Item 7. Management’s Discussion and Analysis
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 two-year period ended February 3, 2023 (our fiscal years 2022 and 2021). Unless otherwise noted, all references herein for the years 2022, 2021, and 2020 represent the fiscal years ended February 3, 2023, January 28, 2022, and January 29, 2021, respectively. Fiscal year 2022 contains 53 weeks of operating results compared to fiscal years 2021 and 2020, which contain 52 weeks. 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 that have been prepared in accordance with accounting principles generally accepted in the United States of America. This discussion and analysis is presented in four sections:
• Executive Overview
• Operations
• Financial Condition, Liquidity and Capital Resources
• Critical Accounting Policies and Estimates
EXECUTIVE OVERVIEW
Net sales for fiscal 2022 increased 0.8% over fiscal 2021 to $97.1 billion. The increase in total sales was primarily driven by the 53rd week, partially offset by a decrease in comparable sales. The 53rd week contributed approximately 1.4% to the sales growth for 2022. Comparable sales decreased 0.9% over fiscal 2021, driven by a 7.6% decrease in comparable customer transactions, partially offset by a 6.7% increase in comparable average ticket. Net earnings for fiscal 2022 decreased 23.8% to $6.4 billion. Diluted earnings per common share decreased 15.5% in fiscal 2022 to $10.17 from $12.04 in fiscal 2021. Included in the fiscal 2022 results is $2.5 billion of pre-tax costs associated with the sale of the Canadian retail business consisting of long-lived asset impairment, loss on sale, and additional closing costs, which decreased diluted earnings per share by $3.64. Adjusting for these items, adjusted diluted earnings per common share increased 14.7% to $13.81 in 2022 from diluted earnings per common share of $12.04 in 2021 (see the non-GAAP financial measures discussion).
For fiscal 2022, cash flows from operating activities were $8.6 billion, with $1.8 billion used for capital expenditures. Continuing to deliver on our commitment to return excess cash to shareholders, the Company repurchased $14.1 billion of common stock and paid $2.4 billion in dividends during the year.
The Total Home strategy remained our focus for the year, which reflects our commitment to provide a full complement of products and services for Pro and DIY consumers alike, enabling a Total Home solution for every project across the home. During the year, our continued investment in the Pro customer helped generate broad-based demand with positive comparable sales in our core Pro categories. In the first quarter, we launched our Pro loyalty program, MVPs Pro Rewards and Partnership Program TM , which is centered on creating a partnership with our Pro customers. In addition, throughout the year, we improved Pro product and service offerings, and enhanced product assortments to meet Pro needs. Demand with our DIY customer was strong in core, home-improvement categories throughout the year, while discretionary DIY category performance lagged due to a short spring season, cycling unprecedented demand over the past two years, and a reduction of holiday purchases.
Our Perpetual Productivity Improvement (PPI) initiatives continued to gain efficiencies through our enhanced labor management tools, store inventory management system, and improved pricing capabilities. Also, to date, we have converted 11 geographic areas to our market-based delivery model for big and bulky product. In this model, product flows directly to customer homes from our distribution network, bypassing stores altogether. We expect these initiatives and our investments in the business to deliver operating margin productivity and drive meaningful long-term shareholder value going forward.
While improving our operating discipline, we have continued to invest in our front-line associates. In addition to the discretionary and profit-sharing bonuses awarded throughout the year, we implemented $170 million in annual wage increases effective December 2022. These compensation investments reflect our commitment to becoming the employer of choice in retail.
With the sale of our Canadian retail business on February 3, 2023, we are focused on the transformation of our U.S. home improvement business to further enhance our operating margin, simplify our business model, and deliver sustainable value to our shareholders. We believe the core demand drivers of our business are disposable personal income, home price appreciation, and the age of the housing stock. The typical homeowner today has significant equity in his or her home, while the housing
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stock continues to age. These factors, along with strong millennial household formation, elderly preference to age in place, and widespread remote work, continue to support the home improvement market, and we believe we are well-positioned to gain market share through our Total Home strategy.
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
2022 2021 2022 vs. 2021 2022 vs. 2021
Net sales 100.00 % 100.00 % N/A 0.8 %
Gross margin 33.23 33.30 (7) 0.6
Expenses:
Selling, general and administrative 20.94 19.01 193 11.1
Depreciation and amortization 1.82 1.73 9 6.2
Operating income 10.47 12.56 (209) (16.0)
Interest – net 1.16 0.92 24 26.8
Pre-tax earnings 9.31 11.64 (233) (19.4)
Income tax provision 2.68 2.87 (19) (6.0)
Net earnings 6.63 % 8.77 % (214) (23.8) %
Basis Point Increase / (Decrease) in Percentage of Net Sales from Prior Year
Percentage Increase / (Decrease) in Dollar Amounts from Prior Year
2021 2020 2021 vs. 2020 2021 vs. 2020
Net sales 100.00 % 100.00 % N/A 7.4 %
Gross margin 33.30 33.01 29 8.4
Expenses:
Selling, general and administrative 19.01 20.68 (167) (1.2)
Depreciation and amortization 1.73 1.56 17 18.8
Operating income 12.56 10.77 179 25.4
Interest – net 0.92 0.95 (3) 4.4
Loss on extinguishment of debt — 1.18 (118) (100.0)
Pre-tax earnings 11.64 8.64 300 44.8
Income tax provision 2.87 2.13 74 45.3
Net earnings 8.77 % 6.51 % 226 44.7 %
The following table sets forth key metrics utilized by management in assessing business performance. 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.
During fiscal 2022, the Company adjusted its comparable sales metric to exclude days affected by national outages with its third-party credit and debit processor. Excluding these days, and the corresponding prior period days, increased comparable sales by approximately 5 basis points for fiscal 2022. The comparable sales metric for fiscal 2021 and 2020 were not impacted or adjusted by similar outages.
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Other Metrics 2022 1
2021 2020
Comparable sales (decrease)/increase 2
(0.9) % 6.9 % 26.1 %
Total customer transactions (in millions) 937 1,002 1,046
Average ticket 3
$ 103.64 $ 96.09 $ 85.67
At end of year:
Number of stores 1,738 1,971 1,974
Sales floor square feet (in millions) 195 208 208
Average store size selling square feet (in thousands) 4
112 106 105
Return on average assets 5
13.9 % 17.5 % 12.4 %
Net earnings to average debt and shareholders’ (deficit)/equity 6
26.6 % 32.3 % 21.9 %
Return on invested capital 6
30.4 % 35.3 % 27.7 %
1 The fiscal year ended February 3, 2023 had 53 weeks. The fiscal years ended January 28, 2022 and January 29, 2021 had 52 weeks.
2 A comparable location is defined as a retail location that has been open longer than 13 months. A location that is identified for relocation is no longer considered comparable in the month of 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. Operating locations which are sold are included in comparable sales until the date of sale. Comparable sales include online sales, which positively impacted the comparable sales increase in fiscal 2022, fiscal 2021, and fiscal 2020 by approximately 45 basis points, 150 basis points, and 565 basis points, respectively. The comparable sales calculation for 2022 included in the preceding table was calculated using sales for a comparable 53-week period.
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. The average Lowe’s-branded home improvement store has approximately 112,000 square feet of retail selling space.
5 Return on average assets is defined as net earnings divided by average total assets for the last five quarters.
6 Return on invested capital is calculated using a non-GAAP financial measure. Net earnings to average debt and shareholders’ (deficit)/equity is the most comparable GAAP ratio. As of February 3, 2023, ROIC was negatively impacted approximately 800 basis points as a result of the sale of the Canadian retail business. See below for additional information and reconciliations of non-GAAP measures.
Non-GAAP Financial Measures
Adjusted Diluted Earnings Per Share
Adjusted diluted earnings per share is considered a non-GAAP financial measure. The Company believes this non-GAAP financial measure provides useful insight for analysts and investors in evaluating what management considers the Company’s core operating performance. Adjusted diluted earnings per share excludes the impact of a discrete item, further described below, not contemplated in the Company’s business outlook for fiscal 2022. There were no non-GAAP adjustments in fiscal 2021.
Fiscal 2022 Impacts
• In the third quarter of fiscal 2022, the Company recognized a pre-tax $2.1 billion long-lived asset impairment of the Canadian retail business. In the fourth quarter of fiscal 2022, the Company recognized additional pre-tax costs totaling $441 million, consisting of the loss on the sale and other closing costs associated with the sale of the Canadian retail business (Canadian retail business transaction costs).
Adjusted diluted earnings per share should not be considered an alternative to, or more meaningful indicator of, the Company’s diluted earnings per common share as prepared in accordance with GAAP. The Company’s methods of determining this non-GAAP financial measure may differ from the method used by other companies and may not be comparable.
2022
Pre-Tax Earnings Tax 1
Net Earnings
Diluted earnings per share, as reported $ 10.17
Non-GAAP adjustments – per share impacts
Canadian retail business transaction costs 3.95 (0.31) 3.64
Adjusted diluted earnings per share $ 13.81
1 Represents the corresponding tax benefit or expense specifically related to the item excluded from adjusted diluted earnings per share.
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Return on Invested Capital
Return on Invested Capital (ROIC) is calculated using a non-GAAP financial measure. Management believes ROIC is a meaningful metric for analysts and investors as a measure of how effectively the Company is using capital to generate financial returns. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by our management may differ from the methods used by other companies. We encourage you to understand the methods used by another company to calculate ROIC before comparing its ROIC to ours.
We define ROIC as the rolling 12 months’ lease adjusted net operating profit after tax (Lease adjusted NOPAT) divided by the average of current year and prior year ending debt and shareholders’ (deficit)/equity. Lease adjusted NOPAT is a non-GAAP financial measure, and net earnings is considered to be the most comparable GAAP financial measure. The calculation of ROIC, together with a reconciliation of net earnings to Lease adjusted NOPAT, is as follows:
(In millions, except percentage data) 2022 2021 2020
Calculation of Return on Invested Capital
Numerator
Net earnings $ 6,437 $ 8,442 $ 5,835
Plus:
Interest expense – net 1,123 885 848
Operating lease interest 163 160 171
Loss on extinguishment of debt — — 1,060
Provision for income taxes 2,599 2,766 1,904
Lease adjusted net operating profit 10,322 12,253 9,818
Less:
Income tax adjustment 1
2,970 3,024 2,416
Lease adjusted net operating profit after tax $ 7,352 $ 9,229 $ 7,402
Denominator
Average debt and shareholders’ (deficit)/equity 2
$ 24,155 $ 26,109 $ 26,686
Net earnings to average debt and shareholders’ (deficit)/equity 26.6 % 32.3 % 21.9 %
Return on invested capital 3
30.4 % 35.3 % 27.7 %
1 Income tax adjustment is defined as net operating profit multiplied by the effective tax rate, which was 28.8%, 24.7%, and 24.6% for 2022, 2021, and 2020, respectively.
2 Average debt and shareholders’ (deficit)/equity is defined as average current year and prior year ending debt, including current maturities, short-term borrowings, and operating lease liabilities, plus the average current year and prior year ending total shareholders’ (deficit)/equity.
3 As of February 3, 2023, ROIC was negatively impacted approximately 800 basis points as a result of the sale of the Canadian retail business.
Fiscal 2022 Compared to Fiscal 2021
For the purpose of the following discussion, comparable store sales, comparable average ticket, and comparable customer transactions are based upon comparable 53-week periods.
Net Sales – Net sales increased 0.8% to $97.1 billion in 2022. The increase in total sales was driven by the 53rd week, partially offset by a decrease in comparable sales. The 53rd week contributed approximately 1.4% to the sales growth for 2022. Comparable sales decreased 0.9% over the same period, driven by a 7.6% decline in comparable customer transactions, partially offset by a 6.7% increase in comparable average ticket. Comparable sales change during each quarter of the fiscal year, as reported, were a decline of 4.0% in the first quarter, decline of 0.3% in the second quarter, increase of 2.2% in the third quarter, and decline of 1.5% in the fourth quarter.
During 2022, we experienced comparable sales increases in six of 14 product categories, led by Rough Plumbing, Building Materials, and Paint. Strength in these categories reflects robust demand from Pro customers, as well as unit price increases
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driven by inflation. We experienced our lowest comparable sales in Seasonal & Outdoor Living, Tools, and Lawn & Garden. Geographically, three of 15 U.S. regions experienced positive comparable sales with strength primarily in the south, while our Canadian operations lagged the U.S.
Gross Margin – Gross margin as a percentage of sales for 2022 contracted 7 basis points compared to 2021. Gross margin was negatively impacted by 30 basis points from higher transportation costs and expansion of our supply chain network and 20 basis points from inventory shrink. These were partially offset by approximately 25 basis points of favorable product mix and 20 basis points of total rate improvement driven by continued improvement in managing product costs and disciplined pricing strategies.
SG&A – SG&A expense for 2022 deleveraged 193 basis points as a percentage of sales compared to 2021. This was primarily driven by the long-lived asset impairment, loss on sale, and other closing costs associated with the sale of the Canadian retail business, partially offset by ongoing productivity initiatives.
Depreciation and Amortization – Depreciation and amortization expense deleveraged 9 basis points for 2022 as a percentage of sales compared to 2021, driven by ongoing capital investments in core business investments. Property, less accumulated depreciation, decreased to $17.6 billion at February 3, 2023, compared to $19.1 billion at January 28, 2022, primarily due to the impairment of the Canadian retail business long-lived assets in the third quarter of 2022.
Interest – Net – Net interest expense is comprised of the following:
(In millions) 2022 2021
Interest expense, net of amount capitalized $ 1,137 $ 869
Amortization of original issue discount and loan costs 20 16
Interest on tax uncertainties 3 12
Interest income (37) (12)
Interest – net $ 1,123 $ 885
Net interest expense in 2022 deleveraged 24 basis points primarily as a result of interest expense related to the issuance of $5.0 billion unsecured notes in March 2022 and $4.8 billion unsecured notes in September 2022.
Income Tax Provision – Our effective income tax rate was 28.8% in 2022 compared to 24.7% in 2021. The 2022 rate was unfavorably impacted by the partial deductibility of long-lived asset impairment and loss on sale associated with the Canadian retail business.
Fiscal 2021 Compared to Fiscal 2020
For a comparison of our results of operations, financial condition, liquidity, and capital resources for the fiscal years ended January 28, 2022, and January 29, 2021, see “ Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations ” of our Annual Report on Form 10-K for the fiscal year ended January 28, 2022, filed with the SEC on March 21, 2022.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Sources of Liquidity
Cash flows from operations, combined with our continued access to capital markets on both a short-term and long-term basis, as needed, remain adequate to fund our operations, make strategic investments to support long-term growth, and return excess cash to shareholders in the form of dividends and share repurchases. We believe these sources of liquidity will continue to support our business for the next twelve months. As of February 3, 2023, we held $1.3 billion of cash and cash equivalents, as well as $3.5 billion in undrawn capacity on our revolving credit facilities.
As of February 3, 2023, our material contractual obligations and commercial commitments consist of leases, long-term debt, purchase obligations, and letters of credit. See Note 6 , Note 8 , and Note 15 of the Notes to the Consolidated Financial
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Statements in Item 8 , “Financial Statements and Supplementary Data”, of this Annual Report for amounts outstanding related to leases, long-term debt, and commitments, respectively, as of February 3, 2023.
Cash Flows Provided by Operating Activities
(In millions) 2022 2021
Net cash provided by operating activities $ 8,589 $ 10,113
Cash flows from operating activities continued to provide the primary source of our liquidity. The decrease in net cash provided by operating activities for the year ended February 3, 2023, compared to the year ended January 28, 2022, was due primarily to changes in working capital. Inventory decreased operating cash flow for fiscal 2022 by approximately $2.6 billion compared to a decrease of $1.4 billion for fiscal 2021. Accounts payable decreased operating cash flow for fiscal 2022 by $549 million compared to an increase of $466 million in fiscal 2021, driving a reduction of $1.0 billion in operating cash flows for fiscal 2022. The increase in inventory is primarily due to product cost and freight inflation compared to the prior year, as well as lower inventory turns year-over-year. The decrease in accounts payable is driven by timing of inventory purchases in the prior year. Other operating liabilities increased operating cash flows $388 million for fiscal 2022 compared to a decrease of $570 million in fiscal 2021. This increase is primarily driven by the deferral of payment of our third and fourth quarter estimated federal tax payments under the income tax relief announced by the Internal Revenue Service for business located in states impacted by Hurricane Ian.
Cash Flows Used in Investing Activities
(In millions) 2022 2021
Net cash used in investing activities $ (1,309) $ (1,646)
Net cash used in investing activities primarily consists of transactions related to capital expenditures, offset by proceeds from the sale of the Canadian retail business.
Capital expenditures
Our capital expenditures generally consist of investments in our strategic initiatives to enhance our ability to serve customers, improve existing stores, and support expansion plans. Capital expenditures were $1.8 billion in 2022 and $1.9 billion in 2021. The following table provides the allocation of capital expenditures for 2022 and 2021:
2022 2021
Existing store investments ¹ 75 % 75 %
Strategic initiatives ² 15 % 15 %
New stores, new corporate facilities and international 3
10 % 10 %
Total capital expenditures 100 % 100 %
1 Includes merchandising resets, facility repairs, replacements of IT and store equipment, among other specific efforts.
2 Represents investments related to our strategic focus areas aimed at improving customers’ experience and driving improved performance in the near and long term.
3 Represents expenditures primarily related to land purchases, buildings, and personal property for new store projects and new corporate facilities projects as well as expenditures related to our international operations.
For 2023, our guidance for capital expenditures is up to $2.0 billion. The following table provides the allocation of our fiscal 2023 capital expenditures guidance:
2023
Existing store investments 70 %
Strategic initiatives 25 %
New stores and corporate facilities 5 %
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Cash Flows Used in Financing Activities
(In millions) 2022 2021
Net cash used in financing activities $ (7,049) $ (12,016)
Net cash used in financing activities primarily consist of transactions related to our debt, share repurchases, and cash dividend payments.
Total Debt
In 2022, we issued $9.8 billion of unsecured notes. This is comprised of $5.0 billion of unsecured notes issued in March 2022 and $4.8 billion of unsecured notes issued in September 2022, the proceeds of which were designated for general corporate purposes. In 2022, we paid approximately $765 million to retire scheduled debts at maturity.
We have a $2.0 billion five-year unsecured revolving third amended and restated credit agreement (the Third Amended and Restated Credit Agreement), with a syndicate of banks, which has a maturity date of December 2026 and an aggregate availability of $2.0 billion. We also have a $2.0 billion five-year unsecured revolving credit agreement dated March 23, 2020, and as amended, (the 2020 Credit Agreement) with a syndicate of banks, which has a maturity date of December 2026 and an aggregate availability of $2.0 billion. Subject to obtaining commitments from the lenders and satisfying other conditions specified in the 2020 Credit Agreement and the Third Amended and Restated Credit Agreement (collectively, the Credit Agreements), the Company may increase the combined aggregate availability of the Credit Agreements by an additional $1.0 billion.
The Credit Agreements support our commercial paper program. The amount available to be drawn under the Credit Agreements is reduced by the amount of borrowings under our commercial paper program. Outstanding borrowings under the Company’s commercial paper program were $499 million, with a weighted average interest rate of 4.78% as of February 3, 2023. There were no outstanding borrowings under the 2020 Credit Agreement or the Third Amended and Restated Credit Agreement as of February 3, 2023. There were no outstanding borrowings under the commercial paper program, the 2020 Credit Agreement, or the Second Amended and Restated Credit Agreement as of January 28, 2022. Total combined availability under the 2020 Credit Agreement and the Third Amended and Restated Credit Agreement as of February 3, 2023, was $3.5 billion.
The Third Amended and Restated Credit Agreement and the 2020 Credit Agreement contain customary representations, warranties, and covenants. We were in compliance with those covenants as of February 3, 2023.
The following table includes additional information related to our debt for 2022 and 2021:
(In millions, except for interest rate data) 2022 2021
Net proceeds from issuance of debt $ 9,667 $ 4,972
Repayment of debt $ (867) $ (2,118)
Net change in commercial paper $ 499 $ —
Maximum commercial paper outstanding at any period $ 2,470 $ 400
Short-term borrowings outstanding at year-end $ 499 $ —
Weighted-average interest rate of short-term borrowings outstanding 4.78 % — %
Share Repurchases
We have an ongoing share repurchase program, authorized by the Company’s Board of Directors, that is executed through purchases made from time to time either in the open market or through private off-market transactions. We also withhold shares from employees to satisfy tax withholding liabilities on share-based payments. Shares repurchased are returned to
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authorized and unissued status. The following table provides, on a settlement date basis, the total number of shares repurchased, average price paid per share, and the total amount paid for share repurchases for 2022 and 2021:
(In millions, except per share data) 2022 2021
Total amount paid for share repurchases $ 14,124 $ 13,012
Total number of shares repurchased 71.2 62.8
Average price paid per share $ 198.39 $ 207.32
As of February 3, 2023, we had $20.7 billion remaining under our share repurchase program with no expiration date.
Dividends
In the third quarter of 2022, we increased our quarterly dividend payment by 31% to $1.05 per share. Our dividend payment dates are established such that dividends are paid in the quarter immediately following the quarter in which they are declared. The following table provides additional information related to our dividend payments for 2022 and 2021:
(In millions, except per share data and percentage data) 2022 2021
Total cash dividend payments $ 2,370 $ 1,984
Dividends paid per share $ 3.70 $ 2.80
Dividend payout ratio 37 % 24 %
Capital Resources
We expect to continue to have access to the capital markets on both short-term and long-term bases when needed for liquidity purposes by issuing commercial paper or new long-term debt. The availability and the borrowing costs of these funds could be adversely affected, however, by a downgrade of our debt ratings or a deterioration of certain financial ratios. The table below reflects our debt ratings by Standard & Poor’s (S&P) and Moody’s as of March 27, 2023, which is disclosed to provide an enhanced understanding of our sources of liquidity and the effect of our ratings on our cost of funds. Our debt ratings have enabled, and should continue to enable, us to refinance our debt as it becomes due at favorable rates in capital markets. Our commercial paper and senior debt ratings may be subject to revision or withdrawal at any time by the assigning rating organization, and each rating should be evaluated independently of any other rating.
Debt Ratings S&P Moody’s
Commercial Paper A-2 P-2
Senior Debt BBB+ Baa1
Outlook Stable Stable
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.
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 included herein. We believe that the following accounting policies affect the most significant estimates and management judgments used in preparing the consolidated financial statements.
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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 2022, our reserve decreased approximately $29 million to $139 million as of February 3, 2023.
We also record an inventory reserve for the estimated shrinkage between physical inventories. This reserve is based primarily on actual shrink results from previous physical inventories. During 2022, the inventory shrink reserve increased approximately $14 million to $428 million as of February 3, 2023, in response to higher volumes and estimated shrinkage rates based on results from previous physical inventories.
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. Generally, these vendor funds do not represent the reimbursement of specific, incremental and identifiable costs that we incurred to sell the vendor’s product. Many of the vendor funds associated with these purchases are earned under agreements that are negotiated on an annual basis or shorter. The funds are recorded as a reduction to the cost of inventory as they are earned. As the related inventory is sold, the amounts are recorded as a reduction to cost of sales. Funds that are determined to be reimbursements of specific, incremental and identifiable costs incurred to sell vendors’ products are recorded as an offset to the related expense.
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 obsolete 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 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 fiscal years. We believe that we have sufficient current and historical knowledge to record reasonable estimates for both of these inventory reserves. However, it is possible that actual results could differ from recorded reserves. A 10% change in either the amount of products considered obsolete or the weighted average estimated loss rate used in the calculation of our obsolete inventory reserve would each have affected net earnings by approximately $10 million for 2022. A 10% change in the estimated shrinkage rate included in the calculation of our inventory shrink reserve would have affected net earnings by approximately $32 million for 2022.
We have not made any material changes in the methodology used to recognize vendor funds during the past three fiscal years. If actual results are not consistent with the assumptions and estimates used, we could be exposed to additional adjustments that could positively or negatively impact gross margin and inventory. However, substantially all receivables associated with these activities do not require subjective long-term estimates because they are collected within the following fiscal year. Adjustments to gross margin and inventory in the following fiscal year have historically not been material.
Long-Lived Asset Impairment
Description
We review the carrying amounts of long-lived assets whenever certain events or changes in circumstances indicate that the carrying amounts may not be recoverable. When evaluating long-lived assets for impairment, our asset group is generally at an individual location level, as that is the lowest level for which cash flows are identifiable. Cash flows for individual locations do not include an allocation of corporate overhead.
We evaluate locations for triggering events relating to long-lived asset impairment on a quarterly basis to determine when a location’s assets may not be recoverable. For operating locations, our primary indicator that assets may not be recoverable is
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consistently negative cash flow for a twelve month period for those locations 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 locations for impairment, including individual locations’ execution of their operating plans and local market conditions, including incursion, which is the opening of either other Lowe’s locations or those of a direct competitor within the same market. We also consider there to be a triggering event when there is a current expectation that it is more likely than not that a given location will be closed or otherwise disposed of significantly before the end of its previously estimated useful life.
During the third quarter of 2022, the Company determined it was more likely than not that the assets within the Canadian retail business would be sold or otherwise disposed of significantly before the end of their previously estimated useful lives and were evaluated for recoverability. Based on the proposed transaction, the Company reconsidered the appropriate asset grouping of long-lived assets attributable to the Company’s Canadian locations given the change in the Company’s expectations regarding use and disposition of its associated assets. The Company determined the total Canada retail business (Canada asset group) to be the appropriate asset group for which Canadian business assets should be evaluated, as this represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. Changes in asset group determinations are accounted for on a prospective basis.
A potential impairment has occurred if the fair value of the asset group is less than the asset group’s carrying value. The carrying value of an operating location’s asset group includes inventory, property, operating and finance lease right-of-use assets and operating liabilities including accounts payables, accrued compensation, and operating lease liabilities. Financial and nonoperating liabilities are excluded from the carrying value of the asset group. When determining the stream of projected future cash flows associated with an individual operating location, 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 operating expense, as well as asset residual values or lease rates. Operating lease payments are included in the projected future cash flows. Financing lease payments are excluded from the projected future cash flows. An impairment loss is recognized when the carrying amount of the operating location is not recoverable and exceeds its fair value.
The carrying value of the Canada asset group included substantially all assets and liabilities of the Canadian retail business, including accounts receivable, inventory, property, operating and finance lease right-of-use assets, definite-lived intangible assets, operating liabilities including accounts payable and accrued compensation, and operating and finance lease liabilities. The cumulative foreign currency translation adjustment balance was excluded from the carrying value of the Canada asset group in evaluating the recoverability of a held and used asset group.
We use an income approach to determine the fair value of our individual operating locations, which requires discounting projected future cash flows. This involves making assumptions regarding both a location’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 market footprint similar in size to ours.
We use a market approach to determine the fair value of our individual locations identified for sale or closure. This involves making assumptions regarding the estimated selling prices or estimated lease rates by obtaining information from property brokers or appraisers in the specific markets being evaluated. The information includes comparable sales of similar assets and assumptions about demand in the market for purchase or lease of these assets. A market approach of an orderly transaction under current market conditions was used in determining the estimated fair value of the Canada asset group, which was based on the proposed transaction price, inclusive of performance-based contingent consideration.
Judgments and uncertainties involved in the estimate
Our impairment evaluations require us to apply judgment in determining whether a triggering event has occurred, including the evaluation of whether it is more likely than not that a location will be closed or an asset will be otherwise disposed of significantly before the end of its previously estimated useful life. Our impairment loss calculations require us to apply judgment in estimating expected future cash flows, including estimated sales, margin, and controllable expenses, assumptions about market performance for operating locations, and estimated selling prices or lease rates for locations identified for closure. We also apply judgment in estimating asset fair values, including the selection of an appropriate discount rate for fair values determined using an income approach.
Effect if actual results differ from assumptions
During fiscal 2022, the Company recorded $2.1 billion of long-lived asset impairment within selling, general and administrative expenses (SG&A) in the consolidated statements of earnings, which reflects the full carrying value of the long-lived assets of the Canada asset group. During fiscal 2021, long-lived asset impairment was immaterial. If the actual results are not consistent
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with the assumptions and judgments we have made in determining whether it is more likely than not that a location will be closed significantly before the end of its useful life or in estimating future cash flows and determining asset fair values, our actual impairment losses could vary from our estimated impairment losses. In the event that our estimates vary from actual results, we may record additional impairment losses, which could be material to our results of operations.
Self-Insurance
Description
We are self-insured for certain losses relating to workers’ compensation, automobile, general and product liability, extended protection plans, and certain medical and dental claims. We have excess insurance coverage above certain retention amounts to limit exposure from single events and earnings volatility. Our self-insured retention or deductible, as applicable, is limited to $2 million per occurrence involving workers’ compensation, $10 million per occurrence involving general liability, product liability, and automobile liability. We do not have any excess insurance coverage for self-insured extended protection plan or 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 2022, our self-insurance liabilities decreased approximately $45 million to $1.1 billion as of February 3, 2023.
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 fiscal years. Although we believe that we have the ability to reasonably estimate losses related to claims, it is possible that actual results could differ from recorded self-insurance liabilities. A 10% change in our self-insurance liability would have affected net earnings by approximately $80 million for 2022. A 100 basis point change in our discount rate would have affected net earnings by approximately $21 million for 2022.