Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

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

F3Q09 Earnings Call

November 16, 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

Matthew Fassler - Goldman Sachs

Colin McGranahan - Sanford C. Bernstein

Deborah Weinswig - Citigroup

David Schick - Stifel Nicolaus

Michael Lasser - Barclays Capital

Chris Horvers - J.P. Morgan

David Strasser - Janney Montgomery Scott

Alan Rifkin - Banc of America

Operator

Good morning, everyone and welcome to Lowe's Companies’ third 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.

Comparable store sales for the quarter were negative 7.5%, within our guidance and driven by a 6.7% reduction in average ticket and a fractional decline in customer traffic. While spending remained weak, we were pleased with our improvement in comps versus the second quarter.

Highlighting that progress, we saw sequential improvement in comp sales in 45 of 50 states in the U.S., with some of the biggest improvements coming in areas hardest hit by the housing downturn. Larry will provide additional details on our regional performance.

Also, our Canadian stores continued their strong sales performance and delivered positive comps in the quarter. We saw a reversal of the five quarter trend of outdoor related products out-comping indoor products. In the third quarter, comps for indoor products exceeded outdoor products by 300 basis points, led by positive comps in appliances, flooring, and interior paint but also reflective of the impact last year’s hurricane had on outdoor categories. In fact, we estimate our Gulf Coast stores negative impacted comps by approximately 100 basis points in the quarter.

In addition, Lowe's self-cannibalization from store expansion negatively impacted comps by approximately 75 basis points, down from nearly 200 basis points in the third quarter of 2008.

While comps remain negative in total, I continue to be pleased with the market share gains we are capturing. According to third-party estimates we gained 130 basis points of unit market share in the third calendar quarter.

The broad-based pressures of the macro environment are still evident in our sales and our quarterly consumer survey indicates homeowners continue to delay large purchases and the initiation of large projects until they feel better about the economic climate.

It’s still early to describe this pent-up demand but it is interesting that topping the list on the consumer survey of delayed projects are flooring updates where we saw some evidence of increased consumer engagement in the quarter in kitchen and bath remodels.

We know exuberant spending during the bubble days impacted the replacement cycle for certain updates and improvements but the fact that these projects are at the top of homeowners’ to do list is encouraging.

Another encouraging sign from our third quarter survey and mirroring other national home price indicators was the fact that consumers perception of the value of their home showed some stabilization. This quarter a slightly lower percentage of respondents indicated that they felt the value of their home was declining, representing the first time in five quarters that we have seen an improvement in this metric on a year-over-year basis.

Considering the pressures from the external environment and the impact of hurricane markets and cannibalization, I am pleased with our performance in the quarter, as well as the continued effort and dedication to customer service by our more than 228,000 employees.

Gross margin increased 22 basis points in the quarter. While the promotional environment is appropriately described as elevated, which is not surprising considering the length of the downturn, our gross margin rate continues to hold up relatively well, a sign that the competitive environment remains rational.

Impacted by weak sales, we again experienced expense deleverage, led by 66 basis points of payroll deleverage. Despite the deleverage, I believe we have managed expenses well and continue to appropriately balance the need to reduce costs with our commitment to customer service.

Also, as detailed in today’s release, we reduced the carrying value of assets for three operating stores and recognized write-offs related to potential store sites we no longer intend to pursue. In addition, as previously announced, we closed our central Milwaukee location on September 20th. Primarily as a result of these items, we recognized a pretax charge of $57 million, or approximately $0.02 per share in the quarter.

Sequentially better sales results, improving gross margin, and solid expense control led to earnings per share of $0.23, which was within our guidance for the quarter. In addition, sound working capital management allowed us to generate substantial cash flow despite a decline in earnings.

As the economy and the housing market continues through the bottoming and recovery process, we know there will be ongoing macroeconomic hurdles to cross, including declining home values and rising unemployment but we are encouraged by the signs of stabilization we are seeing in our business and we are confident we are well-positioned to capture additional market share.

Thanks 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 external pressures remain, we are starting to see some encouraging signs as third quarter comps improved quarter to quarter to negative 7.5%. Comp traffic remains relatively stable and actually ticked up slightly from the second quarter but remain slightly negative while comp average ticket was down 6.7% for the quarter.

Comps for tickets greater than $500 improved sequentially to approximately negative 10% from negative 16% in Q2, driven in part by increased sales in flooring and appliances. On the flip side, comps for tickets under $50 decreased only slightly from the second quarter.

Looking at our results from a regional basis, we saw improving trends Q2 to Q3 in 21 of our 23 U.S. regions with some of the largest quarter to quarter improvement in our western division. While comps are still negative in all four western regions, sales results improved on more than 500 basis points quarter to quarter to single-digit negative. This is an encouraging sign that certain housing markets, including many of the hardest hit, may be reaching a bottom.

The two regions that experienced a quarter to quarter decline in comp sales trends were in the Gulf Coast, where we faced tough comparisons as we cycled against last year’s hurricane related spending. While all regions remain negative, we are encouraged that only three of our 23 regions had double-digit negative comps for the quarter, a small victory but that’s the fewest double-digit comp in region since third quarter 2006.

As I mentioned, two regions in the Gulf Coast faced tough prior year comparisons and those regions reported the lowest comps in the quarter. Additionally, in one of our core markets in the Southeast that was late entering the housing downturn, comps improved quarter over quarter. However, this region still had double-digit negative comps for the quarter.

On the product side, three of our 20 product categories had positive comps for the quarter, appliances, flooring, and paint. Driven by compelling value and consumers’ willingness to invest in products that increase energy efficiency, we saw strong demand in appliances, specifically in high efficiency laundry and refrigeration products.

In flooring, consumers responded favourably to our Stainmaster carpet $39 whole house installation offer, which drove robust carpet sales for the quarter. This suggests that some consumers are feeling a little better about the future and are willing to act on great values to complete certain discretionary home improvement projects.

We continue to see strength in our paint category, one of the most popular DIY projects. Positive comps in this category is another indication of consumers’ willingness to complete simple projects to enhance their home.

In this tough environment, consumers have become more disciplined in their spending and are looking for ways to save money. They are uncertain about the future and many have moved from relying on others to complete home improvement projects to do it yourself. To capitalize on the resurgence of DIY, our print ads have evolved to more prominently feature repair and maintenance related projects. This DIY trend, coupled with our efforts led to third quarter comps above company average in many of our repair categories.

We also added 14 how to informational project boards in key departments in our stores to better assist customers and we now have over 200 how-to videos on lowes.com to give customers project information and tips needed to successfully complete their home improvement projects.

In the third quarter, special order sales improved quarter over quarter, driven primarily by special order carpet and millwork but still delivered a negative comp. While much of the weakness in the special order side of our business has been macro driven, we continued to enhance our offering to balance convenience of quick availability offered by in-stock products with the required investment in inventory.

On that front, we are identifying opportunities to use our special order express program that allows us to keep inventory in our distribution centers and quick ship this to our stores when we receive an order. So in addition to allowing us to better manage our inventory investment and SKUs with slower turnover, we continue to leverage our vendors by placing direct orders to our DCs in truckload quantities instead of special orders that have a higher product and freight cost. By doing this, we are able to pass the savings to our customers.

This is another example of our ability to quickly fulfill demand while providing great value that will help us continue to take market share in specialty retailers.

One example we are very excited about has rolled out recently. We now have a new special order express hardwood flooring program where several of our SKUs are available to consumers in seven days or less and once again by leveraging our distribution network and buying power, we were able to lower retail by over 20% and pass these savings along to consumers. This is a huge win for our flooring department and significantly closes the competitive gap, especially flooring stores. While it is very early in the program, consumers and our sales teams in the stores have reacted very favourably to this new program.

We also saw improvement in our installed sales program in the third quarter with improvement in millwork, window treatments, and carpet. While still negative, comps improved quarter over quarter to negative 2%, which is an increase of approximately 2,000 basis points.

Our comp detail fees, which is the first step in the installation process, were positive for the quarter, again a signal that consumers are starting to feel more comfortable with larger projects.

Sales to commercial business customers fell below the company average for the quarter but we are confident we are gaining market share in the commercial segment. One way we plan to support and strengthen our relationship with CBC customers is through a new credit loyalty program we are launching today with American Express Open. This new program enables small business owners to earn points on virtually all of their purchases and provides them access to discounts with key business service providers. This program has been introduced in select markets as we speak with a broad-based rollout scheduled for first quarter 2010. More details about this exciting new credit offer will be available later today as we formally launch the program.

Despite the external pressures weighing on our sales, we continue to grow our market share. According to third quarter estimates, we gained unit market share in 14 of 20 product categories and remain flat in one in the third calendar quarter versus the same time period a year ago and we gained 130 basis points of total store share in the quarter.

I am also encouraged by our draw rate for the number of times Lowe's was in the consideration set of customers buying the products we sell. Of our 20 categories, 14 improved and one stayed flat, indicating that our value message is resonating with home improvement consumers.

Gross margin for the quarter expanded 22 basis points, aided by lower fuel prices and efficiencies gained by our distribution infrastructure and improved inventory shrink. Our inventory is in good shape coming out of the quarter. We planned conservatively to our seasonal categories and had good sell through on our fall seasonal products. Payroll deleveraged 66 basis points, driven by negative comps and approximately 20% of our stores were operating at base staffing levels in the quarter.

As we continue to manage payroll throughout this downturn, we remain committed to appropriately staffing our stores to ensure great service to customers. For the quarter, our customer service scores improved compared to last year, which demonstrates that our store teams are doing a good job taking care of customers.

For the past three years during this challenging sales environment, I have spent most of my time on these quarterly conference calls discussing in great detail the blocking and tackling we are executing to address the near-term pressures while positioning the company for continued success.

Did we have the right processes in place? Were we aligning payroll to the rate of sales? Were we adjusting our advertising message and spend extracting cost out of the business? All good questions and all are critical for our continued success. However, I probably haven’t done a good job in communicating our merchandising strategy. Some of you may have felt that because we weren’t talking about it as much, maybe we lost some of the excitement in our merchandising. We never lost focus on merchandising as a key differentiator. It has always been and will continue to be a priority for us. Our merchandising efforts remain rooted in customer research. We commissioned consumers studies, scrutinized market tracking surveys, and use that information to ensure we are offering compelling and innovative products that meet consumers’ needs.

Our research tells us consumers want three things when taking on a home improvement project today -- one, a great value; two, a coordinated look; and three, projects easy to complete.

National brands are important to Lowe's and will continue to be important going forward. Our premium brand offer includes many high quality and innovative products such as Valspar paint, Electrolux appliances, and Pella doors and windows, just to name a few.

Another example is the exclusive line addition of [porter cable] product line of affordable, professional grade power tools that enhance our already extensive tool offering. As endorsed on a quality, value, and performance, several porter cable SKUs recently received best buy and recommended buy ratings from a leading consumer magazine. Great products, presentation and service led to 130 basis point unit market share gain in tools in the third quarter according to third party estimates.

Looking ahead to the holiday gift-giving season, where we use this in increased demand for tools, we developed a tool guide catalog to showcase our industry-leading tool assortment. The depth of our assortment meets the needs of the DIY customer as well as professional tradesmen. This catalog is currently available in our stores.

We balanced the use of national brands with proprietary brands to ensure our product offering continues to meet consumers’ evolving needs. Using our research team, our trend and design team has its finger on the pulse of the consumer. This team is responsible for identifying and integrating consumer focused trends and products, as well as the development and management of proprietary brands, product design, and packaging.

Partnered with Lowe's global sourcing to source products, these teams provide a coordinated streamlined process and bring in better merchandising programs to market.

For example, Alman Roth, one of our proprietary brands, is a great example of how we address consumers’ desires for recently priced home décor products. Consumers can shop a wide array of fashion window treatments and pair their selection with coordinated bath accessories. In these fashion categories, style drives consumer purchase decision and as a measure of success, third quarter comps surrounding Roth products were double-digit negative to positive.

Another example where we identified an opportunity to fill a void is with air purifiers. Again, research told us consumers are seeking ways to keep their homes clean and reduce allergens. Our healthy home program fills this need with its affordable and easy solutions to create a healthy home environment which includes our comprehensive product line of [Idyllis] air purifiers. Since launching [Idyllis] last year, demand has been solid.

Demand for products that protect the environment and conserve energy is another growing trend. In short, consumers want products that can measure, reduce, and in some cases generate energy.

While we already offer a wide assortment of products designed to improve energy efficiency, including Energy Star appliances, John Mansfield insulation and weather stripping, to name just a few, we saw an opportunity to add products that help consumers measure energy consumption and in some markets, even generate their own energy.

We are taking advantage of this opportunity by piloting alternative energy related products, including wind turbines and solar roof panels in 22 of our stores in the western division. Our continuing efforts to provide energy efficient product and educating consumers about the environmental benefits of energy efficiency earned us our fourth Energy Star retail partner of the year award.

Also, our focus on preserving natural resources, increasing water efficiency, and the awareness of the water sense label earned us the 2009 water sense retail partner of the year award.

While these are just a few examples of how we are responding to consumer trends and providing customers a great value, they also reinforce our merchandising strategy of listening to consumers and then developing and implementing innovative product solutions.

Our proprietary brands play an important role in our overall brand strategy. We continue to leverage them and manage product line extensions where it make sense from the consumers point of view. These examples demonstrate how we are differentiating our merchandising, providing customer valued solutions.

While my message to investors has been focused on implementing controls during the worst housing market in decades, I hope it is clear we have not lost focus on what is important -- offering innovative products at a great value, driving profitable sales, and providing the great customer service experience that consumers expect from Lowe's.

As it relates to our marketing approach, we remain committed to our everyday low price strategy. Our goal has always been to offer innovative products at all price points along the continuum. To further convey the value message many consumers are looking for today, we strategically use our new lower price and special value strategies to build traffic and ticket.

We remain committed to managing the business for the long-term success. As we look to the balance of the year, our outlook remains cautious as we anticipate continuing headwinds. However, our recent results are adding optimism about an improving external market as our ongoing efforts to evolve with the home improvement consumer gives us confidence that we are well-positioned for the future.

Thanks for your interest in Lowe's and I will now turn the call over to Bob Hull to review our third quarter financial results. Bob.

Robert F. Hull Jr.

Thanks, Larry and good morning, everyone. Sales for the third quarter were $11.4 billion, which represents a 3% decrease from last year’s third quarter. In Q3, total customer count increased 3.6% while average ticket decreased 6.4% to $61.43. Year-to-date, total sales decreased 3.1% to $37.1 billion. Comp sales were negative 7.5% for the quarter. Looking at monthly trends, comps were negative 8.7% in August, negative 7.9% in September, and negative 5.6% in October. The negative 7.5% comp for Q3 represents a 200 basis point sequential improvement from Q2’s negative 9.5% comp.

For the quarter, comp transactions decreased 0.8% and comp average ticket decreased 6.7%. We are encouraged by the improvement in comp average ticket relative to Q2’s 8.6% decline.

With regard to product categories, the categories that performed above average in the third quarter include rough plumbing, paint, lighting, flooring, nursery, seasonal living, lawn and landscape products, fashion plumbing, appliances, and home environment.

For the first nine months of 2009, comp sales were negative 8%.

Gross margin for the third quarter was 34.2% of sales, an increase of 22 basis points from last year’s third quarter. The increase in gross margin was driven by a number of factors.

Lower inventory shrink as a percentage of sales had a positive 12 basis point impact in the quarter. Distribution favourably impacted gross margin by 6 basis points, driven by lower fuel costs. Lastly, product mix positively impacted gross margin by 5 basis points in the quarter.

Year-to-date, gross margin of 34.8% represents an increase of 50 basis points over fiscal 2008.

SG&A for Q3 was 25.2% of sales, which deleveraged 202 basis points, driven by a number of expense lines. For the quarter, store payroll deleveraged 66 basis points. Following an evaluation, we determined the need to reduce the carrying value of three operating stores and certain other assets and as previously announced, we closed one store. This resulted in a pretax charge of $49 million. In addition, we incurred $8 million in write-offs related to the pipeline of potential future store sites we no longer intend to pursue.

In total, SG&A was negatively impacted by $57 million related to the reduction in asset values and discontinued projects which negatively impacted earnings per share in the quarter by approximately $0.02.

In addition, fixed costs, primarily rent and property tax, deleveraged approximately 25 basis points due to the comp sales decline. Employee insurance deleveraged 18 basis points in the quarter, mainly driven by rising healthcare costs and higher enrolment. Lastly, bonus expense deleveraged 15 basis points in the quarter. This is primarily related to our stores as they attained higher performance levels to plan this year.

Year-to-date, SG&A is 24.1% of sales and deleveraged 196 basis points through the first nine months of 2008.

Store opening costs of $10 million leveraged 18 basis points to last year as a percentage of sales. In the third quarter, we opened 12 stores with no relocations. This compares with 39 new stores in Q3 last year.

Depreciation at 3.5% of sales total $403 million and deleveraged 25 basis points compared to last year’s third quarter, primarily due to the negative comp sales and the addition of 84 stores over the past 12 months.

Earnings before interest and taxes or operating margin decreased 187 basis points to 5.3% of sales. Year-to-date operating margin of 7.4% represents a decrease of 166 basis points from 2008. Interest expense at $77 million deleveraged 12 basis points as a percentage of sales. For the quarter, total expenses were 29.6% of sales and deleveraged 221 basis points.

Pretax earnings for the quarter were 4.6% of sales. The effective tax rate for the quarter was 34.9% versus 37.3% for Q3 last year. The decrease in the third quarter effective tax rate was related to the settlement of several state tax matters in the period. This positively impacted earnings per share in the quarter by approximately $0.01.

Earnings per share of $0.23 for the quarter were within our guidance of $0.21 to $0.25 but decreased 30% versus last year’s $0.33. Year-to-date, the total expense associated with the reduction of carrying value of long life assets and write-offs of discontinued projects totalled $118 million, or approximately $0.05. Including these items, earnings per share for the first nine months of 2009 was $1.07, which is down 22% to 2008.

Now I’d like to comment on the balance sheet, starting with assets. Cash and cash equivalents balance at the end of the quarter was $1.1 billion.

Our third quarter inventory balance increased $97 million or 1.2% versus Q3 last year. The increase was due to a 4.9% square footage growth offset by a 4.1% reduction in comp store inventory and a slight decline in distribution inventory.

The inventory turnover, calculated by taking a trailing four quarters cost of sales divided by average inventory for the last five quarters, was 3.65, a decrease of 33 basis points from Q3 2008.

At the end of the third quarter, we owned 88% of our stores, the same as the third quarter last year. Return on assets, determined using a trailing four quarters earnings divided by average assets for the last five quarters, decreased 250 basis points to 5.2%.

Next, I would like to highlight a few items from the liabilities and shareholders’ equity section of the balance sheet. Our debt to equity ratio was 26.1% compared with 29.7% for Q3 last year. At the end of the third quarter, our lease adjusted debt to EBITDAR was 1.58 times.

Return on invested capital, measured using a trailing four quarters earnings plus tax adjusted interest divided by the average debt and equity for the last five quarters decreased 345 basis points for the quarter to 8.1%.

Now, looking at the statement of cash flows, year-to-date cash flows from operations was $4.4 billion, which was essentially flat to last year for the first nine months of 2008. Working capital improvements offset the decline in net earnings.

Cash used and property acquired was $1.4 billion for the first nine months of 2009 compared with $2.5 billion for the same period last year. As a result, year-to-date free cash flow of almost $3 billion represents a 62% increase over the three quarters of 2008.

There were no shares repurchased in the third quarter.

Looking ahead, I would like to address several of the items detailed in Lowe's business outlook. We expect fourth quarter sales to be essentially flat to last year, which incorporates the opening of approximately 13 new stores, two in November, four in December, and seven stores in January. In the quarter, we will open two stores in Monterey, our first stores in Mexico. Comp store sales are estimated to decline 2% to 6% to last year.

EBIT or operating margin for the fourth quarter is expected to increase by approximately 10 basis points to last year as a percentage of sales. The increase is driven by gross margin improvement and store opening cost leverage, offset by SG&A and depreciation deleverage. The anticipated sales and operating margin results are expected to generate diluted earnings per share of $0.09 to $0.13, which ranges from a decrease of 18% to and increase of 18% compared to last year’s $0.11.

For 2009, we expect to open approximately 64 stores, resulting in an increase in square footage of approximately 4%. We are estimating a comp sales decrease of 7% to 8% and a total sales decrease of 2% to 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% for 2009. As a result, we expect diluted earnings per share of $1.16 to $1.20 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 $2.2 billion, with roughly $300 million funded via operating leases, leaving cash CapEx of approximately $1.9 billion for 2009. As a result, we are forecasting free cash flow of approximately $1.7 billion for the year.

Our outlook does not contemplate any share repurchases for the fourth quarter.

Regina, we are now ready for questions.

Question-and-Answer Session

Operator

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

Matthew Fassler - Goldman Sachs

If you could address the setup for the fourth quarter from both the merchandising perspective and a promotional perspective -- obviously last year we saw some competitive disruption so if you could sort of frame your comments on margin and promotional activity as it relates to fourth quarter seasonal goods and perhaps contrast that with how you saw last year shape up.

Larry D. Stone

I’ll start on that one and let Robert and Bob add on. You know, last year in the fourth quarter we had three things kind of going against us. We were getting out of the wallpaper business, which affected our margin. Trim and tree was not selling as robust as we expected, so therefore we took an early discount on that and then power tools, we had some issues with the amount of inventory that we bought in anticipation of a better Christmas season. This year in contrast we don’t have the wallpaper headwind, as we got through that business early in the first quarter of this year. We bought conservative for trim and tree and also on tools and on our tool business, one of the things that we did this year I think will give us a much better sell-through, we landed a number of in-and-out items that we bought. These are items that we traditionally bring in for the Christmas season and sell through them, so we tried to go with more in line products, working with all of our vendors to secure better pricing and better value for the consumer, so we feel real confident about our products as we head into the Christmas season. Our trim and tree business has been solid so far, so we don’t anticipate any headwinds with that business this year and certainly we think consumers will be compelled by the products that we are offering throughout the store as they start to buy for the Christmas season.

Matthew Fassler - Goldman Sachs

That’s great and if I could just ask one follow-up -- within the context of your guidance to somewhat improved same-store sales trends down 2 to down 6, as you look at the different baskets of ticket, the 500 and up that you talk about, the $50 and below that you have discussed, where would you expect to see the biggest improvement among those different segments?

Robert F. Hull Jr.

I think we should we see some additional improvement in the number of transactions or traffic. I think the majority of the increase will continue to come from improvement in average ticket, similar to what we saw in Q3 relative to Q2.

Matthew Fassler - Goldman Sachs

So as you look at the big ticket category, which went from down 17 to down 10, it looks to us like the small ticket stayed sort of at minus 1 and the medium ticket, if you will, everything in between was sort of unchanged. Would you say that it’s the negative 10 that improves a bit or would you say it’s the other categories that likely make headway?

Robert A. Niblock

I think you will probably see potentially some improvement in both -- you will see an improvement in traffic between those customers that are shopping, probably buying a slightly larger ticket. When you think about what we are going up against last year, I mean, in the fourth quarter last year you basically were coming out of the meltdown in the financial markets and a significant amount of unknowns and uncertainty out there from a consumer standpoint as to what the future held. When you roll forward to this year, with where unemployment is at, they may not like the environment but certainly I think they believe that better days are ahead. So probably slightly more optimistic for the longer term than what they were a year ago and we have started to see, just like Larry talked about with the installed carpet promotion, when the right value is out there we have seen consumers respond better than what we have seen in the past, so for those reasons we are more optimistic than we were a year ago looking into the fourth quarter and certainly believe that you will continue to see a pick-up in traffic and those customers spending slightly more as well.

Operator

Our next question comes from the line of Colin McGranahan with Bernstein.

Colin McGranahan - Sanford C. Bernstein

Just following up on the ticket and traffic question, firstly -- and I don’t know if there is any way to do this, I am not looking for an actual number but a pretty substantial improvement in installed sales, negative 2, a 20 point improvement, the $500 plus tickets, negative 16 to negative 10 -- is there any way to tease out the impact from the Stainmaster carpet installation in the installed sales piece and the comps -- or the comp contribution from better appliance sales in the $500 ticket, to just get a sense of what the rest of the underlying ticket and installed sales business look like?

Larry D. Stone

That is something that we can work on. We certainly don’t have those numbers handy today that we can give you but if you go in and you look at the whole installed category as a whole, basically we talked about it all year in every one of our calls that our installed program for our stock carpet program has been extremely strong all year long. The Stainmaster, which includes some stock carpet but predominantly more special order carpet which drove that improvement in installed sales and also drove the improvement in special order sales for the quarter. Certainly major appliances, when I spoke of high efficiency laundry and high efficiency refrigeration, you are certainly going to drive a much higher average ticket on those products which will increase the greater than $500 tickets.

So just a lot of different moving pieces in that but certainly when we evaluate the business and look at it installed or we look at major appliances or any of the various businesses we are trying to extract what drove it and what could be continued success in those businesses and we feel very confident about ourselves as we head into the fourth quarter and hopefully the Christmas season will be strong as well. Power tools, another great example. You have a lot more power tools being sold in probably the $100 to $500 buckets versus greater than $500 or less than $100, so there again that’s another bucket we take an entirely different look at when it comes to power tools.

Colin McGranahan - Sanford C. Bernstein

Okay, that’s helpful and then just one quick follow-up -- there’s been a lot of noise in terms of a ticket trend over the last few years but seasonally, is the -- how much lower is the fourth quarter typically? Because I look at the average ticket at $61.43 here in the third quarter and uncannily it was exactly the same to the penny as the average ticket in the second quarter. So is this now kind of a low $60, $61 ticket? Do you feel like that’s stabilized or is there some seasonality we should be aware of going into the fourth quarter?

Robert F. Hull Jr.

I don’t have the exact ticket by quarter in front of me. I think generally speaking you see a lot of projects in Q3 as folks get ready for the Thanksgiving holiday but I don’t have the specifics regarding average ticket for Q4.

Colin McGranahan - Sanford C. Bernstein

Okay.

Larry D. Stone

One follow-up on that, I think we have all mentioned in our comments about traffic -- certainly during this holiday season, we want to drive a tremendous amount of traffic to the stores and you look at items like trim and tree and you look at electrical cords and a lot of things that really start to sell -- a lot of sales peaks in a lot of those items with lower average ticket sales, so there again it’s always just balance you’ve got of traffic versus ticket. Certainly right now we’d love to have a lot more foot traffic in these stores and that might pull down the average ticket some but there again, if we are getting the traffic in the store and selling these particular items, you are going to mix out better on the margin side of the business.

Operator

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

Deborah Weinswig - Citigroup

Bob, can you discuss some of your expense control initiatives, especially around labor and advertising? And I think that Robert had mentioned that labor was not levered in the quarter -- can you specifically address advertising as well?

Robert F. Hull Jr.

Sure, Deb. I think as we have talked about for some time as it relates to store payroll, we continuously try to evaluate and match the number of hours with forecasted sales. Our teams have done -- the [inaudible] and staffing teams have done a very good job of taking a look at our matrix and trying to understand selling and non-selling hours and adjusting the model on the way down. They’ve had to really take a look at our business over the past now 13 quarters of negative comps, so as we mentioned in the comments, we did deleverage store payroll by 66 basis points in the quarter.

If we look at advertising relative to last year, it was basically flat as a percent of sales so the same spend as a percent of sales last year -- on a more holistic level, we continue to challenge every nickel that goes out the door and have made really good progress across the company, scrutinizing ongoing services provided in our stores, RFP-ing basic things like coffee, paper, register tape, shopping bags, et cetera, continuing to make very good progress across the entire company.

Deborah Weinswig - Citigroup

And then can you also discuss your new store development program? Many retailers have had difficulties getting stores open in this environment, so how much of this are you doing yourself and what are you doing that is outside of the box versus others?

Gregory M. Bridgeford

Actually, we haven’t had an issue with finding GCs. We had a large network of general contractors that we worked with when we were opening up 150 plus stores a year and over the last couple of years, we’ve been able to leverage those relationships and as we have reduced the number of units that we are opening to be able to give a significant chunk of that business to the best performers of those GCs, subcontractors, it hasn’t been an easy market because you have to look at those that are financially stable and able to perform but we’ve kept very, very close tabs on them and actually it’s a minor point but even increased our travel budgets to make sure that our subs were healthy as -- in certain parts of the -- of certain regions where there was a fair number of financial stress on those sectors. But we have not experienced an issue with that and have kept very close tabs with that.

Operator

Our next question comes from the line of David Schick with Stifel Nicolaus.

David Schick - Stifel Nicolaus

Larry talked about the commercial customer and new initiatives there and Robert I think mentioned kitchen and bath as that -- as moving up, or high on the to do list, so I wanted to sort of step back -- if you look at markets where the pro customer is healthiest, can you talk about what you are seeing there and should we think about rough plumbing, which you mentioned as I think a nicely above average category? Are there things we should think about for 2010 in the pro customer?

Larry D. Stone

Certainly commercial customers where the markets have been stronger and some of the markets that are starting to turn, the commercial sales are improving. It’s just really -- if you go back to supply and demand, in a lot of these markets when foreclosures put on the market and customers need somebody to help get the home finished so they can move in, certainly that fits in well with our CBC customers also with our special order programs and our installed programs, so as I mentioned in my comments, we were confident that we are gaining market share on the commercial side of the business. I think we have our teams well-focused and some of the things we talked about at the analyst conference about adding our district commercial account specialists. They are certainly starting to leverage for us in terms of going out and gaining additional market share and serving that broader segment of the commercial business. So we are real confident in what we are doing. I feel very confident as we head into 2010 that as things start to turn better then certainly the commercial business will get better for us.

And categories such as rough plumbing and rough electrical and things like that, I mean, what we have said repeatedly for years, we want to sell the commercial business across the store, not just lumber and build materials and millwork, so categories like rough electrical, rough plumbing, paint, sundries and so forth are important categories to that commercial business customers. That mixes out the margin much more favorably toward the company.

David Schick - Stifel Nicolaus

So should we think about rough plumbing as leading anything or is it too early to think about that?

Larry D. Stone

I certainly think it’s too early but -- for that leading thing. If you think about building a home and certainly rough electrical and rough plumbing both factor into that new home building scenario because you have to sell a lot of copper cable and a lot of pipe as you build new homes but really as you head into the third and fourth quarter, a lot of our plumbing sales, and especially in the later third quarter and early fourth quarter, are driven by pipes bursting and so forth. And on the electrical side, we do sell a lot more cords as we head into the Christmas season. A lot of extension cords and so forth are normally great sellers at this time of the year.

Operator

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

Michael Lasser - Barclays Capital

On the comment about the elevated promotional environment, do you think this is -- the competitive pricing is drawing consumers into the home improvement market or is the pricing the result of the market getting a little bit better? And I asked this because if demand continues to improve, might it be that this promotional intensity continues to increase as more retailers fight for improving demand?

Robert A. Niblock

I think any time you get an environment like we’ve been in for the past three years where you have been in a negative comp sales scenario, so certainly everyone is fighting for foot traffic through the door. You are trying to determine which items the customer is going to respond to. In some cases, that’s using stuff like our new lower price program to draw the customer in, maybe on some consumables they were planning on buying. And then from there, when they are in the store they may pick up other things while they are in there, so you just want to make sure that, particularly in this environment, because we do know the consumer is responding to great value, that you’ve got great value out there and value is the price of the product plus something beyond that, whether that’s knowledge, advice, convenience, whatever it may be that they respond to.

And then as we talked about a little bit today, we are starting to see the consumer start to move a little bit more towards some of those projects. You know, they may be re-carpeting a room, getting ready for the holidays -- they may not yet be putting in a new kitchen of if they are doing it, at least not in the same level that they were in the past. As you know, we have consumers put in new kitchens every day -- it’s just not as many of them as we had in the past. So I think a lot of it is just a reflection of the environment we’ve been in for the past three years as everyone is fighting for foot traffic. I think as the environment gradually gets better, I think you see the lessening in the promotional environment going forward. And then certainly, if you think about around the holidays like this, there’s -- certainly all retailers have seasonal merchandise that they have bought for the holiday period and it will depend on how their sell-through goes as to when they start the discounting of that to try and move through the inventory because in most cases, you don’t want to carry that inventory over.

So yes, in an environment like this, as I said, it’s an elevated from probably what you have seen in years before going into the negative comps but it is certainly not unexpected given the environment that we have seen out there.

Michael Lasser - Barclays Capital

That’s very helpful -- one quick follow-up question; the two-year stack comp improved each month of the quarter. Is that consistent with what you are seeing in the comp improvement in the hardest hit markets? And is the veracity of the improvement in those markets sharper than what you are seeing in other areas that weren’t so hit on the -- hard-hit on the downturn?

Robert A. Niblock

I think from both my comments and from Larry’s, we talked about pretty broad-based improvement. I said that 45 of 50 states had improved and Larry talked about 21 of 23 regions have improved and the primary areas we didn’t get improvement was where you are cycling against last year’s hurricane which you -- obviously with the numbers you are going up against, you would not have expected to have seen improvement. And then, we also talked about I think in our comments some of the largest improvement we had seen was in some of those areas that were previously most hardest hit by the housing downturn, the housing cycle over the past several years, when you think about California, Arizona, Florida, some of those places where you saw nice strong sequential improvement. If you think about it, those areas are furthest through the cycle. We started to see some foreclosure activity moving some of those homes -- the turnover, however it occurs, drives demand and the path to the challenge has always been the amount of homes going into foreclosure versus those coming out. And while there are still a lot of homes to go through foreclosure, we are pleased to see the sequential improvement that we saw through the quarter, including some of those areas that had had the hardest hit and most -- and largest impact on our sales over the past three years, so --

Operator

Our next question comes from the line of Chris Horvers with J.P. Morgan.

Chris Horvers - J.P. Morgan

First, a follow-up question and then one other -- is there any reason to believe that the mark-down pressure that you had in power tools and trim and tree that we could get more than whatever the clearance pressure was on margin last year by seeing a fuller, richer, pricing scenario play out in those categories?

And then secondly, do you think that the -- is the decorative side of your mix picking up? You mentioned trim and tree doing well. Is this a broader sign that perhaps the season is starting earlier? It would seem like the decorative category would favor you versus your competitors, given your market positioning with the female shoppers. Thanks.

Larry D. Stone

The markdown pressure, certainly as we start into the Christmas season, we feel much better than we did last year and as Robert said, with all the meltdown last year in the financial markets and everything, a lot of headwinds and certainly we didn’t want to take any chances in carrying over a lot of inventory that would be obsolete this year, so we made the decision to go ahead and mark those products down and sell through them.

As I stated earlier, we bought more conservatively this year for trim and tree and for tools and once again, we bought less in and out products for tools, so mostly what we bought product in was in line products that if we don’t sell through everything, then certainly a lot of that inventory can go back in line because that inventory just don’t go bad.

Trim and tree, like I said, we are confident right now that things look good. It’s hard to predict what could happen four to five weeks down the road but certainly right now we feel confident with our programs and the way consumers have responded to trim and tree this year.

As far as the decorative side of the business, if you look at all the various products we sell and Robert mentioned in his comments about the indoor categories comping the outdoor categories and certainly we think that mix will continue on the indoor products as we head into the winter months. And we’ve always had a strong following on our décor products, especially around the Christmas season with the things we have in fashion lighting with lamps and so forth, and along with our paint programs and all the various window treatment programs and all the decorative programs that I feel we’ve done a great job over many years in showcasing those products for the customer.

Robert A. Niblock

Also I mentioned in my comments that part of what impacted that flip was the hurricane compare. I mean, obviously last year you had a central hurricane hit. The response to that, there was a lot of outdoor related products that were being sold whereas this year, you are now cycling against that so the flip associated with that.

And then the longer that you go through a cycle like this, what I also mentioned in my comments was some of the pent-up demand that is out there and we believe, as we said from our consumer survey, part of that pent-up demand is showing up on our to-do list of interior projects. So as you go -- when you look at what the future looked like a year ago versus what it looks like today, to my earlier comments about the consumer feeling, even though they don’t like it, feeling relatively better about what the future may hold and that the end of the downturn is near, this year as compared to a year ago, you combine that with some delayed projects and some pent-up demand and I think it supports Larry’s comments that we think the consumer may be more willing to do some things in and around the home as we move through the rest of the quarter.

Chris Horvers - J.P. Morgan

And then one quick one on appliances -- did you mention that category was positive? Was that at all promotional driven and do you think that you are getting to the point of, well, five years later, we worked off the boom years?

Robert A. Niblock

Larry did talk about appliances being positive in the quarter. We were very pleased, as you know, we got a significant line of energy star rated appliances out there, which has been very -- which has seen great customer receptivity though on the whole from a promotional standpoint, it was basically similar to what we have seen in the past, only slightly more promotional than in the past if you look at the number of days on promotion, so obviously the big driver was how well we executed and having the product the customer needs and the customer willing to respond more to upgrading around the home and buying those performance.

Robert F. Hull Jr.

Our margin in appliances was up third quarter this year versus third quarter last year.

Operator

Our next question comes from the line of David Strasser with Janney Montgomery Scott.

David Strasser - Janney Montgomery Scott

Just to follow-up on appliances, as you look out to next year, I mean, you talked a little bit about the cash for clunkers or whatever you want to call it on the appliance side. I’m just trying to get a sense of when the -- the timing of when that is going to peak and if you think there is going to be much of an impact at all.

Larry D. Stone

Certainly the states have had to develop their plan and send it to the Department of Energy by October the 15th and approval is supposed to be granted for each state by November the 30th. There’s approximately $300 million in federal funds that will be distributed to the states based on population and what we know today, there’s 30 state plans with a targeted rollout in the first quarter probably President’s Day or Earth Day is the dates that we are hearing. So a couple of things we’ve done -- we went on lowes.com and added a splash page about where consumers can sign up and get additional information about the various plans and various states as it becomes available.

You know, if you look at our appliance sales, a lot of appliance sales are made because your unit went out so certainly in a lot of cases, you can’t wait until Earth Day or President’s Day to buy a major appliance, so we still feel confident about our sales of major appliances. We certainly think any time you are offering funds for somebody to trade in a clunker than you are certainly going to get some sales and we are on top of it and we’ve got our marketing group and our operations group and our merchants all involved in making sure that Lowe's has the best plan of any major retailer to capture the opportunity as we roll into the first quarter of next year.

David Strasser - Janney Montgomery Scott

Just one other question just round the balance sheet on buy-backs, you didn’t do any in the last quarter. It sounds like you are feeling a little bit more comfortable with where the business is right now -- I mean, does that -- how do you start to think about buy-backs, either in fourth quarter or into 2010?

Robert F. Hull Jr.

We do feel better about our performance. Obviously we were within our guidance targets for Q3. We are looking for some sequential improvement in the fourth quarter so we do certainly feel better about how things are trending and as we talked about at the analyst conference, we do expect to be in the share repurchase market in 2010, so as things continue to unfold, we are going to keep our options open.

David Strasser - Janney Montgomery Scott

Thank you.

Robert F. Hull Jr.

We have time for one more question.

Operator

Our last question comes from the line of Alan Rifkin with Banc of America.

Alan Rifkin - Banc of America

Thank you. My question has to do with the project side of the business -- as you look at various markets in which you operate in, and taking the housing environment together with the unemployment environment in context, could you just shed a little bit of color on what you think the timing with respect to consumers’ willingness to take on major projects may be relative to the performance of those two economic variables within a market? And then I have a follow-up.

Robert A. Niblock

I’ll start and let the others join in. I think you really want to see the project side of the business move in a large way, I think there’s going to have to be a couple of things that’s going to have to happen. One, you are going to have to have unemployment peak and two, you are going to have to have housing prices stop falling on a year-over-year basis. And so you are probably -- I think the current estimate now is that unemployment probably peaks some time the first half of 2010, maybe towards the second quarter or so and it’s probably the second half of 2010 before you get housing prices to bottom out on a year-over-year basis. So I think the consumer maybe -- and a lot of this stuff is market by market. If the environment is better in particular markets, you might start seeing that recovery take place in those larger project items in that market but on a national basis, to really get that moving in the right direction in any meaningful way as you talk about large projects, new kitchens and stuff, I think you are going to have to see that peak in unemployment and that bottoming in housing prices on a year-over-year basis so that the consumer then says, particularly from a housing standpoint, I know that this as bad as it is going to get, I can understand what the value of my home is and now I can -- my mindset can change about thinking about investing in this home versus just monitoring how much the decline is. And then obviously once you got into that psychological point, then certainly hearing media reports about jobs becoming more available, unemployment peaking, people getting hired, I think all those things will help increase the likelihood that someone will be willing to do it.

Now of course, they still either have to have the funds or availability of credit, so there’s some other unknowns out there, you know, what happens in the credit markets but I think those are two key signs.

So our view would be that unless something derails things, it just gradually gets better and then you start seeing maybe some tailwind as you get possibly to the second half of next year on those larger projects.

Alan Rifkin - Banc of America

Just to follow-up, if I may, Robert -- first of all, what percent of your revenues in your opinion are project related? And given what you just said in response to my first question, could we expect that you will become a little bit more aggressive on the availability of credit as we head into Q2 of next year?

Robert A. Niblock

On the availability of credit, obviously that’s granted by AGI Capital through our program. I think if you go back a year ago with the unknowns that were taking place out there in the market, I think that the consumer [inaudible] really pulled back on availability of credit to many consumers that were out there and it’s that pendulum swing. They probably over-swung one way versus the other. And now as we are starting to have our ongoing conversations with them as they are seeing how the market is unfolding, we are starting to see them gradually increase the availability of credit out there to consumers and the other factor too is the overall majority of our consumers that are out there, particularly those that have the best credit scores, have a significant amount of unused credit limit on their line, so they’ve got the ability to spend as it pertains to their proprietary card that they have through Lowe's -- it’s just they are waiting for better clarity.

So where the pull back has been is those with the toughest credit scores but those that are credit worthy, over a majority of them have a significant amount of available to buy on their proprietary credit card. Bob, did you have the numbers on the --

Robert F. Hull Jr.

Our total project sales are roughly about 30%.

Alan Rifkin - Banc of America

Okay. Thank you all very much.

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 fourth quarter results on February 22nd. Have a great day.

Operator

Ladies and gentlemen, this does conclude today’s conference. Thank you all for participating. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Lowe's F3Q09 (Qtr End 10/31/09) Earnings Call Transcript
This Transcript
All Transcripts