depreciation de-leveraged 35 basis points as a percentage of sales in 2007.  This de-leverage was driven by the opening of 153 stores in 2007 and negative comparable store sales.  Property, less accumulated depreciation, increased to $21.4 billion at February 1, 2008, compared to $19.0 billion at February 2, 2007.  At February 1, 2008, we owned 87% of our stores, compared to 86% at February 2, 2007, which includes stores on leased land.

Interest - Net interest expense is comprised of the following:

(In millions)
 
2007
   
2006
 
Interest expense, net of amount capitalized
 
$
230    
$
200  
Amortization of original issue discount and loan costs
    9       6  
Interest income
    (45 )     (52 )
Interest - net
 
$
194    
$
154  

Interest expense increased primarily as a result of the September 2007 $1.3 billion debt issuance and the October 2006 $1 billion debt issuance, partially offset by an increase in capitalized interest.

Income tax provision - Our effective income tax rate was 37.7% in 2007 versus 37.9% in 2006.  The decrease in the effective tax rate was due to a continuation of the effect of increased federal tax credits associated with Welfare to Work and Work Opportunity Tax Credit programs as well as increased state tax credits related to our investments in employees and property.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Inventory

At January 30, 2009, merchandise inventory was $8.2 billion compared to $7.6 billion at February 1, 2008, an increase of 7.9%.  The increase was primarily due to sales floor square footage growth of 7.2%, the timing associated with in-transit inventory, and an increase in distribution center inventory associated with the opening of our fourteenth RDC in Pittston, Pennsylvania.  At January 30, 2009, we also had already stocked or were in the process of stocking new stores scheduled to open in early 2009.  We opened 13 new stores in the first few weeks of 2009 compared to four in the first few weeks of 2008.  Comparable store inventory was down 2.9% at January 30, 2009 compared to the prior year.  We took aggressive
 

 
 

 

 
steps to sell-through seasonal inventory in the fourth quarter of 2008, improving our inventory position entering 2009, and we have taken a cautious approach when building our spring seasonal inventory as we anticipate a continuation of the challenging sales environment.

Cash Flows

The following table summarizes the components of the consolidated statements of cash flows. This table should be read in conjunction with the following discussion and analysis and the consolidated financial statements, including the related notes to the consolidated financial statements:

(In millions)
 
2008
   
2007
   
2006
 
Net cash provided by operating activities
  $ 4,122     $ 4,347     $ 4,502  
Net cash used in investing activities
    (3,226 )     (4,123 )     (3,715 )
Net cash used in financing activities
    (939 )     (307 )     (846 )
Effect of exchange rate changes on cash
    7       -       -  
Net decrease in cash and cash equivalents
    (36 )     (83 )     (59 )
Cash and cash equivalents, beginning of year
    281       364       423  
Cash and cash equivalents, end of year
  $ 245     $ 281     $ 364  
 
Cash flows from operating activities continue to provide the primary source of our liquidity.  The change in cash flows from operating activities in 2008 compared to 2007 resulted primarily from decreased net earnings and an increase in inventory.  This change was partially offset by an increase in accounts payable, which is a result of our continued efforts to improve vendor payment terms.  The change in cash flows from operating activities in 2007 compared to 2006 resulted primarily from decreased net earnings and an increase in inventory as a result of our store expansion program, partially offset by an increase in deferred revenue associated with our extended warranty program.

The primary component of net cash used in investing activities continues to be opening new stores, investing in existing stores through resets and remerchandising, and investing in our distribution center and corporate infrastructure, including enhancements to our information technology systems.  Cash acquisitions of property were $3.3 billion in 2008, $4.0 billion in 2007 and $3.9 billion in 2006.  The January 30, 2009, retail selling space of 187 million square feet represented a 7.2% increase over February 1, 2008.  The February 1, 2008, retail selling space of 174 million square feet represented a 10.9% increase over February 2, 2007.

The change in cash flows from financing activities in 2008 compared to 2007 primarily related to a $2.9 billion decrease in cash flows associated with net borrowing activities, partially offset by a $2.3 billion decrease in repurchases under our share repurchase program.  The change in cash flows from financing activities in 2007 compared to 2006 resulted primarily from a $1.3 billion increase in cash flows associated with net borrowing activities.  This was partially offset by a $538 million increase in share repurchases and an increase in dividends paid from $0.18 per share in 2006 to $0.29 per share in 2007.  The ratio of debt to equity plus debt was 25.1% and 29.3% as of January 30, 2009, and February 1, 2008, respectively.

Sources of Liquidity

In addition to our cash flows from operations, additional liquidity is provided by our short-term borrowing facilities.  We have a $1.75 billion senior credit facility that expires in June 2012.  The senior credit facility supports our commercial paper and revolving credit programs.  The senior credit facility has a $500 million letter of credit sublimit.  Amounts outstanding under letters of credit reduce the amount available for borrowing under the senior credit facility.  Borrowings made are unsecured and are priced at fixed rates based upon market conditions at the time of funding in accordance with the terms of the senior credit facility. The senior credit facility contains certain restrictive covenants, which include maintenance of a debt leverage ratio, as defined by the senior credit facility.  We were in compliance with those covenants at January 30, 2009.  Nineteen banking institutions are participating in the senior credit facility.  As of January 30, 2009, there was $789 million outstanding under the commercial paper program, all of which was issued in the fourth quarter.
 

 
 

 


The weighted-average interest rate on the outstanding commercial paper was 0.84%.  As of January 30, 2009, there were no letters of credit outstanding under the senior credit facility.
 
In addition, we had standby and documentary letters of credit issued through other banking arrangements which totaled $224 million as of January 30, 2009, and $299 million as of February 1, 2008. Commitment fees ranging from 0.225% to 0.50% per annum are paid on the letters of credit amounts outstanding.

We had a Canadian dollar (C$) denominated credit facility in the amount of C$200 million that expired March 30, 2009.  The outstanding borrowings at expiration were repaid with net cash provided by operating activities.  This credit facility was established for the purpose of funding the construction of retail stores and for working capital and other general corporate purposes in Canada.  Borrowings made were unsecured and were priced at fixed rates based upon market conditions at the time of funding in accordance with the terms of the credit facility.  The credit facility contained certain restrictive covenants, which included maintenance of a debt leverage ratio as defined by the credit facility.  We were in compliance with those covenants at January 30, 2009.  Three banking institutions participated in the credit facility.  As of January 30, 2009, there was C$199 million, or the equivalent of $162 million, outstanding under the credit facility.  The weighted-average interest rate on the short-term borrowings was 2.65%.
 
We also have a C$ denominated credit facility in the amount of C$50 million that provides revolving credit support for our Canadian operations.  This uncommitted credit facility provides us with the ability to make unsecured borrowings which are priced at fixed rates based upon market conditions at the time of funding in accordance with the terms of the credit facility.  As of January 30, 2009, there was C$44 million, or the equivalent of $36 million, outstanding under the credit facility.  The weighted-average interest rate on the short-term borrowings was 1.60%.

Our debt ratings at January 30, 2009, were as follows:

Current Debt Ratings
S&P
Moody’s
Fitch
Commercial Paper
A1
P1
F1
Senior Debt
A+
A1
A+
Outlook
Stable
Stable
Negative

We believe that net cash provided by operating and financing activities will be adequate for our expansion plans and for our other operating requirements over the next 12 months.  The availability of funds through the issuance of commercial paper or new debt or the borrowing cost of these funds could be adversely affected due to a debt rating downgrade, which we do not expect, or a deterioration of certain financial ratios.  In addition, continuing volatility in the global capital markets may affect our ability to access those markets for additional borrowings or increase costs associated with those borrowings.  There are no provisions in any agreements that would require early cash settlement of existing debt or leases as a result of a downgrade in our debt rating or a decrease in our stock price.

Cash Requirements

Capital expenditures

Our 2009 capital budget is approximately $2.5 billion, inclusive of approximately $300 million of lease commitments, resulting in a net cash outflow of $2.2 billion in 2009.  Approximately 72% of this planned commitment is for store expansion.  Our expansion plans for 2009 consist of 60 to 70 new stores and are expected to increase sales floor square footage by approximately 4%.  Approximately 98% of the 2009 projects will be owned, which includes approximately 35% ground-leased properties. 

At January 30, 2009, we owned and operated 14 RDCs.  We opened a new RDC in Pittston, Pennsylvania, in 2008.  At January 30, 2009, we also operated 15 FDCs for the handling of lumber, building materials and other long-length items.  We opened a new FDC in Purvis, Mississippi, in 2008.  We are confident that our current distribution network has the capacity to ensure that our stores remain in stock and that customer demand is met.
 

 

 
 

 

 
Debt and capital

On June 30, 2008, we redeemed for cash approximately $19 million principal amount, $14 million carrying amount, of our convertible notes issued in February 2001, which represented all remaining notes outstanding of such issue, at a price equal to the sum of the issuance price plus accrued original issue discount of such notes as of the redemption date ($730.71 per note).  From their issuance through the redemption, principal amounts of $986 million, or approximately 98%, of our February 2001 convertible notes were converted from debt to equity.  During 2008, an insignificant amount was converted from debt to equity.

On June 25, 2008, we completed a single open-market repurchase of approximately $187 million principal amount, $164 million carrying amount, of our senior convertible notes issued in October 2001 at a price of $875.73 per note.  We subsequently redeemed for cash on June 30, 2008, approximately $392 million principal amount, $343 million carrying amount, of our senior convertible notes issued in October 2001, which represented all remaining notes outstanding of such issue, at a price equal to the sum of the issuance price plus accrued original issue discount of such notes as of the redemption date ($875.73 per note).  From their issuance through the redemption, an insignificant amount of our senior convertible notes had converted from debt to equity.

Our share repurchase program is implemented through purchases made from time to time either in the open market or through private transactions.  Shares purchased under the share repurchase program are retired and returned to authorized and unissued status.  During 2008, there were no share repurchases under the share repurchase program.  As of January 30, 2009, we had remaining authorization through fiscal 2009 under the share repurchase program of $2.2 billion.

Our quarterly cash dividend was increased in 2008 to $0.085 per share, a 6% increase over the prior year.

OFF-BALANCE SHEET ARRANGEMENTS
 
Other than in connection with executing operating leases, we do not have any off-balance sheet financing that has, or is reasonably likely to have, a material, current or future effect on our financial condition, cash flows, results of operations, liquidity, capital expenditures or capital resources.
 
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
 
The following table summarizes our significant contractual obligations and commercial commitments:
 
   
Payments Due by Period
 
Contractual Obligations
       
Less than
      1-3       4-5    
After 5
 
(In millions)
 
Total
   
1 year
   
years
   
years
   
years
 
Long-term debt (principal and interest amounts, excluding discount)
  $ 9,256     $ 294     $ 1,044     $ 1,025     $ 6,893  
Capital lease obligations 1
    543       63       122       121       237  
Operating leases 1
    6,185       389       777       763       4,256  
Purchase obligations 2
    995       620       345       16       14  
Total contractual obligations
  $ 16,979     $ 1,366     $ 2,288     $ 1,925     $ 11,400  
 
   
Amount of Commitment Expiration by Period
 
Commercial Commitments
       
Less than
      1-3       4-5    
After 5
 
(In millions)
 
Total
   
1 year
   
years
   
years
   
years
 
Letters of credit 3
  $ 224     $ 220     $ 4     $ -     $ -  

1 Amounts do not include taxes, common area maintenance, insurance or contingent rent because these amounts have historically been insignificant.

 
 

 
 

2 Represents contracts for purchases of merchandise inventory, property and construction of buildings, as well as commitments related to certain marketing and information technology programs.
3 Letters of credit are issued for the purchase of import merchandise inventories, real estate and construction contracts, and insurance programs.

At January 30, 2009, approximately $24 million of the reserve for uncertain tax positions (including penalties and interest) was classified as a current liability.  At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months, due to uncertainties in the timing of the effective settlement of tax positions.

LOWE’S BUSINESS OUTLOOK

As of February 20, 2009, the date of our fourth quarter 2008 earnings release, we expected to open 60 to 70 stores during 2009, resulting in total square footage growth of approximately 4%.  We expected total sales in 2009 to range from a decline of 2% to an increase of 2% and comparable store sales to decline 4% to 8%.  Earnings before interest and taxes as a percentage of sales (operating margin) was expected to decline approximately 170 basis points. In addition, store opening costs were expected to be approximately $50 million. Diluted earnings per share of $1.04 to $1.20 were expected for the fiscal year ending January 29, 2010.  Our outlook for 2009 does not assume any share repurchases.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of the consolidated financial statements and notes to consolidated financial statements presented in this annual report requires us to make estimates that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosures of contingent assets and liabilities.  We base these estimates on historical results and various other assumptions believed to be reasonable, all of which form the basis for making estimates concerning the carrying values of assets and liabilities that are not readily available from other sources.  Actual results may differ from these estimates.

Our significant accounting policies are described in Note 1 to the consolidated financial statements. We believe that the following accounting policies affect the most significant estimates and management judgments used in preparing the consolidated financial statements.

Merchandise Inventory

Description
We record an inventory reserve for the anticipated loss associated with selling inventories below cost.  This reserve is based on our current knowledge with respect to inventory levels, sales trends and historical experience.  During 2008, our reserve decreased approximately $9 million to $58 million as of January 30, 2009.  We also record an inventory reserve for the estimated shrinkage between physical inventories.  This reserve is based primarily on actual shrinkage results from previous physical inventories.  During 2008, the inventory shrinkage reserve decreased approximately $8 million to $129 million as of January 30, 2009.

Judgments and uncertainties involved in the estimate
We do not believe that our merchandise inventories are subject to significant risk of obsolescence in the near term, and we have the ability to adjust purchasing practices based on anticipated sales trends and general economic conditions. However, changes in consumer purchasing patterns or a deterioration in product quality could result in the need for additional reserves.  Likewise, changes in the estimated shrink reserve may be necessary, based on the timing and results of physical inventories.  We also apply judgment in the determination of levels of non-productive inventory and assumptions about net realizable value.

Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to establish our inventory valuation or the related reserves during the past three fiscal years.  We believe that we have sufficient current and historical knowledge to record reasonable estimates for both of these inventory reserves.  However, it is possible that actual results could differ from recorded reserves.  A 10% change in our obsolete inventory reserve would have affected net earnings by approximately

 
 
 

 

 
$4 million for 2008.  A 10% change in our estimated shrinkage reserve would have affected net earnings by approximately $8 million for 2008.

Long-Lived Asset Impairment

Description

We review the carrying amounts of long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

For long-lived assets held-for-use, a potential impairment has occurred if projected future undiscounted cash flows expected to result from the use and eventual disposition of the assets are less than the carrying value of the assets.  An impairment loss is recognized when the carrying amount of the long-lived asset is not recoverable and exceeds its fair value.  We estimate fair value based on projected future discounted cash flows from the use and eventual disposition of the assets.

For long-lived assets to be abandoned, we consider the asset to be disposed of when it ceases to be used.  Until it ceases to be used, we continue to classify the assets as held-for-use and test for potential impairment accordingly.

For long-lived assets held-for-sale, an impairment charge is recorded if the carrying amount of the asset exceeds its fair value less cost to sell.  Fair value is based on a market appraisal or a valuation technique that considers various factors, including local market conditions.

We recorded long-lived asset impairment charges of $21 million during 2008, including $16 million for operating stores and $5 million for relocated stores, closed stores and other excess properties.

Judgments and uncertainties involved in the estimate
Our impairment loss calculations require us to apply judgment in estimating expected future cash flows, including estimated sales, margin and expense growth rates and assumptions about market performance.  We also apply judgment in estimating asset fair values, including the selection of a discount rate that reflects the risk inherent in our current business model.

Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to establish the carrying amounts of long-lived assets during the past three fiscal years.  If actual results are not consistent with the assumptions and judgments used in estimating future cash flows and asset fair values, actual impairment losses could vary positively or negatively from estimated impairment losses.  Of our 1,649 operating stores, only 15 stores were at risk for impairment.  We recorded impairment charges on three stores whose carrying amounts were deemed not recoverable and exceeded the respective fair values.  A 10% decrease in the estimated cash flows associated with long-lived assets evaluated for impairment would have decreased net earnings by approximately $7 million for 2008.  A 10% increase in the estimated cash flows associated with long-lived assets evaluated for impairment would have increased net earnings by approximately $4 million for 2008.

Self-Insurance

Description
We are self-insured for certain losses relating to workers’ compensation; automobile; property; general and product liability; extended warranty; and certain medical and dental claims.  Self-insurance claims filed and claims incurred but not reported are accrued based upon our estimates of the discounted ultimate cost for self-insured claims incurred using actuarial assumptions followed in the insurance industry and historical experience.  During 2008, our self-insurance liability increased approximately $80 million to $751 million as of January 30, 2009.

Judgments and uncertainties involved in the estimate
These estimates are subject to changes in the regulatory environment; utilized discount rate; payroll; sales; and vehicle units; as well as the frequency, lag and severity of claims.


 
 

 

 
Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to establish our self-insurance liability during the past three fiscal years.  Although we believe that we have the ability to reasonably estimate losses related to claims, it is possible that actual results could differ from recorded self-insurance liabilities.  A 10% change in our self-insurance liability would have affected net earnings by approximately $47 million for 2008.  A 100 basis point change in our discount rate would have affected net earnings by approximately $13 million for 2008.

Revenue Recognition

Description
See Note 1 to the consolidated financial statements for a complete discussion of our revenue recognition policies.  The following accounting estimates relating to revenue recognition require management to make assumptions and apply judgment regarding the effects of future events that cannot be determined with certainty.

Revenues from stored value cards, which include gift cards and returned merchandise credits, are deferred and recognized when the cards are redeemed.  We recognize income from unredeemed stored value cards at the point at which redemption becomes remote.  Our stored value cards have no expiration date or dormancy fees.  Therefore, to determine when redemption is remote, we analyze an aging of the unredeemed cards based on the date of last stored value card use. The deferred revenue associated with outstanding stored value cards decreased $39 million to $346 million as of January 30, 2009.  We recognized $21 million of income from unredeemed stored value cards in 2008.

We sell separately-priced extended warranty contracts under a Lowe’s-branded program for which we are ultimately self-insured.  We recognize revenues from extended warranty sales on a straight-line basis over the respective contract term due to a lack of sufficient historical evidence indicating that costs of performing services under the contracts are incurred on other than a straight-line basis.  Extended warranty contract terms primarily range from one to four years from the date of purchase or the end of the manufacturer’s warranty, as applicable.  We consistently group and evaluate extended warranty contracts based on the characteristics of the underlying products and the coverage provided in order to monitor for expected losses.  A loss would be recognized if the expected costs of performing services under the contracts exceeded the amount of unamortized acquisition costs and related deferred revenue associated with the contracts.  Deferred revenues associated with the extended warranty contracts increased $72 million to $479 million as of January 30, 2009.

We record a reserve for anticipated merchandise returns through a reduction of sales and cost of sales in the period that the related sales are recorded. We use historical return levels to estimate return rates.  This, along with historical margin rates, is applied to sales and cost of sales during the estimated average return period. During 2008, the merchandise returns reserve decreased $2 million to $49 million as of January 30, 2009.

Judgments and uncertainties involved in the estimate
For stored value cards, there is judgment inherent in our evaluation of when redemption becomes remote and, therefore, when the related income is recognized.

For extended warranties, there is judgment inherent in our evaluation of expected losses as a result of our methodology for grouping and evaluating extended warranty contracts and from the actuarial determination of the estimated cost of the contracts.  There is also judgment inherent in our determination of the recognition pattern of costs of performing services under these contracts.

For the reserve for anticipated merchandise returns, there is judgment inherent in our estimates of historical return levels and margin rates, and in the determination of the average return period.

Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to recognize income related to unredeemed stored value cards during the past three fiscal years.  We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to recognize income related to unredeemed stored value cards.  However, if actual results are not consistent with our estimates or assumptions, we may incur additional income or expense.  A 10% change in the estimate of unredeemed stored value cards for which redemption is considered remote would have affected net earnings by approximately $4 million in 2008.

 
 
 

 

 
We have not made any material changes in the methodology used to recognize revenue on our extended warranty contracts during the past three fiscal years.  We currently do not anticipate incurring any losses on our extended warranty contracts.  Although we believe that we have the ability to adequately monitor and estimate expected losses under the extended warranty contracts, it is possible that actual results could differ from our estimates.  In addition, if future evidence indicates that the costs of performing services under these contracts are incurred on other than a straight-line basis, the timing of revenue recognition under these contracts could change.  A 10% change in the amount of revenue recognized in 2008 under these contracts would have affected net earnings by approximately $8 million.

We have not made any material changes in the methodology used to estimate sales returns during the past three fiscal years.  We believe we have sufficient current and historical knowledge to record reasonable estimates of sales returns.  However, it is possible that actual returns could differ from our estimates.  A 10% change in actual return rates would have affected net earnings for 2008 by approximately $3 million.  A 10% change in the average return period would have affected net earnings for 2008 by approximately $2 million.

Vendor Funds

Description
We receive funds from vendors in the normal course of business, principally as a result of purchase volumes, sales, early payments or promotions of vendors’ products.

Vendor funds are treated as a reduction of inventory cost, unless they represent a reimbursement of specific, incremental and identifiable costs that we incurred to sell the vendor’s product. Substantially all of the vendor funds that we receive do not meet the specific, incremental and identifiable criteria. Therefore, we treat the majority of these funds as a reduction in the cost of inventory as the amounts are accrued, and recognize these funds as a reduction of cost of sales when the inventory is sold.

Judgments and uncertainties involved in the estimate
Based on the provisions of the vendor agreements in place, we develop vendor fund accrual rates by estimating the point at which we will have completed our performance under the agreement, and the agreed-upon amounts will be earned.  Due to the complexity and diversity of the individual vendor agreements, we perform analyses and review historical trends throughout the year to ensure the amounts earned are appropriately recorded.  As a part of these analyses, we validate our accrual rates based on actual purchase trends and apply those rates to actual purchase volumes to determine the amount of funds accrued and receivable from the vendor.  Amounts accrued throughout the year could be impacted if actual purchase volumes differ from projected annual purchase volumes, especially in the case of programs that provide for increased funding when graduated purchase volumes are met.

Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to recognize vendor funds during the past three fiscal years.  If actual results are not consistent with the assumptions and estimates used, we could be exposed to additional adjustments that could positively or negatively impact gross margin and inventory.  However, substantially all receivables associated with these activities are collected within the following fiscal year and therefore do not require subjective long-term estimates.  Adjustments to gross margin and inventory in the following fiscal year have historically not been material.

 
 
 

 



Interest Rate Risk

Our primary market risk exposure is the potential loss arising from the impact of changing interest rates on long-term debt.  Our policy is to monitor the interest rate risks associated with this debt, and we believe any significant risks could be offset by accessing variable-rate instruments available through our lines of credit.  The following tables summarize our market risks associated with long-term debt, excluding capital leases and other.  The tables present principal cash outflows and related interest rates by year of maturity, excluding unamortized original issue discounts as of January 30, 2009, and February 1, 2008.  The variable interest rate is based on the rate in effect at the end of the year presented.  The fair values included below were determined using quoted market rates or interest rates that are currently available to us for debt with similar terms and remaining maturities.

Long-Term Debt Maturities by Fiscal Year
           
January 30, 2009
                 
                         
             Average              Average  
     
 Fixed
     Interest        Variable      Interest  
(Dollars in millions) 
     Rate      Rate        Rate      Rate  
2009
  $
     1
   
  6.15
%
  $
  -
   
  -
%
2010
   
501
   
          8.25
     
18
   
          4.40
 
2011
   
1
   
          7.63
     
-
   
              -
 
2012
   
551
   
          5.60
     
-
   
-
 
2013
   
1
   
          7.64
     
-
   
-
 
Thereafter
   
3,687
   
5.99
%
   
-
   
-
%
Total
  $
4,742
        $
18
     
Fair value
  $
4,635
        $
18
     
 
Long-Term Debt Maturities by Fiscal Year
February 1, 2008
             
           
 Average
 
     
 Fixed
   
 Interest
 
 (Dollars in millions)    
 Rate
   
 Rate
 
2008
  $
     10
   
7.14
%
2009
   
10
   
5.36
 
2010
   
501
   
8.25
 
2011
   
1
   
7.61
 
2012
   
552
   
5.61
 
Thereafter
   
4,296
   
5.28
%
Total
  $
5,370
     
Fair value
  $
5,406
     
 
Credit Risk

Sales generated through our proprietary credit cards are not reflected in our receivables.  General Electric Company and its subsidiaries (GE) own the total portfolio and perform all program-related services.  The agreements provide that we receive funds from or make payments to GE based upon the expected future profits or losses from our proprietary credit cards after taking into account the cost of capital, certain costs of the proprietary credit card program and, subject to contractual limits, the program’s actual loss experience.  Actual losses and operating costs in excess of contractual limits are absorbed by GE.  During 2008 and 2007, costs associated with our proprietary credit card program did not have a material effect on our results of operations.  Although we anticipate reaching our contractual limits for actual losses under

 
 
 

 


the program during 2009, we do not expect that these losses will have a material adverse effect on our results of operations.

Commodity Price Risk

We purchase certain commodity products that are subject to price volatility caused by factors beyond our control.  Our most significant commodity products are lumber and building materials.  Selling prices of these commodity products are influenced, in part, by the market price we pay, which is determined by industry supply and demand.  During 2008 and 2007, lumber price and building materials price movement did not have a material effect on our results of operations.

Foreign Currency Exchange Rate Risk

Although we have international operating entities, our exposure to foreign currency exchange rate fluctuations is not material to our financial condition and results of operations.
 

We speak throughout this Annual Report about our future, particularly in the “Letter to Shareholders” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” While we believe our estimates and expectations are reasonable, they are not guarantees of future performance.  Our actual results could differ substantially from our expectations because, for example:

• Our sales are dependent upon the health and stability of the general economy, which remains in a prolonged period of recession that has been made worse by the severe accompanying financial/credit crisis.  Rising unemployment, reduced access to credit and reduced consumer confidence have combined to lead to sharply reduced consumer spending, particularly on many of the discretionary, bigger-ticket products we sell.  We monitor key economic indicators including real disposable personal income, employment, housing turnover and homeownership levels. In addition, changes in the level of repairs, remodeling and additions to existing homes, changes in commercial building activity, and the availability and cost of mortgage financing can impact our business.

• Major weather-related events and unseasonable weather may impact sales of seasonal merchandise.  Prolonged and widespread drought conditions could hurt our sales of lawn and garden and related products.

• Our expansion strategy has been and will continue to be impacted by economic conditions, environmental regulations, local zoning issues, availability and development of land, and more stringent land-use regulations. Furthermore, our ability to secure a highly qualified workforce is an important element to the success of our expansion strategy.

• Our business is highly competitive, and, as we build an increasing percentage of our new stores in larger markets and utilize new sales channels such as the internet, we may face new and additional forms of competition.  Promotional pricing and competitor liquidation activities during recessionary periods such as we are experiencing may increase competition and adversely affect our business.

• The ability to continue our everyday low pricing strategy and provide the products that customers want depends on our vendors providing a reliable supply of products at competitive prices and our ability to effectively manage our inventory. As an increasing number of the products we sell are imported, any restrictions or limitations on importation of such products, political or financial instability in some of the countries from which we import them, or a failure to comply with laws and regulations of those countries from which we import them could interrupt our supply of imported inventory.  The current global recession and credit crisis are adversely affecting the operations and financial stability of some of our vendors by reducing their sales and restricting their access to capital.  We may have to replace some of our smaller vendors, and some of our vendors may not be able to fulfill their financial obligations to us or to do so in a timely manner.

• Our goal of increasing our market share and our commitment to keeping our prices low requires us to make substantial investments in new technology and processes whose benefits could take longer than expected to be realized and which could be difficult to implement and integrate.

 
 
 

 


For more information about these and other risks and uncertainties that we are exposed to, you should read the “Risk Factors” included in our Annual Report on Form 10-K to the United States Securities and Exchange Commission. All forward-looking statements in this report speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are qualified by the cautionary statements in this section and in the “Risk Factors” included in our Annual Report on Form 10-K. We do not undertake any obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date of this report.
 
 
Management of Lowe’s Companies, Inc. and its subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting (Internal Control) as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended.  Our Internal Control was designed to provide reasonable assurance to our management and the Board of Directors regarding the reliability of financial reporting and the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error and the circumvention or overriding of controls. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to the reliability of financial reporting and financial statement preparation and presentation.  Further, because of changes in conditions, the effectiveness may vary over time.

Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our Internal Control as of January 30, 2009. In evaluating our Internal Control, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework. Based on our management’s assessment, we have concluded that, as of January 30, 2009, our Internal Control is effective.

Deloitte & Touche LLP, the independent registered public accounting firm that audited the financial statements contained in this report, was engaged to audit our Internal Control. Their report appears on page 27.

 
 
 

 



To the Board of Directors and Shareholders of Lowe’s Companies, Inc.
Mooresville, North Carolina

We have audited the accompanying consolidated balance sheets of Lowe's Companies, Inc. and subsidiaries (the "Company") as of January 30, 2009 and February 1, 2008, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the three fiscal years in the period ended January 30, 2009. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company at January 30, 2009 and February 1, 2008, and the results of its operations and its cash flows for each of the three fiscal years in the period ended January 30, 2009, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of January 30, 2009, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 31, 2009 expressed an unqualified opinion on the Company's internal control over financial reporting.

/s/ Deloitte & Touche LLP

Charlotte, North Carolina
March 31, 2009


 
 

 


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Lowe’s Companies, Inc.
Mooresville, North Carolina

We have audited the internal control over financial reporting of Lowe's Companies, Inc. and subsidiaries (the "Company") as of January 30, 2009 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 30, 2009, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the fiscal year ended January 30, 2009 of the Company and our report dated March 31, 2009 expressed an unqualified opinion on those financial statements.

/s/ Deloitte & Touche LLP

Charlotte, North Carolina
March 31, 2009
 

 
 

 


Lowe's Companies, Inc.
                                 
                                 
                                   
                                   
(In millions, except per share and percentage data)
January 30,
   
%
   
February 1,
   
%
   
February 2,
   
%
 
Fiscal years ended on
2009
   
Sales
   
2008
   
Sales
   
2007
   
Sales
 
Net sales (Note 1)
$ 48,230       100.00 %   $ 48,283       100.00 %   $ 46,927       100.00 %
                                               
Cost of sales (Note 1)
  31,729       65.79       31,556       65.36       30,729       65.48  
                                               
Gross margin
  16,501       34.21       16,727       34.64       16,198       34.52  
                                               
Expenses:
                                             
                                               
Selling, general and administrative (Notes 1, 3, 6, 8, 9 and 12)
11,074       22.96       10,515       21.78       9,738       20.75  
                                               
Store opening costs (Note 1)
  102       0.21       141       0.29       146       0.31  
                                               
Depreciation (Notes 1 and 4)
  1,539       3.19       1,366       2.83       1,162       2.48  
                                               
Interest - net (Notes 10 and 15)
  280       0.58       194       0.40       154       0.33  
                                               
Total expenses
  12,995       26.94       12,216       25.30       11,200       23.87  
                                               
Pre-tax earnings
  3,506       7.27       4,511       9.34       4,998       10.65  
                                               
Income tax provision (Note 10)
  1,311       2.72       1,702       3.52       1,893       4.03  
                                               
Net earnings
$ 2,195       4.55 %   $ 2,809       5.82 %   $ 3,105       6.62 %
                                               
                                               
Basic earnings per share (Note 11)
$ 1.51             $ 1.90             $ 2.02          
                                               
Diluted earnings per share (Note 11)
$ 1.49             $ 1.86             $ 1.99          
                                               
Cash dividends per share
$ 0.335             $ 0.290             $ 0.180          
                                               
 
See accompanying notes to consolidated financial statements.

 
 
 

 


Lowe's Companies, Inc.
                         
                         
                           
                           
     
January 30,
   
%
   
February 1,
   
%
 
(In millions, except par value and percentage data)