LOWES COMPANIES INC quarterly report, Q2 FY2018

Business context and reporting period

Lowe’s Companies, Inc. is a home-improvement retailer. This Form 10-Q covers the second quarter and six months of fiscal 2018, ended August 3, 2018, with comparisons to periods ended August 4, 2017. The request metadata says “2017 Q2,” but the filing itself is for 2018 Q2.

Unless otherwise noted, financial amounts are in U.S. dollars. The interim financial statements are unaudited; the independent accountant performed a review, not an audit.

Financial performance and liquidity

Quarterly operating margin fell to 10.36% from 12.22%, while net margin was 7.28% in both periods. Management reported adjusted diluted EPS, a non-GAAP measure, of $2.07 for Q2 versus $1.57, and $3.26 for the six months versus $2.59. Adjustments included Orchard charges in 2018 and the Australian joint-venture gain and debt-extinguishment loss in 2017.

For Q2, comparable average ticket rose 4.5% and comparable transactions rose 0.6%. For the six-month period, comparable ticket rose 4.4%, while transactions declined 1.4%. Online sales contributed approximately 85 basis points to Q2 comparable sales growth. Eight of 11 product categories had positive Q2 comparable sales.

Six-month operating cash flow was $5.787 billion, versus $5.074 billion. Investing activities used $480 million, including $543 million of capital expenditures; financing activities used $3.637 billion, including $1.846 billion for share repurchases and $678 million in dividend payments. Cash and cash equivalents ended the period at $2.251 billion.

At August 3, 2018, total current and long-term debt, including current maturities, was approximately $15.831 billion; cash and short- and long-term investments totaled approximately $2.729 billion. Current assets were $15.483 billion and current liabilities were $14.581 billion. No short-term borrowings were outstanding at quarter-end. The company said available liquidity was adequate for operations, investment, debt repayment, dividends, and repurchases over the next 12 months; it was in compliance with credit-facility covenants.

Material changes and unusual items

• Q2 included $230 million of non-cash pre-tax charges related to Orchard Supply Hardware (Orchard), including long-lived asset impairments and discontinued projects. The impairment charge on certain Orchard assets was $206 million.
• On August 17, 2018, after quarter-end, Lowe’s committed to exit Orchard and close all 99 stores and a distribution facility by fiscal year-end. It expects a further $390 million to $475 million of pre-tax closing costs in the second half of fiscal 2018, including lease-related charges, accelerated depreciation and amortization, and severance. Estimates may change.
• Q2 2017 included a $96 million gain from the sale of the company’s Australian joint-venture interest. First-half 2017 also included a $464 million debt-extinguishment loss.
• Lowe’s adopted the new revenue-recognition standard (ASC 606) in fiscal 2018 using a modified retrospective method; prior periods were not restated. For Q2, adoption increased reported sales by $144 million and gross margin by $164 million, with no effect on operating income or net earnings. It primarily reclassified proprietary credit-program profit-sharing income from SG&A to sales, limiting period comparability.
• The lower effective tax rate—24.4% for Q2 2018 versus 36.2% a year earlier—primarily reflected the federal corporate tax-rate reduction under the Tax Cuts and Jobs Act. Certain tax-act calculations remained provisional.

Outlook, management commentary, and risks

Lowe’s reduced its fiscal 2018 capital-expenditure forecast by $500 million to approximately $1.2 billion, citing elimination of projects not focused on the core business, productivity, or internal investment hurdles. It expected $3.0 billion of share repurchases for fiscal 2018, including first-half repurchases. The filing excerpt does not provide a clear full-year sales or EPS forecast.

Management described priorities including refocusing on core home improvement, simplifying the organization, improving expense discipline and capital allocation, and building an integrated omnichannel business. It cited delayed spring demand and strength in several seasonal and building-material categories. The company also underwent significant leadership changes; management identified successful leadership transitions as a risk.

Other disclosed risks include changes in economic and housing conditions, consumer spending and credit availability, competition, execution of technology and omnichannel initiatives, hiring and retention, cybersecurity, product and service quality, supply and transportation costs, regulatory changes, and potential impairment charges. The filing reported no material change in market risks and no ordinary-course legal proceedings expected to have a material adverse effect. Management said disclosure controls were effective as of August 3, 2018.

Important facts for investors to verify

• Confirm the requested reporting period: the filing is fiscal 2018 Q2, not 2017 Q2.
• Track Orchard’s store closures, final impairment and exit costs, and cash or earnings effects against the stated $390 million to $475 million estimate.
• Assess reported growth alongside ASC 606’s presentation changes and the non-GAAP adjustments; prior-year figures were not restated.
• Monitor operating-margin pressure, especially SG&A deleverage, and whether sales growth converts to sustained operating and cash-flow improvement.
• Verify progress on the $1.2 billion capital-expenditure forecast, $3.0 billion repurchase plan, debt obligations, and leadership transitions.