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LOW > SEC Filings for LOW > Form 10-K on 2-Apr-2013All Recent SEC Filings

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Form 10-K for LOWES COMPANIES INC


2-Apr-2013

Annual Report


Item 7 - Management's Discussion and Analysis of 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 February 1, 2013 (our fiscal years 2012, 2011 and 2010). Fiscal year 2011 contains 53 weeks of operating results compared to fiscal years 2012 and 2010 which contain 52 weeks. Unless otherwise noted, all references herein for the years 2012, 2011 and 2010 represent the fiscal years ended February 1, 2013, February 3, 2012 and January 28, 2011, respectively. We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements. This discussion should be read in conjunction with our consolidated financial statements and notes to the consolidated financial statements included in this Annual Report on Form 10-K 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:

ˇ Executive Overview

ˇ Operations

ˇ Lowe's Business Outlook

ˇ Financial Condition, Liquidity and Capital Resources

ˇ Off-Balance Sheet Arrangements

ˇ Contractual Obligations and Commercial Commitments

ˇ Critical Accounting Policies and Estimates

EXECUTIVE OVERVIEW

During 2012, we made progress on our key initiatives, continuing our journey to become the customer's first choice in home improvement. The economic environment showed signs of improvement as fiscal 2012 represented the first year of growth across all of the core housing metrics: housing turnover, single-family starts, and median home prices. These recent positive trends helped consumers regain confidence in both the local housing markets and their home values. Consequently, we were able to deliver solid results for the year. Net earnings for 2012 increased 6.5% to $2.0 billion and diluted earnings per share increased 18.2% to $1.69. Net sales for 2012 increased 0.6% to $50.5 billion. Fiscal 2011 contained an extra week which contributed $766 million to 2011 net sales or $0.05 to diluted earnings per share. Comparable sales were 1.4%, driven by a 0.9% increase in comparable average ticket and a 0.5% increase in comparable transactions.

For 2012, cash flows from operating activities were approximately $3.8 billion, with $1.2 billion used for capital expenditures. Our strong financial position and positive cash flows provided us with the ability to make strategic investments in our core business and to return cash to shareholders through both dividends and share repurchases. During fiscal 2012, we paid $704 million in dividends and repurchased approximately 146 million shares of common stock for a total of $4.35 billion under our share repurchase program.

Continuing our journey

In 2012, we continued to deliver on our commitment to retail excellence by building on our core strengths, while developing capabilities to provide seamless support across channels and a simplified home improvement experience.

To further deliver a seamless and simple experience, we continued to upgrade our IT infrastructure and gave customers and associates greater access to information and products through enhanced mobile technology, MyLowes, and flexible fulfillment. In 2012, we made additional improvements to our associates' iPhoneŽ capabilities to enable them to deliver better customer experiences in the aisle by giving them immediate access to the information they need, such as the ability to identify available rebates. Our MyLowes customer base also continues to grow. Since the launch of MyLowes in late


2011, there have been over 18 million unique key fob swipes and over 5 million cardholders have registered their cards on MyLowes. We also experienced strong customer response to our iPhoneŽ and AndroidTM mobile applications which have grown to represent approximately 20% of overall Lowes.com traffic. In addition, flexible fulfillment now allows us to deliver in-stock Lowes.com parcel orders to customers in over 90% of US markets within 24 hours at standard shipping rates.

As we redefine our business to become more seamless and simple, we must also continue to protect retail relevance. In 2012, our focus was on two key initiatives: Value Improvement and Product Differentiation. Value Improvement is designed to enhance our ability to offer compelling products and value while Product Differentiation is designed to help us drive excitement and flexibility in our stores by highlighting innovative products through better display techniques. These strategic initiatives build on Lowe's core strengths and are expected to deliver comparable transaction growth, better gross margins, and greater inventory productivity by localizing assortments and driving excitement in our stores.

Value Improvement enhances our ability to offer compelling products and value by having the right product, at the right quantity, at the right place, at the right time. In 2012, we leveraged our Integrated Planning and Execution tool to create clusters of stores, based on specific differences and customer buying preferences, which enhanced the assortment strategy that was used to guide the line review process. For each cluster, the product assortments were designed to reduce duplication of features and functions within price points to improve the customer experience. We are also working to reduce unit costs by negotiating lower first costs from vendors by eliminating funds set aside for promotional and marketing support. The result is a more localized assortment of products and simpler price point progression within the category. As SKUs are rationalized, the teams are reinvesting the inventory dollars in greater depth of high volume SKUs. In addition, we are increasing our in-stock targets for these new lines to ensure items are available when needed by customers. By the end of 2012, we completed product line reviews and product line resets of approximately 80% and 30% of our business, respectively.

Through our Product Differentiation initiative, we revised many of our end-cap locations to highlight innovative products, significant values, or to showcase specific private or national brands. In addition, we redesigned promotional spaces to better promote seasonally relevant, high value items to drive sales and to provide more open sight lines to navigate and shop at our stores. During 2012, our product differentiation resets were rolled out to approximately 1,250 stores, and we expect to roll the resets out to an additional 160 stores in 2013.

In conjunction with our progress on Value Improvement and Product Differentiation, in 2012 we also initiated sales training programs for store and contact center employees to further develop our sales culture and pave the way for the next phase of our transformation.

Where we go from here - 2013 and beyond

While the housing market is slowly improving, consumers are still coping with the lingering effects of the recession as mortgage delinquency rates remain at historic highs. While we are optimistic about a housing recovery and near-term personal consumption expenditures are expected to grow faster than personal income, employment and income are expected to continue to grow slowly. Consumers will need to continue to prioritize how and where they spend their discretionary income and therefore our outlook for 2013 assumes modest growth in the home improvement market. However we have confidence in our vision and have laid the foundation to continue improving our core business as we move into fiscal year 2013.

In 2013, our Value Improvement initiative will remain the primary focus of the organization. As we improve our product offerings by localizing assortments we expect to drive improved close rates. We also have an opportunity to improve close rates through additional labor in our stores. We expect to add approximately 150 hours per store per week to the staffing model for nearly two-thirds of our stores to help reduce the gap between our weekend versus weekday close rate. Our goal is to better serve customers and close more sales during peak weekday hours by increasing assistance available in the aisles. We believe the increased labor hours and higher in-stock service levels will help us further capitalize on traffic during the week which will result in an improvement in close rates.


In 2013 and beyond, we will further develop our flexible fulfillment capability by deploying Central Dispatch (CDO) and Central Production Offices (CPO). The CDO will allow for centralized delivery scheduling and better route planning, resulting in lower fuel cost, greater fleet utilization, and more productive overall delivery. The CPO will provide operational efficiencies through the consolidation of labor. Today each store has its own installed sales office, whereas, in the future, that labor will be consolidated into our contact centers resulting in a significant reduction of labor hours. The customer's experience will be enhanced through better coordination and consistency.

We will also build trust by partnering with customers to recommend solutions that fit their needs and to help them make the right decisions based on their individual home improvement goals. Beyond 2013, we will further enhance our sales culture by providing our associates the ability to sell seamlessly across channels and to introduce improved project management tools that expand fulfillment capabilities to cultivate personal and simple connections with customers. Associates across selling channels will be provided with a single-view of the customer; one record per customer, from lead capture to project completion. These changes will enable us to improve close rates and capitalize on the momentum of the improving economy and increases in consumer discretionary spending.

By building on core strengths, we have laid the foundation to deliver on our commitment to retail excellence, and will continue to focus on developing the capabilities to provide our customers a seamless and simple home improvement experience going forward.


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           Percentage
                                                                Increase /           Increase /
                                                             (Decrease) in        (Decrease) in
                                                             Percentage of       Dollar Amounts
                                                            Net Sales from      from Prior Year
                                                              Prior Year 1                    1
                                   2012          2011        2012 vs. 2011        2012 vs. 2011
Net sales                        100.00 %      100.00 %                N/A                  0.6 %
Gross margin                      34.30         34.56                  (26 )               (0.1 )
Expenses:
Selling, general and
administrative                    24.24         25.08                  (84 )               (2.8 )
Depreciation                       3.01          2.95                    6                  2.9
Interest - net                     0.84          0.74                   10                 13.9
Total expenses                    28.09         28.77                  (68 )               (1.8 )
Pre-tax earnings                   6.21          5.79                   42                  7.9
Income tax provision               2.33          2.13                   20                 10.4
Net earnings                       3.88 %        3.66 %                 22                  6.5 %
EBIT margin 2                      7.05 %        6.53 %                 52                  8.6 %

                                                               Basis Point           Percentage
                                                                Increase /           Increase /
                                                            (Decrease) in         (Decrease) in
                                                             Percentage of       Dollar Amounts
                                                            Net Sales from      from Prior Year
                                                              Prior Year 1                    1
                                   2011          2010        2011 vs. 2010        2011 vs. 2010
Net sales                        100.00 %      100.00 %                N/A                  2.9 %
Gross margin                      34.56         35.14                  (58 )                1.2
Expenses:
Selling, general and
administrative                    25.08         24.60                   48                  4.9
Depreciation                       2.95          3.25                  (30 )               (6.7 )
Interest - net                     0.74          0.68                    6                 11.7
Total expenses                    28.77         28.53                   24                  3.7
Pre-tax earnings                   5.79          6.61                  (82 )              (10.0 )
Income tax provision               2.13          2.49                  (36 )              (12.4 )
Net earnings                       3.66 %        4.12 %                (46 )               (8.5 ) %
EBIT margin 2                      6.53 %        7.29 %                (76 )               (7.9 ) %


Other Metrics                                  2012          2011          2010
Comparable sales increase 3, 4                  1.4 %         0.0 %         1.3 %
Total customer transactions (in
millions) 1                                     804           810           786
Average ticket 5                          $   62.82     $   62.00     $   62.07
At end of year:
Number of stores                              1,754         1,745         1,749
Sales floor square feet (in millions)           197           197           197
Average store size selling square feet
(in thousands) 6                                113           113           113
Return on average assets 7                      5.7 %         5.4 %         5.8 %
Return on average shareholders' equity
8                                              13.1 %        10.7 %        10.7 %
Return on invested capital 9                    9.3 %         8.7 %         9.0 %

1 Fiscal year ended 2011 had 53 weeks. Fiscal years 2012 and 2010 had 52 weeks. 2 EBIT margin, also referred to as operating margin, is defined as earnings before interest and taxes as a percentage of sales.
3 A comparable location is defined as a location that has been open longer than 13 months. A location that is identified for relocation is no longer considered comparable one month prior to its relocation. The relocated location must then remain open longer than 13 months to be considered comparable. A location we have decided to close is no longer considered comparable as of the beginning of the month in which we announce its closing.
4 Comparable sales are based on comparable 52-week periods for 2012 and 2010 and comparable 53-week periods for 2011.
5 Average ticket is defined as net sales divided by the total number of customer transactions.
6 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.
7 Return on average assets is defined as net earnings divided by average total assets for the last five quarters.
8 Return on average shareholders' equity is defined as net earnings divided by average shareholders' equity for the last five quarters.
9 Return on invested capital is a non-GAAP financial measure. See below for additional information.

Return on Invested Capital

Return on Invested Capital (ROIC) is considered a non-GAAP financial measure. We believe ROIC is a meaningful metric for investors because it measures how effectively the Company uses capital to generate profits.

We define ROIC as trailing four quarters' net operating profit after tax divided by the average of ending debt and equity for the last five quarters. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by our management to calculate ROIC may differ from the methods other companies use to calculate their ROIC. We encourage you to understand the methods used by another company to calculate its ROIC before comparing its ROIC to ours.

We consider return on average debt and equity to be the financial measure computed in accordance with generally accepted accounting principles that is the most directly comparable GAAP financial measure to ROIC. The difference between these two measures is that ROIC adjusts net earnings to exclude tax adjusted interest expense.


The calculation of ROIC, together with a reconciliation to the calculation of return on average debt and equity, the most comparable GAAP financial measure, is as follows:

(In millions, except percentage data)
Calculation of Return on Invested Capital       2012         2011         2010
Numerator
Net earnings                                $  1,959     $  1,839     $  2,010
Plus:
Interest expense - net                           423          371          332
Provision for income taxes                     1,178        1,067        1,218
Earnings before interest and taxes             3,560        3,277        3,560
Less:
Income tax adjustment 1                        1,337        1,203        1,343
Net operating profit after tax              $  2,223     $  2,074     $  2,217

Effective tax rate                              37.6 %       36.7 %       37.7 %
Denominator
Average debt and equity 2                   $ 23,921     $ 23,940     $ 24,634
Return on invested capital                       9.3 %        8.7 %        9.0 %

Calculation of Return on Average Debt and Equity
Numerator
Net earnings                                $  1,959     $  1,839     $  2,010
Denominator
Average debt and equity 2                   $ 23,921     $ 23,940     $ 24,634
Return on average debt and equity                8.2 %        7.7 %        8.2 %

1 Income tax adjustment is defined as earnings before interest and taxes multiplied by the effective tax rate.

2 Average debt and equity is defined as average debt, including current maturities and short-term borrowings, plus total equity for the last five quarters.

Fiscal 2012 Compared to Fiscal 2011

For the purpose of the following discussion, comparable sales, comparable average ticket and comparable customer transactions are based on comparable 52-week periods.

Net sales - Net sales increased 0.6% to $50.5 billion in 2012. The additional week in 2011 and resulting week shift in 2012 negatively impacted sales comparisons by $692 million, or 1.4%. Comparable sales increased 1.4% in 2012, driven by a 0.9% increase in comparable average ticket and a 0.5% increase in comparable customer transactions. Our key initiatives, Value Improvement and Product Differentiation, drove 40 basis points of the increase in sales. In addition, our proprietary credit value proposition, which offers customers the choice of 5% off every day or promotional financing, contributed 65 basis points to the increase in sales. Geographically, all operating divisions in the U.S. delivered positive comparable sales for the year as sales performance was well balanced in 2012. Furthermore, we continued to see strength in our Pro Services business, which outperformed the company average.

We experienced comparable sales above the company average in the following product categories during 2012: Lumber, Tools & Outdoor Power Equipment, Paint, Seasonal Living, Cabinets & Countertops, and Home Fashions, Storage & Cleaning. In addition, Fashion Electrical, Hardware, Flooring and Plumbing performed at approximately the overall company average. Inflation aided comparable sales throughout the year in both the Lumber and Paint categories.


Comparable sales for Paint also benefited from new product offerings. Hurricane Sandy also contributed to comparable sale increases for Lumber, as a result of storm response efforts, and for Tools & Outdoor Power Equipment, due to increased generator sales. In addition, Tools & Outdoor Power Equipment comparable sales were also positively impacted by favorable weather in the first half of the year combined with effective promotions.

Comparable sales were below the company average in Building Materials, Millwork, Appliances, and Lawn & Garden. The timing of storm recovery and repair efforts in 2012 as compared to 2011 resulted in decreased comparable sales in Building Materials. In addition, difficult comparisons to prior year promotional activity led to decreased comparable sales in Millwork and Appliances. Lawn & Garden was impacted by extreme heat and drought conditions in the first half of the year, slightly offset by improved inventory planning and attachment rates in the second half of the year.

Gross margin - Gross margin of 34.3% for 2012 represented a 26 basis point decrease from 2011, primarily driven by an unfavorable 19 basis point impact related to our proprietary credit value proposition. In addition, we experienced a seven basis point unfavorable impact to margin related to pricing and promotional activity.

SG&A - The 84 basis point decrease in SG&A expense as a percentage of sales from 2011 to 2012 was primarily driven by 81 basis points of leverage due to long-lived asset impairment and other costs associated with the 27 store closures and discontinued projects in 2011. We also experienced approximately 35 basis points of leverage associated with our proprietary credit program, which was driven by increased portfolio income as a result of continued growth in the program. These were partially offset by deleverage of approximately 15 basis points associated with incentive compensation, due to higher attainment levels compared to targets for store-based employees relative to last year. In addition, we experienced nine basis points of deleverage in contract labor associated with information technology projects to improve customer experiences.

Depreciation - Depreciation expense deleveraged six basis points for 2012 compared to 2011 primarily due to higher depreciation associated with IT capital investments made to improve customer experiences, which have shorter average useful lives. Property, less accumulated depreciation, decreased to $21.5 billion at February 1, 2013 compared to $22.0 billion at February 3, 2012. At February 1, 2013 and February 3, 2012, we owned 89% of our stores, which included stores on leased land.

Interest - Net - Net interest expense is comprised of the following:

(In millions)                                             2012      2011
Interest expense, net of amount capitalized              $ 427     $ 379
Amortization of original issue discount and loan costs       5         4
Interest income                                             (9 )     (12 )
Interest - net                                           $ 423     $ 371

Net interest expense increased primarily as a result of the issuance of $1.0 billion and $2.0 billion of unsecured notes in November 2011 and April 2012, respectively, partially offset by favorable tax settlements that resulted in a reduced interest accrual during 2012.

Income tax provision - Our effective income tax rate was 37.6% in 2012 compared to 36.7% in 2011. The lower effective tax rate in 2011 was the result of the recognition of one-time federal employee retention benefits from the federal HIRE (Hiring Incentives to Restore Employment) retention tax credit, as well as the favorable settlement of certain state tax matters in the third quarter of 2011.

Fiscal 2011 Compared to Fiscal 2010

For the purpose of the following discussion, comparable sales, comparable average ticket and comparable customer transactions are based on comparable 53-week periods.


Net sales - Net sales increased 2.9% to $50.2 billion in 2011, while comparable sales were flat. The additional week in 2011 contributed 1.6% to the increase in net sales. Comparable customer transactions increased approximately 0.4% and comparable average ticket decreased 0.4% versus 2010.

While comparable sales were flat in 2011, we saw sequential improvement each quarter, with comparable sales of negative 3.3% in the first quarter, negative 0.3% in the second quarter, positive 0.7% in the third quarter and positive 3.4% in the fourth quarter. Unseasonably cold, wet weather, severe storms and flooding during the first quarter as well as comparisons to the 2010 Cash for Appliances government incentive program led to lower performance during the first half of the year. However, as comparisons to the Cash for Appliances program eased and storm recovery efforts were underway, we saw improvement in comparable sales. In addition, strong customer response to our 5% off every-day offer to Lowe's credit cardholders, launched in the first half of 2011, aided comparable sales for the balance of the year.

We experienced comparable sales above the company average in the following product categories during 2011: Building Materials, Fashion Electrical, Paint, Hardware, Plumbing, and Tools & Outdoor Power Equipment. In addition, Seasonal Living, Home Fashions, Storage & Cleaning, Flooring, Lawn & Garden and Lumber performed at approximately the overall company average. Although unfavorable weather in the early part of the year negatively impacted outdoor categories such as Building Materials, recovery efforts after severe spring storms that hit many regions of the country and hurricane Irene positively impacted comparable sales in Building Materials, with particularly strong sales of roofing products and installation services. Plumbing also benefited from the wet weather and storm recovery efforts, with strong sales of pumps & tanks and dehumidifiers. In addition, Tools & Outdoor Power Equipment experienced favorable comparable sales primarily driven by holiday promotions and strong customer response to new products, such as our new line of Kobalt mechanics tools. Fashion Electrical also performed above the company average during 2011, driven by increased customer demand for energy-saving light bulbs, outdoor lighting and electrical cable.

However, difficult comparisons to prior year energy tax credits negatively impacted comparable sales in Millwork. In addition, while we experienced strong market share gains in Cabinets & Countertops, they were not enough to offset the impact of the contracting market, leading to comparable sales below the company average for the year. Appliances also experienced negative comparable sales for the year driven by comparisons to the prior year Cash for Appliances program, . . .

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