EX-13 5 exhibit13.htm EXHIBIT 13 - PORTIONS OF LOWE'S 2009 ANNUAL REPORT TO SHAREHOLDERS exhibit13.htm
Exhibit 13
 
 
 

 

 
 

 
 
 
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 29, 2010 (our fiscal years 2009, 2008 and 2007).  Each of the fiscal years presented contains 52 weeks of operating results.  Unless otherwise noted, all references herein for the years 2009, 2008 and 2007 represent the fiscal years ended January 29, 2010, January 30, 2009, and February 1, 2008, 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.  This discussion and analysis is presented in seven sections:

 
•  
Executive Overview
•  
Operations
•  
Lowe’s Business Outlook
 •  
Financial Condition, Liquidity and Capital Resources
•  
Off-Balance Sheet Arrangements
•  
Contractual Obligations and Commercial Commitments
•  
Critical Accounting Policies and Estimates

EXECUTIVE OVERVIEW

External Factors Impacting Our Business

The external pressures facing our industry continued in 2009, as the effects of declining home prices, rising unemployment and general economic uncertainty led to a reduction in consumer confidence and hesitancy among consumers to spend on discretionary projects.  Unemployment increased from approximately 7.7% at the end of 2008 to 9.7% at the end of 2009, foreclosure rates increased over 20% compared to 2008, and home prices continued to decline, though at a slower pace. As a result, consumers have reordered their priorities and have become more deliberate in their spending decisions, as evidenced by the significant decline in the rate of consumer spending, and the increase in the savings rate to more than 4.0%.  Consumers have also shifted to more Do-It-Yourself (DIY) projects; balancing the tradeoffs of convenience versus the cost.  In many cases, consumers have reduced the scope of their projects or are trading down, while still looking for high quality.  As the consumers’ priorities have shifted, we are focused on understanding how they are making their spending decisions.  Our surveys through secondary research indicate that the home is still very important to consumers and it is still most consumers’ largest asset, even with the declines in home values they have suffered over recent years.  And more importantly, the psychological attachment to the home and what it stands for remains strong.

Highlighting the impact of the current economic environment and consumer behavior on our business, comparable store sales declined 6.7% in 2009.  While customer transactions were down slightly from the prior year, comparable store average ticket declined 5.7%, and tickets greater than $500 declined 11.3% during 2009.

During the second half of 2009, we saw some signs of improvement, specifically improving trends in comparable store sales, including improvements in larger ticket sales. This resulted in a 1.6% decline in comparable store sales for the fourth quarter of 2009, which was our best performance in over three years. During the quarter, we also saw significant sequential improvement in bigger ticket projects and above-average comparable store Installed and Special Order Sales. We view this as an encouraging sign regarding consumers’ willingness to take on larger, more discretionary projects.  Our most recent quarterly survey indicated that homeowners are less likely to delay major product purchases than in the recent past.


 
 

 

Business Strategy

Managing through the Economic Downturn

Our goal remains to drive profitable market share gains during these challenging times as the economy begins to recover.  In order to do so, we continue to focus on customer service, effective management of working capital, and driving cost efficiencies.  According to third-party estimates, we gained approximately 100 basis points of total store unit market share during calendar year 2009, and approximately 400 basis points during the downturn over the past four years.  This is evidence of our commitment to customer service, compelling product offering, and our ability to capitalize on the evolving competitive landscape.

Customer service continues to be a primary focus for driving profitable sales and market share gains.  Through the economic downturn as consumers continued to postpone larger discretionary projects, we have seen resurgence in the DIY trend with smaller repair and maintenance projects in such areas as outdoor and seasonal products, paint, hardware, electrical and plumbing repair. Since some homeowners have taken on their first DIY project in a few years, many are coming to Lowe's not only for products, but for information on how to successfully complete their home-improvement projects. Accordingly, we have added informational project boards in key departments in our stores, as well as how-to videos on Lowes.com, to provide customers information and tips needed to successfully complete these projects.  In 2009, we also made changes to staffing plans and inventory levels to ensure we were well positioned to serve the DIY customer.  In all sales environments, we remain committed to staffing our stores with knowledgeable employees to provide the service that our customers have come to expect.  We know that leadership and great people are the foundation of our success. During 2009, the average tenure of a Lowe’s store manager increased to more than eight years, providing an experienced and knowledgeable leadership base.  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, Installed Sales, and checkout experience.  Our customer service scores, measured by our quarterly Customer Focused process, have never been higher.

During the year, we planned our inventory purchases more conservatively across seasonal categories.  We maintained a competitive assortment in Trim-a-Tree and experienced strong sell through, which resulted in fewer markdowns of these products.  In tools, we purchased more core products to minimize markdowns.  These efforts helped us to continue to increase margins and effectively manage our working capital during the downturn.  As a result, we ended the year with 3.6% lower comparable store inventory compared to 2008.

In addition, during 2009, in light of the current economic cycle, we re-evaluated our future store expansion plans to ensure we were making the most effective use of our capital, which resulted in a reduction in the number of stores we expect to open in 2010, as well as the discontinuation of certain future store projects. The principles that drive our store-expansion plans include a focus on high-volume, metro-market opportunities, particularly in markets where we have minimal coverage, projects that minimize the effects of cannibalization, and projects that will allow us to maintain consistently strong returns on our new store capital investments.

For the past three years during the soft sales environment, we have made decisions to control expenses that have allowed us to maintain profitability while continuing to provide strong customer service. Our largest expense is payroll, and we plan store payroll hours 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.  One of the efficiencies implemented in the fourth quarter is our Facility Service Associate position. This position will help ensure we maintain our shopping environment by having better execution of the general maintenance of our stores, including minor store repairs.  In conjunction with this new position we identified the opportunity to centralize and consolidate our facilities service agreements across our footprint, which allowed us to get better pricing on these contracts.  Lastly, we continue to focus our marketing efforts on advertising effectiveness. We have reduced spending on mass media as the Lowe’s brand gained national awareness and market share, and increased more targeted advertising campaigns including Creative Ideas, internet search and direct mail. We continue to focus on our value messages combined with our Everyday Low Price strategy which continues to resonate well with customers.  These measured steps helped us leverage our marketing expense as a percent of sales during 2009.

 
 
 

 
 
 
Preparing for Economic Recovery

While uncertainty remains, we are encouraged by the results we achieved in the fourth quarter of 2009 and believe that the worst of the economic cycle is likely behind us.  We know that the path to economic recovery will occur at different times and at different rates across all the markets in which we compete.  As a result, we have several initiatives underway to ensure we are best positioned to drive results and gain market share throughout the recovery.

Driven by our commitment to manage the business for the long term, during 2009 we added a Project Specialist-Exteriors position in 1,400 of our stores to capture a larger share of products like roofing, siding, fencing and windows, whose characteristics lend themselves to in-home selling. To continue to grow our Commercial Business Customer (CBC) sales, we also added a District Commercial Account Specialist program and launched a Lowe’s Business Rewards card with American Express to help us better connect with, and become more relevant to, the larger commercial customer. 

Improving customer service and inventory management have always been priorities, but have been especially critical during the economic downturn.  Our multi-year Flexible Fulfillment initiative takes that one step further, and will enable us to better meet customers' needs by better leveraging our entire network's inventory.  Once these systems are in place, it will allow the sale of product in any Lowe's location or Lowes.com to be fulfilled and delivered to the customers’ homes from the most efficient location in the network.  Our goal is to make this a seamless process for the customer and at the same time leverage the inventory that we have throughout our network.

Looking forward to 2010, we are positioning ourselves to capitalize as long term economic conditions improve.  However, we are also focused on shorter term opportunities; including the U.S. Department of Energy approved Energy-Star qualified appliance incentive programs that are currently being offered to consumers by each U.S. state and territory through mid-2010.  These rebates are being funded with $300 million from the American Recovery and Reinvestment Act of 2009. Under this program, eligible consumers can receive rebates to purchase new energy-efficient appliances when they replace used appliances.  We have a cross functional team in place to ensure we have the best execution to be able to capitalize on any opportunities provided by the upcoming government programs.
 
OPERATIONS

The following tables set 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
 
   
2009
   
2008
   
2009 vs. 2008
   
2009 vs. 2008
 
Net sales
    100.00 %     100.00 %     N/A       (2.1 )%
Gross margin
    34.86       34.21       65       (0.2 )
Expenses:
                               
Selling, general and administrative
    24.75       22.96       179       5.5  
Store opening costs
    0.10       0.21       (11 )     (51.7 )
Depreciation
    3.42       3.19       23       4.9  
Interest - net
    0.61       0.58       3       2.4  
Total expenses
    28.88       26.94       194       4.9  
Pre-tax earnings
    5.98       7.27       (129 )     (19.4 )
Income tax provision
    2.20       2.72       (52 )     (20.5 )
Net earnings
    3.78 %     4.55 %     (77 )     (18.8 )%
                                 
EBIT margin 1
    6.59 %     7.85 %     (126 )     (17.8 )%
                                 
                   
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 )%
                                 
EBIT margin 1
    7.85 %     9.74 %     (189 )     (19.5 )%

Other Metrics
 
2009
   
2008
   
2007
 
Comparable store sales decrease
    (6.7 )%     (7.2 )%     (5.1 )%
Total customer transactions (in millions)
    766       740       720  
Average ticket
  $ 61.66     $ 65.15     $ 67.05  
                         
At end of year:
                       
Number of stores
    1,710       1,649       1,534  
Sales floor square feet (in millions)
    193       187       174  
Average store size selling square feet (in thousands)
    113       113       113  
                         
Return on average assets 
    5.3 %     6.8 %     9.5 %
Return on average shareholders' equity
    9.5 %     12.7 %     17.7 %
 
1 EBIT margin is defined as earnings before interest and taxes as a percentage of sales (operating margin).

 
 
 

 


2 A comparable store is defined 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.
3 Average ticket is defined as net sales divided by the total number of customer transactions.
4 Average store size selling square feet is defined as sales floor square feet divided by the number of stores open at the end of the period.
5 Return on average assets is defined as net earnings divided by average total assets for the last five quarters.
6 Return on average shareholders’ equity is defined as net earnings divided by average shareholders’ equity for the last five quarters.

 
2009 Compared to 2008

Net sales – Reflective of the continued challenging sales environment, net sales decreased 2.1% to $47.2 billion in 2009.  Comparable store sales declined 6.7% in 2009 compared to a decline of 7.2% in 2008.  Total customer transactions increased 3.4% compared to 2008, driven by our store expansion program.  However, average ticket decreased 5.4% to $61.66, primarily as a result of fewer project sales.  Comparable store customer transactions declined 1.0%, and comparable store average ticket declined 5.7% compared to 2008.
 
Customers continued to focus on routine maintenance and repairs instead of larger discretionary projects during 2009.  We experienced solid sales performance in paint and nursery as a result of the continued willingness of homeowners to take on smaller DIY projects to maintain their homes and improve their outdoor space.  The paint category had positive comparable store sales performance for each quarter during 2009.  Appliances also performed better than our average comparable store sales change driven by attractive value and customers’ willingness to invest in products that increase energy efficiency.  However, certain of our other categories, including windows & walls, cabinets & countertops, and millwork, which are more discretionary in nature, experienced double-digit declines in comparable store sales for the year. We also experienced continued weakness in other categories, including rough electrical, lumber, and outdoor power equipment which also experienced double-digit declines in comparable store sales driven by comparisons to last year’s hurricane-related spending.

Due to consumers’ continued hesitancy to take on larger discretionary projects, we experienced higher than average declines within all specialty sales categories during 2009.  Special Order Sales had a 15.8% decline in comparable store sales, due to weakness in cabinets & countertops, windows & walls, lighting and millwork.  Comparable store Installed Sales declined 11.4% for 2009.  However, both Special Order Sales and Installed Sales experienced sequential improvement in the third quarter of 2009, and positive comparable store sales in the fourth quarter of 2009, as the economic pressures lessened.  Sales to Commercial Business Customers declined 9.1% in 2009 driven by continued project delays within the remodel and repair businesses.

From a geographic market perspective, we experienced continued pressure from the declining housing market, with the most pronounced declines in the Mid-Atlantic and Florida markets for the year.  Many areas were impacted by several years of housing pressure as well as the financial markets.  However, we have seen evidence of broad-based stabilization, as we experienced sequential improvement in comparable store sales for all 50 states from the third to the fourth quarter, and 26 states had positive comparable results in the fourth quarter.  For 2009, the northeast and north-central markets performed above the Company average, and for the fourth quarter of 2009 these areas delivered positive comparable store sales results. As a result, we experienced a comparable store sales decline of 1.6% for the fourth quarter, compared to a decline of 6.7% for the year.

Gross margin - For 2009, gross margin of 34.86% represented a 65 basis point increase from 2008.  Margin rate improvement contributed approximately 52 basis points of this increase, primarily driven by a moderating promotional environment and decreased seasonal markdowns.  The seasonal living category experienced strong margin increases compared to the prior year driven by reduced markdowns as a result of rationalizing purchase levels earlier in the year.  The flooring and lighting product categories also experienced strong improvement compared to the prior year driven by the more rational promotional environment and our decision to not repeat certain prior year promotions. In addition, margin was positively impacted by lower inventory shrink, which provided 12 basis points of leverage.


 
 

 
 
 
For the fourth quarter of 2009, gross margin of 34.95% represented a 122 basis point increase from the fourth quarter of 2008.  In the fourth quarter of 2008, we experienced lower margin rates as a result of our efforts to clear seasonal inventory in our seasonal living and tools categories, as well as markdowns associated with our decision to exit wallpaper.  In addition, there has been a more rational promotional environment in the current year, which positively impacted the seasonal living, windows & walls and lighting categories.

SG&A - The increase in SG&A as a percentage of sales from 2008 to 2009 was primarily driven by de-leverage of 61 basis points in store payroll. As sales per store declined, an increased number of stores met the base staffing hours threshold, which increased the proportion of fixed-to-total payroll.  Although this created 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, and will ensure we have a knowledgeable and engaged team in position as consumer demand stabilizes.   We also experienced de-leverage of approximately 40 basis points in bonus expense attributable to higher achievement against performance targets in the current year.  As a result of current year performance and continued expansion rationalization, we experienced 20 basis points of de-leverage associated with the write-off of new store projects that we are no longer pursuing and long-lived asset impairment charges.  Employee insurance costs also de-leveraged 18 basis points as a result of rising health care expenses, higher enrollment and higher administrative costs.  In the current year, credit programs de-leveraged 16 basis points due to increases in aged losses and bankruptcies as a result of higher unemployment and credit market tightening.  Additionally, we experienced de-leverage of approximately 16 basis points in fixed expenses such as property taxes, utilities and rent during the year as a result of sales declines.  For the fourth quarter of 2009, SG&A de-leveraged 103 basis points as compared to the fourth quarter of 2008.  The de-leverage was primarily attributable to the same factors that contributed to the de-leverage in SG&A for the full 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 $49 million in 2009, compared to $102 million in 2008.  These costs are associated with the opening of 62 stores in 2009, as compared with the opening of 115 stores in 2008.  Store opening costs for stores opened during both 2009 and 2008 averaged approximately $0.8 million per store.  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 23 basis points as a percentage of sales in 2009.  This de-leverage was driven by the comparable store sales declines and the addition of 62 new stores in 2009.  Property, less accumulated depreciation, decreased to $22.5 billion at January 29, 2010, compared to $22.7 billion at January 30, 2009.  At January 29, 2010, and January 30, 2009, we owned 88% of our stores which included stores on leased land.

Interest - Net interest expense is comprised of the following:

(In millions)
 
2009
   
2008
 
Interest expense, net of amount capitalized
  $ 300     $ 314  
Amortization of original issue discount and loan costs
    4       6  
Interest income
    (17 )     (40 )
Interest - net
  $ 287     $ 280  

Net interest expense increased primarily as a result of the lower interest income due to lower interest rates and lower capitalized interest associated with fewer stores under construction, partially offset by lower interest associated with favorable tax settlements during the year.

Income tax provision - Our effective income tax rate was 36.9% in 2009 versus 37.4% in 2008.  The decrease in the effective tax rate was primarily due to favorable state tax settlements.


 
 

 


2008 Compared to 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 experienced 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 2008.  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 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 2007’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.

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 ensured that we maintained 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 in 2008, 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 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 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.

LOWE’S BUSINESS OUTLOOK

As of February 22, 2010, the date of our fourth quarter 2009 earnings release, we expected to open 40 to 45 stores during 2010, resulting in total square footage growth of approximately 2%.  We expected total sales in 2010 to increase 4% to 6% and comparable store sales to increase 1% to 3%.  Earnings before interest and taxes as a percentage of sales (operating margin) was expected to increase 40 to 50 basis points. Depreciation expense was expected to be approximately $1.62 billion.  Diluted earnings per share of $1.30 to $1.42 were expected for the year ending January 28, 2011.  While we expect to make share repurchases during 2010, our outlook for 2010 does not assume any share repurchases.
 

 
 

 
 

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

Cash flows from operating activities continued to provide the primary source of our liquidity.  The decrease in net cash flows provided by operating activities for 2009 versus 2008 was primarily driven by lower net earnings, partially offset by working capital improvements.  The decrease in net cash used in investing activities for 2009 versus 2008 was driven by a 45% decline in property acquired due to a reduction in our store expansion program.  The increase in cash used in financing activities for 2009 versus 2008 was attributable to approximately $1.0 billion of net repayment activity in 2009 related to short-term borrowings and $500 million in share repurchases under our share repurchase program in 2009, partially offset by the redemption in June 2008 of our convertible notes.

Sources of Liquidity

In addition to our cash flows from operations, 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 29, 2010.  Nineteen banking institutions are participating in the senior credit facility.  As of January 29, 2010, there were no outstanding borrowings or letters of credit outstanding under the senior credit facility and no outstanding borrowings under the commercial paper program.

We have a Canadian dollar (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 29, 2010, there were no borrowings outstanding under this credit facility.

Our debt ratings at January 29, 2010, were as follows:

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

On March 25, 2010, Fitch affirmed our commercial paper rating at F1, affirmed our senior debt rating at A+, and changed our outlook from negative to stable.

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.  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 2010 capital budget is approximately $2.1 billion, inclusive of approximately $400 million of lease commitments, resulting in a planned net cash outflow of $1.7 billion.  Approximately 62% of the planned net cash outflow is for store
 

 
 

 
 

expansion and approximately 21% is for investment in our existing stores through resets and remerchandising.  Our store expansion plans for 2010 consist of 40 to 45 new stores and are expected to increase sales floor square footage by approximately 2%.  Approximately 93% of the 2010 projects will be owned, of which 43% will be ground-leased.  Other planned capital expenditures include investing in our distribution and corporate infrastructure, including enhancements in information technology.   

During 2009, we entered into a joint venture agreement with Australian retailer Woolworths Limited, to develop a chain of home improvement stores in Australia.  We expect to contribute approximately $100 million per year over four years to the joint venture, of which we are a one-third owner.

At January 29, 2010, we owned and operated 14 regional distribution centers.  At January 29, 2010, we also operated 15 flatbed distribution centers for the handling of lumber, building materials and other long-length items.  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

The $500 million 8.25% Notes due June 1, 2010 will be repaid with net cash provided by operating and financing activities.

Dividends declared during 2009 totaled $522 million.  The decline in cash dividend payments from $491 million in 2008 to $391 million in 2009 was primarily due to a shift in the timing of dividend payments for dividends declared in the fourth quarter of 2009.  Dividends declared in the fourth quarter of 2009 were paid in 2010 and totaled $131 million.

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.   Authorization available for share repurchases under the program during 2009 expired as of January 29, 2010.  However, on January 29, 2010, the Board of Directors authorized an additional $5 billion in share repurchases with no expiration.  We expect to utilize the $5 billion authorization over the next three years.

The ratio of debt to equity plus debt was 21.0% and 25.1% as of January 29, 2010, and January 30, 2009, respectively.

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)
  $ 8,974     $ 791     $ 1,057     $ 445     $ 6,681  
Capitalized lease obligations
    587       66       131       124       266  
Operating leases
    6,164       409       815       787       4,153  
Purchase obligations
    673       418       193       60       2  
Total contractual obligations
  $ 16,398     $ 1,684     $ 2,196     $ 1,416     $ 11,102  
                                         
   
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
  $ 327     $ 324     $ 3     $ -     $ -  
Surety bonds
  $ 286     $ 276     $ 10     $ -     $ -  

1 Amounts do not include taxes, common area maintenance, insurance or contingent rent because these amounts have historically been insignificant.
2 Represents commitments related to certain marketing and information technology programs, purchases of merchandise inventory and construction of buildings.
3 Letters of credit are issued for the purchase of import merchandise inventories, real estate and construction contracts, and insurance programs.
4 Surety bonds are issued primarily to secure payment of workers’ compensation liability claims in states where we are self-insured.

At January 29, 2010, approximately $9 million of the reserve for uncertain tax positions (including penalties and interest) was classified as a current liability and $160 million was classified as a non-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.
 
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 obsolete 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 2009, our reserve decreased approximately $9 million to $49 million as of January 29, 2010.

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 2009, the inventory shrinkage reserve increased approximately $9 million to $138 million as of January 29, 2010.

In addition, 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, which generally do not represent the reimbursement of specific, incremental and identifiable costs that we incurred to sell the vendor’s product.  We treat 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
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.

For vendor funds, we develop accrual rates based on the provisions of the agreements in place.  Due to the complexity and diversity of the individual vendor agreements, we perform analyses and review historical purchase trends and volumes throughout the year, adjust accrual rates as appropriate and confirm actual amounts with select vendors to ensure the amounts earned are appropriately recorded.  Amounts accrued throughout the year could be impacted if actual purchase volumes differ from projected 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 establish our inventory valuation or the related reserves for obsolete inventory or inventory shrinkage during the past three 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 the amount of products considered obsolete and, therefore, included in the calculation of our obsolete inventory reserve would have affected net earnings by approximately $3 million for 2009.  A 10% change in the estimated shrinkage rate included in the calculation of our inventory shrinkage reserve would have affected net earnings by approximately $9 million for 2009.

We have not made any material changes in the methodology used to recognize vendor funds during the past three 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 do not require subjective long-term estimates because they are collected within the following year.  Adjustments to gross margin and inventory in the following year have historically not been material.

Long-Lived Asset Impairment - Operating Stores

Description
At January 29, 2010, $19.2 billion of our long-lived assets were associated with stores currently in operation.  We review the carrying amounts of operating stores whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable.  When evaluating operating stores for impairment, our asset group is at an individual store level,
 

 
 

 
 

as that is the lowest level for which cash flows are identifiable.  Cash flows for individual operating stores do not include an allocation of corporate overhead.

We evaluate operating stores on a quarterly basis to determine when store assets may not be recoverable.  Our primary indicator that operating store assets may not be recoverable is consistently negative cash flow for a 12 month period for those stores that have been open in the same location for a sufficient period of time to allow for meaningful analysis of ongoing operating results.  Management also monitors other factors when evaluating operating stores for impairment, including individual stores’ execution of their operating plans and local market conditions, including incursion, which is the opening of either other Lowe’s stores or direct competitors’ stores within the same market.

For operating stores, a potential impairment has occurred if projected future undiscounted cash flows expected to result from the use and eventual disposition of the store assets are less than the carrying amount of the assets.  When determining the stream of projected future cash flows associated with an individual operating store, management makes assumptions, incorporating local market conditions, about key store variables including sales growth rates, gross margin and controllable expenses, such as store payroll and occupancy expense.

An impairment loss is recognized when the carrying amount of the operating store is not recoverable and exceeds its fair value.  We generally use an income approach to determine the fair value of our individual operating stores, which requires discounting projected future cash flows.  This involves making assumptions regarding both a store’s future cash flows, as described above, and an appropriate discount rate to determine the present value of those future cash flows.  We discount our cash flow estimates at a rate commensurate with the risk that selected market participants would assign to the cash flows.  The selected market participants represent a group of other retailers with a store footprint similar in size to ours.

We recorded operating store impairment losses of $53 million during 2009 compared to $16 million during 2008.

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 controllable expenses and assumptions about market performance.  We also apply judgment in estimating asset fair values, including the selection of an appropriate discount rate.

Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to estimate the future cash flows of operating stores during the past three years.  If the actual results of our operating stores are not consistent with the assumptions and judgments we have made in estimating future cash flows and determining asset fair values, our actual impairment losses could vary positively or negatively from our estimated impairment losses.   A 10% reduction in projected sales used to estimate future cash flows at the time that the operating stores were evaluated for impairment would have increased recognized impairment losses by $31 million.  A 10% increase in projected sales used to estimate future cash flows at the time that the operating stores were evaluated for impairment would have reduced recognized impairment losses by $3 million.  We analyzed other assumptions made in estimating the future cash flows of the operating stores evaluated for impairment, but the sensitivity of those assumptions was not significant to the estimates.

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 2009, our self-insurance liability increased approximately $41 million to $792 million as of January 29, 2010.

Judgments and uncertainties involved in the estimate
These estimates are subject to changes in the regulatory environment; utilized discount rate; projected exposures including 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 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 $50 million for 2009.  A 100 basis point change in our discount rate would have affected net earnings by approximately $14 million for 2009.

Revenue Recognition

Description
See Note 1 to the consolidated financial statements for a 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.

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 $70 million to $549 million as of January 29, 2010.

We defer revenue and cost of sales associated with transactions for which customers have not yet taken possession of merchandise or for which installation has not yet been completed.  Revenue is deferred based on the actual amounts received.  We use historical gross margin rates to estimate the adjustment to cost of sales for these transactions.  During 2009, deferred revenues associated with these transactions increased $26 million to $354 million as of January 29, 2010.

Judgments and uncertainties involved in the estimate
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 deferral of revenue and cost of sales associated with transactions for which customers have not yet taken possession of merchandise or for which installation has not yet been completed, there is judgment inherent in our estimates of gross margin rates.

Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to recognize revenue on our extended warranty contracts during the past three 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 2009 under these contracts would have affected net earnings by approximately $9 million.

We have not made any material changes in the methodology used to reverse net sales and cost of sales related to amounts received for which customers have not yet taken possession of merchandise or for which installation has not yet been completed.  We believe we have sufficient current and historical knowledge to record reasonable estimates related to the impact to cost of sales for these transactions.  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 the gross margin rates applied to these transactions would have affected net earnings by approximately $6 million in 2009.
 

 
 

 

 

In addition to the risks inherent in our operations, we are exposed to certain market risks, including changes in interest rates, commodity prices and foreign currency exchange rates.

Interest Rate Risk

Fluctuations in interest rates do not have a material impact on our financial condition and results of operations because our long-term debt is carried at amortized cost and primarily consists of fixed rate instruments.  Therefore providing quantitative information about interest rate risk is not meaningful for financial instruments.

Commodity Price Risk

We purchase certain commodity products that are subject to price volatility caused by factors beyond our control.  We believe that the price volatility of these products is mitigated by our selling prices and through fixed-price supply agreements with vendors.  The selling prices of these commodity products are influenced, in part, by the market price we pay, which is determined by industry supply and demand.

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 in forward-looking statements about our future, particularly in the “Letter to Shareholders” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  The words “believe,” “expect,” “will,” “should,” and other similar expressions are intended to identify those forward-looking statements.  While we believe our 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 we believe is recovering slowly from a prolonged period of recession that was made worse by the severe accompanying financial/credit crisis.  Continued high rates of unemployment, the psychological effect of falling home prices, 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.  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 negatively impact our sales particularly of seasonal merchandise.  Prolonged and widespread drought conditions could, for example, hurt our sales of lawn and garden and related products.

• Our expansion strategy is 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 challenging economic periods such as we are continuing to experience 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 from which we are beginning to recover and credit crisis that continues to some extent have adversely affected the operations and financial stability of some of our vendors by reducing their sales and restricting their access to capital.

• 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.

• Changes in existing or new laws and regulations that affect employment/labor, trade, product safety, transportation/logistics, energy costs, health care, tax or environmental issues, could have an adverse impact, directly or indirectly, on our financial condition and results of operations.

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 29, 2010.  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 29, 2010, 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 29.
 
 
 
 

 



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 29, 2010 and January 30, 2009, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the three fiscal years in the period ended January 29, 2010. 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 29, 2010 and January 30, 2009, and the results of its operations and its cash flows for each of the three fiscal years in the period ended January 29, 2010, 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 29, 2010, 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 30, 2010 expressed an unqualified opinion on the Company's internal control over financial reporting.


/s/ Deloitte & Touche LLP

Charlotte, North Carolina
March 30, 2010
 

 
 

 

 
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 29, 2010, 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 29, 2010, 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 29, 2010 of the Company and our report dated March 30, 2010 expressed an unqualified opinion on those financial statements.


/s/ Deloitte & Touche LLP

Charlotte, North Carolina
March 30, 2010
 

 
 

 
 

Lowe's Companies, Inc.
                                   
Consolidated Statements of Earnings
                             
                                     
(In millions, except per share and percentage data)
 
January 29,
%
   
January 30,
%
   
February 1,
%
 
Fiscal years ended on
 
2010
Sales
   
2009
Sales
   
2008
Sales
 
Net sales
 
$
47,220 
 
100.00 
%
 
$
48,230 
 
100.00 
%
 
$
48,283 
 
100.00 
%
                                     
Cost of sales
   
30,757 
 
65.14 
     
31,729 
 
65.79 
     
31,556 
 
65.36 
 
                                     
Gross margin
   
16,463 
 
34.86 
     
16,501 
 
34.21 
     
16,727 
 
34.64 
 
                                     
Expenses:
                                   
                                     
Selling, general and administrative
   
11,688 
 
24.75 
     
11,074 
 
22.96 
     
10,515 
 
21.78 
 
                                     
Store opening costs
   
49 
 
0.10 
     
102 
 
0.21 
     
141 
 
0.29 
 
                                     
Depreciation
   
1,614 
 
3.42 
     
1,539 
 
3.19 
     
1,366 
 
2.83 
 
                                     
Interest - net
   
287 
 
0.61 
     
280 
 
0.58 
     
194 
 
0.40 
 
                                     
Total expenses
   
13,638 
 
28.88 
     
12,995 
 
26.94 
     
12,216 
 
25.30 
 
                                     
Pre-tax earnings
   
2,825 
 
5.98 
     
3,506 
 
7.27 
     
4,511 
 
9.34 
 
                                     
Income tax provision
   
1,042 
 
2.20 
     
1,311 
 
2.72 
     
1,702 
 
3.52 
 
                                     
Net earnings
 
$
1,783 
 
3.78 
%
 
$
2,195 
 
4.55 
%
 
$
2,809 
 
5.82 
%
                                     
                                     
Basic earnings per common share
 
$
 1.21 
       
$
 1.50 
       
$
 1.89 
     
                                     
Diluted earnings per common share
$
 1.21 
       
$
 1.49 
       
$
 1.86 
     
                                     
Cash dividends per share
 
$
 0.355 
       
$
 0.335 
       
$
 0.290 
     
                                     
                                     
See accompanying notes to consolidated financial statements.
                         
 

 
 

 
 

Lowe's Companies, Inc.
                         
Consolidated Balance Sheets
                         
                           
     
January 29,
   
%
   
January 30,
   
%
 
(In millions, except par value and percentage data)
   
2010
   
Total
   
2009
   
Total
 
Assets
                         
      Current assets:
                         
      Cash and cash equivalents
    $ 632       1.9 %   $ 245       0.8 %
      Short-term investments
      425       1.3       416       1.3  
      Merchandise inventory - net
      8,249       25.0       8,209       25.2  
      Deferred income taxes - net
      208       0.6       105       0.3  
      Other current assets
      218       0.7       215       0.6  
      Total current assets
      9,732       29.5       9,190       28.2  
      Property, less accumulated depreciation
    22,499       68.2       22,722       69.6  
      Long-term investments
      277       0.8       253       0.8  
      Other assets
      497       1.5       460       1.4  
      Total assets
    $ 33,005       100.0 %   $ 32,625       100.0 %
                                   
Liabilities and shareholders' equity
                                 
      Current liabilities:
                                 
      Short-term borrowings
    $ -       - %   $ 987       3.0 %
      Current maturities of long-term debt
      552       1.7       34       0.1  
      Accounts payable
      4,287       13.0       4,109       12.6  
      Accrued compensation and employee benefits
      577       1.7       434       1.3  
      Deferred revenue
      683       2.1       674       2.1  
      Other current liabilities
      1,256       3.8       1,322       4.1  
      Total current liabilities
      7,355       22.3       7,560       23.2  
      Long-term debt, excluding current maturities
    4,528       13.7       5,039       15.4  
      Deferred income taxes - net
      598       1.8       599       1.8  
      Other liabilities
      1,455       4.4       1,372       4.3  
      Total liabilities
      13,936       42.2       14,570       44.7  
                                   
      Commitments and contingencies
                                 
                                   
      Shareholders' equity:
                                 
      Preferred stock - $5 par value, none issued
      -       -       -       -  
      Common stock - $.50 par value;
                                 
          Shares issued and outstanding
                                 
          January 29, 2010
 1,459 
                               
          January 30, 2009
 1,470 
    729       2.2       735       2.2  
      Capital in excess of par value
      6       -       277       0.8  
      Retained earnings
      18,307       55.5       17,049       52.3  
      Accumulated other comprehensive income (loss)
    27       0.1       (6 )     -  
      Total shareholders' equity
      19,069       57.8       18,055       55.3  
      Total liabilities and shareholders' equity
    $ 33,005       100.0 %   $ 32,625       100.0 %
                                   
See accompanying notes to consolidated financial statements.
                                 
 

 
 

 
 

                                   
Consolidated Statements of Shareholders' Equity
                               
                                     
                           
Accumulated
       
               
Capital in
         
Other
   
Total
 
   
Common Stock
   
Excess of
   
Retained
   
Comprehensive
   
Shareholders'
 
(In millions)
 
Shares
   
Amount
   
Par Value
   
Earnings
   
Income (Loss)
   
Equity
 
Balance February 2, 2007
    1,525     $ 762     $ 102     $ 14,860     $ 1     $ 15,725  
Cumulative effect adjustment
                            (8 )             (8 )
Comprehensive income:
                                               
   Net earnings
                            2,809                  
   Foreign currency translation
                                    7          
Total comprehensive income
                                            2,816  
Tax effect of non-qualified stock options exercised
                                         
   and restricted stock vested
                    12                       12  
Cash dividends declared
                            (428 )             (428 )
Share-based payment expense
                    99                       99  
Repurchase of common stock
    (76 )     (38 )     (349 )     (1,888 )             (2,275 )
Conversion of debt to common stock
    1       -       13                       13  
Employee stock options exercised
                                               
   and restricted stock issued
    5       3       61                       64  
Employee stock purchase plan
    3       2       78                       80  
Balance February 1, 2008
    1,458     $ 729     $ 16     $ 15,345     $ 8     $ 16,098  
Comprehensive income:
                                               
   Net earnings
                            2,195                  
   Foreign currency translation
                                    (13 )        
   Net unrealized investment losses
                                    (1 )        
Total comprehensive income
                                            2,181  
Tax effect of non-qualified stock options exercised
                                         
   and restricted stock vested
                    5                       5  
Cash dividends declared
                            (491 )             (491 )
Share-based payment expense
                    95                       95  
Repurchase of common stock
    -       -       (8 )                     (8 )
Conversion of debt to common stock
    -       -       1                       1  
Employee stock options exercised
                                               
   and restricted stock issued
    8       4       94                       98  
Employee stock purchase plan
    4       2       74                       76  
Balance January 30, 2009
    1,470     $ 735     $ 277     $ 17,049     $ (6 )   $ 18,055  
Comprehensive income:
                                               
   Net earnings
                            1,783                  
   Foreign currency translation
                                    32          
   Net unrealized investment gains
                                    1          
Total comprehensive income
                                            1,816  
Tax effect of non-qualified stock options exercised
                                         
   and restricted stock vested
                    (6 )                     (6 )
Cash dividends declared
                            (522 )             (522 )
Share-based payment expense
                    102                       102  
Repurchase of common stock
    (22 )     (11 )     (490 )     (3 )             (504 )
Employee stock options exercised
                                               
   and restricted stock issued
    7       3       50                       53  
Employee stock purchase plan
    4       2       73                       75  
Balance January 29, 2010
    1,459     $ 729     $ 6     $ 18,307     $ 27     $ 19,069  
                                                 
See accompanying notes to consolidated financial statements.
                                         
 

 
 

 

 
                 
Consolidated Statements of Cash Flows
                 
                   
                   
(In millions)
 
January 29,
   
January 30,
   
February 1,
 
Fiscal years ended on
 
2010
   
2009
   
2008
 
Cash flows from operating activities:
                 
     Net earnings
  $ 1,783     $ 2,195     $ 2,809  
     Adjustments to reconcile net earnings to net cash provided by operating activities:
                 
         Depreciation and amortization
    1,733       1,667       1,464  
         Deferred income taxes
    (123 )     69       2  
         Loss on property and other assets - net
    193       89       51  
         Loss on redemption of long-term debt
    -       8       -  
         Share-based payment expense
    102       95       99  
         Changes in operating assets and liabilities:
                       
           Merchandise inventory - net
    (28 )     (611 )     (464 )
           Other operating assets
    7       31       (64 )
           Accounts payable
    175       402       185  
           Other operating liabilities
    212       177       265  
     Net cash provided by operating activities
    4,054       4,122       4,347  
                         
Cash flows from investing activities:
                       
     Purchases of short-term investments
    (344 )     (210 )     (920 )
     Proceeds from sale/maturity of short-term investments
    624       431       1,183  
     Purchases of long-term investments
    (1,483 )     (1,148 )     (1,588 )
     Proceeds from sale/maturity of long-term investments
    1,160       994       1,162  
     Increase in other long-term assets
    (62 )     (56 )     (7 )
     Property acquired
    (1,799 )     (3,266 )     (4,010 )
     Proceeds from sale of property and other long-term assets
    18       29       57  
     Net cash used in investing activities
    (1,886 )     (3,226 )     (4,123 )
                         
Cash flows from financing activities:
                       
     Net (decrease) increase in short-term borrowings
    (1,007 )     (57 )     1,041  
     Proceeds from issuance of long-term debt
    10       15       1,296  
     Repayment of long-term debt
    (37 )     (573 )     (96 )
     Proceeds from issuance of common stock under employee stock purchase plan
    75       76       80  
     Proceeds from issuance of common stock from stock options exercised
    53       98       69  
     Cash dividend payments
    (391 )     (491 )     (428 )
     Repurchases of common stock
    (504 )     (8 )     (2,275 )
     Excess tax benefits of share-based payments
    -       1       6  
     Net cash used in financing activities
    (1,801 )     (939 )     (307 )
                         
Effect of exchange rate changes on cash
    20       7       -  
                         
Net increase (decrease) in cash and cash equivalents
    387       (36 )     (83 )
Cash and cash equivalents, beginning of year
    245       281       364  
Cash and cash equivalents, end of year
  $ 632     $ 245     $ 281  
                         
See accompanying notes to consolidated financial statements.
                       
 

 
 

 
 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JANUARY 29, 2010, JANUARY 30, 2009 AND FEBRUARY 1, 2008

NOTE 1: Summary of Significant Accounting Policies -

Lowe’s Companies, Inc. and subsidiaries (the Company) is the world's second-largest home improvement retailer and operated 1,710 stores in the United States and Canada at January 29, 2010.  Below are those accounting policies considered by the Company to be significant.

Fiscal Year - The Company’s fiscal year ends on the Friday nearest the end of January.  Each of the fiscal years presented contained 52 weeks. All references herein for the years 2009, 2008 and 2007 represent the fiscal years ended January 29, 2010, January 30, 2009, and February 1, 2008, respectively.

Principles of Consolidation - The consolidated financial statements include the accounts of the Company and its wholly-owned or controlled operating subsidiaries. All intercompany accounts and transactions have been eliminated.

Foreign Currency - The functional currencies of the Company’s international subsidiaries are primarily the local currencies of the countries in which the subsidiaries are located. Foreign currency denominated assets and liabilities are translated into U.S. dollars using the exchange rates in effect at the consolidated balance sheet date. Results of operations and cash flows are translated using the average exchange rates throughout the period. The effect of exchange rate fluctuations on translation of assets and liabilities is included as a component of shareholders' equity in accumulated other comprehensive income (loss). Gains and losses from foreign currency transactions, which are included in selling, general and administrative (SG&A) expense, have not been significant.

Use of Estimates - The preparation of the Company’s financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosures of contingent assets and liabilities.  The Company bases 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.

Cash and Cash Equivalents - Cash and cash equivalents include cash on hand, demand deposits and short-term investments with original maturities of three months or less when purchased.  Cash and cash equivalents are carried at amortized cost on the consolidated balance sheets.  The majority of payments due from financial institutions for the settlement of credit card and debit card transactions process within two business days and are, therefore, classified as cash and cash equivalents.

Investments - The Company has a cash management program which provides for the investment of cash balances not expected to be used in current operations in financial instruments that have maturities of up to 10 years. Variable-rate demand notes, which have stated maturity dates in excess of 10 years, meet this maturity requirement of the cash management program because the maturity date of these investments is determined based on the interest rate reset date or par value put date for the purpose of applying this criteria.

Investments, exclusive of cash equivalents, with a stated maturity date of one year or less from the balance sheet date or that are expected to be used in current operations, are classified as short-term investments. The Company’s trading securities are also classified as short-term investments.  All other investments are classified as long-term. As of January 29, 2010, investments consisted primarily of municipal bonds, money market funds,  mutual funds, tax-exempt commercial paper, and certificates of deposit.  Restricted balances pledged as collateral for letters of credit for the Company’s extended warranty program and for a portion of the Company’s casualty insurance and Installed Sales program liabilities are also classified as investments.

The Company maintains investment securities in conjunction with certain employee benefit plans that are classified as trading securities.  These securities are carried at fair market value with unrealized gains and losses included in SG&A
 

 
 

 
 

expense.  All other investment securities are classified as available-for-sale and are carried at fair market value with unrealized gains and losses included in accumulated other comprehensive income (loss) in shareholders' equity.

Merchandise Inventory - Inventory is stated at the lower of cost or market using the first-in, first-out method of inventory accounting. The cost of inventory also includes certain costs associated with the preparation of inventory for resale, including distribution center costs, and is net of vendor funds.

The Company records an inventory reserve for the anticipated loss associated with selling inventories below cost.  This reserve is based on management’s current knowledge with respect to inventory levels, sales trends and historical experience. Management does not believe the Company’s merchandise inventories are subject to significant risk of obsolescence in the near term, and management has the ability to adjust purchasing practices based on anticipated sales trends and general economic conditions.  However, changes in consumer purchasing patterns could result in the need for additional reserves.  The Company also records an inventory reserve for the estimated shrinkage between physical inventories.  This reserve is based primarily on actual shrink results from previous physical inventories.  Changes in the estimated shrink reserve may be necessary based on the timing and results of physical inventories.

The Company receives funds from vendors in the normal course of business, principally as a result of purchase volumes, sales, early payments or promotions of vendors’ products, which generally do not represent the reimbursement of specific, incremental and identifiable costs incurred by the Company to sell the vendor’s product.  These funds are treated as a reduction in the cost of inventory as the amounts are accrued, and are recognized as a reduction of cost of sales when the inventory is sold.  The Company develops accrual rates for vendor funds based on the provisions of the agreements in place.  Due to the complexity and diversity of the individual vendor agreements, the Company performs analyses and reviews historical trends throughout the year and confirms actual amounts with select vendors to ensure the amounts earned are appropriately recorded.  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.

Derivative Financial Instruments - The Company occasionally utilizes derivative financial instruments to manage certain business risks.  However, the amounts were not material to the Company’s consolidated financial statements in any of the years presented.  The Company does not use derivative financial instruments for trading purposes.

Credit Programs - The majority of the Company’s accounts receivable arises from sales of goods and services to Commercial Business Customers. The Company has an agreement with GE Money Bank (GE) under which GE purchases at face value new commercial business accounts receivable originated by the Company and services these accounts.  This agreement ends in December 2016, unless terminated sooner by the parties.  The Company accounts for these transfers as sales of the accounts receivable.  When the Company sells its commercial business accounts receivable, it retains certain interests in those receivables, including the funding of a loss reserve and its obligation related to GE’s ongoing servicing of the receivables sold.  Any gain or loss on the sale is determined based on the previous carrying amounts of the transferred assets allocated at fair value between the receivables sold and the interests retained. Fair value is based on the present value of expected future cash flows, taking into account the key assumptions of anticipated credit losses, payment rates, late fee rates, GE’s servicing costs and the discount rate commensurate with the uncertainty involved.  Due to the short-term nature of the receivables sold, changes to the key assumptions would not materially impact the recorded gain or loss on the sales of receivables or the fair value of the retained interests in the receivables.

Total commercial business accounts receivable sold to GE were $1.6 billion in 2009, $1.7 billion in 2008, and $1.8 billion in 2007.  During 2009, 2008 and 2007, the Company recognized losses of $31 million, $38 million and $34 million, respectively, on these receivable sales as SG&A expense, which primarily relates to the fair value of the obligations incurred related to servicing costs that are remitted to GE monthly.  At January 29, 2010 and January 30, 2009, the fair value of the retained interests was determined based on the present value of expected future cash flows and was insignificant.

Sales generated through the Company’s proprietary credit cards are not reflected in receivables.  Under an agreement with GE, credit is extended directly to customers by GE.  All credit-program-related services are performed and controlled directly by GE.  The Company has the option, but no obligation, to purchase the receivables at the end of the agreement in
 

 
 

 

 
December 2016.  Tender costs, including amounts associated with accepting the Company’s proprietary credit cards, are recorded in SG&A expense in the consolidated statements of earnings.

The total portfolio of receivables held by GE, including both receivables originated by GE from the Company’s proprietary credit cards and commercial business accounts receivable originated by the Company and sold to GE, approximated $6.5 billion at January 29, 2010, and $6.8 billion at January 30, 2009.

Property and Depreciation - Property is recorded at cost. Costs associated with major additions are capitalized and depreciated. Capital assets are expected to yield future benefits and have useful lives which exceed one year.  The total cost of a capital asset generally includes all applicable sales taxes, delivery costs, installation costs and other appropriate costs incurred by the Company including interest in the case of self-constructed assets.  Upon disposal, the cost of properties and related accumulated depreciation are removed from the accounts, with gains and losses reflected in SG&A expense on the consolidated statements of earnings.

Depreciation is provided over the estimated useful lives of the depreciable assets. Assets are depreciated using the straight-line method. Assets under capital lease and leasehold improvements are depreciated over the shorter of their estimated useful lives or the term of the related lease, which may include one or more option renewal periods where failure to exercise such options would result in an economic penalty in such amount that renewal appears, at the inception of the lease, to be reasonably assured.  During the term of a lease, if leasehold improvements are placed in service significantly after the inception of the lease, the Company depreciates these leasehold improvements over the shorter of the useful life of the leasehold assets or a term that includes lease renewal periods deemed to be reasonably assured at the time the leasehold improvements are placed into service.  The amortization of these assets is included in depreciation expense on the consolidated financial statements.

Long-Lived Asset Impairment/Exit Activities - The carrying amounts of long-lived assets are reviewed whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable.

Long-lived assets held-for-use includes operating stores as well as excess properties, such as relocated stores, closed stores and other properties, which do not meet the held-for-sale criteria. A potential impairment has occurred for long-lived assets held-for-use if projected future undiscounted cash flows expected to result from the use and eventual disposition of the assets are less than the carrying amounts of the assets.  An impairment loss is recorded for long-lived assets held-for-use when the carrying amount of the asset is not recoverable and exceeds its fair value.

Excess properties that are expected to be sold within the next 12 months and meet the other relevant held-for-sale criteria are classified as long-lived assets held-for-sale.  An impairment loss is recorded for long-lived assets held-for-sale when the carrying amount of the asset exceeds its fair value less cost to sell.  A long-lived asset is not depreciated while it is classified as held-for-sale.

For long-lived assets to be abandoned, the Company considers the asset to be disposed of when it ceases to be used.  Until it ceases to be used, the Company continues to classify the asset as held-for-use and tests for potential impairment accordingly.  If the Company commits to a plan to abandon a long-lived asset before the end of its previously estimated useful life, its depreciable life is re-evaluated.

Impairment losses are included in SG&A expense.  The Company recorded long-lived asset impairment losses of $114 million during 2009, including $53 million for operating stores and $61 million for excess properties.  The Company recorded long-lived asset impairment losses of $21 million during 2008, including $16 million for operating stores and $5 million for excess properties.  The Company recorded long-lived asset impairment losses of $28 million during 2007 for excess properties.

The net carrying amount of excess properties that do not meet the held-for-sale criteria is included in other assets (non-current) on the consolidated balance sheets and totaled $205 million and $174 million at January 29, 2010 and January 30, 2009, respectively.
 

 
 

 
 

When operating leased locations are closed, a liability is recognized for the fair value of future contractual obligations, including future minimum lease payments, property taxes, utilities and common area maintenance, net of estimated sublease income.

Leases - For lease agreements that provide for escalating rent payments or free-rent occupancy periods, the Company recognizes rent expense on a straight-line basis over the non-cancelable lease term and option renewal periods where failure to exercise such options would result in an economic penalty in such amount that renewal appears, at the inception of the lease, to be reasonably assured.  The lease term commences on the date that the Company takes possession of or controls the physical use of the property.  Deferred rent is included in other liabilities (non-current) on the consolidated balance sheets.

Accounts Payable - The Company has an agreement with a third party to provide an accounts payable tracking system which facilitates participating suppliers’ ability to finance payment obligations from the Company with designated third-party financial institutions.  Participating suppliers may, at their sole discretion, make offers to finance one or more payment obligations of the Company prior to their scheduled due dates at a discounted price to participating financial institutions.  The Company’s goal in entering into this arrangement is to capture overall supply chain savings, in the form of pricing, payment terms or vendor funding, created by facilitating suppliers’ ability to finance payment obligations at more favorable discount rates, while providing them with greater working capital flexibility.

The Company’s obligations to its suppliers, including amounts due and scheduled payment dates, are not impacted by suppliers’ decisions to finance amounts under this arrangement.  However, the Company’s right to offset balances due from suppliers against payment obligations is restricted by this arrangement for those payment obligations that have been financed by suppliers.  As of January 29, 2010 and January 30, 2009, $602 million and $393 million, respectively, of the Company’s outstanding payment obligations had been placed on the accounts payable tracking system, and participating suppliers had financed $253 million and $370 million, respectively, of those payment obligations to participating financial institutions.

Self-Insurance - The Company is self-insured for certain losses relating to workers’ compensation, automobile, property, and general and product liability claims.  The Company has stop-loss coverage to limit the exposure arising from these claims.  The Company is also self-insured for certain losses relating to extended warranty and medical and dental claims.  Self-insurance claims filed and claims incurred but not reported are accrued based upon management’s estimates of the discounted ultimate cost for self-insured claims incurred using actuarial assumptions followed in the insurance industry and historical experience.  Although management believes it has the ability to reasonably estimate losses related to claims, it is possible that actual results could differ from recorded self-insurance liabilities.

Income Taxes - The Company establishes deferred income tax assets and liabilities for temporary differences between the tax and financial accounting bases of assets and liabilities.  The tax effects of such differences are reflected in the balance sheet at the enacted tax rates expected to be in effect when the differences reverse.  A valuation allowance is recorded to reduce the carrying amount of deferred tax assets if it is more likely than not that all or a portion of the asset will not be realized.  The tax balances and income tax expense recognized by the Company are based on management’s interpretation of the tax statutes of multiple jurisdictions.

The Company establishes a liability for tax positions for which there is uncertainty as to whether or not the position will be ultimately sustained.  The Company includes interest related to tax issues as part of net interest on the consolidated financial statements.  The Company records any applicable penalties related to tax issues within the income tax provision.

Revenue Recognition - The Company recognizes revenues, net of sales tax, when sales transactions occur and customers take possession of the merchandise. A provision for anticipated merchandise returns is provided through a reduction of sales and cost of sales in the period that the related sales are recorded.  Revenues from product installation services are recognized when the installation is completed.  Deferred revenues associated with amounts received for which customers have not yet taken possession of merchandise or for which installation has not yet been completed were $354 million and $328 million at January 29, 2010, and January 30, 2009, respectively.
 

 
 

 

Revenues from stored-value cards, which include gift cards and returned merchandise credits, are deferred and recognized when the cards are redeemed.  The liability associated with outstanding stored-value cards was $329 million and $346 million at January 29, 2010, and January 30, 2009, respectively, and these amounts are included in deferred revenue on the consolidated balance sheets.The Company recognizes income from unredeemed stored-value cards at the point at which redemption becomes remote.  The Company’s stored-value cards have no expiration date or dormancy fees.  Therefore, to determine when redemption is remote, the Company analyzes an aging of the unredeemed cards based on the date of last stored-value card use. 

Extended Warranties - The Company sells separately-priced extended warranty contracts under a Lowe’s-branded program for which the Company is ultimately self-insured.  The Company recognizes revenue from extended warranty sales on a straight-line basis over the respective contract term.  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.  The Company’s extended warranty deferred revenue is included in other liabilities (non-current) on the consolidated balance sheets.  Changes in deferred revenue for extended warranty contracts are summarized as follows:

       
(In millions)
 
2009
   
2008
 
Extended warranty deferred revenue, beginning of year
  $ 479     $ 407  
Additions to deferred revenue
    220       193  
Deferred revenue recognized
    (150 )     (121 )
Extended warranty deferred revenue, end of year
  $ 549     $ 479  

Incremental direct acquisition costs associated with the sale of extended warranties are also deferred and recognized as expense on a straight-line basis over the respective contract term. Deferred costs associated with extended warranty contracts were $150 million and $121 million at January 29, 2010 and January 30, 2009, respectively.  The Company’s extended warranty deferred costs are included in other assets (non-current) on the consolidated balance sheets.  All other costs, such as costs of services performed under the contract, general and administrative expenses and advertising expenses are expensed as incurred.

The liability for extended warranty claims incurred is included in other current liabilities on the consolidated balance sheets.  Changes in the liability for extended warranty claims are summarized as follows:

       
(In millions)
 
2009
   
2008
 
Liability for extended warranty claims, beginning of year
  $ 17     $ 14  
Accrual for claims incurred
    67       53  
Claim payments
    (61 )     (50 )
Liability for extended warranty claims, end of year
  $ 23     $ 17  
 

 
 

 
 
 
Cost of Sales and Selling, General and Administrative Expenses - The following lists the primary costs classified in each major expense category:

Cost of Sales
 
Selling, General and Administrative
§ Total cost of products sold, including:
- Purchase costs, net of vendor funds;
- Freight expenses associated with moving merchandise inventories from vendors to retail stores;
- Costs associated with operating the Company’s distribution network, including payroll and benefit costs and occupancy costs;
§ Costs of installation services provided;
§ Costs associated with delivery of products directly from vendors to customers by third parties;
§ Costs associated with inventory shrinkage and obsolescence.
 
 
§ Payroll and benefit costs for retail and corporate employees;
§ Occupancy costs of retail and corporate facilities;
§ Advertising;
§ Costs associated with delivery of products from stores to customers;
§ Third-party, in-store service costs;
§ Tender costs, including bank charges, costs associated with credit card interchange fees and amounts associated with accepting the Company’s proprietary credit cards;
§ Costs associated with self-insured plans, and premium costs for stop-loss coverage and fully insured plans;
§ Long-lived asset impairment losses and gains/losses on disposal of assets;
§ Other administrative costs, such as supplies, and travel and entertainment.


Advertising - Costs associated with advertising are charged to expense as incurred.  Advertising expenses were $750 million, $789 million and $788 million in 2009, 2008 and 2007, respectively.

Shipping and Handling Costs - The Company includes shipping and handling costs relating to the delivery of products directly from vendors to customers by third parties in cost of sales.  Shipping and handling costs, which include third party delivery costs, salaries, and vehicle operations expenses relating to the delivery of products from stores to customers, are classified as SG&A expense.  Shipping and handling costs included in SG&A expense were $371 million, $378 million and $361 million in 2009, 2008 and 2007, respectively.

Store Opening Costs - Costs of opening new or relocated retail stores, which include payroll and supply costs incurred prior to store opening and grand opening advertising costs, are charged to expense as incurred.

Comprehensive Income - The Company reports comprehensive income on its consolidated statements of shareholders’ equity.  Comprehensive income represents changes in shareholders' equity from non-owner sources and is comprised primarily of net earnings plus or minus unrealized gains or losses on available-for-sale securities, as well as foreign currency translation adjustments.  Unrealized gains, net of tax, on available-for-sale securities classified in accumulated other comprehensive income (loss) on the consolidated balance sheets were $2 million at both of January 29, 2010 and January 30, 2009.  Foreign currency translation gains, net of tax, classified in accumulated other comprehensive income (loss) were $25 million at January 29, 2010. Foreign currency translation losses, net of tax, classified in accumulated other comprehensive income (loss) were $8 million at January 30, 2009.  The reclassification adjustments for gains/losses included in net earnings were not significant for any of the periods presented.

Recent Accounting Pronouncements - In June 2009, the Financial Accounting Standards Board (FASB) issued authoritative guidance which amends the derecognition guidance on accounting for transfers of financial assets.  The guidance is effective for financial asset transfers occurring in fiscal years beginning after November 15, 2009, and interim periods within those fiscal years.  The adoption of the guidance will not have a material impact on the Company’s consolidated financial statements.

In June 2009, the FASB issued authoritative guidance which amends the consolidation guidance for variable interest entities.  The guidance is effective for fiscal years beginning after November 15, 2009, and interim periods within those
 

 
 

 

 
fiscal years.  The adoption of the guidance will not have a material impact on the Company’s consolidated financial statements.

In October 2009, the FASB issued authoritative guidance on multiple-deliverable revenue arrangements, which addresses the unit of accounting for arrangements involving multiple deliverables.  The guidance also addresses how arrangement consideration should be allocated to separate units of accounting, when applicable, and expands the disclosure requirements for multiple-deliverable arrangements.  The guidance is effective for fiscal years beginning after June 15, 2010.  The Company does not expect the adoption of the guidance to have a material impact on its consolidated financial statements.

In January 2010, the FASB issued authoritative guidance related to fair value measurements which requires additional disclosures about transfers into and out of Levels 1 and 2, and separate disclosures about purchases, sales, issuances and settlements relating to Level 3 measurements.  The guidance also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value.  The guidance is effective for the first reporting period, to include interim periods, beginning after December 15, 2009, except for the portion of the guidance relating to Level 3 activity, which is effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  The Company does not expect the adoption of the guidance to have a material impact on its consolidated financial statements.

Segment Information - The Company’s home improvement retail stores represent a single operating segment based on the way the Company manages its business.  Operating decisions are made at the Company level in order to maintain a consistent retail store presentation.  The Company’s home improvement retail stores sell similar products and services, use similar processes to sell those products and services, and sell their products and services to similar classes of customers.  The amounts of long-lived assets and net sales outside the U.S. were not significant for any of the periods presented.

Reclassifications - Certain prior period amounts have been reclassified to conform to current classifications. The long-term portion of the self-insurance liabilities, primarily for workers’ compensation, automobile, property, and general and product liability claims, of $462 million at January 30, 2009, previously classified as current on the consolidated balance sheets, has been reclassified to other liabilities (non-current).  The current portion of these self-insurance liabilities, previously reported as a single line item on the consolidated balance sheets, has been combined with other current liabilities.  The non-current portion of deferred income taxes related to these self-insurance liabilities has also been reclassified from current to non-current deferred income taxes in the consolidated balance sheets.  These changes were not material and had no impact on the consolidated statements of earnings, shareholders’ equity or cash flows for any of the periods presented.

Note 2: Fair Value Measurements and Financial Instruments -
 
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The authoritative guidance for fair value measurements establishes a three-level hierarchy, which encourages an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The three levels of the hierarchy are defined as follows:

·  
Level 1 - inputs to the valuation techniques that are quoted prices in active markets for identical assets or liabilities

·  
Level 2 - inputs to the valuation techniques that are other than quoted prices but are observable for the assets or liabilities, either directly or indirectly

·  
Level 3 - inputs to the valuation techniques that are unobservable for the assets or liabilities


 
 

 
 

Assets and Liabilities that are Measured at Fair Value on a Recurring Basis

The following tables present the Company’s financial assets measured at fair value on a recurring basis as of January 29, 2010, and January 30, 2009, classified by fair value hierarchy:
 
         
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices in Active Markets for Identical Assets
   
Significant Other
Observable Inputs
   
Significant
Unobservable Inputs
 
(In millions)
 
January 29, 2010
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Available-for-sale securities
  $ 383     $ 70     $ 313     $ -  
Trading securities
    42       42       -       -  
Total short-term investments     425       112       313       -  
 
                               
Available-for-sale securities
    277       -       277       -  
Total long-term investments   $  277     $ -      277     $ -  
 
         
Fair Value Measurements at Reporting Date Using
 
         
Quoted Prices in Active Markets for Identical Assets
   
Significant Other
Observable Inputs
   
Significant
Unobservable Inputs
 
(In millions)
 
January 30, 2009
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Available-for-sale securities
  $ 385     $ 81     $ 304     $ -  
Trading securities
    31       31       -       -  
Total short-term investments     416       112       304       -  
 
                               
Available-for-sale securities
    253       -       253       -  
Total long-term investments   $  253     $ -      253     $ -  

 
When available, quoted prices are used to determine fair value.  When quoted prices in active markets are available, investments are classified within Level 1 of the fair value hierarchy. The Company’s Level 1 investments primarily consist of investments in money market and mutual funds. When quoted prices in active markets are not available, fair values are determined using pricing models and the inputs to those pricing models are based on observable market inputs.  The inputs to the pricing models are typically benchmark yields, reported trades, broker-dealer quotes, issuer spreads and benchmark securities, among others. The Company’s Level 2 investments primarily consist of investments in municipal bonds.
 
Assets and Liabilities that are Measured at Fair Value on a Non-recurring Basis
 
Effective January 31, 2009, the Company adopted authoritative guidance issued by the FASB for non-financial assets and liabilities measured at fair value on a non-recurring basis.

During 2009, the Company had no significant measurements of assets or liabilities at fair value on a non-recurring basis subsequent to their initial recognition, except as it relates to long-lived asset impairment.

The Company reviews the carrying amounts of long-lived assets whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable.  An impairment loss is recognized when the carrying amount of the


 
 

 
 

long-lived asset is not recoverable and exceeds its fair value.  The Company estimated the fair values of long-lived assets held-for-use, including operating stores, based on the Company’s own judgments about the assumptions that market participants would use in pricing the asset and on observable market data, when available.  The Company classified these fair value measurements as Level 3.

In the determination of impairment for operating stores, the Company used an income approach to determine the fair value of individual operating stores, which required discounting projected future cash flows.   When determining the stream of projected future cash flows associated with an individual operating store, management made assumptions, incorporating local market conditions, about key store variables including sales growth rates, gross margin and controllable expenses such as store payroll and occupancy expense.  In order to calculate the present value of those future cash flows, the Company discounted cash flow estimates at a rate commensurate with the risk that selected market participants would assign to the cash flows.  The selected market participants represent a group of other retailers with a store footprint similar in size to the Company’s.

In the determination of impairment for excess properties held-for-use, the fair values were the estimated selling prices.  The Company determined the estimated selling prices by obtaining information from brokers in the specific markets being evaluated.  The information included comparable sales of similar assets and assumptions about demand in the market for these assets.

In the determination of impairment for excess properties held-for-sale, the fair values were the estimated selling prices, as determined for excess properties held-for-use, less cost to sell.

The following table presents the Company’s non-financial assets required to be measured at fair value on a non-recurring basis and any resulting realized losses included in earnings. Because long-lived assets are not measured at fair value on a recurring basis, certain carrying amounts and fair value measurements included in the table may reflect values at earlier measurement dates and may no longer represent the carrying amounts and fair values at January 29, 2010.

   
Fair Value Measurements - Non-recurring Basis
 
       
Operating Stores
 
Excess Properties
 
(In millions)
 
Total
 
Long-lived assets held-for-use
 
Long-lived assets held-for-use
 
Long-lived assets held-for-sale
 
For the year ended January 29, 2010:
                       
Fair value measurements
  $ 105     $ 6     $ 74     $ 25  
Previous carrying amounts
    219       59       114       46  
Impairment losses
  $ (114 )   $ (53 )   $ (40 )   $ (21 )

The Company’s financial instruments not measured at fair value on a recurring basis include cash and cash equivalents, accounts receivable, short-term borrowings, accounts payable, accrued liabilities and long-term debt and are reflected in the financial statements at cost.  With the exception of long-term debt, cost approximates fair value for these items due to their short-term nature.  Estimated fair values for long-term debt have been determined using available market information, including reported trades, benchmark yields and broker-dealer quotes.

Carrying amounts and the related estimated fair value of the Company’s long-term debt, excluding capital leases and other, are as follows:
 
   
January 29, 2010
   
January 30, 2009
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
(In millions)
 
Amount
   
Value
   
Amount
   
Value
 
Long-term debt (excluding capital leases and other)
$ 4,737     $ 5,127     $ 4,726     $ 4,653  
 

 
 

 
 

NOTE 3: Investments -

The amortized costs, gross unrealized holding gains and losses, and fair values of the Company’s investment securities classified as available-for-sale at January 29, 2010, and January 30, 2009, are as follows:

   
January 29, 2010
 
Type
Amortized
 
Gross Unrealized
 
Gross Unrealized
 
Fair
 
(In millions)
Costs
 
Gains
 
Losses
 
Values
 
Municipal bonds
  $ 301     $ 2     $ -     $ 303  
Money market funds
    68       -       -       68  
Tax-exempt commercial paper
    10       -       -       10  
Certificates of deposit
    2       -       -       2  
Classified as short-term
    381       2       -       383  
Municipal bonds