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Executives

Robert Niblock – Chairman and CEO

Mike Brown – Executive VP, Store Operations

Robert Hull – CFO

Larry Stone - President and Chief Operating Officer

Analysts

Christopher Horvers - JP Morgan Chase & Co

Deborah Weinswig – Citigroup

Michael Lasser - Barclays Capital

Scott Ciccarelli – RBC Capital

Dennis McGill - Zelman & Associates

Colin McGranahan - Sanford C. Bernstein & Co.

Eric Bosshard - Cleveland Research

Mike Baker – Deutsche Bank

David Strasser - Janney Montgomery Scott

Matthew Fassler - Goldman Sachs Group Inc.

Bud Bugatch – Raymond James

Peter Benedict - Robert W. Baird

Lowe’s Companies (LOW) Q2 2010 Results Call August 16, 2010 9:00 AM ET

Operator

Good morning everyone, and welcome to Lowe’s Companies second quarter 2010 earnings conference call. [Operator instructions.]

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 reconciliation to 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. Michael Brown, executive vice president of store operations; 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 Niblock

Good morning and thanks for your interest in Lowe’s. Following my remarks, Mike Brown will review our operational performance and Bob Hull will review our financial results. While the economic climate has improved compared to a year ago, ongoing uncertainty in employment and housing continues to weigh on consumers, resulting in a fragile consumer mindset and a sluggish economic recovery.

Over the first half of the year we saw consumers slowly return to more discretionary projects as encouraging economic data reduced their cautious stance. But when data was negative, we saw moderation in customer shopping patterns. As a result, we see the economy bouncing along the bottom in 2010, resulting in a transition year for our industry.

In our second quarter consumer survey, more homeowners indicated that they are spending money on essential, versus non-essential, items. But, more than half of the home improvement projects consumers have planned in the next six months are considered discretionary. This inconsistency further indicates that consumers are uncertain about the macro-environment as well as their personal financial situation. Over the near term, it’s unclear where the next data point will land. As a result, we don’t expect strong industry growth until we experience consistent improvements in the labor and housing markets, which likely will not occur until 2011.

Although sales for the quarter trended below our expectations, with our flexibility and focus on execution we were able to deliver solid results for the quarter, including earnings per share within our guidance. Sales for the quarter increased 3.7% and comparable store sales increased 1.6%. Although gross margin was negatively impacted by product mix due to strong appliance sales, the promotional environment remained rational and we had a slight increase in our gross margin rate for the quarter.

We leveraged expenses in the quarter and delivered earnings per share of $0.58. I would like to thank our more than 238,000 employees for their hard work and dedication, which allowed us to deliver solid earnings for the quarter.

During the second quarter, we continued to benefit from the cash for appliances rebate program, which aided overall comp sales by approximately 25 basis points and helped drive double-digit comps in our appliance category.

Home environment, seasonal living, and rough plumbing categories benefitted from the extreme heat across much of the U.S., as we experienced strong air conditioning, seasonal cooling, and dehumidifier sales. However, extreme heat did negatively impact sales in our nursery category. Seasonal living also benefitted from robust sales in grills and grill accessories associated with the Memorial Day, Father’s Day, and July 4 holidays. Likewise, our Father’s Day tool event was a success, driving above-planned sales and demonstrating that we had the right inventory to meet customer demand.

We were also pleased with our sell-through of seasonal inventory, which has us well-positioned to minimize indices and markdowns. While overall inventory levels were up 5.7% in the quarter, we significantly improved our de-leveraged versus Q1 and expect inventory to only be up slightly at year end.

Comp traffic was down slightly for the quarter, but comp average ticket was up 2.1%. Ticket benefitted from strong sales of appliances, air conditioners, and grills. Certain product categories such as nursery and lawn and landscape, which traditionally drive traffic in the second quarter, were negatively impacted by the extreme heat. Comps for tickets greater than $500 were nearly 2%, while comps for tickets less than $50 were essentially flat.

We continue to be pleased with our performance in Canada. For the quarter we had 2.4% comps in Canadian dollars and over 11% comps in U.S. dollars, contributing 10 basis points to our consolidated performance. Our expansion in this market continues, with our first stores outside Ontario opening in the second half of 2010, and we expect to end the year with 25 stores in Canada.

We remain committed to driving profitable market share gains and we use third-party data to gauge our retail market penetration. On a rolling four-quarters basis, we gained 50 basis points in total store unit market share with gains in 12 of our 20 product categories. Differentiation is an important part of our merchandising strategy, and we’re committed to offering a wide selection of national brand name merchandise.

Last quarter we announced our channel-exclusive partnership with Stainmaster carpet, the brand most requested by consumers. This great brand, together with our easy to understand and value-based carpet installation offer, positions us to increase sales and capture market share as consumer spending rebounds.

We also recently announced our new Valspar paint line. Valspar’s high-def advanced color system provides exceptional color accuracy, superior fade resistance, and durability. Painting is an easy and affordable discretionary project that helps consumers personalize their homes.

Our strong financial position, together with our commitment to providing great service and quality products, will allow us drive profitable market share gains and create value for shareholders. We view 2010 as a year of transition for the home improvement industry, and we don’t expect consistent improvement in core demand until the fundamentals of the labor and housing markets improve. In the interim, we continue to focus on operational efficiency and we are ready to respond if demand is better or worse than expected.

Thanks again for your interest, and now I’ll turn it over to Mike Brown to provide an update on successes in the quarter as well as how the operations team is focused on managing in today’s uncertain environment. Mike?

Mike Brown

Thanks Robert, and good morning. I’d like to spend time this morning reviewing our second quarter performance as well as discussing how we continue to execute through this uncertain environment.

Comps for the quarter were 1.6%, which was slightly below expectations. Domestic performance was balanced, with 19 of our 23 U.S. regions generating positive comps. We saw particular strength in markets that first entered the downturn, Florida, the Northeast, and Arizona. This was the fourth consecutive quarter of above average [unintelligible] for these markets.

In contrast, the Gulf Coast region had the lowest [comp points] as we cycle last year’s hurricane sales. Extreme heat in the East and Midwest had a mixed effect on sales, while reduced demand in outdoor living categories, particularly nursery, we were prepared and capitalized on strong demand for air conditioners and fans.

The cash for appliances rebate program continued in the second quarter, although in fewer states, and consumers continued to take advantage of this program to replace their appliances with new, more energy efficient models, particularly refrigerators, ranges, dishwashers, and laundry products.

As we mentioned last quarter, we formed a cross-functional team to ensure our stores and store employees had the information, the processes, and inventory necessary to help customers purchase qualifying appliances while minimizing the efforts needed to collect state rebates.

This program was a great example of our ability to quickly respond to opportunities in the marketplace with a coordinated plan of attack and to execute those plans with precision and consistency in our stores. As a result, third-party estimates suggest we gained 160 basis points in appliance unit share in the second quarter.

Now focusing on our specialty sales, during the second quarter, commercial install sales exceeded our overall sales trends, reflecting the investments that we have made in these businesses. Commercial sales during the quarter posted comps above the company average, reflecting solid growth in both ticket and traffic.

In our Q1 call, we discussed our district commercial account specialists, who continue to cultivate relationships with existing customers as well as develop new customers, and we continue to evaluate this position and make adjustments as needed. In fact, this quarter we added five additional markets to our program, bringing the total of our district commercial account specialists to 130. We’re also leveraging our store commercial sales team, as we continue to focus on the state of our business. Our commercial business is an important part of our overall growth and results for the quarter proved that our strategies are working.

Install sales produced high single digit comps for the quarter. Carpet, roofing, fencing, and windows performed above our overall install sales trend. The increases in the roofing, fencing, and windows were driven in part by our project specialist exteriors, which we have in approximately 1,400 stores. We continue to monitor their performance and make adjustments as the environment and our experiences warrant. We are currently rebalancing the number of PSEs we have in several markets and are evaluating additional products for them to sell.

Across our company, we continue to capitalize on sales opportunities, both through the larger initiatives like the ones I highlighted earlier, and through the smaller opportunities that present themselves daily through employees as they interact with customers in our aisles. We’re still seeing customers waver between larger ticket replacements and smaller ticket fixes, and we have positioned our employees with the training and tools needed to help customers with any purchase.

We continue to focus on product sales where we can assist a customer with better understanding their entire project and recommending all the related items to complete their project. By doing this, we can provide the customer with a better shopping experience and at the same time we can increase our average ticket.

Now moving on to staffing, Q2 payroll remained flat year over year as a percent of sales, despite sales falling below our expectations and the addition of our project specialist exteriors and the facilities associate positions.

We attribute this performance to the flexibility of our staffing model. We used more seasonal part time employees as we build our spring staffing. This allowed us to support strong seasonal sales in Q1 and to adjust quickly to the changing sales environment throughout Q2. So after Memorial Day we were able to ramp hours down more quickly from our staffing spring hours build.

We’ve also gained a number of efficiencies as we continue to refine our store processes. Some examples include updates to our [unintelligible] program, our product handling procedures, and a new cash handling tool, and we started by asking those who knew best, our store employees. This approach continues to prove beneficial as we make improvements to our operating model, and I would like to say thank you to our employees for helping make a difference in our performance.

I’d also like to add a little more color around our facility services associate. We’re still refining this position’s responsibilities. However, we’re pleased with the impact these associates are having on our facilities and recurring maintenance expenses. In addition to handling most of the stores’ janitorial tasks, they have successfully assumed new responsibilities, including basic plumbing, store equipment repair, and other forms of maintenance.

We continue to work through our remaining expense contracts and will make changes as we see opportunities. This position was implemented at the end of our second quarter last year, so we expect to see leverage on this expense line headed into the second half.

Of course, while we want to manage expenses, we’re in the business of serving customers, and even though we managed to generate expense leverage on our relatively low comp, we’re very proud of our continued trend of improving customer service scores. In fact, this latest quarter is another in our series of improving year over year customer service scores since we began measuring them in the current format in 2006.

We believe this improvement is the result of a consistent alignment of our resources and a continued focus on providing great customer service. For example, this year we implemented the new service and sales employee incentive program, which combines what previously were many different incentive programs into a single program that compensates all employees in each store that meet predetermined customer service thresholds and store performance goals.

So, we’re pleased with having improved second quarter customer service scores while maintaining flat payroll to sales. However, we know that we must continue to operate efficiently through the remainder of this year. We continue to work with our operations team to identify better ways to complete tasks and put more of our total employee hours into customer facing positions. We’re very excited about many smaller initiatives that have resulted from these efforts, and these initiatives should help us continue to realize efficiencies in our stores, both through the remainder of this year and in the future.

Finally, we continue to invest time and resources in improvements to our planning tools and infrastructure so we can more efficiently and effectively serve customers over the long haul. We had previously mentioned our integrated planning and execution, or IP&E, initiative. This new set of processes and system tools will help us better tailor our merchandizing programs to individual stores. In other words, we will be able to more specifically determine what products, facings, and quantities to offer in different geographies.

This fall we will test IP&E in seven of our 20 merchandizing divisions, and we will fully realize the benefits of IP&E after we have rolled this tool out to all merchandizing divisions. The system will improve sales and better optimize inventory investments, resulting in enhanced profitability. I

n the face of an uncertain economic environment, we continue to focus on maintaining flexibility and prudently manage expenses while also investing in new tools and strategies to become even more nimble in the future.

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

Robert Hull

Thanks Mike, and good morning everyone. Sales for the second quarter were $14.4 billion, which represents a 3.7% increase over last year’s second quarter. In Q2 total average ticket increased 2.3% to $62.84 and total customer transactions increased 1.4%. Comp sales were positive 1.6% for the quarter, which was below our guidance of 2% to 4%.

Looking at monthly trends, comps were flat in May, 3.2% in June, and 1.4% in July. A holiday shift impacted the monthly comps, as the Memorial Day weekend occurred in fiscal June in 2010, compared with May in 2009. We estimate that this holiday shift negatively impacted May comps and positively affected June comps by approximately 300 basis points each.

For the quarter, comp average ticket increased 2.1% and comp transactions decreased 0.5%. As Robert noted, the increase in average ticket was driven by strength in appliances, air conditioners, and grills, while the extreme heat had a negative impact on comp transactions.

Year to date, sales of $26.7 billion represent a 4.2% increase over the first half of 2009, driven by new stores and a comp store sales increase of 2%.

With regard to product categories, the categories that performed above average in the second quarter include lumber, tools, rough plumbing, rough electrical, windows and walls, home organization, seasonal living, appliances, and home environment.

Gross margin for the second quarter was 34.9% of sales, an increase of 2 basis points over last year’s second quarter. In the quarter we saw margin improvement in seasonal living and outdoor power equipment as a result of better sell-through of seasonal inventory this year relative to last year. In addition, windows and walls and millwork had margin increases as these categories were cycling markdowns associated with prior year reset activity.

Sales mix negatively impacted gross margin by 28 basis points. More than half of the negative mix impact was driven by our appliance business. Year to date gross margin was 35% to sales, a decrease of 11 basis points from the first half of 2009.

SG&A for Q2 was 22.2% of sales, which leveraged 34 basis points. During the quarter we recognized $15 million of asset impairment and discontinued project expense, which compares with $48 million in Q2 last year. The year over year reduction in these expenses drove 25 basis points in expense leverage in the quarter.

We experienced 20 basis points of leverage associated with our proprietary credit program due to fewer losses and lower money costs, offset somewhat by lower portfolio income. Bonus expense leveraged 10 basis points in the quarter, due to lower attainment levels relative to plan, compared with this time last year.

Slightly offsetting these items was de-leverage in fleet and bank card expenses. Fleet expense de-leveraged by 10 basis points due to an increase in the number of deliveries as a result of strong appliance sales and higher fuel costs relative to last year. Bank card expense deleveraged 5 basis points in the quarter due to a combination of higher bank card volumes, which grew faster than total sales, and increased interchange fees. Lastly, for the quarter store [apparel] was flat for last year as a percentage of sales.

Year to date, SG&A was 23.5% of sales, which de-leveraged 18 basis points to the first half of 2009. Depreciation for the quarter was $398 million, which was 2.8% of sales and leveraged 18 basis points compared with last year’s second quarter due to slower square footage growth, assets becoming full depreciated, and positive comp sales.

Interest before interest and taxes increased 54 basis points to 9.9% of sales, which was higher than our estimated 40 basis points of improvement, as a result of the staffing flexibility that Mike highlighted. For the first half of 2010, EBIT was 8.5% of sales, which was 25 basis points higher than the same period last year.

Interest expense was $84 million for the quarter, and de-leveraged 4 basis points to last year as a percentage of sales. For the quarter, total expenses were 25.6% of sales, and leveraged 48 basis points. Year to date, total expenses were 27.1% to sales and leveraged 34 basis points to last year.

Pre-tax earnings for the quarter were 9.3% of sales. The effective tax rate for the quarter was 37.7% versus 37.6% for Q2 last year. Net earnings were $832 million for the quarter, which is a 9.6% increase over Q2 2009.

Earnings per share of $0.58 for the quarter was within our guidance of $0.57 to $0.59 and increased13.7% versus last year’s $0.51. For the first six months of 2010, earnings per share of $0.92 represents a 9.5% increase over the first half of 2009.

Now to a few items on the balance sheet, starting with assets. Cash and cash equivalents balance at the end of the quarter was $1.2 billion. Our second quarter inventory balance of $8.7 billion increased $464 million or 5.7% versus Q2 last year. The increase was due to new stores, an approximate 1% increase in comp store inventory, and distribution. The 5.7% increase in the second quarter was much lower than our first quarter’s 9.8% increase.

As the year progresses we will continue to reduce the rate of inventory growth versus last year, and we expect inventory to be up 1% to 2% at year end. Inventory turnover, calculated by taking the trailing four quarters cost of sales, divided by average inventory for the last five quarters, was 3.63, a decrease of 9 basis points from Q2 2009.

Return on assets, determined using a trailing four quarters’ earnings divided by average assets for the last five quarters, decreased 27 basis points to 5.4%

Moving on to the liability section of the balance sheet. Accounts payable of $4.9 billion represents a 2% decrease from Q2 last year. The reduction in accounts payable relates to the timing of purchases. Our debt to equity ratio was 29%, compared to 26.5% for Q2 last year. At the end of the second quarter, lease-adjusted debt to EBITA was 1.63 times. Return on invested capital, measured using the trailing four quarters earnings plus tax-adjusted interest, divided by average debt and equity over the last five quarters, decreased 37 basis points to 8.4%

Now, looking at the statement of cash flows, cash flow from operations was $2.8 billion, which was lower than last year due largely to the increase in inventory and a decrease in accounts payable. Cash used and property acquired was $612 million, a 40% decrease due to the reduction in our store expansion program. As a result, year to date free cash flow was almost $2.2 billion. During the quarter, we repurchased 22.7 million shares at an average price of $24.23 for a total repurchase amount of $550 million. We have $4 billion remaining on our share repurchase authorization.

Looking ahead, I’d like to address several of the items detailed in Lowe’s business outlook. We expect third quarter total sales to increase 3% to 5%, which incorporates a comp sales increase of 1% to 3% and approximately 2% in square footage growth, which assumes the opening of 12 new stores in the quarter.

We expect our comp performance to be more balanced in Q3 across both merchandise divisions and regions of the country. We expect EBIT improvement to come from gross margin expansion and expense leverage. Margin improvement will come from a number of sources, including the full rollout of the price optimization tool, lower markdowns due to better seasonal sell-through in Q2 this year, a higher proportion of imported product compared to last year, and with appliance sales expected to be more in line with the total company performance, we don’t expect as large of a negative sales mix impact as we experienced the past two quarters.

SG&A leverage comps comparison to last year’s asset impairment and discontinued project charges, which totaled $57 million in Q3 2009, offset somewhat by deleverage from proprietary credit. Depreciation for Q3 is projected to be approximately $400 million, and leverage about 20 basis points to last year’s third quarter. As a result, earnings before interest and taxes for the third quarter are expected to increase by approximately $120 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 forecast to be 37.8% for the quarter. We expect earnings per share of $0.28 to $0.32, which represents an increase of 20% to 37% over last year’s $0.23. 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 approximately 2%, and as a result, a total sales increase of approximately 4%. For the fiscal year we’re anticipating an EBIT increase by approximately 70 basis points. For 2010 interest expense is expected to be approximately $325 million. For the year we expect effective tax rate to be 37.8%.

The sum of these inputs should yield earnings per share of $1.38 to $1.45, which represents an increase of 14% to 20% over 2009. For the year, we are forecasting cash flows from operations to be approximately $4.1 billion. Our capital expenditures for 2010 are forecasted to be approximately $2.15 billion, with roughly $350 million funded by operating leases resulting in cash capital expenditures of approximately $1.8 billion.

As a result, we are forecasting free cash flow of $2.3 billion for the year. Our guidance for 2010 includes share repurchase activity through Q2 but does not include any impact from future share repurchases.

Operator, we’re now ready for questions.

Question-and-Answer Session

Operator

[Operator instructions.] Our first question comes from the line of Chris Horvers with JP Morgan.

Christopher Horvers - JP Morgan Chase & Co

As you look at your – the comp guidance for the back half, roughly 2% at the midpoint, can you – you mentioned being a more balanced – can you talk about your outlook for traffic and ticket, and what categories overall get you to that 2% comp guidance?

Robert Hull

I’ll start with thoughts on traffic and ticket and let others chime in on drivers of the business in the second half. As we’ve talked about, in the second quarter the strength of appliances, grills, and ACs had strong impact on ticket, but the weather negatively impacted traffic. We expect more normal activity in the second half of the year, and really all of the 1% to 3% comp to be driven by comp transactions, with comp ticket being essentially flat.

Larry Stone

Chris, it’s Larry Stone. A lot of our second half business, as you know, kind of makes a shift. We think we should have a good nursery season as we head into the third quarter, with all the extreme heat we’ve had in the parts of the country during the second quarter, so we think there is some upside on the nursery business. We have a lot of strong fall seasonal programs planned. It’s a good time for installation sales, a good time for a lot of fix-up projects on the inside of the homes, which a lot of the new projects are need to do projects, kind of what Mike Brown said in his comments, versus projects more discretionary in nature. We still expect our appliance business to be strong in the third quarter, although not as strong as it’s been maybe in the first half of the year due to cash for appliances. A lot of seasonal business, such as our heat – fall heating business, our snow blower business, just a lot of different categories. To Bob’s point, we see more of a balanced approach to our business as we head into the second half, and that’s kind of held through the last part of the second quarter this year.

Christopher Horvers

So then the appliance business, you’ve been able to see positive comps even in states where there was a big lift, or on average nationally?

Larry Stone

Yes, if you take out the cash for appliance program we’d still have high single digit comps in appliances for the second quarter. And as we talked about, in the first quarter on this call, we had a lot of appliance inventory that we had purchased knowing that we had the holidays coming up, Memorial Day, July 4, and certainly a lot of appliance sales due to extreme heat, based on the forecasts we put the heat was going to be there, so we knew we’d sell a lot of refrigeration products, especially when compressors start to go bad with the extreme heat we experienced. So our appliance business has been extremely strong, like I said, even without cash for appliances, still high single digit comps.

Christopher Horvers

And then just as a follow up, the hurricane compare and cannibalization, is that something that helps the 2% as well?

Robert Hull

It does. We estimate that the comparison to last year’s hurricane-elevated sales hurt Q2 by about 45 basis points. We cycle that and really there’s no impact. In fact to the extent that there’s any hurricane activity this year, it could be a net positive impact that is not contemplated in our outlook. Cannibalization hurts second quarter by roughly 40 basis points. We expect that to drop nominally to be 35 or so basis points. So yes, so net net there’s a little bit of less drag in Q3 relative to Q2.

Operator

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

Deborah Weinswig – Citigroup

Can you go through some of the – or provide some additional comments in terms of what you’re saying with regards to big ticket? I do believe you called that a stronger category.

Larry Stone

Certainly big tickets in terms of some of the discretionary projects, like kitchen cabinets is one we like to talk about a lot, we do see some movement in kitchen cabinet sales, albeit not as strongly as we’d like to see it. Our flooring business, especially our carpet business, has still been very strong for us, so we’ve had good response there. But as I’ve stated many times on these calls, we’re seeing good lift, but just not as big a ticket as we would have had, say three or four years ago in products like that. So I still think people are doing the carpet jobs. They’re just doing smaller rooms or in terms of square footage versus what we did several years ago.

Other businesses, that are passion businesses, like passion plumbing, passion lighting, and so forth, in our home décor business, still are really good, albeit it doesn’t produce that big ticket you’re referring to. Our millwork business was extremely good in the second quarter, with windows driving a lot of sales for us in that category. So some of the new initiatives we’ve put in, like the project specialists, exteriors, really have driven some of those categories.

Mike Brown

I think just to add on to that, the PSE programs I referenced, when you look at the categories they’re focusing on, those tickets typically have a larger ticket when you’re reroofing a house versus a typical install ticket it’s more so. It’s exponentially bigger than the average ticket that we have on the traditional install sales area. So we feel comfortable that the PSE programs that we have in place are working, and again we’re looking at adding some additional product lines to the components that they’re selling our customers in the home.

Robert Hull

And Deborah, this is Robert. Just a couple of other things that were in my comments. As we said, we expect appliances sales to continue to be strong, but there won’t be as much of the cash for appliances states out there, so you won’t have as much of that impacting Q3 versus Q2. So a little bit of that rebalancing of ticket and traffic mix that we talked about. And as I also mentioned, air conditioner sales this year compared to last year we sold much more in Q2, whereas last year you had more of them sold in Q3. And so due to the extreme heat, so obviously that front-loaded some of those sales, [unintelligible] in great shape with our AC inventory from a sell-through standpoint, [grow a] ticket a little bit higher in the second quarter versus a year ago. That also contributes to that rebalancing that we’re anticipating as we go into the third quarter and the second half of the year.

Deborah Weinswig

Okay, and then in terms of my follow up question, can you just provide some additional details on the IP&E initiative and what are some of the examples of the changes that you’re making in the categories that you’re rolling out?

Mike Brown

We’ve taken a comprehensive look at how we’re doing with the line reviews and how we’re sorting products by store, by store volume, and geographic ties, and as I mentioned we’re doing – we’re looking at seven of our 20 merchandising divisions to roll out as a test this year. And really what that gives us is more efficiency in how we’re allocating inventory planning, and how we’re allocating space planning and storage and even to that matter it could even reference staffing as well. So we feel like that’s a huge benefit for us longer term as we continue to go through the rollout into the remaining categories in 2011.

Operator

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

Michael Lasser - Barclays Capital

On the third and fourth quarter comp guidance, is there anything that you’re seeing in the business today that would lend you some optimism that the two or three year stack comps are going to accelerate, as implied by the outlook?

Robert Hull

I think what we mentioned in my comments is we expect to see more balance across both region and product categories in Q3 and in fact we’re seeing that, so we’re comfortable with what we’re seeing in trends thus far relative to the balance across the business.

Michael Lasser

Okay, and then if the sales environment continues to be characterized as somewhat inconsistent does that change how you think about capital deployment with respect to store growth and share repurchases as you move into next year?

Robert Hull

Yes, so as Mike talked about in his comments we’re certainly looking to be more productive in the store environment. We’re also looking at other expenses in capital as well to understand the payback of all of our initiatives. So we continue to evaluate that, our cap ex forecast for the year actually came down about $40 million. Now it rounds up to $1.8 billion versus rounding down to $1.8 billion. So we continue to take a look at things, scrutinize how we spend and whether the customer gives us credit for that. But to date our outlook for 2010 has been outlined and we’ll provide more details on 2011 in the fall.

Operator

Our next question comes from the line of Scott Ciccarelli of RBC Capital

Scott Ciccarelli – RBC Capital

[Unusually], comp softened a bit in July and we saw a little bit of a downward trend, but there’s obviously a lot of moving pieces. You mentioned that the heat and the weather – I’m wondering was there any kind of noticeable change in mix or anything else of note following the expiration of the tax credits and just in terms of difference in how consumers were allocating their spending dollars?

Robert Niblock

Scott, I’ll start off. I think overall, built into our guidance for the back half of the year, certainly we’ve taken down what we thought our sales and comps were going to be slightly for the back half of the year, so we’re expecting the back half of 2010 to be slightly softer than what we had previously anticipated, and I think that – if you think about any of the economic data that has come out, whether it’s got consumer confidence, consumer sentiment, certainly jobs growth is not coming in the way that it was anticipated to be earlier in the year. If you think about some of the recent stuff, the Fed announcement last week with some of the things that they’re going to be doing to try and make sure that they’re continuing to be active in helping liquidity and recovery out there in the marketplace.

I think we’ve taken all that into account in trying to build our guidance for the back half of the year. I think also other things that we’ve talked about on the call that helped certain categories and hurt others and certainly contribute to the traffic versus ticket mix was the extreme heat that we had in the quarter. It certainly let us clear out a lot of seasonal merchandise like fans and air conditioners.

As we move into the third quarter of the year, as Larry mentioned, that’s going to lead to an opportunity for restoration of lawns as we go into our fall lawn – in lawn and garden season. So we think that certainly gives us some great opportunity there.

We still think there’s going to be great demand out there for appliances as we go over the balance of the year. We’ve continued to see strong trends there. As you know we’ve got a great lineup of appliances with key brands that are out there. And then other things like we mentioned our Stainmaster carpet exclusivity and the promotions of that kickoff this quarter.

As we think about people that are doing some of those discretionary projects, fixing up around the home, we think that certainly gives us great opportunity to capture some share in that category. So I think we’ve tried to take those into account but certainly as I said in my comments it is a challenging environment. We don’t expect to be ongoing robust demand until we get consistent improvement in both labor and the housing markets. So we think we’re into 2011 before that happens. So I think all those things have been built into how we’ve characterized our guidance over the back half of the year.

Scott Ciccarelli

All right, that’s helpful. And just a quick follow up. You’ve talked about a more balanced sales trend going forward. Does that imply there were significant regional differences in the quarter? And maybe you talked about that but I think I might have missed it.

Mike Brown

When we looked at regional balances we had 19 of our 23 regions that posted positive comps, so we saw a lot of balance actually in Q2, and as we, as Larry alluded to, and Robert and Bob earlier, when you look at how the normal home center category – how the business takes place in the second half of the year there’s a more balanced approach to the overall business. You don’t have the seasonal spikes that you see in early spring and that’s just the typical [unintelligible] environment.

Robert Hull

Another thing to add is, I mentioned the hurricane drag in Q2, that apparently impacted two of the four regions of that negative comp in the second quarter so we expect them to comp positive in the third quarter as well.

Operator

Our next question comes from the line of Dennis McGill with Zelman & Associates

Dennis McGill - Zelman & Associates

First question just has to do with thinking about the expense leverage for the year, bringing down the revenue guidance for the full year, but seeing some opportunity to expand margin slightly more than you were looking at before. Can you just highlight some of the bigger areas that are standing out favorably relative to your initial guidance?

Robert Hull

Sure, just a couple items. One is the flat payroll leverage that Mike and the team were able to achieve in the second quarter, so if you assume similar comp performance in the second half, we would expect roughly flat payroll as a percent of sales in the second half of 2010 versus second half of 2009. That was not contemplated in our outlook 90 days ago. Also we continue to take a look at a lot of other areas for expense reduction, so that’s certainly providing some opportunities as well.

Dennis McGill

Okay. And then the second question. It’s I guess three quarters where you’ve repurchased roughly about half a billion of stock and the price of the stock’s been fluctuating quite a bit. Can we assume that it will remain a pretty structured program? Are you fairly agnostic to where the stock is trading and where valuation is?

Robert Hull

We don’t provide specific outlook on future share repurchases. However, we have indicated that the $5 billion authorization that was provided by our board last January, that would be realized roughly over the next two to three years.

Robert Niblock

And we’ve repurchased 1 billion year to date, Dennis.

Operator

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

Colin McGranahan - Sanford C. Bernstein

Just a quick question on inventory. If you could – obviously the pace of growth relative to sales has moderated a bit here, but still running a bit ahead. I know you expected to be in line by the end of the year, but can you characterize where the faster inventory growth has been through the second quarter? And any other comments on where you might have more inventory than you want?

Larry Stone

As we stated in the first quarter and held through the second quarter as well, we did buy a lot of appliance inventory, and certainly the strong performance we produced in the first quarter to the second quarter shows that was the right move, and as we said in the first quarter call, we did anticipate a lot of sales that would come as the result of the holidays and as a result of the hotter weather. So I think that’s been a real good move for the company. We don’t anticipate any major markdowns with appliance inventory. We’ll continue to sell through it as we work through the back half of the year.

We also made some strategic purchases in flooring to capture more market share, and on our seasonal inventory I think we did a much better job this year of planning our seasonal inventory and as Robert stated in his comments we feel real good about our inventory levels in seasonal products. So if you look at it, 1% up in comp stores, we feel like we can get that back hopefully flat by the end of the year, and we’re going to work hard on our seasonal programs.

As we mentioned also just take a hard look at what we buy as we head into the third and fourth quarter in terms of categories - that gives us opportunity for additional sales in categories that we might feel like we don’t have a big sales lift and we won’t buy as heavy. But I still feel good about our inventory. I still think we made the right decisions and quite frankly we hope to get it worked down to those numbers by the year end and be basically flat year over year.

Robert Hull

Hey Colin, this is Bob. At the end of the Q1 call we said we thought Q2 inventory would be up roughly 7% to 8% so we came in better than that at 5.7% A lot of that is due to the seasonal sell-through that we saw in the quarter.

Colin McGranahan

All right. And then just one quick follow up to that. As you think about the back half and, certainly elevated uncertainty, are you planning the back half seasonal categories, so trim a tree and things like that, above, at, or below your overall comp plan?

Robert Hull

It would be below our overall comp plan on things like trim a tree. We bought conservatively. We didn’t, as we said, last year we took a look at those seasonal programs and we didn’t – we’re not quite sure how the seasons are going to play out, so we bought conservatively in all those programs. Now the thing about it is as you have inventory, products like that, sometimes we move around so we get different products moving in different parts of the country, so we’ll once again use our distribution at work to make sure we have the right products for those categories as we head into that season.

Operator

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

Eric Bosshard - Cleveland Research

In light of your outlook for the second half, can you just give a little more color in how you’re thinking about planned promotions and inventory that you would bring in to drive sales, how you’re thinking about managing that in this type of environment?

Robert Hull

From the inventory perspective we think the inventory is going to be up 1% to 2% by year end. We were at 5.7% increase at the end of Q2 so we’re going to continue to be smart about our purchase activity through the balance of the year, focused on buying what’s selling, in order for us to reduce the level of increase year over year.

Larry Stone

We also took a hard look at all the seasonal categories, as you know, into the fall categories, certainly some building material categories, as we mentioned earlier, such as installation. You’ve got opportunities for those sales as you head into the third quarter, as people get ready for the winter, other categories such as tools, which is always a good traffic driver as we head into the fourth quarter. We’ve taken a hard look at what we’re buying this year. We talked a couple of years ago about buying less in and out inventory, inventory we bring in and try to sell through, and really focus more on our core programs. So I think throughout our 20 merchandising divisions everybody’s taken a hard look, going back to Bob’s point about what’s selling, what do we need to bring in, and how do we balance the sales and inventory and achieve the numbers that we’ve put forth in the forecast today.

Eric Bosshard

And then secondly, in terms of store opens in this continued sluggish environment, can you just talk about how the new stores you’re opening are performing and if there’s any different thought about the pace of store opens or even any evaluation of store closings?

Robert Hull

As we’ve talked about discussing new store productivity for 2010, we have a very productive class-average first year sales in the $33 million range. We’re seeing some very strong openings also, as you might expect, in some markets. We’re seeing some openings a little soft, but on balance we continue to be pleased with what we’re seeing in new stores. New store productivity for Q2 is 88%, so a strong showing for the second quarter. We did close a store in this quarter, so we do continue to take a look at store performance and viability of markets long term. So it’s something to continue to look at on an ongoing basis.

Robert Niblock

Eric this is Robert. I think no different than we’ve been through the entire economic cycle, as you know, we’ve continued to reevaluate our expansion program in light of - economic data in light of where recovery is and when recovery will take place and how robust it will be, and so we’ll continue to evaluate all the economic data points that come out between now and the end of the year as we’re finalizing our next year, 2011, expansion program. We’ll update you on whatever our final decisions are there when we get to our analyst conference in December. But it’s something no different than what we’ve done in the environment to date. We continue to evaluate all the data points and we make the necessary adjustments. And we won’t change that stance going forward.

Operator

Our next question comes from the line of Mike Baker of Deutsche Bank.

Mike Baker – Deutsche Bank

Can you talk about inflation, how much lumber inflation may have impacted your results?

Robert Hull

In the quarter, total inflation impact was a positive 40 basis points. That was driven entirely by lumber and plywood.

Mike Baker

Okay, thanks. And then the weakness in the tickets less than $50 relative to last quarter were flat, I think it was up 3% last year, is that entirely due to the nursery business, or was it something else there?

Robert Hull

[I believe] nursery and long landscape products.

Mike Baker

Okay, and so I think that probably comes back. And then lastly, I don’t think you specifically talked about California when you talked about your regions. Can you put that in context of your overall comp? Better or worse?

Mike Brown

The western division in total is still performing relative to how it has in the past, and the second quarter not quite as strong as it was in the first quarter, but still yet we’re seeing – we saw what we’ve deemed as positive comps in all four of our operating regions in the western division in Q2.

Mike Baker

So western division positive, not as positive as last quarter relative to the [unintelligible] average. Could you talk about that?

Mike Brown

What we saw, if you look at it again, a lot of it was driven by seasonality. So if you look at the seasonality impact to Q2 versus Q1 in the western division, we can attribute the vast majority of the variance between Q1 and Q2 comp just tied to seasonal.

Operator

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

David Strasser - Janney Montgomery Scott

One clarification. When you talked about flooring inventory you said you’d made a bet there. Was that hardwood flooring or carpet, because I know you talked about some of the carpet as well?

Larry Stone

Basically all three, carpet, ceramic, and hardwood flooring. So all three categories we made inventory investments in.

David Strasser

As an attempt to go after market share?

Larry Stone

That’s correct.

David Strasser

Okay, and just another question. I know we’ve talked a lot about appliances. I just wanted to follow up because last year I remember, and I don’t know if you guys led it, but I know you were a big part of the promotional environment right around Black Friday. It seemed like an area where you guys – where everybody decided to really play a bit more aggressively than in the past it seemed in appliances. They became a Black Friday type of product. As we sort of look into this year is that – do you see – are you prepared for something like that within the guidance, that even if it expanded – even if that promotion expanded beyond some of that Black Friday into a broader November type of promotion?

Robert Niblock

Obviously we’re not going to talk about what we’re planning to do for Black Friday at this point in time, but certainly I think we – every year as we get through major promotions such as the Black Friday promotion, immediately the merchants and operating teams sit down and do a download, kind of a postmortem as to what worked, what didn’t, what we think will happen next year from a competitive response. We try and take all of that into account and at least at this point we think we’ve got a reasonable plan and that we think we’ve adequately taken those type of items into account as we – into our guidance as we head into the back half of the year.

David Strasser

If I could just follow up on that, when you did the post-mortem on that last year what was your thoughts on the relative success of that program?

Larry Stone

We felt good about our program and quite frankly it was pretty promotional there for a while, but then it kind of settled down. But we [unintelligible] that all into consideration and certainly we think the promotional environment, hopefully it’s going to be more rational than it was on Black Friday. But there again we can’t tell you what the competition’s going to do, and certainly we have our plans and programs in place, and our buys made and so forth. So our goal is to take market share and as Bob likes to tell me, profitable market share, so certainly we think our programs that we have in place are good, strong, solid programs that will drive share increase for our company.

Operator

Our next question comes from Matt Fassler with Goldman Sachs.

Matt Fassler - Goldman Sachs

First of all, on the market share numbers, I believe you gave us a trailing four quarter number today up 50 basis points. I think last quarter you gave us both a trailing four quarter and a single quarter number. Any sense as to what the single quarter number was in Q2?

Robert Niblock

I don’t think – we’ve transitioned to a rolling four quarter, so we don’t have that information with us. I’d just follow up with the IR group if you need that.

Matt Fassler

Got it. Okay. Fair enough. Secondly, just to follow up, I think essentially on a question that Mike Baker asked, if you think about the trends in traffic, which were exceptionally strong in 1Q and less so, kind of reverse course, in Q2, and then thinking about it evening out in 3Q, should we think about that as all about weather, in essence? Do you think the underlying traffic trend probably is a low single digit number going forward?

Robert Niblock

I think a lot of it has to do with the product categories and weather. In second quarter a lot of landscaping, nursery, are pretty highly trafficked categories, get a lot of footsteps in the store. Extreme heat discouraged people from spending a lot of time outdoors working on their yards as Larry indicated. A lot of opportunity for fall restorations, so we think that gets back to somewhat of the trend we’ve seen from the prior few quarters.

Matt Fassler

Got it. And then finally on the buyback, just to clarify. Is there any buyback whatsoever embedded in your guidance for the quarter or for the year?

Robert Hull

Our outlook that we provide does not assume any prospective share repurchase included in year to date activities for Q2.

Operator

Our next question comes from the line of Bud Bugatch of Raymond James.

Bud Bugatch – Raymond James

Robert, on the first quarter you were more upbeat than you are on this call. You were talking about a more engaged consumer, I think, on the first call, first quarter call. And that was in mid-May. When during the quarter did you start to get more cautious and was there a specific event or series of events that made you come that way, and can you elaborate on that perhaps?

Robert Niblock

I don’t know where specifically in the quarter, but as we’ve continued to watch the economic data that has come out, I think obviously we knew there was – when we said at the end of our fourth quarter conference call we said that there were some one-time items that specifically helped the first quarter, including a very heavy cash for appliances program and the restoration from a tough winter that took place because people were repairing their lawns and gardens and other things that were damaged at the end of – coming out of a tough winter. When you look at – we continue to monitor the economic data that’s come out, but probably the biggest thing is that jobs growth has not been what people had been anticipating. It looks like things are starting to get pushed out a little bit. So as we look at that we obviously took what was going on with the heat, extreme heat we had in the quarter. We didn’t know it was going to be quite that extreme an impact it would have on certain categories. That had some impact on what you’re seeing. But I think the biggest thing is just continue to monitor the overall macro-environment. What we’re hearing in our consumer survey, what we’re seeing from the data points as they come out, and how the consumer has reacted through the quarter, we need to temper slightly our outlook for the balance of the year because we think things are going to be a little bit slower than we had previously anticipated.

Bud Bugatch

I think you also talked about the fact that you’re seeing discretionary plans improve, and I think you mentioned, perhaps, kitchen counters, or maybe Larry did. Can you maybe give us a little bit more color on where you’re seeing discretionary plans improve and what gives you some comfort that that will come to pass at the end of 2010 or maybe into 2011?

Larry Stone

If you look at our comps for kitchen cabinets, although they were below the company comp average, they were still decent for the second quarter, and there again is this whole thing about discretionary purchases. So we’ve done a lot with our kitchen specialists, working this whole thing that Mike Brown has put in place about selling kitchens versus cabinets. I think we’ve done a good job - when we do get the opportunity to sell a kitchen we’re doing a good job of selling the total package in those regards and there again consumers are still spending money, albeit at a much slower pace, as Robert has alluded to several times in his comments. So there again it’s up to our sales teams in the stores to get those potential customers and close those sales and make sure that we garner every sale that we can possibly get, especially in these large project areas. Robert’s point – just as a lot of the data keeps coming out we think it just kind of gets consumers saying well, I think I’ll wait on these larger projects. And we think once some positive data does come out, that certainly there’s a lot of projects in the backlog that we have an opportunity to capture more sales. But to Bob Hull’s point also, we just see a real balance in the business right now. It’s kind of balanced out in the latter part of the second quarter as we head into the third quarter, so that balance is good as well because you’re selling categories across the store, which we think will help achieve our results in the third and fourth quarters.

Bud Bugatch

So just as a last follow up, just recognizing that cabinets were still below company average, were they positive at least during the quarter? I know that’s not a big margin. And did they improve during the quarter? And what can you tell us about ticket and cabinets?

Larry Stone

They were slightly negative in the second quarter and the average ticket is up slightly, but not a lot, in cabinets because there again we’re trying to sell more the project but customers are, as I said earlier, still holding back on some of those purchases. So we might be selling not as much in terms of countertops with some jobs and we might not be selling all the different accessories you can buy with a kitchen, which you can come back and add those on later. So you might be selling the base kitchen, as an example, but you might not be selling all the additional moldings and so forth that goes with it. But your additional add on purchases you can do later on.

Bud Bugatch

And just was there any movement during the quarter in those comps? How did they trend over the quarter?

Larry Stone

No, basically it’s pretty much even throughout the quarter.

Operator

Our final question will come from the line of Peter Benedict with Robert W. Baird

Peter Benedict - Robert W. Baird

A couple questions. First, can you just talk about the zone pricing efforts that you’ve got underway? I think you’re going to be expanding those in the back half of the year. Could you just give a sense of what your plans are on that front?

Larry Stone

Certainly we’ve taken a hard look at what we call price optimization and looked at our various patch areas we have throughout the U.S. and our Canadian stores as well. And we felt like, based on comments in the first quarter, we needed to expand some of our patch areas, and make sure we have the correct price in the markets that we work in. So we continue to work that, and no results to release today but just something we’ve worked on quite a bit as we go up against various competitors. It gives us an opportunity to be priced more competitively in those various markets by having more patch areas by using our price optimization tools.

Peter Benedict

And then with the first half behind you now in terms of the normalized sales and margin prospects for the business, has your view on that changed at all? I think at last September you were thinking something north of 300 afoot in sales, 9% to 9.5% EBIT margins. What could you tell us about your current thinking on that front?

Larry Stone

At this time our long-term view of the world hasn’t changed materially. Certainly some of the recent data points are soft, but [unintelligible] the business has not changed significantly.

Robert Niblock

Thanks, as always, thanks for your continued interest in Lowe’s. We look forward to speaking with you again when we report our third quarter results on November 15. Have a great day.

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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.

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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.

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