Lowe's F1Q09 (Qtr End 5/1/09) Earnings Call Transcript

May.18.09 | About: Lowe's Companies, (LOW)

Lowe's Companies, Inc. (NYSE:LOW)

F1Q09 Earnings Call

May 18, 2009 9:00 am ET


Robert A. Niblock - Chairman of the Board, Chief Executive Officer

Larry D. Stone - President, Chief Operating Officer

Robert F. Hull Jr. - Chief Financial Officer, Executive Vice President

Gregory M. Bridgeford - Executive Vice President, Business Development


Matthew Fassler - Goldman Sachs

Christopher Horvers - J.P. Morgan

Colin McGranahan - Sanford C. Bernstein

Budd Bugatch - Raymond James

Deborah Weinswig - Citigroup

Eric Bosshard - Cleveland Research

Stephen Chick - FBR Capital Markets


Good morning, everyone and welcome to Lowe's Companies’ first quarter 2009 earnings conference call. This call is being recorded.

Statements made during this call will include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Management’s expectations and opinions reflected in those statements are subject to risks and the company can give no assurance that they will prove to be correct. Those risks are described in the company’s earnings release and in its filings with the Securities and Exchange Commission.

Also, during this call, management will be using certain non-GAAP financial measures. You can find a presentation of the most directly comparable GAAP financial measures and other information about them posted on Lowe's investor relations website under corporate information and investor documents.

Hosting today’s conference will be Mr. Robert Niblock, Chairman and CEO; Mr. Larry Stone, President and COO; and Mr. Bob Hull, Executive Vice President and CFO.

I will now turn the program over to Mr. Niblock for opening remarks. Please go ahead, sir.

Robert A. Niblock

Good morning and thanks for your interest in Lowe's. Following my remarks, Larry Stone will review our operational performance, including what we are doing to manage the business in today’s challenging environment. Then Bob Hull will review our financial results.

While the external environment remains challenging, I believe our first quarter results represent a solid performance in a tough environment and reflect the ongoing commitment of our more than 228,000 employees to serve customers. For the quarter, total sales were down 1.5% and comp store sales declined 6.6%. However, we continued to capture significant market share during the quarter.

According to third-party measures, Lowe's gained 160 basis points of unit market share in the first calendar quarter, a sign of the evolving competitive landscape and a clear indication our employees did not let a tough economic backdrop impact their dedication to customer service.

Over the past few years, as intensifying macro pressures led to weakness in industry sales, the comp sales impact of self-cannibalization from new stores grew and peaked in the middle of last year at nearly 200 basis points. Based on market level dynamics, we have slowed our store opening plans in 2008 and 2009, reducing the cannibalization drag with comp sales for the first quarter being negatively impacted by only 140 basis points from our new store openings.

Our diligent store selection review process adds confidence that we are making prudent store expansion decisions that will drive long-term shareholder value. The cannibalization drag on comps is expected to continue to decline throughout the year.

As we contemplate macroeconomic conditions and our outlook, clearly the sales environment remains challenging, evidenced by our 11th consecutive quarter of negative comps. And the greatest weakness remains in bigger ticket discretionary projects. But despite a late spring in some parts of the country, as weather warmed, we saw many consumers take on traditional outdoor projects. Consistent with trends over the past two years, outdoor products, which accounted for approximately 35% of our sales in the quarter, comped 700 basis points better than indoor products.

Another trend we are watching and one that appears to be a result of consumers looking to save money in difficult economic times is a resurgence of DIY, or do-it-yourself. Through the late 90s and the first half of this decade, we experienced significant growth in the DIFM, or do-it-for-me segment of our business. Consumers had the cash but not the time or the inclination to take on many projects around the house and they increasingly wanted someone else to tackle the more difficult projects.

Throughout this downturn as consumers’ net worth eroded and their concerns about the future escalated, they have increasingly become more disciplined in their spending. As a result, many homeowners have gone back to doing some of the things they previously relied on others to do.

One of the biggest potential benefits of a resurgence in DIY is an increase in foot traffic as consumers make additional trips to Lowe's. Our business model in our store serves the needs of DIY customers extremely well.

In the first quarter, we saw evidence of this trend with relative strength in categories like paint, the number one DIY project, and also in OPE repair and maintenance products, which had mid-single-digit positive comps in the quarter, as consumers migrated back to maintaining their own lines. In addition, we experienced over 20% comps in products such as vegetable plants and seeds as many consumers planted gardens to grow their own vegetables and herbs.

Following what was one of the most promotional fourth quarters we’ve seen in decades, today retail broadly and home improvement specifically has returned to a more rational promotional environment, similar to what we experienced in the past few years. A more rational environment combined with changes in mix and solid shrink results allow us to deliver an increase in our gross margin percentage compared to last year’s first quarter, representing a substantial improvement over our fourth quarter performance.

On the expense side, our employees did a great job managing in a negative comp environment and minimized deleverage for the quarter by appropriately managing payroll and constantly striving to add efficiencies to our operations.

Market share gains, solid gross margin performance, and appropriate expense management helped us to deliver earnings per share of $0.32, which exceeded our guidance for the quarter of $0.23 to $0.27.

We are obviously watching many of the macro variables that most of you are watching. There have been some encouraging signs in recent weeks that suggest perhaps the worst is behind us. Consumer confidence has ticked up, housing turnover, especially in certain markets, is showing signs of a bottom, and home prices have slowed their rate of decline. But let’s not forget that the current [rates] for most of these macro variables are still historic lows. Unemployment continues to rise and while the credit freeze has continued to thaw, credit markets are not as free as they need to be or probably should be.

While we are hopeful recent signs of improvement will ultimately prove the worst has passed, as we look to the balance of the year it is clear that macro headwinds remain strong.

While we encouraged by the relative improvement in our performance for the first quarter, we think it’s prudent to continue to plan conservatively until greater visibility is present.

In this time of significant uncertainty, we feel confident we have the flexibility in our staffing models and in our logistics and distribution systems to perfectly respond to both upside and downside scenarios.

Thanks again for your interest and now I will turn it over to Larry Stone to provide more details on the quarter. Larry.

Larry D. Stone

Thanks, Robert and good morning. While we saw some encouraging signs that home improvement customers remain willing to spend on routine maintenance and outdoor projects, weakness continues in bigger ticket discretionary projects which continue to pressure sales overall.

Our negative 6.6 comp for the quarter was driven by a 2.6% decline in transactions and a 4.2% decline in average ticket. Relative stability in transaction count is certainly encouraging but many consumers continue to postpone or stretch out major projects across several months, which is pressuring average ticket.

Highlighting this fact, first quarter comps for tickets below $50 were flat and comps for tickets above $500 were negative 14%. In the first quarter, only two regions in five product categories delivered positive comps.

On the regional front, following a very weak fourth quarter, consumers showed some signs of life as 19 of our 23 U.S. regions saw an improvement in this year’s first quarter from the fourth quarter of 2008. Three of the four regions that experienced a quarter-to-quarter reduction in comp trends were in Texas and the Gulf Coast, where comps have been relatively strong but hurricane recovery spending has begun to wane.

The trend in remaining regions was down only fractionally from the fourth quarter. Nine of our 23 regions had double-digit negative comps in the quarter, including all four of our western division regions. While each of these double-digit negative comps in regions were far better than the fourth quarter, comps remain very solid.

We are watching foreclosure data closely in these markets and we are working to maximize opportunities as these markets work towards stabilization, both from a housing turnover and home price perspective.

In addition to the western division, our southern Florida region had double-digit negative comps, along with parts of the northeast and mid-Atlantic areas. Many of these areas have seen relative weakness as a result of several years of housing pressures as well as the financial market turmoil of the past several months.

But in spite of what remains fairly broad-based macro driven sales weakness, we did have positive comps in Southern Texas, the area most impacted by last year’s hurricanes, and in one region in Ohio Valley driven by the continued stability of this part of the country.

We also had better-than-company average comps throughout most of the center of the country. In addition, and providing evidence that many smaller markets continue to perform relatively well, our 94K small market stores only had a slightly negative comp in the quarter.

In Canada, while we only had seven stores in the comp base in the first quarter, in constant currency those stores delivered a low-single-digit negative comp for the quarter.

On the product side, we did see relative strength in many of our outdoor and seasonal products as Spring arrived across the country, highlighted by positive comps in lawn and landscape and nursery products. We also continued to see better results in smaller project categories like paint, which also had positive comps in the quarter.

In addition, our home environment category had positive comps driven by affordable appliances and air conditioners. Strong demand for roofing products, primarily in the hurricane markets, helped our building products category deliver positive comps for the quarter.

But on the more negative side, as I mentioned, project related and more fashion oriented categories continued to show the greatest weakness. In project categories such as cabinets and counter-tops, flooring and millwork, we posted double-digit negative comps in the quarter. In addition, fashion categories like lighting, windows and walls, home organization, and fashion plumbing also had double-digit negative comps as consumers put off discretionary projects in home enhancement and instead focused more on basic maintenance and repair.

But despite fighting external pressures that led to continued weak demand in negative comps in most categories, we gained unit market share in 15 of our 20 product categories according to third-party measures as we continued to provide a great offering to consumers and capitalize on the evolving competitive landscape.

Our installed sales performance remains very weak. Resurgence of DIY, combined with consumers’ reluctance to take on major projects, led to a negative 23% comps for installed business in the first quarter. Our special order sales, which were also driven by project business, remained weak as well, delivering negative 26% comps.

Once again, we experienced weakness in special order cabinets and counter-tops, millwork, fashion plumbing, and flooring. Sales to commercial business customer remains one of the relative bright spots and this business delivered comps close to company average.

As anticipated, we experienced significant improvement in our gross margin performance from last quarter as competitive pressures eased and many of the drags on margin were unique to the fourth quarter. But our gross margin improvement was greater than we expected during the quarter, driven by many factors, including a rational competitive environment which led to better-than-expected margin rates in several categories.

In addition, favourable mix shifts, both across our 20 product categories and within the categories themselves, contributed to the margin improvement. Finally, better-than-expected shrink [inaudible] margin in the quarter.

Our inventory is in great shape coming out of the quarter. Year-over-year inventory growth was primarily driven by new stores and a new distribution center as comp store inventory was down 2.8%. We continued to work to manage inventory in comp stores in this difficult sales environment and we have successfully reduced the average comp store inventory by over 12% during the past three years.

We will continue to look for ways to further leverage our distribution centers to manage inventory in the coming quarters.

We are in the middle of our spring selling season and our seasonal categories we planned conservatively but we will watch demand trends closely as we move through the second quarter and ensure we are managing inventory appropriately. Based on what we see today, we don’t anticipate any seasonal mark-down pressures outside the norm in the second quarter.

We expect a relatively rational promotional environment to continue but we continue to face macroeconomic uncertainty, as well as our toughest year-over-year gross margin comparisons in the second quarter.

Based on these dynamics, and what we feel is a prudently conservative plan, we expect gross margin to be up slightly in the second quarter and up 40 to 50 basis points for the fiscal year.

Our results for the quarter reflect good expense management in what is obviously a tough environment. Payroll deleveraged 65 basis points, driven by negative comps and approximately 15% of our stores operating at base staffing levels in the quarter. As you may remember, we made small changes to our staffing matrix as we entered a new fiscal year to reflect recent efficiency gains in some of our processes. Those changes, along with disciplined hiring practices heading into the spring, allowed us to minimize the deleverage on payroll caused by our third year of negative comps.

As we managed the payroll lines through this downturn, we have kept a close eye on customer focus scores to ensure we are providing great service in our stores. This quarter, our customer focus scores went up across the board and continued to set new highs.

So, while we are reducing payroll hours in our stores to match the negative comp environment, we are confident we are maintaining the level of service customers expect from Lowe's.

While we are obviously focused keenly on managing the business in this current difficult environment, we continue to identify opportunities that will ensure the company is well-positioned to take advantage of opportunities as the macroeconomic environment improves.

Some initiatives will improve profitability both in the near-term and the long-term, while others will capitalize on the change in trends within home improvement retail.

One example is our cost reduction initiative, where there are multiple efforts underway to drive down costs. On that front, we have recently rolled out a new automated spend management system for expense purchases that will provide cost savings, enhanced controls, as well as automated processing for all non-merchandising purchases.

The primary purpose of this tool is to provide cost control and management approval for expenses prior to the acquisition of goods and services. Purchase orders and invoices can be routed electronically, driving down the cost of processing those transactions and with aggregated data, the tool also streamlines the strategic sourcing [embedding] process as well as online auctions, allowing Lowe's to put more [source in the fence] to drive down cost.

The spend management application has been available across the company for only 30 days but we are confident this system will drive significant cost savings over time.

Another longer term initiative we are working on involves developing a next generation installed sales model. I mentioned in my comments the resurgence of DIY and the decline in sales in our installed sales programs. When the economy improves, we know installed sales will continue to be a critical part of our offering, especially as it pertains to large projects like kitchens and flooring, so we are looking for ways to expand the model and provide better service to customers as preferences evolve.

One of the ways we are doing that is by testing a centralized project management model that will enable Lowe's to capture an increased share of project revenue while providing an experience that will differentiate Lowe's.

We will provide more details as this test continues but we are optimistic these changes will position us very well for the eventual increase in project demand when economic conditions improve.

While sales remained weak, we continued to capitalize on the opportunities that are available and drive solid market share gains. Strong gross margin, solid expense management, and a focus on inventory control all led to our solid results for the quarter.

Considering the challenges we faced during the first quarter, I am pleased with our performance. But as we look to the second quarter and the balance of the year, we remain focused on maintaining flexibility to appropriately adjust our operations to an uncertain and ever-changing external backdrop.

Thanks for your attention. Now I will turn the call over to Bob Hull to review our financial results. Bob.

Robert F. Hull Jr.

Thanks, Larry and good morning, everyone. Sales for the first quarter were $11.8 billion, which represents a 1.5% decrease from last year’s first quarter. In Q1, average ticket decreased 3.8% to $63.71 and was offset slightly by a 2.4% increase in total customer count.

Comp sales were negative 6.6% for the quarter, which was within our guidance of negative 6% to 10%. Looking at the monthly trends, comps were negative 6.4% in February, negative 5.5% in March, and negative 8% in April. Adjusting for the impact of the Easter Holiday occurring in a different fiscal month than last year, March and April comps are estimated to have been negative 6.4% and negative 6.6% respectively.

For the quarter, comp transactions decreased 2.6% and comp average ticket decreased 4.2%.

Looking at some specific impacts to comp sales in the quarter, cannibalization negatively impacted comp store sales by approximately 140 basis points. We estimate that sales in hurricane impacted markets positively impacted our first quarter comp sales by approximately 90 basis points.

We experienced building material inflation driven by roofing, which had approximately 60 basis points positive impact on first quarter comps.

With regard to product categories, the categories that performed above average in the first quarter include building materials, rough plumbing, hardware, paint, nursery, seasonal living, lawn and landscape products, appliances, and home environment. Lumber performed at approximately overall corporate average.

Gross margin for the first quarter was 35.5% of sales and increased 77 basis points from last year’s first quarter, which exceeded our expectations. The gross margin out-performance was driven by a number of factors.

As we noted on last earning’s call, our fourth quarter gross margin was impacted by an elevated level of promotional activity. We knew that there were several factors unique to the fourth quarter and we expected the promotional environment to become more rational in the first quarter, but thinking conservatively our guidance assumes we would continue to experience elevated promotions.

Encouragingly, the promotional environment moderated and we chose not to repeat some of our Q1 2008 promotions that were a drag on gross margin. Also, we expected the mix of products sold to negatively impact gross margin in the quarter. However, due primarily to better-than-planned sales in rough plumbing, hardware, and paint, all higher-than-company average margin categories, the mix of products sold had a slight positive impact on gross margin in Q1.

Lastly, we continued to see positive results related to inventory shrink, which was 13 basis points lower than Q1 last year and was slightly better than we expected.

SG&A for Q1 was 24.9% of sales, which deleverage 219 basis points, driven by store payroll, our proprietary credit program, bonus and fixed expenses. For the quarter, store payroll deleveraged 65 basis points, driven by negative comps. As expected, we experienced higher losses associated with our proprietary credit program, which caused 60 basis points of deleverage in the first quarter.

In addition, bonus expense deleveraged 46 basis points due to an increase in expected attainment levels. Lastly, rent, property taxes, utilities, and other fixed expenses deleveraged approximately 30 basis points due to the comp sales decline.

Store opening costs of $13 million leveraged four basis points to last year as a percentage of sales. In the first quarter, we opened 21 new stores. This compares to 20 stores in Q1 last year.

Depreciation at 3.4% of sales totalled $401 million and deleveraged 27 basis points compared to last year’s first quarter, primarily due to negative comp sales and the addition of 116 stores over the past 12 months.

Earnings before interest and taxes decreased 165 basis points to 7.1% of sales. Interest expense at $78 million for the quarter deleveraged three basis points as a percentage of sales. For the quarter, total expenses were 29% of sales and deleveraged 245 basis points.

Pretax earnings for the quarter were 6.4% of sales. The effective tax rate for the quarter was 37.4% versus 37.6% for Q1 last year. Earnings per share of $0.32 for the quarter exceeded our guidance of $0.23 to $0.27 but decreased 22% versus last year’s $0.41.

Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents balance at the end of the quarter was $682 million. Our first quarter inventory balance of $9 billion increased $575 million, or 6.8%, versus Q1 last year. The increase was due to square footage growth of 7%, a higher level of in-transit inventory, and an increase in distribution inventory associated with the opening of our 14th RDC in Piston, Pennsylvania.

Comp store inventory was down 2.8% in Q1 versus last year. Inventory turnover, calculated by taking a trailing four quarters cost of sales divided by average inventory for the last five quarters, was 3.76, a decrease of 16 basis points from Q1 2008.

At the end of the first quarter, we owned 88% of our stores versus 87% at the end of the first quarter last year. Return on assets, determined using a trailing four quarters earnings divided by average assets for the last five quarters, decreased 248 basis points to 6.3%.

Moving on to the liability section of the balance sheet, we ended the quarter with no short-term borrowings. Our strong, operating cash flows in the quarter allowed us to repay the nearly $1 billion in short-term debt that was outstanding at the end of the fourth quarter.

Accounts payable of $5.8 billion represents a 9.3% increase over Q1 last year. The growth in accounts payable is higher than our 6.8% increase in our inventory, which is attributable to ongoing efforts to improve vendor payment terms.

Our debt-to-equity ratio was 27.5% compared with 34.6% for Q1 last year. At the end of the first quarter, lease adjusted debt to EBITDAR was 1.45 times.

Return on invested capital, measured using a trailing four quarters earnings plus tax adjusted interest divided by average debt and equity for the last five quarters decreased 340 basis points for the quarter to 9.7%.

Now, looking at the statement of cash flows, cash flow from operations was $2.3 billion, which was 8% lower than Q1 2008, primarily caused by 22% lower net earnings. Cash used in [property acquired] was $572 million, a 29% decrease due to a reduction in our store expansion program. As a result, the first quarter free cash flow of almost $1.8 billion was up slightly versus last year. There were no shares repurchased in the first quarter.

Looking ahead, I would like to address several of the items detailed in Lowe's business outlook. We expect second quarter total sales to range from an increase of 1% to a decline of 2%, which incorporates a comp sales decline of 4% to 8% and the opening of approximately 18 new stores in the quarter, seven in May, eight in June, and three in July.

We expect gross margin to increase slightly in Q2 as a percent of sales.

For SG&A, we anticipate the following deleverage -- store payroll, 45 basis points; credit, 35 basis points; insurance, 25 basis points; fixed costs, 25 basis points; as well as a number of expense lines with smaller impacts.

Depreciation for Q2 is estimated to be approximately $407 million and deleverage about 20 basis points to last year’s second quarter.

As a result, earnings before interest and taxes for the second quarter are expected to decrease by approximately 160 basis points from last year as a percentage of sales. For the quarter, interest expense is expected to be approximately $78 million.

The income tax rate is forecasted to be 37.3% for the quarter.

We expect earnings per share of $0.51 to $0.55, which represents a decline of 13% to 19% over last year’s $0.63.

During the quarter, we adopted the FASB [staff] position, or FSP, related to EITF03-6-1. FSP, which deals with share-based payment, requires both a change in our method of calculating EPS and retroactive adoption. The amount of securities involved is insignificant and the impact to prior periods is less than a penny per share. However, as a result of rounding our second quarter 2008, earnings per share is now $0.63 versus the $0.64 reported last August. Earnings per share for fiscal 2008 are unchanged at $1.49.

For 2009, we expect to open 60 to 70 stores, resulting in an increase in square footage of approximately 4%.

We are estimating 2009 comp sales to be negative 4% to 8% and as a result, total sales should range from an increase of 1% to a decline of 2%.

For the fiscal year, we are anticipating an EBIT decline of 130 to 140 basis points.

For 2009, interest expense is expected to be approximately $310 million.

For the year, we expect the effective tax rate to be 37.3%.

The sum of these inputs should yield earnings per share of $1.13 to $1.25, which represents a decrease of 16% to 24% from 2008.

For the year, we are forecasting cash flows from operations to be approximately $3.8 billion. Our capital plan for 2009 is approximately $2.5 billion with roughly $300 million [floated] by operating leases resulting in cash capital expenditures of approximately $2.2 billion. As a result, we are forecasting free cash flow of $1.6 billion for the year.

Our guidance for 2009 does not assume any share repurchases.

Operator, we are now ready for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Matthew Fassler of Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thanks a lot and good morning to you. I want to focus on the outdoor business and the mix and what that will mean for comps over the rest of the year. And I’m asking because of your comments on the outdoor business and also because it seems like some of the bigger ticket businesses actually took a step back, if you look at [inaudible] is about $500 if you are looking at installed sales, so can you say where that 35% goes for the second and third quarters? And then just also talk to us about within that tickets of $50 and under or some of the sources of strength, whether you saw indoor businesses that are not as explicitly lawn and garden related contribute to the same-store recovery?

Robert F. Hull Jr.

So if you think about the relative mix of indoor products versus outdoor products, as Larry stated, it’s 35% outdoor in Q1, 40% outdoor in Q2, 30% outdoor in Q3, and 20% outdoor in Q4.

Matthew Fassler - Goldman Sachs

And if you think about the sources of strength in terms of the same-store sales recovery, whether it’s within the small ticket business or in general, were indoor and outdoor represented equally or was outdoor a disproportionate source of strength?

Robert F. Hull Jr.

I think generally speaking, the outdoor tickets performed relatively better across the board. I mentioned a couple of the items that performed better and the comments regarding margin -- paint, hardware, rough plumbing -- a lot of small items, small ticket items in those categories, so those performed above our plan in Q1, as well as the outdoor categories. So we are seeing small ticket performance do well across the board.

Matthew Fassler - Goldman Sachs

And just by way of follow-up, Robert, at the outset of the call, alluded to the late arriving spring, which suggested that weather was not a particular help for you in the first quarter per se. If you think about the way the weather broke at the end of the quarter and the beginning of Q2, how would you characterize that versus what would be optimal [inaudible]?

Larry D. Stone

I’ll try to address that. Certainly going back to your first question, a lot of those smaller tickets, as we keep saying, a lot of the maintenance items are still driving some interior categories, as Bob said, to plumbing and paint and so forth.

As far as the spring, we’ve had a pretty wet spring in a lot of parts of the country, so certainly a lot of the categories that you would expect to sell well in Spring have been selling -- talk about plants, lawn and landscape products, nursery products, and so forth and we think the bigger ticket purchases, such as tractors and so forth, probably are going to be a little bit lighter this year than normal. But overall, we are pleased with our performance for those categories based on the relevance in the markets and Robert also alluded to his comments about the fact that people are repairing a lot of their outdoor power equipment and things like that.

So we plan for a conservative year in outdoor power equipment and so far our plans have been pretty much what we thought they would be in that category.

Matthew Fassler - Goldman Sachs

Thank you so much.


Your next question comes from the line of Christopher Horvers of J.P. Morgan.

Christopher Horvers - J.P. Morgan

Thanks and good morning -- first, a follow-up to Matt’s question; as you think about the comp cadence into the balance of the year, Bob, if you look at it on a two-year basis, are you essentially just saying look, we are going to fly now at let’s say a minus 6 two-year comp basis and that’s how you are planning the year at this point?

Robert F. Hull Jr.

We take a look at a lot of factors, certainly the macro factors but also the mix of indoor/outdoor businesses, cannibalization, the impact of competitor store openings, hurricane impacts, et cetera. We do expect the impact of cannibalization to decrease as the year progresses. As we mentioned, it was 140 basis point impact in Q1, expected to be roughly 140 basis points in Q2, declined roughly to 110, 100 to 110 in Q3 and down 60 to 70 in Q4. Also the impact of competitor openings decreases from roughly 60 basis points in Q1 down to 20 basis points in Q2 and -- excuse me, 25 basis points in Q2 and 20 basis points in the back half. So we know the back half is still going to be tough, as evidenced by our guidance of down 4% to 8% for the year. There are some factors regarding fewer store openings that will provide less headwind going forward.

Christopher Horvers - J.P. Morgan

So then -- so those sound like positives. So it that the mix shift to non-outdoor categories beyond 2Q is a governing factor?

Robert F. Hull Jr.

That’s a slight negative. So if you think about the outdoor -- the indoor business being a greater proportion in the back half of the year relative to the average for the year, it’s a slight negative in the back half of the year.

Robert A. Niblock

Obviously what Bob talked about, the mix shift is a slight negative. We’ve got hurricane performance from last year that we will be going up against, which is a negative. That assumes no additional hurricanes plus we are expecting continued job losses. I would expect unemployment in the second half of the year to be greater than it is currently, so there are positives out there in the environment but there are also some negatives out there and it’s also the fact that we are going to try and be conservative in our outlook because we don’t know what will be out there in the future from an overall macroeconomic environment. So we think that we’ve tried to take all of the positives and negatives that we are aware, plus everything that we are in control of with the plans that our merchants and operators have, and opportunities to pursue business and we think we’ve taken all of that into account and tried to provide the best guidance we can.

Christopher Horvers - J.P. Morgan

Okay, and just a quick follow-up here on gross margin, clearly as you look into the back half of the year, you have this 65 basis points in gross margin comparisons to the fourth quarter for the clearance and the wallpaper exit -- is there anything embedded in your gross margin outlook for a continued positive margin mix, both within categories and the overall categories together?

Robert F. Hull Jr.

We think the margin mix for Q2 is relatively flat. We think the categories that I noted that performed better in Q1 will continue to outperform, offset by maybe a little bit higher penetration of some lower margin outdoor categories. We do, as you mention, did have some one-time items in Q4 that we will cycle up against. We do think, as Larry indicated, margins can be up 40 to 50 basis points for the year. Q2 is our toughest two-year comparisons, also our toughest three-year comparisons as Q207 margins were up 102 basis points. So not all quarters remained equal -- we think we will have good gross margin expansion in the back half of the year, some of which is driven by the one-time Q4 factors that we are going up against.

Christopher Horvers - J.P. Morgan

Thank you.


Your next question comes from the line of Colin McGranahan of Bernstein.

Colin McGranahan - Sanford C. Bernstein

Good morning. Thank you. I wanted to focus on installed sales from two perspectives. Clearly at a negative 23 comp, the business is weak and I understand the consumer shift away from do-it-for-me to do-it-yourself and clearly some of that is cyclical, so question number one is just tactically, what can you do about the cost overhead in that business, both in the near run and then as you are thinking about a new model with a more centralized project management -- is that a lower cost of delivery model?

And then secondly, and I guess this is more strategic around the business, how can you be confident that the strong growth in installed sales and do-it-for-me that you saw during the 2000s wasn’t really just a function of probably the most significant home price appreciation environment we’ve seen in generations, and that that’s a very different business going forward with an outlook of potentially not a lot of home price depreciation for a very long time?

Larry D. Stone

I’ll start and let Robert and Bob add to it -- certainly installed sales, to your point, during the ‘05/06 time period were certainly a great sales driver for the company. The cost overhead that is basically in the stores, you have the selling function of whether it’s installed or somebody is just taking it with them or whatever, so your sales costs are pretty much a sunk cost. The cost that we have in stores as a production piece, and that’s what we are taking a hard look at with our new model, how do we take that production piece in the store and better leverage throughout the whole company? So we don’t want to get into the details of the new model on the call as we will talk about it more later in the year as we develop the test, but certainly that speaks to we’re taking a look at how we can better leverage that piece in our stores to give better service and at the same time figure out a way to just take some costs out of the program.

As far as where we think the installed piece will go in the future, certainly DIFM, we think will come back, maybe not as strong as it was in the past but certainly as people recover from the economic issues of today, we think there will be more money in the markets and certainly a lot of the projects that people are doing today or putting off and waiting until things improve will need to be done by our installed group. And all installers, as you know, do not work for Lowe's. They are sub-contractors, so certainly there’s no sunk costs in those folks but right now we’ve got an abundance of installers working with us. We haven’t been able to leverage a lot of our costs with those folks, so we still think it’s a viable business model for the future.

Robert A. Niblock

One thing I will add is yeah, I agree that the level of installed sales that we might see in the future may not be the same level of installed sales that we saw in the past. Some of those smaller projects, people may continue to do those themselves, whether they are going to put down laminate flooring, whether they are going put up a garage door opener or install a storm door, those type of things. But most people are not going to install a new kitchen in their home.

So as Larry said, the purpose of the new model is one, to restructure the way we do the production office to get better efficiency out of that, and then two, when we are putting in those larger projects, those kitchens, so on and so forth, how do we sell more of the total project? So we are selling more than just the cabinets and the counter-tops and those type of things. We are selling more of the project across the entire store by having a better model, making sure the customer understands the full range of products that we have available in-store and through our special order process.

And then I guess the final thing I would say is that if you think about a lot of the alternatives for going out and putting in let’s say a new kitchen, the alternate concepts that were out there, as we move through this cycle, there’s going to be fewer of those competitors likely out there still in business. So when the environment does come back and people are putting in more new kitchens than they are putting in today -- people still are putting in new kitchens today but when they are putting more of them in the future, even though the pie may be smaller than it was in that timeframe that you mentioned, we think we are going to have a larger share of that pie because there will be fewer competitors that we will be going up against in this space.

Colin McGranahan - Sanford C. Bernstein

Okay, great. Thank you.


Your next question comes from the line of Budd Bugatch of Raymond James.

Budd Bugatch - Raymond James

Good morning and thank you for taking my question. I see that adjusting for the calendar, the comps were essentially pretty much similar month over month. I was curious -- you talked about the big ticket and the little ticket comps, small ticket comps being 0% for the small comps and down I think 14 for the big tickets. Can you kind of talk about that as the quarter unfolded? Was there any material change there? And what was the size of the bucket each of those represented of total company sales?

Robert F. Hull Jr.

Budd, there was really no material change in both the mix and the performance of big and small tickets across the quarter.

Budd Bugatch - Raymond James

And percentage of business, total company sales for the big ticket and small ticket overall in the quarter? I’m sorry?

Robert F. Hull Jr.

No real change in the mix -- relatively constant across the quarter.

Budd Bugatch - Raymond James

Yeah, and what percentage of the total sales did the big ticket represent in the quarter?

Robert F. Hull Jr.

Big tickets greater than 500 is roughly 30% of our sales.

Budd Bugatch - Raymond James

And the small tickets?

Robert F. Hull Jr.

Fifteen, 16%.

Budd Bugatch - Raymond James

Okay. Thanks, Bob, very much.


Your next question comes from the line of Deborah Weinswig of Citigroup.

Deborah Weinswig - Citigroup

Good morning and congratulations on a great quarter. A few questions -- Bob, how should we think about your leverage point currently and what is the projected impact of the new automated spend management system?

Robert F. Hull Jr.

The impact of the spend management, we expect to eventually, the next five years, be about $200 million or so, but that’s over five years. As Larry just mentioned, it just rolled out so we are just gaining traction with that system but we think it’s a couple hundred million dollars over the next five years, so more to come on that initiative.

As far as the leverage point, are you asking what level of comps it takes to leverage?

Deborah Weinswig - Citigroup


Robert F. Hull Jr.

Roughly 1.5%, generally speaking.

Deborah Weinswig - Citigroup

Okay. And then what are your goals with regard to comp store inventory relative to comps? I believe in the quarter that comps were down 6.6 and comp store inventory was down just 2.8.

Robert F. Hull Jr.

As Larry mentioned, comp store inventories have come down for three consecutive years -- it was down roughly 12%. As you think about operating a big box home improvement store, there was certain inventory required to be relevant across our space, carry 40,000 SKUs, some odd SKUs to allow professional customers and contractors to [complete] projects, et cetera. So as Larry mentioned, we are certainly focused on inventory productivity. We think the rate of increasing inventory comes down again in Q2 relative to the 6.8% in Q1 and the 7.9% in Q4. In fact, we think total inventory is close to flat at the end of this year, relative to the end of 2008.

So we are focused on inventory productivity -- it just doesn’t always come as smooth as you would like.

Robert A. Niblock

I would say in a negative comp environment, you are not going to pull inventory down as much as your comps decline. On the reverse side, in a positive comp environment, you are not going to grow inventory as much as your comps grow. As we said, there’s a certain base level of inventory you need there for presentations to make sure you have the entire project and so we are trying to minimize the offset, the negative leverage, the negative drag of inventory in the declining comp environment but we would expect to see benefit of that and leverage as -- once we get to the point where we are in a positive comp environment.

Deborah Weinswig - Citigroup

Okay, and then last question for you, Robert -- you talked about the competitive landscape being more rational. Can you please provide some color around that? And then also from an advertising and marketing standpoint, where are you getting the biggest benefit from your spend these days?

Robert A. Niblock

Just overall from the competitive landscape, what we talked about in the fourth quarter of last year was that we saw significant pull-back in consumer spending once we went through the significant disruption that we saw in the financial markets, kind of in that October/November timeframe.

Now, when you look at the overall and you look at consumer confidence, consumer sentiment, anything, all those numbers pulled back significantly during that period of time because many consumers didn’t know what the future held. Certainly we’ve moved through that, we’ve gotten through the worst of the [inaudible] financial prices, stress test is out -- not as bad as what it was feared, those type of things. So you’ve seen consumer confidence, consumer sentiment tick up off their all-time lows, even though they are still at historic lows. So we have seen some improvement there.

I think what we talked about in the fourth quarter was everything that we talked about caused significant markdowns across all retail channels in the fourth quarter. So it was kind of unprecedented. Everyone was trying to clear inventory, particularly their seasonal inventories, so you were really competing for those few available dollars that the consumer was going to spend during that key holiday season.

So we marked down stuff early because we wanted to get through the seasonal categories. We didn’t want to be left with the product at the end of season. I think obviously with what happened in the fourth quarter, many retailers have taken that into account as they are building their inventory plans for the year, and we built our inventory plans a little bit more conservative.

So we have seen -- it’s still promotional out there. Any time you are in an environment where you’ve got going on three years of negative comps, you are going to have promotions out there but it’s more rational than what we saw in the fourth quarter. It’s kind of back to what we have seen over the past couple of years.

Your other question was with regard to marketing spend, where we are seeing the biggest pay-back. I’ll see if Larry wants to add some color on that.

Larry D. Stone

Deborah, in the quarter, we tried to really have a balance in terms of the value-minded consumer, new lower prices, special values on certain promotions on certain products, but really we tried to have project ideas for the consumer they can do in a weekend and in terms of dollar spend, something they could afford in the budgets today. So we really tried to target those categories for the home enhancement and our spring campaigns that we kicked off and just tried to make sure that we had those value-minded consumers in mind as we went forward in the first quarter.

Deborah Weinswig - Citigroup

Thanks so much. I appreciate the color and best of luck.


Your next question comes from the line of Eric Bosshard of Cleveland Research.

Eric Bosshard - Cleveland Research

Good morning. In terms of store [inaudible] come out about the progress of the 94K, can you just talk about what you are seeing out of new store opens from this year and perhaps the last year or two, and also how you are thinking on a go-forward basis with the number and size and location of new stores?

Robert F. Hull Jr.

I’ll start with just speaking about the performance of the new stores and new store productivity. Certainly the volume from new store sales in the first year has come down over the past couple of years but as I mentioned at the analyst conference last September, new store productivity has come down from the 80% to roughly 70% range over the past couple of years. It was roughly 72% in the first quarter. We actually expect it to tick up slightly for the remainder of the year, largely due to an acceleration of the store opening schedule.

Larry talked about the relative strength of the 94Ks -- those are markets that never had a large home price appreciation run-up, so there’s really no reason why they would fall and they are kind of steady state markets.

Robert A. Niblock

We’ve talked about previously that our prototypical store for most markets has now gone from the 117 to the 103K format. We think that that store provides everything we need in those markets to be able to meet the customers’ needs based on the anticipated volume in those markets. And as we’ve tested that concept, we still will put the 117K in a few markets where they are expected to be extremely high volume stores for the holding capacity and those type of things. But probably over the next year or so, you may see a few more or 94Ks be a little bit higher percentage of the mix than what you saw in the past because in a lot of these mid-tier markets, where in the past we were going in and carving it up and putting a second store in, we want those markets to recover so you are going to see us putting some of those 94Ks in some of the kind of single store markets that are out there, and then still focus on those metro markets where there’s long-term tremendous opportunity and we are way under-stored, but it takes so long to find the location, get the permitting and approval and so on and so forth and getting into those markets. And we have -- we’ll have some of those stores opening up this year and some opening up over the next several years and in most cases, those are [three] areas within those markets where the project has been in the pipeline for several years. It’s just taken this long to get through all of the approval process and finally get the store built, so -- Greg, do you have any other comments?

Gregory M. Bridgeford

Just from a geographic standpoint, Eric, we are pretty well balanced this year. We have a handful of units in California, Florida, and Arizona -- I think there are eight total, but we have seven, for example, in Texas. So it’s well-balanced across, as Robert said, across small markets and large markets and geographically, it’s as balanced a program as we ever put out there with heavily weighted -- heavier weighted towards the front-end, I’d say, about 60% of our units are -- approximately 60% of our units open up the first half of the year, about 40% the second half of the year.

Robert A. Niblock

Operator, I think we have time for one more question.


Your next question comes from the line of Stephen Chick of FBR.

Stephen Chick - FBR Capital Markets

I guess the first question maybe is for Larry -- in your comments about -- well, I was wondering if you could get maybe a little more granular in your comments about say some of these markets where the foreclosure activity is heaviest? In the western division, for instance, California, where the turnover I think is 85% off of trough and the foreclosure activity has obviously been pretty heavy, I was wondering if you could speak to, when you say trends are down double-digits but better than the fourth quarter, I was wondering if you could assign some numbers to that for us. And then secondly, when you are saying you are watching the foreclosure data closely, what exactly does that mean and are you seeing any activity related to those foreclosures so far?

Gregory M. Bridgeford

I’ll start and talk about the economic profiles we are seeing out there in markets that you are very familiar with -- Nevada, California, Arizona, Florida, we are seeing significant spikes in turnover versus what we have seen over the last two years and it is in the bubble markets that you described.

We are seeing -- and turnover represents sales opportunities for us, so in particular in some of the more difficult markets that went into the cycle and the process, the tough housing process early on, we are seeing them start to exhibit a strong turnover figure that are primarily foreclosure. And I’ll ask Larry if he wants to comment on how we are addressing the foreclosure opportunities in those markets.

Larry D. Stone

Well, certainly Stephen, on the foreclosure piece and especially in the western markets, we are working closely with our commercial sales team to work with the various organizations in the markets to make sure that we are getting our fair share of the activity as these homes were brought up to standards so they can be resold to consumers.

As far as the comp data you asked about, it’s between 100 to 200 basis points improvement in the first quarter versus fourth quarter, so certainly a good improvement but still got a long ways to go to get those markets recover to where they were several years ago. But we thought we had a real solid plan that our teams are working on in the field to drive a continued sales improvement as these houses are refurbished and put back on the market. And at the same time, we work with a lot of consumers that buy houses on a foreclosure market and we work closely with those folks to make sure we, to Robert’s point earlier, sell the project versus just sell the item.

So we’ve got some good solid programs out there. I feel like there’s a huge opportunity for us down the road. It’s just going to take some time for all of this to straighten out and get back on some kind of a normal plane and once that happens, we think there’s a lot of opportunity to drive sales, especially in the western division.

Stephen Chick - FBR Capital Markets

And is there a different mix of some of the items that are being purchased with this renovation? I mean, is the margin on this stuff that’s assigned to these types of activities kind of better than some of the high ticket stuff that’s been hurting you? And are you seeing that in a market like California help your decremental margin a little bit?

Larry D. Stone

It’s really hard to quantify all that because I think it really depends on the house and the situation in some markets. You know, consumers have, when their house got foreclosed on, they were taking a lot of the fixtures out and we still haven’t quite figured out why but that’s happening in a lot of markets, so you have an opportunity to sell new vanities, new commodes, so forth.

I think the primary thing that we sell in a lot of these markets is really a lot of new paint, new floor covering, and really just the spruce up pieces to get the house back working and be presented to the consumer. But it does vary across the markets and just anecdotally talking to a lot of our store managers and hearing some of the things that happened, where somebody is taking down the front door of a house and put plywood up, so there’s an opportunity to sell an installed door. But it varies across all markets so nothing really can we quantify that we give basis points or sales on -- tied to, but it just varies across the markets.

Stephen Chick - FBR Capital Markets

Okay, and if I could, the 100 to 200 basis point improvement from the fourth quarter, is that -- are you seeing that kind of continuously month-to-month get a little better in that market or is it volatile? I would assume with the turnover numbers that you would see it inching upwards, but --

Larry D. Stone

It’s been improvement for the last several quarters and certainly we hope it will continue to improve and be glad today that we can state it’s flowed double-digits, so that’s something of a goal that we have in the near future, hopefully.

Stephen Chick - FBR Capital Markets

Okay, that’s helpful. And then if I could, maybe for Bob -- the private label credit proprietary credit card impact of I think you said 65 basis points for the quarter, is that -- that’s a little more than what you expected, is that correct?

Robert F. Hull Jr.

We thought it would be closer to 50 -- 90 days ago, it turned about to be 60 basis points, so slightly worse. As you know, unemployment ticked up relative to where folks thought and bankruptcies increased as well, which drove that increase in Q1 relative to our expectations.

Stephen Chick - FBR Capital Markets

Okay. Should we still be thinking about 10 basis points and I think you had said 60 million for the year -- is there a different figure we should be thinking about for ’09?

Robert F. Hull Jr.

Roughly 35 basis point deleverage in the second quarter and then we will actually get some slight leverage in the back half of the year as we cycle last year’s increase in losses. We’ll reach a point where all of the losses from this point forward will be borne by GE, so we will reach the -- a loss cap, so we’ll have some benefit in the back half of the year but it will be 35 basis point deleverage in Q2.

Stephen Chick - FBR Capital Markets

Okay. All right, so the year, it sounds like still kind of shakes out the same.

Robert F. Hull Jr.


Stephen Chick - FBR Capital Markets

Okay. And then would you care to give us -- I mean, given that May is such an important month of the quarter and I know you are kind of not fully through it but any commentary on where you are running month-to-date?

Robert A. Niblock

I think we’ve already exceeded the number of questions that you can ask but with regard to May, no, the only thing we will say is we’ve taken that into account in building our guidance for the second quarter, so as you know, we don’t like to comment on how the trends are running for the first few weeks but we’ve taken that appropriately into account in building our guidance for the second quarter.

Stephen Chick - FBR Capital Markets

Okay, thanks. I appreciate it.

Robert A. Niblock

Thanks, and as always, thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our second quarter results on August 17th. Have a great day.

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