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Executives

Robert Niblock - Chairman and CEO

Larry Stone - President and COO

Bob Hull - Executive Vice President and CFO

Analysts

Colin McGranahan - Bernstein

Peter Benedict – Robert Baird

David Schick - Stifel Nicolaus

Alan Rifkin - Bank of America

Dan Binder – Jefferies

Wayne Hood – BMO Capital

Budd Bugatch – Raymond James

Chris Horvers – JP Morgan

Stephen Chick – FBR Capital Markets

Lowe’s Companies, Inc. (LOW) F4Q09 Earnings Call February 22, 2010 9:00 AM ET

Operator

(Operator Instructions) Welcome to Lowe's Companies Fourth Quarter and Fiscal Year 2009 Earnings Conference Call.

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.

Robert 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.

Improving trends and comp sales including improvement in larger ticket comps combined with solid new store sales led to a 1.8% increase in total sales and only a 1.6% decline in comp sales, both better than our expectation heading into the quarter and also our best comp performance in three and a half years. Comp transactions increased 50 basis points and comp ticket declined only 2.1%.

During the quarter we saw sequential improvement in bigger ticket projects and above average comps in our specialty sales area of installed and special order sales. We view this as an encouraging sign regarding consumer’s willingness to take on larger, more discretionary products. This belief is supported by our fourth quarter consumer survey where homeowners told us they’re less likely to delay major product purchases than in the recent past.

While uncertainty remains, there are many indications that the worst of the economic cycle is likely behind us. However, we still face the psychological impact of consumers wondering when home prices will finally bottom and when the job market will improve. On a relative basis the economic outlook is much better than a year ago.

Evidence of an improving environment is found in the fact that we experienced a sequential improvement in comps in all 50 states from the third quarter to the fourth quarter and 26 states had positive comps in the fourth quarter. Our gulf coast regions that are cycling hurricane recovery spending were a drag on comps. Most stores in those areas saw sequential improvement from the third quarter.

Our Canadian stores had an extremely strong quarter, delivering a positive 16% comp in constant currency and over 40% comps in US dollars. The government sponsored home innovation tax credit, which expired on January 31, had a strong positive impact. The tax credit, combined with solid execution by our team in Canada ensured that we gained market share during the quarter. We have only seven comp stores in Canada but because of their strong performance those stores added 20 basis points to the overall company comp in the quarter.

On the expansion front, we continue to see a decline in the impact of self cannibalization which we estimate at approximately 100 basis points in the quarter, down over 80 basis points from last year’s fourth quarter and the lowest rate in many years.

We saw too short of our expected openings in the quarter as our first stores in Mexico slipped into the first quarter of 2010. Unlike our expansion into Canada, one of our goals in Mexico was to develop and utilize stand alone systems to provide enhance portability, lower costs, and speed to market for expansion into other countries. Our desire to ensure those systems were functioning as intended in order to provide customers a seamless experience caused a slight delay in our store openings. Our two stores in Monterrey opened on February 8th with a tremendous response from customers. It’s obviously early, but we’re excited about the reception we’re seeing in the Monterrey market.

We ended 2010 with the highest annual gross margin rate in the company’s history. This year’s fourth quarter we experienced a more rational promotional environment than last year. We had an appropriate buying plan for seasonal products and I believe our gross margin results for the quarter and the year are testament to our ability to effectively manage the business through this four year downturn. When viewed in conjunction with third party data showing solid market share gains, these results show our ability to profitably drive sales.

I’m also pleased with our expense management in the quarter and for the year. We’ve remained committed to investing in the future, retaining talent and rewarding great customer service throughout this downturn. While some may feel that providing great customer service doesn’t qualify as a company specific initiative, I feel that commitment shared by more than 238,000 employees, has Lowe’s uniquely positioned to capitalize on the markedly different competitive landscape we’ll experience as the economy bottoms and home improvement demand improves.

We delivered $0.14 in earnings per share in the quarter and $1.21 in earnings per share for the year. Our fourth quarter EPS was the first year over year increase in earnings since the second quarter 2007. I remain confident that we’re taking appropriate steps to drive sales and earnings while also balancing efforts to manage expenses with our commitment to customer service.

As we look to 2010, it appears the housing correction process is well under way as we cycle through excess housing inventory. There’s still some cleansing to go. The employment situation remains a concern and our outlook assumes the second half of the year will be better than the first as macro variables continue to stabilize and support home improvement demand.

As we’ve seen over the past three years, many factors could impact the timing and trajectory of the recovery. We feel we’re being appropriately conservative in our outlook considering the uncertainties and we remain confident in our ability to react appropriately to an environment that is different than we expect.

Thanks again for your interest. Now I’ll turn it over to Larry Stone to provide more details on the quarter and the year.

Larry Stone

I stand focused on the customers in delivering great service; we drove sales in a tough environment. Comps for the quarter were -1.6% ahead of our expectations as we headed into the quarter. Comp traffic was slightly positive for the quarter while comp average ticket was down only 2%. The comp transactions for tickets greater than $500 were down only 1% which was an improvement of more than 900 basis points from Q3 to Q4. This is an encouraging sign that some consumers are beginning to tackle the big ticket projects on their to do list. Comp transactions for tickets less than $50 were flat for the quarter.

Looking at our results from a regional basis, 13 of our 23 US regions had positive comps for the quarter and we saw improvement in sequential trends in 22 of our 23 regions, with some of the largest quarter to quarter improvement in our Northeast division. In the fourth quarter, our Northeast division had positive comps in 12 of our 20 merchandising divisions. Appliances and kitchen cabinets led the way, each posted double digit positive comps.

We also experienced strong single digit comps in flooring, paint, and millwork. Although our Western division remained slightly negative for the quarter, we saw a sequential improvement of nearly 600 basis points. In fact, two of the four Western regions had positive comps for the quarter. The one region that experienced a sequential decline in comps sales trends was in the gulf coast. For the quarter, our two gulf coast regions had double digit negative comps as we faced tough comparisons against last year’s hurricane related spending. As Robert mentioned, our Canadian stores had strong comps of 16% measured in constant currency for the fourth quarter.

On the product side, five of our 20 product categories had positive comps for the quarter; appliances, seasonal living, paint, flooring, and cabinets and countertops. We continue to see strong demand for energy efficient appliances, specifically refrigeration products, laundry and dishwashers.

While not much of a contributor to fourth quarter comps, as the government run appliance rebate program gears up we have a cross functional team in place including members from merchandising, marketing, store operations, and logistics and distribution, to make sure Lowe’s has the best in store execution of any major retailer to capture this opportunity.

In seasonal living, we had great sell through on our trim a tree products which helped drive positive comps for the quarter. Additionally, in our year round markets we saw strong demand for grills and grill accessories. Paint continues to perform well as consumers complete small projects to enhance their homes. In fact, paint had positive comps for all four quarters of fiscal 2009. Additionally, strong paint accessory sales driven by our focus on simplifying the shopping experience and ensuring we equip the customers with everything needed to successfully complete their projects, helped drive positive comps.

During the quarter we saw consumers respond to our easy to understand value based offers like our whole house carpet installation program, which helped drive positive comps in flooring. Also, our cabinet offer resonated with consumers helping cabinets and countertops deliver a positive comp for the quarter. This is a very encouraging sign since we’ve had over three years of negative comps in this category.

Our results in both flooring and cabinets and countertops are another sign that consumers are beginning to show willingness to tackle big ticket discretionary projects. Clear evidence that trend is in our installed sales which had a positive comps in the quarter driven in part by consumer’s response to our carpet and kitchen cabinet offers. Special order sales, which is also project driven had positive comps for the quarter, driven by the solid demand for special order kitchen cabinets.

For the quarter, sales to commercial business customers fell below the company average, reflective of the weak housing environment. But, we’re confident we’re gaining market share in commercial segment as our fourth quarter results were our best performance for fiscal 2009.

To help drive sales and become more relevant to the trades person, repair/remodeler, and property maintenance professional, we’re leveraging the district commercial accounts specialist position that we now have in 125 markets. This position is responsible for growing relationships with existing customers as well as introducing Lowe’s to new customers that have been using different channels for their product needs.

We also refined our QSP (Quote Support Program) that supports our store teams when a customer requests a quote for a large project. We remain committed to driving profitable market share gains and we use third party data as a barometer of our retail market penetration. According to these measures we gained unit market share in 10 of our product categories during the calendar quarter, fewer category gains than in the recent past but solid gains after all. In fact, we were only slightly negative in most of the other categories.

Gross margin for the quarter was 35% up 122 basis points over last year. This year we planned more conservatively across all seasonal categories. We maintained a competitive assortment in trim a tree and had great sell through. In tools we purchased more in line merchandise that would require fewer mark downs at end of season had we not experience sell through. Thankfully we experience a more rational promotional environment, effectively executed our mark down plans and did not experience the gross margin pressures of last year.

As we enter 2010 our inventory is in great shape. We continue to diligently manage expenses but due to continued sales pressure, SG&A de-levered 103 basis points. We remain committed to ensuring our stores are appropriately staffed. In the fourth quarter, which is our lowest volume quarter, almost 40% of our stores were operating at base staffing levels, which minimized our flexibility and payroll de-leveraged 48 basis points.

I’m very encouraged by the continuing trend of improved customer service scores that we’ve seen through this downturn. It would have been easy to cut deeper to drive a few more dollars to the bottom line but we remain committed to delivering great customer service. I feel that our commitment has us better positioned with a more knowledgeable and engaged team than anyone else in home improvement retailing as we start to see signs of stabilizing demand.

Looking ahead to 2010, while some of the macro economic pressures appear to be lessening, uncertainty remains and we continue to plan conservatively and focus on things we can control. While most economists forecast 2010 total sales for home improvement industry will remain roughly flat to 2009, we expect comp growth. Our great team of engaged employees, combined with several new initiatives, will ensure we’re well positioned to deliver great customer service as well as profitably grow sales and drive market share gains in 2010.

We’ve added a Project Exterior Specialist (PES) in 1,400 of our stores, supported by a centralized project management model to capture larger share products like roofing, siding, fencing and windows, whose characteristics require in home selling to compete effectively. This position grew from lessons learned during a three year test conducted in Atlanta, Dallas, and Philadelphia markets. Although we have only recently added this position, initial customer response has been strong and this initiative positions us to capture a larger part of this market segment.

Earlier I mentioned the work we’re doing to grow our CBC sales with the addition of the district commercial account specialist and our expanded quote support program. These initiatives will help us better connect with and become more relevant to the commercial customer.

Another initiative to drive sales and share gains is our enhanced Lowes.com platform. In January, we launched our new platform that features improved search capabilities, greater product content to give consumer an improved online shopping experience. While internet sales are a small percentage of our business today, we anticipate an increased functionality will help drive more incremental sales this year and in the future.

These highlight just a few examples of what we’re doing to grow our business and capitalize on the opportunities within our industry as some of the local and regional players exit the market. Rest assured we’re not just focused on growing sales; we have our eye on expenses as well. We expect to leverage expenses in a positive comping environment. Though we face some headwinds in 2010, including a roll out of our sales and service initiatives I mentioned earlier.

These initiatives will help us profitably grow market share but require us to make investments now to develop infrastructure with the payoff coming in the second half of 2010 and beyond. Bob will highlight a few of the other pressure points but let me comment on ones most directly connected to store operations.

First, the store payroll, our biggest expense, let me tell you a few things we’re facing on that line. Our people are a competitive advantage and the great service they provide is a key differentiator for Lowe’s. To reward our employees hard work and efforts in delivering great service and helping drive results in a challenging sales environment, our 2010 outlook includes a merit increase for Vice Presidents and below. While this will pressure expenses, we feel this is the right thing to do to keep our more than 238,000 employees engaged and motivated.

In the fourth quarter we rolled out our FSA (Facility Service Associate) position. This position will help us ensure we maintain our inviting shopping environment by having better execution of the general maintenance of our stores including minor store repairs. Having a store position dedicated, this function will allow us to redirect non-selling hours back to the sales floor and we expect to realize cost reductions as many third party service contracts expire.

In conjunction with this new position, we identified the opportunity to centralize and consolidate our facility service agreements across our footprint. By using centralized consolidated service agreements, we’re able to get better pricing on facilities management contracts and as service contracts expire throughout the year we will more fully realize the benefits of FSA.

Building on our solid foundation with the addition of our new sales positions, facility service position, and our enhanced Lowes.com site, we’re positioned to meet the every evolving needs of the home improvement consumer. While these initiatives will lead to slightly de-leverage this year, ultimately they’ll drive market share and better position us for success.

Our fourth quarter results give us optimism that the external environment is showing signs of improvement. We delivered solid results, controlled expenses, and managed inventory in a tough environment. While this is a good indication that macro pressures are lessening, as we look to 2010 we know uncertainties remain. We continue to manage the business for the long term and we’re confident our ongoing efforts to drive profitable sales and efficiencies will help position Lowe’s to become the first choice for home improvement.

Thanks for your interest in Lowe’s. I’ll now turn the call over to Bob Hull to review our fourth quarter financial results.

Bob Hull

Sales for the fourth quarter were $10.2 billion which represents a 1.8% increase from last year’s fourth quarter. In Q4 total customer count increased by 3.7% but was offset slightly by a decrease in average ticket of 1.8% to $59.98. For 2009 total sales of $47.2 billion were down 2.1% from last year. Comp sales were -1.6% for the quarter which is better than our guidance of -2% to -6%.

Looking at monthly trends, comps were -2% in November, -0.4% in December, and -2.7% in January. For the quarter, comp transactions increased 0.5% and comp average ticket decreased 2.1%. As a reminder, last year’s fourth quarter comp sales results included an estimated 100 basis point positive impact from sales associated with hurricane affected markets. Given the mild storm season in 2009 this resulted in a negative impact of approximately 100 basis points on this year’s fourth quarter comp sales.

With regard to product categories, the categories that performed above average in the fourth quarter include; rough plumbing, paint, flooring, seasonal living, lawn and landscape, cabinets and countertops, and appliances. Millwork, tools, and hardware performed at approximately the overall corporate average.

For the year, comp sales were -6.7%. For 2009 comp transactions decreased 1% and comp average ticket decreased 5.7%. For the year, the categories that performed above average include; building materials, rough plumbing, hardware, paint, nursery, seasonal living, lawn and landscape, and appliances.

Gross margin for the fourth quarter was 35% to sales and increased 122 basis points over last year’s fourth quarter. The increase in gross margin was primarily related to easy comparisons as gross margin declined 115 basis points in Q4 2008. As we noted last year, our efforts to clear seasonal inventory in trim a tree and tools, the markdowns associated with our decision to exit wallpaper, and the competitive environment all pressured gross margin.

This year, we conservatively purchased seasonal inventory and the competitive environment was much more rational than last year. Also helping gross margin in the quarter was a 10 basis point positive impact from lower inventory shrink. For the year, gross margin of 34.9% represents an increase of 65 basis points over fiscal 2008.

SG&A for Q4 was 27.2% to sales which de-leveraged 103 basis points driven by bonus and store payroll. As our performance improved versus our expectations we increased our bonus accruals in the fourth quarter which caused 89 basis points of de-leverage, this compares with the opposite trend last year as we reduced bonus accruals as performance deteriorated and we experienced bonus leverage in Q4 2008. For the quarter, store payroll de-leveraged 48 basis points related to adding the Facility Service Associate and Exterior Solutions Sales positions that Larry described.

As a result of the higher store payroll and increased in state unemployment tax rates, payroll tax expense de-leveraged 10 basis points in the quarter. These items were offset by 35 basis points of leverage associated with the proprietary credit program.

I also want to highlight several unusual items that impacted the fourth quarter. In Q4 we incurred $35 million in expense related to long live asset impairment charge primarily related to non-operating assets. This compares to $18 million for similar charges in Q4 last year resulting in 17 basis points of expense de-leverage.

During the fourth quarter we incurred $6 billion in expense associated with the write off of new store projects that we are no longer pursuing. In Q4 2008 this figure was $18 million causing 13 basis points of expense leverage. Lastly, in the quarter we received our share of the bank card anti-trust settlement which is approximately $12 million and favorably impacted SG&A by 12 basis points. For the year, SG&A was 24.8% of sales and de-leveraged 179 basis points to 2008.

In the fourth quarter, store opening costs of $12 million leveraged 21 basis points to last year as a percentage of sales. We opened 11 new stores in the quarter, this compares to 33 new stores in Q4 last year. Depreciation at 3.9% of sales totaled $401 million and leveraged 2 basis points compared with last year’s fourth quarter.

Earnings before interest and taxes increased 42 basis points to 3.7% of sales. For the year, EBIT of 6.6% represents a decrease of 126 basis points from 2008. Interest expense at $56 million for the quarter leveraged 15 basis points as a percentage of sales. This leverage relates to a reduction in estimated interest payments associated with settling certain state tax matters.

For the quarter, total expenses were 31.8% of sales and de-leveraged 65 basis points. Pre-tax earnings for the quarter were 3.2% of sales. The effective tax rate for the quarter was 36.3% versus 37.5% for Q4 last year. For the year the effective tax rate was 36.9% compared with 37.4% for 2008. Q4 net earnings of $205 million increased 27% versus last year.

Earnings per share of $0.14 for the fourth quarter exceeded our guidance of $0.09 to $0.13 and increased 27% versus last year’s $0.11. For fiscal 2009 earnings per share of $1.21 were down 19% to 2008 but exceeded our original 2009 guidance of $1.04 to $1.20 provided with our Q4 2008 earnings release last February.

Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents balance at the end of the quarter was $632 million. Our fourth quarter inventory balance of $8.2 billion increased $40 million or 0.5% versus Q4 last year. The increase was due to square footage growth of 3.5% offset by comp store inventory reduction of 3.6% in Q4.

Inventory turnover calculated by taking the trailing four quarter cost of sales divided by average inventory for the last five quarters was 3.65% a decrease of 26 basis points from Q4 2008. At the end of the fourth quarter we owned 88% of our stores the same as last year. Return on assets determined using a trailing four quarters earnings divided by average assets for the last five quarters decreased 149 basis points to 5.3%.

Moving on to the liabilities section of the balance sheet, we finished the year with no short term borrowings. This represents a reduction of $987 million from Q4 last year. We ended the quarter with accounts payable of $4.3 billion which was a 4.3% increase over Q4 last year. Our debt to equity ratio was 26.6% compared with 33.6% for the end of 2008. At the end of the fourth quarter lease adjusted debt to EBITDA was 1.57 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 212 basis points for the quarter at 8.2%.

Now looking at the statement of cash flows, for the year, cash flow from operations was $4.1 billion and cash used and property acquired was $1.8 billion resulting in free cash flow of $2.3 billion which was a $1.4 billion higher than 2008. During the quarter we repurchased 21.9 million shares at an average price of $22.81 for a total repurchase amount of $500 million. This left $1.7 billion remaining under our 2007 share repurchase authorization that expired at the end of fiscal 2009. However, our Board of Directors has approved a new $5 billion share repurchase authorization that we expect to use over the next three years.

Looking ahead, I’d like to address several of the items detailed in the Lowe’s business outlook. While I’m not sure if this was the first time, it’s certainly unusual to have snow on the ground simultaneously in all 48 contiguous states as we did two weekends ago. As a result of the abnormally high snowfall in February we have tempered our outlook for Q1 slightly. We expect first quarter total sales to range from an increase of 1% to 3% which assumes comp sales of -2% to flat and the opening of approximately 11 new stores in the quarter, five in February, four in March, and two in April.

We expect gross margin to be flat to down slightly in Q1 as a percent to sales. As a reminder, gross margin increased 77 basis points in Q1 2009. For SG&A we anticipate de-leverage of approximately 90 basis points. The largest driver is store payroll which we estimate to de-leverage 30 to 40 basis points. In addition, there are several discrete items causing expense de-leverage in the first quarter. As a result of the snowfall I mentioned, we will incur extraordinary snow removal and building repair expenses that we expect to negatively impact Q1 by 15 basis points.

In the first quarter we expect payroll tax de-leverage of approximately 10 basis points driven by both a higher wage base and higher tax rates. Given the current environment, numerous states have increased their unemployment tax rates, some more than 100% which we estimate will cause five of the 10 basis point de-leverage in Q1. Lastly, in the first quarter we expect that expense associated with delivering products to customer’s homes to de-leverage 10 basis points driven by both more deliveries and higher fuel prices.

Depreciation for Q1 is expected to be approximately $400 million. As a result, earnings before interest and taxes for the first quarter are expected to decrease by 90 to 100 basis points to last year as a percentage of sales. For the quarter, interest expense is expected to be approximately $80 million. The income tax rate is forecasted to be 37.8% for the quarter and for the year. We expect earnings per share of $0.27 to $0.29 which represents a decline of 9% to 16% from last year’s $0.32.

For 2010 we expect to open 40 to 45 stores resulting in an increase in square footage of approximately 2%. We’re estimating 2010 comp sales to be 1% to 3% and as a result total sales should increased 4% to 6%. For the year, we are anticipating an EBIT increase of 40 to 50 basis points. For 2010 we expect depreciation expense of about $1.6 billion and interest expense of approximately $280 million. The sum of these inputs should yield earnings per share of $1.30 to $1.42 which represents an increase of 7% to 17% over 2009.

For the year we are forecasting cash flows from operations to be approximately $4 billion. Our capital plan for 2010 is approximately $2.1 billion with roughly $400 million funded by operating leases resulting in cash capital expenditures of approximately $1.7 billion. While we expect to be in the market, our guidance does not assume any share repurchases for 2010.

Before we take questions, I wanted to inform you that beginning in 2010; store opening costs will be consolidated into SG&A on our income statement. With the lower rate of square footage growth, store opening expenses now an insignificant portion of our total expenses.

We are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Colin McGranahan - Bernstein

Colin McGranahan - Bernstein

I wanted to focus on market share trends. I’m not sure I caught it but if you could provide the total store unit market share. When you think about the product categories where 10 of 20 you gain share, I guess just slightly negative share loss in the other 10 of 20. Why in those categories where you are losing market share, why do you think you were losing market share, to whom do you think you were losing it to, and what’s in the plan this year to reverse that and get back to more product category market share gains.

Robert Niblock

Total unit share was up 40 basis points year over year. One of the details on where we’d gotten dropped market share some thoughts on that was the other part of your question.

Larry Stone

If you look at seven of the categories that we did not have a positive gain, six out of the seven had less than 50 basis points of decline so very, very minor, some of them as much as two tenths of a percent. Going in looking at those various categories, as an example, all these numbers that we used in this third party they’re just barometers that we look at things. Certainly we talk about, we use them as a yardstick of how we’re doing in various bedded landscape.

Some of the categories like flooring for example, we’re slightly down in flooring for the quarter but there again we had one of our best quarters in flooring. This is calendar quarter then versus fiscal quarter so you do have a month that’s off on the match each time. We went in and looked at the various, dissected each one that we were down in, made sure that we had direct advertising plans, we worked with store ops to make sure we had the staffing plan, and looked at our inventory results. We take a real deep dive on each category to make sure there’s nothing that really caused any concern.

The couple that we were off more than 1% we did go in and look at those and quite frankly there was a promotional one of them we did last year we elected not to do this year. We drove some sales last year with promotion but quite frankly it’s not profitable sales so we elected not to do it this year. We take all this as directional. We do deep dives in each category just to make sure there’s nothing that we’re missing as we go through these various numbers each quarter.

Colin McGranahan - Bernstein

The other part of it was do you have a sense of who you think that was doing better in those categories that didn’t have positive share gains.

Larry Stone

Quite frankly in the ones we were down in we didn’t see any, there’s always a lot of small players out there that are nibblers in some of the categories. We went back and looked at advertising plan of all the people we compete with and say storage as an example, we didn’t see anything that gave us any concern that we were losing any noticeable market share to anybody in the fourth quarter.

We just think it’s one of those things quite frankly we didn’t do as we’d done in the past but still positive in 10 out of the 20. As I iterated a moment ago, six of them are just down slightly. Overall we still feel like it’s a very strong quarter. Robert’s comment, 40 basis points in total gain year over year is still pretty strong in our industry.

Robert Niblock

Keep in mind too that the survey is based on customer recall and hides the categories in which they define that they’re shopping in versus maybe the way that we manage our business. We use it, as we’ve said in the past, only pertains to retail customers it has nothing to do with commercial side of the business on this survey. We look at being up in 10 categories that was up in more categories than the other major players that were out there. Directionally we still think, when you look at the overall 40 basis points for total store we think we continue to move in the right direction.

Operator

Your next question comes from Peter Benedict – Robert Baird

Peter Benedict – Robert Baird

I want to dive into the improvement in big ticket a little bit further. Any regional color to that or was there any tie to home price trends across market. What can you tell us about that?

Robert Niblock

I think Larry talked about it in his comments that he saw some pretty good improvement in the Northeast; we’re seeing those markets continue to come back. Basically as you looked at one, we’ll continue to see strong performance in appliances, those types of things. We continue to have appliances be strong for us. We did, as we said, had positive comps in appliances across the quarter. As we’re starting to see some of these markets that were the early ones going into the downturn starting to come out, you’re starting to see better performance and the consumer is starting to take on some projects in those areas.

Keep in mind as well; we’re going up against extremely weak numbers from last year also. It was pretty broad based as far as the improvement in ticket that about 17 or so of our regions saw an improvement in big ticket for the quarter versus last year, but obviously some of them more so than others. Larry talked a little bit in his comments about the Northeast and some of the strength we saw there.

Larry Stone

The Northeast was certainly a stronger than most, a lot of homes there, a lot of older homes certainly I think people respond to our carpet offer and our cabinet offer then Robert’s point about major appliances. The Northeast was extremely strong for the quarter with double digit comps in a couple categories which is very, very encouraging based on the trends that we’ve had for the past three years in home improvement.

Peter Benedict – Robert Baird

Its safe to assume that improved comp outlook for 2010 versus what you were thinking in September is pretty much driven by this better big ticket experiences you’ve had over the past few months, is that safe to say?

Robert Niblock

I think what we’ve talked about during the entire downturn, I think during the past three, three and a half years we’ve talked about that we’ve continued to gain market share, we continued to see better performance on traffic versus ticket. Our belief was that if we continue to gain those customers through the downturn that as the environment starts to improve and they start feeling better about spending money on discretionary projects that if we’ve done a good job taking care of that customers then hopefully they’re spending that money with us.

As I said in my comments, we’ve still got to go through the remainder of the bottoming process. We think the worst of it is behind us but certainly when you roll back compared to a year ago I think that the American consumer feels much better about their outlook on the future then where they stood a year ago. We’re going up against incredibly weak numbers from a year ago. We’re starting to see them feel a little bit more easy about taking on discretionary product and project purchases. Assuming that we don’t have anything unexpected from a setback in the overall macro environment we think that we’ll continue to see hopefully gradual improvement throughout 2010.

Operator

Your next question comes from David Schick - Stifel Nicolaus

David Schick - Stifel Nicolaus

A proxy for these consumers that you talk about feeling a little better, you talked about the substantial improvement in the larger ticket and yet you talked about special order coming in the mix. If we just look at within any category that good, better, best spectrum, are you seeing changes within that as well?

Larry Stone

Certainly as I mentioned in my comments our appliance business, energy efficiency appliances still continue to drive a large share of our appliance market. Refrigeration and laundry and dishwashers are certainly people are trading up in those categories. Front end laundry still continues to be a great seller for us and we think that people are really concerned about saving energy and saving water and so forth. That’s been a real winner for us last year basically it’s been just a great line for us.

If you look in carpet and things like that we’ve had some great promotions on Stainmaster carpet in the fourth quarter and certainly you have a lot of carpet business prior to Thanksgiving as people are trying to get ready for the holidays. Then you have a little blip after Thanksgiving then it really slows down around Christmas. There again that drove positive sales.

In kitchen cabinets, as I mentioned in my comments, the first time in over three and a half years we had positive comps in kitchen cabinets. We had some great offers out there, great value for the consumer and we were very pleased that consumers responded to those offers in the fourth quarter.

David Schick - Stifel Nicolaus

In fashion plumbing, for example, without promotions are they migrating back up good, better, best or is it where just in those categories you mentioned?

Larry Stone

Fashion plumbing, energy efficient toilets are really doing well for us. I think everybody once again is concerned about saving the environment and saving water. Energy efficient toilets had a great quarter and certainly we feel like there’s a lot of opportunity in that line. Vanities on the other hand are fashion forward vanity program the merchant’s done a great job with that and certainly if you look at the price points that we have on a lot of these furniture style vanities we were way below some of the leading magazines you can find them in. There again that’s been a real leader for us in the fourth quarter.

We’re starting to see people do these; we call them weekend projects on vanities and replacing faucets and so forth. Certainly in plumbing you’re kind of seeing people trade up from going from the standard say 30 to 21 vanity to more the furniture style vanity in some categories but this whole look that consumers are after trying to put the whole room together that that’s why our weekend project business that we’ve really concentrated on for the past couple years is really starting to pay off.

I think some mix across the lines you’ll see some trade up in some lines like faucets. I think if people want to replace the faucet they’re probably looking more to the mid to upper price points in some of those categories. Still you have this whole thing that we’ve tried to say all along, providing products all across the spectrum is what we try to do as a major home improvement retailer.

Operator

Your next question comes from Alan Rifkin - Bank of America

Alan Rifkin - Bank of America

With the project category sequentially improving so significantly from Q3 to this quarter, and obviously with this category being a major beneficiary of the improving housing environment, can you maybe shed some color on how you’re going to approach this specific area in 2010 from a merchandising, advertising and credit standpoint?

Robert Niblock

Obviously we still have all the credit vehicles that we had out there other than we have brought in a new American Express program primarily gauged for the business customers, not a lot of changes out there in credit. Obviously I think we talked about as we were in the middle of the downturn GE did the majority of their tightening and most of that is behind us. The credit is still tight out there but we don’t have that tightening and pulling down of credit lines that we has as we were in the middle of the downturn for most of the customers. We’ve cycled through the majority of that.

We’re seeing the consumer gradually, more people coming in doing projects that we had in the past. Its really probably more of the focus on the small projects, weekend projects versus the major renovations is probably where a lot of our focus will be as we continue to monitor the environment and we’ll be agile in our ability to be able to make changes as we test the environment.

Like I said, home prices are still declining, we’ve still got unemployment, and the consumer out there is still looking for great value. As I mentioned before, remember we’re going up against incredibly weak numbers a year ago. We see it as signs as moving in the right direction. Part of the bottoming process that we’re going through and I think the consumer is still, credit is still tight, we’ve still got unemployment, consumers still going to be challenged on many fronts and so they’re going to be looking for great value and we want to be there to provide that great value.

If you think about the fact that if they put off upgrades, if they put off improvements to their home that they had the desire to do because of uncertainty out there, what the environment as we continue to see the macro environment slowly improve because it an evolving process more than we’ll hopefully come off the fence particularly if there’s great value there to spur them and move forward with those projects and we want to be there to take care of their need whether its a simple weekend repainting or whether its a major kitchen install.

I think a lot of the stuff that Larry talked about, let’s say with the Project Exterior Specialist, some of those things are also used to try to capitalize on some of that opportunity that’ll become available as the environment improves and consumers feel better about pursuing those types of projects.

Alan Rifkin - Bank of America

Why do you think the CBC part of the business is not seeing the sequential improvement that you’ve seen on the projects side? Can you explain that apparent dislocation?

Larry Stone

As I mentioned, in the fourth quarter we had our best results of the year so certainly that’s encouraging. The positioned we rolled out last year, the District Account Specialist, certainly that’s starting to pay dividends for us as those folks are spending a lot of time trying to cultivate relationships, looking at different segments of the business we can go after. I was encouraged with fourth quarter results based on the weak housing environment.

You’ve got to remember; we really don’t cater to new home builders but certainly the repair and remodel business it goes back to this whole thing of people kind of putting off bigger projects until things improve. Once we think that people do get the better feel for how the economy is doing certainly that will pick that business up. A lot of times customers just have the repair and remodel person to pick out the materials and buy them here. It depends on the individual and how they want to go to market.

I feel real confident about what we’re doing with out commercial business, I feel real confident about out teams that we have in stores, the way that we compensate the folks and inventory levels we’ve got. I think it’s just a matter of things turning around a little bit and I think that business will be back to where we’d like for it to be. There again, reemphasizing one more time, very encouraged with the fourth quarter numbers compared to the first three quarters of fiscal 2009.

Robert Niblock

Keep in mind we’ve talked about in the past this kind of movement back to DIY so you have more customers that are choosing to do stuff themselves that previously may have outsourced some of those projects, that’s probably having some impact as well on the timing of that recovery.

Operator

Your next question comes from Dan Binder – Jefferies

Dan Binder – Jefferies

The gross margin outlook for Q1 is flat to down slightly, I was just curious if you have a broad view on how the year should look, it is flattish year for you and is there a margin impact from the improvement in big ticket?

Bob Hull

We do expect margin to be slightly down for the quarter. We expect it to be up for the year probably about half or slightly more than half of the EBIT expansion for the year will come from gross margin. As you think about fuel prices, I mentioned the fuel price impact on store deliveries, fuel as it relates to distribution gets capitalized into inventory so that’ll start impacting us late Q1 into Q2 to be somewhat of a headwind but we do expect margin to be up for the year.

Dan Binder – Jefferies

Was the softer January comp a function of just having a lot less clearance year over year, was it weather related or anything in particular?

Bob Hull

Primarily weather related. We take a look at our indoor/outdoor report which is products primarily used for indoor use versus outdoor use. The indoor categories performed consistent in January with what we saw in November, we saw a pretty big drop in the outdoor categories directly related to the snow, primarily early January.

Operator

Your next question comes from Wayne Hood – BMO Capital

Wayne Hood – BMO Capital

I was curious about what you’re seeing with the number of quotes that the stores are receiving right now and the close rate around that. Is it a combination of that close rate improving on some of those big ticket areas or just the absolute number of quotes that are coming through? I’m sure all of us on this like just wondering about what you plan to do about pricing with lumber as we get into the spring, maybe they pulled forward some demand and it subsides as we get later into spring.

Larry Stone

On our quote process for years we’ve talked about stores have people that are experienced and we have other stores that’s not as experienced. Certainly what we try to do with the whole quote process just have a more centralized place that we could help the stores with quotes for large projects. The close rate keeps improving every quarter. The team of folks that we have at the corporate end do a great have looking at the quotes and helping the stores walk through what they’re quoting against and so forth. A lot of cases a lot of this product goes direct to the jobsite which is great for us. We’re basically handling the paper and getting it to the customer.

I think that program will continue to pay dividends for the company and certainly I feel good about it because now we do have a standardized process that we use for all the stores. We feel good about the program; all of the stores are on board with the program. As far as lumber prices go, I know lumber is running up some right now. Right now is probably one of our slowest times for lumber. Hopefully as spring gets here we will start to sell more lumber. A lot of the things driven by the prices on random links and so forth you’ve got a lot of wide widths and long links of lumber that we do not sell as much of as we did many, many years ago.

If you look at price running at $40 a thousand on lumber, quite frankly we’re not going to get that kind of gain because we sell more nairs and more short links versus lumberyards and so forth. We do have our eye on it; we think the units could have more dollars based on inflation depending on how it goes in the first quarter. There again, if demand is not there the mills are going to have to slow down again so we think prices could drop depending on demand of the first quarter.

Wayne Hood – BMO Capital

Is there any guidance that you would care to offer with us about what you think the penetration around lumber might impact gross margin in the quarter? In other words, if the mix shifts a little bit is there something embedded in that gross margin rate that you’ve given us to reflect that?

Bob Hull

We don’t expect the lumber pricing mix of lumber to have too dramatic an impact on gross margin. What I was going to say, if you think about our outlook for Q1 we do expect some positive impact from lumber prices, lumber inflation have some positive impact in the first quarter, that’s somewhat offset by the deflation we’re now seeing in roofing. The net of the two is going to have some slight positive impact in Q1.

Robert Niblock

On the detail fees which is our proxy for the number of people that are potentially concerned in taking on a project we did see a double digit increase in our detail fees in Q4. To Larry’s point, obviously the folks are making sure we’re closing those detail fees and continue to see an improving close rate. Just the fact that we go that many people potentially interested in a project they’re going to pay a fee to come out and get a quote for what it would be to do the project in their home certainly is just one of those indicators that we’re looking at.

The consumer is out there thinking about more of these discretionary type projects as the environment improves overall, just another sign that we think we’re going through that bottoming process.

Operator

Your next question comes from Budd Bugatch – Raymond James

Budd Bugatch – Raymond James

Looking at the SG&A leverage and de-leverage for the year, you’ve got us with an expectation of about 40 to 50 basis points of de-leverage from store payroll and payroll taxes in the first quarter. When do you expect that to turn around and how would you expect that to play out during the entire year?

Bob Hull

It’s going to be down roughly 90 basis points for Q1. We expect some slight de-leverage for the year so it’s going to moderate as the year progresses. The three items I mentioned in my comments; snow removal, payroll taxes, and fuel are somewhat disproportionately impacted in Q1 so all three of those moderate as the year progresses. The other thing that should help is we were forecasting for comp sales to improve as the year progresses so as comps rise less de-leverage in some areas and certainly as we get positive comps in the back half of the year should get some fixed cost leverage.

Budd Bugatch – Raymond James

Did you just say that you expect SG&A as a total to de-leverage modestly during the entire year?

Bob Hull

That is correct, largely driven by the big decline in Q1.

Budd Bugatch – Raymond James

I thought you said that the gross margin would account, the improvement would account for roughly half of the 40 to 50 basis points of Op margin expectation for the year? The difference is where, in depreciation?

Bob Hull

Deprecation is about 15 basis points.

Operator

Your next question comes from Chris Horvers – JP Morgan

Chris Horvers – JP Morgan

It seems like the cooler and snowier weather perhaps hurting you here in February and that affected your outlook here in 1Q. Could you describe how you took that into account, balancing top line versus margin, how the negative start to the quarter on the weather side is? As a follow up, perhaps how much February is as a percentage of 1Q sales?

Bob Hull

If you think about not all weeks are built the same, so the first three weeks of February, while that represents roughly 23% of the calendar quarter, it only represents 18% of our sales. These are our lowest volume weeks by far of the quarter. As I mentioned in my comments, we do temper our outlook for Q1 by roughly 1% based on what we’ve seen to start the quarter so the disproportionate high level of show we’ve seen, even though they’re low volume weeks have had an impact which is why we tempered our outlook for Q1 slightly.

Chris Horvers – JP Morgan

Can you talk about some of the store initiatives like the FSA program, it sounds like that got a start here in the fourth quarter, could you talk about the timing of that and perhaps if that had any impact on your SG&A leverage in 4Q?

Larry Stone

The FSA position we did start in the fourth quarter. We just went back, as things have slowed, we’ve taken a look at a lot of different things and certainly that was a line item that we felt like we could better do in the store versus contracts we had with third parties throughout the nation, it varied all across by store and by district and region and so forth. We’ve combined all that, working with Greg’s real estate team to come out with national contracts. There are some things that we feel like we can just do better on our own.

Eventually we’ll get leverage out of that position as we head into the year but we’ve got to unwind some contracts, that’s going to take sometimes a quarter or two to unwind these various contracts. Overall at the end of the day it’s going to be a better shopping experience for the customer and quite frankly we’ll do a much better job of taking care of our stores ourselves because this position has authority to get the things done. If they can’t do it in-house then we’ll certainly sub it out to somebody. We have somebody in each store that’s going to be look at that facility a lot better than what we’re going in the past in my opinion.

Chris Horvers – JP Morgan

On the appliance side, how are you incorporating the cash for appliances program into your 1Q comp guidance?

Larry Stone

Certainly right now there are 13 active states, three of those states have water heaters only and one state, Oregon, has no products that we sell in terms of major appliances. We’ve got nine states that have an active program right now so certainly our team are looking at state by state and we make sure that we have all the communications with our stores, with our customers, and making sure we’ve got the inventory and everything in line to execute a great program.

As far as building in a whole lot, it’s not been a kind of business you can see some impact when it happens but its not enough right not to materially affect our outlook for the first quarter. Certainly as we get more into the program we’ll take a hard look at it and any guidance we need to update we’ll do it during the year.

Operator

Your last question comes from Stephen Chick – FBR Capital Markets

Stephen Chick – FBR Capital Markets

At your analyst day I think your 2010 comp outlook was up 1% and looks like you’re raising that a little bit to up 1% to 3% for this year. Can you speak to what your traffic or your transaction count versus ticket is within that and if you can even take it a step further and what you’re thinking the big ticket within the ticket comp will look like versus less than $50 transactions?

Robert Niblock

We’ve continued to see stronger traffic than ticket through the downturn. As we said, we would continue to maintain those and gain customers. As things start to improve we would see that becoming more balanced. For example, this quarter on a comp basis obviously our transactions were up but our ticket was still down so we’d see that hopefully coming more in line since you have a balance over the year moving towards positive ticket and positive transactions to make up that 1.3% comp.

Obviously part of that would come from continual improvement in the larger ticket items like we discussed. We saw improvement in that during the quarter, as we said, we’re going up against weaker comparisons. When you think about what’s happening with the government extension for the home buying credit that is in place now through the end of April that covers both first time home buyers as well as someone that’s in a home that’s moving up to another home, the impact of that.

A favorable impact turnover all those things should help us obviously continue to see that ticket move up as we progress through the year, the overall economy continuing to improve should help as well. We’re going to look at it being that coming from a balance of both sides.

Stephen Chick – FBR Capital Markets

For your first quarter comp guidance it’s a pretty good acceleration, if you looked at three year stack trends and things like that versus the fourth quarter is it based upon what you said about the storms in February you expect to accelerate from where you are today despite the costs being a little tough? As I remember, you had a pretty good April a year ago with season. I want to make sure I have your expectations right.

Bob Hull

Based on the snow storms to date our performance is worse than we expected which is why we tempered our outlook for Q1. We certainly do expect performance to improve for the balance of the quarter.

Robert 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 first quarter results on May 17th. Have a great day.

Operator

This does conclude today’s conference call. Thank you for participating. You may now disconnect.

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Source: Lowe’s Companies, Inc. F4Q09 (Qtr End 01/29/10) Earnings Call Transcript
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