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

F2Q09 Earnings Call

August 17, 2009 9:00 am ET

Executives

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

Analysts

Budd Bugatch - Raymond James

Brian Nagel - Oppenheimer

Deborah Weinswig - Citigroup

Michael Lasser - Barclays Capital

Gregory Melich - Morgan Stanley

David Fick - Stifel Nicolaus

Scot Ciccarelli - RBC Capital Markets

Matthew Fassler - Goldman Sachs

Eric Bosshard - Cleveland Research

Operator

Good morning, everyone and welcome to the Lowe's Companies’ second 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, and then Bob Hull will review our financial results.

As expected, home improvement spending remained weak in the quarter. But even in this weak environment, we were disappointed with the magnitude of erosion in our comp sales performance from the first quarter. We expected challenging economic conditions but wavering levels of consumer confidence, unseasonable weather in many areas, and tougher-than-anticipated comparisons to last year’s stimulus related spending led to lower sales than we expected.

We continue to see relative strength in outdoor products in the quarter but that was more than offset by pronounced weakness in larger ticket discretionary project. The decline in average ticket was the largest driver of our negative comp and was down 8.6% in the quarter. Our comp for tickets greater than $500 was negative 16%. For $500 plus tickets, in Q2 we were lapping the toughest comparison to last year’s stimulus aided comp sales. However, in recent weeks, some categories have experienced an increase in detail fees. The small fee we charge to take in-home measurements that is the first step in the installation process, which should lead to improved trends in many of our installed sales categories.

Not surprisingly, consumer research suggests that in this uncertain economic environment, consumers are only taking on home improvement projects that they feel are absolutely necessary and are postponing discretionary projects until clarity about the future returns.

In fact, 40% of consumers say they have a major home improvement project they are postponing because they are waiting for their confidence about the future to improve.

On the flip side, we saw better performance from the transaction side of comp, with only a 0.9% decline in customer count. Our comp for tickets less than $50 was slightly positive in the quarter. I feel the relative stability of traffic indicates our stores were ready for the late spring season, successfully transitioning to summer categories, and provided great service to customers. Evidence of this is found in our continued market share gains. In the second quarter, we added 70 basis points of total store unit market share according to third-party estimates.

I would like to thank our more than 228,000 employees whose customer focus and hard work made those gains possible.

As I mentioned, I think our store employees and merchants did a great job getting ready for spring and preparing for the continued out-performance of our outdoor categories. We had positive comps in our nursery category and above average comps in lawn and landscape and outdoor power equipment.

Being ready to serve customers with the right product and great service helped drive outdoor product related comps nearly 500 basis points higher than indoor products.

Also I mentioned last quarter a growing trend of a return to DIY. We continue to see evidence of that trend in the second quarter with strong performance in TDIY categories like paint, hardware, and rough plumbing and also in products like mower repair parts, grill repair parts, and gardening supplies.

As the return to DIY leads to more frequent trips to our stores, we have an opportunity to capture additional traffic item sales like HVAC filters and bird seed, as well as items like trash bags and cleaning chemicals. We saw positive mid-single-digit comps in cleaning chemicals and bird seed and above average comps in HVAC filters in the quarter which I believe is evidence of the foot traffic generated by the shift to DIY.

Despite the weak demand environment, our entire organization worked to maintain gross margin by moving products more efficiently, minimizing the impact of markdowns, and reducing shrink. Combined with a favourable product mix and a rational competitive environment, these efforts led to a 50 basis point increase in gross margin, better than our expectations when we began the quarter.

Expenses were also managed well, especially payroll, during what has now been 12 consecutive quarters of negative comps. While payroll did deleverage, I believe we maintained an appropriate balance between cost control and service in our stores.

Our efforts to maintain gross margin and control expenses allowed us to deliver earnings per share of $0.51, in line with our guidance despite the weaker-than-expected sales results, and also after taking into account a $48 million pretax charge primarily related to our new store pipeline evaluation.

In the end, I don’t think our comp erosion from first quarter represented a significant shift in the consumer. Home improvement consumers have been and remain reluctant to spend on much beyond the necessities. Our research suggests that the number of projects the average home improvement consumer plans to take on in the coming year has dropped only slightly from a few years ago but the expected spend on those projects has declined substantially.

But in addition to an obviously cautious home improvement consumer, with hindsight I think the erosion in comp performance from first to second quarters had a lot to do with cycling last year’s stimulus checks and relatively little positive offsets to date from this year’s stimulus package. That is supported by the fact that we saw progressively improving comp sales through the month of July and continued better performance into the first two weeks of the third quarter as the comparisons to last year’s stimulus ease.

Significant headwinds remain, including the pressures of the economic backdrop and cycling last year’s hurricane spending along the Gulf Coast. But there are also encouraging signs that a bottoming process is underway. We are maintaining what we feel is an appropriately cautious sales outlook and are building our plans accordingly but as the second quarter results show, we feel we have the flexibility to appropriately adjust either a weaker or stronger-than-expected sales environment while continuing to deliver great service to customers and reasonable profit for shareholders.

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

Larry D. Stone

Thanks, Robert and good morning. Today I will share some details of the quarter and what we are doing to manage the business in this challenging sales environment. The current economic conditions continue to weigh on consumers and pressure our sales. The effect of these pressures is our negative 9.5% comp for the quarter, driven by consumers’ hesitancy to take on big ticket discretionary projects which led to an 8.6% decrease in comp average ticket.

Comp traffic continues to share signs of stabilization as our comp customer count was down only slightly for the quarter. The sequential improvement in first quarter this year did not continue into the second quarter. Last quarter, 19 of our 23 U.S. regions achieved better comps sequentially. This quarter, only six regions have sequentially better comps with some of the biggest quarter-to-quarter declines in our core markets where we have the highest concentration of stores, including the Southeast and the Ohio Valley.

Although second quarter comps are weak, three of our four western regions and three regions in the Northeast improved sequentially. Macro pressures remain broad-based, leading to 12 or 23 regions experiencing double-digit negative comps for the quarter.

In our western division, comps improved quarter to quarter but they are still double-digit negative.

Our positive housing turnovers is an encouraging sign, home prices are still declining and consumer confidence remains weak. We are watching foreclosure data in key housing markets and we are working to build relationships with commercial business customers to capitalize on opportunities as these markets move towards home price stabilization.

Additionally, parts of the Southeast division had double-digit negative comps, driven to some degree by the stimulus spending on home improvement last year when these markets had more stable housing pricing. Also our sales in parts of the Northeast were impacted by the unseasonably cool wet weather.

On the product side, as we examined our sales it was clear that small projects, maintenance and repair products, and outdoor products experienced the best performance. Only two of our 20 product categories, nursery and paint, achieved positive comps for the quarter. Sales in these categories, the two most popular DIY projects, were driven by consumers’ willingness to complete small projects and enhance the appearance of their home and outdoor space.

Lawn and landscape products, including mulches, soil, seed, and patio block, continue to perform better than the company average as consumers continued to do outdoor projects to improve the appearance of their homes.

As more consumers tackle basic repair and maintenance projects, we experienced relatively solid demand in [positive repair] and repair parts for outdoor power equipment. In fact, for the quarter we had double-digit positive comps in OPE repair parts. Also, we continue to see positive comps in tillers as consumers continue to plant gardens in many of our markets.

Selling to the DIY customer has always been a priority of Lowe's and with the resurgence of DIY, many customers may be tackling their first home improvement project in a while and many are looking to Lowe's not only for home improvement products but for how-to information to successfully complete their projects.

Consumer research tells us that interior painting is one of the top home improvement projects that will be planned and completed in the next 12 months. Painting is one of the easier DIY projects but like most projects, having the right tools plus the confidence you are doing it right can go a long way in customer satisfaction. That is why we are focused on spending more time with these customers, providing them with project information and tips that make their project easier to do.

With this resurgence in mind, we’ve tweaked our staffing model to ensure departments that feature more project basics like paint, rough plumbing, rough electrical, and hardware remain appropriately staffed. This is just another example of how we continue to maximize every sales opportunity.

Consumers continued to postpone discretionary projects, which are a primary driver of our special order sales. Soft project sales led to a negative 23% comp for the quarter with the most pronounced weakness in special order cabinets and counter tops, fashion plumbing, and flooring. Special order flooring was negatively impacted from cycling an aggressive promotion last year for installed carpet, as well as the consumer shift to our improved and expanded offering of stock carpet that delivered double-digit positive comps in the quarter.

The resurgence of DIY, coupled with fewer discretionary projects, led to a negative 22% comp in installed sales. During the quarter, we saw soft demand for installed millwork, flooring, and cabinets and countertops. Sales to commercial business customers fell slightly below the company average for the quarter. As I mentioned earlier, we continue to work on building relationships with CBC customers to provide them with products and services needed to maintain and restore foreclosed homes.

Despite the external pressures weighing on our sales, we continue to grow our market share. According to third party estimates, we gained unit market share in 13 of 20 product categories in the second calendar quarter versus the same time period a year ago and we gained 70 basis points of total store share in the quarter, a good indication that our value message is still connecting with customers.

Gross margin for the quarter expanded 50 basis points, aided by lower fuel costs combined with our efficient distribution infrastructure. Improved inventory shrink and favorable mix shifts also contributed to the margin improvement in the second quarter.

Our merchants and operators continue to work together to find the right products and take care of the customers during this tough economic time. We planned conservatively for our seasonal categories and overall we are in good shape as we head into the third quarter. The exception to this would be air conditioners, as the cool weather in the Northeast did impact our sales. However, the hotter weather we have experienced in August has led to stronger sales this month and currently our inventory is up only $16 million compared to last year. We do have markdowns in place and we should move through the majority of this overage in the next month.

As a result of our sales performance for the quarter, payroll deleveraged 59 basis points. Despite the external pressures weighing on our business, we remain committed to appropriately staffing our stores with knowledgeable employees, ensuring we provide the service customers have come to expect from Lowe's.

Our customer service scores improved in the second quarter of this year compared to last year. I am very proud of our teams as they continued to deliver on our service commitment and this commitment has helped us increase our market share.

Throughout my career with Lowe's, improving customer service and managing inventory has always been priorities. Flexible fulfillment is one initiative we are working on to enable us to better meet customers’ needs by leveraging our network’s inventory. Once these systems are in place, they will allow the sale of product in any Lowe's location, including the Internet, to be fulfilled and delivered to the customers’ homes from the most efficient node in our network. I know that those of you who have followed us for a while know flexible fulfillment has been something that we have discussed before but with enhanced focus and resources, we are making progress and expect to [implement deliverables] in 2010.

Flexible fulfillment is another example of how we plan to continue to balance investment in our business to drive efficiencies in the future.

Needless to say we are disappointed with this quarter’s sales results but we will continue to capitalize on the opportunities to properly capture market share. As we look to the balance of the year, our outlook remains cautious as we anticipate continuing macro headwinds, evidenced by this quarter’s results, we’re committed to diligently managing expenses while continuing to deliver on our customer service commitment.

Thank you for your attention. Now I will turn the call over to Bob Hull to review our second quarter financial results. Bob.

Robert F. Hull Jr.

Thanks, Larry and good morning, everyone. Sales for the second quarter were $13.8 billion, which represents a 4.6% decrease from last year’s second quarter. In Q2, total customer count increased 4% but average ticket decreased 8.2% to $61.43. For the first half of 2009, total sales decreased 3.2% to $25.7 billion. Comp sales were negative 9.5% for the quarter. Looking at the monthly trends, comps were negative 7.9% in May, negative 9.9% in June, and negative 10.6% in July.

For the quarter, comp transactions decreased 0.9% and comp average ticket decreased 8.6%. We are encouraged by the improvement in comp traffic relative to Q1’s 2.6% decline.

With regard to product categories, the categories that performed above average in the second quarter include building materials, rough plumbing, hardware, paint, nursery, outdoor power equipment, and lawn and landscape products. In addition, seasonal living and appliances performed at approximately the overall corporate average.

For the first half of 2009, comp sales were negative 8.2%.

Gross margin for the second quarter was 34.8% of sales, an increase of 50 basis points from last year’s second quarter. The increase in gross margin was driven by a number of factors.

First, the margin mix of products sold had a 19 basis point positive impact on gross margin.

Distribution favourably impacted gross margin by 13 basis points, largely driven by lower fuel costs.

Lastly, lower inventory shrink as a percentage of sales had a positive impact of 10 basis points.

Year-to-date, gross margin of 35.1% represents an increase of 62 basis points over fiscal 2008.

SG&A for Q2 was 22.5% of sales, which deleveraged 167 basis points, driven by store payroll, credit, fixed expenses, and bonus.

For the quarter, store payroll deleveraged 59 basis points.

Proprietary credit deleveraged 27 basis points, due to higher losses than last year. In addition, rent, property taxes, utilities and other fixed expenses deleveraged approximately 20 basis points due to the comp sales decline.

Bonus expense deleveraged 19 basis points in the quarter. This was primarily related to our stores as they attained higher performance levels this year versus missing many of our performance targets in the first half of 2008, largely driven by our better-than-planned first quarter results.

Given this challenging economic environment, we have re-evaluated our future store expansion plan. For 2010, new store openings will be likely in the range of 35 to 45 stores. We will provide a more detailed update on our future store expansion plan at our analyst conference next month.

As a result of the lower store opening plans, we have decided to walk away from a number of future store projects. We recorded expense of $48 million, primarily to write-off previously capitalized costs and reduce the value of these discontinued projects, which is included in SG&A for the quarter.

Year-to-date, SG&A is 23.6% of sales and deleveraged 191 basis points through the first half of 2008.

Store opening costs of $14 million leveraged four basis points to last year as a percentage of sales. In the second quarter, we opened 18 stores with no relocations. This compares to 23 new stores in Q2 last year.

Depreciation at 2.9% of sales total $408 million and deleveraged 32 basis points compared to last year’s second quarter, primarily due to the negative comp sales and the addition of 111 stores over the past 12 months.

Earnings before interest and taxes or operating margin decreased 145 basis points to 9.3% of sales. Year-to-date operating margin of 8.3% represents a decrease of 156 basis points from the first half of 2008. Interest expense at $76 million deleveraged 8 basis points as a percentage of sales. For the quarter, total expenses were 26.1% of sales and deleveraged 203 basis points.

Pretax earnings for the quarter were 8.8% of sales. The effective tax rate for the quarter was 37.6% versus 37.4% for Q2 last year.

Earnings per share of $0.51 for the quarter were at the low-end of our guidance of $0.51 to $0.55 but decreased 19% versus last year’s $0.63.

As a reminder, during the first quarter we adopted the FASB staff position or FSP related to EITF 0361. The 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 but as a result of rounding, our second quarter 2008 earnings per share is now $0.63 versus the $0.64 reported last year.

Earnings per share for fiscal 2008 are unchanged at $1.49.

For the first six months of fiscal 2009, earnings per share of $0.84 were down 19% to 2008.

Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents balance at the end of the quarter was $1.1 billion.

Our second quarter inventory balance increased $250 million or 3.1% versus Q2 last year. The increase was due to a 6.8% square footage growth and higher distribution inventory as a result of opening our 14th regional distribution center. These were offset somewhat by a 5.2% reduction in comp store inventory.

The inventory turnover, calculated by taking a trailing our quarters cost of sales divided by average inventory for the last five quarters, was 3.72, a decrease of 29 basis points from Q2 2008.

At the end of the second quarter, we owned 88% of our stores versus 87% at the end of second quarter last year. Return on assets, determined using a trailing four quarters earnings divided by average assets for the last five quarters, decreased 267 basis points to 5.7%.

Next, I would like to highlight a few items from the liability section of the balance sheet. Our debt to equity ratio was 26.5% compared to 30.1% for Q2 last year. At the end of the second quarter, lease adjusted debt to EBITDAR was 1.52 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 367 basis points for the quarter to 8.8%.

Now, looking at the statement of cash flows, year-to-date cash flows from operations was $3.7 billion, a decrease of $152 million, or 4% over the first half of 2008. The decrease is attributable to lower net earnings offset somewhat by working capital improvements.

Cash used and property required was $1.1 billion for the first six months of 2009 compared to $1.6 billion for the same timeframe last year. As a result, year-to-date free cash flow of $2.6 billion represents a 17% increase over the first half of 2008.

There were no shares repurchased in the second quarter.

Looking ahead, I would like to address several of the items detailed in Lowe's business outlook. We expect a third quarter sales decrease of 2% to 5%, which incorporates the opening of approximately 11 new stores, two in August, three in September, and six stores in October. Comp store sales are estimated to decline 6% to 10% to last year.

EBIT or operating margin for the third quarter is expected to decline by approximately 170 basis points to last year as a percentage of sales. The anticipated sales and operating margin declines are expected to generated diluted earnings per share of $0.21 to $0.25, which represents a decrease of 24% to 36% compared to last year’s $0.33.

For 2009, we expect to open 62 to 66 stores, resulting in an increase in square footage of approximately 4%. We are estimating a comp sales decrease of 7% to 9% and a total sales decrease of approximately 3%.

For the fiscal year, we are anticipating an operating margin decrease of approximately 130 basis points. We are forecasting an effective tax rate of 37.5% for 2009. As a result, we expect diluted earnings per share of $1.13 to $1.21 for the year.

For the year, we expect cash flow from operations to be approximately $3.6 billion. We forecast total capital expenditures of approximately $2.4 billion, with roughly $300 million funded via operating leases, leaving cash CapEx of approximately $2.1 billion for 2009. As a result, we are forecasting free cash flow of approximately $1.5 billion for the year.

Our outlook does not contemplate any share repurchases for the third quarter or fiscal 2009.

Celeste, we are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Budd Bugatch with Raymond James.

Budd Bugatch - Raymond James

Good morning, Robert. Good morning, Larry. Can you give us maybe a little bit more color on the impact of special order sales and installed sales on the overall comp number and when do you think that might turn around? What are you looking for on that on forward into 2010?

Larry D. Stone

I’ll start off and then let Robert and Bob join in. Certainly installed, as Robert mentioned in his comments in a few categories we’ve noticed our detail fees have increased and installed sales for the -- starting off in the third quarter have improved in a couple of categories but that’s still the big bogey that we think consumers are just not willing to go out and spend on categories like kitchen cabinets and counter tops and even on our installed carpet program.

Our stock program that I mentioned in my comments has been extremely strong with double-digit positive comps in the second quarter. So once again we think once the housing kind of bottoms out and people get more confidence that the economy is starting to turn, I think there’s a big backlog on these projects but right now we are just seeing people spend on the smaller projects but certainly we’ve got the processes in place. We continue to have our sales specialists focused on the projects that do come on board and I just think it’s going to take a while before that business comes back, probably some time in 2010 would be a good estimate in my opinion.

Robert A. Niblock

The impact of installed and special order has negatively impacted our comps about 200 basis points in the quarter.

Budd Bugatch - Raymond James

Okay, and what’s the indicator you are looking forward now that you think will indicate that this has turned? Is it housing values? I mean, we are seeing a better velocity at least relatively in some of the housing indicators, so is it value or is it -- or is it just all of the above?

Larry D. Stone

Well, Budd, I mean obviously there’s a lot of inputs into the consumer’s decision-making process but I think a key item is seeing a bottoming in housing prices. If you think about for the number of homeowners that are out there, for them to move on those discretionary side larger projects, I think they want to know how bad are things going to get, how low is the value of my home going to go before they get off the fence and start spending on those major projects.

So yes, the velocity of housing, the turnover number has bottomed. There’s still a lot of pressures out there in the economy. Obviously you know where unemployment is at.

Budd Bugatch - Raymond James

And just finally, is there any impact of the stimulus into your forward thinking right now? I mean, I know last year you had 100 to 150 basis points of stimulus affecting last year’s second quarter and the stimulus now is going to affect the second half of this year and maybe into 2010. Any of that projected into your outlook?

Larry D. Stone

We haven’t specifically built anything into that, only to the extent that it is on the overall economist consensus outlook that’s out there and how we are thinking about the overall economy recovery would be the only thing but no, we’ve not specifically built anything from that into our outlook.

Budd Bugatch - Raymond James

Thank you very much. Good luck.

Operator

Your next question comes from the line of Brian Nagel with Oppenheimer.

Brian Nagel - Oppenheimer

Good morning. A couple of questions, if I could -- first off, I guess more or less a point of clarification -- Robert, you talked about sales in July improving a bit and then that improvement continuing into August but I think the numbers, the quarterly or the monthly numbers that Bob gave us suggest that sales continued to decelerate through the quarter, so maybe -- I just want to make sure I had those numbers correct and then also maybe it’s a function of the comparisons with last year but if you could further expand upon that.

Robert A. Niblock

Yeah, it is true that as you look at the quarters that through the quarter sales decelerated but within the month of July, as you look at the trends, in particular the traffic side of the comp, we saw improvements in that during the month of July and then those improvements have continued into our first two weeks of August. So you know, in a tough environment like this, we think traffic is key. We are continuing to have traffic come into the store and kind of a follow-up to the response to Budd’s question, once we see the consumers mindset change towards where is the value of their home going and they start those discretionary projects, hopefully having that traffic in the store today will be a good leading indicator of the opportunity in the future but we’ve got to get to that point and obviously we still have some challenges and headwinds from the economic standpoint and from a housing/pricing standpoint before we get there.

Brian Nagel - Oppenheimer

Okay, that’s helpful and the second question I have with respect to the lower number of new store openings for 2010, if you -- as you look at the stores that you will no longer be opening that you had planned to, was it a really broad-based decision or were you targeting certain areas of the country where you decided to pull back in store openings?

Robert A. Niblock

What we did, Brian, it’s part of the ongoing evaluation process we’ve been going through really for the past couple of years in a challenging environment and as we look out and say okay, when is the recovery going to take place, there are obviously things that have been deeper and longer than most people anticipated when we first got into the process. We went in and were constantly reevaluating what we think these store, our opening volumes are going to be so it may be based on stores falling below our hurdle rate. In other cases, it may be the new store had an acceptable hurdle rate but it would be cannibalized -- having too much of a cannibalization impact on existing stores now that we’ve gone through three years of negative comps.

So it was part of the overall evaluation process to look at those that were in the pipeline and it’s kind of looking all across the country and in some cases, it’s on a facts and circumstances based for each individual site that we made the decision on.

Brian Nagel - Oppenheimer

Okay. Thank you very much.

Operator

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

Deborah Weinswig - Citigroup

Good morning. Larry, you had stated that I think sales to commercial business customers fell slightly more than the company and you are working to build relationships with those customers. Can you elaborate in terms of what you are doing specifically and is there anything differently than what you’ve done in the past, especially as it relates to the foreclosure market?

Larry D. Stone

Certainly we are trying to work with various organizations in each market -- realtors and banks and so forth because a lot of those homes have been foreclosed on and we’ve repeatedly said if the bank owns the home, then there is certainly a good opportunity to work with the folks they have worked with in terms of growing that commercial business so it varies by market and in some markets, it’s the real estate agents that we are working with in trying to get the jobs and so forth. In some cases, we’ve actually used our installed sales team to do the projects that say in a small market where a realtor might be working with the bank to get a house ready to sell and so forth, so it varies all across the U.S. and certainly the amount of spend on foreclosed homes varies quite a bit. If it’s just a home, then a customer basically left the home pretty much intact, the spend is much less versus a home where a lot of the fixtures and so forth were taken out and it’s pretty hard to quantify that across the U.S. because it varies quite a bit by market.

It’s just a continual effort to drive more sales at that relationship with those CBC customers and also with the lending institutions and the realtors throughout the U.S.

Deborah Weinswig - Citigroup

Okay, and then Robert, you referred to one of the issues surrounding comps this quarter being the stimulus from last year. What is it that you saw in this quarter that makes you feel differently this year versus last year in terms of the benefit and how much do you now think the benefit was to last year’s second quarter?

Robert A. Niblock

I think we previously said we thought the benefit last year was 100 to 150 basis points and in hindsight, it was probably at least 200 basis points of benefit, so maybe approaching 100 basis points more than what we previously thought.

And I think last year obviously you think about it, there was a discrete amount of money put into individuals’ hands from a rebate check and the money that they received then was prior to the collapse that we saw in the financial markets and the significant -- unemployment was on the rise, a significant increase in unemployment that we saw in the second half of last year so in many parts of the country when that money was put into the consumers’ hands, they had it seems like a propensity to spend it and I think obviously part of it wound up in our channel, whereas this year there hasn’t been that discrete amount of money that’s been put in someone’s hands in a large dollar sum like that and obviously the consumer is in a much different mindset today, given the state of the overall economy. So I think those things combined, it’s just probably our trendline last year was decelerating more than what we anticipated and stimulus filled that gap and it was a bigger impact than what we -- the actual impact was bigger than what we estimated when we looked at the numbers last year.

Deborah Weinswig - Citigroup

Okay, and then last question for Bob, any view for you to provide additional details at the upcoming analyst meeting with regard to the square footage growth changes but will there be a great focus going forward on the smaller stores and refinance or returns there are maybe greater than you expected?

Robert A. Niblock

Deborah, we’re still looking at kind of a barbell strategy. We think there’s still great opportunity in many of the metro markets. A lot of the metro markets, we still feel like we are under-stored and it’s a great opportunity. A lot of those markets, land was very tough to come by previously and in these current economic times, we’re finding more opportunities than we have in the past to put a Lowe's store in some of those metro markets. We’ll continue with our in-fill strategies and the other top 100 markets as prudent. As Robert said, we do look at it on a market-by-market basis. We do evaluate the whole market and the related cannibalization impact, so depending on household growth in those markets would dictate our comfort level to put a store there. And then lastly, the 94Ks continues to perform well and as we talked about, we’ve got several stores open less square footage than 94K that we are continuing to evaluate so we think there’s opportunity in all markets but we are sitting a little bit more cautiously going forward.

Deborah Weinswig - Citigroup

Okay, great. Well, thanks so much and best of luck.

Operator

Your next question comes from the line of Michael Lasser with Barclays.

Michael Lasser - Barclays Capital

Good morning. Thanks a lot for taking my question. Given the weakness that you are seeing in bigger ticket items and the research that you cited that showed consumers are probably going to spend less on home improvement projects, how long do you think it’s going to take for positive comps to return, give the changing dynamics between ticket and traffic? Another way to say it is can you see positive comps such that traffic will return without that big ticket spending?

Robert A. Niblock

I assume you are talking about overall comps being --

Michael Lasser - Barclays Capital

Yes.

Robert A. Niblock

Yeah, I mean certainly I think in an environment like this, I think traffic is what’s king, so that’s what we are after is maintain the traffic. As the environment improves, as the consumer’s outlook improves, housing prices have bottomed, I think that will help from a ticket standpoint and then certainly we’re doing everything we can to try and get those add-on sales and we’ll drive the traffic through the store.

You know, housing prices aren’t looking to bottom until maybe the first half of next year so hopefully by the first half of next year, unless we have another set-back in the overall economy, hopefully we can start moving at least to flat comps maybe in the first half of next year and then certainly hopefully positive comps as we move through the year next year.

Michael Lasser - Barclays Capital

And as a quick follow-up, on the reduction in store openings, is this a change in the way that you see the longer term market opportunity or is it more so that some of these sites that currently do not have hurdle rates will when the environment changes?

Robert A. Niblock

Obviously I think it’s just an extension of the store opening process and because in any of these cases, you are opening a store that we had planned that store two or three years ago, the surrounding stores were doing a greater volume. Now those surrounding stores after three years in many cases of negative comps, the volume has dropped to the point where you don’t want to cannibalize them. It’s going to take a few years for those store volumes to recover to the point that you will be ready to cannibalize the site. So it’s really just going through and looking at it on a market-by-market basis and deciding is it best just to walk away now and come back to this market at some point in time in the future? So it really kind of -- we still think there’s great long-term opportunity out there but that overall number of stores that we are talking about opening, the timeline on that gets extended.

Michael Lasser - Barclays Capital

And one quick last one -- your guidance for the rest of the year would kind of suggest that the margin performance is going to deteriorate somewhat from what you saw it the first half of the year. Is there anything that’s happening, particularly on the gross margin side even though comparisons are becoming much easier that would suggest that that performance will be somewhat restrained?

Robert F. Hull Jr.

Actually gross margin for the second half as a percent of sales increased relative to last year was actually slightly higher -- I think we had 62 basis points improvement in the first half. Our outlook is 70 basis points for the year would suggest a little bit higher performance in the back half. Obviously that skews a little bit lower than that in Q3, a little bit higher than that in Q4 relative to the easier margin comparisons we have relative to Q4 2008.

Michael Lasser - Barclays Capital

Okay. Thank you very much.

Operator

Your next question comes from the line of Gregory Melich with Morgan Stanley.

Gregory Melich - Morgan Stanley

Two questions -- one on the credit and then on DIY. If you think about how credit drives the larger ticket, what did credit drop as a percentage of sales in the quarter and could you just give us an update on what percentage of your sales are on those larger tickets, like you did in the first quarter?

Robert F. Hull Jr.

I can tell you that credit as a total percentage of the mix was roughly 20%. In the second quarter, that’s down from about 21.5% from Q2 last year -- actually bank card mix dropped by a similar amount with the cash and debit card increasing in mix. I don’t have the specific big ticket amount in front of me -- certainly the credit does play an impact in the big tickets and has an impact in the overall big ticket performance. We are certainly seeing a different dynamic in the credit markets this year relative to last year, which is having an impact on the extension of credit.

Robert A. Niblock

When you talk about big tickets, just keep in mind that’s not always done on the credit card. It can be -- I think there’s big tickets and when we speak about it, it’s in all forms so not specifically to the credit card but when I talked about sales greater than $500, the comp being down about 16%, that’s a -- those tickets above $500 is somewhere in the neighborhood of 30% of our total sales, so --

Gregory Melich - Morgan Stanley

Okay, great. And then secondly, Larry, you got into the DIY and how it’s always been an important focus but growing -- beyond adding staffing into the categories where that’s important, are there other initiatives that you have or things that you can do to try to get people to put more in the basket if they are doing a project or, I don’t know, in-store kiosks or other things that we should look for?

Larry D. Stone

Certainly, Greg. I think the thing that we’ve really tried to emphasize in the last three years, we spent a lot more time working on our new lower priced strategy. The special values, which would come in maybe for a weekend with special values and so forth to really hit it pretty hard and drive that traffic into the store. Clinics certainly have come back in some of our markets. The kids clinic has proven to be very, very successful for us and not only gets the parents into the stores to shop but it really drives hopefully a lot of DIY-ers in the future for our company. Lowes.com has many, many how-to videos and information now where customers go online and look at various ways to do projects so as I said in my comments, DIY has always been very important to us as a company and we continue to exploit that business as we move forward.

Inside the store, we’ve got a tremendous focus on selling related items. We’ve always had that but now even a more renewed focus. Our cart starter areas, our side stacks -- everything that we are trying to do inside the store is really to enhance that ticket and drive as much ticket as we possibly can on the smaller purchases, so it’s all throughout the store, [challenging merchants] with better packaging, better signage, better how to, I mean, the whole gamut of things that you would do in a basic retail operation but just with a tremendous amount of focus from all parts of the organization.

Gregory Melich - Morgan Stanley

Great, thanks.

Operator

Your next question comes from the line of David Fick with Stifel Nicolaus.

David Fick - Stifel Nicolaus

Good morning. You talked about some details on different line items but the share gains that you mentioned, can you talk about those categories where you are gaining share and losing share and how you feel about those? And relatedly, are there any new market entrants or exits into the categories?

Robert A. Niblock

Certainly we can go through that. As we talk about share gains, we talk about unit volume share, we said we were up 70 basis points in total in the quarter and this is from a third party estimate, and keep in mind that this only relates to DIY spend -- this isn’t anything to do with a commercial spend but we saw in hardware, we saw an improvement, lawn and landscape, rough electrical. We saw a slight improvement in appliances in the quarter, seasonal area of the store so a lot of those kind of DIY type projects that we talked about where the customer can come, get everything they need for that project, get the how-to advice if they are somewhat hesitant than DIY and a while are moving back into that category, our nursery category some of those. So we saw across the board some nice improvements in our share volume on a unit basis in a lot of those key categories.

David Fick - Stifel Nicolaus

Okay, and is there anything you guys are picking up in terms of either mass discount players trying to play in a category or the opposite, closing the stores from stuff that you guys can pick up on, you know, [inaudible], whatever, just kind of your view on competitive entries and exits into different categories would be helpful.

Gregory M. Bridgeford

One area that we’ve seen a lot of closures and probably the predominant sector that’s been hurt by the current -- nature of the current downturn is lumber building material dealers of all sorts, and I think you see that reflected in the strength that we’ve exhibited in in building materials and rough plumbing and hardware and some of the core categories, so when you -- it’s a lot of anecdotal information but that seems to be the one category with or sector within our industry that seems most impacted by the nature of the current downturn.

David Fick - Stifel Nicolaus

Thanks.

Operator

Your next question comes from the line of Scot Ciccarelli with RBC Capital Markets.

Scot Ciccarelli - RBC Capital Markets

You guys in the past have provided some guidelines regarding how the outdoor mix changes quarter by quarter relative to the indoor mix. I was wondering if there’s a similar color you might be able to provide us in terms of big ticket purchases versus small ticket purchases and how that kind of flexes during the course of the year?

Robert F. Hull Jr.

Generally speaking, the big ticket categories seem to peak in the third quarter if you think about a lot of folks try to get their homes ready for the holiday season and a lot of big projects take place in the third quarter, so we’re about to bump up against the cyclical peak, if you will, in big tickets as it relates to a percentage across the year.

Scot Ciccarelli - RBC Capital Markets

Okay, and is there any geographic difference that you’ve seen in terms of the big ticket versus smaller ticket mix?

Robert F. Hull Jr.

Scott, no real big differences. I mean, certainly as we talk about the pressure in the western division and so forth in the Northeast, your big ticket sales as we stated previously many years ago, some of our best home décor stores were on the West Coast and certainly large kitchen cabinet sales and so forth, so you did have a higher percent of their sales being done in larger tickets, so people are spending a lot more on housing projects in the west versus the Midwest but recently it’s been pretty well-balanced across the U.S.

We still have strong pockets of stores that did not have a big upswing in housing prices, so the stores are still pretty much strong versus how they were three or four years ago. S

Scot Ciccarelli - RBC Capital Markets

Okay, great. Thanks a lot, guys.

Operator

Your next question comes from the line of Matthew Fassler with Goldman Sachs.

Matthew Fassler - Goldman Sachs

Thanks a lot and good morning. First, a couple of follow-ups on the weather -- I just want to try to sort of reconcile the comments on the outdoor categories leading the mix while the weather was in fact a problem for you. It would have been that much stronger if the weather had been more seasonal for you?

Larry D. Stone

In certain categories, and air conditioners is one that I highlight in my comments. Certainly the Northeast is a very strong air conditioner market for the company -- a lot of window units are still using them, apartments and so forth and we had a very weak season in the Northeast in terms of air conditioner sales. And some of the outdoor categories also suffered as a result of cool wet weather but you know, just say in time big ticket, [snow PE] and so forth are slow but that’s why I made the comment about outdoor power equipment repair parts. People are really coming back and getting the moors out of the basement so to speak, and fixing them up and using them for one more season. So there again, we think, as we said earlier, a lot of pent-up demand could happen in the next year or so as things continue to improve. But the wet weather in the cool spring hit some -- a lot of different categories but really air conditioners was probably one of the biggest ones this year that we got hit with in terms of sales slow-down.

Matthew Fassler - Goldman Sachs

And following up on that, what kind of margin exposure or what kind of margin pressure have you factored in to your third quarter numbers based on air conditioner markdowns? Is it material relative to the overall number?

Larry D. Stone

It’s really immaterial. As I said in my comments, we’ve got about $16 million more in inventory than we had last year and based on the first couple of weeks of August, we’ve been going through that inventory at a pretty good clip so we feel like in the next three to four weeks, we should be back in line with what we had last year. And quite frankly, when you get into this late in the season, there’s no reason to really try to give it away because people are just not going to buy it if it’s not hot, so we think we have a great opportunity based on the weather forecasts that we are looking at in the next couple, three weeks to blow through a lot of that inventory without discounting is substantially.

Matthew Fassler - Goldman Sachs

Got it, and then finally, following up on Greg’s question on credit, a question for Bob -- you spoke about the mix that you are experiencing in the different I guess credit methods of payment. What are you seeing from your partner in terms of how they are treating your customers’ new applications, turn-downs, et cetera? What do the metrics look like and how are they evolving from earlier in the year?

Robert F. Hull Jr.

The approval levels have dropped slightly from this time last year. As you would imagine, everybody is tightening their lending standards and our partner is no different. The drop is not as dramatic as we once thought. I think roughly 85% of our consumers are homeowners. They’ve got very good credit scores. The commercial customers, this is their livelihood so they are paying their bills in order to be able to procure more product so we are not seeing much degradation -- in fact, towards the tail end of 2008, our partner took certain risk actions and now they are reversing some of those risk actions so we’ve got a good balanced approach to try to grow sales profitably with our credit partner.

Matthew Fassler - Goldman Sachs

If you think about -- just to follow-up on that, if you think about what you are seeing sequentially, is this sort of as big a drop as you’ve seen year-on-year or had you already turned the corner in that regard in terms of approvals?

Robert F. Hull Jr.

The approvals have -- they’ve dropped. Probably the biggest drop was Q4 last year, Q1 this year, so we are seeing some relative stabilization there as it relates to approval levels.

Matthew Fassler - Goldman Sachs

Got it. Thank you so much.

Robert A. Niblock

I think we’ve got time for one more question.

Operator

Okay. Your final question comes from the line of Eric Bosshard with Cleveland Research.

Eric Bosshard - Cleveland Research

Good morning. A question on the second half. Seasonal and outdoor certainly a favorable contributor in the first half and the second quarter. As that becomes a smaller piece of the business in the second half, what are the thoughts in terms of driving traffic? Is there any thought of increased promotion or anything different to try to drive traffic other than the focus on core DIY categories you’ve talked about?

Larry D. Stone

Certainly as we get into the third quarter and we start to switch out to more of the seasonal fall products, we get into seasonal heat and certainly as we get into the latter part of the third quarter into our trim the tree and get ready for Christmas, we don’t see anything right now that makes us think we need to do anything drastic to change people coming into our stores. We think we’ve got great values every day and certainly the special values in the new lower price and all the things we are doing from a marketing standpoint, we feel real comfortable that we can continue to drive traffic without having to do anything that would be beyond the norm of what we’ve done in the first half of the year.

Eric Bosshard - Cleveland Research

Perfect. Okay, that’s all I needed. Thank you.

Robert A. Niblock

Thanks for your continued interest in Lowe's. We look forward to speaking with you again when we report our third quarter results on November 16th. Have a great day.

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Source: Lowe's F2Q09 (Qtr End 7/31/09) Earnings Call Transcript
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